Exercise Session 5

(maximum 45 minutes)
Question A

True of False. If the answer is false, explain the true answer:

1. Companies recognize a gain or loss when shareholders exercise convertible preference shares..
2. A company should allocate the proceeds from the sale of debt with detachable share warrants
between the two securities based on their fair values.
3. If an employee fails to exercise a share option before its expiration date, the company should
decrease compensation expense.

Question B
Multiple Choice. Write the right answer

1. When convertible debt is not converted at maturity, ….

A. a gain or loss is recorded for the difference between the book value of the debt and the present
value of the cash flows.
B. the amount originally allocated to equity is recorded as a gain on retirement.
C. the amount allocated to the equity component at the issuance date is recorded as a loss on
retirement.
D. the carrying value of the bond equals its face value and it is removed from the books.

2. The conversion of preference shares into ordinary shares requires that any excess of the par value
of the ordinary shares issued over the carrying amount of the preference shares being converted
should be….
A. reflected currently in income.
B. reflected currently in other comprehensive income.
C. treated as a prior period adjustment.
D. treated as a direct reduction of retained earnings.

3. When the cash proceeds from bonds issued with detachable share warrants exceed the fair value
of the bonds without the warrants, the excess should be credited to…
A. Share Premium—Ordinary.
B. Retained Earnings.
C. A share liability account.
D. Answer: Share Premium—Share Warrants.

4. Compensation expense resulting from a share option plan is generally….

A. recognized in the period of exercise.
B. recognized in the period of the grant.
C. allocated to the periods benefited by the employee's required service.
D. allocated over the periods of the employee's service life to retirement.
Question C
Give the entry(ies) required to record each transaction:
1. Beauty Corp. issued €2,500,000 par value 10% convertible bonds at 98. If the bonds had not
been convertible, the company’s investment banker determines that they would have been
sold at 95.
2. Best Company issued €10,000,000 par value 10% bonds at 98. One share warrant was issued
with each €100 par value bond. At the time of issuance, the warrants were selling for €4. The
net present value of the bonds without the warrants was €9,500,000.
3. Join, Inc. called its convertible debt in 2023. Assume the following related to the transaction:
The 11% €10,000,000 par value bonds were converted into 1,000,000 shares of €3 par value
ordinary shares on July 1, 2023. The carrying amount of the debt on July 1 was €9,600,000. The
Share Premium––Conversion Equity account had a balance of €200,000 and the company paid
an additional €50,000 to the bondholders to induce conversion of all the bonds. The company
records the conversion using the book value method.

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