Accounting for Stock Issuance Common Stock Issuance for Cash: Cash …………………………….. Amnt. Rec’d Common Stock……………..Legal Capital Paid-in Capital in Excess.....Difference Preferred Stock Issuance for Cash: Cash …………………………….. Amnt. Rec’d Preferred Stock……………..Legal Capital Paid-in Capital in Excess.....Difference

Bond Issuance Journal Entries Issuance:Dr CashRec’d Dr Bond DiscountDif Cr Bond PayableFace Cr Bond PremiumDif Dr Unamort. Bond Issue CostsAmnt Cr CashAmnt Interest Date: Dr Interest ExpenseEffInt Dr Bond PremiumDif Dr Bond PremiumDif Cr Bond DiscountDif Cr Interest Payable (Cash)Contract Note: 2 JE’s can replace this compound JE Dr Bond Issue ExpenseSL amort Cr Unam. Bond Issue CostsSL amort APB 21 requires the use of the Effective Interest Method. (The Straight-line Method may be used if the result is not materially different.)

Extinguishment of Debt (even if convertible) (paying creditors to be relieved of all obligations) Gains/losses are recognized in the period of extinguishmentGains/losses are recognized in the period of extinguishment Gain/loss equals the difference between:Gain/loss equals the difference between: (a) the bond’s reacquisition cost & (b) its net book value (face +/- unamortized premium or discount & issue costs) Bonds PayableFace Bond PremiumBV Bond DiscountBV Unamortized Issue CostsBV CashAmntPd Loss or GainDifDif

(1) Convertible Bonds: Bonds that can be converted into Common Stock At issuance -- no value is placed on conversion featureAt issuance -- no value is placed on conversion feature At conversion -- valuation options:At conversion -- valuation options: –(a) cost: book value of the bonds (most common), or –(b) market: market value of either the stock or the bonds, depending on which is more reliably determinable –Note: if “sweetener” is offered, expense (BCExp) at FMV Issuer (market value approach): Loss on Redemptionplug Bonds PayableBV Bond PremiumBV Common StockPar Add’l Pd in CapitalMkt-Par Investor: Stock InvestmentMkt Bond Investment BV Gain on Conversion plug

(2) Convertible Preferred Stock At issuance -- record as the issuance of preferred stockAt issuance -- record as the issuance of preferred stock When exercised --When exercised -- –No Gain or Loss is recognized (owners to owners) –Value using the Book Value Method -- Exercise: Convertible P/SPar P-I-C on Conv. P/SRelVal Common StockPar Add’l PIC - C/SDif Exercise (C/S Par > P/S BV): Convertible P/SPar P-I-C on Conv. P/SRelVal Ret. Earnings (or P-I-C)Dif Common StockPar

(3) Debt Issued with Detachable Purchase Warrants At issuance -- value the detachable warrant -- allocate the proceeds to both debt & equity (stock warrants) based on relative market valuesAt issuance -- value the detachable warrant -- allocate the proceeds to both debt & equity (stock warrants) based on relative market values –proportional method -- determinable based on relative FMV immediately after issuance, or –incremental method -- first value the security with the known FVM … allocate remainder to the other security Issuance: CashRec’d Bond DiscountDif Bond PremiumDif Bonds PayableFace PIC - stock warrantsRelVal Exercise: CashRec’d PIC - stock warrantsBV Common Stock Par PIC - C/SDif

Bond Investment Journal Entries: Net Method Acquisition:Dr Bond InvestmentPV Cr CashAmntPd Interest Date: Dr CashAmntRec’d Dr Bond Investment Dif Dr Bond Investment Dif Cr Bond Investment Dif Cr Interest RevenueEffRate Note: 2 JE’s can replace this compound JE INVESTORS may record using either the GROSS or NET method (use of the discount/premium accounts are optional)

Homework Hint: General Rule: Record at FMV of what is given or the FMV of what is received -- whichever is more clearly determinable.Record at FMV of what is given or the FMV of what is received -- whichever is more clearly determinable. If both are known, we would prefer to use the fair market value of what is given up. (However … your book indicates that this may not be done in practice.If both are known, we would prefer to use the fair market value of what is given up. (However … your book indicates that this may not be done in practice.

Stock Options (part of Executive Compensation) Fair Value Method -- based on Option Pricing ModelFair Value Method -- based on Option Pricing Model Intrinsic Value Method -- based on difference between the warrant’s option price & the stock priceIntrinsic Value Method -- based on difference between the warrant’s option price & the stock price –Example: An option to purchase stock at $50 when the stock is selling at $55 is $5 –Example: An option to purchase stock at $50 when the stock is selling at $45 is $0 Record Compensation Expense : Compensation Exp. $$$ PIC - Stock Options $$$ P-I-C from expired stock options if unused

Black-Scholes Option Pricing Model The value of an option is, simply stated, a function of the current stock price, the exercise price, and the probabilities that the stock price will rise above and below the exercise price