Convertible Debt at Time of Issuance n E16-1 (part 1) Cash9,900,000 Bond discount100,000 Bonds payable10,000,000 Bond issue costs70,000 Cash70,000

Time of “Normal” Conversion Text (p. 797) Carrying amount of bonds (book value): Bonds payable1,000 Bond premium50 1,050

Time of “Normal” Conversion Bonds payable1,000 Premium on bonds payable50

Time of “Normal” Conversion Bonds payable1,000 Premium on bonds payable50 Common stock (par value)100 APIC (1,050 – 100)950

Induced Conversions Involves a “sweetner” E16-1 (part 3)

Induced Conversions Book value of bonds: Bonds payable10,000,000 Discount on bonds payable55,000 9,945,000 Par value of stock1,000,000 APIC8,945,000 9,945,000 Debt conversion expense75,000 Bonds payable10,000,000 Discount on bonds payable55,000 Common stock1,000,000 APIC8,945,000 Cash75,000

Convertible Preferred Stock  Is equity - unless mandatory redeemable  Conversion is an equity transaction -- no gain or loss recognized  Book value of preferred used to record conversion

Conv. Preferred Stock – Text P. 798 Book value of preferred: Preferred1,000 APIC – preferred 200 1,200 Preferred stock1000 APIC – preferred200

Conv. Preferred Stock – Text P. 798 Book value of preferred: Preferred1,000 APIC – preferred200 1,200 Preferred stock1000 APIC – preferred200 Common stock (1,000 x $2 par)2,000

Conv. Preferred Stock – Text P. 798 Book value of preferred: Preferred1,000 APIC – preferred200 1,200 Preferred stock1000 APIC – preferred200 Retained earnings800 Common stock (1,000 x $2 par)2,000

Conv. Preferred Stock – Text P. 781 What if convertible into 400 shares of common? Book value of preferred: Preferred1,000 APIC – preferred200 1,200 Preferred stock1000 APIC – preferred200

Conv. Preferred Stock – Text P. 781 What if convertible into 400 shares of common? Book value of preferred: Preferred1,000 APIC – preferred200 1,200 Preferred stock1000 APIC – preferred200 Common stock (400 x $2 par)800

Conv. Preferred Stock – Text P. 781 What if convertible into 400 shares of common? Book value of preferred: Preferred1,000 APIC – preferred200 1,200 Preferred stock1000 APIC – preferred200 Common stock (400 x $2 par)800 APIC – common400

Stock Warrants  Entitle holder to acquire additional shares within a specified period at a specified price  Typical uses “Equity kicker” Evidence of preemptive right of existing stockholders Stock-based compensation for executives (stock options)

Stock Warrants (cont.)  Detachable Proportional method (if FV of both debt and warrant determinable) Incremental method (if FV of both not determinable)  Nondetachable No part of proceeds allocated to warrants  See text examples pp

Stock Warrants (cont.)  Allocated to warrants: 300,000/10,200,000 x 10,000,000 =294,118  Allocated to bonds: 9,900,000/10,200,000 x 10,000,000 =9,705,882 10,000,000 Cash9,705,882 Discount on bonds payable294,118 Bonds payable10,000,000 Cash294,118 APIC - stock warrants294,118

Stock Warrants (cont.)  What if proceeds = $9,700,000?  Allocated to warrants: 300,000/10,200,000 x 9,700,000 =285,294  Allocated to bonds: 9,900,000/10,200,000 x 9,700,000 =9,414,706 9,700,000 Cash9,414,706 Discount on bonds payable585,294 Bonds payable10,000,000 Cash285,294 APIC - stock warrants285,294

Stock Compensation Plans  Stock option plans: incentive plans [qualified for tax purposes] non-qualified plans  Stock appreciation rights  Performance plans

Stock Options - Important Dates Work start date Vesting date Date option vests – employee must do nothing else Exercise date Employee exercises options Grant date Options are granted to employee Expiration date Unexercised options expire

Stock Option Plans w Accounting method Now required - fair value method (SFAS 123R) Previously required - intrinsic value method (APBO 25)

Fair Value Method  Total compensation cost (TCC) Fair value at grant date of options expected to vest  Allocate TCC over service period  See page 806

Stock Appreciation Rights [SARs] n SARs are designed to mitigate employee’s cash flow problems in non-qualified plans n Employee gets a right to receive any appreciation in share value at exercise date equal to market price less a pre-established amount n Employee receives cash or stock only for the appreciation.

Stock Appreciation Rights (SARs): Example w Given: w SAR program is established: January 1, 2010 w SAR exercise period: any time next five years w Pre-established price per SAR: $10 w Number of SARs granted: 10,000 w Market prices of the stock: w Dec 31, 10: $ 3; Dec 31, 11: $7; Dec 31, 12: $ 5. w Service period: 2 years ( ) w The SARs are held for 3 years and then exercised. w Determine the compensation expense for 2010, 11, and 12.

Stock Appreciation Rights (SARs): Entries Dec 31, 2010Compensation Expense $15,000 Liability for SARs$15,000 DebitCredit Dec 31, 2011Compensation Expense $55,000 Liability for SARs$55,000 Dec 31, 2012Liability for SARs $20,000 Compensation Expense$20,000 Dec 31, 2012Liability for SARs $50,000 Cash$50,000 (SARs exercised end of the third year)