TRUE-FALSE—Conceptual
1. The recording of convertible bonds at the date of issue is the same as the recording of straight debt issues.
2. Companies recognize the gain or loss on retiring convertible debt as comprehensive income.
3. The FASB states that when an issuer makes an additional payment to encourage conversion, the payment should be reported as an expense.
4. The market value method is used to account for the exercise of convertible preferred stock.
5. Companies recognize a gain or loss when stockholders exercise convertible preferred stock.
6. A company should allocate the proceeds from the sale of debt with detachable stock warrants between the two securities based on their market values.
7. Nondetachable warrants, as with detachable warrants, require an allocation of the proceeds between the bonds and the warrants.
8. The intrinsic value of a stock option is the difference between the market price of the stock and the exercise price of the options at the grant date.
9. Under the fair value method, companies compute total compensation expense based on the fair value of options on the date of exercise.
10. The service period in stock option plans is the time between the grant date and the vesting date.
11. If an employee fails to exercise a stock option before its expiration date, the company should decrease compensation expense.
12. If an employee forfeits a stock option because of failure to satisfy a service requirement, the company should record paid-in capital from expired options.
13. If preferred stock is cumulative and no dividends are declared, the company subtracts the current year preferred dividend in computing earnings per share.
14. When stock dividends or stock splits occur, companies must restate the shares outstand-ing after the stock dividend or split, in order to compute the weighted-average number of shares.
15. If a stock dividend occurs after year-end, but before issuing the financial statements, a company must restate the weighted-average number of shares outstanding for the year.
16. Preferred dividends are subtracted from net income but not income from continuing operations in computing earnings per share.
17. When a company has a complex capital structure, it must report both basic and diluted earnings per share.
18. In computing diluted earnings per share, stock options are considered dilutive when their option price is greater than the market price.
19. In a contingent issue agreement, the contingent shares are considered outstanding for computing diluted EPS when the earnings or market price level is met by the end of the year.
20. A company should report per share amounts for Net income, but not for income from continuing operations.
MULTIPLE CHOICE—Dilutive Securities, Conceptual
21. Convertible bonds
a. have priority over other indebtedness.
b. are usually secured by a first or second mortgage.
c. pay interest only in the event earnings are sufficient to cover the interest.
d. may be exchanged for equity securities.
22. The conversion of bonds is most commonly recorded by the
a. incremental method.
b. proportional method.
c. market value method.
d. book value method.
23. If a company offers additional considerations to convertible bondholders in order to encourage conversion, it is called a(an):
a. forced conversion.
b. sweetener.
c. additional conversion.
d. end conversion.
S24. Corporations issue convertible debt for two main reasons. One is the desire to raise equity capital that, assuming conversion, will arise when the original debt is converted. The other is
a. the ease with which convertible debt is sold even if the company has a poor credit rating.
b. the fact that equity capital has issue costs that convertible debt does not.
c. that many corporations can obtain debt financing at lower rates.
d. that convertible bonds will always sell at a premium.
S25. When convertible debt is retired by the issuer, any material difference between the cash acquisition price and the carrying amount of the debt should be
a. reflected currently in income.
b. reflected currently in income as a discontinued operations item.
c. treated as a prior period adjustment.
d. treated as an adjustment of additional paid-in capital.
S26. The conversion of preferred stock into common stock requires that any excess of the par value of the common shares issued over the carrying amount of the preferred being converted should be
a. reflected currently in income.
b. reflected currently in income as a discontinued operations item.
c. treated as a prior period adjustment.
d. treated as a direct reduction of retained earnings.
27. The conversion of preferred stock is recorded by the
a. incremental method.
b. book value method.
c. market value method.
d. par value method.
28. When the cash proceeds from a bond issued with detachable stock warrants exceed the sum of the par value of the bonds and the fair value of the warrants, the excess should be credited to
a. additional paid-in capital from stock warrants.
b. retained earnings.
c. a liability account.
d. premium on bonds payable.
29. Proceeds from an issue of debt securities having stock warrants should not be allocated between debt and equity features when
a. the market value of the warrants is not readily available.
b. exercise of the warrants within the next few fiscal periods seems remote.
c. the allocation would result in a discount on the debt security.
d. the warrants issued with the debt securities are nondetachable.
30. Stock warrants outstanding should be classified as
a. liabilities.
b. reductions of capital contributed in excess of par value.
c. assets.
d. Paid-in capital-stock warrants
P31. A corporation issues bonds with detachable warrants. The amount to be recorded as paid-in capital is preferably
a. zero.
b. calculated by the excess of the proceeds over the face amount of the bonds.
c. equal to the market value of the warrants.
d. based on the relative market values of the two securities involved.
P32. The distribution of stock rights to existing common stockholders will increase paid-in capital at the
Date of Issuance Date of Exercise
of the Rights of the Rights
a. Yes Yes
b. Yes No
c. No Yes
d. No No
S33. The major difference between convertible debt and stock warrants is that upon exercise of the warrants
a. the stock is held by the company for a defined period of time before they are issued to the warrant holder.
b. the holder has to pay a certain amount of cash to obtain the shares.
c. the stock involved is restricted and can only be sold by the recipient after a set period of time.
d. no paid-in capital in excess of par can be a part of the transaction.
S34. Which of the following is not a characteristic of a noncompensatory stock option plan?
a. Substantially all full-time employees may participate on an equitable basis.
b. The plan offers no substantive option feature.
c. Unlimited time period permitted for exercise of an option as long as the holder is still employed by the company.
d. Discount from the market price of the stock no greater than would be reasonable in an offer of stock to stockholders or others.
35. The date on which to measure the compensation element in a stock option granted to a corporate employee ordinarily is the date on which the employee
a. is granted the option.
b. has performed all conditions precedent to exercising the option.
c. may first exercise the option.
d. exercises the option.
36. Compensation expense resulting from a compensatory stock 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.
37. Which of the following is an advantage of a restricted-stock plan?
a. It creates new job opportunities in a company.
b. It never becomes completely worthless.
c. It increases the market price of the stock.
c. It increases the profit of a company.
38. Which of the following is not a characteristic of a noncompensatory stock purchase plan?
a. It is open to almost all full-time employees.
b. The discount from market price is small.
c. The plan offers no substantive option feature.
d. It is not open to almost all full-time employees
39. Under the intrinsic value method, compensation expense resulting from an incentive stock option is
a. not recognized if the market price does not exceed the option price at the date of grant.
b. recognized in the period of the grant.
c. allocated to the periods benefited by the employee's required service.
d. recognized in the period of exercise.
*40. For stock appreciation rights, the measurement date for computing compensation is the date
a. the rights mature.
b. the stock’s price reaches a predetermined amount.
c. of grant.
d. of exercise.
*41. An executive pays no taxes at the time of exercise in a(an)
a. stock appreciation rights plan.
b. incentive stock option plan.
c. nonqualified stock option plan.
d. Taxes would be paid in all of these.
*42. A company estimates the fair value of SARs, using an option-pricing model, for
a. share-based equity awards.
b. share-based liability awards.
c. both equity awards and liability awards.
d. neither equity awards or liability awards.
MULTIPLE CHOICE—Dilutive Securities, Computational
43. Fogel Co. has $4,000,000 of 8% convertible bonds outstanding. Each $1,000 bond is convertible into 30 shares of $30 par value common stock. The bonds pay interest on January 31 and July 31. On July 31, 2018, the holders of $1,280,000 bonds exercised the conversion privilege. On that date the market price of the bonds was 105 and the market price of the common stock was $36. The total unamortized bond premium at the date of conversion was $280,000. Fogel should record, as a result of this conversion, a
a. credit of $217,600 to Paid-in Capital in Excess of Par.
b. credit of $192,000 to Paid-in Capital in Excess of Par.
c. credit of $89,600 to Premium on Bonds Payable.
d. loss of $12,800.
44. On July 1, 2018, an interest payment date, $150,000 of Parks Co. bonds were converted into 3,000 shares of Parks Co. common stock each having a par value of $45 and a market value of $54. There is $6,000 unamortized discount on the bonds. Using the book value method, Parks would record
a. no change in paid-in capital in excess of par.
b. a $9,000 increase in paid-in capital in excess of par.
c. a $18,000 increase in paid-in capital in excess of par.
d. a $12,000 increase in paid-in capital in excess of par.
45. Morgan Corporation had two issues of securities outstanding: common stock and an 8% convertible bond issue in the face amount of $16,000,000. Interest payment dates of the bond issue are June 30th and December 31st. The conversion clause in the bond indenture entitles the bondholders to receive forty shares of $20 par value common stock in exchange for each $1,000 bond. On June 30, 2018, the holders of $2,400,000 face value bonds exercised the conversion privilege. The market price of the bonds on that date was $1,100 per bond and the market price of the common stock was $35. The total unamortized bond discount at the date of conversion was $1,000,000. In applying the book value method, what amount should Morgan credit to the account "paid-in capital in excess of par," as a result of this conversion?
a. $ 330,000.
b. $ 160,000.
c. $1,440,000.
d. $ 720,000.
Chang Corporation issued $6,000,000 of 9%, ten-year convertible bonds on July 1, 2017 at 96.1 plus accrued interest. The bonds were dated April 1, 2017 with interest payable April 1 and October 1. Bond discount is amortized semiannually on a straight-line basis. On April 1, 2018, $1,200,000 of these bonds were converted into 500 shares of $20 par value common stock. Accrued interest was paid in cash at the time of conversion.
46. If "interest payable" were credited when the bonds were issued, what should be the amount of the debit to "interest expense" on October 1, 2017?
a. $129,000.
b. $135,000.
c. $141,000.
d. $270,000.
Chang Corporation issued $6,000,000 of 9%, ten-year convertible bonds on July 1, 2017 at 96.1 plus accrued interest. The bonds were dated April 1, 2017 with interest payable April 1 and October 1. Bond discount is amortized semiannually on a straight-line basis. On April 1, 2018, $1,200,000 of these bonds were converted into 500 shares of $20 par value common stock. Accrued interest was paid in cash at the time of conversion.
47. What should be the amount of the unamortized bond discount on April 1, 2018 relating to the bonds converted?
a. $46,800.
b. $43,200.
c. $23,400.
d. $44,400.
Chang Corporation issued $6,000,000 of 9%, ten-year convertible bonds on July 1, 2017 at 96.1 plus accrued interest. The bonds were dated April 1, 2017 with interest payable April 1 and October 1. Bond discount is amortized semiannually on a straight-line basis. On April 1, 2018, $1,200,000 of these bonds were converted into 500 shares of $20 par value common stock. Accrued interest was paid in cash at the time of conversion.
48. What was the effective interest rate on the bonds when they were issued?
a. 9%
b. Above 9%
c. Below 9%
d. Cannot determine from the information given.
49. Litke Corporation issued at a premium of $10,000 a $200,000 bond issue convertible into 4,000 shares of common stock (par value $20). At the time of the conversion, the unamortized premium is $4,000, the market value of the bonds is $220,000, and the stock is quoted on the market at $60 per share. If the bonds are converted into common, what is the amount of paid-in capital in excess of par to be recorded on the conversion of the bonds?
a. $130,000
b. $124,000
c. $144,000
d. $120,000
50. In 2017, Eklund, Inc., issued for $103 per share, 90,000 shares of $100 par value
convertible preferred stock. One share of preferred stock can be converted into three shares of Eklund's $25 par value common stock at the option of the preferred stockholder. In August 2018, all of the preferred stock was converted into common stock. The market value of the common stock at the date of the conversion was $30 per share. What total amount should be credited to additional paid-in capital from common stock as a result of the conversion of the preferred stock into common stock?
a. $1,530,000.
b. $1,170,000.
c. $2,250,000.
d. $2,520,000.
51. On December 1, 2018, Lester Company issued at 103, eight hundred of its 9%, $1,000 bonds. Attached to each bond was one detachable stock warrant entitling the holder to purchase 10 shares of Lester's common stock. On December 1, 2018, the market value of the bonds, without the stock warrants, was 95, and the market value of each stock purchase warrant was $50. The amount of the proceeds from the issuance that should be accounted for as the initial carrying value of the bonds payable would be
a. $774,560.
b. $782,800.
c. $800,000.
d. $824,000.
52. On March 1, 2018, Ruiz Corporation issued $2,000,000 of 8% nonconvertible bonds at 104, which are due on February 28, 2038. In addition, each $1,000 bond was issued with 25 detachable stock warrants, each of which entitled the bondholder to purchase for $50 one share of Ruiz common stock, par value $25. The bonds without the warrants would normally sell at 95. On March 1, 2018, the fair value of Ruiz’s common stock was $40 per share and the fair value of the warrants was $2.00. What amount should Ruiz record on March 1, 2018 as paid-in capital from stock warrants?
a. $73,600
b. $85,200
c. $104,000
d. $100,000
53. During 2018, Gordon Company issued at 104 five hundred, $1,000 bonds due in ten years. One detachable stock warrant entitling the holder to purchase 15 shares of Gordon’s common stock was attached to each bond. At the date of issuance, the market value of the bonds, without the stock warrants, was quoted at 96. The market value of each detachable warrant was quoted at $40. What amount, if any, of the proceeds from the issuance should be accounted for as part of Gordon’s stockholders' equity?
a. $0
b. $20,000
c. $20,800
d. $19,760
54. On April 7, 2018, Kegin Corporation sold a $6,000,000, twenty-year, 8 percent bond issue for $6,360,000. Each $1,000 bond has two detachable warrants, each of which permits the purchase of one share of the corporation's common stock for $30. The stock has a par value of $25 per share. Immediately after the sale of the bonds, the corporation's securities had the following market values:
8% bond without warrants $1,008
Warrants 21
Common stock 28
What accounts should Kegin credit to record the sale of the bonds?
a. Bonds Payable $6,000,000
Premium on Bonds Payable 232,800
Paid-in Capital—Stock Warrants 127,200
b. Bonds Payable $6,000,000
Premium on Bonds Payable 48,000
Paid-in Capital—Stock Warrants 252,000
c. Bonds Payable $6,000,000
Premium on Bonds Payable 105,600
Paid-in Capital—Stock Warrants 254,400
d. Bonds Payable $6,000,000
Premiums on Bonds Payable 360,000
On May 1, 2018, Payne Co. issued $1,500,000 of 7% bonds at 103, which are due on April 30, 2028. Twenty detachable stock warrants entitling the holder to purchase for $40 one share of Payne’s common stock, $15 par value, were attached to each $1,000 bond. The bonds without the warrants would sell at 96. On May 1, 2018, the fair value of Payne’s common stock was $35 per share and of the warrants was $2.
55. On May 1, 2018, Payne should credit Paid-in Capital from Stock Warrants for
a. $57,600.
b. $60,000.
c. $61,800.
d. $105,000.
On May 1, 2018, Payne Co. issued $1,500,000 of 7% bonds at 103, which are due on April 30, 2028. Twenty detachable stock warrants entitling the holder to purchase for $40 one share of Payne’s common stock, $15 par value, were attached to each $1,000 bond. The bonds without the warrants would sell at 96. On May 1, 2018, the fair value of Payne’s common stock was $35 per share and of the warrants was $2.
56. On May 1, 2018, Payne should record the bonds with a
a. discount of $60,000.
b. discount of $16,800.
c. discount of $15,000.
d. premium of $45,000.
57. On July 1, 2018, Chen Company issued for $9,450,000 a total of 90,000 shares of $100
par value, 7% noncumulative preferred stock along with one detachable warrant for each share issued. Each warrant contains a right to purchase one share of Chen $10 par value common stock for $15 per share. The stock without the warrants would normally sell for $9,225,000. The market price of the rights on July 1, 2018, was $2.50 per right. On October 31, 2018, when the market price of the common stock was $19 per share and the market value of the rights was $3.00 per right, 36,000 rights were exercised. As a result of the exercise of the 36,000 rights and the issuance of the related common stock, what journal entry would Chen make?
a. Cash 540,000
Common Stock 360,000
Paid-in Capital in Excess of Par—Common Stock 180,000
b. Cash 540,000
Paid-in Capital—Stock Warrants 90,000
Common Stock 360,000
Paid-in Capital in Excess of Par—Common Stock 270,000
c. Cash 540,000
Paid-in Capital—Stock Warrants 225,000
Common Stock 360,000
Paid-in Capital in Excess of Par—Common Stock 405,000
d. Cash 540,000
Paid-in Capital—Stock Warrants 135,000
Common Stock 360,000
Paid-in Capital in Excess of Par—Common Stock 315,000
58. Vernon Corporation offered detachable 5-year warrants to buy one share of common stock (par value $5) at $20 (at a time when the stock was selling for $32). The price paid for 800, $1,000 bonds with the warrants attached was $820,000. The market price of the Vernon bonds without the warrants was $720,000, and the market price of the warrants without the bonds was $80,000. What amount should be allocated to the warrants?
a. $80,000
b. $82,000
c. $96,000
d. $100,000
On May 1, 2018, Marly Co. issued $2,500,000 of 7% bonds at 103, which are due on April 30, 2028. Twenty detachable stock warrants entitling the holder to purchase for $40 one share of Marly’s common stock, $15 par value, were attached to each $1,000 bond. The bonds without the warrants would sell at 96. On May 1, 2018, the fair value of Marly’s common stock was $35 per share and of the warrants was $2.
59. On May 1, 2018, Marly should record the bonds with a
a. discount of $100,000.
b. discount of $25,000.
c. discount of $28,000.
d. premium of $75,000.
On May 1, 2018, Marly Co. issued $2,500,000 of 7% bonds at 103, which are due on April 30, 2028. Twenty detachable stock warrants entitling the holder to purchase for $40 one share of Marly’s common stock, $15 par value, were attached to each $1,000 bond. The bonds without the warrants would sell at 96. On May 1, 2018, the fair value of Marly’s common stock was $35 per share and of the warrants was $2.
60. On May 1, 2018, Marly should credit Paid-in Capital from Stock Warrants for
a. $175,000
b. $103,000
c. $100,000
d. $ 96,000
61. On January 1, 2018, Ellison Company granted Sam Wine, an employee, an option to buy 1,000 shares of Ellison Co. stock for $30 per share, the option exercisable for 5 years from date of grant. Using a fair value option pricing model, total compensation expense is determined to be $6,000. Wine exercised his option on October 1, 2018 and sold his 1,000 shares on December 1, 2018. Quoted market prices of Ellison Co. stock in 2018 were:
July 1 $30 per share
October 1 $36 per share
December 1 $40 per share
The service period is for three years beginning January 1, 2018. As a result of the option granted to Wine, using the fair value method, Ellison should recognize compensation expense for 2018 on its books in the amount of
a. $6,000.
b. $2,000.
c. $1,500.
d. $0.
62. On January 1, 2018, Trent Company granted Dick Williams, an employee, an option to buy 400 shares of Trent Co. stock for $30 per share, the option exercisable for 5 years from date of grant. Using a fair value option pricing model, total compensation expense is determined to be $5,400. Williams exercised his option on September 1, 2018, and sold his 400 shares on December 1, 2018. Quoted market prices of Trent Co. stock during 2018 were:
January 1 $30 per share
September 1 $36 per share
December 1 $40 per share
The service period is for two years beginning January 1, 2018. As a result of the option granted to Williams, using the fair value method, Trent should recognize compensation expense for 2018 on its books in the amount of
a. $6,000.
b. $5,400.
c. $2,700.
d. $0.
63. On December 31, 2017, Gonzalez Company granted some of its executives options to purchase 180,000 shares of the company’s $10 par common stock at an option price of $50 per share. The Black-Scholes option pricing model determines total compensation expense to be $1,350,000. The options become exercisable on January 1, 2018, and represent compensation for executives’ services over a three-year period beginning January 1, 2018. At December 31, 2018 none of the executives had exercised their options. What is the impact on Gonzalez’s net income for the year ended December 31, 2018 as a result of this transaction under the fair value method?
a. $ 450,000 increase.
b. $1,350,000 decrease.
c. $ 450,000 decrease.
d. $0.
64. On January 1, 2018 Reese Company granted Jack Buchanan, an employee, an option to buy 300 shares of Reese Co. stock for $40 per share, the option exercisable for 5 years from date of grant. Using a fair value option pricing model, total compensation expense is determined to be $4,800. Buchanan exercised his option on September 1, 2018, and sold his 300 shares on December 1, 2018. Quoted market prices of Reese Co. stock during 2018 were:
January 1 $40 per share
September 1 $48 per share
December 1 $54 per share
The service period is for two years beginning January 1, 2018. As a result of the option granted to Buchanan, using the fair value method, Reese should recognize compensation expense for 2018 on its books in the amount of
a. $0.
b. $2,400.
c. $4,800
d. $5,600
65. On June 30, 2018, Yang Corporation granted compensatory stock options for 25,000 shares of its $24 par value common stock to certain of its key employees. The market price of the common stock on that date was $31 per share and the option price was $28. Using a fair value option pricing model, total compensation expense is determined to be $100,000. The options are exercisable beginning January 1, 2020, providing those key employees are still in the employ of the company at the time the options are exercised. The options expire on June 30, 2021.
On January 4, 2020, when the market price of the stock was $36 per share, all options for the 25,000 shares were exercised. The service period is for two years beginning January 1, 2018. Using the fair value method, what should be the amount of compensation expense recorded by Yang Corporation for these options on December 31, 2018?
a. $100,000
b. $50,000
c. $23,438
d. $0
66. In order to retain certain key executives, Smiley Corporation granted them incentive stock options on December 31, 2017. 150,000 options were granted at an option price of $35
per share. Market prices of the stock were as follows:
December 31, 2018 $46 per share
December 31, 2019 51 per share
The options were granted as compensation for executives’ services to be rendered over a two-year period beginning January 1, 2018. The Black-Scholes option pricing model determines total compensation expense to be $1,500,000. What amount of compensation expense should Smiley recognize as a result of this plan for the year ended December 31, 2018 under the fair value method?
a. $2,625,000.
b. $1,650,000.
c. $1,500,000.
d. $ 750,000.
67. On January 1, 2018, Ritter Company granted stock options to officers and key employees for the purchase of 20,000 shares of the company's $1 par common stock at $20 per share as additional compensation for services to be rendered over the next three years. The options are exercisable during a five-year period beginning January 1, 2021 by grantees still employed by Ritter. The Black-Scholes option pricing model determines total compensation expense to be $180,000. The market price of common stock was $26 per share at the date of grant. The journal entry to record the compensation expense related to these options for 2018 would include a credit to the Paid-in Capital—Stock Options account for
a. $0.
b. $36,000.
c. $40,000.
d. $60,000.
68. On January 1, 2018, Evans Company granted Tim Telfer, an employee, an option to buy 5,000 shares of Evans Co. stock for $25 per share, the option exercisable for 5 years from date of grant. Using a fair value option pricing model, total compensation expense is determined to be $37,500. Telfer exercised his option on September 1, 2018, and sold his 5,000 shares on December 1, 2018. Quoted market prices of Evans Co. stock during 2018 were
January 1 $25 per share
September 1 $30 per share
December 1 $34 per share
The service period is for three years beginning January 1, 2018. As a result of the option granted to Telfer, using the fair value method, Evans should recognize compensation expense for 2018 on its books in the amount of
a. $45,000.
b. $37,500.
c. $12,500.
d. $ 7,500.
69. On December 31, 2017, Kessler Company granted some of its executives options to
purchase 60,000 shares of the company's $10 par common stock at an option price of $50 per share. The options become exercisable on January 1, 2018, and represent compensation for executives' services over a three-year period beginning January 1, 2018. The Black-Scholes option pricing model determines total compensation expense to be $360,000. At December 31, 2018, none of the executives had exercised their options. What is the impact on Kessler's net income for the year ended December 31, 2018 as a result of this transaction under the fair value method?
a. $120,000 increase
b. $0
c. $120,000 decrease
d. $360,000 decrease
70. Weiser Corp. on January 1, 2015, granted stock options for 60,000 shares of its $10 par value common stock to its key employees. The market price of the common stock on that date was $23 per share and the option price was $20. The Black-Scholes option pricing model determines total compensation expense to be $630,000. The options are exercisable beginning January 1, 2018, provided those key employees are still in Weiser’s employ at the time the options are exercised. The options expire on January 1, 2019.
The amount of compensation expense Weiser should record for 2017 under the fair value method is
a. $0.
b. $105,000.
c. $210,000.
d. $315,000.
