Accounting

Week 8 Assignment

14-3

1. No value or $500,000 of goodwill, because many transactions seem to imply a common share value in the range of $5.

1. Avoid overstating assets and provide lower future depreciation. Land is at $350,000 and building at $1,450,000.

1. Clear valuation at $6.10. Discounting is not permitted.

1. Machinery is valued at $300,000 and customer lists valued at $1,200,000. This is $1,500,000.

1. Clear valuation at $5.

15-6

Case A: This financial instrument is debt. The interest payments must be made in cash or shares priced at current market values, and as long as the market price is not fixed, this is debt. Price risk has not transferred to the investor.

Case B: This financial instrument is equity. The shares are convertible to common shares, another equity instrument. There is no forced cash payment.

Case C: This financial instrument is a compound instrument, part debt and part equity. The interest payments have to be made semi-annually, so the present value of the interest obligation is debt. The residual is assigned to principal and it is equity because the company cannot be forced to pay cash.  

Case D: This is a liability. The investor can demand redemption of principal, which makes the instrument debt

Case E: This is perpetual debt, and it is recorded as a liability. The principal portion is equity since it never has to be repaid. The obligation to pay annual interest is a financial liability. However, the value assigned to the indefinite equity payment is zero, so the equity component is zero.

Case F: These shares are equity because they are convertible into common equity at the option of the investor. The company has the option to redeem for cash, but it cannot be forced to do so by the investor; this feature does not make the financial instrument a liability.

15-8

Principal:        $800,000 × (.81630) =        $653,040

Interest payments:        ($800,000 × 6%) × (2.62432) =         125,967

        Bond liability                         $779,007

Cash                806,000

Discount on bonds payabl                 21,000

        Bonds payable                        800,000

        Contributed capital: common share conversion

            rights                         27,000

Year 1

        Interest expense ($779,000 x 7%)                54,530