Accounting for Treasury Stock, Issuance of Stock, and Convertible Bonds

Treasury Stock Accounting

1. (a) For numerous reasons, a corporation may reacquire shares of its own capital stock. When a company purchases treasury stock, it usually accounts for the stock using the cost method.

Required

Explain how a company would account for each of the following:

1. Purchase of shares at a price less than par value.
2. Subsequent resale of treasury shares at a price less than purchase price, but more than par value.
3. Subsequent resale of treasury shares at a price greater than both purchase price and par value.
4. Effect on net income due to treasury stock transactions. (10 marks)

(b) Ellison Company's balance sheet shows:

Required

Record the following transactions by the cost method.

(a) Bought 10,000 shares of its common stock at $ 29 a share.
(b) Sold 5,000 treasury shares at $ 30 a share.
(c) Sold 2,000 shares of treasury stock at $ 26 a share. (15 marks)

2. Indicate the effect of each of the following transactions on total stockholders' equity by placing an "X" in the appropriate column.

(b) Alex Corporation has issued 2,000 shares of common stock and 400 shares of preferred stock for a lump sum of $72,000 cash.

Required

(a) Give the entry for the issuance assuming the par value of the common stock was $ 5 and the market value $ 30, and the par value of the preferred was $ 40 and the market value $ 50. (Each valuation is on a per share basis and there are ready markets for each stock.)

(b) Give the entry for the issuance assuming the same facts as (a) above except the preferred stock has no ready market and the common stock has a market value of $ 25 per share. (12 marks)

(c) Describe the journal entry for a stock dividend on common stock (which has a par value). (4 marks)

                            
3. (a)  Define the following:

(i)  The computation of earnings per common share
(ii) Complex capital structure
(iii) Basic earnings per share
(iv) Diluted earnings per share  (8 marks)    

(b) Santana Corporation has 400,000 shares of common stock outstanding throughout 2020. In addition, the corporation has 5,000, 20-year, 7% bonds issued at par in 2018. Each $ 1,000 bond is convertible into 20 shares of common stock after 9/23/20. During the year 2020, the corporation earned $ 800,000 after deducting all expenses. The tax rate was 30%.   

Required

Compute the proper earnings per share (Basic EPS and EPS assuming bond conversion) for the year 2020. (8 marks)

(c) Sun Company has the following changes in its ordinary outstanding shares during 2020:

Required

(i) Calculate the weighted average outstanding shares as of 31 December 2020. [6 marks]

(ii) Calculate the earnings per share “Basic EPS”, assume that the net income was  $ 800,000. [3 marks]

4. (a) Discuss what accounting treatment is required for convertible debt and for debt issued with stock warrants?  Explain the rationale. (8 marks)

(b) For each of the unrelated transactions described below, present the entries required to record the bond transactions.

i. On August 1, 2019, Lane Corporation called its 10% convertible bonds for conversion. The $ 8,000,000 par bonds were converted into 320,000 shares of $20 par common stock. On August 1, there was $700,000 of unamortized premium applicable to the bonds. The fair market value of the common stock was $20 per share. Ignore all interest payments.

ii. Packard, Inc. decides to issue convertible bonds instead of common stock. The company issues 10% convertible bonds, par $3,000,000, at 97. The investment banker indicates that if the bonds had not been convertible, they would have sold at 94.

iii. Gomez Company issues $ 5,000,000 of bonds with a coupon rate of 8%. To help the sale, detachable stock warrants are issued at the rate of ten warrants for each $1,000 bond sold. It is estimated that the value of the bonds without the warrants is $4,935,000 and the value of the warrants is $315,000. The bonds with the warrants sold at $ 101. (12 marks)

(c) XYZ Company issues 4,000 convertible bonds on January 1, 2020. The bond has 6 years life, and are issued at par, with a face value $ 2,000 for each bond. Interest is payable annually December 31, at 7%. Each bond can be converted into 400 shares at a par value of $1. When the bonds were issued the market interest of similar bonds was 9%.

Required

Calculate the liability and equity component of the convertible bonds on January 1, 2020 (5 marks)