Using Your Judgment 16-4 (Essay) On January 1, 2013, Garner issued 10-year, $200

Question

Using Your Judgment 16-4 (Essay) On January 1, 2013, Garner issued 10-year, $200,000 face value, 6% bonds at par. Each $1,000 bond is convertible into 30 shares of Garner $2 par value common stock. The company has had 10,000 shares of common stock (and no preferred stock) outstanding throughout its life. None of the bonds have been converted as of the end of 2014. (Ignore all tax effects.) Show how Garner will report income and EPS for 2014 and 2013. Briefly discuss the importance of GAAP for EPS to analysts evaluating companies based on price-earnings ratios. Consider comparisons for a company over time, as well as comparisons between companies at a point in time. In order to converge GAAP and IFRS, the FASB is considering whether the equity element of a convertible bond should be reported as equity. Describe how the journal entry you made in part (a) above would differ under IFRS. In terms of the accounting principles discussed in Chapter 2, what does IFRS for convertible debt accomplish that GAAP potentially sacrifices? What does GAAP for convertible debt accomplish that IFRS potentially sacrifices?

Explanation / Answer

A. Income will be reduced by $12,000 for both the years i.e. 2014 and 2013

EPS will be reduced by ($12,000/10,000 shares). Since no shares is issued, so number of closing units is 10,000 for both ywears. So effect of EPS will be $1.2 per shares.

To compare the earnings of different companies, investors and analysts often use the ratio earnings per share (EPS). To calculate EPS you take the earnings left over for shareholders and divide by the number of shares outstanding. You can think of EPS as a per-capita way of describing earnings. Because every company has a different number of shares owned by the public, comparing only companies' earnings figures does not indicate how much money each company made for each of its shares, so we need EPS to make valid comparison

example, take two companies: ABC Corp. and XYZ Corp. They both have earnings of $1 million but ABC Corp has 1 million shares outstanding while XYZ Corp. only has 100,000 shares outstanding. ABC Corp. has EPS of $1 per share ($1 million/1 million shares) while XYZ Corp. has EPS of $10 per share ($1 million/100,000 shares).

B. In GAAP the cost of issuance is recorded as assets and amortised year after year, whereas in IFRS the sa,e cost is shown as an expense in the year of issuance. So the journals would be different in both the cases.

GAAP - Preliminary expense (assets) Dr. To cash/bank

ifrs - cost written off in p/l

C. Authoritative literature is FASB

D. Many companies use employee stock options plans to retain and attract employees,[3] the objective being to give employees an incentive to behave in ways that will boost the company's stock price. If the company's stock market price rises above the call price, the employee could exercise the option, pay the exercise price and would be issued with ordinary shares in the company. The employee would experience a direct financial benefit of the difference between the market and the exercise prices. If the market price falls below the stock exercise price at the time near expiration, the employee is not obligated to exercise the option, in which case the option will lapse. Restrictions on the option, such as vesting and non-transferring, attempt to align the holder's interest with those of the business shareholders.

Fair value of the stock issued is the market value at which it is traded.

E. If expense is not to be booked by the company, then the same should be shown separately as asset and amortise the same accordingly.

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