AFM 391 Spring 2020 Midterm Exam SolutionQUESTIONS AND ANSWERS

Question 1 PV of bonds (i.e. selling price) N 20 %i 5 PMT 20000 (500,000x 4%) FV CPT PV = $ 437,689 a) Dr. Cash 437,689 Cr. Bonds payable..................................................................... 437,689 b) Date Cash Interest Expense Discount Amortization Carrying Value of Bonds Jun 1/20 437,689 Nov 30/20 20,000 21,884 1,884 439,573 May 31/21 20,000 21,979 1,979 441,552 Nov 30/21 20,000 22,078 2,078 443,630 May 31/22 20,000 22,181 2,181 445,811 Nov 30/20 Interest expense................................................................................ 21,884 Cash .......................................................................................... 20,000 Bonds payable........................................................................... 1,884 Dec 31/20 Interest expense (1 ÷ 6 x $ 21,979).................................................. 3,663 Interest payable (1 ÷ 6 x $ 20,000) ........................................... 3,333 Bonds payable........................................................................... 330 c) Jun 1 2022 Cost to repurchase ($ 500,000 x 20% )................................................... $ 100,000 Bond carrying value ($ 445,811 x 20%) ................................................. 89,162 Loss on bond redemption........................................................................ $ (10,838) Bonds payable.................................................................................. 89,162 Loss on bond redemption................................................................. 10,838 Cash .......................................................................................... 100,000 Question 2 Dec. 31, 2021 Dr. Compensation expense $350,000 Cr. Liability for stock appreciation rights $350,000 (($21 - $16) × 210,000 SARs)/3 = $350,000 Dec. 31, 2022 Dr. Liability for stock appreciation rights $70,000 Cr. Compensation expense $70,000 ($18 - $16) × 210,000 SARs × 2/3 - $350,000 = ($70,000) Dec. 31, 2023 Dr. Compensation expense $560,000 Cr. Liability for stock appreciation rights $560,000 ($20 - $16) × 210,000 SARs - $280,000 = $560,000 Jan. 1, 2024 Dr. Liability for stock appreciation rights $400,000 Cr. Cash $400,000 ($20 - $16) × 100,000 SARs = $400,000 Dec. 31, 2024 Dr. Compensation expense $220,000 Cr. Liability for stock appreciation rights $220,000 ($22 - $16) × 110,000 SARs - $440,000 = $440,000 Jan. 1, 2025 Dr. Liability for stock appreciation rights $300,000 Cr. Cash $300,000 ($22 - $16) × 50,000 SARs = $300,000 Dec. 31, 2025 Dr. Liability for stock appreciation rights $360,000 Cr. Compensation expense $360,000 When market price is lower than benchmark price, the cumulative obligation is reported at $0. Dec. 31, 2026 No journal entry is necessary Question 3 January 1, 2020 Extraction Rights 15,000,000 Cash .......................................................................................... 15,000,000 Extraction Rights 1,361,166 Provision for Decommissioning Liability ................................ 1,361,166 5 N 8 I FV CPT PV = 1,361,166 **Site restoration obligation allowable terminology b) December 31, 2020 Depreciation Expense 3,272,233 (($ 15,000,000 + $ 1,361,166) ÷ 5) Accumulated Depreciation ....................................................... 3,272,233 Credit to the Extraction rights itself also valid Interest Expense** 108,893 ($ 1,361,166 x 8%) Provision for Decommissioning Liability ................................ 108,893 c) • EFL should record a provision of $2,500,000 (the midpoint of the range) • They should disclose the range and exposure ($2M - $3M) • Contingent gains cannot be recorded d) • Differences under ASPE – interest expense = accretion expense; ARO = SRO • Contingent gain recorded as the minimum of the range = $2.0 million but needs to describe the disclosure of the nature of the event including the range • Contingent gains cannot be recorded under ASPE whereas IFRS a contingent asset can be recorded if virtually certain but that is not the case here. Question 4 Jan. 15 Dr. Common shares (250,000 sh × $10/sh) 2,500,000 Cr. Contributed surplus—from repurchases 750,000 Cr. Cash (250,000 sh - $7/sh) 1,750,000 Aug. 20 Dr. Common shares (475,000 sh × $10/sh) 4,750,000 Dr. Contributed surplus (650 + 750) 1,400,000 Dr. Retained earnings (remainder) 500,000 Cr. Cash (475,000 sh × $14/sh) 6,650,000 Question 5 Jan 1, 2021 - Date of grant- No journal entry required. Date Account Debit Credit Dec 31, 2021 Compensation expense 247,500* Contributed surplus-Employee stock option 247,500 *(180,000 x 2.75) = 495,000 495,000/2 = 247,500 Date Account Debit Credit Dec 31, 2022 Compensation expense 247,500 Contributed surplus-Employee stock option 247,500 The total cost of the option is $495,000 options. This amount should be amortized over the vesting period (2 years). 495,000/2 = 247,500. Date Account Debit Credit Mar 31, 2023 Cash 900,000* Contributed surplus- stock option 82,500** Common Shares 982,500 *30,000 options x $30 = 900,000 ** (495,000 x 30,000/180,000) = 82,500 Date Account Debit Credit Dec 31, 2027 Contributed surplus- stock option 412,500* Contributed surplus- expired stock option 412,500 *(495,000 – 82,500) = 412,500 Question 6 Part 1 Journal Entries: Date Account Debit Credit Jan 1, 2019 Cash 200,000* Common Shares 200,000 *(20,000 x 10) = 200,000 Date Account Debit Credit Jan 1, 2019 Cash *600,000 Preferred Shares 500,000** Contributed Surplus 100,000 *(5,000 x 120) = 600,000 ** (5,000 x 100) = 500,000 Date Account Debit Credit Mar 20, 2019 Cash 400,000* Common Shares 400,000 *(20,000 x 20) = 400,000 Date Account Debit Credit April 30, 2019 Common Shares 30,000* Contributed Surplus 6,000 Cash 24,000** *(2,000 x 15) = 30,000 ** (2,000 x 12) = 24,000 September 1: Assume that the vesting period of stock option is Jan 1 – August 31, 2019 and grant date is Jan 1, 2019. Exercise period starts on Sept 1, 2019 and ends on Aug 31, 2024. Date Account Debit Credit Sep 1, 2019 Compensation Expense 20,000* Contributed surplus-employee stock options 20,000 * Estimated value of stock options $20,000 (given) Date Account Debit Credit Sep 2, 2019 Common Shares 30,000* Contributed Surplus (Type B) 6,000 Contributed surplus on common shares (Type C) 1,053** Retained Earnings 6,947 Cash 44,000*** *(2,000 x 15) = 30,000 **($20,000 × (2,000 sh / 38,000 sh) *** (2,000 x 22) = 44,000 Date Account Debit Credit Dec 31, 2019 Retained Earnings 50,000 Dividend payable-common shares 20,000 Dividend payable-preferred shares 30,000 Part 2 C/S P/S C.C. Type A C.C. Type B C.C. Type C Retained Earnings AOCI Total Net Income 130,000 OCI 250 Total Comprehensive Income 130,000 250 130,250 Dividends declared (50,000) (50,000) C/S issued during year 600,000 600,000 P/S issued 500,000 100,000 600,000 Repurchase C/S (30,000) 6,000 (24,000) C/S issued as compensation 20,000 20,000 Repurchase C/S (30,000) (6,000) (1,053) (6,947) (44,000) December 31, 2019 540,000 500,000 100,000 0 18,947 73,053 250 1,232,250 Question 7 Assess the Situation (Issue): Role: External Auditor at PMC LLP Issue: Discuss the financial reporting implications of the convertible bond transaction and the impact on the loan covenant Key Decision Maker: Andrea Lewis, Krystin Cooper & William Roberts Constraint: Debt / Equity Ratio cannot exceed 2.5:1, currently 1.78:1 Situation: tremendous success in kids clothing, want to expand internationally, don’t have the financing To Max of 3 marks Analyze the Issue Framework: ASPE Two valid Alternatives under ASPE: • Allocation value to debt and equity components using: 1. Incremental method – estimate fair value of each component and allocate in descending order of reliability of fair value estimate. Least reliably estimated component allocated the remaining value. 2. Zero common equity method – zero value assigned to the common equity component Incremental Method: Dr. Cash (given) Cr. Bonds payable (given) 22,700,000 21,013,098 Cr. Contributed surplus—conversion rights 1,686,902 Zero Common Equity Method: Dr. Cash 22,700,000; Cr. Bonds Payable 22,700,000 Debt Equity D/E Incremental 47,170,000 26,500,000 1.78 21,013,098 1,686,902 68,183,098 28,186,902 2.42