Question

In: Accounting

The cloudy afternoon mirrored the mood of the conference of division managers. Claude Meyer, assistant to...

The cloudy afternoon mirrored the mood of the conference of division managers. Claude Meyer, assistant to the controller for Hunt Manufacturing, wore one of the gloomy faces that were just emerging from the conference room. “Wow, I knew it was bad, but not that bad,” Claude thought to himself. “I don't look forward to sharing those numbers with shareholders.” The numbers he discussed with himself were fourth quarter losses which more than offset the profits of the first three quarters. Everyone had known for some time that poor sales forecasts and production delays had wreaked havoc on the bottom line, but most were caught off guard by the severity of damage. Later that night he sat alone in his office, scanning and rescanning the preliminary financial statements on his computer monitor. Suddenly his mood brightened. “This may work,” he said aloud, though no one could hear. Fifteen minutes later he congratulated himself, “Yes!” The next day he eagerly explained his plan to Susan Barr, controller of Hunt for the last six years. The plan involved $300 million in convertible bonds issued three years earlier. Meyer: By swapping stock for the bonds, we can eliminate a substantial liability from the balance sheet, wipe out most of our interest expense, and reduce our loss. In fact, the book value of the bonds is significantly more than the market value of the stock we'd issue. I think we can produce a profit. Barr: But Claude, our bondholders are not inclined to convert the bonds. Meyer: Right. But, the bonds are callable. As of this year, we can call the bonds at a call premium of 1%. Given the choice of accepting that redemption price or converting to stock, they'll all convert. We won't have to pay a cent. And, since no cash will be paid, we won't pay taxes either. Would this action by Claude Meyer be possible under International Financial Reporting Standards (IFRS)? Why or why not?

Solutions

Expert Solution

The action by Claude Meyer is very much possible under IFRS because :

1) The year has not ended yet, so CEO can make an attempt to correct/improve the year's result.

2) The bonds are callable or convertible, so converting into shares will eliminate the interest expense of the year and thus, converting losses into profits.

3) The shareholder's are only provided with the audited financial results, so controller can take action to improve the results before audit during the year.

4) The action taken by Controller with the advice of Assistant is within the Prudence and Materiality principle of accounting. Moreover, as transactions are recorded in current year, so reliability and Going concern principles are also complied with under the action.

5) The economic entity principle also applicable here as controller action is for the benefits of the company and owners, the shareholders.

Thus, Claude Meyer can suggest the conversion of the bonds to Controller to improve upon the losses of the year.

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