Question

1.

On January 1, 2020, Ginseng Inc. entered into a forward contract to purchase U.S. $6,000 for $6,336 Canadian in 30 days. On January 15, the fair value of the contract was $40 (reflecting the present value of the future cash flows under the contract). Assume that the company would like to update its records on January 15. (a) Prepare only the necessary journal entries on January 1 and 15, 2020.

2.

(Derivative Transaction) On April 1, 2020, Petey Ltd. paid $175 for a call to buy 700 shares of NorthernTel at a strike price of $27 per share any time during the next six months. The market price of NorthernTel's shares was $27 per share on April 1, 2020. On June 30, 2020, the market price for NorthernTel's stock was $38 per share, and the fair value of the option was $10,000.

Instructions

a. Prepare the journal entry to record the purchase of the call option on April 1, 2020.

b. Prepare the journal entry(ies) to recognize the change in the call option's fair value as at June 30, 2020.

c. Prepare the journal entry that would be required if Petey Ltd. exercised the call option and took delivery of the shares as soon as the market opened on July 1, 2020.

3.

(Issuance and Conversion of Bonds) The following are unrelated transactions.

1. On March 1, 2020, Loma Corporation issued $300,000 of 8% non-convertible bonds at 104, which are due on February 28, 2040. In addition, each $1,000 bond was issued with 25 detachable stock warrants, each of which entitled the bondholder to purchase one of Loma's no par value common shares for $50. The bonds without the warrants would normally sell at 95. Loma prepares its financial statements in accordance with IFRS.
2. Grand Corp. issued $10 million of par value, 9% convertible bonds at 97. If the bonds had not been convertible, the company's investment banker estimates they would have been sold at 93. Grand Corp. has adopted ASPE, and would like to explore all options available to report the convertible bond.
3. Hussein Limited issued $20 million of par value, 7% bonds at 98. One detachable stock purchase warrant was issued with each $100 par value bond. At the time of issuance, the warrants were selling for $6. Hussein Limited has adopted ASPE.
4. On July 1, 2020, Tien Limited called its 9% convertible bonds for conversion. The $10 million of par value bonds were converted into 1 million common shares. On July 1, there was $75,000 of unamortized discount applicable to the bonds, and the company paid an additional $65,000 to the bondholders to induce conversion of all the bonds. At the time of conversion, the balance in the account Contributed Surplus—Conversion Rights was $270,000, and the bond's fair value (ignoring the conversion feature) was $9,955,000. The company records conversion using the book value method.
5. On December 1, 2020, Horton Company issued 500 of its $1,000, 9% bonds at 103. Attached to each bond was one detachable stock warrant entitling the holder to purchase 10 of Horton's common shares. On December 1, 2020, the fair value of the bonds, without the stock warrants, was 95. Horton Company prepares its financial statements in accordance with IFRS.

Instructions

Present the required entry(ies) to record each of the above transactions. For transaction 4, prepare the journal entries if Tien Limited prepares its financial statements using IFRS and if it uses ASPE.

4.

(Issuance, Exercise, and Termination of Stock Options) On January 1, 2020, Waldorf Corporation granted 40,000 options to key executives. Each option allows the executive to purchase one share of Waldorf's common shares at a price of $30 per share. The options were exercisable within a two-year period beginning January 1, 2022, if the grantee was still employed by the company at the time of the exercise. On the grant date, Waldorf's shares were trading at $25 per share, and a fair value options pricing model determined total compensation to be $1,680,000. Management has assumed that there will be no forfeitures because they do not expect any of the key executives to leave.

On May 1, 2022, 12,000 options were exercised when the market price of Waldorf's shares was $34 per share. The remaining options lapsed in 2023 because executives decided not to exercise them. Management was indeed correct in their assumption regarding forfeitures in that all executives remained with the company. Assume that Waldorf follows IFRS.

Instructions

a. Prepare the necessary journal entries related to the stock option plan for the years ended December 31, 2020 through 2023.

b. What is the significance of the $25 market price of the Waldorf shares at the date of grant? Would the exercise price normally be higher or lower than the market price of the shares on the date of grant?

c. What is the significance of the $34 market price of the Waldorf shares at May 1, 2022, the date of the exercise of the stock options?

d. What likely happened to the market price of the shares in 2023?

5.

(Share Appreciation Rights) Parsons Limited established a share appreciation rights program that entitled its new president, Brandon Sutton, to receive cash for the difference between the shares' fair value and a pre-established price of $32 (also fair value on December 31, 2019), on 50,000 SARs. The date of grant is December 31, 2019, and the required employment (service) period is four years. The president exercised all of the SARs on December 31, 2024. The shares' fair value fluctuated as follows: December 31, 2020, $36; December 31, 2021, $39; December 31, 2022, $45; December 31, 2023, $36; and December 31, 2024, $48. The company recognizes the SARs in its financial statements. Assume that Parsons follows ASPE.

Instructions

a. show a five-year (2020 to 2024) schedule of compensation expense pertaining to the 50,000 SARs granted to Brandon Sutton.

b. Prepare the journal entry for compensation expense in 2020, 2023, and 2024 relative to the 50,000 SARs.

c. From the perspective of the employee, contrast the features of a share appreciation right to the features of a compensatory stock option.

Answer 1

Answer:

1.

(a)

January 1, 2020

No journal entry necessary since the fair value of the forward contract would be $0.

January 15, 2020

Derivatives – Financial Assets/Liabilities ...... 40

Gain or Loss on Derivatives.............     40

2.

a.

April 1, 2020

Derivatives – Financial Assets/Liabilities.....	175
Cash.....................................................		175

b.

June 30, 2020

Derivatives – Financial Assets/Liabilities.....	9,825
Gain or Loss on Derivatives 1 ............		9,825
1($10,000 – $175)

c.

July, 1, 2020

FV-NI Investments2.............................................	26,600
Gain or Loss on Derivatives..............................	2,300
Cash (700 X $27)........................................		18,900
Derivatives–Financial Assets/Liabilities....		10,000
2 700 X $38

3.

1.

2.

Under ASPE, the first option is to measure the component that is most easily measurable first (often the debt component), and apply the residual to the other component. The second option is to measure the equity component at $0. The entries under these two approaches are, respectively, as follows:

3.

Under ASPE, the first option is to measure the component that is most easily measurable first, and apply the residual to the other component.

The second option is to measure the equity component at $0.

Cash ...................................................... 19,600,000

Bonds Payable.............................. 19,600,000

4.

5.

The warrants are equity instruments since they are fixed for fixed.

4.

a.

1/1/20 No entry

12/31/20 Compensation Expense....................  840,000

  Contributed Surplus—

   Stock Options.........................   840,000

    ($1,680,000 X 1/2)

12/31/21 Compensation Expense....................  840,000

  Contributed Surplus—

   Stock Options..........................   840,000

5/1/22 Cash (12,000 X $30)..........................  360,000

  Contributed Surplus—

   Stock Options¹..................................  504,000

  Common Shares .........................   864,000

  ¹($1,680,000 X 12,000/40,000)

12/31/23 Contributed Surplus—

   Stock Options...................................   1,176,000

  Contributed Surplus –

   Expired Stock Options²............       1,176,000

² ($1,680,000 – $504,000)

b.

The market price of the Waldorf shares at the date of grant would likely be lower than the exercise price. The objective of issuing the stock options is principally to motivate employees to work at enhancing the market value of the company’s shares. The options have a service period, typically of more than one year. Consequently, the company would want to allow for an upward movement in the share price to justify the remuneration of key employees whose work would have led to the increase in the market value of the shares. If the market value of the shares at the date of grant was at or greater than the exercise price, the incentive would be substantially removed, and so the plan would be less effective.

c.

The market price of the Waldorf shares at May 1, 2022 of $34 is not used in recording the exercise of the stock options. From an accounting perspective, the market price is not relevant. It is nonetheless relevant to the executives in making their decision to exercise their stock options. The market price is mentioned to indicate that the timing of the exercise is justified, or at least makes sense. The market price of the shares exceeds the cash paid. Executives exercising a stock option would have paid $30 and could resell the shares immediately for $34, for a gain of $4 per share.

d.

During 2023 the market price of the shares likely fell below $30 per share. This would explain why no additional stock options were exercised, and were left to lapse, as there was no benefit to be gained by the executives in exercising them. They could not recover the cash required to exercise the stock option through the resale of the shares if the stock price was below the exercise price of $30 per share.

5.

a.   

Schedule of Compensation Expense - Share Appreciation Rights (50,000)

Date		Fair Value		Pre-esta-blished Price		Cumulative Compen- sation Recognizable		Percen-tage Accrued		Compen- sation Accrued to Date		Expense 2020		Expense 2021		Expense 2022		Expense 2023		Expense 2024
12/31/20 12/31/21 12/31/22 12/31/23 12/31/24		$36 39 45 36 48		$32 32 32 32 32		$200,000  350,000  650,000  200,000  800,000		25% 50% 75% 100% —		$50,000  125,000  175,000  312,500  487,500 (287,500)  200,000  600,000 $800,000		$50,000		$125,000		$312,500		$(287,500)		$600,000

b.

2020

Compensation Expense.........................................................................  50,000

Liability under Share Appreciation Rights Plans..........................  50,000

2023

Liability under Share Appreciation Rights Plans.................................. 287,500

Compensation Expense ..................................................................................... 287,500

2024

Compensation Expense......................................................................... 600,000

Liability under Share Appreciation Rights Plans ........................................ 600,000

c.

From the perspective of the employee, the characteristics of the SAR and the stock option are very different. Although both provide a form of compensation based on the increase in the fair value of the shares of the employer, the differences in the features are important to the employee.

In the case of the exercise of stock options, the employee must provide cash and the options to obtain shares in the company. In order to recover the cash, the shares obtained from the stock option need to be sold. On the other hand,
the employee need not pay any cash to the company in exercising a SAR. The latter seems more attractive on this basis alone.