ROGEN PAUL GOMEZ GEROMO BSIA-II

TTH 8:30-11:30

1. On December 31, 2019, Gaiety Company issued 5,000 of its 8% 10-year P1,000 face value
bonds with detachable warrants at 110. Each bond carried a detachable warrant for 10 ordinary
shares of P100 par value at a specified option price of P120. Immediately after issuance, the
market value of the bonds without warrants was P4,800,000 and the market value of the
warrants was P1,200,000. On December 31, 2019, what amount should be reported as bonds
payable?

ANSWER: P4,800,000

2. On December 31, 2019, Gallant Company issued P8,000.000 of 12% bonds payable maturing
in 5 years. The bonds pay interest semiannually. The bonds include nondetachable warrants
giving the bondholders the right to purchase 16,000 P100 par value ordinary shares for P150
per share within the next three years. The bonds and warrants were issued at 120. The value of
the warrants at the time of issuance was P1,500,000. The market rate of interest for similar
bonds without the warrants is 10%. The PV of 1 at 5% for ten periods is .61, and the PV of an
ordinary annuity of 1 at 5% for ten periods is 7.72. On December 31, 2019, what amount should
be reported as increase in shareholders’ equity?

ANSWER: P1, 014, 400

SOLUTION:

PV of principal P8,000,000 x .61 = P4,880,000

PV of interest P480,000 x 7.72 = P3,705,600

Total Present Value P8,585,600

Issue price of bonds with warrant P8,000,000 x 120% = P9,600,000

Present value of bonds payable P8,585,600

Residual amount allocated to warrants – equity component P1,014,400

3. Habitable Company issued 5,000 convertible bonds on January 1, 2019. The bonds have a
three-year term and are issued at 110 with a face value of P1,000 per bond. Interest is payable
annually in arrears at a nominal 6% interest rate. Each bond is convertible at anytime up to
maturity into 100 shares with par value of P5. It is reliably determined that the bonds would sell
only at P4,600,000 without the conversion privilege. What is the equity component of the
issuance of the convertible bonds on January 1, 2019?

ANSWER: P900,000

SOLUTION:

Issue price of bonds with warrants P5,000,000 x 110% = P5,500,000

Market value of bonds without warrants P4,600,000

Residual amount allocated to warrants – equity component P 900,000

4. On July 1, 2019, after recording interest and amortization. Hackneyed Company converted
P5,000,000 of its 12% convertible bonds into 50,000 shares of P50 par value. On the conversion
date, the carrying amount of the bonds was P6,000,000, the market value of the bonds was
P6,500,000, and the share was publicly trading at P150. The entity incurred P100,000 in
connection with the conversion. When the bonds were originally issued, the equity component
was recorded at P1,500,000. What amount of share premium should be recorded as a result of
the conversion?

ANSWER: P3,400,000

SOLUTION:

Carrying amount of the bonds P6,000,000

Less par value of share capital

(50,000 shares x P50 par value) P2,500,000

Less conversion expense P 100,000

Share premium P3,400,000

5. On January 1, 2019, X Company borrowed P1,000,000 in the form of a two-year note payable
with an interest rate of 12%. Interest is payable every December 31. The principal is payable on
December 31, 2020.

ANSWER:

January 1, 2019 Cash P1,000,000

Notes Payable P1,000,000

December 31, 2019. Interest expense P120,000 (1,000,000 x 12%)

Cash P120,000

December 31, 2020 Interest expense P120,000 (1,000,000 x 12%)

Cash P120,000

December 31, 2020 Notes payable P1,000,000

Cash P1,000,000

6. On January 1, 2019, Roselie Company purchased inventory with payments in installment of

P200,000 per year for two years to be paid on January 1, 2020 and January 1, 2021. The cash
price is P338,000 and the effective rate is 12%.

Interest expense 2019

Interest payable 2019

ANSWER: a. P40,560 b. P21,440

 SOLUTION:

Date Payment Interest Expense Principal Present value

Jan.1, 2019 P338,000

Jan.1, 2020 P200,000 P40,560 P159,440 P178,560

Jan.1, 2021 P200,000 P21,440 P178,560 -

7. On January 1, 2019, Probono Company purchased land with payments in installment with a
down-payment of P100,000 and a payment of P200,000 per year for two years to be paid each
December 31. The cash price is P438,000 and the effective rate is 12%.

Amortization table

Date Payment Interest Expense Principal Present Value

Jan.1, 2019 P438,000

Dec.31, 2019 P200,000 P52,560 P147,440 P290,560

Dec.31, 2020 P200,000 P9,440 P290,560 -

How much is the interest expense for 2020?

ANSWER: Interest expense for 2020 is P9,440

8.Sacrilege Company frequently borrows from the bank in order to maintain sufficient
operating cash. The following loans were at a 12% interest rate, with interest payable at
maturity. The entity repaid each loan on its scheduled maturity date.

Date of loan Amount Maturity date Term of loan

11/1/2019 500,000 10/31/2020 1 year
2/1/2020 1,500,000 7/31/2020 6
months
5/1/2020 800,000 1/31/2021 9
months
 The entity records interest expense when the loans are repaid. As a result, interest
expense of P150,000 was recorded in 2020. If no correction is made, by what amount
would 2020 interest expense be understated?

ANSWER:

January 1 – October 31, 2019 (500,000 x 12% x 10/12) P50,000

February 1 – July 31, 2019 (1,500,00 x 12% x 6/12) P90,000
May 1 – December 31, 2019 (800, 000 x 12% x 8/12) P64,000
Total interest expense for 2019 P204,000
Recorded interest expense in 2019 (150,000)
Understatement of interest expense P 54,000

9.Sacrosanct Company offered a contest in which the winner would receive P1,000,000,
payable over twenty years. On December 31, 2019, the entity announced the winner of the
contest and signed a note payable to the winner for P1,000,000, payable in P50,000
installments every January 1. Also on December 31, 2019, the entity purchased an annuity for
P418,250 to provide the P950,000 prize remaining after the first P50,000 installment, which
was paid on January 1, 2020.

On December 31, 2019, what amount should be reported as note payable-contest winner, net
of current portion?

ANSWER:

Contest Prize Expense P418,250

Discount on Note Payable 531, 750

Note Payable – current P950,000

Contest Prize Expense P50,000

Note payable – current P50,000

The noncurrent note payable of P950,000 is presented minus the discount on note
payable of P531, 750 or P418, 250.
In the 2019 income statement, what amount should be reported as contest prize expense?

ANSWER: Contest prize expense for 2019 (418,250 + 50,000) P468,250

1.What is the proper treatment of compound financial instrument?

A. liability and equity component shall be accounted separately in accordance with the
substance of the contractual arrangement and the definition of a financial liability and an
equity.
B.The whole instrument shall be treated as a financial liability or equity instrument at the
option of the holder.
C.The whole instrument shall be treated as a financial liability or equity instrument at the
option of the issuer.
D.The whole instrument shall be treated as a financial liability.

2.When bonds payable are issued with detachable share warrants, how shall the issue price be
allocated?
A.The issue price shall be allocated pro-rata to liability component and equity component based
on their relative fair value.
B.The issue price shall be allocated pro-rata to liability component and equity component based
on their book value.
C.The issue price shall be allocated first to the fair value of equity component and the
remainder of issue price to liability component.
D.The issue price shall be allocated first to the fair value of liability component ex-warrant and
the remainder of issue price to equity component.

3.When bonds payable are issued with non-detachable share warrants, how shall the issue
price be allocated when the fair market value of bonds ex-warrants is unknown?
A.The issue price shall be treated wholly as bonds payable.
B.The issue price shall be treated wholly as share warrants.
C.The issue price shall be allocated first to the fair value of equity component and the
remainder of issue price to liability component.
D.The issue price shall be allocated first to the liability component as the present value of
principal bond liability plus the present value of future interest payments using effective
interest rate for similar bonds without the warrants and the remainder of issue price to the
share warrants.

PART I
Parker Co. $50 par value common stock has always traded above par. During year 1,
Parker had several transactions that affected the following balance sheet accounts:
I. Bond discount
II. Bond premium
III. Bond payable
IV. Common stock
V. Additional paid-in capital
VI. Retained earnings
For each of the following items, determine whether the transaction Increased,
Decreased, or had No effect for each of the items in the chart.

Bond Bond Bonds Commo Additiona Retained

discount premium payable n l paid in earnings
stock capital

1. Parker Increase No Effect Increase No No Effect No Effect

issued bonds Effect
payable with
a nominal
interest rate
that was less
than the
market rate of
interest.
2. Parker No Effect Increase Increase No No Effect No Effect
issued Effect
convertible
bonds, which
are common
stock
equivalents,
for an amount
in excess of
the bonds’
face amount.
3. Parker No Effect Decreas Decreas Increase Increase No Effect
issued e e
common
stock when
the
convertible
bonds
described in
item 2. Were
submitted for
conversion.
Each $1,000
bond was
converted into
twenty
common
shares. The
book value
method was
used for the
early
conversion.
4. Parker No Effect No Effect Increase No No Effect No Effect
issued bonds Effect
with
nondetachabl
e warrants for
an amount
equal to the
face amount
of the bonds.
The stock
warrants do
not have a
determinable
value.
5. Parker Increase No Effect Increase No Increase No Effect
issued bonds, Effect
with
detachable
stock
warrants, for
an amount
equal to the
face amount
of the bonds.
The stock
warrants have
a
determinable
value.
6. Parker Decreas No Effect Decreas No No Effect Decreas
redeemed a e e Effect e
bond issued
at 8% at a
discount for
an amount
that was
102% of face
value.
7. Parker No Effect Increase Increase No No Effect No Effect
issued bonds Effect
payable with
a nominal rate
of interest that
is higher than
the market
rate.
8. Parker No Effect Decreas Decreas No No Effect Increase
called a bond e e Effect
that was
issued at
105 at a time
when the
market value
of the bond
was less than
its carrying
value.