Intermediate Accounting Vol 2 Canadian 2nd Edition Lo Test Bank Download

Intermediate Accounting, Volume 2, 2e
Chapter 14 – Complex Financial Instruments
Solution Manual for Intermediate Accounting Vol 2

Canadian 2nd Edition Lo Fisher 0132965879
9780132965873
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Intermediate Accounting, Vol. 2, 2e (Lo/Fisher)

Chapter 14 Complex Financial Instruments
14.1 Learning Objective 1
1) Which of the following is correct about financial instruments?

A) Accounting for financial instruments has been consistent.
B) There is no economic substance to financial instruments.
C) They may be used in support of innovations designed to circumvent accounting standards.
D) All financial instruments are accounted for at fair value.
Answer: C
Diff: 2
Skill: Concept
Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial
instruments, and identify when transactions involve such instruments.
2) Which statement is correct about accounting for financial instruments?

A) All financial instruments are accounted for at fair value through profit or loss.
B) All are accounted for in accordance to their economic substance.
C) All financial instruments are accounted for at amortized cost.
D) All financial instruments are accounted for at fair value through OCI.
Answer: B
Diff: 2
Skill: Concept
3) What is a derivative and what are two reasons why parties would enter into a derivative contract?
Answer: A derivative is a financial instrument that is derived from some other underlying quantity.
Parties enter into derivative contracts for two reasons: to hedge or to speculate.
Diff: 2
Skill: Concept
14-1
Copyright © 2014 Pearson Canada, Inc.
4) Describe the underlying quantity that the derivative instrument derives its value from?
Answer: That underlying quantity is something implicitly part of the asset that is related to the
derivative. The quantity varies. Examples the price of a share, the value of a stock index, the exchange
rate, the temperature.
Diff: 2
Skill: Concept
14-2
5) What is hedging?
Answer: Hedging involves identifying a risk and trying to mitigate that risk by entering into derivative
contract. For example, a Canadian manufacturer that purchases inventory from a US supplier on credit is
subject to the risk that the US dollar may strengthen (appreciate) against the Canadian dollar. The
manufacturer can reduce the foreign exchange risk by entering into a forward contract to buy US dollars
at a future date at a specified exchange rate, effectively locking in its cost of inventory at the time of
purchase.
Diff: 2
Skill: Concept
6) What is speculation?
Answer: Speculation is purposefully taking on an identified risk with a view to making a profit. For
instance, one can take a gamble that the exchange rate will move in his/her favour by entering into a
forward exchange agreement. For example, a party could bet that the US dollar will weaken against the
Canadian dollar. If the US$ weakens during the period, the speculator will make a profit, but if the US$
strengthens in the period, the speculator will lose money.
Diff: 2
Skill: Concept
7) What is an option?
A) A contract that gives the holder the right to sell an instrument at a pre-specified price.
B) A contract that is derived from some other underlying quantity, index, asset or event.
C) A contract that gives the holder the right to acquire an instrument at a pre-specified price.
D) A contract that gives the holder the right to buy or sell something at a specified price.
Answer: D
Diff: 2
Skill: Concept
8) What is a "call" option?

Answer: C
Diff: 2
Skill: Concept
14-3
9) Which of the following is correct regarding a call option?

A) The intrinsic value of a call option is the greater of zero and (K- S), the difference between the market
price and the strike price.
B) The time value of an option reflects the probability that the future market price of the underlying
instrument will not exceed the strike price.
C) The time value decreases with the length of time to expiration and the volatility of the underlying
instrument (such as the share price).
D) The time value is always positive until the option expires, so the total value of an unexpired option is
always greater than the intrinsic value.
Answer: D
Diff: 2
Skill: Concept
10) What is a "put" option?

Answer: A
Diff: 2
Skill: Concept
11) What is a "swap"?

A) A contract in which two parties agree to exchange cash flows (e.g. interest cash flows).
B) A contract in which one party commits upfront to buy or sell commonly traded items at a defined price
and maturity date.
C) A contract in which one party commits upfront to buy or sell something at a defined price at a defined
future date.
D) A contact that gives the right, but not the obligation, to buy a share at a specified price over a specified
period of time.
Answer: A
Diff: 2
Skill: Concept
12) Which of the following is an example of a "swap"?

A) Right to buy 100 shares of CIBC over the next 5 years.
B) Commitment to buy 100 barrels of oil next month at $125/barrel.
C) Commitment to buy $100,000 US dollars in 4 months at US$=1.10.
D) Pay interest at prime +3% in exchange for receiving interest at 5%.
Answer: D
Diff: 2
Skill: Concept
14-4
13) What is a "future"?

and maturity date.
future date.
period of time.
Answer: B
Diff: 2
Skill: Concept
14) Which of the following is an example of a "future"?

C) Commitment to buy $100,000 US dollars in 120 days at US$=1.10.
Answer: B
Diff: 2
Skill: Concept
15) What is a "forward"?

and maturity date.
future date.
period of time.
Answer: C
Diff: 2
Skill: Concept
16) Which of the following is an example of a "forward"?

C) Commitment to buy $100,000 US dollars in 120 days at US$=1.10.
Answer: C
Diff: 2
Skill: Concept
14-5
17) What is a "warrant"?

and maturity date.
future date.
period of time.
Answer: D
Diff: 2
Skill: Concept
18) Which of the following is an example of a "warrant"?

A) Right to buy 100 shares of CIBC at $50.00 per share over the next 5 years.
C) Commitment to buy $100,000 US dollars in 4 months at US$=1.10.
Answer: A
Diff: 2
Skill: Concept
19) Contrast options with warrants.

Answer: The main differences are that warrants are issued only by the company whose shares are the
underlying instrument. Compared with options, warrants also tend to have longer times to maturity
(typically three to ten years) and they tend to be issued in combination with other financial instruments
such as bonds, preferred shares and commons shares.
Diff: 2
Skill: Concept
14-6
20) Indicate whether the following statements are true or false with respect to characteristics of stock
options.
Item True / False

a. A stock option provides a right to sell but not a right to buy a share.
b. An option’s fair value is at least as high as its exercise price.
A stock option’s fair value decreases with the volatility of the
c. underlying stock.
A stock option’s intrinsic value is the price of the share at the time
d. of exercise.
e. An option’s intrinsic value cannot be negative.
An option’s intrinsic value remains the same until the option
f. matures.
An out-of-the-money call option is one in which the exercise price
g. is higher than the market price.
Answer:
Item True / False
False
a. A stock option provides a right to sell but not a right to buy a share. (Can be either)
b. An option’s fair value is at least as high as its exercise price. False
A stock option’s fair value decreases with the volatility of the
c. underlying stock. False
A stock option’s intrinsic value is the price of the share at the time
d. of exercise. False
e. An option’s intrinsic value cannot be negative. True
False
An option’s intrinsic value remains the same until the option (Is a function of the
f. matures. market price)
An out-of-the-money call option is one in which the exercise price
g. is higher than the market price. True
Diff: 2
Skill: Concept
14-7
21) In the table below, choose the financial instrument that best explains the example on the right side.
Types of financial instrument to select from: Financial asset, financial liability, equity, compound
instrument, basic option, swap, forward, future, warrant, put option, or call option.
Type of financial
instrument Example
A company contracts with an investment bank to pay the bank prime rate + 1%
interest on $25 million of debt in exchange for receiving 5% from the bank.
Company Abacus issues $10 million debentures with warrants to purchase
shares for $10/share within 8 years.
A company contracts to sell 100 barrels of oil at $110/barrel in March on the
Chicago Mercantile Exchange.
Note payable
A company purchases the right but not the obligation to purchase 5,000 shares in
another company at $15 each over a 12-year period.
Company X contracts to buy 1,000 oz of silver at $40/oz on March 15, 2017, from
Company Y
Note receivable
A company purchases the right but not the obligation to purchase U.S. dollars
for CAD$1.08/US$ within a 30-month period.
Answer:
Type of financial
instrument Example
A company contracts with an investment bank to pay the bank prime rate +
1% interest on $25 million of debt in exchange for receiving 5% from the
Swap bank.
Company Abacus issues $10 million debentures with warrants to purchase
Compound interest shares for $10/share within 8 years.
A company contracts to sell 100 barrels of oil at $110/barrel in March on the
Future Chicago Mercantile Exchange.
Financial liability Note payable
A company purchases the right but not the obligation to purchase 5,000
Warrant shares in another company at $15 each over a 12-year period.
Company X contracts to buy 1,000 oz of silver at $40/oz on March 15, 2017,
Forward from Company Y
Financial asset Note receivable
A company purchases the right but not the obligation to purchase U.S.
Call option dollars for CAD$1.08/US$ within a 30-month period.
Diff: 2
Skill: Concept
14-8
22) Explain how bonds issued with warrants alleviate adverse selection problem.
Answer: With such an instrument, the company is initially issuing debt, which does not send the
negative signal that share issuances do. Investors who hold these bonds will exercise the warrants only
when it is beneficial to them- holders of the warrants would exercise the warrants only if the warrants are
in-the-money, which is when the company is doing well. Upon exercise, the warrant holders contribute to
the firm an amount of cash equal to the exercise price. The company increases equity not by issuing
shares directly, but by issuing shares indirectly via investors exercising their warrants to buy shares.
Diff: 2
Skill: Concept
23) Explain how convertible bonds alleviate moral hazard.

Answer: This instrument provides the company with funds in more than one stage, which is helpful at
alleviating moral hazard. Investors do not want to give too much money to management when outcomes
are highly uncertain because management may misspend the funds. At the same time, the conversion
option is a commitment from investors to provide additional funding—but only if the company performs
well. If the company performs poorly, the conversion option will be out-of-the-money, and investors will
choose to not exercise these rights.
Diff: 2
Skill: Concept
24) Briefly describe a compound financial instrument and its advantages.

Answer: A compound financial instrument is one that has more than one component, for example, debt
and equity. A company that issues common shares sends a negative signal to investors, because the share
issuance indicates a lack of confidence in the future prospects of the company. Compound financial
instruments issue shares indirectly via conversion of bonds, options or warrants into shares. It provides
the company with money in stages to prevent management overspending and conversion only occurs if
the company is doing well.
Diff: 2
Skill: Concept
14-9
1) How should warrants on the company's own common shares be accounted for?
A) Fair value.
B) Fair value through profit or loss.
C) Amortized cost.
D) Historical cost.
Answer: D
Diff: 1
Skill: Concept
Objective: 14.2 Apply the accounting standards for derivatives.
2) How are derivative contracts generally accounted for?

A) Fair value.
B) Fair value with changes recorded through income.
C) Amortized cost.
D) Historical cost.
Answer: B
Diff: 2
Skill: Concept
3) Assume that Ariel agrees to purchase US$500,000 for C$550,000 on January 15, 2013. The exchange rate
at year end is US$1=C$0.95 and the January 15, 2017 exchange rate is US$1=C$0.97. What journal entry is
required when the contract is initiated?
A) 0
B) $65,000 loss.
C) $75,000 gain.
D) $75,000 loss.
Answer: A
Diff: 2
Skill: Comp
4) On December 15, a company enters into a foreign currency forward to buy €300,000 at C$1.60 per euro
in 30 days. The exchange rate on the day of the company's year-end of December 31 was C$1.59: €l.
Required:
Record the journal entries related to this forward contract.
Answer:
Dec 15 No entry. A forward contract is executory—nothing has changed hands between the
parties to the contract.
Dec 31 Dr. Loss on foreign currency forward

($0.01/€1 × €300,000) 3,000
Cr. Foreign currency forward (a liability account) 3,000
Diff: 1
Skill: Comp
14-10
5) On December 15, a company enters into a foreign currency forward to buy €100,000 at C$1.60 per euro
in 30 days. The exchange rate on the day of the company's year-end of December 31 was C$1.55: €l.
Required:
Record the journal entries related to this forward contract.
Answer:
Dec 15 No entry. A forward contract is executory—nothing has
changed hands between the parties to the contract.
Dec 31 Dr. Loss on foreign currency forward 5,000

($0.05/€1 × €100,000)
Cr. Foreign currency forward (a liability account) 5,000
Diff: 1
Skill: Comp
6) A company pays $7,000 to purchase futures contracts to buy 200 oz of gold at $1,600/oz. At the
company's year-end, the price of gold was $1,625 and the value of the company's futures contracts
increased to $10,000.
Required:
Record the journal entries related to these futures.
Answer:
Purchase Dr. Gold futures 7,000
Cr. Cash 7,000
Year-end Dr. Gold futures ($10,000 - $7,000) 3,000

Cr. Gain on gold futures 3,000
Diff: 1
Skill: Comp
7) A company pays $5,000 to purchase futures contracts to buy 50 oz of silver at $40/oz. At the company's
year-end, the price of silver rose and the value of the company's futures contracts increased to $6,000.
Required:
Record the journal entries related to these futures.
Answer:
Purchase Dr. Silver futures 5,000
Cr. Cash 5,000
Year-end Dr. Silver futures ($6,000 - $5,000) 1,000

Cr. Gain on silver futures 1,000
Diff: 1
Skill: Comp
14-11
8) On December 15th, 2018, Hammer paid $20,000 to purchase a futures contract that entitles the
company to buy US$1 million at a cost of C$1.04 million on March 15, 2019. On December 31,st ,
Hammer's year end, the exchange rate is US$1:C$1.09.
Required:
Record the journal entry for (a) the purchase of the futures contract and (b) at year-end.
Answer:
Date Account DR CR
Dec 15, 2018 Foreign currency derivative (classified as held- 20,000
for-trading financial asset)
Cash 20,000
Year-end Foreign currency derivative ($1m × .05) 50,000
Gain on silver futures 50,000
Diff: 1
Skill: Comp
9) Amel Company issues convertible bonds with face value of $7,000,000 and receives proceeds of
$7,500,000. Each $1,000 bond can be converted, at the option of the holder, into 40 common shares. The
underwriter estimated the market value of the bonds alone, excluding the conversion rights, to be
approximately $7,200,000.
Required:
Record the journal entry for the issuance of these bonds.
Answer: IFRS requires use of the incremental method. In this case, the conversion right is allocated the
residual amount.
Account DR CR
Cash $7,500,000
Bonds payable (standalone market value) 7,200,000
Contributed surplus 300,000
Diff: 1
Skill: Comp
14-12
10) Becamel Company issued 100,000 preferred shares and received proceeds of $6,500,000. These shares
have a par value of $60 per share and pay cumulative dividends of 8%. Buyers of the preferred shares
also received a detachable warrant with each share purchased. Each warrant gives the holder the right to
buy one common share at $30 per share within 10 years. The underwriter estimated that the market value
of the preferred shares alone, excluding the conversion rights, is approximately $62 per share. Shortly
after the issuance of the preferred shares, the detachable warrants traded at $3 each.
Required:
Record the journal entry for the issuance of these shares and warrants.
Answer: IFRS requires use of the incremental method. Values for both components are available.
However, market prices are more reliable than estimates from the underwriter, so we first assign value to
the warrants, and assign the residual to the preferred shares.
Account DR CR
Cash (given) 6,500,000
Contributed surplus–conversion rights
(100,000 warrants × $3/warrant) 300,000
Preferred shares–par value (100,000 sh × $60/sh) 6,000,000
Contributed surplus–preferred shares, excess
over par (remainder) 200,000
Diff: 1
Skill: Comp
14-13
11) On September 30, 2018, Pennsylvania Co. issued $3 million of 10%, 10-year convertible bonds
maturing on September 30, 2028, with semi-annual coupon payments on March 31 and September 30.
Each $1,000 bond can be converted into 80 no par value common shares. In addition, each bond included
20 detachable common stock warrants with an exercise price of $20 each. Immediately after issuance, the
warrants traded at $5 each on the open market. Gross proceeds on issuance were $4.6 million (including
accrued interest). From these proceeds, the company paid underwriting fees of $55,000. Without the
warrants and conversion features the bond would be expected to yield 6% annually. Pennsylvania's year-
end is December 31.
On February 22, 2021, warrant holders exercised one-half of the warrants. The shares of Pennsylvania
traded at $44 each on this day.
Required:
a) Determine how Niagara should allocate the $4,600,000 proceeds into its components.
b) Prepare all the journal entries for fiscal year 2018.
c) Record the journal entry for the exercise of stock warrants on February 22, 2021.
Answer:
a) Allocation of proceeds:
14-14
b) Journal entries for 2018:
c) Journal entries for exercise of stock warrants:
Diff: 1
Skill: Comp
14-15
12) On August 15, 2018, Madison Company issued 80,000 options on the shares of MVC (Middefield
Valley Corporation). Each option gives the option holder the right to buy one share of MVC at $70 per
share until March 16, 2019. Madison received $800,000 for issuing these options. At the company's year-
end of December 31, 2018, the options contracts traded on the Montreal Exchange at $9.50 per contract.
On March 16, 2019, MVC shares closed at $63 per share, so none of the options was exercised.
Required:
Record the journal entries related to these call options.
Answer:
2018 Aug 15 Dr. Cash 800,000
Cr. Liability for call options issued 800,000
(Proceeds equals $10.00/option)
2018 Dec 31 Dr. Liability for call options issued 40,000

Cr. Gain on call option issued 40,000
(80,000 options × ($9.50/option - $10.00/option))
2019 Mar 16 Dr. Liability for call options issued 760,000

($800,000 - $40,000)
Since the options expire unexercised, liability is extinguished.

Diff: 2
Skill: Comp
14-16
13) On August 15, 2018, Madison Company issued 10,000 options on the shares of MVC (Middefield
Valley Corporation). Each option gives the option holder the right to buy one share of MVC at $70 per
share until March 16, 2019. Madison received $100,000 for issuing these options. At the company's year-
end of December 31, 2018, the options contracts traded on the Montreal Exchange at $9.50 per contract.
On March 16, 2019, MVC shares closed at $63 per share, so none of the options was exercised.
Required:
Record the journal entries related to these call options.
Answer:
2018 Aug 15 Dr. Cash 100,000
2018 Dec 31 Dr. Liability for call options issued 5,000

2019 Mar 16 Dr. Liability for call options issued 95,000

($100,000 - $10,000)
Since the options expire unexercised, liability is extinguished.

Diff: 2
Skill: Comp
14-17
14) Sorrentino Corporation issued call options on 20,000 shares of BWC Inc. on October 21, 2019. These
options give the holder the right to buy BWC shares at $35 per share until May 17, 2020. For issuing these
options, Sorrentino received $20,000. On December 31, 2019 (Sorrentino's fiscal year-end), the options
traded on the Montreal Exchange for $2.00 per option. On May 17, 2020, BWC's share price increased to
$38 and the option holders exercised their options. Sorrentino had no holdings of BWC shares.
Required:
For Sorrentino Corporation, record the journal entries related to these call options.
Answer:
2019 Oct 21 Dr. Cash 20,000
2019 Dec 31 Dr. Loss on call options issued 20,000

(20,000 options × ($2/option - $1/option))
2020 May 17 Dr. BWC shares held for trading 760,000

(20,000 sh × $38/sh)
Cr. Cash 760,000
Dr. Cash (20,000 sh × $35/sh) 700,000

Dr. Liability for call options issued 40,000
($20,000 + $20,000)
Dr. Loss on call options exercised 20,000
Cr. BWC shares held for trading 760,000
When the options are exercised, the company must deliver the shares to the option holders. Therefore, the
company must first purchase the shares on the exchange at the prevailing price of $38.
Diff: 2
Skill: Comp
14-18
15) Naples Corporation issued call options on 20,000 shares of VESPUS Inc. on October 21, 2019. These
options give the holder the right to buy VESPUS shares at $35 per share until May 17, 2020. For issuing
these options, Naples received $60,000. On December 31, 2020 (Naples's fiscal year-end), the options
traded on the Montreal Exchange for $3.50 per option. On May 17, 2020, VESPUS's share price increased
to $40 and the option holders exercised their options. Naples had no holdings of VESPUS shares.
Required:
For Naples Corporation, record the journal entries related to these call options.
Answer:
2019 Oct 21 Dr. Cash 60,000

2020 May 17 Dr. VESPUS shares held for trading 800,000

(20,000 sh × $40/sh)
Cr. Cash 800,000
Dr. Cash (20,000 sh × $35/sh) 700,000

Dr. Liability for call options issued
($60,000 + $10,000) 70,000
Cr. VESPUS shares held for trading 800,000
Diff: 2
Skill: Comp
14-19
16) Roman Corporation issued call options on 5,000 shares of POMPEI Inc. on October 21, 2019. These
options give the holder the right to buy POMPEI shares at $35 per share until May 17, 2020. For issuing
these options, Roman received $15,000. On December 31, 2019 (Roman's fiscal year-end), the options
traded on the Montreal Exchange for $3.50 per option. On May 17, 2020, POMPEI's share price increased
to $40 and the option holders exercised their options. Roman had no holdings of POMPEI shares.
Required:
For Roman Corporation, record the journal entries related to these call options.
Answer:
2019 Oct 21 Dr. Cash 15,000

2020 May 17 Dr. POMPEI shares held for trading 200,000

(5,000 sh × $40/sh)
Cr. Cash 200,000
Dr. Cash (5,000 sh × $35/sh) 175,000

Dr. Liability for call options issued
($2,500 + $15,000) 17,500
Cr. POMPEI shares held for trading 200,000
Diff: 2
Skill: Comp
17) How should employee stock options be accounted for?

A) Historical cost.
B) Fair value with changes recorded through income.
C) Amortized cost.
D) Fair value.
Answer: A
Diff: 1
Skill: Concept
14-20
18) Which is a derivative on the company's own common shares?

A) Interest rate swap contract.
B) Foreign exchange forward contract.
C) Employee stock option.
D) Commodity futures contract.
Answer: C
Diff: 1
Skill: Concept
19) Which is a derivative on the company's own common shares?

A) Accounts payable.
B) Warrants on common shares.
C) Commodity futures contract.
D) Warranty provision.
Answer: B
Diff: 1
Skill: Concept
20) Assume that MAK agrees to purchase US$500,000 for C$550,000 on January 15, 2018. The exchange
rate at year end is US$1 = C$0.95 and the January 15, 2018 exchange rate is US$1 = C$0.97. What journal
entry is required at year end?
A) 0
B) $65,000 loss.
C) $75,000 gain.
D) $75,000 loss.
Answer: D
Explanation: D) 550,000 - (500,000 × 0.95) = 75,000 loss
Diff: 2
Skill: Comp
21) Assume that Barun agrees to purchase US$500,000 for C$550,000 on January 15, 2018. The exchange
entry is required at Jan 15, 2018?
A) $10,000 gain.
B) $10,000 loss.
C) $75,000 gain.
D) $75,000 loss.
Answer: A
Explanation: A) At Jan 15, 2013: 500 ∗.97 = 485k
At year end: 500 ∗.95 = 475
Change is 485 - 475 = 10,000 gain
Diff: 3
Skill: Comp
14-21
22) Assume that Signh agrees to purchase US$100,000 for C$84,745 on January 15, 2018. The exchange
entry is required at January 15, 2013?
A) $701 loss.
B) $701 gain.
C) $711 loss.
D) $711 gain.
Answer: B
Explanation: B) At Jan 15, 2013: 100 / 1.19 = 84,034
At year end: 100 / 1.20 = 83,333
Change is 84,034 - 83,333 = 701 gain
Diff: 3
Skill: Comp
23) Assume that Millan agrees to purchase US$100,000 for C$84,745 on January 15, 2018. The exchange
entry is required at year end?
A) $701 loss.
B) $701 gain.
C) $1,412 loss.
D) $1,412 gain.
Answer: C
Explanation: C) At purchase: 84,745
At year end: 100 / 1.20 = 83,333
Change is 84,745 - 83,333= 1,412 loss
Diff: 2
Skill: Comp
24) Assume that Aero agrees to purchase US$50,000 for C$52,000 on January 15, 2018. The exchange rate
at year end is US$1 = C$0.98 and the January 15, 2018 exchange rate is US$1 = C$0.97. What journal entry
is required at year end?
A) $3,000 loss.
B) $3,000 gain.
C) $3,500 loss.
D) $3,500 gain.
Answer: A
Explanation: A) 52,000 - (50,000 × 0.98) = 3,000 loss
Diff: 2
Skill: Comp
14-22
25) Assume that Aero agrees to purchase US$50,000 for C$52,000 on January 15, 2018. The exchange rate
at year end is US$1 = C$0.98 and the January 15, 2018 exchange rate is US$1 = C$0.97. What journal entry
is required at Jan 15, 2013?
A) $500 loss.
B) $500 gain.
C) $3,500 loss.
D) $3,500 gain.
Answer: A
Explanation: A) At year-end: (50,000 × 0.98) = 49,000
At Jan 15 2013: 50,000 × 0.97 = 48,500
Change is 49,000 - 48,500 = 500 loss
Diff: 2
Skill: Comp
1) Which method is used under IFRS to account for compound instruments?

A) Fair value method.
B) Proportional method.
C) Incremental method.
D) Zero common equity method.
Answer: C
Diff: 1
Skill: Concept
Objective: 14.3 Apply the accounting standards for compound financial instruments from the perspective of the
issuer.
2) Enterprises need to separate the components of a compound financial instrument and account for each
component separately. (a) What are the three alterative methods of allocating the cost to the components?
(b) Contrast the reporting requirements for compound financial instruments under IFRS and ASPE.
Answer:
(a) The three alternative methods are:
i. Proportional method
ii. Incremental method
iii. Zero common equity method
(b)IFRS recommends the incremental method and ASPE recommends either the incremental method or
the zero common equity method.
Diff: 1
Skill: Concept
issuer.
14-23
3) Which statement best describes the "zero common equity method"?

A) Under this method of accounting, for a convertible bond, all of the bond value would be counted as a
liability.
B) Under this method of accounting, for a convertible bond, the issuing entity would record a liability for
the estimated value of the bond without the conversion feature.
C) Under this method of accounting, for a convertible bond, an estimate would be made of the fair value
of all components and allocated proportionally to all components.
D) Under this method of accounting, the common share component is considered the least reliably
measured amount.
Answer: A
Diff: 1
Skill: Concept
issuer.
4) Which statement best explains the accounting for compound instruments?

A) Once separated, each component is accounted for at fair value with changes recorded through income.
B) Once separated, each component is accounted for in accordance with its substance.
C) Once separated, each component is accounted for at amortized cost.
D) Once separated, each component is accounted for at historical cost.
Answer: B
Diff: 2
Skill: Concept
issuer.
5) How would the liability portion of the compound instrument be recorded?

A) Once separated, this component is accounted for at fair value with changes recorded through income.
B) Once separated, this component is accounted for in accordance with its substance.
C) Once separated, this component is accounted for at amortized cost.
D) Once separated, this component is accounted for at historical cost.
Answer: C
Diff: 2
Skill: Concept
issuer.
14-24
6) A company issues convertible bonds with face value of $5,000,000 and receives proceeds of $6,500,000.
Each $1,000 bond can be converted, at the option of the holder, into 80 common shares. The underwriter
estimated the market value of the bonds alone, excluding the conversion rights, to be approximately
$6,300,000.
Required:
Record the journal entry for the issuance of these bonds based on IFRS.
residual amount.
Dr. Cash (given) 6,500,000

Cr. Bonds payable (standalone market value) 6,300,000
Cr. Contributed surplus—conversion rights 200,000
Diff: 1
Skill: Comp
issuer.
7) A company issues convertible bonds with face value of $10,000,000 and receives proceeds of
$10,500,000. Each $1,000 bond can be converted, at the option of the holder, into 800 common shares. The
underwriter estimated the market value of the bonds alone, excluding the conversion rights, to be
approximately $8,300,000.
Required:
residual amount.

Cr. Contributed surplus—conversion rights 2,200,000
Diff: 1
Skill: Comp
issuer.
14-25
8) A company issues convertible bonds with face value of $7,000,000 and receives proceeds of $8,500,000.
Each $1,000 bond can be converted, at the option of the holder, into 100 common shares. The underwriter
estimated the market value of the bonds alone, excluding the conversion rights, to be approximately
$7,300,000.
Required:
residual amount.

Diff: 1
Skill: Comp
issuer.
9) A company issued 95,000 preferred shares and received proceeds of $6,000,000. These shares have a
par value of $48 per share and pay cumulative dividends of 6%. Buyers of the preferred shares also
received a detachable warrant with each share purchased. Each warrant gives the holder the right to buy
one common share at $35 per share within 10 years.
The underwriter estimated that the market value of the preferred shares alone, excluding the conversion
rights, is approximately $64 per share. Shortly after the issuance of the preferred shares, the detachable
warrants traded at $8 each.
Required:
Record the journal entry for the issuance of these shares and warrants under IFRS.

(95,000 warrants × $8/warrant)
Cr. Preferred shares—par value (95,000 sh × $48/sh) 4,560,000
Cr. Contributed surplus—preferred shares, excess 680,000
over par (remainder)
Diff: 1
Skill: Comp
issuer.
14-26
Required:

Cr. Contributed surplus—preferred shares, excess 2,875,000
Diff: 1
Skill: Comp
issuer.
Required:

Cr. Contributed surplus—preferred shares, excess 1,225,000
Diff: 1
Skill: Comp
issuer.
14-27
Required:

Diff: 1
Skill: Comp
issuer.
14-28
Required:

Diff: 1
Skill: Comp
issuer.
14) A company had a debt-to-equity ratio of 1.64 before issuing convertible bonds. This ratio included
$500,000 in equity. The company issued convertible bonds. The value reported for the bonds on the
balance sheet is $180,000 and the conversion rights are valued at $22,000.
Required:
After the issuance of the convertible bonds, what is the value of the debt-to-equity ratio?
Answer:
Total liabilities before bond issuance = $500,000 × 1.64 = $820,000.
Total liabilities after bond issuance = $820,000 + $180,000 = $1,000,000.
Total equity after bond issuance = $500,000 + $22,000 = $522,000.
Debt-to-equity after bond issuance = $1,000,000 / $522,000 = 1.916 or 1.92
Diff: 1
Skill: Comp
issuer.
14-29
Required:
Answer:
Total liabilities after bond issuance = $742,500 + $200,000 = $942,500
Debt-to-equity after bond issuance = $942,500 / $522,000 = 1.984 or 1.98
Diff: 1
Skill: Comp
issuer.
Required:
Answer:
Total liabilities after bond issuance = $775,000 + $180,000 = $955,000.
Debt-to-equity after bond issuance = $955,000 / $522,000 = 1.83
Diff: 1
Skill: Comp
issuer.
14-30
17) LMN Company reported the following amounts on its balance sheet at July 31, 2018:
Liabilities
Convertible bonds payable, $10,000,000 face value 9%, due July 31, 2019 9,909,091
Equity
Contributed surplus—common stock conversion rights 300,000
Preferred shares, no par, 3,000,000 shares authorized, 10,000
outstanding 1,100,000
Common shares, no par, 1,000,000 shares authorized, 180,000
outstanding 4,500,000
Additional information
1. The bonds pay interest each July 31. Each $1,000 bond is convertible into 10 common shares. The bonds
were originally issued to yield 10%. On July 31, 2019, all the bonds were converted after the final interest
payment was made. LMN uses the book value method to record bond conversions as recommended
under IFRS.
2. No other share or bond transactions occurred during the year.
Required:
a. Prepare the journal entry to record the bond interest payment on July 31, 2019.
b. Calculate the total number of common shares outstanding after the bonds' conversion on July 31, 2019.
c. Prepare the journal entry to record the bond conversion.
Answer:
a. Journal entry for interest on July 31, 2019:
Dr. Interest expense ($9,909,091 × 10%) 990,909
Cr. Convertible bonds payable 90,909
Cr. Cash ($10,000,000 × 9%) 900,000
b. Number of shares outstanding before conversion 180,000

Shares issued upon conversion ($10,000,000 × 10 shares / $1,000) 100,000
Number of shares outstanding after conversion 280,000
c. Dr. Convertible bonds payable 10,000,000

Dr. Contributed surplus—common stock 300,000
conversion rights
Cr. Common shares 10,300,000
Diff: 2
Skill: Comp
issuer.
14-31
18) LMN Company reported the following amounts on its balance sheet at July 31, 2019:
Liabilities
Convertible bonds payable, $10,000,000 face value 8%, due July 31, 2019 9,818,182
Equity
Contributed surplus—common stock conversion rights 300,000
Preferred shares, no par, 3,000,000 shares authorized, 10,000 outstanding 1,100,000
Common shares, no par, 1,000,000 shares authorized, 180,000 outstanding 4,500,000
Additional information
1. The bonds pay interest each July 31. Each $1,000 bond is convertible into 5 common shares. The bonds
were originally issued to yield 10%. On July 31, 2019, all the bonds were converted after the final interest
payment was made. LMN uses the book value method to record bond conversions as recommended
under IFRS.
2. No other share or bond transactions occurred during the year.
Required:
a. Prepare the journal entry to record the bond interest payment on July 31, 2019.
b. Calculate the total number of common shares outstanding after the bonds' conversion on July 31, 2019.
c. Prepare the journal entry to record the bond conversion.
Answer:
a. Journal entry for interest on July 31, 2019:
Dr. Interest expense ($9,818,182 × 10%) 981,818
Cr. Convertible bonds payable 181,818
Cr. Cash ($10,000,000 × 8%) 800,000
b. Number of shares outstanding before conversion 180,000

Shares issued upon conversion ($10,000,000 × 5 shares / $1,000) 50,000
Number of shares outstanding after conversion 230,000
c. Dr. Convertible bonds payable 10,000,000

Dr. Contributed surplus—common stock 300,000
conversion rights
Diff: 2
Skill: Comp
issuer.
14-32
19) On January 1, 2019, Wayward Co. issued a $22 million, 8%, 6-year convertible bond with annual
coupon payments. Each $1,000 bond was convertible into 35 shares of Wayward's common shares.
Moonbeam Investments purchased the entire bond issue for $22.7 million on January 1, 2019. Moonbeam
estimated that without the conversion feature, the bonds would have sold for $21,013,098 (to yield 9%).
On January 1, 2020, Moonbeam converted bonds with a par value of $8.8 million. At the time of
conversion, the shares were selling at $30 each.
Required:
a. Prepare the journal entry to record the issuance of convertible bonds.
b. Prepare the journal entry to record the conversion according to IFRS (book value method).
c. Prepare the journal entry to record the conversion according ASPE (market value method).
Answer:
a. Journal entry for issuance:
Cr. Bonds payable (given) 21,013,098
b. Journal entry for conversion under IFRS (book value method):

Dr. Bonds payable* 8,457,711
Dr. Contributed surplus—conversion rights ($1,686,902 × 40%) 674,761
Cr. Common stock (100,000 shares) 9,132,472
*PV of principal ($8,800,000 / 1.095)

PV of coupons ($8,800,000 × 8% × PVFA(9%,5)
Carrying value of bond at time of conversion 8,457,711
Using BAII Plus financial calculator:
5 N, 9 I/Y, 8800000 FV, 704000 PMT, CPT PV 8,457,711
c. Journal entry for conversion under ASPE (market value method):

Dr. Bonds payable 8,457,711
Dr. Contributed surplus - conversion rights ($1,686,902 × 40%) 674,761
Cr. Common stock (8.8 million/1,000 *35 sh × $30/sh) 9,240,000
Dr. Loss on conversion 107,528
Diff: 2
Skill: Comp
issuer.
14-33
20) Which method is used under ASPE to account for compound instruments?
A) Fair value method.
B) Proportional method.
C) Book value method.
D) Zero common equity method.
Answer: D
Diff: 1
Skill: Concept
issuer.
21) Which method is used under ASPE to account for compound instruments?
A) Incremental method.
B) Fair value method.
C) Proportional method.
D) Book value method.
Answer: A
Diff: 1
Skill: Concept
issuer.
22) Which statement best describes the "incremental method"?

liability.
C) Under this method of accounting, for a convertible bond, an estimate would be made of the fair value
of all components and allocated proportionally to all components.
D) Under this method of accounting, the common share component is considered the most reliably
measured amount.
Answer: B
Diff: 2
Skill: Concept
issuer.
14-34
23) Which statement best describes the "proportional method"?

liability.
C) Under this method of accounting, for a convertible bond, estimate the fair value of all components and
allocate proportionally to them.
D) Under this method of accounting, the common share component is considered the least reliably
measured amount.
Answer: C
Diff: 2
Skill: Concept
issuer.
24) How would the equity portion of the compound instrument be recorded?
A) Once separated, this component is accounted for at fair value through profit or loss.
B) Once separated, this component is accounted for in accordance with its substance.
C) Once separated, this component is accounted for amortized cost.
D) Once separated, this component is accounted for at historical cost.
Answer: D
Diff: 2
Skill: Concept
issuer.
25) How would the exercise of an option, that was part of an initial compound instrument, be recorded?
A) Common stock is recorded at an amount equal to the fair value of the options at date of conversion.
B) Common stock is recorded at an amount equal to the price determined by the Black-Sholes model.
C) Common stock is recorded at an amount equal to the market price of the shares on conversion date.
D) Common stock is recorded at an amount equal to the cash received plus the contributed surplus
initially recorded.
Answer: D
Diff: 2
Skill: Concept
issuer.
26) How would exercise of warrants that were part of an original compound instrument be recorded?
A) Common stock is recorded at an amount equal to the fair value of the options at date of conversion.
B) Common stock is recorded at an amount equal to the cash received plus the contributed surplus
initially recorded
C) Common stock is recorded at an amount equal to the market price of the shares on conversion date.
D) Common stock is recorded at an amount equal to the price determined by the Black-Sholes model.
Answer: B
Diff: 2
Skill: Concept
issuer.
14-35
27) How is the subsequent conversion of bonds into common shares recorded under IFRS?
A) Book value.
B) Market value.
C) Fair value.
D) Historical value.
Answer: A
Diff: 2
Skill: Concept
issuer.
28) Explain the conceptual meaning of the difference between the book value and market value methods
of recording the conversion of bonds into common shares.
Answer: Under the "book value" method used under IFRS:
On conversion of a convertible instrument at maturity, the entity derecognizes the liability component
and recognizes it as equity. The original equity component remains as equity (although it may be
transferred from one line item within equity to another). There is no gain or loss on conversion at
maturity.
Under the "market value" used under ASPE:

The difference between the carrying amount of a financial liability (or part of a financial liability)
extinguished or transferred to another party and the fair value of the consideration paid, including any
non-cash assets transferred, liabilities assumed or equity instruments issued, shall be recognized in net
income for the period.
The book value method records the common shares at the current book value of the convertible bond and
related contributed surplus; no gain or loss is recorded. In contrast, the market value method records the
shares at their fair value at date of conversion, recording a loss for the difference between the market
value and the book value as determined above.
Diff: 2
Skill: Concept
issuer.
14-36
1) Which method must be used under IFRS to account for employee stock options?
A) Intrinsic value of options.
B) Time value of options.
C) Market value of the shares.
D) Fair value on the grant date of the options.
Answer: D
Diff: 1
Skill: Concept
Objective: 14.4 Apply the accounting standards for employee stock compensation plans from the perspective of the
issuer.
2) What are the similarities and differences between forwards and futures?
Answer: A forward is a contract in which one party commits upfront to buy or sell something at a
defined price at a defined future date. A future is similar to a forward but the contract is written in more
standardized terms (e.g., prices, maturity dates) and involves commonly traded items (e.g., commodities,
currencies).
Diff: 1
Skill: Concept
issuer.
3) List three common stock compensation plans and describe them.

Answer:
a) Employee stock options. An option contract gives the holder the right, but not the obligation, to buy or
sell something at a specified price. The most common type of option is a call option, which gives the
holder the right to acquire an underlying instrument at a pre-specified price within a defined period of
time.
b) Stock appreciation rights (SARs). Similar to stock options, employees benefit from SARs when the
actual stock price rises above a pre-determined benchmark price.
c) Warrants provide the holder with the right, but not the obligation, to buy a company's shares at a
specified price over a specified period of time. Thus, warrants are similar to call options. The main
differences are that warrants are issued only by the company whose shares are the underlying
instrument. Compared with options, warrants also tend to have longer times to maturity (typically three
to ten years), and they tend to be issued in combination with other financial instruments such as bonds,
preferred shares, and common shares.
Diff: 1
Skill: Concept
issuer.
14-37
4) Which statement is correct about the accounting for employee stock options?
A) The expense is recorded over the period of vesting.
B) The expense is recorded over the period to expiry.
C) The expense is recorded immediately upon grant date.
D) No expense is recorded for accounting purposes.
Answer: A
Diff: 2
Skill: Concept
issuer.
5) O'Neil Motor Parts issued 110,000 stock options to its employees. The company granted the stock
options at-the-money, when the share price was $40. These options have no vesting conditions. By year-
end, the share price had increased to $42. O'Neil's management estimates the value of these options at the
grant date to be $1.60 each.
Required:
Record the issuance of the stock options.
Answer: Note that in the absence of other information, the expense is assumed to be incurred in the
period that an enterprise grants the options.
Dr. Compensation expense or stock option expense 176,000

Cr. Contributed surplus—stock options (110,000 × $1.60) 176,000
Diff: 1
Skill: Comp
issuer.
6) O'Neil Manufacturing issued 200,000 stock options to its employees. The company granted the stock
end, the share price had increased to $42. O'Neil's management estimates the value of these options at the
grant date to be $1.75 each.
Required:

Diff: 1
Skill: Comp
issuer.
14-38
7) McMillan Manufacturing issued 60,000 stock options to its employees. The company granted the stock
end, the share price had increased to $42. McMillan's management estimates the value of these options at
the grant date to be $1.10 each.
Required:

Diff: 1
Skill: Comp
issuer.
8) Price Farms granted 290,000 stock options to its employees. The options expire 45 years after the grant
date of January 1, 2016, when the share price was $23. Employees still employed by Price five years after
the grant date may exercise the option to purchase shares at $45 each; that is, the options vest to the
employees after five years. A consultant estimated the value of each option at the date of grant to be $1.50
each.
Required:
Record the journal entries relating to the issuance of stock options.
Answer: Since the options vest after five years, the compensation expense should be amortized over this
five-year vesting period. Price should record the following entry each year from 2016 to 2020.
Dr. Compensation expense (290,000 options × $1.5/option / 5 yr) 87,000

Cr. Contributed surplus—stock options 87,000
Diff: 1
Skill: Comp
issuer.
14-39
9) Princeton Inc. granted 290,000 stock options to its employees. The options expire 45 years after the
grant date of January 1, 2016, when the share price was $23. Employees still employed by the company
four years after the grant date may exercise the option to purchase shares at $45 each; that is, the options
vest to the employees after five years. A consultant estimated the value of each option at the date of grant
to be $2.50 each.
Required:
five-year vesting period. Princeton should record the following entry each year from 2016 to 2019.
Dr. Compensation expense (290,000 options × $2.5/option / 4 yr) 181,250

Diff: 1
Skill: Comp
issuer.
10) AnnuG Inc. granted 200,000 stock options to its employees. The options expire 45 years after the grant
date of January 1, 2015, when the share price was $23. Employees still employed by the company six
years after the grant date may exercise the option to purchase shares at $45 each; that is, the options vest
to the employees after five years. A consultant estimated the value of each option at the date of grant to
be $2.50 each.
Required:
five-year vesting period. AnnuG should record the following entry each year from 2015 to 2019.
Dr. Compensation expense (200,000 options × $2.5/option / 5 yr)100,000

Diff: 1
Skill: Comp
issuer.
14-40
11) Windy Lake Lodge issued 24,000 at-the-money stock options to its management on January 1, 2015.
These options vest on January 1, 2018. Windy Lake's share price was $19 on the grant date and $22 on the
vesting date. Estimates of the fair value of the options showed that they were worth $3 on the grant date
and $11 on the vesting date. On the vesting date, management exercised all 24,000 options. Windy Lake
has a December 31 year-end.
Required:
Record all of the journal entries relating to the stock options.
Answer:
2015 Dec 31 Dr. Compensation expense 24,000
(24,000 options × $3/option / 3 years)
2016 Dec 31 Same entry as above.
2018 Jan 1 Dr. Cash (24,000 sh × $19/sh) 456,000

Dr. Contributed surplus—stock options 72,000
($24,000/year × 3 years)
Cr. Common stock 528,000
Diff: 1
Skill: Comp
issuer.
12) Breezy Lodge issued 25,000 at-the-money stock options to its management on January 1, 2015. These
options vest on January 1, 2018. Breezy's share price was $18 on the grant date and $25 on the vesting
date. Estimates of the fair value of the options showed that they were worth $4 on the grant date and $11
on the vesting date. On the vesting date, management exercised all 25,000 options. Breezy has a
December 31 year-end.
Required:
Answer:
2018 Jan 1 Dr. Cash (25,000 sh × $18/sh) 450,000

($33,333/year × 3 years)
Diff: 1
Skill: Comp
issuer.
14-41
13) Nappy Lodge issued 15,000 at-the-money stock options to its management on January 1, 2015. These
options vest on January 1, 2018. Nappy's share price was $20 on the grant date and $25 on the vesting
date. Estimates of the fair value of the options showed that they were worth $3 on the grant date and $11
on the vesting date. On the vesting date, management exercised all 15,000 options. Nappy has a
December 31 year-end.
Required:
Answer:
2018 Jan 1 Dr. Cash (15,000 sh × $20/sh) 300,000

($15,000/year × 3 years)
Diff: 1
Skill: Comp
issuer.
14-42
14) On January 1, 2015, Gilmore Inc. granted stock options to officers and key employees for the purchase
of 100,000 of the company's no par value common shares at $28 each. The options were exercisable within
a five-year period beginning January 1, 2017 by grantees still in the employ of the company, and they
expire December 31, 2021. The market price of Gilmore's common share was $20 per share at the date of
grant. Using the Black-Scholes option pricing model, the company estimated the value of each option on
January 1, 2015 to be $4.00.
On March 31, 2017, 60,000 options were exercised when the market value of common stock was $44 per
share. The remainder of the options expired unexercised. The company has a December 31 year-end.
Required:
Record the journal entries for Gilmore's stock options.
Answer:
The total cost of the options is 100,000 options × $4/option = $400,000. This amount should be amortized
over the vesting period (two years), which is presumed to be the period of service expected from the
option grant.

2017 Mar 31 Dr. Cash (60,000 shares × $28/share) 1,680,000

($400,000 × 60,000 options / 100,000 options)
2021 Dec 31 Dr. Contributed surplus—stock options 160,000

($400,000 - $240,000)
Cr. Contributed surplus—expired stock options 160,000
Diff: 2
Skill: Comp
issuer.
14-43
15) On January 1, 2015, Braeben Inc. granted stock options to officers and key employees for the purchase
of 180,000 of the company's no par value common shares at $30 each. The options were exercisable within
a five-year period beginning January 1, 2017 by grantees still in the employ of the company, and they
expire December 31, 2021. The market price of Braeben's common share was $20 per share at the date of
grant. Using the Black-Scholes option pricing model, the company estimated the value of each option on
January 1, 2015 to be $2.75.
On March 31, 2017, 30,000 options were exercised when the market value of common stock was $44 per
share. The remainder of the options expired unexercised. The company has a December 31 year-end.
Required:
Record the journal entries for Braeben's stock options.
Answer:
The total cost of the options is 180,000 options × $2.75/option = $495,000. This amount should be
amortized over the vesting period (two years), which is presumed to be the period of service expected
from the option grant.

2017 Mar 31 Dr. Cash (30,000 shares × $30/share) 900,000

($495,000 × 30,000 options / 180,000 options)
Cr. Common shares 982,500
2021 Dec 31 Dr. Contributed surplus—stock options 415,500

($495,000 - $82,500)
Cr. Contributed surplus—expired stock options 415,500
Diff: 2
Skill: Comp
issuer.
16) Which method must be used under ASPE to account for employee stock options?
A) Intrinsic value of options.
B) Time value of options.
C) Fair value of the options.
D) Market value of the shares.
Answer: C
Diff: 1
Skill: Concept
issuer.
14-44
1) What is a "hedge"?
A) A financial instrument that is speculative and increases the risk for the company.
B) An instrument that moves in the opposite direction to another financial asset or liability.
C) An instrument that moves in the same direction as another financial asset or liability.
D) A financial instrument that is prohibited by accounting standards under IFRS and ASPE.
Answer: B
Diff: 2
Skill: Concept
Objective: 14.5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be
appropriate.
2) Which step is not required for hedge accounting under IFRS?

A) Demonstration of hedge's effectiveness.
B) Identification of the risk exposure.
C) Payment of fees to the counterparty.
D) Designation of the hedging instrument.
Answer: C
Diff: 2
Skill: Concept
appropriate.
3) Which statement is correct about hedge accounting?

A) Hedge accounting must be reported in profit or loss.
B) Hedge accounting must be reported in OCI.
C) The financial effects of the hedging item and instrument offset 100% in hedge accounting.
D) It permits the hedging item and the hedging instrument to be recorded in the same way.
Answer: D
Diff: 2
Skill: Concept
appropriate.
4) Explain what a "fair value" and "cash flow" hedge is and how each is accounted for under IFRS.
Answer:
Fair value hedge - Reduces the exposure to changes in fair value.
Cash flow hedge - A financial instrument that reduces the exposure to changes in future cash flows.
For fair value hedges, the changes in fair value for both the hedged item and the hedging instrument flow
through income. For cash flow hedges, the changes in cash flow pass through OCI.
Diff: 2
Skill: Concept
appropriate.
14-45
5) Give 4 examples of cash flow hedges:

Answer: (1) future interest payments on variable rate debt or (2) interest payments on foreign-
denominated debt (3) an expected inventory purchase priced in a foreign currency or (4) the anticipated
sale of offshore property.
Diff: 2
Skill: Concept
appropriate.
6) Identify the type of hedge under each of the following transactions:
Fair value hedge or

Item cash flow hedge?
A swap of investment with a fixed interest rate with one
providing a variable return.
A swap of a Euro-dollar denominated bond payable for
one denominated in US dollars.
A futures contract to sell 1,000 oz of silver at USD$45/oz.
A swap of investment with a variable interest rate with
one providing a fixed return.
Answer:
Fair value hedge or
Item cash flow hedge?
A swap of investment with a fixed interest rate with one
providing a variable return. Fair value
A swap of a Euro-dollar denominated bond payable for
one denominated in US dollars. Cash flow
A futures contract to sell 1,000 oz of silver at USD$45/oz. Fair value
A swap of investment with a variable interest rate with
one providing a fixed return. Cash flow
Diff: 2
Skill: Concept
appropriate.
14-46
7) A company located in Canada spends $2,000 to purchase a foreign currency futures contract to buy
US$100,000 at C$1.05:US$1.00. The contract matures 110 days later. Under which of the following
circumstances could the company consider this future contract to be a fair value hedge for accounting
purposes?
Answer:
Diff: 2
Skill: Concept
appropriate.
14-47
8) On December 1, 2015, Mackenzie Mann Ltd. entered into a binding agreement to buy inventory costing
US$300,000 for delivery on February 16, 2016. Terms of the sale were COD (cash on delivery). Mackenzie
Mann, which has a December 31 year-end, decided to hedge its foreign exchange risk and entered into a
forward agreement to receive US$300,000 at that time. Mackenzie Mann designated the forward a fair
value hedge. Pertinent exchange rates follow:
Date Spot Rate C$ per US$1 Forward rate for delivery on

February 16, 2016 CS$ per US$1
December 1, 2015 1.010 1.000
December 31, 2015 .980 .995
February 16, 2016 .990 .990
Required:
Record the required journal entries for December 1, December 31, and February 16 using the net method.
If no entries are required, state "no entry required" and indicate why.
Answer:
Date Account DR CR
Dec. 1, 2015 No entry required– the contract to purchase the
inventory and the forward contract are both
mutually unexecuted contracts
Dec. 31, 2015 Foreign exchange gains and losses 1,500
Forward contract receivable (US dollars) 1,500
Contract commitment asset 1,500
Foreign exchange gains and losses 1,500
US$300,000 × (0.995 - 1.000)
Feb. 16, 2016 Foreign exchange gains and losses 1,500
Forward contract receivable (US dollars) 1,500
Foreign exchange gains and losses 1,500
US$300,000 × (0.990 - 0.995)
Cash (US$) (US$300,000 × 0.990) 297,000
Forward contract receivable (US dollars) ($1,500 3,000
+ $1,500)
Cash (C$) (US$300,000 × 1.000) 300,000
Inventory (US$) (US$300,000 × 1.000) 300,000
Cash (C$) (US$300,000 × 0.990) 297,000
Diff: 2
Skill: Comp
appropriate.
14-48

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Intermediate Accounting, Volume 2, 2e

Chapter 14 – Complex Financial Instruments

Solution Manual for Intermediate Accounting Vol 2

Solution manual: https://testbankpack.com/p/solution-manual-for-intermediate-

Test bank: https://testbankpack.com/p/test-bank-for-intermediate-accounting-

Intermediate Accounting, Vol. 2, 2e (Lo/Fisher)

14.1 Learning Objective 1

1) Which of the following is correct about financial instruments?

2) Which statement is correct about accounting for financial instruments?

8) What is a "call" option?

9) Which of the following is correct regarding a call option?

10) What is a "put" option?

11) What is a "swap"?

12) Which of the following is an example of a "swap"?

13) What is a "future"?

14) Which of the following is an example of a "future"?

15) What is a "forward"?

16) Which of the following is an example of a "forward"?

17) What is a "warrant"?

18) Which of the following is an example of a "warrant"?

19) Contrast options with warrants.

Item True / False

23) Explain how convertible bonds alleviate moral hazard.

24) Briefly describe a compound financial instrument and its advantages.

14.2 Learning Objective 2

2) How are derivative contracts generally accounted for?

Dec 31 Dr. Loss on foreign currency forward

Dec 31 Dr. Loss on foreign currency forward 5,000

Year-end Dr. Gold futures ($10,000 - $7,000) 3,000

Year-end Dr. Silver futures ($6,000 - $5,000) 1,000

b) Journal entries for 2018:

c) Journal entries for exercise of stock warrants:

2018 Dec 31 Dr. Liability for call options issued 40,000

2019 Mar 16 Dr. Liability for call options issued 760,000

Since the options expire unexercised, liability is extinguished.

2018 Dec 31 Dr. Liability for call options issued 5,000

2019 Mar 16 Dr. Liability for call options issued 95,000

Since the options expire unexercised, liability is extinguished.

2019 Dec 31 Dr. Loss on call options issued 20,000

2020 May 17 Dr. BWC shares held for trading 760,000

Dr. Cash (20,000 sh × $35/sh) 700,000

2019 Dec 31 Dr. Loss on call options issued 10,000

2020 May 17 Dr. VESPUS shares held for trading 800,000

Dr. Cash (20,000 sh × $35/sh) 700,000

2019 Dec 31 Dr. Loss on call options issued 2,500

2020 May 17 Dr. POMPEI shares held for trading 200,000

Dr. Cash (5,000 sh × $35/sh) 175,000

17) How should employee stock options be accounted for?

18) Which is a derivative on the company's own common shares?

19) Which is a derivative on the company's own common shares?

14.3 Learning Objective 3

1) Which method is used under IFRS to account for compound instruments?

3) Which statement best describes the "zero common equity method"?

4) Which statement best explains the accounting for compound instruments?

5) How would the liability portion of the compound instrument be recorded?

Dr. Cash (given) 6,500,000

Dr. Cash (given) 10,500,000

Dr. Cash (given) 8,500,000

Dr. Cash (given) 6,000,000

Dr. Cash (given) 7,000,000

Dr. Cash (given) 7,000,000

Dr. Cash (given) 6,100,000

Dr. Cash (given) 5,750,000

b. Number of shares outstanding before conversion 180,000