P15-19. Stock option accounting: Transitioning to current GAAP (LO
15-6)
Requirement 1:
Under the intrinsic value method allowed by pre-Codification SFAS
No. 123, but later disallowed by pre-Codification SFAS No. 123(R),
share. In this case, Riley would record $300 of compensation
grant date stock price and options exercise price must have
totaled $6.6 million.
Requirement 2:
According to the note, the fair value of options award in 2004 and
($6.6 million) on the grant date.
Requirement 3:
SFAS No. 123(R) required firms that had previously used the
intrinsic value method to change to the fair value method for
compensation expense by reducing the amount of options
awarded or by curtailing their use altogether.
Requirement 4:
Ball, like many other firms, reduced the value of options awarded
Requirement 5:
If Ball was like most other firms, the 2005 tax benefits associated
pre-codification SFAS No. 123(R) or current GAAP.
P15-20. Distinguishing liabilities from equities (LO 15-3)
Requirement 1:
The company’s Series B preferred stock has a mandatory
Accounting Standards Codification and thus in current GAAP.
Requirement 2:
Immediately prior to SFAS No. 150, the Series B preferred stock
B preferred would have likely been shown as part of stockholders’
equity.
Requirement 3:
GAAP requires the Series B preferred stock to be classified as
statement treatment in keeping with the balance sheet treatment.
Requirement 4:
The company’s Series A preferred stock has a contingent
Series A dividends will be treated as GAAP (and IRS) preferred
stock dividends.
Requirement 5:
Redemption of the Series B preferred stock is mandatory, which
circumstances, which means that the instrument does not closely
resemble debt.
Requirement 6:
One reason why mandatorily redeemable preferred stock became
less popular after SFAS No. 150 is that firms are now required to
issuing debt in the future. See Chapter 7 for additional discussion
of contracting incentives and debt covenants.
Financial Reporting and Analysis (7th Ed.)
Chapter 15 Solutions
Financial Reporting for Owners’ Equity
Cases
Cases
C15-1. Groupe Casino: Determine whether it is debt or equity (LO
15-5)
Requirement 1:
International Accounting Standards (IAS) No. 32 states that “[t]he
issuer of a financial instrument shall classify the instrument, or its
No. 32 provides the following definitions for financial liabilities and
equity instruments:
A financial liability is any liability that is: (a) a contractual obligation
for which the entity is or may be obliged to deliver a variable number
of the entity’s own equity instruments, or is a derivative that will or
equity instruments.
An equity instrument is any contract that evidences a residual
interest in the assets of the entity after deducting all of its liabilities.
Requirement 2:
Equity treatment seems appropriate in this case. The notes have
no maturity date and the lender cannot force redemption. Moreover,
seem to represent a strong “residual” claim to the assets of the
entity.
Requirement 3:
The following entries would be made on the books of Groupe
Casino:
DR Interest on perpetual obligation notes 30
CR Interest payable
Casino’s balance sheet. Interest would not flow to the income
statement but instead to the statement of changes in stockholders’
equity as equity dividends already do.
Requirement 4:
The ASC Glossary defines a financial liability as “a contract that
terms with the second entity.”
The Glossary defines an equity security as “Any security
representing an ownership interest in an entity (for example,
the issuing entity or is redeemable at the option of the investor.”
For the reasons described in Requirement 2, liability treatment
suspect that most observers would favor equity treatment under
U.S. GAAP.
C15-2. Employee stock option accounting at Starbucks Corporation
(LO 15-7)
Requirement 1:
A stock option’s fair value increases with the duration of the option
has a longer duration and higher fair value, reflecting the greater
probability that market price of SBUX shares will rise above $23.00
at sometime over the ensuring 10 years.
The employee stock option tranches issued on January 1, 2017
(described in the problem statement) have identical exercise prices
2017 are likely to be exercised in 2019 and thus have an expected
characterized by a longer (expected) duration have a higher fair
value.
Requirement 2:
January 1, 2017:
No entry needed at date of grant
No other entries are required even though the market price of SBUX
shares ($40) exceeds the option exercise price at December 31,
2017.
Requirement 3:
There will be no expense in 2018 (Year 2) associated with the first
tranche of stock options because the entire grant-date fair value of
those options was expensed over the one year vesting period (see
that compensation expense does not depend on the market value of
SBUX shares prevailing at year-end.
Requirement 4:
The entry to record the exercise in early 2015 of 10,000 employee
stock options from the December 31, 2014 tranche is:
the calculated fair value of the options at the grant date (10,000
options X $2).
Requirement 5:
Employee stock options that are “underwater”—meaning they have
an exercise price ($19) that exceeds the prevailing market price ($10,
exercise price ($15) can overcome this lack of incentive/retention
value.
Requirement 6:
To avoid triggering accounting recognition of additional compensation
expense, employees must exchange old underwater options for new
options that have a grant-date fair value equal to the remaining
generous and granted 10 million of the new options, additional
compensation expense would have been recorded.
C15-3. RN-Nabisco Group: Dividends and agency costs (LO 15-4)
This case describes a “partial spin-off” in which RJR Holdings is
offering to sell 25% of its ownership interest in a subsidiary—the
substantial influence over its financing, operating, and investment
activities.
The board at Holdings has announced a 45% (of earnings) dividend
payout rate for Nabisco Group shares. The board also says it
prospectus do not present any new agency problems for potential
investors.
The second paragraph of the prospectus extract says that Nabisco
Group dividends will be paid out of the lesser of (1) the Available
restriction on Nabisco dividend payments—funds must be available
in Holdings.
We also learn in this paragraph that ANDA will be “increased or
Now we have a potential agency problem!
To illustrate the nature of this agency problem, suppose Nabisco
Group reports net income of $100 million. With the dividend payout
owners of Reynolds stock. So, here is what will happen to the $45
million in dividends:
Nabisco Stock Reynolds Stock
($ in millions) Outsiders Holdings Outsiders
Buyout
Group
Nabisco Group pays $45 million dividend:
The buyout group receives $16,538,000 as its share of the Nabisco
Group dividend.
Now, suppose, instead, that Holdings decides to charge Nabisco
a $45 million dividend on Reynolds stock. Here is what would
happen:
Nabisco Stock Reynolds Stock
($ in millions) Outsiders Holdings Outsiders
Buyout
Group
Now the buyout group receives $22,050,000 instead of just
including the buyout group itself.
Of course, the story is incomplete because actions of this sort would
undoubtedly cause the price of Nabisco stock to fall. This would
RJR Nabisco withdrew its Nabisco Group stock offering in late June