Financial Accounting

Motivations of Managers to Window Dress Financial Statements

Companys motives
To meet revenue targets
To attract investors
To get loans
To manage/ minimize loans
To comply with COA requirements
To report higher income
To smoothen the income of the company
This would indicate a stable company, lower volatility. Therefore, it would be easier and
cheaper for the company to raise funds as lending/ financial institutions would see them
as a low-risk company, which would result to a lower cost of financing.
Peoples motives
Management incentives
Bonuses
Promotions
Stock options management would have motivation to prop stock prices/ increase market
value of the stocks
Expenses under the discretion of the management
1. Bad debt
2. Impairment loss
3. Depreciation expense

Financial Reports

Auditors report
The balance sheet or statement of financial position
Shows the liquidity position and capital structure of the company
The P & L or income statement
Shows the operations/ operating performance of the company

The statement of cash flows

Statement of Changes in Equity
Notes to financial statement

How to Evaluate the Companys Accounting Policies/ Evaluating A Companys

Accounting Policy

Aggressive VS conservative
Aggressive accounting policies tend to overstate assets, understate liabilities, overstate equity,
overstate revenues, understate expenses
Example: FOB shipping point more aggressive than FOB destination point
Auditors Opinion
Unqualified fairly stated
Qualified
Issued when there is deviation from Accounting standards in one or 2 accounts, material
misstatement
Scope limitation
Management does not want to make changes
Look for the phrase except for
Adverse
Not consistent with general accounting principles
GOCC/ PNCC
Disclaimer
No opinion
Ask why?
None has been issued yet because prior to the publishing or release of the report, auditors
will discuss the opinion with management, management can decide to change auditors.
Valid changes
1. 5 years change of auditor is based on policy
2. A multinational mother company changed its auditor
Accounting policy choices

Management can choose accounting policies to employ

Depreciation
Straight-line method
Double Decline
Sum of the Years Digit
Cost flow for Inventory (LIFO, FIFO)
Assumptions and estimates
Depreciation (estimated useful life)
Classification and presentation

Basic Accounting Equations

Assets = Liabilities + Equity
Revenues Expenses = Net Income/ Net Loss

Accounts Receivable
Net realizable value gross accounts receivable less allowance for doubtful accounts
Balance Sheet
Income Statement
Net
Accounts
(1,000,000.0 Retained
(1,000,000.0 Impairme 1,000,000.
Inco (1,000,000.0
Receivables
0)
Earnings
0)
nt Loss
00
me
0)
In this case, the accounts were not written off.
Aging of accounts receivables most common method of provisioning
- Current (within term)
- Past due
Aging of AR 100M
Current
45M
1-30 days past
due
20M
31-60 days past
due
20M
61-90 days past
10M

due
Over 90 days
past due

Has a higher percentage of

5M uncollectibility
100 M

Balance Sheet Method - % of accounts receivables

Income Statement Method - % of Sales
Banks (BSP) -> automatically considers 2% of loans as provisions or impairment loss.
Impairment loss not a tax deductible expense
Write off AR Tax deductible
CASE 1: no impairment loss
Before the 300,000 write off
Gross AR
15,000,000.00
ADA
1,000,000.00
NRV
14,000,000.00
*No effect on income statement / NRV still the same

After the 300,000 write off

Gross AR
14,700,000.00
ADA
700,000.00
NRV
14,000,000.00

CASE 2: with impairment loss

BS Before the 1.2M write
of
BS after 1.2 M write of
Gross AR
ADA

15,000,000.00
1,000,000.00

Gross AR

13,800,000.
00

ADA

(200,000.00
)

Impairme
nt Loss

13,800,000. Retained
NRV
14,000,000.00
NRV
00
Earnings
Implication of Case 2: The company has been underproviding

Income Statement
Net
incom (200,000.00
200,000.00 e
)
Balance Sheet
(200,000.0
0)

If the amount of write-off is within the provision, no effect on Income Statement. However, if its greater than
the provision or allowance for doubtful accounts (ADA), then income statement is affected, net income
decreases and retained earnings decreases.
To determine whether the AR is underprovided, compare the % change in sales to % change in Gross AR.

Accounting Policy for Inventories

Lower of cost and net realizable value

Net realizable value for inventories estimated selling price less estimated costs to complete and estimated
costs to sell.

Lower of cost method you use which one is lower, the COST or the MARKET value of inventory using NRV (net
realizable value)
Determining the Net Realizable
Value
Estimated Selling
Price
Less Estimated Cost
to Sell
NRV
Balance Sheet

17,000,000.
00
850,000.00
16,150,00
0.00

Income Statement
Net
Inventori
Retained
Impairme (3,850,000.
Inco (3,850,000.0
es
(3,850,000.00) Earnings
(3,850,000.00)
nt Loss
00)
me
0)
The difference between Initial cost and NRV = 3,850,000

Accounting Policy for Intangible Assets

No physical substance
Intangible assets subject to amortization
Goodwill premium that you pay for acquiring a company/ reflected on the balance sheet as the excess of
the acquisition price over the fair market value of the net asset acquired.

Accounting policy for Investment Properties

Investment property land and/or building held to generate income or for capital appreciation or both.
Not used for operations
Initially at cost
Subsequently: either at (a) cost less accumulated depreciation and accumulated impairment losses or (b) fair
value
Exercise Sheet #6 KEY WORDS to be leased / held for appreciation
CASE 1: Cost less accumulated depreciation and accumulated impairment loss
31-Dec-13
Balance Sheet

Investment
Property Office
condominium

20,000,000.00

Cash

(20,000,000.0
0)
31-Dec-14

Bought office condo at 20M

Income Statement

depreciation year 1
Balance Sheet

Investment
Property Office
(1,000,000.00 Retained
(1,000,000.00
condominium
)
Earnings
)
The book value of the condo is 19,000,000.00

Income Statement
Office
condominiu
mdepreciation
expense

1,000,00
0.00

Net
Incom
e

(1,000,00
0.00)

CASE 2: Fair Value Approach

31-Dec-13
Balance Sheet
Investment
Property Office
condominium

20,000,000.00

Cash

(20,000,000.0
0)
31-Dec-14

Bought office condo at 20M

Income Statement

depreciation
Balance Sheet

Investment
Property Office
condominium

2,000,000.00

Retained
Earnings

Income Statement

2,000,000.00

Unrealized
gains investment
property

2,000,00
0.00

Net
Incom
e

2,000,00
0.00

Unrealized gains or losses occur when the fair value of the assets change while the company still
holds them.
No depreciation when using the fair value approach
Unrealized gains and losses are recognized in the income statement.
Note that investment properties are currently used to generate income or for appreciation.
Land held for future development asset account for land that will be developed by the company; long
term inventory; use NRV
When investment properties or assets are reclassified, check the reclassification when the
amount is big?
Fair values should be disclosed in the NOTES TO FINANCIAL STATEMENTS.

Capitalized Costs for Property, Plant, and Equipment (PPE)

-

Acquisition costs
Incidental costs to put the asset into use

Borrowing costs during self-construction

Freight
Duties and taxes
Asset retirement obligations (ARO)

Asset Retirement Obligations (ARO)

ARO refer to the cost of dismantlement, removal or restoration which an entity incurs as a consequence of
using the item during a particular period. These are measured at the present value of the estimated costs of
these obligations.
Recognized as a liability
Exercise Sheet #10
Formula for future value FV = P(1+r)^n
N= number of years
Formula for present value P = FV(1+r) ^ -n
1,518,881.8
0 6

2 1,746,714.14

Interest
Rate
$227,832.2
8 (P1 x
interest
rate)
$262,007.1
2
(P2 x
interest
rate)

3 2,008,721.26

$301,308.1 2,310,029.
9 45

4 2,310,029.45
5

$346,504.4 2,656,533.
2 87
$398,480.0

1 1,518,881.86

Future
Value
1,746,714.
14

2,008,721.
26

2,656,533.87

3,055,013.
95

6 3,055,013.95

$458,252.0 3,513,266.
9 04

7 3,513,266.04

$526,989.9 4,040,255.
1 94

8 4,040,255.94

$606,038.3 4,646,294.
9 34

9 4,646,294.34

$696,944.1 5,343,238.
5 49

10 5,343,238.49

$801,485.7 6,144,724.
7 26

11 6,144,724.26

$921,708.6 7,066,432.
4 90

12 7,066,432.90

$1,059,964 8,126,397.
.93 83

13 8,126,397.83

$1,218,959 9,345,357.
.67 51

14 9,345,357.51

$1,401,803 10,747,161
.63 .13

10,747,161.1
15 3

$1,612,074 12,359,235
.17 .30

12,359,235.3
16 0

$1,853,885 14,213,120
.30 .60

31-Dec-13

Equipment
Cash

14,213,120.6
17 0

$2,131,968 16,345,088
.09 .69

16,345,088.6
18 9

$2,451,763 18,796,851
.30 .99

18,796,851.9
19 9

$2,819,527 21,616,379
.80 .79

21,616,379.7
20 9

$3,242,456 24,858,836
.97 .76

24,858,836.7
21 6

$3,728,825 28,587,662
.51 .27

28,587,662.2
22 7

$4,288,149 32,875,811
.34 .61

32,875,811.6
23 1

$4,931,371 37,807,183
.74 .35

37,807,183.3
24 5

$5,671,077 43,478,260
.50 .86

43,478,260.8
25 6

$6,521,739 50,000,000
.13 .00

Cell site was put up. NPV of ARO is included in the capitalized cost of asset
Balance Sheet
Income Statement
201,518,881.
86
(200,000,000

ARO

1,518,881.86

.00)
31-Dec-14

Equipment

Recognize asset retirement obligation / depreciation and interest expense

Balance Sheet
Income Statement
net
(8,060,7
Retained
(8,060,7
Depreciation
8,060,7 incom
(8,060,75
55.27)
Earnings
55.27)
Expense
55.27
e
5.27)
227,
ARO
832.28
Net
Retained
(227,8
Interest
227,8 incom
(227,8
Earnings
32.28)
expense
32.28
e
32.28)

in 25 years

Cash

Balance Sheet
(50,000,0
00.00)
ARO
(10,000,0
00.00)

Cash

Retained
Earnings

in 25 years

Cash

Balance Sheet
45,000,0
00.00
ARO
Retained
Earnings

actual cost incurred is 60M

Income Statement
(50,000,0
00.00)
Net
(10,000,0 Expense from
10,000,0 incom
00.00)
ARO
00.00
e

(10,000,00
0.00)

actual cost incurred is 45M

Income Statement
(50,000,0
00.00)
Net
5,000,0 Gains from
5,000,0 incom
00.00
ARO
00.00
e

5,000,0
00.00

Accounting Policy for PPE

Cost less accumulated depreciation and accumulated impairment losses

Exercise Sheet #7

31-Dec-13
Balance Sheet
Equipment

500,000.00

Cash

(500,000.00)
31-Dec-14

Bought equipment at 500k

Income Statement

depreciation
Balance Sheet

Retained
Depreciation
Equipment
(50,000.00)
Earnings
(50,000.00)
Expense

Book value in 2013 500K

Book value in 2014 450K

Book value = Equipment (gross) accumulated depreciation

Exercise Sheet #8
Materials

5,000,000.0
0

Labor

2,000,000.0
0

Overhead
Interest during
construction (1year)
Total Capitalized
Cost of the Plant

31-Dec-12
Cash

Income Statement
Net
50, Incom
000.00
e

1,000,000.0
0
500,000.00
8,500,000.
00

Balance Sheet
Notes Payable

borrowed money from the bank

Income Statement

(50,0
00.00)

5,000,000.00
31-Dec-13

Plant
Cash
31-Dec-14

Cash
Plant
Cash

5,000,000.00
Interest expense during period of construction is capitalized
Balance Sheet
Income Statement
8,500,0
00.00
(8,500,0
00.00)

paid of debt; recognized interest and depreciation expense

Balance Sheet
Income Statement
(5,000,0
(5,000,0
00.00)
Notes Payable
00.00)
net
(425,0
Retained
(425,0 depreciation
425,0 incom
00.00)
Earnings
00.00)
expense
00.00
e
net
Retained
(500,0
interest
500,0 incom
(500,000.00)
Earnings
00.00)
expense
00.00
e

(425,0
00.00)
(500,0
00.00)

Or

Revaluation Model - Appraised value less accumulated depreciation and accumulated impairment
losses
Exercise Sheet #9
31-Dec-12

bought land for 5M

Balance Sheet

Land
Cash

Income Statement

5,000,000.00
(5,000,000.00)
31-Dec-13

Land revalued at Php 6M

Balance Sheet

Land

1,000,000.00

Revaluation
Increment (Equity
Account)

Income Statement

1,000,000.00

31-Dec-14

Land revalued at Php 6.5M

Balance Sheet

Land

1.
2.
3.
4.

500,000.00

Income Statement

Revaluation
Increment (Equity
Account)

500,000.00

Impairment Loss
Compare carrying amount (book value) with recoverable amount
Recoverable amount is the greater of fair value less cost to sell and value in use
Value in use is the PV of cash flows from an asset or cash generating unit discounted at an appropriate rate
If carrying amount is greater than recoverable amount, impairment loss is recognized in the
profit and loss statement
Exercise Sheet #11
31-Dec-12

bought land for 5M

Balance Sheet

Land

5,000,000.00

Cash

(5,000,000.0
0)
31-Dec-13
Balance Sheet
(200,0
00.00)

Land

Retained
Earnings

Income Statement

recoverable amount is 4.8M

Income Statement
Net
(200,0
Impairment
200,0 incom
00.00)
Loss
00.00
e

fair value in use net cost to sell 5.5M

Balance Sheet
Income Statement
Recovery from
Net
200,
Retained
200, impairment
200,0 incom
Land
000.00
Earnings
000.00
loss
00.00
e
NOTE: You can recover an amount only up to the amount equal to the impairment loss.

(200,0
00.00)

31-Dec-14

200,0
00.00

Recovery from impairment loss should be disclosed in the notes to financial statements

Accounting Policy for Equity Investments

Investments at fair value through profit and loss mark-to market

Mark to market value
Short term investments
Stricter accounting standards
Unrealized gains or losses are recognized in the income statement
#12 - A
15-Apr-15
Balance Sheet

IFVPL

Income Statement

2,900,000.0
0

(2,900,000.0
0)
30-Apr-15
losses or gains are recorded during the time the market value has changed
Balance Sheet
Income Statement
Unreali
zed
loss
Net
Retained
from
(130,000.00
inco
IFVPL
(130,000.00) Earnings
(130,000.00)
IFVPL
)
me
(130,000.00)
22-May-15
Balance Sheet
Income Statement
2,870,0
Cash
00.00
Cash

IFVPL
-

(2,770,000.0
0)

Retained
Earnings

100,000.00

Losses or gains are recognized each transaction date.

Gains
from
IFVPL

100,000.00

Net
inco
me

100,000.00

Investments available for sale (AFS)

Mark-to-market
Depends on the management whether or not to buy?
Long term investment
Unrealized gains and or losses are recognized in the balance sheet (other comprehensive income OCI)
Gains and/or losses are realized ONLY WHEN YOU SELL THEM.
Other comprehensive income equity account statement of changes in equity?
#12 B
15-Apr-15
Balance Sheet

AFS

2,900,000.0
0

Cash

(2,900,000.
00)
30-Apr-15

Income Statement

no effect on income statement

Balance Sheet
(130,000.00
)

AFS

Other
Comprehensiv
e Income

(130,000.00
)

22-May-15
Balance Sheet

Cash

AFS

2,870,0
00.00
(2,770,000.
00)

Other
Comprehensiv
e Income
Retained
Earnings

Income Statement
130,
000.00

(30,000.00)

Loss
from the
sale of
(30,000.00
AFS
)

Net
incom
e

(30,000.00)

Take note that there is no word UNREALIZED in the income statement account. Losses really been realized
or there were really some losses and cant be recovered. When the securities are already sold, GAINS OR
LOSSES ARE UNREALIZED.
Unrealized gains or losses are only used when values of UNSOLD IFVPL increase or decrease.
NOTES: Security Bank/ Union Bank they are trading substantial amount of marketable securities
CASH DIVIDENDS from AFS OR IFVPL Dividend income

Investments in associates equity

Application of the Equity Method

Investment is originally reported at cost
Subsequently, the investment is adjusted for the following:
a. share in the net income/loss of the associate.
b. cash dividends distributed by the associate are treated as reductions to investment and not as
dividend income.
Equity investment in an ASSOCIATE = if you own more than 20% but less than 50% of the company
= has the right to nominate directors
NOTES:
BPI 40% owned by AC
MWC 49% owned by AC but considered as subsidiary of AC

31-Dec-13
Balance Sheet
Investment on
Associates

200,000,000.0
0

Cash

(200,000,000.
00)
31-Dec-14

bought 30% of Beta company

Income Statement

reported net income of 20 M

Balance Sheet
Investment on
Associates

6,000,000.00

Retained
Earnings

31-Dec-14
Balance Sheet
Investment on
Associates
Cash

Income Statement

6,000,000.00

Share in
the net
income of
associate

6,000,00
0.00

Net
Incom
e

6,000,00
0.00

declared 5M cash dividends

Income Statement

(1,500,000.00)
1,500,00
0.00

Investments in subsidiaries consolidate

50+1% - general rule
Has operating and financial control of the company

Capitalize or Expense?

Research and development costs - EXPENSE

Software development costs
Some can be capitalized and some can be expensed
Pre-technological Phase
Technological/Feasibility Phase
Expense
Capitalized

31-Dec-14
Balance Sheet

Commercial Phase
Expense

Software development cost is expensed

Income Statement

Cash
31-Dec-14

(10,000,000.
00)

Retained
Earnings

Balance Sheet
SDC -intangible
asset

10,000,000.
00

Cash

(10,000,000.
00)

Software
Net
(10,000,000.0 Developme 10,000,000
Inco
0)
nt Cost
.00
me
Software development cost is capitalized
Income Statement

(10,000,000.
00)

31-Dec-15
Balance Sheet
SDC intangible asset

(2,000,00
0.00)

Retained
Earnings

(2,000,00
0.00)

Amortizatio
n Expense

Income Statement
Net
2,000,0
inco
00.00
me

(2,000,00
0.00)

Marketing and promotions cost - expense

Training costs - expense
Foreign exchange losses expense
To detect whether or not the company is over capitalizing development cost, compare % change
SDC-IA account with % change in sales
Overcapitalizing no change in revenues
When a company is overcapitalizing, write off all the capitalization (the entire account?) then charge them
against equity.
Some companies tend to defer recognition of expenses.

Liabilities

Current to be paid in less than 12 months

We can also have something like CURRENT PORTION OF A LONG TERM DEBT
Non-Current paid beyond 1 year

On-Balance Sheet or Off-Balance Sheet

On or Off?

For a liability to be on balance-sheet, the two following two questions should be answered
with a YES
Does the obligation exist?
Can the amount of the obligation be determined or reasonably estimated?
Off balance sheet liabilities are found in the NOTES TO THE FINANCIAL STATEMENTS

Exercise Sheet #16

30-Jun-14
Balance Sheet
10,000,000.0
0

Cash

31-Dec-14

Cash

Cash

Notes Payable
Current
Portion of the
Long Term
Debt

borrowed 5-year 10M loan

Income Statement
8,000,000.00

2,000,000.00
Paid debt and interest expense
Balance Sheet
Income Statement
(1,000,0
(1,000,0
00.00)
Notes Payable
00.00)

Net
(500,0
Retained
(500,0
Interest
500,0 incom
(500,0
00.00)
Earnings
00.00)
expense
00.00
e
00.00)
Current portion of long term debt will remain the same until notes payable becomes zero
As of December 31, 2014
Current portion of Long Term Debt
Php 2,000,000.00
Long term portion of Long term debt Php 7,000,000.00

Criteria for Capital Lease

There should be a bargain purchase option

There should be transfer of ownership at the end of the lease term.
The lease term is almost equivalent to the economic useful life of the asset.
The present value of lease payments is almost equivalent to the market price of the leased asset.

NPV = P1/(1+r)1 + P2/(1+r)2 + Pi/(1+r)i

Exercise Sheet #15
31-Dec-13

leased equipment for 4 years

Balance Sheet

Leased
Asset
Cash
31-Dec-14

Cash
Leased
Asset

Obligation
328,322.
328,322.51 Under Capital
51
Lease
Obligation
($100,000.00) Under Capital
100,000.
Lease
00
Recognize depreciation expense/ interest expense and pay 100k
Balance Sheet
Income Statement
Obligation
-100,000.00
Under Capital 65,751.6
Lease
2
net
Retained
Depreciation 82,080.6
-82,080.63
82,080.6
inco
Earnings
Expense
3
3
me
Net
Retained
Interest
$34,248.
34,248.3
inco
Earnings
expense
38
8
me

Composition of Equity

Income Statement

Paid in capital
Additional Paid In Capital
Retained earnings

82,080.
63
34,248.
38

Revaluation surplus/increment
Other Comprehensive Income
Treasury stocks
When a company is undervalued, it tends to buy back its shares
Negative effect on equity
Reasons for buy-back operations
To support market price
Undervalued
To trigger market activity/price movement?
Buy-back operations should be disclosed
Non-controlling interest/ Minority interest

Exercise Sheet #18

3-Jan-15
Cash

issuance of common shares

Balance Sheet
1,500,000,000.00
Common Stock
1,000,000,000.00
Additional Paid-in
Capital - Common
Stock

Income Statement
XYZ Company
Profit and Loss Statement
For the Year Ending December 31, 2014
Sales
Cost of sales
Gross profit
Operating Expenses
Income before interest and taxes
Interest expense

500,000,000.00

Income Statement

Income before taxes

Income Taxes
Net income

The P & L:Revenue and Expense Recognition

Two basic principles guide the preparation of the P & L : accrual and matching
Accrual accounting means that revenue is recognized when earned, not when collected, and expenses are
recognized when incurred, not when paid.
Matching of revenues and expenses then follows.
Accrual Principle
Based on the accrual principle, revenues are recognized when earned, not when collected and expenses are
recognized when incurred, not when paid.

How to check the quality of earnings:

1. Core business (compare recurring vs nonrecurring transactions) What are responsible for the changes in
earnings
2. Operating Cash Flows should be checked
a. This is the excess amount you have generated from operating activities
b. Positive operating cash flows show that cost operations have already been covered
3. Stability of earnings
a. Can be a function of the nature of business
i. For instance Banks are better capitalized therefore earnings wouldnt be much affected by crisis
ii. Power generation companies are capital intensive, subjected to heavy regulation, and affected
by who is in position
iii. Property companies go through a cycle; collection period is long and could be risky
4. Diversity of sources of revenues

Statement of Cash Flows

Cash Flows From Operating Activities

Cash Flows From Investing Activities
Investing and Divesting activities are indicators of the direction that the company is taking

We can also see how the company finances its expansion. In analyzing the investing activities of the
company, there should be proper matching.
Cash Flows From Financing Activities

2 APPROACHES IN DETERMINING THE OPERATING CASH FLOWS:

1. Direct Method (can determine exactly how much you pay suppliers)
Direct Approach
2012
2013
Collection From Sales
A/R Beginning

3,150,000.
00

Add: Sales for the year

21,000,000
.00

25,000,000
.00

Total

21,000,000
.00

28,150,000
.00

Less: A/R ending

3,150,000.
00

4,500,000.
00

Collection

17,850,000
.00

23,650,00
0.00

20,000,000
.00

20,500,000
.00

Purchases
Cost of Sales +/- Changes in
inventory

2,000,000.
00

22,500,000
.00
Accounts Payable
-

2,500,000.
00

20,000,000
.00

22,500,000
.00

Total

20,000,000
.00

25,000,000
.00

Less AP Ending

2,500,000.
00

(5,000,000.
00)

Payment

17,500,000
.00

20,000,00
0.00

Accrued Expense Payable

Accrued Expense Payable
(beginning)

Add: Exp

260,000.00

Subtotal
Less Accrued expense payable
ending

260,000.00

Utilities

240,000.00

Accounts Payable (beginning)

20,000.00

Income Taxes Payable

Beginning

277,500.00

Add Income Taxes for the Year

579,000.00

Total

856,500.00

Less Ending

144,750.00

Income taxes Paid

711,750.0
0

2. Indirect method. (starts with EBIT, you add the changes in AR, AP,)
Indirect
approach
STEPS
Operating Cash Flow Activities
1
2

start with
EBIT
Add back
all noncash
expense

Earnings before Taxes

1,850,000.0
0

Depreciation Expense

590,000.00

Increase in Accounts Receivables

(3,150,000.0
0)

Increase in Inventories

(3,200,000.0
0)

Increase in accounts Payable

2,500,000.0
0

Increase in accrued expense payable

Income Taxes Paid

20,000.00

(277,500.00)
(1,667,500.0
0)

Cashflows from Operating Activities

HYBRID AND COMPOUND SECURITIES

they have the characteristics of both debt and equity. So you have to separate what is attributed to equity
and debt
this is to lower down financing cost
convertible bond Exercise #17
Formula for Net Present Value
Let Pi = denote payment for each year i=1,2,3

NPV = P1/(1+r)1 + P2/(1+r)2 + Pi/(1+r)i

r = interest rate if theres no option to convert
Years
Paymen
t
PV (principal amount)
APIC attributable to option to
convert

31-Dec13
Cash

$951,963,37
4.64 Interest
$48,036,625. Principa
36 l

100,000,000.00 100,000,000.00
$114,235,604.9
6
$115,943,877.55
$14,235,604.96
$966,198,979.5
9

$15,943,877.55

3
1,100,000,000.0
0
$117,857,142.8
6
($982,142,857.1
4)

$982,142,857.14

issuance of 3-year convertible bond

Balance Sheet
Bonds
1,000,000,000.00
Payable
Additional
Paid In
Capital

Income Statement
951,963,374.64
48,036,625.36

$0.00

from
Option To
Convert
31-Dec14

conversion of 40%
Balance Sheet
Common
Stock
Additional
Paid In
Capital
from
Option To
Convert
Additonal
Paid In
Capital Common
Stock
Bonds
Payable

31-Dec14

Cash

Income Statement
80,000,000.00

(19,214,650.14
)
320,000,000.00

(380,785,349.8
6)

Payment of interest
Balance Sheet
Bonds
(100,000,000.00)
Payable
Retained
Earnings

Income Statement
$14,235,604.96
($114,235,604.
96)

Intere
st
expen
se

$114,235,60
4.96

Net
inco
me

($114,235,604
.96)