What are shareholders and what is the difference between the preferred and common stock they buy quizlet?
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A convertible instrument may contain a beneficial conversion feature (BCF) or a contingent BCF if the conversion option is not accounted for separately. A warrant to acquire a convertible instrument may also contain a BCF. See FG 8.2.2.5A for additional information on warrants to acquire a convertible instrument. Show
The ASC Master Glossary provides the definition of a beneficial conversion feature. Definition from ASC Master Glossary Beneficial Conversion Feature: A nondetachable conversion feature that is in the money at the commitment date. A convertible instrument contains a BCF when the effective conversion price is less than the fair value of the shares into which the instrument is convertible at the commitment date. See FG 7.9.2A for information on the conversion of convertible preferred stock with a BCF. Determining the commitment date The commitment date is the date on which an agreement meets the definition of a firm commitment. To have a firm commitment, an issuer should have a legally-enforceable agreement that specifies the significant terms and provides a disincentive for nonperformance that is sufficiently large to make performance probable. ASC 470-20, Debt with Conversion and Other Options, provides guidance on determining a convertible instrument’s commitment date. ASC 470-20-30-12 If an agreement includes subjective provisions that permit either party to rescind its commitment to consummate the transaction, a commitment date does not occur until the provisions expire or the convertible instrument is issued, whichever is earlier. Both of the following are examples of subjective provisions that permit either party to rescind its commitment to consummate the transaction:
As a practical matter, because of clauses such as those in (a) and (b), the commitment date typically does not occur until the date the convertible instrument is issued (i.e., the date cash and securities are exchanged). Question FG 7-7 discusses the commitment date for convertible instruments issued under an overallotment option. Question FG 7-7 PwC response The commitment date for instruments issued under a greenshoe is the date the underwriter exercises its greenshoe and the securities are delivered. Prior to then, there is no commitment on the part of the underwriter to purchase the securities. It is possible for a convertible instrument that was out-of-the-money when it was priced (so that there is no beneficial conversion feature for the initial securities sold) to be in-the-money on the date the greenshoe is exercised. This would result in a BCF for the securities sold under the greenshoe. See FG 6.9.2 for information on greenshoes. Question FG 7-8 addresses how a private reporting entity that issues a convertible instrument prior to an IPO should assess whether a BCF exists. Question FG 7-8 PwC response An issuer should consider all information available when estimating the commitment date fair value of its common stock, including the anticipated IPO price. The SEC staff has said that convertible instruments with a conversion price below the IPO price issued within one year of the filing of an initial registration statement are presumed to contain a BCF. To overcome this presumption, an issuer would have to make an assertion that the accounting conversion price represented fair value at the commitment date (i.e., the issue date) and should ensure that appropriate evidence exists to support that assertion. As part of this process, reporting entities should consider any valuations that an underwriter has discussed with management and/or the board of directors. Determining the conversion price To determine whether a convertible instrument contains a BCF, an issuer should compare the conversion price and the issuer’s stock price on the commitment date. The conversion price is calculated by dividing the proceeds allocated to the convertible instrument by the number of shares into which the instrument is convertible. Often, the conversion price is the same as the instrument’s contractual conversion rate; however, in some cases, the conversion price does not equal the stated conversion rate. For example, when detachable warrants are issued with a convertible instrument, the issuer should allocate the proceeds between the convertible instrument and the warrants. This reduces the proceeds allocated to the convertible instrument and as a result, lowers the conversion price. Issuance costs do not affect whether an instrument contains a BCF. BCFs in instruments issued to pay dividends or interest in kind Some convertible instruments require or allow declared dividends or accrued interest to be paid in kind (PIK) with additional units of that convertible instrument, or a different series of convertible instruments. To determine whether a convertible instrument issued to satisfy a dividend or interest payment contains a BCF, the commitment date for the newly issued convertible instrument must be determined (see FG 7.7.2 for measurement of PIK dividends). The commitment date of the newly issued convertible instrument will ultimately depend upon whether payment in kind is discretionary or not. ASC 470-20-30-16 If dividends or interest on a convertible instrument must be paid in kind with the same convertible instruments as those in the original issuance and are not discretionary, the commitment date for the original instrument is the commitment date for the convertible instruments that are issued to satisfy interest or dividends requirements. ASC 470-20-30-17 For purposes of the preceding paragraph, dividends or interest are not discretionary if both of the following conditions exist:
Excerpt from ASC 470-20-30-18 Otherwise, the commitment date for the convertible instruments issued as paid-in-kind interest or dividends is the date that the interest or the dividends are accrued and the fair value of the underlying issuer stock at the recognition or declaration date shall be used to measure the intrinsic value of the conversion option embedded in the paid-in-kind instruments. In evaluating whether “the holder will always receive the number of shares upon conversion as if all accumulated dividends or interest have been paid in kind,” we understand that certain convertible instruments call for the forfeiture of accrued interest or dividends from the last dividend or interest payment date to the date of conversion. We believe the presence of this provision in a convertible instrument does not necessarily preclude the paid-in-kind feature from being considered “not discretionary” as long as interest or dividends when paid, are contractually required to be paid in kind. Other views may also be acceptable. Measurement and recognition A BCF is measured as the intrinsic value of the conversion option at the commitment date, representing the difference between the effective conversion price and the issuer’s stock price on the commitment date. A BCF should be separated from a convertible instrument and recorded in additional paid-in capital. SEC registrants should present the BCF as mezzanine equity in periods in which it is redeemable, as described in ASC 480-10-S99-3A. Excerpt from ASC 480-10-S99-3A ...the equity-classified component of the convertible debt instrument should be considered redeemable if at the balance sheet date the issuer can be required to settle the convertible debt instrument for cash or other assets (that is, the instrument is currently redeemable or convertible for cash or other assets). Although technically not required for nonpublic entities, mezzanine equity presentation is strongly encouraged. See FG 7.3.4 for more information on mezzanine presentation. Separating a BCF will create a discount in the convertible instrument which will result in additional interest expense or deemed dividends. Instruments with a multiple-step discount Some convertible instruments have a conversion price that decreases over time; this is called a multiple-step discount. ASC 470-20-30-15 provides guidance on determining the intrinsic value of a convertible instrument with a multiple-step discount. Excerpt from ASC 470-20-30-15 If an instrument incorporates a multiple-step discount, the computation of the intrinsic value shall use the conversion terms that are most beneficial to the investor. For example, assume convertible preferred stock has a conversion price of (1) $10 at issuance, (2) $9 six months after issuance, (3) $8 twelve months after issuance and (4) $7 twenty-four months after issuance. The issuer should compare the most favorable conversion price to the investor (in this example, the conversion price of $7, twenty-four months after issuance) and compare that with the commitment date stock price to determine the BCF amount, if any. Contingently adjusting conversion prices Some convertible instruments have a conversion price that adjusts if certain contingent events occur. As noted in ASC 470-20-30-7, an issuer should measure a BCF using the most favorable conversion price that will be in effect at the conversion date presuming there will be no change in circumstances other than the passage of time. That is, it should not include future contingent adjustments in the measurement of the BCF but would nonetheless need to consider whether a BCF is present without the contingent adjustment. Example FG 7-1 and Example FG 7-2 illustrate how to measure and record a BCF in convertible preferred stock issued with warrants. EXAMPLE FG 7-1 FG Corp issues $1,000 stated value convertible preferred stock and 100 detachable warrants to purchase its common stock, in exchange for $1,000 in cash. FG Corp’s stock price on the date the instruments are issued, which is the commitment date, is $18 per share. The convertible preferred stock has a stated conversion price of $20; therefore, it is convertible into 50 shares of FG Corp’s common stock ($1,000 stated value / $20 conversion price). FG Corp concludes that the warrants meet the requirements for equity classification. Since the warrants are classified as equity, FG Corp allocates the proceeds from the issuance of the preferred stock and warrants using the relative fair value method. The sales proceeds allocated to the convertible preferred stock and warrants are $700 and $300, respectively. How should FG Corp record the issuance of the convertible preferred stock and warrants? Analysis FG Corp should first determine whether the convertible preferred stock contains a BCF by determining the effective conversion price and comparing it to FG Corp’s stock price on the commitment date. The effective conversion price is calculated by dividing (1) the proceeds allocated to the convertible preferred stock ($700) by (2) the number of shares into which the debt is convertible (50 shares). $700 / 50 shares = $14 conversion price The convertible preferred stock does contain a BCF because the $18 commitment date stock price is greater than the $14 effective conversion price. The BCF is measured as the difference between the commitment date stock price ($18) and the conversion price ($14) multiplied by the number of shares into which the preferred stock is convertible (50 shares). ($18 - $14) x 50 = $200 To record the issuance of the convertible debt and warrants, FG Corp should record the following journal entry.
EXAMPLE FG 7-2 FG Corp issues $1,000 of convertible perpetual preferred stock and 100 detachable warrants to purchase its common stock in exchange for $1,000 cash. The convertible preferred stock is convertible into 100 shares ($1,000 convertible preferred stock / 100 shares = $10 conversion price) immediately upon issuance. The warrants have a strike price of $10 per share. FG Corp’s stock price on the date the instrument is issued, which is the commitment date, is $10 per share. The fair value of the warrants on that date is $300. FG Corp concludes that the warrants should be classified as a liability. Since the warrants are classified as a liability, FG Corp first allocates the proceeds to the warrant based on its fair value ($300); the remaining proceeds ($700) are allocated to the convertible preferred stock. How should FG Corp record the issuance of the convertible preferred stock and warrants? Analysis FG Corp should first determine whether the convertible preferred stock contains a BCF by determining the effective conversion price and comparing that to FG Corp’s stock price on the commitment date. The effective conversion price would be calculated by dividing (1) the proceeds allocated to the convertible preferred stock ($700) by (2) the number of shares into which it is convertible (100 shares). $700 / 100 shares = $7 conversion price The convertible preferred stock contains a BCF because the $10 commitment date stock price is greater than the $7 effective conversion price. The BCF is measured as the difference between the commitment date stock price ($10) and the accounting conversion price ($7) multiplied by the number of shares into which the preferred stock is convertible (100 shares). ($10 - $7) × 100 = $300 To record the issuance of the convertible debt and warrants, FG Corp would record the following journal entry.
Because the convertible preferred shares are perpetual (have no stated maturity date) and are convertible at any time, the discount created in the convertible preferred stock is fully amortized at issuance (i.e., recorded as a deemed dividend), thereby increasing the convertible preferred stock’s carrying amount from $400 to $700.
Contingent BCFs An issuer may issue convertible preferred stock with a conversion price that adjusts over the term of the instrument. For example, the conversion price may be reduced if the fair value of the underlying stock declines to, or below, a specified price after the commitment date. In such situations, the issuer must determine not only whether a BCF is present at inception, but must also measure and account for the contingently adjustable conversion ratio, which is described in ASC 470-20-35-1 through ASC 470-20-35-5. Often, these adjustments decrease the instrument’s conversion price, which may have the effect of creating a new BCF if one has not been previously recorded or may increase the intrinsic value of a previously recorded BCF. ASC 470-20-25-6 provides guidance on the measurement of a contingent BCF. ASC 470-20-25-6 A contingent beneficial conversion feature shall be measured using the commitment date stock price (see paragraphs 470-20-30-9 through 30-12) but, as discussed in paragraph 470-20-35-3, shall not be recognized in earnings until the contingency is resolved. In some situations, it is not possible to measure a contingent BCF at the commitment date. For example, there may be a conversion feature that will be adjusted for the future issuance of shares at a price below the instrument’s original strike price, commonly referred to as a “down-round” provision. In such situations, the contingent BCF should be measured when the contingency is resolved. When a contingent event occurs and an instrument either becomes convertible or the conversion price is adjusted, the issuer should recalculate the BCF using the current conversion price. If the newly calculated BCF amount exceeds the previously recorded BCF, the issuer should record the additional BCF amount as an increase to additional paid-in capital. If an instrument’s conversion price increases so that the newly calculated BCF amount is less than the previously recorded BCF amount, the issuer should record the difference as a decrease to additional paid-in capital. However, any previously recognized amortization of the discount created by initially separating the BCF should not be reversed. Example FG 7-3 illustrates how to measure and record a contingent BCF. EXAMPLE FG 7-3 FG Corp issues $1,000 of convertible preferred stock in exchange for $1,000 cash. FG Corp’s stock price on the date the instrument is issued, which is the commitment date, is $18 per share. The convertible preferred stock has a stated conversion price of $20 at issuance; therefore, it is convertible into 50 shares of FG Corp’s common stock ($1,000 preferred stock / $20 conversion price). The terms of the instrument include a down-round provision, requiring the conversion price to be reduced for any subsequent at market issuance of shares at a price below the instrument’s original strike price. One year after issuance, FG Corp issues shares at $13 per share, which is the then market price for its shares. Accordingly, FG Corp reduces the instrument’s conversion price to $13; therefore, it is convertible into 77 shares of FG Corp’s common stock ($1,000 preferred stock / $13 conversion price). No BCF existed at inception as FG Corp’s stock price of $18 was less than the conversion price of $20. When and how should FG Corp record the contingent BCF triggered by issuance of additional shares? Analysis The contingent BCF cannot be calculated until additional shares are issued; therefore, the contingent BCF should be measured and recorded when FG Corp issues the additional shares. We believe the BCF amount should be calculated as the intrinsic spread between the adjusted effective accounting conversion price ($13) and the original commitment date market price ($18), multiplied by the new number of shares into which the security is legally convertible when the contingent event occurs (77 shares). ($18 - $13) × 77 shares = $385 To record the BCF, FG Corp should record the following journal entry.
This approach to calculating a contingent BCF (the “intrinsic method”) is referenced in ASC 470-20-55-24. However, a literal read of ASC 470-20-35-1 would indicate that the BCF amount should be calculated by multiplying the additional shares to be received once the conversion price is adjusted by the commitment date stock price. In this example, this would result in a charge of $486 ((77 shares – 50 shares) × $18). These methods produce the same result when the original conversion option strike price is equal to the stock price at the commitment date (i.e., the option is at the money) but produce different results when the original conversion option strike price differs from the commitment date stock price. The approach described in ASC 470-20-35-1 would result in an inaccurate contingent BCF whenever the original conversion option is issued at other than at-the-money. For that reason, we believe that the intrinsic method is more reliable. Resetting of a conversion option for a change in stock price Some convertible instruments pay a fixed monetary amount to the investor upon conversion. To do this, the instrument’s conversion price is adjusted for increases or decreases in the fair value of the issuer’s stock. ASC 470-20-55-19 provides guidance for these instruments, which are in substance, stock-settled debt. ASC 470-20-55-19 If the conversion price was described as $1 million divided by the market price of the common stock on the date of the conversion, that is, resetting at the date of conversion, the holder is guaranteed to receive $1 million in value upon conversion and, therefore, there is no beneficial conversion option and the convertible instrument would be considered stock-settled debt. However, if the conversion price does not fully reset (for example, resets on specified dates before maturity), the reset represents a contingent beneficial conversion feature subject to this Subtopic. The issuer should assess the reset terms of its convertible instrument to determine whether it is stock-settled debt or a convertible instrument with a contingent BCF. Amortization of the discount created by separating a BCF The method of recognizing a discount created by separating a BCF, or contingent BCF, from convertible preferred stock depends on the terms of the convertible preferred stock. A BCF discount created in an equity instrument with a stated or mandatory redemption date should be amortized over the period from the issuance date through the stated maturity or redemption date using the interest method. The amortization should be accounted for as a deemed dividend, provided the preferred stock is classified as equity. Discounts created by separating a BCF from perpetual convertible preferred stock should be amortized over the period from the issuance date through the first date the investor can exercise the conversion option (i.e., the first conversion date) using the interest method. If preferred stock is immediately convertible, the discount should be amortized all at once upon issuance. If the convertible preferred stock is redeemable (1) at the option of the investor or, (2) upon the occurrence of an event that is not within the issuer’s control, we believe the BCF discount may be accreted over a period of time from the issuance date through (1) the first conversion date, or (2) the first put date. The amortization should be accounted for as a dividend, provided the preferred stock is classified as equity. What are shareholders and what is the difference between the preferred and common stock they buy what type of business entity issues these types of stocks quizlet?Shareholders buy stock in a corporation. Those who hold common stock can vote for the corporate board. Those who hold preferred stock have no vote. Corporations issue and sell stock.
What are shareholders and what is the difference between the preferred and common stock they buy?Key Takeaways
The main difference between preferred and common stock is that preferred stock gives no voting rights to shareholders while common stock does. Preferred shareholders have priority over a company's income, meaning they are paid dividends before common shareholders.
What are two differences between common and preferred stock?Common stock has higher long-term growth potential but also has lower priority for dividends and a payout in the event of a liquidation. Lenders, suppliers and preferred shareholders are all in line for a payout ahead of common stockholders.
Why do most people who buy stock Choose common stock over preferred stock?Most people who buy stock choose common stock over preferred stock because holders of common stock have voting rights in the corporation and their dividends increase if the company's stock increases in value. Most people also invest for capital gains (increase in stock price) than for dividends.
What are the key differences between common stock preferred stock and corporate bonds?Key Takeaways
Companies offer corporate bonds and preferred stocks to investors as a way to raise money. Bonds offer investors regular interest payments, while preferred stocks pay set dividends. Both bonds and preferred stocks are sensitive to interest rates, rising when they fall and vice versa.
Why do most people who buy stock Choose common stock over preferred stock quizlet?Question #3- Why do most people who buy stock choose common stock over preferred stock? Preferred stock doesn't allow the shareholder voting rights and partial ownership of the corporation, where as common stock does. Most people find security in owning and having a sense of control over their investments.
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