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Chapter 15

ACTG 3120 Chapter Notes - Chapter 15: Put Option, Accrual, Cash Flow Hedge


Department
Accounting
Course Code
ACTG 3120
Professor
Elizabeth Farrell
Chapter
15

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Chapter 15: Complex Financial Instruments
Redeemable Shares: retired for cash at a certain time at a certain price
Hybrid financial instruments: elements of both debt and equity
Convertible debt: convertible into either a fixed or variable number of shares; either at
investor’s or company’s (mandatory) option
Substance over form: classify based on nature of instrument, not on name or label
Classification will not change the tax status of an instrument
Classification Factors
Debt: creditors have an enforceable legal right to receive payment
o if no maturity date (demand loans or lines of credit), lenders have option of
demanding repayment
Equity
o investors cannot demand payment
o voluntary payment is an action of the company
Chart discussing classification based on substance:

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Retractable preferred shares
allows the investor to force the company to repurchase the share at a specified price
CLASSIFY AS DEBT IF:
o Redemption Contractually Required
o Redemption at Option Investor
o Redemption Terms e.g Dividend Escalation Will Force Redemption
IF DEBT DIVIDENDS REPORTED I/S
When preferred shares are classified as debt, their dividends are reported as a financing
expense, a deduction in earnings, not a direct deduction in R/E
Mandatory dividends are a liability
Dividends are recorded annually whether or not declared
If they are mandatory and must be fully paid in cash prior to redemption, they are
accrued as time passes
Perpetual Debt
provides the holder with a contractual right to receive cash interest, but the principal
(1) never has to be repaid,
(2) has to be repaid only in the indefinite future, or
(3) has to be repaid only in highly unlikely situations, such as upon liquidation of the
company.
reported entirely as a liability; equity portion valued as ZERO
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