Question 1

The accounting classification of a financial instrument is determined by its tax status.

Accepted Answer

The accounting classification of a financial instrument is primarily determined by its economic characteristics and the entity's business model for managing the instrument, not by its tax status.

Question 2

Rights granted to existing shareholders entitling them to purchase additional shares result in a credit to Contributed Surplus.

Accepted Answer

Rights granted to existing shareholders to purchase additional shares do not directly result in a credit to Contributed Surplus. These rights are essentially options given to shareholders and do not impact the company's financial statements until exercised. When exercised, the transaction typically results in an increase in share capital (or common stock) and additional paid-in capital (or contributed surplus) based on the proceeds received over the par value of the shares.

Question 3

The conversion of preferred shares at a premium results in a debit directly to shareholder equity at the date of conversion.

Accepted Answer

The conversion of preferred shares at a premium typically results in a reclassification within equity, not a direct debit to shareholder equity.

Question 4

If a financial instrument is an equity instrument in substance, but its legal form is debt, any periodic payments made to investors will be accrued on the company's financial statements as interest expense.

Accepted Answer

Periodic payments on an instrument that is equity in substance would not be recorded as interest expense, but rather as distributions to equity holders, such as dividends. Interest expense is associated with debt instruments.

Question 5

Cash flow hedges do not exist under ASPE.

Accepted Answer

Cash flow hedges do exist under Accounting Standards for Private Enterprises (ASPE) in Canada, but they are addressed differently compared to International Financial Reporting Standards (IFRS). ASPE provides guidance on hedge accounting, including cash flow hedges, in Section 3856, Financial Instruments.

Question 6

Perpetual Debt is accounted for as equity.

Accepted Answer

Perpetual debt is accounted for as a liability, not equity, because it represents a financial obligation that the issuer has to pay interest on indefinitely, without a maturity date.

Question 7

Securities issued as debt, but intended by the issuing corporation to be exchanged for shares by the investors at some time prior to maturity, are known as "hybrid securities".

Accepted Answer

Securities described are known as "convertible securities," not hybrid securities. Hybrid securities typically combine features of both debt and equity, such as preferred stock or convertible bonds, but the key distinction is that convertible securities specifically refer to debt that can be converted into equity, not a general class of securities with mixed features.

Question 8

When a bond has interest which may be paid in a fixed number of shares, these bonds would be classified as equity,

Accepted Answer

Bonds that may have interest paid in a fixed number of shares are typically classified as convertible bonds, which are a type of debt instrument, not equity. Equity represents ownership shares in a company, whereas convertible bonds are loans that can be converted into a predetermined number of shares.

Question 9

Stock options have no intrinsic value when the market price of the share exceeds its conversion price.

Accepted Answer

Stock options have intrinsic value when the market price of the share exceeds the exercise (or conversion) price, as the holder can buy the stock at below market value.

Question 10

Mutual companies will tend to record their instruments as liabilities, since these are redeemable at any time at the investor's option.

Accepted Answer

Mutual companies typically issue instruments that are considered equity, not liabilities, because these instruments represent ownership interests rather than obligations to return capital. Redemption features do not automatically classify them as liabilities.

Question 11

If it is the company's option to repay the debentures through the issuance of common shares, the principal component of the bonds is debt.

Accepted Answer

The answer of If it is the company's option to...

Question 12

Convertible debt that is convertible to a variable number of shares at the investor's option will normally be classified as a liability.

Accepted Answer

The answer of Convertible debt that is convertible to a...

Question 13

A financial instrument is any contract that gives rise to a financial asset of one party and a financial liability or equity instrument of another party.

Accepted Answer

The answer of A financial instrument is any contract that...

Question 14

ASPE records complex financial instruments in keeping with their legal form, while IFRS records these based on their substance.

Accepted Answer

The answer of ASPE records complex financial instruments in keeping...

Question 15

One of the most common forms of hybrid security is convertible debt.

Accepted Answer

The answer of One of the most common forms of...

Question 16

Retractable preferred shares are always classified as debt.

Accepted Answer

Retractable preferred shares are not always classified as debt; their classification depends on the specific terms and conditions of the shares, which might lead to them being classified as equity in some cases and as debt in others.

Question 17

The issuance of stock options will have a positive effect on a company's debt-to-equity ratio over time.

Accepted Answer

Issuing stock options does not immediately affect a company's debt-to-equity ratio because options are not considered debt and do not directly change the equity amount until they are exercised. When exercised, they can increase equity, potentially improving the debt-to-equity ratio, but the initial issuance itself does not have a direct impact.

Question 18

The conversion option attached to convertible bonds, which have a floating conversion price per share, has an intrinsic value which is based on the fair market value of the shares at the time.

Accepted Answer

The answer of The conversion option attached to convertible bonds,...

Question 19

Options are ONLY for the purpose of buying or selling financial instruments.

Accepted Answer

Options give the holder the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a specified price within a set time period, but they can also be used for hedging, speculation, or generating income, not just for buying or selling financial instruments.

Question 20

Once the market price of shares rises above the conversion price on convertible bonds, the bond ceases to trade as debt, and is effectively traded as equity.

Accepted Answer

Convertible bonds continue to trade as debt until the holder decides to convert them into equity, regardless of the market price of the shares relative to the conversion price.

Quiz 15: Financial Instruments: Complex Debt and Equity