Question 4 (10 marks):

On May 1, 2016 123 Inc. issued 600, ten-year 8% bonds for $1,000 each. The bonds pay interest annually on April 30. These bonds can be converted by the bondholders into common shares at a rate of 25 common shares for each bond converted (so far no bonds have been converted).

Required:

You have been asked to calculate what impact these bonds had on the earnings per share. Net income for 2016 was $2 million and there are 500,000 common shares (and no preference shares) outstanding. Assume a tax rate of 20%.

Question 5 (10 marks):

123 acquired 25% of the outstanding common shares of another public company, Alphabet Soup Inc. on November 1, 2015. The purchase price was $2.5M for 125,000 shares. Alphabet declared and paid a $1.50 per share cash dividend on January 15, and again on August 15, 2016. Alphabet reported net income of $1,040,000 on its October 31, 2016 financial statement. The fair market value of Alphabet's shares was $20.25 per share at October 31, 2016.

Required

Given the complex circumstances of this acquisition it is unclear whether 123 can exercise significant influence over Alphabet. Accordingly you have been asked to prepare two sets of journal entries depending on whether 123 must use the equity method of accounting or FV-OCI.

Indicate which method of accounting will result in a higher level of net income and explain why that occurred.