Biosciences Unlimited Inc. began operations on January 2, 2010, with the issuance of 100,000 shares of $50
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Rafel: What are we going to do? The banks won’t loan us any more money, and we’ve got to have $10 million to complete the project. We are so close! It would be a disaster to quit now. The only thing I can think of is to issue additional stock. Do you have any suggestions?
Oscar: I guess you’re right. But if the banks won’t loan us any more money, how do you think we can find any investors to buy stock?
Rafel: I’ve been thinking about that. What if we promise the investors that we will pay them 2% of net sales until they have received an amount equal to what they paid for the stock?
Oscar: What happens when we pay back the $10 million? Do the investors get to keep the stock? If they do, it’ll dilute our ownership.
Rafel: How about, if after we pay back the $10 million, we make them turn in their stock for $100 per share? That’s twice what they paid for it, plus they would have already gotten all their money back. That’s a $100 profit per share for the investors.
Oscar: It could work. We get our money, but don’t have to pay any interest, dividends, or the $50 until we start generating net sales. At the same time, the investors could get their money back plus $50 per share.
Rafel: We’ll need current financial statements for the new investors. I’ll get our accountant working on them and contact our attorney to draw up a legally binding contract for the new investors. Yes, this could work.
In late 2010, the attorney and the various regulatory authorities approved the new stock offering, and 200,000 shares of common stock were privately sold to new investors at the stock’s par of $50.
In preparing financial statements for 2010, Rafel Baltis and Emma Cavins, the controller for Biosciences Unlimited Inc., have the following conversation:
Emma: Rafel, I’ve got a problem.
Rafel: What’s that, Emma?
Emma: Issuing common stock to raise that additional $10 million was a great idea. But .
Rafel: But what?
Emma: I’ve got to prepare the 2010 annual financial statements, and I am not sure how to classify the common stock.
Rafel: What do you mean? It’s common stock.
Emma: I’m not so sure. I called the auditor and explained how we are contractually obligated to pay the new stockholders 2% of net sales until $50 per share is paid. Then, we may be obligated to pay them $100 per share.
Rafel: So .
Emma: So the auditor thinks that we should classify the additional issuance of $10 million as debt, not stock! And, if we put the $10 million on the balance sheet as debt, we will violate our other loan agreements with the banks. And, if these agreements are violated, the banks may call in all our debt immediately. If they do that, we are in deep trouble. We’ll probably have to file for bankruptcy. We just don’t have the cash to pay off the banks.
1. Discuss the arguments for and against classifying the issuance of the $10 million of stock as debt.
2. What do you think might be a practical solution to this classification problem?
Financial Statements
Financial statements are the standardized formats to present the financial information related to a business or an organization for its users. Financial statements contain the historical information as well as current period’s financial... Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on... Balance Sheet
Balance sheet is a statement of the financial position of a business that list all the assets, liabilities, and owner’s equity and shareholder’s equity at a particular point of time. A balance sheet is also called as a “statement of financial...
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