In my last posting I tried to make assets out of liabilities.\u00a0 Now I want to make some profits out of my liabilities.\u00a0 This is a piece of cake under current GAAP but my current favorite again relates to the issue of the convertible debt that seems to be so popular with companies with a bit of a going concern problem.<\/p>\n
When you issue the convertible debt with warrants, there are all sorts of nasty minefields that have to be faced to stop the warrants and the embedded derivative or the beneficial conversion feature from becoming a nasty liability all over again rather than being comfortably lost in stockholders equity.\u00a0 EITF 00-19 is the usual problem with all its complex conditions for recognition of those nasty derivatives as equity.<\/p>\n
Not a problem.\u00a0 This is about making profits; not recreating liabilities that already exist.\u00a0 All I have to ensure is that I have a seriously declining share price to make the profit.\u00a0 Well actually I make the profit up front and it could come back to bite me later on if I am not ingenious.<\/p>\n
What you do off course is split out the warrant and the embedded derivative from the convertible debt at the issue date.\u00a0 That will be done based on the \u201cfair value\u201d using the option pricing model with some huge volatility assessment for good measure.\u00a0 You put those in as separate liabilities because they fail one of the numerous EITF 00-19 tests for classification as equity.\u00a0 Since my share price is declining rapidly, the value of these derivatives drops much faster so the liability starts to disappear.\u00a0 Since the liability is disappearing the gain goes to income as a nice fat illusory profit.<\/p>\n
Now of course I do have the problem with the debt.\u00a0 It is a debt that requires interest imputation.\u00a0 However, by pulling out the derivative, the debt is at a really low value so the imputed interest is far less than the derivative gain.\u00a0 It will catch up of course but by then I had better do some fancy debt redemption to get rid of the future interest cost that might hit the income statement in future years.<\/p>\n
I liked convertible debt accounting under .APB 14.\u00a0 It was simple.\u00a0 Now it is really silly accounting that creates false illusions.<\/p>\n","protected":false},"excerpt":{"rendered":"
In my last posting I tried to make assets out of liabilities.\u00a0 Now I want to make some profits out of my liabilities.\u00a0 This is a piece of cake under current GAAP but my current favorite again relates to the issue of the convertible debt that seems to be so popular with companies with a … Continue reading “How to create profits out of thin air”<\/span><\/a><\/p>\n","protected":false},"author":7,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[3],"tags":[12,23,4,5,27,6,28,29,9,30,31,32,33],"class_list":["post-23","post","type-post","status-publish","format-standard","hentry","category-accounting","tag-accounting","tag-assets","tag-conversion","tag-convertible-debt","tag-debt","tag-derivatives","tag-eitf-00-19","tag-gaap","tag-liabilities","tag-option-pricing","tag-pricing-model","tag-profit","tag-stockholders-equity"],"_links":{"self":[{"href":"https:\/\/www.excelsisaccounting.com\/blog\/index.php\/wp-json\/wp\/v2\/posts\/23","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.excelsisaccounting.com\/blog\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.excelsisaccounting.com\/blog\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.excelsisaccounting.com\/blog\/index.php\/wp-json\/wp\/v2\/users\/7"}],"replies":[{"embeddable":true,"href":"https:\/\/www.excelsisaccounting.com\/blog\/index.php\/wp-json\/wp\/v2\/comments?post=23"}],"version-history":[{"count":0,"href":"https:\/\/www.excelsisaccounting.com\/blog\/index.php\/wp-json\/wp\/v2\/posts\/23\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.excelsisaccounting.com\/blog\/index.php\/wp-json\/wp\/v2\/media?parent=23"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.excelsisaccounting.com\/blog\/index.php\/wp-json\/wp\/v2\/categories?post=23"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.excelsisaccounting.com\/blog\/index.php\/wp-json\/wp\/v2\/tags?post=23"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}