Acct 387 - Chapter 17 1

Issuance, Conversion and Retirement of Convertible Securities

In general, there is no value assigned to the conversion feature of a convertible security

Issue as a straight debt issue

At time of conversion, issue stock at either book value of debt (preferred method) or market value of stock (will recognize a gain or loss) (For preferred stock use book value method)

Acct 387 - Chapter 17 2

Retirement is treated the same as a nonconvertible, with material gains or losses treated as extraordinary

Payments to induce conversion (sweeteners) should be expensed.

Exercise 2

Acct 387 - Chapter 17 3

Stock Warrants

Warrants are rights to purchase a specified number of shares at a given price for a given period of time.

They are issued (1) to sweeten another security; (2) to satisfy a preemptive right (memo entry only); and (3) as employee compensation.

Acct 387 - Chapter 17 4

When issued with another security must determine the value of the warrants using the proportional or incremental method.

Value assigned to warrants should be credited to PIC - Stock Warrants.

If warrants are exercised, issue stock at book value of warrants plus cash received.

If warrants lapse, move amount to PIC - expired warrants.

Exercise 7,8

Acct 387 - Chapter 17 5

Stock Compensation Plans

Stock Compensation Plans fall into three models:

Stock Option plans - accounted for under fair value or intrinsic value

Stock Appreciation rights - accounted for under fair value or intrinsic value

Performance plans - accounted for at market value at exercise date

The goal is to assign compensation to period benefited.

Exercise 11

Acct 387 - Chapter 17 6

Earnings per ShareSimple Capital Structure

If there are no securities that can be converted into common stock and the effect of that conversion is to reduce EPS, company has a simple capital structure.

Acct 387 - Chapter 17 7

EPS = Net Income - Preferred DividendWeighted Avg. Shares Outstanding

Preferred Dividends subtracted is paid or not paid if cumulative

Weighted average shares need to be adjusted for splits, dividends and changes during the year.

Exercise 15, 16

Acct 387 - Chapter 17 8

EPS - Complex Capital Structure

If convertible securities would reduce EPS if converted, they are said to be dilutive.

Add the impact of the conversion into the numerator and denominator (i.e. interest saved versus more shares issued) and see if EPS goes down.

Acct 387 - Chapter 17 9

For option and warrants, securities are dilutive if they are "in the money".

For these, assume they are exercised and the proceeds used to buy treasury stock. Add additional shares into denominator.

Shares under contingent issue agreements should be added if the conditions have been met.

Disclose basic and diluted.

Exercise 23, 24, Problem 4, 8