Chapter 16 - Handouts

Chapter16- 2

C H A P T E RC H A P T E R 1616

DILUTIVE SECURITIES ANDDILUTIVE SECURITIES ANDEARNINGS PER SHAREEARNINGS PER SHARE

Intermediate Accounting13th Edition

Kieso, Weygandt, and Warfield

Chapter16-3

1. Describe the accounting for the issuance, conversion, andretirement of convertible securities.

2. Explain the accounting for convertible preferred stock.

3. Contrast the accounting for stock warrants and for stockwarrants issued with other securities.

4. Describe the accounting for stock compensation plans undergenerally accepted accounting principles.

5. Discuss the controversy involving stock compensation plans.

6. Compute earnings per share in a simple capital structure.

7. Compute earnings per share in a complex capital structure.

Learning ObjectivesLearning ObjectivesLearning Objectives

Chapter16- 4

Debt and equityDebt and equity

Convertible debtConvertible debt

Convertible preferredConvertible preferredstockstock

Stock warrantsStock warrants

Accounting forAccounting forcompensationcompensation

Dilutive Securities andDilutive Securities andCompensation PlansCompensation Plans

Computing EarningsComputing EarningsPer SharePer Share

Simple capital structureSimple capital structure

Complex capitalComplex capitalstructurestructure

Dilutive Securities and Earnings Per ShareDilutive Securities and Earnings Per ShareDilutive Securities and Earnings Per Share

Chapter16-5

Should companies report these instrumentsas a liability or equity.

Debt and EquityDebt and EquityDebt and Equity

Stock OptionsStock Options ConvertibleConvertibleSecuritiesSecurities Preferred StockPreferred Stock

Chapter16- 6

(at the holder’s option)

Benefit of a Bond (guaranteed interest)

Privilege of Exchanging it for Stock

Bonds which can be converted into othercorporate securities are called convertiblebonds.

+

Accounting for Convertible DebtAccounting for Convertible DebtAccounting for Convertible Debt

LO 1 Describe the accounting for the issuance, conversion,and retirement of convertible securities.

Chapter16-7

Desire to raise equity capital without givingup more ownership control than necessary.

Obtain common stock financing at cheaperrates.

Two main reasons corporations issueconvertibles:



Chapter16- 8

At Time of Issuance



Convertible bonds recorded as straight debt issue,with any discount or premium amortized over theterm of the debt.

Chapter16-9

BE16BE16--11:: KC Inc. issued $4,000,000 par value, 7%KC Inc. issued $4,000,000 par value, 7%convertible bonds at 99 for cash. If the bonds had notconvertible bonds at 99 for cash. If the bonds had notincluded the conversion feature, they would have soldincluded the conversion feature, they would have soldfor 95.for 95.

Cash 3,960,000

Bonds payable 4,000,000

Journal entry at date of issuance:

Discount on bonds payable 40,000

($5,000,000 x 99% = $4,950,000)



Chapter16- 10

At Time of Conversion



Companies use the book value method whenconverting bonds.

When the debt holder converts the debt to equity,the issuing company recognizes no gain or loss uponconversion.

Chapter16-11

BE16BE16--22: Yuen Corp. has outstanding 2,000, $1,000 bonds,: Yuen Corp. has outstanding 2,000, $1,000 bonds,each convertible into 50 shares of $10 par value commoneach convertible into 50 shares of $10 par value commonstock. The bonds are converted on December 31, 2010, whenstock. The bonds are converted on December 31, 2010, whenthe unamortized discount is $30,000 and the market price ofthe unamortized discount is $30,000 and the market price ofthe stock is $21 per share.the stock is $21 per share.


Common stock (2,000 x 50 x $10) 1,000,000

Journal entry at conversion:


Additional paid-in capital 970,000



Chapter16- 12

Issuer wishes to encourage prompt conversion.

Issuer offers additional consideration, called a“sweetener.”

Sweetener is an expense of the period.



Induced Conversion

Chapter16-13

BE16BE16--22: Yuen Corp. has outstanding 2,000, $1,000 bonds,: Yuen Corp. has outstanding 2,000, $1,000 bonds,each convertible into 50 shares of $10 par value commoneach convertible into 50 shares of $10 par value commonstock. Assume Yuen wanted to reduce its annual interest coststock. Assume Yuen wanted to reduce its annual interest costand agreed to pay the bond holders $70,000 to convert.and agreed to pay the bond holders $70,000 to convert.


Common stock (2,000 x 50 x $10) 1,000,000

Journal entry at conversion:


Additional paid-in capital 970,000



Debt conversion expense 70,000

Cash 70,000

Chapter16- 14

Recognized same as retiring debt that is notconvertible.

Difference between the acquisition price andcarrying amount should be reported as gain orloss in the income statement.



Retirement of Convertible Debt

Chapter16-15

Convertible preferred stock is considered part ofstockholders’ equity.

No gain or loss recognized when converted.

Use book value method.

Convertible Preferred StockConvertible Preferred StockConvertible Preferred Stock

LO 2 Explain the accounting for convertible preferred stock.

Convertible preferred stock includes an option forthe holder to convert preferred shares into a fixednumber of common shares.

Chapter16- 16

BE16BE16--33 : Gall Inc. issued 2,000 shares of $10 par value: Gall Inc. issued 2,000 shares of $10 par valuecommon stock upon conversion of 1,000 shares of $50 parcommon stock upon conversion of 1,000 shares of $50 parvalue preferred stock. The preferred stock was originallyvalue preferred stock. The preferred stock was originallyissued at $60 per share. The common stock is trading atissued at $60 per share. The common stock is trading at$26 per share at the time of conversion.$26 per share at the time of conversion.

Preferred stock 50,000

Common stock (2,000 x $10 par) 20,000

Journal entry to record conversion:

Paid-in capital – Preferred stock 10,000

Paid-in capital – Common stock 40,000

Convertible Preferred StockConvertible Preferred StockConvertible Preferred Stock

LO 2 Explain the accounting for convertible preferred stock.Chapter

16-17

Certificates entitling the holder to acquireshares of stock at a certain price within astated period.

Normally arise:1. To make a security more attractive

2. As evidence of preemptive right

3. As compensation to employees

Stock WarrantsStock WarrantsStock Warrants

LO 3 Contrast the accounting for stock warrants andfor stock warrants issued with other securities.

Chapter16- 18

Issued with Other Securities



Detachable Stock Warrants:

Proceeds allocated between the two securities.

Allocation based on fair market values.

Two methods of allocation:

(1) the proportional method and

(2) the incremental method

Chapter16-19

Proportional Method



Determine:

1. value of the bonds without the warrants, and

2. value of the warrants.

The proportional method allocates the proceeds usingthe proportion of the two amounts, based on fairvalues.

Chapter16- 20

BE16-4 : Margolf Corp. issued 2,000, $1,000 bonds at 101.Each bond was issued with one detachable stock warrant.After issuance, the bonds were selling in the market at 98,and the warrants had a market value of $40. Use theproportional method to record the issuance of the bonds andwarrants.

Number Amount Price Total PercentBonds 2,000 x 1,000$ x 0.98$ = 1,960,000$ 96%Warrants 2,000 x 40$ = 80,000 4%

Total Fair Market Value 2,040,000$ 100%

Allocation: Bonds WarrantsIssue price 2,020,000$ 2,020,000$ Bond face value 2,000,000$Allocation % 96% 4% Allocated FMV 1,940,784Total 1,940,784$ 79,216$ Discount 59,216$


LO 3Chapter

16-21

CashCash 2,020,0002,020,000

Bonds payableBonds payable 2,000,0002,000,000

Discount on bonds payableDiscount on bonds payable 59,21659,216

PaidPaid--in capitalin capital –– Stock warrantsStock warrants 79,21679,216

BE16-4: Margolf Corp. issued 2,000, $1,000 bonds at 101.Each bond was issued with one detachable stock warrant.After issuance, the bonds were selling in the market at 98,and the warrants had a market value of $40. Use theproportional method to record the issuance of the bonds andwarrants.



Chapter16- 22

Incremental Method



Where a company cannot determine the fair value ofeither the warrants or the bonds.

Use the security for which fair value candetermined.

Allocate the remainder of the purchase price tothe security for which it does not know fair value.

Chapter16-23

BE16-5: McCarthy Inc. issued 2,000, $1,000 bonds at 101.Each bond was issued with one detachable stock warrant. Afterissuance, the bonds were selling in the market at 98. Themarket price of the warrants, without the bonds, cannot bedetermined. Use the incremental method to record the issuanceof the bonds and warrants.

Number Amount Price Total PercentBonds 2,000 x 1,000$ x 0.98$ = 1,960,000$ 100%Warrants 2,000 x = - 0%

Total Fair Market Value 1,960,000$ 100%

Allocation: BondsIssue price 2,020,000$ Bond face value 2,000,000$Bonds 1,960,000 Allocated FMV 1,960,000Warrants 60,000$ Discount 40,000$



Chapter16- 24

CashCash 2,020,0002,020,000

Bonds payableBonds payable 2,000,0002,000,000

Discount on bonds payableDiscount on bonds payable 40,00040,000

PaidPaid--in capitalin capital –– Stock warrantsStock warrants 60,00060,000



BE16-5: McCarthy Inc. issued 2,000, $1,000 bonds at 101.Each bond was issued with one detachable stock warrant. Afterissuance, the bonds were selling in the market at 98. Themarket price of the warrants, without the bonds, cannot bedetermined. Use the incremental method to record the issuanceof the bonds and warrants.

Chapter16-25

Conceptual Questions



Detachable warrants involvestwo securities,

a debt security,

a warrant to purchase common stock.

Nondetachable warrants

no allocation of proceeds between the bonds and thewarrants,

companies record the entire proceeds as debt.

Chapter16- 26

Rights to Subscribe to Additional Shares



Stock Rights - existing stockholders have the right(preemptive privilege) to purchase newly issued sharesin proportion to their holdings.

Price is normally less than current market value.

Companies make only a memorandum entry.

Chapter16-27

LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.

Stock Option - gives key employees option to purchasestock at a given price over extended period of time.

Effective compensation programs are ones that:1. base compensation on performance2. motivate employees,3. help retain executives and recruit new talent,4. maximize employee’s after-tax benefit, and5. use performance criteria over which employee has

control.

Stock Compensation Plans

Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation

Chapter16- 28

The Major Reporting Issue

New FASB standard requires companies to recognizecompensation cost using the fair-value method.*

Under fair-value method, companies use acceptableoption-pricing models to value the options at the dateof grant.



Chapter16-29

Two main accounting issues:

1. How to determine compensation expense.

2. Over what periods to allocate compensationexpense.



Chapter16- 30

Determining Expense

Compensation expense based on the fair valueof the options expected to vest on the date theoptions are granted to the employee(s) (i.e., thegrant date).


Allocating Compensation Expense

Over the periods in which employees performthe service—the service period.


Chapter16-31



E16-12 On January 1, 2009, Scooby Corporation granted 10,000options to key executives. Each option allows the executive topurchase one share of Scooby’s $5 par value common stock at a priceof $20 per share. The options were exercisable within a 2-yearperiod beginning January 1, 2011, if the grantee is still employed bythe company at the time of the exercise. On the grant date,Scooby’s stock was trading at $25 per share, and a fair value optionpricing model determines total compensation to be $450,000.On May 1, 2011, 9,000 options were exercised when the market priceof Scooby’s stock was $30 per share. The remaining options lapsedin 2013 because executives decided not to exercise their options .Instructions: Prepare the necessary journal entries related to thestock-option plan for the years 2009 through 2013.

Chapter16- 32

No entry on date of grant.No entry on date of grant.

E16-12: Prepare the necessary journal entries related to thestock option plan for the years 2009 through 2013.


1/1/091/1/09

Compensation expenseCompensation expense 225,000225,000PaidPaid--in capitalin capital--stock optionsstock options 225,000225,000

12/31/0912/31/09

Compensation expenseCompensation expense 225,000225,000

PaidPaid--in capitalin capital--stock optionsstock options 225,000225,00012/31/1012/31/10

($450,000 x ½)


Chapter16-33


CashCash (9,000 x $20)(9,000 x $20) 180,000180,000

Common stockCommon stock (9,000 x $5)(9,000 x $5) 45,00045,000

5/1/115/1/11

PaidPaid--in capitalin capital--stock optionsstock options 45,00045,000PaidPaid--in capitalin capital--expired optionsexpired options 45,00045,000

1/1/131/1/13

($450,000 x 9,000 / 10,000 = $405,000)

PaidPaid--in capitalin capital--stock optionsstock options 405,000405,000

PaidPaid--in capital in excess of parin capital in excess of par 540,000540,000

($450,000 – $405,000)


E16-12: Prepare the necessary journal entries related to thestock option plan for the years 2009 through 2013.

Chapter16- 34

Restricted Stock

Transfer shares of stock to employees, subject to anagreement that the shares cannot be sold, transferred, orpledged until vesting occurs.

Major Advantages:

1. Never becomes completely worthless.

2. Generally results in less dilution to existing stockholders.

3. Better aligns employee incentives with company incentives.



Chapter16-35



Illustration: On January 1, 2010, Ogden Company issues1,000 shares of restricted stock to its CEO, ChristieDeGeorge. Ogden’s stock has a fair value of $20 per share onJanuary 1, 2010. Additional information is as follows.

1. The service period related to the restricted stock isfive years.

2. Vesting occurs if DeGeorge stays with the company fora five-year period.

3. The par value of the stock is $1 per share.

Ogden makes the following entry on the grant date (January1, 2010).

Chapter16- 36



Illustration: Ogden makes the following entry on the grantdate (January 1, 2010).

Unearned Compensation 20,000

Common Stock (1,000 x $1) 1,000

Paid-in Capital in Excess of Par (1,000 x $19) 19,000

Unearned Compensation represents the cost of services yet to beperformed, which is not an asset. Unearned Compensation isreported as a component of stockholders’ equity in the balance sheet.

Chapter16-37



Illustration: Record the journal entry at December 31, 2010,Ogden records compensation expense.

Compensation expense 4,000

Unearned compensation 4,000

Ogden records compensation expense of $4,000 for each ofthe next four years (2011, 2012, 2013, and 2014).

Chapter16- 38



Illustration: Assume that DeGeorge leaves on February 3,2012 (before any expense has been recorded during 2012).The entry to record this forfeiture is as follows

Common Stock 1,000

Paid-in Capital in Excess of Par 19,000

Compensation Expense ($4,000 x 2) 8,000

Unearned Compensation 12,000

Chapter16-39

Employee Stock-Purchase Plans (ESPPs)

Generally permit all employees to purchase stock at adiscounted price for a short period of time.

Plans are considered compensatory unless they satisfyall three conditions presented below.

1. Substantially all full-time employees may participateon an equitable basis.

2. The discount from market is small.

3. The plan offers no substantive option feature.



Chapter16- 40

Disclosure of Compensation Plans


Company with one or more share-based paymentarrangements must disclose:

1. The nature and terms of such arrangements.

2. The effect on the income statement of compensationcost.

3. The method of estimating the fair value of the goodsor services received, or the fair value of the equityinstruments granted (or offered to grant).

4. The cash flow effects.LO 4 Describe the accounting for stock compensation plans

under generally accepted accounting principles.Chapter

16-41

Debate over Stock Option Accounting

When first proposed, there was considerableopposition to the fair-value approach because it couldresult in substantial, previously unrecognizedcompensation expense.

Offsetting such opposition is the need for greatertransparency in financial reporting.

LO 5 Discuss the controversy involving stock compensation plans.


Chapter16- 42

Earnings per share indicates the income earned byeach share of common stock.

Companies report earnings per share only for commonstock.

When income statement contains intermediatecomponents of income, companies should discloseearnings per share for each component.

LO 6 Compute earnings per share in a simple capital structure.

Computing Earnings Per ShareComputing Earnings Per ShareComputing Earnings Per Share

Illustration 16Illustration 16--77

Chapter16-43 LO 6 Compute earnings per share in a simple capital structure.

Earnings Per Share-Simple Capital StructureEarnings Per ShareEarnings Per Share--Simple Capital StructureSimple Capital Structure

Simple Structure--Only common stock; nopotentially dilutive securities.

Complex Structure--Potentially dilutive securitiesare present.

“Dilutive” means the ability to influence the EPS ina downward direction.

Chapter16- 44 LO 6 Compute earnings per share in a simple capital structure.


Preferred Stock Dividends

Subtracts the current year preferred stock dividendfrom net income to arrive at income available tocommon stockholders.


Preferred dividends are subtracted on cumulativepreferred stock, whether declared or not.



Weighted-Average Number of Shares

Companies must weight the shares by the fractionof the period they are outstanding.

Stock dividends or stock splits: companies needto restate the shares outstanding before thestock dividend or split.

Chapter16- 46 LO 6 Compute earnings per share in a simple capital structure.


E16-16: On January 1, 2010, Chang Corp. had 480,000shares of common stock outstanding. During 2010, it hadthe following transactions that affected the commonstock account.

February 1 Issued 120,000 SharesMarch 1 Issued a 20% stock dividendMay 1 Acquired 100,000 share of treasury stockJune 1 Issued a 3-for-1 stock splitOctober 1 Reissued 60,000 shares of treasury stock

Instructions Determine the weighted-average number ofshares outstanding as of December 31, 2010.



Weighted-Average Number of SharesWeighted

Change in Shares Fraction 20% 3/1 AverageDate Shares Outstanding of Year Dividend Split Shares

Jan. 1 480,000 x 1/12 x 120% x 3 144,000Feb. 1 120,000 600,000 x 1/12 x 120% x 3 180,000Mar. 1 120,000 720,000 x 2/12 x 3 360,000May 1 (100,000) 620,000 x 1/12 x 3 155,000June 1 3/1 split 1,860,000 x 4/12 x 620,000Oct. 1 60,000 1,920,000 x 3/12 x 480,000

1,939,000

Chapter16- 48 LO 7 Compute earnings per share in a complex capital structure.

Earnings Per Share-Complex Capital StructureEarnings Per ShareEarnings Per Share--Complex Capital StructureComplex Capital Structure

Complex Capital Structure exists when a business

has

convertible securities,

options, warrants, or other rights

that upon conversion or exercise could dilute earningsper share.

Company reports both basic and diluted earnings pershare.

Chapter16-49 LO 7 Compute earnings per share in a complex capital structure.


Diluted EPS includes the effect of all potential dilutivecommon shares that were outstanding during the period.

Companies will not report diluted EPS if the securities intheir capital structure are antidilutive.


Chapter16- 50

Diluted EPS – Convertible Securities

Measure the dilutive effects of potentialconversion on EPS using the if-converted method.

This method for a convertible bond assumes:

(1) the conversion at the beginning of the period (orat the time of issuance of the security, if issuedduring the period), and

(2) the elimination of related interest, net of tax.

LO 7 Compute earnings per share in a complex capital structure.




E16-22 (Convertible Bonds): In 2010 Buraka Enterprisesissued, at par, 75, $1,000, 8% bonds, each convertible into 100shares of common stock. Buraka had revenues of $17,500 andexpenses other than interest and taxes of $8,400 for 2011.(Assume that the tax rate is 40%.) Throughout 2011, 2,000shares of common stock were outstanding; none of the bondswas converted or redeemed.Instructions

(a) Compute diluted earnings per share for 2011.(b) Assume same facts as those for Part (a), except the 75

bonds were issued on September 1, 2011 (rather than in2010), and none have been converted or redeemed.



E16-22 (a) Compute diluted earnings per share for 2011.

Calculation of Net IncomeCalculation of Net Income

RevenuesRevenues $17,500$17,500

ExpensesExpenses 8,4008,400

Bond interest expenseBond interest expense (75 x $1,000 x 8%)(75 x $1,000 x 8%) 6,0006,000

Income before taxesIncome before taxes 3,1003,100

Income tax expenseIncome tax expense (40%)(40%) 1,2401,240

Net incomeNet income $ 1,860$ 1,860




When calculating Diluted EPS, begin with BasisEPS.

Net income = $1,860

Weighted average shares = 2,000== $.93$.93

Basic EPS




When calculating Diluted EPS, begin with Basis EPS.

$1,860

2,000== $.57$.57

Diluted EPS

++ $6,000 (1 - .40)

7,500

Basic EPS= .93

$5,460

9,500==

Effect on EPS = .48

++



Revenues 17,500$Expenses 8,400Bond interest expense (75 x $1,000 x 8% x 4/12) 2,000Income before taxes 7,100Income taxes (40%) 2,840Net income 4,260$

Calculation of Net IncomeCalculation of Net Income

E16-22 (b) Assume bonds were issued on Sept. 1, 2011 .



E16-22 (b) Assume bonds were issued on Sept. 1, 2011 .


$4,260

2,000== $1.21$1.21

Diluted EPS

$2,000 (1 - .40)

7,500 x 4/12 yr.

$5,460

4,500==

Effect on EPS = .48Basic EPS= 2.13

++

++



P16-8 (Variation-Convertible Preferred Stock): Priorto 2010, Barkley Company issued 40,000 shares of 6%convertible, cumulative preferred stock, $100 par value.Each share is convertible into 5 shares of common stock.Net income for 2010 was $1,200,000. There were600,000 common shares outstanding during 2010. Therewere no changes during 2010 in the number of common orpreferred shares outstanding.

Instructions

(a) Compute diluted earnings per share for 2010.



P16-8 (a) Compute diluted earnings per share for 2010.


Net income $1,200,000 – Pfd. Div. $240,000*

Weighted average shares = 600,000== $1.60$1.60

Basic EPS

** 40,000 shares x $100 par x 6% = $240,000 dividend40,000 shares x $100 par x 6% = $240,000 dividend




600,000==

$1.50$1.50

Diluted EPS

$240,000

Basic EPS = 1.60

==

Effect onEPS = 1.20

P16-8 (a) Compute diluted earnings per share for 2010.

$1,200,000 – $240,000

200,000*

$1,200,000

800,000

**(40,000 x 5)(40,000 x 5)

++

++



600,000==

$1.67$1.67

Diluted EPS

$240,000

Basic EPS = 1.60

==

Effect onEPS = 2.00

P16-8 (a) Compute diluted earnings per share for 2010assuming each share of preferred is convertible into 3shares of common stock.

$1,200,000 – $240,000

120,000*

$1,200,000

720,000

**(40,000 x 3)(40,000 x 3)

++

++



600,000==

$1.67$1.67

Diluted EPS

$240,000

Basic EPS = 1.60

==

Effect onEPS = 2.00

$1,200,000 – $240,000

120,000*

$1,200,000

720,000

**(40,000 x 3)(40,000 x 3)

Antidilutive

Basic = Diluted EPS

P16-8 (a) Compute diluted earnings per share for 2010assuming each share of preferred is convertible into 3shares of common stock.

++

++

Chapter16- 62

Diluted EPS – Options and Warrants

Measure the dilutive effects of potential conversionusing the treasury-stock method.

This method assumes:

(1) company exercises the options or warrants at thebeginning of the year (or date of issue if later),and

(2) that it uses those proceeds to purchase commonstock for the treasury.





E16-26 (EPS with Options): Zambrano Company’s net incomefor 2010 is $40,000. The only potentially dilutive securitiesoutstanding were 1,000 options issued during 2009, eachexercisable for one share at $8. None has been exercised, and10,000 shares of common were outstanding during 2010. Theaverage market price of the stock during 2010 was $20.

Instructions(a) Compute diluted earnings per share.

(b) Assume the 1,000 options were issued on October 1,2010 (rather than in 2009). The average market priceduring the last 3 months of 2010 was $20.

Chapter16- 64

Proceeds if shares issuedProceeds if shares issued (1,000 x $8)(1,000 x $8) $8,000$8,000

Purchase price for treasury sharesPurchase price for treasury shares $20$20

Shares assumed purchasedShares assumed purchased 400400

Shares assumed issuedShares assumed issued 1,0001,000

Incremental share increaseIncremental share increase 600600




TreasuryTreasury--Stock MethodStock Method

÷÷





$40,000

10,000== $3.77$3.77

Diluted EPS

++

600

Basic EPS= 4.00

$40,000

10,600==

Options

++



Proceeds if shares issued (1,000 x $8) 8,000$Purchase price for treasury shares 20$Shares assumed purchased 400Shares assumed issued 1,000Incremental share increase 600Weight for 3 months assumed outstanding 3/12Weighted incremental share increase 150

TreasuryTreasury--Stock MethodStock Method

÷÷

E16-26 (b) Compute diluted earnings per share assumingthe 1,000 options were issued on October 1, 2010.

xx



E16-26 (b) Compute diluted earnings per share assumingthe 1,000 options were issued on October 1, 2010.

$40,000

10,000== $3.94$3.94

Diluted EPS

150

Basic EPS= 4.00

$40,000

10,150==

Options

++

Chapter16- 68

Contingent Issue AgreementContingent shares are issued as a result of the:

1. passage of time or

2. attainment of a certain earnings or market pricelevel.



Antidilution RevisitedIgnore antidilutive securities in all calculations and incomputing diluted earnings per share.

Chapter16-69

EPS Presentation and Disclosure

A company should show per share amounts for:

income from continuing operations,

income before extraordinary items, and

net income.

Per share amounts for a discontinued operation or anextraordinary item should be presented on the face ofthe income statement or in the notes.





Complex capital structures and dual presentation of EPS requirethe following additional disclosures in note form.

1. Description of pertinent rights and privileges of the varioussecurities outstanding.

2. A reconciliation of the numerators and denominators of the basicand diluted per share computations, including individual income andshare amount effects of all securities that affect EPS.

3. The effect given preferred dividends in determining incomeavailable to common stockholders in computing basic EPS.

4. Securities that could potentially dilute basic EPS in the future thatwere excluded in the computation because they would beantidilutive.

5. Effect of conversions subsequent to year-end, but before issuingstatements.


Summary of EPS ComputationSummary of EPS ComputationSummary of EPS Computation


Chapter16- 72 LO 7


Summary of EPSComputation

Summary of EPSSummary of EPSComputationComputation

Chapter16-73

Under U.S. GAAP, all of the proceeds of convertible debt arerecorded as long-term debt. Under iGAAP, convertible bonds are“bifurcated”—separated into the equity component (the value ofthe conversion option) of the bond issue and the debt component.

Although the calculation of basic and diluted earnings per share issimilar between iGAAP and U.S. GAAP, the Boards are working toresolve the few minor differences in EPS reporting.

Other EPS differences relate to (1) the treasury-stock method andhow the proceeds from extinguishment of a liability should beaccounted for, and (2) how to compute the weighted-average ofcontingently issuable shares.

Chapter16- 74 LO 8LO 8 Explain the accounting for stock appreciation rights plans.Explain the accounting for stock appreciation rights plans.

Stock-Appreciation Rights (SARs):

The company gives an executive the right to receivecompensation equal to the share appreciation.

Share appreciation is the excess of the market price ofthe stock at the date of exercise over a pre-establishedprice.

The company may pay the share appreciation in cash, shares,or a combination of both.

The accounting for stock-appreciation rights depends onwhether the company classifies the rights as equity or as aliability.

Chapter16-75 LO 8LO 8 Explain the accounting for stock appreciation rights plans.Explain the accounting for stock appreciation rights plans.

SARS— Share-Based Equity Awards

Companies classify SARs as equity awards if at the date ofexercise, the holder receives shares of stock from the companyupon exercise.

holder receives shares in an amount equal to the share-priceappreciation (the difference between the market price andthe pre-established price).

At the date of grant, the company determines a fair valuefor the SAR and then allocates this amount to compensationexpense over the service period of the employees.


SARS— Share-Based Liability Awards

Companies classify SARs as liability awards if at the date ofexercise, the holder receives a cash payment. Accounting:

1. Measure the fair value of the award at the grant date and accruecompensation over the service period.

2. Remeasure the fair value each reporting period, until the award issettled; adjust the compensation cost each period for changes infair value pro-rated for the portion of the service period completed.

3. Once the service period is completed, determine compensationexpense each subsequent period by reporting the full change inmarket price as an adjustment to compensation expense.


Illustration: American Hotels, Inc. establishes a stock-appreciation rights plan on January 1, 2010. The planentitles executives to receive cash at the date of exercisefor the difference between the market price of the stockand the pre-established price of $10 on 10,000 SARs. Thefair value of the SARs on December 31, 2010, is $3, andthe service period runs for two years (2010–2011).

Illustration 16A-1 indicates the amount of compensationexpense to be recorded each period.


Illustration 16Illustration 16--A1A1

American Hotels records compensation expense in the firstyear as follows.

Compensation Expense 15,000Liability under Stock-Appreciation Plan 15,000


In 2012, when it records negative compensation expense,American would debit the account for $20,000. The entry torecord the negative compensation expense is as follows.

Liability under Stock-Appreciation Plan 20,000

Compensation Expense 20,000

At December 31, 2012, the executives receive $50,000.American would remove the liability with the following entry.

Liability under Stock-Appreciation Plan 50,000

Cash 50,000

Chapter16- 80 LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.

Illustration 16Illustration 16--B1B1Balance Sheet for Comprehensive Illustration

Chapter16-81

Illustration 16Illustration 16--B1B1Balance Sheet for Comprehensive Illustration

LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.

Chapter16- 82

Illustration 16Illustration 16--B2B2

Computation of Earnings per Share—Simple Capital Structure

Solution onSolution onnotes pagenotes page LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.

Chapter16-83

Diluted Earnings Per Share

Steps for computing diluted earnings per share:1. Determine, for each dilutive security, the per share effect

assuming exercise/conversion.

2. Rank the results from step 1 from smallest to largestearnings effect per share.

3. Beginning with the earnings per share based upon theweighted-average of common shares outstanding, recalculateearnings per share by adding the smallest per share effectsfrom step 2. Continue this process so long as eachrecalculated earnings per share is smaller than the previousamount.


Chapter16- 84

The first step is to determine a per share effect for eachpotentially dilutive security.

Per Share Effect of Options (Treasury-Stock Method) , DilutedEarnings per Share


LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.Chapter

16-85


Per Share Effect of 8% Bonds (If-Converted Method), DilutedEarnings per Share



Chapter16- 86


Per Share Effect of 10% Bonds (If-Converted Method), DilutedEarnings per Share



16-87


Per Share Effect of 10% Convertible Preferred (If-ConvertedMethod), Diluted Earnings per Share



Chapter16- 88


Ranking of per Share Effects (Smallest to Largest), DilutedEarnings per Share



16-89

The next step is to determine earnings per share givingeffect to the ranking

Recomputation of EPS Using Incremental Effect of OptionsIllustration 16Illustration 16--B8B8


The effect of the options is dilutive.

Chapter16- 90


Recomputation of EPS Using Incremental Effect of 8% ConvertibleBonds Illustration 16Illustration 16--B9B9


The effect of the 8% convertible bonds is dilutive.Chapter

16-91


Recomputation of EPS Using Incremental Effect of 10%Convertible Bonds Illustration 16Illustration 16--B10B10


The effect of the 10% convertible bonds is dilutive.

Chapter16- 92


Recomputation of EPS Using Incremental Effect of 10%Convertible Preferred Illustration 16Illustration 16--B11B11


The effect of the 10% convertible preferred is NOT dilutive.Chapter

16-93

Finally, Webster Corporation’s disclosure of earnings pershare on its income statement.

Illustration 16Illustration 16 --B12B12


The effect of the 10% convertible preferred is NOT dilutive.

Chapter16- 94

Assume that Barton Company provides the following information.Illustration 16Illustration 16--B13B13


BartonCompany Data

Basic andDiluted EPS


Chapter 16 - Handouts

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Transcript of Chapter 16 - Handouts