· 1 corporate financial reporting 2 16 - dilutive securities & e.p.s dilutive securities and...

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· 1 CORPORATE FINANCIAL REPORTING 2 16 - Dilutive Securities & E.P.S Dilutive Securities and EPS

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· 1

CORPORATE FINANCIAL REPORTING 2

16 - Dilutive Securities & E.P.S

Dilutive Securities and EPS

· 2

DILUTIVE SECURITIESDilutive securities are: convertible debt & convertible preferred stock, stock warrants & stock options, & “contingent” shares.

· 3

DILUTIVE SECURITIES Convertible Debt

Our company issues 100,000 6% bonds (each with a face value of $1,000) for $100,400,000. Each bond is convertible into 40 shares of our $1 par common stock. Our investment banking firm believes that, had the bonds not been convertible the bonds would have been issued for their face value.

· 4

DILUTIVE SECURITIES Convertible Preferred Stock

Our company issues 1,000,000 shares of 6% preferred stock (each with a par value of $100) for $100,400,000. Each share is convertible into 40 shares of our $1 par common stock. Our investment banking firm believes that, had the stock not been convertible, the stock would have been issued for its face value.

· 5

DILUTIVE SECURITIESStock Warrants

Stock warrants are usually issued in conjunction with other financial instruments but can be issued to existing shareholders for “free”.They entitle the warrant holder to buy common stock at a (usually) bargain price.

· 6

DILUTIVE SECURITIESStock Warrants

Our company issues 100,000 6% bonds (each with a face value of $1,000) for $100,500,000. Each bond has an attached warrant allowing the holder of the warrant to purchase 10 shares of our $1 par common stock for $5/share.Immediately after issue, the warrants are traded in the market for $4.

· 7

DILUTIVE SECURITIESShare Based Payment Plans[FAS 123R (ASC 718) / IFRS 2]

There are several kinds of stock compensation plans:

Stock appreciation rights plans

Stock option plans

Restricted stock plans

Employee stock purchase plans

· 8

DILUTIVE SECURITIESStock Appreciation Right Plans

1/08 12/08 12/09 12/10 12/11 12/12 12/13 12/14

MP=$8 $9 $10 $9 $11 $12 $15 $14Stock appreciation SAR’s SAR’s SAR’srights granted for vest exercised expire 1,000 shares

How do SARs work?

What journal entries should the company make?

The income tax rate for the company is 40% for all years. IRS says SAR tax compensation expense = cash paid the year SARs are exercised.

· 9

DILUTIVE SECURITIESStock Options

Different perspectives: tax treatment of stock options &

financial reporting of stock options

Stock Option Plans Tax Reporting

1/07 12/09 12/11 12/14 12/17

Stock options stock employee options employee granted for options exercises - expire sells the1,000 shares vest pays $10 sharesexercise price=mp=$10 (mp=$18) for $30

On how much gain is the employee taxed?

How much expense may the employer report?

The answers? It depends on the type of plan:INCENTIVE STOCK OPTION or NONQUALIFIED STOCK OPTION

· 10

Stock Option Plans - Tax ReportingGain for the EMPLOYEE

1/07 12/09 12/11 12/14 12/17

Stock options stock employee options employee granted for options exercises - expire sells the 1,000 shares vest pays $10 sharesexercise price=mp=$10 (mp=$18) for $30

ISO NQSOat grant -- --at exercise -- $ 8 incomeat stock sale $20 income $12 income

· 11

Stock Option Plans - Tax ReportingExpense for the EMPLOYER

1/07 12/09 12/11 12/14 12/17

Stock options stock employee options employee granted for options exercises - expire sells the 1,000 shares vest pays $10 sharesexercise price=mp=$10 (mp=$18) for $30

ISO NQSOat grant -- --at exercise -- ($ 8)at stock sale -- --

· 12

· 13

Stock Option PlansFinancial Reporting

In general there are two types of stock option plans for financial reporting:Noncompensatory – designed to raise capital and encourage employee ownership (no compensation expense).Compensatory – result in compensation expense.

· 14

DILUTIVE SECURITIESCompensatory Stock Option Plan (&NQSO) 1/07 12/07 12/08 12/09 12/10 12/11 12/12 12/13

xx MP= 8 9 10 9 11 12 15 14Stock options stock stockgranted for options options1,000 shares vest expireexercise price = $8par value of c/s = $1

A person with 100 options quits the company.

A person with 850 options exercises them.

A person with 50 options forgets to exercise them.

The income tax rate for the company is 40% for all years.

· 15

DILUTIVE SECURITIESRestricted Stock Plans

1/07 12/07 12/08 12/09 12/10 12/11 12/12 12/13

MP= 8 9 10 9 11 12 15 141000 shares Restrictedof Restricted Stock vestsStock granted

How does Restricted Stock work?

What journal entries should the company make?

The tax rate for the company is 40% for all years.

· 16

DILUTIVE SECURITIES

QUESTIONS BEFORE WE MOVE ON TO EARNINGS PER SHARE?

· 17

EARNINGS PER SHARE

FASB says corporations fall into one of two categories:◊ corporations with a simple capital structure and◊ corporations with a complex capital structure.(FAS 128 & IAS 33)

· 18

EARNINGS PER SHARESimple Capital Structure

A corporation has a simple capital structure if it has no dilutive securities - that is it only has common stock and NO:convertible debt or convertible preferred stock, stock warrants or stock options, or contingent shares.

· 19

EARNINGS PER SHARESimple Capital Structure

A corporation with a simple capital structure calculates one eps (called “basic earnings per share”) like this: net income - pref. stock dividends declared* weighted avg. no. of shares of common stock**

· 20

EARNINGS PER SHAREComplex Capital Structure

A corporation has a complex capital structure if it has dilutive securities - that is it has common stock, ANDconvert. debt/convert pref. stock, stock warrants/options, or contingent shares.

· 21

EARNINGS PER SHAREComplex Capital Structure

A corporation with a complex capital structure calculates TWO eps: ◊ basic eps (exactly like a corporation with a simple capital structure)◊ diluted eps which assumes that the dilutive securities did become common stock.

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EARNINGS PER SHAREComplex Capital Structure

This is why I think the FASB requires two eps. Suppose in 2013 Company A has the following: ◊ net income of $100,000 ◊ 10,000 shares of convertible P/S that are convertible into 20,000 shares of common stock ◊ 20,000 shares of common stock

· 23

EARNINGS PER SHAREComplex Capital Structure

And in 2014, the following happened:◊ net income $100,000◊ on 1/1/14 the preferred stock all converted into 20,000 shares of common stock◊ common stock outstanding all year was now 40,000 shares

· 24

DILUTED EPSConvertible Preferred Stock Treatment

In the denominator, assume the convertible P/S converts to common stock at the beginning of the year*.

IF that had happened, the P/S would not have been paid dividends, so add back (to income available to common stockholders) in the numerator the dividends declared on the convertible P/S.

· 25

DILUTED EPSConvertible Preferred Stock Example

◊ 2013 net income: $100,000◊ P/S declared $1,000 dividends◊ P/S is convertible into 5,000 shares of common◊ C/S outstanding all year: 10,000 shares

· 26

DILUTED EPSConvertible Bonds Example

2013 Income Statement: Revenue $ xxxxxx Expense ( xxxxx)

Int. expense ( 10,000) all on bonds Inc. bef. tax 100,000 Inc. tax (30%) ( 30,000)

Net income $70,000The company has 200,000 shares of common stock and also has bonds convertible into 100,000 shares of common stock.

· 27

DILUTED EPSStock Options Example

◊ 2013 net income: $9,000◊ C/S outstanding all year: 1,000 shares◊ stock options for 100 shares of common stock outstanding all year.◊ option price $5/share.

◊ C/S average price in 2010: $8/share.

· 28

DILUTED EPSContingent shares Example

2011 NI: $10,000outstanding: 10,000 shares of common stockIn 2012, we tell management if NI > $20,000 before 2015, they get 500 shares free (it is a one time offer)2012 NI: $18,0002013 NI: $22,000

· 29

EARNINGS PER SHARE

When making assumptions for dilutedeps calculation, you can never increase eps: NI : $100,000P/S: 10,000 shares, convertible into 4,000 shares of common P/S declared $5,000 of dividendsC/S: 100,000 shares

· 30

EARNINGS PER SHAREAverage No. of Common Shares

This can be tedious in the real world.The idea is to calculate the weighted average number of shares of common stock outstanding during the year - but remember you do NOT weight shares for stock dividends or stock splits in the year they happened.

· 31

EARNINGS PER SHARECalculating Avg. No. of Common Shares

2012: (our first year of business) NI : $360,000 1/1: 80,000 shares outstanding 7/1: 20,000 shares issued for cash2013: NI : $500,000 1/1: 100,000 shares outstanding 7/1: 30,000 shares issued for cash 8/1: 2 for 1 stock split12/1: bought 1,000 shares as T/S