chapter 16 - handouts
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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:
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- 8
At Time of Issuance
Accounting for Convertible DebtAccounting for Convertible DebtAccounting for Convertible Debt
LO 1 Describe the accounting for the issuance, conversion,and retirement of convertible securities.
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)
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- 10
At Time of Conversion
Accounting for Convertible DebtAccounting for Convertible DebtAccounting for Convertible Debt
LO 1 Describe the accounting for the issuance, conversion,and retirement of convertible securities.
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.
Bonds payable 2,000,000
Common stock (2,000 x 50 x $10) 1,000,000
Journal entry at conversion:
Discount on bonds payable 30,000
Additional paid-in capital 970,000
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- 12
Issuer wishes to encourage prompt conversion.
Issuer offers additional consideration, called a“sweetener.”
Sweetener is an expense of the period.
Accounting for Convertible DebtAccounting for Convertible DebtAccounting for Convertible Debt
LO 1 Describe the accounting for the issuance, conversion,and retirement of convertible securities.
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.
Bonds payable 2,000,000
Common stock (2,000 x 50 x $10) 1,000,000
Journal entry at conversion:
Discount on bonds payable 30,000
Additional paid-in capital 970,000
Accounting for Convertible DebtAccounting for Convertible DebtAccounting for Convertible Debt
LO 1 Describe the accounting for the issuance, conversion,and retirement of convertible securities.
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.
Accounting for Convertible DebtAccounting for Convertible DebtAccounting for Convertible Debt
LO 1 Describe the accounting for the issuance, conversion,and retirement of convertible securities.
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
Stock WarrantsStock WarrantsStock Warrants
LO 3 Contrast the accounting for stock warrants andfor stock warrants 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
Stock WarrantsStock WarrantsStock Warrants
LO 3 Contrast the accounting for stock warrants andfor stock warrants issued with other securities.
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$
Stock WarrantsStock WarrantsStock Warrants
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.
Stock WarrantsStock WarrantsStock Warrants
LO 3 Contrast the accounting for stock warrants andfor stock warrants issued with other securities.
Chapter16- 22
Incremental Method
Stock WarrantsStock WarrantsStock Warrants
LO 3 Contrast the accounting for stock warrants andfor stock warrants issued with other securities.
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$
Stock WarrantsStock WarrantsStock Warrants
LO 3 Contrast the accounting for stock warrants andfor stock warrants issued with other securities.
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
Stock WarrantsStock WarrantsStock Warrants
LO 3 Contrast the accounting for stock warrants andfor stock warrants issued with other securities.
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
Stock WarrantsStock WarrantsStock Warrants
LO 3 Contrast the accounting for stock warrants andfor stock warrants issued with other securities.
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 WarrantsStock WarrantsStock Warrants
LO 3 Contrast the accounting for stock warrants andfor stock warrants issued with other securities.
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.
LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
Chapter16-29
Two main accounting issues:
1. How to determine compensation expense.
2. Over what periods to allocate compensationexpense.
LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
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).
LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.
Allocating Compensation Expense
Over the periods in which employees performthe service—the service period.
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
Chapter16-31
LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
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.
LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.
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)
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
Chapter16-33
LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.
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)
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
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.
LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
Chapter16-35
LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
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
LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
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
LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
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
LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
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.
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
LO 4 Describe the accounting for stock compensation plansunder generally accepted accounting principles.
Chapter16- 40
Disclosure of Compensation Plans
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
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.
Accounting for Stock CompensationAccounting for Stock CompensationAccounting for Stock Compensation
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.
Earnings Per Share-Simple Capital StructureEarnings Per ShareEarnings Per Share--Simple Capital StructureSimple Capital Structure
Preferred Stock Dividends
Subtracts the current year preferred stock dividendfrom net income to arrive at income available tocommon stockholders.
Illustration 16Illustration 16--88
Preferred dividends are subtracted on cumulativepreferred stock, whether declared or not.
Chapter16-45 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
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.
Earnings Per Share-Simple Capital StructureEarnings Per ShareEarnings Per Share--Simple Capital StructureSimple 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.
Chapter16-47 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
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.
Earnings Per Share-Complex Capital StructureEarnings Per ShareEarnings Per Share--Complex Capital StructureComplex 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.
Illustration 16Illustration 16--1717
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.
Earnings Per Share-Complex Capital StructureEarnings Per ShareEarnings Per Share--Complex Capital StructureComplex Capital Structure
Chapter16-51 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
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.
Chapter16- 52 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
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
Chapter16-53 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
E16-22 (a) Compute diluted earnings per share for 2011.
When calculating Diluted EPS, begin with BasisEPS.
Net income = $1,860
Weighted average shares = 2,000== $.93$.93
Basic EPS
Chapter16- 54 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
E16-22 (a) Compute diluted earnings per share for 2011.
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
$5,460
9,500==
Effect on EPS = .48
++
Chapter16-55 LO 7 Compute earnings per share in a complex capital structure.
Earnings Per Share-Complex Capital StructureEarnings Per ShareEarnings Per Share--Complex Capital StructureComplex Capital Structure
Revenues 17,500$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 .
Chapter16- 56 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
E16-22 (b) Assume bonds were issued on Sept. 1, 2011 .
When calculating Diluted EPS, begin with Basis EPS.
$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
++
++
Chapter16-57 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
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.
Chapter16- 58 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
P16-8 (a) Compute diluted earnings per share for 2010.
When calculating Diluted EPS, begin with Basis EPS.
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
Chapter16-59 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
When calculating Diluted EPS, begin with BasisEPS.
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)
++
++
Chapter16- 60 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
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)
++
++
Chapter16-61 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
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.
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
Chapter16-63 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
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
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
E16-26 (a) Compute diluted earnings per share for 2010.
TreasuryTreasury--Stock MethodStock Method
÷÷
Chapter16-65 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
E16-26 (a) Compute diluted earnings per share for 2010.
When calculating Diluted EPS, begin with BasisEPS.
$40,000
10,000== $3.77$3.77
Diluted EPS
++
600
Basic EPS= 4.00
$40,000
10,600==
Options
++
Chapter16- 66 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
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
Chapter16-67 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
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.
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
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.
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
Chapter16- 70 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 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.
Chapter16-71 LO 7 Compute earnings per share in a complex capital structure.
Summary of EPS ComputationSummary of EPS ComputationSummary of EPS Computation
Illustration 16Illustration 16--2727
Chapter16- 72 LO 7
Illustration 16Illustration 16--2828
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.
Chapter16- 76 LO 8LO 8 Explain the accounting for stock appreciation rights plans.Explain the accounting for stock appreciation rights plans.
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.
Chapter16-77 LO 8LO 8 Explain the accounting for stock appreciation rights plans.Explain the accounting for stock appreciation rights plans.
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.
Chapter16- 78 LO 8LO 8 Explain the accounting for stock appreciation rights plans.Explain the accounting for stock appreciation rights plans.
Illustration 16Illustration 16--A1A1
American Hotels records compensation expense in the firstyear as follows.
Compensation Expense 15,000Liability under Stock-Appreciation Plan 15,000
Chapter16-79 LO 8LO 8 Explain the accounting for stock appreciation rights plans.Explain the accounting for stock appreciation rights plans.
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.
LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.
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
Illustration 16Illustration 16--B3B3
LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.Chapter
16-85
The first step is to determine a per share effect for eachpotentially dilutive security.
Per Share Effect of 8% Bonds (If-Converted Method), DilutedEarnings per Share
Illustration 16Illustration 16--B4B4
LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.
Chapter16- 86
The first step is to determine a per share effect for eachpotentially dilutive security.
Per Share Effect of 10% Bonds (If-Converted Method), DilutedEarnings per Share
Illustration 16Illustration 16--B5B5
LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.Chapter
16-87
The first step is to determine a per share effect for eachpotentially dilutive security.
Per Share Effect of 10% Convertible Preferred (If-ConvertedMethod), Diluted Earnings per Share
Illustration 16Illustration 16--B6B6
LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.
Chapter16- 88
The first step is to determine a per share effect for eachpotentially dilutive security.
Ranking of per Share Effects (Smallest to Largest), DilutedEarnings per Share
Illustration 16Illustration 16--B7B7
LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.Chapter
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
LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.
The effect of the options is dilutive.
Chapter16- 90
The next step is to determine earnings per share givingeffect to the ranking
Recomputation of EPS Using Incremental Effect of 8% ConvertibleBonds Illustration 16Illustration 16--B9B9
LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.
The effect of the 8% convertible bonds is dilutive.Chapter
16-91
The next step is to determine earnings per share givingeffect to the ranking
Recomputation of EPS Using Incremental Effect of 10%Convertible Bonds Illustration 16Illustration 16--B10B10
LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.
The effect of the 10% convertible bonds is dilutive.
Chapter16- 92
The next step is to determine earnings per share givingeffect to the ranking
Recomputation of EPS Using Incremental Effect of 10%Convertible Preferred Illustration 16Illustration 16--B11B11
LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.
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
LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.
The effect of the 10% convertible preferred is NOT dilutive.
Chapter16- 94
Assume that Barton Company provides the following information.Illustration 16Illustration 16--B13B13
LO 9 Compute earnings per share in a complex situation.LO 9 Compute earnings per share in a complex situation.
BartonCompany Data
Basic andDiluted EPS
Illustration 16Illustration 16--B14B14