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Share-Based Compensation and Earnings Per Share. Sid Glandon, DBA, CPA Associate Professor of Accounting The University of Texas at El Paso. Stock Compensation Plans. Provide employee incentives: Stock award plans Stock option plans Stock appreciation rights

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Share based compensation and earnings per share

Share-Based Compensation and Earnings Per Share

Sid Glandon, DBA, CPA

Associate Professor of Accounting

The University of Texas at El Paso


Stock compensation plans
Stock Compensation Plans

  • Provide employee incentives:

    • Stock award plans

    • Stock option plans

    • Stock appreciation rights

    • Broad-based (noncompensatory plans)


Stock award plans
Stock Award Plans

  • Restricted shares are issued as compensation

  • Compensation expense is recognized over the vesting period

  • At the end of the vesting period the normal equity accounts are credited for common stock and additional paid-in capital



Stock option plans
Stock Option Plans

  • Important dates

    • Grant date of options

    • Vesting date

    • Exercise date of options

  • Compensation expense recognized by

    • Fair value method (SFAS 123)



Example fact pattern
Example: Fact Pattern

  • Grant date, January 1, 2001

  • 10,000 options granted

  • One option = one $1 par value share

  • Exercise price: $60; Market price: $70

  • Options exercisable within 10 years

  • Service period is 2 years

  • 2,000 options exercised on June 1, 2004

  • 8,000 options expired on January 1, 2011

  • Using an option pricing model the fair value of options is $220,000





Stock appreciation rights sars
Stock Appreciation Rights SARs

  • SARs are designed to mitigate employee cash flow problems in non-qualified plans

  • Employee gets right to receive any appreciation in share value at exercise date equal to market price

    • Less pre-established amount

  • Employee receives cash or stock only for the appreciation


Example stock appreciation rights
Example: Stock Appreciation Rights

  • Fact Pattern:

    • SARs program established, January 1, 2001

    • Exercise period, over next five years

      • Pre-established price per SAR $10

      • Number of SARs granted, 10,000

    • Market prices of stock at December 31,

      • 2001, $13

      • 2002, $17

      • 2003, $15

    • Service period: 2 years

    • The SARs are exercised on December 31, 2003





Earnings per share eps
Earnings Per Share (EPS) Appreciation Rights

  • Most important number in income statement

  • Dilution of EPS means reduction in EPS

  • Potential conversion of dilutive securities into common stock

  • If dilution takes place extent of reduction must be disclosed


Basic eps
Basic EPS Appreciation Rights


Basic eps1
Basic EPS Appreciation Rights

  • Fact Pattern:

    • Beginning balance = 800,000 shares

    • Issued 100,000 shares on April 1

    • Reacquired 300,000 shares on July 1

    • Net income = $1,700,000

    • Preferred dividends = $250,000



Basic earnings per share
Basic Earnings Per Share Appreciation Rights


Stock dividends and splits
Stock Dividends and Splits Appreciation Rights

  • Restatement of weighted shares outstanding before the dividend or split

  • Deemed to have been outstanding since the beginning of the year

  • After year end but before issuance of financial statements require restatement to beginning of year


Basic eps with stock dividends
Basic EPS with Stock Dividends Appreciation Rights

  • Fact Pattern:

    • Beginning balance = 800,000 shares

    • Issued 100,000 shares on April 1

    • Reacquired 300,000 shares on July 1

    • 25% stock dividend on October 1

    • Issue 120,000 shares on November 1

    • Net income = $1,500,000

    • Preferred dividends = $481,125



Basic eps with stock dividends1
Basic EPS with Stock Dividends Appreciation Rights


Complex capital structures
Complex Capital Structures Appreciation Rights

  • Stock options, rights and warrants

  • Convertible securities

    • Convertible bonds

    • Convertible preferred stock

  • Only dilutive securities are considered

  • Antidilutive securities are ignored


Dilution
Dilution Appreciation Rights

  • Reduction in EPS if potentially dilutive:

    • Stock options, rights or warrants

    • Convertible securities

  • Assumed exercised or converted at beginning of the year

  • Two EPS calculations

    • Basic EPS, and

    • Diluted EPS



Methods
Methods Appreciation Rights

  • Treasury stock method

    • Options, Rights and Warrants

  • If converted method

    • Convertible Securities

  • Maximum dilutive conversion rate is used in calculating diluted EPS


Treasury stock method
Treasury Stock Method Appreciation Rights

  • Options, rights and warrants are included in EPS computations

  • Assumed exercised at beginning of year

  • Proceeds from exercise are assumed used to buy back common shares

  • Exercise price per share must be less than market price per share for dilution


Treasury stock method1
Treasury Stock Method Appreciation Rights

  • Fact Pattern:

    • Exercise price = $10 per share

    • Average market price = $40 per share

    • 1,000 options outstanding and assumed exercised

    • Additional shares added to weighted-average common shares outstanding



If converted method
If-Converted Method Appreciation Rights

  • Conversion of securities into common stock is assumed to occur at the beginning of the year

  • Related interest effect (net of tax) and/or convertible preferred dividends are removed from the calculation of income available to common shares

  • Weighted average number of shares is increased by additional common shares assumed issued at beginning of year


If converted method1
If-Converted Method Appreciation Rights

  • Fact Pattern:

    • Net income = $500,000

    • Common shares outstanding = 250,000

    • $1,000,000 6% convertible bonds

    • Each $1,000 bond convertible into 25 shares of common stock

    • Income tax rate = 35%





Complex capital structures1
Complex Capital Structures Appreciation Rights

  • Requires duel presentation

    • Basic earnings per share

    • Diluted earnings per share


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