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CHAPTER 16 - PowerPoint PPT Presentation


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CHAPTER 16. Dilutive Securities and Earnings per Share. ……..…………………………………………………………. Convertible Bonds. exchanged for stock at the bond holder’s option increases the value of the bond a “sweetener” might be offered to induce conversion. ACCOUNTING FOR CONVERTIBLE DEBT.

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slide1

CHAPTER 16

Dilutive Securities

and Earnings per Share

……..…………………………………………………………...

Convertible Bonds

  • exchanged for stock at the bond holder’s option
  • increases the value of the bond
  • a “sweetener” might be offered to induce conversion
slide2

ACCOUNTING FOR CONVERTIBLE DEBT

At Time of Issuance

  • recorded like a straight debt issue
  • no value allocated to conversion privilege
  • FASB considers the privilege inseparable from the bond

Cash 106,000

Bonds Payable 100,000

Premium on Bonds Payable 6,000

slide3

Bonds Payable

Premium Bond Pay

100,000

1,000

6,000

5,000

At Time of Conversion

  • stock is recorded at book value of the converted bonds
slide4

Induced Conversions

  • record the “sweetener” as an expense

Debt Conversion Expense 7,000

Bonds Payable 100,000

Premium on Bonds Payable 5,000

Common Stock 20,000

Paid-in Cap – excess of par 85,000

Cash 7,000

This is the same whether or not there is a sweetener.

slide5

Retirement of Convertible Debt

  • recorded like a straight debt retirement

Clear-out the balances of bonds and premium.

Not an extraordinary item

slide6

CONVERTIBLE PREFERRED STOCK

Preferred Stock

Add. Paid-in Capital

250,000

40,000

  • at conversion, common stock is recorded at book value of the converted preferred
slide7

STOCK WARRANTS

  • options to buy shares of stock at a certain price
  • warrants are issued
    • with bonds or preferred stock as an “added bonus”
    • to common stockholders with a preemptive right
    • to executives and employees
slide8

Warrants Issued with Other Securities

Example

Sold 500 $1,000 bonds for $505,000. Included with each bond is a 5-year warrant to buy 1 share of common for $25.

Incremental Method

Assume the market value of each warrant is $30 and the market value of the bonds (alone) is unknown.

slide9

Proportional Method

Assume the market value of each warrant is $30 and the market value of each bond is $990.

Mkt Value Book Value

Bonds $495,000

Warrants 15,000

slide10

STOCK COMPENSATION PLANS

Effective Compensation

  • motivate performance
    • compensation tied to performance
    • performance over which employee has control
    • short- and long-term performance
  • retain and recruit executives

Stock price is thought to be

better that Sales or other

accounting measures.

Stock options are very

attractive to managers.

slide11

The Expected Value of a Share of Stock

$ 8

18

40

22

12

Expected value $100

Possible

Stock Values Probability

$80 10%

$90 20%

$100 40%

$110 20%

$120 10%

What is the value of an option to buy 1 share of stock at $100?

slide12

The Value of a Stock Option

Possible Value of Option

Stock Values Probability to buy at $100

$80 10%

$90 20%

$100 40%

$110 20%

$120 10%

$0 $ 0

$0 0

$0 0

$10 2

$20 2

Expected value $ 4

An option to buy has value.

slide13

The Value of Volatility

Possible Value of Option

Stock Values Probability to buy at $100

$60 10%

$80 20%

$100 40%

$120 20%

$140 10%

$0 $ 0

$0 0

$0 0

$20 4

$40 4

Expected value $ 8

slide14

Accounting for Stock Compensation

  • Valuation
    • intrinsic value method: excess of market price over exercise price
    • fair value method: estimated value of options expected to vest
    • value generally measured at grant date
    • FASB now requires fair value method
  • Allocation of expense
    • expense recognized in the service period
    • generally service period = vesting period
slide15

Exercise 16-10 (Modified)

Columbo Company adopted a stock option plan: options to buy 30,000 shares of $10 par common stock at $40.

Options were exercisable 2 years after grant date. Value of options was $450,000.

November 1, 2007 Plan adopted

no entry

2-year service period beginning on the grant date.

January 2, 2008 Options granted

no entry

slide16

December 31, 2008 (first year of service period completed)

December 31, 2009 (second year of service completed)

slide17

January 3, 2010 20,000 options were exercised

January 2, 2014 10,000 options expired

slide18

DISCLOSURE OF COMPENSATION PLANS

  • number and weighted average fair value of options
    • granted
    • exercised
    • forfeited
    • outstanding
  • average remaining life of options outstanding
slide19

EARNINGS PER SHARE – SIMPLE

Net Income - Preferred Dividends

Weighted Average Shares Outstanding

=

EPS

Current year preferred dividend

or

Dividend that should have been declared

if the preferred stock is cumulative

slide20

Weighted Average Shares Outstanding

1/1 – 4/1 90,000

4/1 – 7/1 120,000

7/1 –11/1 81,000

11/1 – 12/31 141,000

Dates Shares Fraction

Outstanding Outstanding of Year

New stock issued

Stock repurchased

slide21

Weighted Average with Stock Dividend or Split

# Shares

1/1 Beginning balance 80,000

3/1 Issued 30,000 shares 110,000

8/1 2 for 1 stock split 220,000

10/1 Purchsd 20,000 shares 200,000

1/1 – 3/1

3/1 – 10/1

10/1 – 12/31

Dates Shares Fraction

Outstnd Outstnd Rstmt of Year

slide22

EARNINGS PER SHARE – COMPLEX

  • Dilutive securities have an adverse effect on EPS
    • convertible securities
    • options or warrants
  • Firms must report both Basic EPS and Dilutive EPS
slide23

Convertible Securities: If-Converted Method

1/1 Beginning balance: 200,000 shares common

5/1 Issued $500,000, 8% bonds for $535,530 (effective interest = 7%) convertible into 24,000 shares common

Net Income (net of 40% tax): $350,000

Net Income $350,000

Add: Bond interest (net of tax)

$535,530 x 7% x 8/12 $24,991

Less: 40% tax 9,997 14,994

Adjusted net income $364,994

slide24

1/1 Beginning balance: 200,000 shares common

5/1 Issued $500,000, 8% bonds for $535,530 (effective interest = 7%) convertible into 24,000 shares common

Net Income (net of 40% tax): $350,000

1/1 – 5/1

5/1 – 12/31

Dates Shares Out Fraction

Outstanding if Converted of Year

Basic EPS =

Diluted EPS =

slide25

Antidilutive Convertible Securities

Outstanding for the year:

500,000 shares common

$1,000,000, 10% bonds issued at par convertible into 50,000 shares common

Net Income (net of 30% tax): $600,000

Bond interest (net of tax)

$1,000,000 x 10% x (1 - .30) $70,000

Basic EPS =

“Diluted” EPS =

Any security that increases EPS should be excluded.

slide26

Market Price - Option Price

Market Price

$50 - $30

=

x 1,500

$50

Options and Warrants: Treasury Stock Method

  • Options and warrants are dilutive if the exercise price is lower than the market price.
  • Increases the potential shares outstanding.
  • No effect on net income.

Potential

Add. Shares

=

x # of Options

= 600

Basic EPS =

Diluted EPS =

slide27

EPS Presentation

Exercise 16-18

slide28

STOCK OPTIONS - OTHER STUFF

APB Opinion #25

  • Old approach that some firms follow.

Incentive Stock Options

Nonqualified Options

  • Tax advantages to employee
  • Tax advantages to firm
  • option price = market price on grant date
  • option price is usually less than market price
  • no compensation expense
  • compensation expense = mkt price - option price
slide29

Stock Appreciation Rights

  • right to receive compensation equal to the market price over a pre-established price
  • at the end of each year of the service period
    • estimate total SAR compensation (market price - pre-established price) x # of rights
    • multiply by % compensation accrued
    • bring cumulative compensation up to date

This might mean recording negative compensation in some years.

Estimate of total compensation will change from year to year.