Ch. 15: Dilutive Securities

Question 1

Earnings per Share (EPS)

Answer 1

Indicates the income earned by each share of common stock

Common stock ONLY

Companies should disclose intermediate components EPS (discontinued operations)

Question 2

Types of EPS calculations

Answer 2

Simple Capital Structure: Common stock (no dilutive securities)

Complex Capital Structure: Includes diluted EPS

Question 3

Dilutive

Answer 3

Ability to influence EPS in a downward direction

Question 4

Basic EPS Formula

Answer 4

(Net Income - Dividends) / (Weighted Average # of Shares Outstanding)

Question 5

Stock splits effect

Answer 5

When this occurs, companies need to restate the shares outstanding before the share dividend or split

Question 6

4 Types of Dilutive Securities

Answer 6

Convertible Debt
Convertible Preferred Stock
Stock warrant
Stock compensation plans

Question 7

Convertible Debt (Bonds)

Answer 7

A bond that can be exchanged for common stock

Investors purchase these because: benefit of a bond & privilege of exchanging it for stock

Companies issue convertible bonds to: raise equity without giving control & to obtain debt financing at cheaper rates

Question 8

Accounting for Convertible Debt

Answer 8

Record the same as issuance for any other bond

No need to separately account for the value of the convertible feature

IFRS requires to record the liability and equity separately

Question 9

Convertible Debt Induced Conversion

Answer 9

Issuer offers additional consideration, called a “sweetener”
Sweetener is recognized as an expense of the period

Question 10

Convertible Debt Retirement

Answer 10

Record the same as any other bond

Difference between the acquisition price and carrying amount should be report as a gain or loss on the income statement

Question 11

Convertible Preferred Stock

Answer 11

Includes an option for the holder to convert preferred shares into a fixed number of common shares

Classified as part of stockholders’ equity, unless mandatory redemption exists

Use book value method

Recognize no gain or loss when converted

Question 12

Stock Warrants

Answer 12

Certificates that entitle the holder to acquire shares of stock at a certain price within a stated period

1. To make the security more attractive
2. Existing stockholders have a preemptive right to purchase common stock first
3. To executives and employees as a form of compensation

Generally these warrants last 5 years, sometimes 10

Question 13

Accounting for Stock Warrants

Answer 13

In practice, stock warrants are usually attached to debt as long-term options to buy common stock @ fixed price

Proceeds allocate between 2 securities based on FMV

Allocate through proportional method & incremental method

Amount of stock warrants is credited in Paid-in capital

Question 14

Detachable Warrants involve 2 Securities

Answer 14

Debt security

A warrant to purchase common stock

Question 15

Non-detachable warrants

Answer 15

Do not require an allocation of proceeds between the bonds and the warrants

Companies record the entire proceeds as debt

Question 16

Accounting for detachable stock warrants

Answer 16

Determine value of bonds without the warrants and the value of the warrants

Proportional method allocates the proceeds using the proportion of the two amounts based on fair values

Question 17

Stock Warrants: Incremental Method

Answer 17

Company can’t determine the fair value of either the warrants or the bonds

• Use the security for which fair value can be determined
• Allocate the remainder of the purchase price to the security of which it does not know fair value