Ch 16 Dilutive Securities and EPS

Question 1

antidilutive securities

Answer 1

Securities, which upon conversion or exercise, increase earnings per share (or reduce the loss per share). Companies with complex capital structures will not report diluted EPS if the securities in their capital structure are antidilutive; they will report only the basic EPS number. (p. 904).

Question 2

basic EPS

Answer 2

The earnings per share for a simple capital structure. A company with a complex capital structure reports both basic EPS and diluted EPS amounts on the face of its income statement. (p. 904).

Question 3

complex capital structure

Answer 3

A capital structure that includes securities that could have a dilutive effect on earnings per common share. (p. 900).

Question 4

convertible bonds

Answer 4

Bond that permits its holder to exchange it for (?convert it to?) other corporate securities (typically common stock) for a specified period of time after issuance. The sale of a convertible bond is recorded like a straight-debt issue; upon conversion, the company records the securities exchanged for the bond at the carrying amount (book value) of the bond. The company amortizes, either at its maturity or upon conversion, any discount or premium that results from the issuance of the bond. (p. 884).

Question 5

convertible preferred stock

Answer 5

Preferred stock that allows stockholders, at their option, to exchange preferred shares for shares of common stock at a predetermined ratio. The convertible preferred stockholder not only enjoys a preferred claim on dividends but also has the option of converting into a common stockholder with unlimited participation in earnings. (p. 886).

Question 6

detachable stock warrants

Answer 6

A warrant (option to buy common stock at a fixed price) that can be ?detached? from the related security (a bond) and traded as a separate security for a specified period of time. To account for detachable stock warrants, companies separate debt issued with detachable warrants into debt and equity components, using either the proportional method or the incremental method. (p. 888).

Question 7

diluted EPS

Answer 7

The earnings per share for a complex capital structure. Diluted EPS begins with the basic EPS computation but includes the effect of all potential dilutive common shares outstanding during the period. It is computed as income available to common stockholders divided by weighted-average number of shares outstanding, plus the impact of convertibles, options, warrants, and other dilutive securities. (p. 904).

Question 8

dilutive securities

Answer 8

Securities that can be converted to common stock. Upon conversion or exercise by the holder, the dilutive securities reduce (dilute) earnings per share. Companies with dilutive securities report both basic EPS and diluted EPS in their income statements. (pp. 884, 904).

Question 9

earnings per share

Answer 9

A distilled and important income figure, calculated as net income minus preferred dividends (income available to common stockholders), divided by the weighted-average number of shares outstanding. Companies must disclose earnings per share on the face of the income statement. (p. 899).

Question 10

fair value method (stock compensation)

Answer 10

The amount at which a company can exchange a financial instrument in a current transaction between willing parties. Companies account for expense related to stock options and restricted stock at fair value. (p. 892).

Question 11

grant date

Answer 11

The date at which a company grants stock options to employees. Public companies estimate the options? fair value as of that date, using an option-pricing model and any adjustments needed for unique factors. No adjustments occur after the grant date in response to subsequent changes (up or down) in the stock price. (p. 892).

Question 12

if-converted method

Answer 12

Method of measuring the dilutive effects of potential conversion on EPS, for companies with securities convertible into common stock. For a convertible bond, this method assumes the conversion of the convertible securities at the beginning of the period and the elimination of related interest, net of tax. The additional shares assumed issued increase the weighted-average number of shares outstanding (the denominator), and the amount of interest expense increases net income (the numerator). (p. 905).

Question 13

income available to common stockholders

Answer 13

The numerator used in a basic earnings per share calculation when a company has both common and preferred stock outstanding. Computed as net income minus preferred dividends. (p. 900).

Question 14

incremental method

Answer 14

When a company cannot determine the fair value of either the warrants or the bonds, the company uses the security for which it can determine the fair value, and allocates the remainder of the purchase price to the security for which it does not know the fair value. (p. 889).

Question 15

induced conversion

Answer 15

The offer of additional consideration, to prompt conversion of convertible debt to equity securities. (p. 885).

Question 16

intrinsic-value method

Answer 16

Method for reporting the granting of stock options. It measures compensation cost as what the holder of the stock option would receive today if the option was immediately exercised. The intrinsic value is the difference between the market price of the stock and the exercise price of the options at the grant date. Use of this approach for most stock-based compensation plans is not allowed under GAAP, which generally requires the fair value method. (p. 892).

Question 17

proportional method

Answer 17

Used to account for the proceeds of an issue of detachable warrants, by allocating the proceeds based on the proportion of the following two amounts: (1) the value of the bonds without the warrants, and (2) the value of the warrants. (p. 888).

Question 18

restricted-stock plans

Answer 18

Restricted-stock plans transfer shares of stock to employees, subject to an agreement that the shares cannot be sold, transferred, or pledged until vesting occurs. (p. 894).

Question 19

service period

Answer 19

For stock options, the period in which employees perform services, typically represented by the time between the grant date and the vesting date. A company generally determines total compensation cost of the options at the grant date and allocates it as an expense in the periods in which employees perform the services. (p. 893).

Question 20

simple capital structure

Answer 20

Capital structure that consists only of common stock and other securities (preferred stock, bonds, warrants) that are not dilutive. A company has a simple capital structure if does not include potential common stock that upon conversion or exercise could dilute earnings per share. (p. 900).

Question 21

stock option

Answer 21

Gives key employees the option to purchase common stock at a given price over an extended period of time. (p. 891).

Question 22

stock-based compensation plans

Answer 22

These plans provide the employee with the opportunity to receive stock if the performance of the company is satisfactory. (p. 891).

Question 23

stock right

Answer 23

Upon the issue of new stock, the old stockholders generally have the right to purchase newly issued shares in proportion to their holdings, to avoid a dilution of voting rights. (p. 890).

Question 24

treasury-stock method

Answer 24

Method of measuring the dilutive effects on EPS of stock options and warrants outstanding. This method assumes that a company exercises the options or warrants and uses those proceeds to purchase common stock for the treasury at the average price of common shares during the period. If such purchases result in dilution (assuming the market price of the stock is above the exercise price), the company reports potential common shares in its diluted EPS. (p. 907).

Question 25

warrants

Answer 25

Long-term options, issued with other securities, to buy common stock at a fixed price for a specified period of time (generally 5 years, occasionally 10). Companies account for debt issued with nondetachable warrants as straight debt. To account for detachable stock warrants, companies separate debt issued with detachable warrants into debt and equity components, using either the proportional method or the incremental method. (p. 887).

Question 26

weighted-average number of shares outstanding

Answer 26

The denominator used in an earnings per share calculation. Companies weight the shares of stock issued or purchased during a period by the fraction of the period they are outstanding, to determine the equivalent number of whole shares outstanding for the year. (p. 901).

Question 27

percentage approach

Answer 27

A method of allocating compensation expense over the service period. At the end of each period, total compensation expense reported to date should equal the percentage of the total service period that has elapsed, multiplied by the total estimated compensation cost. (p. 915).

Question 28

share appreciation

Answer 28

The excess of the market price of the stock at the date of exercise over a pre-established price. (p. 914).

Question 29

stock-appreciation rights (SARs)

Answer 29

A plan in which the company gives an executive the right to receive compensation equal to the share appreciation. (p. 914).

Question 30

control number

Answer 30

The measure the company uses, that is, income from continuing operations (adjusted for preferred dividends), to determine whether potential common stock is dilutive or antidilutive. (p. 920).