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ACG3141 > Ch 16 Dilutive Securities & EPS > Flashcards

Ch 16 Dilutive Securities & EPS Flashcards

1
Q

LO1 - Describe the accounting for the issuance, conversion, and retirement of convertible securities

A
  • use the same method as recording straight debt, amortize discounts/premiums assuming bonds will be held to maturity
  • if converted, principal accounting problem is to determine the amount to record the securities for the bonds
  • book value method is GAAP
  • retirement of convertible debt is considered debt retirement, difference between carrying amount and the cash paid should result in a gain/loss
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2
Q

LO2 - Explain the accounting for convertible preferred stock

A
  • use book value method

- debit preferred stock along w/ any APIC, credit common stock and APIC (if excess exists)

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3
Q

LO3 - Contrast the accounting for stock warrants and for stock warrants issues with other securities (part 1)

A

Stock warrants

  • allocate the proceeds from the sale of debt w/ detachable warrants between the two securities.
  • warrants that are detachable can be traded separately from the debt so fair value can be determined
  • 2 methods of allocation: proportional and incremental
  • nondetachable warrants do not require an allocation of proceeds between bonds and warrants, instead record all proceeds to debt
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4
Q

LO3 - Contrast the accounting for stock warrants and for stock warrants issues with other securities (part 2)

A

Stock rights

  • no entry is required when a company issues rights to existing stockholders
  • only need to make a memorandum entry to indicate the number of rights issues to existing stockholders and to ensure the company has add’l unissued stock registered for issuance in case the stockholders exercise the rights.
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5
Q

LO4 - Describe the accounting for stock compensation plans

A
  • must use fair value approach
  • company computes total compensation expense based on the fair value of the options it expects to vest on grant date
  • recognize compensation expense in the periods in which the employee performs the services
  • restricted stock plans follow the same general accounting principles as those for stock options, if vesting does not occur, reverse the compensation expense
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6
Q

LO5 - Discuss the controversy involving stock compensation plans

A
  • when first proposed, considerable opposition to the fair value approach b/c it could result in substantial, previously unrecognized compensation expense.
  • corporate America, especially the high-tech sector vocally opposed the proposed standard b/c they would be at a competitive disadvantage w/ larger companies that could withstand higher compensation charges
  • offsetting such opposition is the need for greater transparency in financial reporting, which our capital markets depend on
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7
Q

LO6 - Compute earnings per share in a simple capital structure

A

-net income - preferred dividends/weighted avg #
of shares outstanding
-capital structure with no dilutive securities

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8
Q

LO7 - Compute earnings per share in a complex capital structure

A
  • complex capital structure requires dual presentation of EPS, each with equal prominence on the income statement
  • two presentations - basic EPS and diluted EPS
  • basic EPS relies on weighted average common shares outstanding (the EPS for a simple capital structure)
  • diluted EPS indicates the dilution of EPS that will occur if all potential issuances of common stock were exercised
  • should exclude anti dilutive securities when computing EPS
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9
Q

Antidilutive Securities

A

-securities, which upon conversion or exercise, increase the EPS or reduct the loss per share

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10
Q

Basic EPS

A

-the EPS for a simple capital structure

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11
Q

Complex Capital Structure

A

-capital structure that includes securities that could have a dilutive effect on earnings per common share

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12
Q

Control Number

A
  • measure the company uses to determine whether potential common stock is dilutive or anti dilutive
  • income from continuing operation, adjusted for preferred dividends
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13
Q

Convertible Bonds

A
  • bond that permits its holder to exchange it for other corp securities (typically common stock) for a specified 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
  • company amortizes, either at maturity or upon conversion, any discount/premium that results from bond issuance
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14
Q

Convertible Preferred Stock

A
  • preferred stock that allows stockholders, at their option, to exchange preferred shares for shares of common stock at a predetermined ratio
  • 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
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15
Q

Detachable Stock Warrants

A
  • 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 incremental method
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16
Q

Diluted EPS

A
  • earnings per share for a complex capital structure
  • diluted EPS begins w/ the basic EPS computation but includes the effect of all potential dilutive common shares outstanding during the period
  • 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
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17
Q

Dilutive Securities

A
  • securities that can be converted to common stock
  • upon conversion/exercise by the holder, the dilutive securities reduce EPS
  • companies w/ dilutive securities report both basic EPS and diluted EPS in their income statements
18
Q

Earnings Per Share

A

-a distilled and important income figure, calculated as
net income - preferred dividends/weighted average number of shares outstanding
-companies must disclose EPS on the face of the income statement

19
Q

Fair Value Method

A
  • 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
20
Q

Grant Date

A
  • 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/down) in the stock price
21
Q

If-Converted Method

A
  • method of measuring the dilutive effects of potential conversion of EPS, for companies with securities convertible into common stock
  • for 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, and the amount of interest expense increases net income
22
Q

Income Available to Common Stockholders

A
  • the numerator used in a basic EPS calculation when a company has both common and preferred stock outstanding
  • computed as net income - preferred dividends
23
Q

Incremental Method

A
  • used when a company cannot determine the fair value of either warrants or the bonds
  • the company uses the security it can determine the fair value, then allocates the remainder of the purchase price to the unknown security
24
Q

Induced Conversion

A

-to offer additional consideration to prompt conversion of convertible debt to equity securities

25
Q

Intrinsic-Value Method

A
  • method for reporting the granting of stock options
  • measures compensation cost as what the holder of the stock option would receive today if the option was immediately exercised
  • intrinsic value = difference between market price and exercise price of the options at the grant date
  • not allowed under GAAP, must use fair value method
26
Q

Percentage Approach

A
  • the method of allocating compensation expense over the service period
  • at the end of each period, total compensation expense reported to date = the percentage of the total service period that has elapsed X the total estimated compensation cost
27
Q

Proportional Method

A
  • used to account for the proceeds of an issue of detachable warrants
  • allocating the proceeds based on the proportion of:
    1) value of bonds w/o the warrants
    2) value of the warrants
28
Q

Restricted-Stock Plans

A

-transfer shares of stock to employees, subject to an agreement that the shares cannot be sold, transferred, or pledged until vesting occurs

29
Q

Service Period

A
  • the period in which employees perform services, typically represented by the time between the grant date and the vesting date
  • determine the total compensation cost of the options at the grant date and allocate it as an expense in the periods in which employees perform the services
30
Q

Share Appreciation

A

-the excess of the market price of the stock at the date of exercise over a pre-established price

31
Q

Simple Capital Structure

A
  • capital structure that consists only of a common stock and other securities (preferred stock, bonds, warrants) that are not dilutive
  • does not include any potential common stock that upon exercise could dilute EPS
32
Q

Stock-Appreciation Rights (SARs)

A

-a plan in which the company gives an executive the right to receive compensation equal to the share appreciation

33
Q

Stock-Based Compensation Plans

A

-plans that provide the employee with the opportunity to receive stock if the performance of the company is satisfactory

34
Q

Stock Option

A

-gives key employees the option to purchase common stock at a given price over an extended period of time

35
Q

Stock Right

A

-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 dilution of voting rights

36
Q

Treasury-Stock Method

A
  • method of measuring the dilutive effects on EPS of stock options and warrants outstanding
  • 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
37
Q

Warrants

A
  • long term options, issued with other securities, to buy common stock at a fixed price for a specified period of time (generally 5 years, sometimes 10)
  • companies account for debt issued with nondetachable warrants as straight debt
  • for detachable stock warrants, companies separate debit issued with detachable warrants into debt and equity components, using either the proportional method or incremental method
  • often referred to as stock options
38
Q

Weighted-Average Number of Shares Outstanding

A

-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

39
Q

Difference between convertible securities & warrants

A

the holder has to pay a certain amount of money to obtain the shares

40
Q

Detachable Warrants

A
  • involves 2 securities:
    1) debt - remains outstanding until maturity
    2) warrant to purchase common stock
  • separate treatment is justified
41
Q

Nondetachable Warrants

A
  • do not require an allocation of proceeds between bonds and warrants
  • record entire proceeds from nondetachable warrants as debt

ACG3141 (9 decks)

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