Equity Flashcards
What rights does each share of stock carry?
Each share of stock has certain rights and privileges, including the right to vote for directors, share in profits and losses, and share in corporate assets upon liquidation.
What is the preemptive right?
The preemptive right allows existing stockholders to maintain their ownership level by sharing proportionately in any new issues of stock in the same class.
What are the advantages of the share system?
The share system facilitates dividend payouts and stockholder meetings, and is governed by the Uniform Stock Transfer Act and the Uniform Commercial Code.
What does common stock represent?
Common stock represents the basic ownership interest in a corporation, bearing the ultimate risks of loss and receiving the benefits of success.
What is preferred stock?
Preferred stock represents special preference given in exchange for sacrificing some rights of common stock, often having preference to claims on earnings and liquidation.
What is stockholders’ equity?
Stockholders’ equity represents a claim against a portion of the total assets of the company, also known as owners’ equity, shareholders’ equity, or corporate capital.
How is stockholders’ equity calculated?
Stockholders’ equity is the difference between the assets and liabilities of a company, also referred to as the residual interest.
What is Legal Capital?
Legal Capital is the par value of the stock issued by the company.
What is contributed capital?
Contributed capital is how much the investors contributed to the company.
What are the two primary sources of equity?
The two primary sources of equity are contributed capital and earned capital.
What is the formula for stockholders’ equity?
Stockholders’ equity = Capital Stock + Additional Paid-In Capital + Retained Earnings - Treasury Stock (at cost).
What is earned capital?
Earned capital (Retained Earnings) is what the company earned and kept, consisting of cumulative earnings and losses.
What is capital stock?
Capital stock is part of contributed capital, including common and preferred stock issued by a company.
What is additional paid-in capital?
Additional Paid-In Capital is part of contributed capital that increases when stock is sold or issued above par.
What does retained earnings represent?
Retained earnings represent undistributed income that remains invested in the company.
What is treasury stock?
Treasury stock is when a company buys back its own stock, shown as a negative in accounting.
What is the nature of treasury stock in accounting?
Treasury stock is a contra-equity account with a normal debit balance.
How is treasury stock accounted for when reacquired?
When reacquiring stock, debit Treasury Stock for the cost of the acquisition and credit Cash.
What happens when treasury stock is sold for more than its cost?
When selling treasury stock for more than its cost, the excess is credited to Paid in Capital from Treasury Stock.
Can treasury stock transactions increase retained earnings?
Treasury stock transactions can decrease but not increase retained earnings.
What are the procedures for issuing stock?
- State must authorize stock. 2. Corporation offers shares for sale. 3. Corporation receives funds for stock and issues shares.
What are authorized shares?
Authorized shares are how many shares of stock a company could issue, if it chose to.
What are Issued Shares?
Issued Shares are the total number of shares a company has distributed. They cannot exceed the authorized number.
What are Outstanding Shares?
Outstanding Shares are the shares that are in the hands of stockholders. They are calculated as issued shares minus treasury shares.
What is Par Value?
Par Value is a number assigned to the stock that has no relationship to its fair value. It is usually low and helps companies avoid contingent liability associated with stock issued below par.
What is Additional Paid-In Capital?
Additional Paid-In Capital refers to capital in excess of par value. It is also called additional paid-in capital.
How is Common Stock valued when issued?
For example, if 10,000 shares of $2 par value common stock are issued for $10, the valuation would be:
- Common Stock: $20,000
- Additional Paid-In Capital: $80,000
What is No-Par Stock?
No-Par Stock has no par value, meaning there is no additional paid-in capital. All value is attributed to the stock itself.
What are the advantages of No-Par Stock?
No-Par Stock avoids contingent liability that could occur if a corporation issues par value stock at a discount and the questionable treatment of using par value as the basis for fair value.
What are the disadvantages of No-Par Stock?
Some states levy high taxes on no-par issues, and in some states, the total issue price for no-par stock may be considered legal capital, reducing flexibility in paying dividends.
How is No-Par Stock recorded?
No-Par Stock is issued for whatever price it will bring, without a premium or discount. It should be carried at issue price without any additional paid-in capital or discount reported.
What is No-Par Stock with Stated Value?
No-Par Stock with Stated Value acts like par value. Excess over stated value is recorded as Additional Paid-In Capital in Excess of Stated Value.
What are the requirements for No-Par Stock with Stated Value?
Some states require a stated value for no-par stock, and a company cannot issue below it. When shares are issued above stated value, the stated value is accounted for as common stock, and the excess is recorded as paid-in capital in excess of stated value.
What is lump-sum issuance or exchange?
When corporations issue two or more classes of securities for a single lump sum payment, often occurring during acquisitions.
What are the two methods for allocating proceeds in lump-sum issuance?
Proportional and Incremental methods.
Describe the Proportional Method.
The lump sum received is allocated proportionally to classes of securities based on fair market value.
Describe the Incremental Method.
Used when fair value cannot be determined for all classes. Fair value is used for known classes, and the remainder is allocated to unknown values.
What is the valuation issue in stock issued in noncash transactions?
Companies should record stock at either the fair value of the stock issued or the fair value of the noncash consideration received, whichever is more clearly determinable.
What should companies consider when exchanging unissued stock or treasury stock?
The cost of the shares should NOT be considered the decisive factor in establishing the fair value of the property or services.
How should companies adjust the ‘paid in capital in excess of par - common stock’ amount?
Adjust it to reflect the fair value of the transaction.
What is watered stock?
Watered stock is when a company intentionally overvalues the property or service received, creating inflated asset values.
What are secret reserves?
Secret reserves are when a company intentionally undervalues recorded assets, resulting from excessive depreciation or understatement of assets.
How should direct costs of issuing stock be reported?
Direct costs to sell stock are reported as a reduction of the proceeds received from the sale of stock.
What is treasury stock?
Treasury stock is repurchased stock that is not considered an asset and reduces stockholders’ equity.
What are some reasons a company would reacquire stock?
- To provide tax-efficient distributions to shareholders.
- To increase earnings per share and return on equity.
- To provide stock for employee compensation.
- To thwart takeover attempts.
- To create demand and stabilize stock price.
- To ‘go private’ by eliminating outside ownership.
What is the effect of stock buybacks on stock price?
Stock buybacks can stabilize or increase stock price.
What is the impact of buybacks on companies?
Buybacks can hurt companies in the long run, even if they think their shares are undervalued.
What is the effect of treasury stock transactions on retained earnings?
Treasury stock transactions may decrease retained earnings in certain circumstances.
What is the Treasury Stock account?
The Treasury Stock account is a Contra-Equity Account with a normal debit balance.
What are the two methods for acquiring treasury stock?
The two methods are the cost method and the par value method.
IFRS only allows the cost method.
How is treasury stock recorded using the cost method?
Debit the Treasury Stock account for the reacquisition cost; report this account as a deduction from total paid-in capital and retained earnings.
How is treasury stock recorded using the par value method?
Record all transactions in treasury shares at their par value and report treasury stock as a deduction from capital stock only.
What happens when selling treasury stock above cost?
When the selling price exceeds cost, credit the difference to Paid-in Capital from Treasury Stock.
Don’t credit a gain account because treasury stock isn’t an asset.
How should gains on sales of treasury stock be recorded?
Gains on sales of treasury stock using the cost method should be credited to Paid-in Capital from Treasury Stock.
A gain should not be recognized from stock transactions with a company’s own stockholders.
What is the treatment of treasury stock gains on the balance sheet?
List Paid-in Capital separately on the balance sheet.
Treasury stock ‘Gain’ cannot increase retained earnings.
What happens when selling treasury stock below cost?
Debit the excess of cost over selling price to Paid-In Capital from Treasury Stock.
If the credit balance in Paid-In Capital from Treasury Stock is eliminated, debit any additional costs to retained earnings.
Can treasury stock decrease retained earnings?
Yes, treasury stock can decrease retained earnings, but it cannot increase it.
What is the process for retiring treasury stock?
The board may approve the retirement of treasury shares, which cancels treasury stock and reduces the number of outstanding shares.
What happens to retired shares?
Retired shares become ‘authorized and unissued’ and reduce the total approved number of shares.
What are the key differences between preferred stock and common stock?
Preferred stock possesses certain preferences or features not found in common stock, such as preference as to dividends, preference to assets during liquidations, convertibility to common stock, callability, and lack of voting rights.
What is a redeemable preferred stock?
A type of preferred stock that is most like debt, with a mandatory redemption date and amount.
What is the preference for dividends in preferred stock?
Preference for dividends does not ensure payment; companies must pay dividends on preferred stock before common stock.
What is cumulative preferred stock?
Cumulative preferred stock requires the corporation to pay all accumulated dividends before paying dividends to common stockholders.
What are dividends in arrears on cumulative preferred stock?
Dividends in arrears on cumulative preferred stock are disclosed in the notes to financial statements.
What is participating preferred stock?
Participating preferred stock may provide holders with more than the stated amount, allowing them to receive their prescribed return and additional dividends if the company pays amounts in excess of the stated preferred stock rate.
What happens if a company fails to pay a dividend for participating preferred stock?
If a company fails to pay a dividend for participating preferred stock in any year, it does not have to pay that before paying common dividends.
What is Callable Preferred Stock?
Callable Preferred Stock permits the corporation to call or redeem outstanding shares at specified future dates and prices. Many preferred issues are callable, with the call price typically slightly above the issue price.
What is the purpose of Callable Preferred Stock?
It allows the corporation to use capital obtained by issuing stock while it’s needed, then give it back.
What is Redeemable Preferred Stock?
Redeemable Preferred Stock is more like debt than other kinds of stock. It can set a ceiling on share price unless convertible into common stock.
What are Class B Shares?
Class B Shares are a type of common stock that carry super voting powers and are used to protect owner interest. They are controversial and used by companies like Dow Jones & Co, Ford, NY Times, and Google.
Why do tightly held companies create new classes of stock?
To provide cash, increase liquidity, or put public value on a company without diluting owner voting control.
How is accounting for Preferred Stock similar to Common Stock?
Proceeds are allocated between par value and additional paid-in capital, with separate accounts maintained for different classes of shares.
What is Convertible Preferred Stock?
Convertible Preferred Stock is considered a part of stockholders’ equity, and the book value method is employed for its accounting.
What is the Book Value Method for Convertible Preferred Stock?
The method involves debiting Preferred Stock and related Paid-In Capital in Excess of Par - Preferred Stock account, and crediting Common Stock and Paid-In Capital in Excess of Par - Common Stock.
What happens when preferred stock is converted into common stock?
Any excess of the par value of the common shares issued over the carrying amount of the preferred being converted should be accounted for.
How is Preferred Stock classified in financial statements?
Preferred Stock is classified as stockholders’ equity and reported at par value as the first item in the section, with excess over par reported as additional paid-in capital.
What are dividends of preferred stock considered?
Dividends of preferred stock are a distribution of income, not an expense.
What must companies disclose regarding preferred stock?
Companies must disclose the pertinent rights of outstanding preferred stock.
What are dividend payouts?
Dividend payouts are important signals for the market, indicating a portion of a company’s profits.
A dividend check provides proof that at least some portion of a company’s profits is genuine.
Why are companies reluctant to reduce or eliminate dividends?
Companies are reluctant to reduce or eliminate their dividend as securities markets might view the change negatively.
What factors influence a company’s dividend policy?
The type of shareholder a company has (taxable or nontaxable, retail investor or institutional investor) plays a role in determining the company’s dividend policy.
Why are dividend amounts usually less than retained earnings?
Dividend amounts are usually less than retained earnings for several reasons, including maintaining agreements with creditors and meeting state incorporation requirements.
What is one reason companies retain earnings instead of paying dividends?
To finance growth or expansion, companies may retain assets that would otherwise be paid out as dividends, often referred to as ‘plowing profits back into business.’
What is the purpose of smoothing out dividend payments?
Smoothing out dividend payments allows companies to accumulate dividends in good years and use those earnings for dividends in bad years.
What must management consider before declaring a dividend?
Management must consider the availability of funds to pay the dividend and ensure that both the present and expected future financial position warrant it.
What does the SEC encourage companies to disclose?
The SEC encourages companies to disclose their dividend policies in their annual reports, especially if they do not pay dividends or expect to pay them in the foreseeable future.
What is a liquidating dividend?
A liquidating dividend is a dividend not based on retained earnings.
What are the types of dividends?
Cash Dividends, Property Dividends, Liquidating Dividends, Stock Dividends.
How do dividends affect stockholders’ equity?
All dividends, except stock dividends, reduce stockholders’ equity.
What is the process for declaring cash dividends?
The board votes by resolution to declare a dividend.
What are cash dividends based on?
Cash dividends are based on the number of dividends outstanding.
What is a declared cash dividend considered?
A declared cash dividend is a liability, typically a current liability.
How are cash dividends typically declared?
Cash dividends are typically declared as a certain percent of par, or an amount per share.
Do companies declare or pay cash dividends on treasury stock?
No, companies do not declare or pay cash dividends on treasury stock.
What is the goal of growth companies regarding cash dividends?
Growth companies pay little or no cash dividends to use funds to expand internally.
What is recorded on the date of declaration?
At declaration: Debit Retained Earnings (or Cash Dividend declared), Credit Dividends Payable.
What happens on the date of record?
At date of record - no entries. Need to know who owns the stock on this date.
What is recorded on the date of payment?
At date of payment: Debit Dividends Payable, Credit Cash.
Who has priority in dividend distributions?
Preferred shareholders have priority over common shareholders.
What are property dividends?
Dividends payable in assets of the corporation other than cash, such as merchandise, real estate, or investments.
What should a company do when distributing property dividends?
RESTATE AT FAIR VALUE the property and recognize any gain or loss.
How are equity investments recorded when paying a dividend?
At date of declaration:
Equity Investments (Adjust to fair value) $100,000
Unrealized Holding Gain or Loss - Income $100,000
Retained Earnings (Property Dividend declared) $500,000
Property Dividends Payable $500,000
At date of record:
Property Dividends Payable $500,000
At date of payment:
Equity Investments $500,000
What is a liquidating dividend?
A return to stockholders of a portion of their original investment, based on something other than retained earnings.
How do liquidating dividends affect paid-in capital?
Liquidating dividends reduce paid-in capital.
What does depletion represent in the context of stockholder’s investment?
Depletion represents a return of part of the stockholder’s investment.
How do companies in extractive industries typically pay dividends?
Companies might pay dividends equal to the total of accumulated income.
What is an example of a dividend issued by a mining company?
A mining company issues a dividend to common stockholders of $1.0 million, noting $750,000 is income for shareholders which reduces retained earnings. The remainder is a return of capital (liquidating dividend).
What is a stock dividend?
A stock dividend has no effect on total stockholders’ equity and involves the issuance of stock to existing stockholders on a pro-rata basis, with no consideration.
What is the purpose of a stock dividend?
A stock dividend allows management to capitalize earnings to retain them in the business permanently.
What is a small stock dividend?
A small stock dividend is when the dividend is less than 20-25% of the common shares outstanding at the time of declaration, using the fair value option.
How is the fair value of a small stock dividend recorded?
The fair value of the stock issued is transferred from retained earnings.
What is a large stock dividend?
A large stock dividend is when the dividend is 20-25% of the number of shares previously outstanding, using par value.
How is the par value of a large stock dividend recorded?
Par value is transferred from retained earnings to capital stock.
How do stock dividends affect assets or liabilities?
Stock dividends don’t affect any asset or liability.
What do stock dividends reflect in terms of stockholders’ equity?
Stock dividends reflect a reclassification of stockholders’ equity without changing the total.
What happens to shareholders’ ownership in a stock dividend?
Each shareholder retains ownership of the same pro-rata share.
What effect does a stock dividend have on the total number of shares outstanding?
A stock dividend increases the total number of shares outstanding but doesn’t decrease the par value.
Are there any restrictions on issuing stock dividends on treasury stock?
Some states prohibit issuance of stock dividends on treasury stock.
What defines a large stock dividend?
Large stock dividends are dividends where more than 20-25% of the number of previously outstanding shares are issued.
What happens to the total par value of outstanding shares with large stock dividends?
It increases the total par value of outstanding shares.
How do stock dividends affect the marketability of a stock?
Stock dividends increase the marketability of a stock.
What is the accounting entry for a small stock dividend?
At date of declaration, the entry is:
Retained Earnings: 12,500
Common Stock Dividend Distributable: 10,000
Paid-In Capital in Excess of Par - Common Stock: 2,500
Example: If a company has 1,000 shares of $100 par value common stock and $100,000 of retained earnings, and declares a 10% stock dividend, issuing 100 additional shares at a fair value of $125.
How are common stock dividends distributable reported on the balance sheet?
Common stock dividends distributable are reported on the balance sheet as an adder to common stock.
What is the accounting entry for a large stock dividend?
At date of declaration, the entry is:
Retained Earnings: 2,500,000
Common Stock Dividend Distributable: 2,500,000
Example: If a company has 1,000,000 shares of $10 par value common stock with a fair value of $200 per share and declares a 25% stock dividend.
What is a stock split?
A method to reduce the market value of shares so they are within the range of the majority of potential investors.
What accounting entries are required for stock splits?
Requires no entries from an accounting standpoint except a memorandum note to indicate the changed par value and increased number of shares.
What happens in a two-for-one stock split?
A two-for-one split doubles the number of shares and cuts the price in half.
What is a reverse stock split?
A reverse stock split combines shares and increases the stock price.
Do stock splits affect retained earnings?
Stock splits have no effect on retained earnings.
Where is Stockholders’ Equity presented?
Stockholders’ equity is presented on the Balance Sheet and on the Statement of Stockholders Equity.
What are the components of Stockholders’ Equity presentation?
- Balance at beginning of period
- Additions
- Deductions
- Balance at end of period
What is becoming popular for the presentation of changes in Stockholders’ Equity?
A columnar format for the presentation of changes is becoming popular.
What should companies disclose regarding Stockholders’ Equity?
Companies should disclose changes in the separate accounts comprising stockholders equity.
What are the two main sections of Stockholders’ Equity?
The two main sections are Contributed Capital and Retained Earnings.
What should be disclosed regarding restrictions on retained earnings?
Restrictions on retained earnings should be disclosed in notes.
What should be described about restrictions on retained earnings?
Describe amounts and nature of restrictions, and amounts unrestricted.
What are some reasons for placing restrictions on retained earnings?
Restrictions can be placed by the company for future expansion, to maintain working capital, for creditor requirements, etc.
How do analysts use Stockholders’ Equity ratios?
Analysts use stockholders’ equity ratios to evaluate a company’s profitability and long-term solvency.
What is the Return on Common Stock Equity Ratio also known as?
It is also known as Return on Equity, or ROE.
How is ROE calculated?
ROE = (Net Income - Preferred Dividends) / Average Common Stockholders’ Equity.
What does a higher ROE indicate?
Higher ratios are better for stockholders.
What does ROE measure?
ROE measures profitability from the common stockholders’ viewpoint.
What is the Payout Ratio?
Payout Ratio = Cash Dividends / (Net Income - Preferred Dividends).
What does the Payout Ratio indicate?
It is the ratio of cash dividends paid to common stockholders to net income available to common stockholders.
How is Book Value per Share (BVPS) calculated?
BVPS = Common Stockholders’ Equity / Outstanding Shares.
What does BVPS represent?
The amount each share would receive if the company were liquidated, based on the amounts reported in the balance sheet.
What complicates the calculation of BVPS when preferred stock is present?
It becomes more complicated when there is preferred stock; you have to remove amounts owed to preferred stockholders before calculating, including dividends in arrears.
What is book value per share based on?
Book value per share is based on common shares outstanding.
What are Dilutive Securities?
Securities that are not common stock but allow the owner to obtain common stock upon exercise of an option or a conversion privilege.
What are the most common examples of dilutive securities?
Stock options, warrants, convertible debt, and convertible preferred stock.
What are the three types of dilutive securities?
- Stock options (Equity)
- Preferred stock (convertible into common stock) (Equity)
- Convertible securities (convertible into common stock) (Equity unless it’s a bond (liability))
How are convertible bonds classified?
As a liability that can be changed into other corporate securities during a specific time period after issuance.
What are the two main reasons to issue convertible bonds?
- To raise equity capital without giving up more ownership control than necessary.
- To obtain debt financing at cheaper rates.
How is accounting for convertible bonds recorded at the time of issuance?
Record like straight debt issues. Amortize any discount or premium.
Debit Cash, Debit a Discount on Bonds Payable - or - Credit a Premium on Bonds Payable, Credit Bonds Payable.
How is accounting for convertible bonds recorded at the time of conversion?
Use the book value method to record the conversion. Recognize no gain or loss upon conversion and record it at the carrying amount of the bond.
What are stock warrants?
Long-term options to buy common stock at a fixed price.
What do stock warrants entitle the holder to do?
Acquire shares of stock at a certain price within a stated period.
What is the dilutive effect of stock warrants?
Warrants reduce earnings per share like the conversion of convertible securities.
What are the three situations when warrants are issued?
- To make security more attractive. 2. As evidence of the preemptive right. 3. As compensation.
What is the typical life of a stock warrant?
Usually five years, occasionally 10 years.
How are proceeds allocated between securities?
Based on fair market values.
What are the two methods of allocation for stock warrants?
- Proportional method. 2. Incremental method.
What is the Proportional Method?
A method to determine the value of bonds without warrants and allocate proceeds based on aggregate fair values.
How do you calculate the total fair market value of bonds and warrants?
Total Fair Market Value is calculated by adding the fair market value of bonds and warrants.
How do you calculate the proportion of bonds and warrants?
Divide the fair market value of bonds by the total fair market value to find the percentage for bonds and the remainder for warrants.
What is the Incremental Method?
Used when a company cannot determine the fair value of either the warrants or the bonds, allocating the remainder to the unknown security.
How do you allocate the purchase price when the market price of warrants is unknown?
Use the fair value of the security that can be determined and allocate the remainder to the security with unknown fair value.
What is a debt security?
A financial instrument that represents a loan made by an investor to a borrower.
What are nondetachable warrants?
Warrants that are recorded as debt and do not require allocation of proceeds between bonds and warrants.
How are proceeds recorded for nondetachable warrants?
The entire proceeds are recorded as debt without allocating any proceeds to equity features.
What is a Stock Right?
Rights to subscribe to additional shares to prevent dilution of voting rights without consent.
What is the preemptive right of existing stockholders?
Existing stockholders have the right to purchase newly issued shares in proportion to their holdings.
What is the typical pricing for Stock Rights?
The price is normally less than the current price of shares.
When do companies make an entry for Stock Rights?
Companies only make a memorandum entry when they give rights and only make an entry when the right is exercised.
What is the duration of warrants for stock rights?
Warrants for stock rights are typically of short duration.
What are Stock Options?
Options given to key employees to purchase common stock at a given price over an extended period of time.
What are effective compensation programs based on?
Base compensation on performance, motivate employees, help retain executives and recruit new talent, and maximize after-tax benefits.
What is the major reporting issue for stock-option plans?
Use the Fair Value Method for Compensation Cost.
What does GAAP require for recognizing compensation?
GAAP requires companies to recognize compensation using the fair value method.
How is the fair value of stock options determined?
Companies use acceptable option-pricing models to value the options at the date of the grant.
How does IFRS treat share-based compensation?
IFRS follows the same model as GAAP for recognizing share-based compensation.
What are the two main accounting issues for stock-option plans?
- How to determine compensation expense
- Over what periods to allocate compensation expense
How is total compensation expense determined under the fair value method?
Total compensation expense is based on the fair value of options expected to vest on the grant date.
How should fair value be estimated?
Estimate fair value using an option pricing model with adjustments for unique factors.
When should compensation expense be recognized?
Compensation expense should be recognized in the periods in which the employees perform the service.
What is the service period in relation to stock options?
The service period is also the vesting period unless otherwise specified.
What happens to compensation expense upon expiration of options?
A company does not adjust compensation expense upon expiration of the options.
What should a company do if an employee forfeits stock options?
The company should adjust the estimate of compensation expense for the current period as a change in estimate.
What are shares transferred to employees subject to restrictions?
Restricted Stock until vesting occurs. Subject to forfeiture if vesting conditions are not met.
How is restricted stock recorded?
Record at Fair Value.
What is a major advantage of restricted stock?
Restricted stock never becomes completely worthless.
How does restricted stock compare in size to stock options?
Restricted stock is one third the size of stock options, because restricted stock has more value.
What is another advantage of restricted stock?
Restricted stock generally results in less dilution to existing stockholders.
How does restricted stock align employee incentives?
Better aligns employee incentives with company incentives. Holder is essentially a stockholder and should be interested in long-term objectives of the company.
What is reported as part of stockholders’ equity?
Unearned compensation.
What are Employee Stock Purchase Plans?
Plans that generally permit all employees to purchase stock at a discounted price for a short period of time.
What is the purpose of Employee Stock Purchase Plans?
To secure equity capital or to induce widespread ownership of common stock among employees.
How is the compensation element measured in Employee Stock Purchase Plans?
Measure the compensation element on the date on which the employee is granted the option.
When are Employee Stock Purchase Plans considered compensatory?
Unless they satisfy all three of these conditions: 1. Substantially all full-time employees may participate on an equitable basis.
What are Employee Stock Purchase Plans?
Employee Stock Purchase Plans allow employees to purchase stock at a discounted price for a short period of time.
What is the purpose of Employee Stock Purchase Plans?
They are used to secure equity capital or to induce widespread ownership of common stock among employees.
What conditions must be satisfied for plans to be considered compensatory?
- Substantially all full-time employees may participate on an equitable basis.
- Discount from market is small, not exceeding the per-share amount of cost avoided.
- Plan offers no substantive option feature.
How should compensation expense be recorded?
Compensation expense should be recorded over the service life of the employees.
What disclosures are required for compensation plans?
Companies must disclose the status of plans, the nature and terms of arrangements, effects on shareholders, the impact on the income statement, fair value estimation methods, and cash flow effects.
What was controversial about the fair value method for accounting for stock options?
It results in greater compensation costs compared to the intrinsic value model, leading many companies to resist its use.
What is the intrinsic value method?
The intrinsic value is the actual value of an asset based on its true value, which may differ from the current market value.
What is the FASB’s stance on accounting for stock options?
FASB believes companies should follow the neutrality concept in accounting.
What is the effect of voluntary expensing of stock options?
Companies that voluntarily expensed stock options performed better in the market due to increased investor trust in transparent accounting.
What does earnings per share indicate?
Earnings per share indicates the earnings for each share of common stock and is generally reported below net income on the income statement.
How should earnings per share be disclosed when there are intermediate components of income?
Companies should disclose earnings per share for each component to help users recognize the effects on EPS from continuing operations versus irregular items.
What is the formula for Basic EPS?
Basic EPS = Net income / Number of Shares Outstanding
What is Earnings per Share in a Simple Capital Structure?
Only common stock, no potential common stock that could dilute earnings.
How do you calculate income available to common stockholders?
Subtract current year preferred stock dividend from net income.
For noncumulative, only subtract if they are declared. Preferred dividends are subtracted on cumulative preferred stock whether they are declared or not.
What is the formula for EPS?
EPS = (Net Income - Preferred Dividends) / Weighted Avg Number of Shares Outstanding
How is the Weighted Average Number of Shares Outstanding calculated?
Companies must weight the shares by the fraction of the period they are outstanding.
How should companies handle stock dividends and stock splits?
Companies need to restate shares outstanding before dividend or split, to calculate weighted avg.
When a stock dividend or stock split occurs, the additional shares are considered outstanding at the beginning of the earliest year reported.
How are stock dividends counted if issued midyear?
Count it for the full year because net assets don’t change in a stock dividend or split.
How do you restate prior amounts for a stock dividend or split?
For a 50% Stock dividend, restate prior amounts by 1.5. For a three way stock split, restate prior amounts by 3.
What is Earnings per Share in a Complex Capital Structure?
Includes securities that could have a dilutive effect on earnings per common share.
What defines a complex capital structure?
A complex capital structure exists when a corporation has convertible securities, options, warrants, or other rights that upon conversion or exercise could dilute earnings per share.
What do companies with complex capital structures report?
Both basic and diluted earnings per share.
How is Complex Earnings Per Share calculated?
Complex Earnings Per Share = Basic EPS - Impacts of Convertibles - Impacts of Options, Warrants &
What is the formula for Complex Earnings Per Share?
Complex Earnings Per Share = Basic EPS - Impacts of Convertibles - Impacts of Options, Warrants
None
What is the first step to calculate Complex EPS?
Calculate Basic EPS
None
What is the second step in calculating Complex EPS?
Adjust the denominator by adding shares assumed to be issued or required to be issued.
Weight them in.
What is the third step in calculating Complex EPS?
Adjust the numerator by adding back in interest because expense was eliminated (net of tax and prorated for midyear sales).
None
What is the formula for Basic EPS?
(Net income - Preferred dividends (for current year only)) / Weighted avg of Shares Outstanding
None
What are antidilutive securities?
Antidilutive securities are securities that upon conversion or exercise INCREASE EPS.
Companies will not report dilutive EPS if securities are antidilutive.
What should companies report if securities are antidilutive?
Companies report only the basic number.
This is based on the principle of conservatism.
What to do if the conversion rate on a dilutive security changes during the period?
Use the most dilutive one.
None
How should Convertible Preferred Stock be treated in EPS calculations?
Do not subtract preferred dividends from net income in computing the numerator because it is assumed to be converted to common shares.
None
What does the Diluted EPS calculation consider?
Diluted EPS calculation considers convertible bonds, convertible preferred stock, stock warrants/options, and other dilutive securities.
None
What is the if-converted method for Diluted EPS?
Measure the dilutive effects of potential conversion on EPS using the if-converted method, assuming conversion is at the beginning of the period and related interest is eliminated net of tax.
None
What to do if a security has multiple conversion factors for different years?
Use the biggest one.
None
What happens before exercising options and warrants?
You have to pay money to the company, which is assumed to be used to buy back common stock.
None
What is the effect on shares when options and warrants are exercised?
Shares go up by the number exercised, then down by the number the company buys back.
The incremental increase is the difference.
How are options treated in the EPS calculation?
Options don’t pay dividends, so just add the amount to the denominator and re-calculate.
Remember to prorate if the option happens mid-year.
What does it mean if the exercise price exceeds the market price?
The transaction would be antidilutive.
None
What does the Treasury Stock Method assume?
Exercise options and warrants at the beginning of the year, and the company uses proceeds to buy back common stock for treasury.
Number of shares goes up and then down.
How do you calculate shares assumed purchased using the Treasury Stock method?
Proceeds if shares issued / average market price = Shares assumed purchased.
What is the formula for calculating the change in the number of outstanding shares?
Shares assumed issued - Shares assumed purchased = Incremental Share Increase.
What does the Treasury Stock method use to calculate the number of common shares repurchased?
The proceeds assumed to be received upon exercise of the options and warrants.
What is a Contingent Issue Agreement?
When a company promises to issue more shares if a certain stock price is met.
What should a company show in EPS for Complex Capital Structure?
Per share amounts for income from continuing operations, discontinued operations, income before extraordinary items, and net income.
What additional disclosures are required for EPS calculations?
- Description of pertinent rights & privileges of outstanding securities.
- Reconciliation of numerators and denominators of basic and diluted computations.
- Effect given to preferred dividends in determining income available for common stockholders.
- Securities that could potentially dilute basic EPS in the future that were excluded because they are antidilutive.
- Effect of conversions subsequent to year-end but before statements were issued.
What are Stock-appreciation rights (SARs)?
Company gives an executive the right to receive compensation equal to the share appreciation.
How is share appreciation defined in a SARs plan?
Share appreciation = excess of the market price of the stock at the date of exercise over a pre-established price.
How may a company pay the share appreciation in a SARs plan?
In cash, shares, or a combination of both.
Does the executive have to make a cash outlay at the date of exercise in a SARs plan?
The executive often does not have to make a cash outlay at the date of exercise.
What does the company do instead of issuing shares in a SARs plan?
The company awards the executive cash or stock having a fair value equivalent to the appreciation.
What is share appreciation?
Share appreciation is the excess of the market price of the stock at the date of exercise over a pre-established price.
How can a company pay share appreciation?
The company may pay the share appreciation in cash, shares, or a combination of both.
How does accounting for stock-appreciation rights (SARs) depend on classification?
Accounting for SARs depends on whether the company classifies the rights as equity or a liability.
When do taxes apply for executives under SARs?
An executive pays taxes at the time of exercise, unlike in an incentive stock option plan.
How are SARs classified as equity awards?
Companies classify SARs as equity awards if, at the date of exercise, the holder receives shares of stock from the company upon exercise.
What do holders receive under SARs?
Holders receive an amount equal to the share-price appreciation.
How does a company determine fair value for SARs?
The company determines the fair value at the date of grant and allocates the amount to compensation expense over the service period of the employee.
How are SARs classified as liability awards?
Companies classify SARs as liability awards if, at the date of exercise, the holder receives a cash payment.
What happens to compensation expense for liability awards?
Compensation expense changes as the value of the liability changes.
What model is used to estimate fair value for SARs?
Use an option-pricing model to estimate fair value and record expense or decrease in expense at the end of each period.
What is the percentage approach for charging compensation expense?
Charge % equal to Year # / Total Years less prior expense amount in each year.
How is compensation expense adjusted if the exercise date is later than the service period?
Adjust compensation expense whenever a change in market price of stock occurs in subsequent reporting periods, until the rights expire or are exercised.
Can cumulative compensation expense be negative?
Cumulative compensation expense cannot be negative.
