Final Exam (New Material)

Question 1

Stock Warrants

Answer 1

• Give holder the option to buy a share of stock at a fixed price
• Bundled or sold with other securities at a single price
• Warrant typically specifies earliest and latest date purchase is allowed

Question 2

Why issue stock warrants?

Answer 2

• Provide equity kicker
• Given to current stockholders when substantial new stock issue is going to be made
• Issued to employees as compensation (stock options)
• Important dates: announcement, issuance, and exercise dates

Question 3

Warrants issued with other Securities

Answer 3

• This only applies when warranty is separable (if inseparable, treat as convertible security)
• To assess separate value, determine MV of bonds without warratns and MV of separable stock options

Question 4

2 methods for separable warrants/securities:

Answer 4

• Proportional method: used if the FMV of both security and warrant can be readily estimated
• Incremental method: used if the FMV of wither the bond and warrant cannot be estimated easily

Question 5

Noncompensatory Plan

Answer 5

• Intent to encourage employee ownership, not to provide incentive compensation
• Enables employees to purchase the firm’s stock as a slight discount
• Criteria: specified purchase price, discount cannot exceed 5%, all full-time employees can participate
• Accounted for like normal stock purchases

Question 6

Compensatory Plans

Answer 6

• Companies give employees shares of stock, stock options, or compensation based on price appreciatio
• Employee has the right to buy at pre-specified amount

Question 7

Service period

Answer 7

Time between grant date and vesting date`

Question 8

Out of the money/in the money

Answer 8

market price is lower/market price is higher

Question 9

APB 25 Implications

Answer 9

• Assumed that out of the money options held no value (did not have to disclose)
• Large amounts of stock were issued and no compensation expense recognized

Question 10

Are stock options costless?

Answer 10

The value of the shares held by existing shareholders is “diluted” by issuing stock for prices below the current market price. This dilution should be reflected on the company’s balance sheet

Question 11

FMV Method Total compensation cost

Answer 11

• Value of options on day of grant

- Allocated to expense during the service period

Question 12

Estimated Total Compensation Cost (TCC)

Answer 12

TCC = FVN(1-FR)^SP
FV = fair value of each option (remains constant throughout service period)
N = number of options awarded
FR = expected annual rate of option forfeiture (updated based on actual forfeiture, reuslts in new TCC)
SP = service period in years
***Stock option valuation on the date of grant, do not update that value, but update forfeiture rate

Question 13

Catch up approach

Answer 13

Based on new TCC, estimate how much compensation cost should have been expensed to date and make entry to bring total cost recognized to this

Question 14

Qualified vs. non-qualified

Answer 14

Employee doesnt pay taxes until selling the share if qualified but employer cannot take deduction
**Qualified or nonqualified affects the accounting for taxes

Question 15

Qualified Plans

Answer 15

• Referred to as “incentive stock option plans”
• Reserved for top executive because no tax benefit received
• VERY beneficial for the option holders
• These cannot be issued in the money

Question 16

Nonqualified plans

Answer 16

• Most common option offered to employees
• Can be issued in or out of the money
• Market - exercise * shares is considered taxable income for employees and firm recognizes as taxable expense
• Tax advantage for firms

Question 17

Deferred taxes with options plans

Answer 17

If nonqualified, must account for effects on compensation cost which will create a DTA

Question 18

Unexercised expired options

Answer 18

The accounting for any vested options that expire is back out DTA, record tax expense, reclassify APIC to APIC expired stock options

Question 19

Stock Appreciation Rights

Answer 19

• Give holder a payment of either cash or equivalent shares of stock equal to increase in firm’s stock price over a set price
• SAR’s avoid having employees pay the exercise price to receive the option benefits

Question 20

Earnings per share

Answer 20

• Net income alone is not appropriate performance measure

- EPS is a way of evaluating amount of capital that was used to generate income

Question 21

If shares issued at market price:

Answer 21

NO DILUTION

Question 22

If shares issued below market price:

Answer 22

DILUTION

Question 23

Basic EPS

Answer 23

Based on weighted average of shares actually outstanding

Net income - preferred / weighted average shares outstanding

Question 24

Dilutive EPS

Answer 24

Based on revised calculations of shares outstanding if all possible dilutive conversions occured
-Worst case scenario for common shareholders

Question 25

Complex capital structure

Answer 25

Contains financial instruments to allow holder to purchase common stock as pre-specified price that is potentially less than market value

Question 26

ME

Answer 26

Rank by marginal effect starting by closest to 0

Question 27

Operating activities

Answer 27

Normal operations of the business (business revenues and related expenses)
-Includes interest expense on loans, interest or dividends received
=NI - CA + CL

Question 28

Investing activities

Answer 28

Purchase and sale of LONG TERM assets and investments (typically non current and some current related to investment securities)
-Purchase/sale of PPE, purchase/sale of investment securities, making loans to other or collecting loans
=Change in NCA

Question 29

Financing activities

Answer 29

Typically noncurrent liabilities, current liabilities related to loans
-Borrowing and repayment of loan principal, issuing or repurchasing own stock, dividends to shareholders
=NCL + CC - Div

Question 30

Operating indirect method

Answer 30

Net income + change in current liab - change in current assets + depreciation +/- other non cash items