Third Exam Flashcards
Stock options
The right to purchase stock at a predetermined “exercise” price over some number of years
Are stock options an expense?
Yes (controversial though - people argo that on exercise price there is no gain or loss)
Why would companies give stock options?
Allows higher salaries, aligns interest of employees and shareholders (higher profitability), start-ups want to conserve cash
Current Shareholder Valuation
Shareholders are joined by the new shareholders that hold options
MV=PV of dividends - MV of outstanding options
Current Option Holders
How much of the firm will shareholders give up because of the options?
MV=FMV of outstanding options at year end (vested and expected to be vested)
MV of Common Stock
- Discount dividends on expected earnings AFTER deducting stock option expenses
- Then subtract FMV of outstanding options
FMV per option = 15.34
2738 options expected to vest
The expense recognized over the vesting period = 42000
Employees exercise 1/2 of the options (1396) that vested in 2014 when the stock price is $120
When options are issued…
The total market value of the options is $42,000. This cost is expensed over the vesting period of the options
FMV per option = 15.34
2738 options expected to vest
The expense recognized over the vesting period = 42000
Employees exercise 1/2 of the options (1396) that vested in 2014 when the stock price is $120
Over the vesting period…
In each year, debit compensation expense for $14,000, credit APIC for $14,000
So over the 3 year vesting period the total compensation expense will be $42,000 and so will the APIC
FMV per option = 15.34
2738 options expected to vest
The expense recognized over the vesting period = 42000
Employees exercise 1/2 of the options (1396) that vested in 2014 when the stock price is $120
When employees exercise options…
Options exercised represent half of the vested options, so reclassify half of the APIC (21,000)
Debit cash for 73,926 (1369*54), debit APIC for 21,000, and credit common stock for 94,926
Why do stock options appear on the Consolidated Statement of Cash Flows?
They do not require cash outflows, so they need to be “added back”
Tax benefits from stock-based awards
The company gets a tax deduction upon exercise of the difference between the stock price and the exercise price
Parent’s percentage ownership of the subsidiary…less than 20%
The investment is recorded at market value on the balance sheet
Dividends and changes in fair value appear on the income statement as other income
FAIR VALUE METHOD
(Passive Investment)
Parent’s percentage ownership of the subsidiary…between 20% and 50%
The investment appears on the balance sheet at the original cost + share of subsidiary’s income - share of dividends
Income = share of sub’s income (one line consolidation)
EQUITY METHOD
(The company exercises some control over the subsidiary)
Parent’s percentage ownership of the subsidiary…over 50%
The parent and the sub’s financial statements are combined.
“Non-controlling interest” subtracts the portion of the subsidiary the parent does not own.
The net income impact is similar to the one-line consolidation scenario. (The net income impact is similar to the one-line consolidation scenario)
Variable Interest Entities Problem
VIEs may be designed to manage earnings, but it is hard to detect. By contrast, you may be able to detect inventory misstatement by analyzing the balance sheet and the income statement.
