1. Intermediate Accounting - Chapter 16
4/17/2017
CHAPTER 16
Dilutive Securities
and Earnings per Share
……..…………………………………………………………...
Convertible Bonds
exchanged for stock at the bond holder’s option
increases the value of the bond
a “sweetener” might be offered to induce conversion

2. ACCOUNTING FOR CONVERTIBLE DEBT
At Time of Issuance
recorded like a straight debt issue
no value allocated to conversion privilege
FASB considers the privilege inseparable from the bond
Cash ,000
Bonds Payable 100,000
Premium on Bonds Payable 6,000

3. At Time of Conversion
stock is recorded at book value of the converted bonds
Bonds Payable
100,000
Premium Bond Pay
6,000
1,000
5,000

4. This is the same whether or not there is a sweetener.
Induced Conversions
record the “sweetener” as an expense
Debt Conversion Expense 7,000
Bonds Payable 100,000
Premium on Bonds Payable 5,000
Common Stock 20,000
Paid-in Cap – excess of par 85,000
Cash 7,000
This is the same whether or not there is a sweetener.

5. Retirement of Convertible Debt
recorded like a straight debt retirement
Clear-out the balances of bonds and premium.
Not an extraordinary item

6. CONVERTIBLE PREFERRED STOCK
at conversion, common stock is recorded at book value of the converted preferred
Preferred Stock
250,000
Add. Paid-in Capital
40,000

7. STOCK WARRANTS options to buy shares of stock at a certain price
warrants are issued
with bonds or preferred stock as an “added bonus”
to common stockholders with a preemptive right
to executives and employees

8. Warrants Issued with Other Securities
Example
Sold 500 $1,000 bonds for $505,000. Included with each bond is a 5-year warrant to buy 1 share of common for $25.
Incremental Method
Assume the market value of each warrant is $30 and the market value of the bonds (alone) is unknown.

9. Proportional Method
Assume the market value of each warrant is $30 and the market value of each bond is $990.
Mkt Value Book Value
Bonds $495,000
Warrants 15,000

10. STOCK COMPENSATION PLANS
Effective Compensation
motivate performance
compensation tied to performance
performance over which employee has control
short- and long-term performance
retain and recruit executives
Stock price is thought to be
better that Sales or other
accounting measures.
Stock options are very
attractive to managers.

11. What is the value of an option to buy 1 share of stock at $100?
The Expected Value of a Share of Stock
Possible
Stock Values Probability
$80 10%
$90 20%
$100 40%
$110 20%
$120 10%
$ 8 18 40 22 12
Expected value $100
What is the value of an option to buy 1 share of stock at $100?

12. The Value of a Stock Option
Possible Value of Option
Stock Values Probability to buy at $100
$80 10%
$90 20%
$100 40%
$110 20%
$120 10%
$0 $ 0
$0 0
$10 2 $
Expected value $ 4
An option to buy has value.

13. The Value of Volatility
Possible Value of Option
Stock Values Probability to buy at $100
$60 10%
$80 20%
$100 40%
$120 20%
$140 10%
$0 $ 0
$0 0
$20 4 $
Expected value $ 8

14. Accounting for Stock Compensation
Valuation
intrinsic value method: excess of market price over exercise price
fair value method: estimated value of options expected to vest
value generally measured at grant date
FASB now requires fair value method
Allocation of expense
expense recognized in the service period
generally service period = vesting period

15. 2-year service period beginning on the grant date.
Exercise (Modified)
Columbo Company adopted a stock option plan: options to buy 30,000 shares of $10 par common stock at $40.
Options were exercisable 2 years after grant date. Value of options was $450,000.
November 1, Plan adopted
no entry
2-year service period beginning on the grant date.
January 2, Options granted
no entry

16. December 31, 2008 (first year of service period completed)
December 31, (second year of service completed)

17. January 3, 2010 20,000 options were exercised
January 2, ,000 options expired

18. DISCLOSURE OF COMPENSATION PLANS
number and weighted average fair value of options
granted
exercised
forfeited
outstanding
average remaining life of options outstanding

19. EARNINGS PER SHARE – SIMPLE
Net Income - Preferred Dividends
Weighted Average Shares Outstanding
EPS =
Current year preferred dividend or
Dividend that should have been declared
if the preferred stock is cumulative

20. Weighted Average Shares Outstanding
1/1 – 4/1 90,000
4/1 – 7/1 120,000
7/1 –11/1 81,000
11/1 – 12/31 141,000
Dates Shares Fraction
Outstanding Outstanding of Year
New stock issued
Stock repurchased

21. Weighted Average with Stock Dividend or Split
# Shares
1/1 Beginning balance 80,000
3/1 Issued 30,000 shares 110,000
8/1 2 for 1 stock split 220,000
10/1 Purchsd 20,000 shares 200,000
Dates Shares Fraction
Outstnd Outstnd Rstmt of Year
1/1 – 3/1
3/1 – 10/1
10/1 – 12/31

22. EARNINGS PER SHARE – COMPLEX
Dilutive securities have an adverse effect on EPS
convertible securities
options or warrants
Firms must report both Basic EPS and Dilutive EPS

23. Convertible Securities: If-Converted Method
1/1 Beginning balance: 200,000 shares common
5/1 Issued $500,000, 8% bonds for $535,530 (effective interest = 7%) convertible into 24,000 shares common
Net Income (net of 40% tax): $350,000
Net Income $350,000
Add: Bond interest (net of tax)
$535,530 x 7% x 8/12 $24,991
Less: 40% tax 9, ,994
Adjusted net income $364,994

24. 1/1 Beginning balance: 200,000 shares common
5/1 Issued $500,000, 8% bonds for $535,530 (effective interest = 7%) convertible into 24,000 shares common
Net Income (net of 40% tax): $350,000
Dates Shares Out Fraction
Outstanding if Converted of Year
1/1 – 5/1
5/1 – 12/31
Basic EPS =
Diluted EPS =

25. Any security that increases EPS should be excluded.
Antidilutive Convertible Securities
Outstanding for the year:
500,000 shares common
$1,000,000, 10% bonds issued at par convertible into 50,000 shares common
Net Income (net of 30% tax): $600,000
Bond interest (net of tax)
$1,000,000 x 10% x ( ) $70,000
Basic EPS =
“Diluted” EPS =
Any security that increases EPS should be excluded.

26. Options and Warrants: Treasury Stock Method
Options and warrants are dilutive if the exercise price is lower than the market price.
Increases the potential shares outstanding.
No effect on net income.
Market Price - Option Price
Market Price
Potential
Add. Shares =
x # of Options
$ $30
$50 =
x 1,500 =
Basic EPS =
Diluted EPS =

27. EPS Presentation
Exercise 16-18

28. Old approach that some firms follow.
STOCK OPTIONS - OTHER STUFF
APB Opinion #25
Old approach that some firms follow.
Incentive Stock Options
Nonqualified Options
Tax advantages to employee
Tax advantages to firm
option price = market price on grant date
option price is usually less than market price
no compensation expense
compensation expense = mkt price - option price

29. Stock Appreciation Rights
right to receive compensation equal to the market price over a pre-established price
at the end of each year of the service period
estimate total SAR compensation (market price - pre-established price) x # of rights
multiply by % compensation accrued
bring cumulative compensation up to date
This might mean recording negative compensation in some years.
Estimate of total compensation will change from year to year.