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Learning Objectives
1. Describe the accounting for the issuance, conversion, and retirement of convertible securities. Explain the accounting for convertible preferred stock. Contrast the accounting for stock warrants and for stock warrants issued with other securities. Describe the accounting for stock compensation plans under generally accepted accounting principles. Discuss the controversy involving stock compensation plans. Compute earnings per share in a simple capital structure. Compute earnings per share in a complex capital structure.
2. 3.
4.
5. 6. 7.
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Stock Options
Convertible Securities
Preferred Stock
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+
Privilege of Exchanging it for Stock
(at the holders option)
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LO 1 Describe the accounting for the issuance, conversion, and retirement of convertible securities.
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LO 1 Describe the accounting for the issuance, conversion, and retirement of convertible securities.
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LO 1 Describe the accounting for the issuance, conversion, and retirement of convertible securities.
Cash
Discount on bonds payable Bonds payable
($4,000,000 x 99% = $3,960,000)
3,960,000
40,000 4,000,000
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LO 1 Describe the accounting for the issuance, conversion, and retirement of convertible securities.
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LO 1 Describe the accounting for the issuance, conversion, and retirement of convertible securities.
1,000,000
970,000
LO 1 Describe the accounting for the issuance, conversion, and retirement of convertible securities.
Issuer wishes to encourage prompt conversion. Issuer offers additional consideration, called a sweetener.
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LO 1 Describe the accounting for the issuance, conversion, and retirement of convertible securities.
Bonds payable
Discount on bonds payable Common stock (2,000 x 50 x $10) Additional paid-in capital Debt conversion expense Cash
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2,000,000
30,000 1,000,000 970,000 70,000 70,000
LO 1 Describe the accounting for the issuance, conversion, and retirement of convertible securities.
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LO 1 Describe the accounting for the issuance, conversion, and retirement of convertible securities.
When preference shares are converted or repurchased, there is no gain or loss recognized.
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20,000
40,000
Stock Warrants
Warrants are certificates entitling the holder to acquire shares at a certain price within a stated period. Normally arises under three situations: 1. To make the security more attractive.
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LO 3 Contrast the accounting for stock warrants and for stock warrants issued with other securities.
Stock Warrants
Stock Warrants Issued with Other Securities
Basically long-term options to buy common stock at a fixed price.
Generally life of warrants is five years, occasionally ten years. Proceeds allocated between the two securities.
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Stock Warrants
Proportional Method
Determine:
1. value of the bonds without the warrants, and 2. value of the warrants.
The proportional method allocates the proceeds using the proportion of the two amounts, based on fair values.
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LO 3 Contrast the accounting for stock warrants and for stock warrants issued with other securities.
Stock Warrants
BE16-4: Margolf Corp. issued 2,000, $1,000 bonds at 101. Each bond was issued with one detachable stock warrant. After issuance, the bonds were selling in the market at 98, and the warrants had a market value of $40. Use the proportional method to record the issuance of the bonds and warrants.
Bonds Warrants
Number Amount Price 2,000 x $ 1,000 x $ 0.98 = $ 2,000 x $ 40 = Total Fair Market Value $ Bonds $ 2,020,000 96% $ 1,940,784 Warrants $ 2,020,000 4% $ 79,216
LO 3
Stock Warrants
BE16-4: Margolf Corp. issued 2,000, $1,000 bonds at 101. Each bond was issued with one detachable stock warrant. After issuance, the bonds were selling in the market at 98, and the warrants had a market value of $40. Use the proportional method to record the issuance of the bonds and warrants.
Cash
Discount on bonds payable Bonds payable Paid-in capital Stock warrants
2,020,000
59,216 2,000,000 79,216
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LO 3 Contrast the accounting for stock warrants and for stock warrants issued with other securities.
Stock Warrants
Incremental Method
Where a company cannot determine the fair value of either
the warrants or the bonds.
Use the security for which fair value can determined. Allocate the remainder of the purchase price to the security for which it does not know fair value.
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LO 3 Contrast the accounting for stock warrants and for stock warrants issued with other securities.
Stock Warrants
BE16-5: McCarthy Inc. issued 2,000, $1,000 bonds at 101. Each bond was issued with one detachable stock warrant. After issuance, the bonds were selling in the market at 98. The market price of the warrants, without the bonds, cannot be determined. Use the incremental method to record the issuance of the bonds and warrants.
Number Amount Price 2,000 x $ 1,000 x $ 0.98 = $ 2,000 x = Total Fair Market Value $ Bonds $ 2,020,000 1,960,000 $ 60,000 Total 1,960,000 1,960,000 Percent 100% 0% 100%
Bonds Warrants
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LO 3 Contrast the accounting for stock warrants and for stock warrants issued with other securities.
Stock Warrants
BE16-5: McCarthy Inc. issued 2,000, $1,000 bonds at 101. Each bond was issued with one detachable stock warrant. After issuance, the bonds were selling in the market at 98. The market price of the warrants, without the bonds, cannot be determined. Use the incremental method to record the issuance of the bonds and warrants.
Cash
Discount on bonds payable Bonds payable Paid-in capital Stock warrants
2,020,000
40,000 2,000,000 60,000
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LO 3 Contrast the accounting for stock warrants and for stock warrants issued with other securities.
Stock Warrants
Conceptual Questions
Detachable warrants involves two securities,
a debt security,
Nondetachable warrants
no allocation of proceeds between the bonds and the warrants, companies record the entire proceeds as debt.
LO 3 Contrast the accounting for stock warrants and for stock warrants issued with other securities.
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Stock Warrants
Rights to Subscribe to Additional Shares
Share Rights - existing stockholders have the right
(preemptive privilege) to purchase newly issued shares in proportion to their holdings.
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LO 3 Contrast the accounting for stock warrants and for stock warrants issued with other securities.
Stock Warrants
Share Compensation Plans
Share Option - gives key employees option to purchase
ordinary shares at a given price over extended period of time. Effective compensation programs are ones that:
1. base compensation on performance
2. motivate employees, 3. help retain executives and recruit new talent,
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Stock Warrants
The Major Reporting Issue
FASB guidelines require companies to recognize
compensation cost using the fair-value method. Under the fair-value method, companies use acceptable option-pricing models to value the options at the date of grant.
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LO 3 Contrast the accounting for stock warrants and for stock warrants issued with other securities.
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LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
Compensation expense based on the fair value of the options expected to vest on the date the options are granted to the employee(s) (i.e., the grant date).
Over the periods in which employees perform the servicethe service period.
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LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
executives options to purchase 2,000 shares each of the companys $1 par value common stock. The company grants the
options on January 1, 2012. The executives may exercise the options at any time within the next 10 years. The option price per share is $60, and the market price of the shares at the date of grant is $70 per share. Under the fair value method, the company computes total compensation expense by applying an acceptable fair value option-pricing model. The fair value option-pricing model determines Chens total compensation expense to be $220,000.
LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
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110,000 * 110,000
110,000 110,000
LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
162,000
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LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
* ($220,000 x 80%)
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LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
If an employee forfeits a stock option because the employee fails to satisfy a service requirement (e.g., leaves employment), the company should adjust the estimate of compensation expense recorded in the current period (as a change in
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LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
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LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
2. Vesting occurs if DeGeorge stays with the company for a fiveyear period. 3. The par value of the stock is $1 per share. Ogden makes the following entry on the grant date (January 1, 2012).
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LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
Unearned Compensation represents the cost of services yet to be performed, which is not an asset. Unearned Compensation is reported as a component of stockholders equity in the balance sheet.
LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
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Ogden records compensation expense of $4,000 for each of the next four years (2013, 2014, 2015, and 2016).
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LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
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LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
LO 4 Describe the accounting for stock compensation plans under generally accepted accounting principles.
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Preferred dividends are subtracted on cumulative preferred stock, whether declared or not.
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Illustration 16-10
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LO 6
convertible securities,
options, warrants, or other rights
that upon conversion or exercise could dilute earnings per share. Company reports both basic and diluted earnings per
share.
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Illustration 16-17
Companies will not report diluted EPS if the securities in their capital structure are antidilutive.
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Basic EPS
Net income = $1,860
=
Weighted average shares = 2,000
$.93
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Diluted EPS
$1,860 + $6,000 (1 - .40) $5,460
=
2,000
=
9,500
$.57
7,500
Revenues Expenses Bond interest expense (75 x $1,000 x 8% x 4/12) Income before taxes Income taxes (40%) Net income
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Diluted EPS
$4,260 + 2,000 $2,000 (1 - .40) $5,460
= +
7,500 x 4/12 yr. 4,500
= $1.21
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Basic EPS
Net income $1,200,000 Pfd. Div. $240,000*
= $1.60
Weighted average shares = 600,000
Diluted EPS
$1,200,000 $240,000 600,000
+ $240,000 + 200,000*
$1,200,000 800,000
$1.50
Basic EPS = 1.60
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*(40,000 x 5)
Diluted EPS
$1,200,000 $240,000 600,000
+ $240,000 + 120,000*
$1,200,000 720,000
$1.67
Basic EPS = 1.60
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*(40,000 x 3)
Diluted EPS
$1,200,000 $240,000 600,000
$1,200,000 720,000
$1.67
Basic EPS = 1.60
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*(40,000 x 3)
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Instructions
(a) Compute diluted earnings per share. (b) Assume the 1,000 options were issued on October 1, 2012 (rather than in 2011). The average market price during the last 3 months of 2012 was $20.
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Treasury-Stock Method
Proceeds if shares issued (1,000 x $8) Purchase price for treasury shares Shares assumed purchased Shares assumed issued Incremental share increase $8,000
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Diluted EPS
$40,000 10,000
+
= +
600
$40,000
= $3.77
10,600
Options
LO 7 Compute earnings per share in a complex capital structure.
Proceeds if shares issued (1,000 x $8) Purchase price for treasury shares Shares assumed purchased Shares assumed issued Incremental share increase Weight for 3 months assumed outstanding Weighted incremental share increase
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3/12 150
Diluted EPS
$40,000 $40,000
=
10,000
= $3.94
10,150
150
Options
Antidilution Revisited
Ignore antidilutive securities in all calculations and in computing diluted earnings per share.
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Income from continuing operations, Income before extraordinary items, and Net income.
Per share amounts for a discontinued operation or an extraordinary item should be presented on the face of the income statement or in the notes.
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3.
4.
5.
Securities that could potentially dilute basic EPS in the future that were excluded in the computation because they would be antidilutive.
Effect of conversions subsequent to year-end, but before issuing statements.
LO 7 Compute earnings per share in a complex capital structure.
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LO 7
Illustration 16-28
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LO 7
APPENDIX
16A
The company gives an executive the right to receive compensation equal to the share appreciation.
Share appreciation is the excess of the market price of the stock at the date of exercise over a pre-established price.
The company may pay the share appreciation in cash, shares, or a combination of both.
The accounting for stock-appreciation rights depends on whether the company classifies the rights as equity or as a liability.
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APPENDIX
16A
Holder receives shares in an amount equal to the share-price appreciation (the difference between the market price and the pre-established price).
At the date of grant, the company determines a fair value for the
SAR and then allocates this amount to compensation expense over the service period of the employees.
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APPENDIX
16A
2.
Remeasure the fair value each reporting period, until the award is
settled; adjust the compensation cost each period for changes in fair value pro-rated for the portion of the service period completed.
3.
Once the service period is completed, determine compensation expense each subsequent period by reporting the full change in market price as an adjustment to compensation expense.
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APPENDIX
16A
Illustration: American Hotels, Inc. establishes a shareappreciation rights plan on January 1, 2012. The plan entitles executives to receive cash at the date of exercise for the difference between the market price of the stock and the preestablished price of $10 on 10,000 SARs. The fair value of the
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APPENDIX
16A
Compensation Expense
Liability under Stock-Appreciation Plan
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15,000
15,000
APPENDIX
16A
In 2013, when it records negative compensation expense, American would debit the account for $20,000. The entry to record
At December 31, 2014, the executives receive $50,000. American would remove the liability with the following entry. Liability under Stock-Appreciation Plan Cash
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50,000 50,000
APPENDIX
16B
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APPENDIX
16B
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APPENDIX
16B
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APPENDIX
16B
2. Rank the results from step 1 from smallest to largest earnings effect per share.
3. Beginning with the earnings per share based upon the weightedaverage of ordinary shares outstanding, recalculate earnings per share by adding the smallest per share effects from step 2. Continue this process so long as each recalculated earnings per share is smaller than the previous amount.
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APPENDIX
16B
The first step is to determine a per share effect for each potentially dilutive security.
Per Share Effect of Options (Treasury-Share Method), Diluted Earnings per Share
Illustration 16-B3
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APPENDIX
16B
The first step is to determine a per share effect for each potentially dilutive security.
Per Share Effect of 8% Bonds (If-Converted Method), Diluted Earnings per Share
Illustration 16-B4
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APPENDIX
16B
The first step is to determine a per share effect for each potentially dilutive security.
Per Share Effect of 10% Bonds (If-Converted Method), Diluted Earnings per Share
Illustration 16-B5
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APPENDIX
16B
The first step is to determine a per share effect for each potentially dilutive security.
Per Share Effect of 10% Convertible Preference Shares (If-Converted Method), Diluted Earnings per Share
Illustration 16-B6
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APPENDIX
16B
The first step is to determine a per share effect for each potentially dilutive security.
Ranking of per Share Effects (Smallest to Largest), Diluted Earnings per Share
Illustration 16-B7
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APPENDIX
16B
The next step is to determine earnings per share giving effect to the ranking
Recomputation of EPS Using Incremental Effect of Options
Illustration 16-B8
APPENDIX
16B
The next step is to determine earnings per share giving effect to the ranking
Recomputation of EPS Using Incremental Effect of 8% Convertible Bonds Illustration 16-B9
APPENDIX
16B
The next step is to determine earnings per share giving effect to the ranking
Recomputation of EPS Using Incremental Effect of 10% Convertible Bonds Illustration 16-B10
APPENDIX
16B
The next step is to determine earnings per share giving effect to the ranking
Recomputation of EPS Using Incremental Effect of 10% Convertible Preference Shares Illustration 16-B11
APPENDIX
16B
Finally, Webster Corporations disclosure of earnings per share on its income statement.
Illustration 16-B12
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APPENDIX
Assume that Barton Company provides the following information.
16B
Illustration 16-B14
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RELEVANT FACTS
A significant difference between IFRS and GAAP is the accounting for securities with characteristics of debt and equity, such as convertible debt. Under GAAP, all of the proceeds of convertible debt are recorded as long-term debt. Under IFRS, convertible bonds are bifurcatedseparated into the equity component (the value of the conversion option) of the bond issue and the debt component. Both IFRS and GAAP follow the same model for recognizing stockbased compensation: The fair value of shares and options awarded to employees is recognized over the period to which the employees services relate.
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RELEVANT FACTS
Related to employee share-purchase plans, under IFRS all employee share-purchase plans are deemed to be compensatory; that is, compensation expense is recorded for the amount of the discount. Under GAAP, these plans are often considered noncompensatory and therefore no compensation is recorded. Certain conditions must exist before a plan can be considered noncompensatorythe most important being that the discount generally cannot exceed 5%. Modification of a share option results in the recognition of any incremental fair value under both IFRS and GAAP. However, if the modification leads to a reduction, IFRS does not permit the reduction but GAAP does.
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RELEVANT FACTS
Although the calculation of basic and diluted earnings per share is similar between IFRS and GAAP, the Boards are working to resolve the few minor differences in EPS reporting. One proposal in the FASB project concerns contracts that can be settled in either cash or shares. IFRS requires that share settlement must be used, while GAAP gives companies a choice. The FASB project proposes adopting the IFRS approach, thus converging GAAP and IFRS in this regard. Other EPS differences relate to (1) the treasury-stock method and how the proceeds from extinguishment of a liability should be accounted for, and (2) how to compute the weighted average of contingently issuable shares.
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d. the accounting for modifications of share options, when the value increases.
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c.
IFRS separates the proceeds of a convertible bond between debt and equity, based on relative fair values.
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d. Both GAAP and IFRS separate the proceeds of convertible bonds between debt and equity.
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Copyright
Copyright 2012 John Wiley & Sons, Inc. All rights reserved.
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