Dilutive Securities

1
Chapter 17

• Dilutive Securities

2
Dilutive Securities

• Securities which are not common stock in form but
  enable their holders to obtain common stock upon
  exercise or conversion

3
Accounting for Convertible Debt

• A convertible bond combines the benefits of a
  bond with the privilege of exchanging it for
  stock at the holders option

4
Accounting for Convertible Debt

• At Issuance recorded the same as issuance of
  any other bond
• At Interest Dates recorded the same as any
  other bond
• At Conversion recorded using either market
  value or book value approach
• If retired for cash, instead of converted,
  recorded the same as any other bond

5
Accounting for Convertible Debt

• Induced Conversions
• Additional consideration given to induce
  conversion should be recognized as an expense of
  the current period
• Retirement of convertible debt treat as any
  other debt retirement. Any gain or loss is NOT
  recognized as extraordinary

6
Accounting for Conversion of Convertible Debt

• Market Value Approach
• Use market value of stock, if determinable
  Otherwise, use market value of bonds
• Less common approach
• Any gain or loss on conversion is treated as an
  ordinary item.
• Book Value Approach is GAAP
• Use book value of bonds
• No gain or loss recognized

7
Accounting for Convertible Preferred Stock

• Handled at Issuance and Conversion in the same
  manner as Convertible Debt, but only the book
  value method should be used
• Exception If the par value of the common stock
  exceeds the preferred stocks book value, the
  difference is debited to Retained Earnings

8
Accounting for Stock Warrants

• Warrant entitles holder to acquire shares of
  stock at a certain price within a stated period
• Normally used as
• An equity kicker to make another security more
  attractive
• A pre-emptive right to purchase additional shares
  given to existing shareholders
• Compensation to executives and employees

9
Accounting for Stock Warrants

• Detachable stock warrants can be traded
  separately, and therefore, have a market value.
• Nondetachable stock warrants do not trade
  separately nor have market value

10
Detachable Stock Warrants

• Proportional method use when the value of the
  bonds without the warrants and the value of the
  warrants are both known
• Allocate the sale price of the bonds between the
  bonds and the warrants based on their respective
  market values

11
Detachable Stock Warrants

• Incremental method use when only the value of
  the bonds without the warrants or the value of
  the warrants is known
• Subtract the market value of the known security
  from the sale price of the bonds to determine the
  value of the other security

12
Detachable Stock Warrants

• Warrants not exercises transfer the carrying
  value from the PIC-Stock Warrants account to the
  PIC-From Expired Warrants account

13
Accounting for Stock Warrants

• Nondetachable stock warrants record the entire
  proceeds as debt
• Stock warrants representing stock rights to
  existing shareholders do not require any journal
  entry at the date of issuance

14
Stock Compensation Plans

• Arrangements where selected employees are given
  the option to purchase common stock in the
  company at a given price over an extended period
  of time

15
Stock Compensation Plans

• Major accounting issue what is value of the
  compensation received?
• Intrinsic value method
• Fair value method

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Stock Compensation Plans

• Intrinsic Value Method compensation expense
  market price of the stock exercise price of the
  options at the measurement date (usually the
  grant date)
• Fair Value Method compensation expense fair
  value of the stock options expected to vest at
  the grant date based on an acceptable option
  pricing model (Black-Scholes)

17
Fair Value Method

• Vesting occurs on the date the employees right
  to receive or retain the shares is no longer
  contingent on remaining in the service of the
  employer
• Stock options issued to non-employees for goods
  or services must be recognized using this method

18
Stock Compensation Plans

• Under SFAS 123, FASB encourages, but does not
  require, the use of the fair value method.
• Most companies use the intrinsic value method
  because it results in a lower compensation
  expense amount

19
Stock Compensation Plans

• Allocating Compensation Expense recognized over
  the service period (time between grant date and
  vesting date)
• On date of grant no journal entry required
• Allocate amount of compensation expense evenly
  over the service period under both methods (Dr.
  Compensation Expense Cr. PIC-Stock Options)

20
Stock Compensation Plans

• Recording the exercise of options the same
  accounts are affected under both methods (Dr.
  Cash Dr. PIC-Stock Options Cr. CS Cr. PIC Excess
  of Par)
• Recording the expiration of options no
  adjustment is made to compensation expense (Dr.
  PIC-Stock Options Cr. PIC-Expired Stock Options)

21
Stock Compensation Plans

• Recording the forfeiture of options occurs if
  the employee leaves the company before the
  vesting date (Dr. PIC-Stock Options Cr.
  Compensation Expense)

22
Stock Compensation Plans

• Types of plans several different types of plans
  exist and are used to compensate executives
• Incentive or nonqualified stock option plans
• Stock appreciation rights
• Performance-type plans
• Noncompensatory plans

23
Disclosure of Stock Compensation Plans

• For each type of plan a company offers it, must
  disclose
• of shares under option
• options exercised and forfeited
• weighted average options prices for these
  categories
• weighted average fair value of options granted
  during the year

24
Disclosure of Stock Compensation Plans

• For each type of plan
• Average remaining contractual life of the options
  outstanding
• method and significant assumptions used to
  estimate the fair value of the options

25
Disclosure of Stock Compensation Plans

• If the company uses the intrinsic value method it
  must still disclose the following, as if the fair
  value method had been used
• pro-forma net income
• pro-forma earnings per share

26
Stock Option Compensation Plans

• Debate over stock options the chronology of
  events related to SFAS 123 shows the impact
  that social, economic, and public policy goals
  can have on the development of accounting
  standards

27
Computing Earnings Per Share

• Simple capital structures companies that have
  only commons tock or no securities that could
  dilute EPS if converted or exercised
• EPS NI minus Preferred Stock Dividends divided
  by Weighted Average of Shares Outstanding

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EPS

• EPS is calculated for each component of income
  income from continuing operations, income before
  extraordinary items or changes in accounting
  principle, and net income

29
EPS

• Preferred stock dividends are the current years
  dividend only
• If none declared, then calculate an amount equal
  to what the current dividend would have been
• Dont include dividends in arrears
• If a net loss, then add the preferred dividend

30
EPS

• Weighted average shares outstanding equals No. of
  shares outstanding times fraction of year
  outstanding
• If a stock dividend/split occurs during the year,
  treat it as if it occurred at the beginning of
  the year

31
EPS

• Complex capital structures when a company has
  convertible securities, options, warrants, and
  other rights that upon conversion or exercise
  could dilute EPS

32
EPS

• Diluted EPS equals (NI--Preferred
  Dividend)/(Weighted Ave shares outstanding)
  minus (impact of convertible securities) minus
  (impact of options, warrants, and other dilutive
  securities)

33
EPS

• Convertible securities
• If convertible bonds, use the if-converted method
• Treat conversion as occurring at the beginning of
  the year, or at the issuance date, if it occurred
  during the year
• Eliminate related interest expense, net of tax

34
EPS

• If convertible preferred stock
• Eliminate preferred dividend from numerator
• Increase weighted average number of shares
  outstanding in denominator

35
EPS

• Use the most advantageous conversion rate
  available to the holder of the security

36
EPS

• Options and warrants use the treasury stock
  method and assume
• Exercise at the beginning of the year or issue
  date, if it occurs during the year
• Proceeds are used to purchase commons tock for
  treasury stock

37
EPS

• Options and warrants use the treasury stock
  method and assume
• If exercise price lt market price of stock,
  dilution occurs
• If exercise pricegt market price of stock,
  securities are antidilutive and can be ignored in
  the diluted EPS calculation

38
EPS

• Contingent shares are included in the computation
  of the diluted EPS

39
EPS

• Presentation and disclosure
• EPS is presented for income from continuing
  operations, income before extraordinary items or
  change in accounting principle, and net income
• Reported for all periods presented
• Prior period EPS is restated for any prior period
  adjustments
• Footnotes are required for diluted EPS