ACC 232 1st Edition Exam 3 Study Guide Chapters 16 18 Chapter 16 Dilutive securities and Earnings per share Dilutive security security that will be converted into common stock and increase the number of shares of common stock in calculating earnings per share Reasons a company would issue a dilutive security Convertible bonds conversion is a sweetener and would lower the interest rate that company pays on the bond conversion would save cash to retire bonds at maturity Convertible preferred stock lower dividend rate because the conversion is a sweetener Both cases future ownership without giving ownership rights until they convert Record a convertible bond being issued Issue a bond for 100 that would be issued for 95 if it wasn t convertible Cash 1 000 000 Bonds payable 1 000 000 Conversion We trade the bond for 10 000 shares of 20 par value stock with a fair market value of 140 Bonds payable 1 000 000 Common stock 200 000 Paid in capital in excess of par Par 800 000 over par Induced conversion if the bond is callable we call the bond and the bondholders convert instead Incentive we will pay you 30 000 to convert Debt conversion expense 30 000 Cash 30 000 Bonds retire unconverted usual accounting treatment Convertible preferred stock When issued Cash 1 000 000 Preferred stock Par Paid in capital preferred stock 800 000 200 000 When converted Preferred stock 800 000 Paid in capital preferred stock 200 000 Common stock Paid in capital common stock 200 000 800 000 Par Stock warrants certificate that entitles the holder to acquire shares of stock for a certain time period for a certain price a long term call option Allocate the proceeds proportionally to the warrants and the bonds If the warrants can trade separately after the bonds issued and we can establish a fair market value on the bonds and the warrants 2 000 000 worth of bonds are issued a 101 or 2 020 000 The bonds have a FMV of 98 and the warrant have a market value or 40 X 2 000 80 000 The bonds by themselves have a FMV of 98 X 2 000 000 or 1 960 000 The total FMV of the transaction 1 960 000 80 000 2 040 000 The total proceeds are 2 020 0000 To the bonds 1 960 000 2 040 000 96 078 of the 2 020 000 1 940 784 To the warrants 80 000 2 040 000 3 922 of the 2 020 000 79 216 Cash 2 020 000 Discount on bonds payable 59 216 Bonds payable Paid in capital stock warrants the common stock paid in capital 2 000 000 79 216 When the warrants are exercised this amount goes into If we can t establish a FMV to one of the securities then we allocate all of the FMV to the other security and the rest of the proceeds go to the warrants IF the value of the bonds was 100 then Cash 2 020 000 Bonds payable 2 000 000 FMV Paid in capital stock warrants 20 000 Plug Nondetachable warrants the entire proceeds are recorded as debt Stock Right Privilege to buy the stock typically at a price below the current market price When the company does this they do not make an entry Stock options issued to executives Compensation expense recorded in the service period necessary to earn the options Comp determined on the date they are granted at the expected value on the date they vest Compensation will be recorded as an expense during the service period The fair value of stock options is determined to be 220 000 IN the first year Compensation expense 110 000 Paid in capital stock options 110 000 The second year same entry If one of the executives exercises the option then we get 120 000 cash 2 000 shares X 60 option price Cash Paid in capital stock options 120 000 44 000 Common stock Paid in capital common stock 2 000 162 000 If the options expire unexercised Paid in capital stock options 176 000 Paid in capital stock options expired 176 000 Restricted Stock plans transfer shares to the employees with the agreement that the employees cannot sell the shares Unearned compensation 20 000 Common stock Paid in capital in excess of par common stock 1 000 19 000 Compensation expense Unearned compensation 20 000 20 000 What if someone doesn t earn their stock Common Stock Paid in capital Unearned compensation IF it is two years into the plan Compensation expense Unearned compensation 1 000 19 000 20 000 8 000 12 000 Stock purchase plans discount is recorded as compensation Earnings per share Earnings available to common stockholders weighted average number of common shares outstanding EPS starts at earnings before discontinued operations Weighted average number of shares outstanding January 1 we have 90 000 shares On April 1 we issue 30 000 shares On July 1 we buy 39 000 shares of treasury stock on November 1 we issue 60 000 shares at the end the year we have 141 000 shares Weighted average 1 Jan 90 000 12 12 1 Apr 30 000 9 12 1 Jul 39 000 6 12 1 Nov 60 000 2 12 1 Jan 1 Apr Share outstanding 90 000 3 12 120 000 3 12 90 000 22 500 19 500 10 000 103 000 22 500 30 000 1 Jul 81 000 1 Nov 141 000 4 12 2 12 27 000 23 500 103 000 Beginning 100 000 shares March 1 Issue 20 000 shares June 1 we have a 50 stock dividend Novmeber 1 we issue 20 000 1 Jan 100 000 1 5 150 000 1 Mar 20 000 1 5 30 000 June 1 we have a 50 stock dividend 1 Nov 20 000 20 000 End of the year 200 000 12 12 10 12 150 000 24 000 2 12 3 333 177 333 Earnings are 2 000 000 and preferred dividends are 400 000 and weighted average shares outstanding are 80 000 then EPS is 2 000 000 400 000 1 600 000 of earnings available to common stockholders 1 600 000 80 000 shares 20 per share Complex capital structure convertible securities warrants and options Diluted EPS what happens to EPS if we convert the convertibles and exercise the warrants and options Earnings are 210 000 and weighted average number of shares are 100 000 so EPS is not calculated Two convertible bond issues EX 1 1 000 000 X 6 60 000 converts into 20 000 shares 1 000 000 at 10 100 000 converts into 32 000 shares sold on April 1 so interest expense is 100 000 X 9 12 75 000 Tax rate is 40 No preferred stock so what is Primary EPS 210 000 100 000 shares 2 10 If diluted EPS is lower we report diluted EPS Earnings are 210 000 60 000 X 1 40 100 000 X 1 40 X 9 12 210 000 36 000 45 000 291 000 Shares would be 100 000 20 …