ACC 232 1st EditionExam # 3 Study Guide Chapters 16 & 18Chapter 16 Dilutive securities and Earnings per shareDilutive security-security that will be converted into common stock, and increase the number of shares of common stockin 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 convertibleCash $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 Par Paid-in capital in excess of par $800,000 over parInduced conversion - if the bond is callable, we call the bond, and the bondholders convert instead.Incentive - we will pay you $30,000 to convertDebt conversion expense $30,000 Cash $30,000 Bonds retire unconverted - usual accounting treatmentConvertible preferred stockWhen issued:Cash $1,000,000 Preferred stock (Par) $800,000 Paid in capital preferred stock $200,000 When converted:Preferred stock $800,000 Paid in capital preferred stock $200,000 Common stock $200,000 Par Paid in capital - common stock $800,000 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 = $80,000The 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 = $1,940,784To the warrants $80,000 / $2,040,000 = 3.922% of the $2,020,000 = $79,216Cash $2,020,000 Discount on bonds payable $59,216 Bonds payable $2,000,000 Paid in capital - stock warrants $79,216 When the warrants are exercised, this amount goes into the common stock paid in capitalIf 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, thenCash $2,020,000 Bonds payable $2,000,000 FMV Paid in capital - stock warrants $20,000 PlugNondetachable 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 entryIf one of the executives exercises the option, then we get $120,000 cash (2,000 shares X $60 option price)Cash $120,000 Paid in capital - stock options $44,000Common stock $2,000 Paid in capital - common stock $162,000 If the options expire unexercisedPaid 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 sharesUnearned compensation $20,000 Common stock $1,000 Paid in capital in excess of par - common stock $19,000 Compensation expense $20,000 Unearned compensation $20,000 What if someone doesn't earn their stock, Common Stock $1,000 Paid in capital $19,000 Unearned compensation $20,000 IF it is two years into the plan Compensation expense $8,000 Unearned compensation $12,000 Stock purchase plans - discount is recorded as compensationEarnings per share: Earnings available to common stockholders / weighted average number of common shares outstanding (EPS) starts at earnings before discontinued operationsWeighted average number of shares outstandingJanuary 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 sharesWeighted average1-Jan 90,000 12/12 90,0001-Apr 30,000 9/12 22,5001-Jul -39,000 6/12 -19,5001-Nov 60,000 2/12 10,000103,000Share outstanding1-Jan 90,000 3/12 22,5001-Apr 120,000 3/12 30,0001-Jul 81,000 4/12 27,0001-Nov 141,000 2/12 23,500103,000Beginning, 100,000 sharesMarch 1, Issue 20,000 sharesJune 1, we have a 50% stock dividendNovmeber 1 we issue 20,0001-Jan 100,000 1.5 150,000 12/12 150,0001-Mar 20,000 1.5 30,000 10/12 24,000June 1 we have a 50% stock dividend1-Nov 20,000 20,000 2/12 3,333End of the year 200,000 177,333Earnings 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 shareComplex capital structure, convertible securities, warrants and options Diluted EPS - what happens to EPS if we convert the convertibles, and exercise the warrants and optionsEarnings are $210,000, and weighted average number of shares are 100,000, so EPS is not calculated.Two convertible bond issuesEX 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 = $75,000Tax 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)) +