Professional Documents
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Problem
◦ P1 part 4(exercising warrants)
Suggested homework problems for Chapter 16
Quiz 1 has 10 questions these HW problems cover all the material for that quiz
1. JE| exercising employee stock options
2. JE| issuing warrant
Example
3. JE| exercising warrant What is the credit to
4. Compensation expense timing or amount for stock options additional paid in capital
5. Diluted EPS calculation/convertible preferred when exercising these options?
6. Diluted EPS calculation/convertible bond
7. Basic EPS calculation/preferred dividends
8. Weighted average number of shares calculation/stock splits
9. CPA exam question on above topics
10. CPA exam question on above topics
Convertible Preferred Stock: Concepts
Convertible preferred stock is equity on the B/S, unless it is redeemable preferred stock.
◦ If it is redeemable then it is debt.
Stock warrants are issued by the company they are redeemed for stock. (the company
issues stock for the warrant + cash)
$9,800/$10,200 FMV
X $9,704 $10,000 - 9,704 = 296
$10,100 [issue] Discount on Bond Payable
Proportional Method: Example
Journal entries:
Cash 10,100
Discount (Bonds Payable) 296
Bonds Payable 10,000
Stock warrants 396
Incremental Method: Example
Example:
o Bonds, with a par value of $10,000 and detachable warrants, are sold at 10,100.
o Market price of warrants, $300.
o Market price of bonds without warrants, not determinable.
Cash 499,000
Discount on bond payable 5,000
Bond payable 500,000
Paid in Capital – Stock warrants 4,000
Stock Rights
o Stock rights give existing shareholders preemptive rights to buy shares.
o Unlike warrants, rights are of short duration.
o No journal entries are made, when rights are issued.
o On January 14th when the stock is trading for $34 per share, 1,000 of the stock rights are exercised.
What is the Journal entry to record this transaction?
Cash 32,000
Common Stock 1,000
Cash
APIC – Common 31,000
$32 x 1,000
Stock Compensation Plans
These plans provide employee incentives and may be:
1. Stock option plans:
2. Stock appreciation rights
3. Performance plans
Stock Option Plans: Accounting Issues
What is the value of the compensation?
When, if at all, should it be recognized?
◦ the fair value method
Stock Options: Important Dates
Grant Vesting Exercise Expiration
date date date date
Vesting
Measuring Compensation Expense
Fair value method (required method):
Compensation expense is:
o the fair value of the options on grant date that are expected to vest.
> The compensation expense is calculated using the fair value method.
The service period is usually the period between the grant date
and the vesting date.
Y Corp. Example - this problem has 6 parts
1. Company issues 100,000 stock holders rights. 10 rights needed to buy one share of stock. Rights entitle
holders to buy shares at $32 within 30 days.
◦ No entry needed
We need this later
2. Issue $200,000 bond for $205,000 with 2,000 detachable warrants.
Bonds trade at 96 without warrants and warrants trade at $8 each.
Strike price on warrants is $30 and Par value of the stock is $1
What portion of the value belongs to bonds/warrants?
192/208=92.3077%
96% * $200,000 = 192,000
16/208 = 7.6923%
$8 * 2,000 = 16,000
Total Value $208,000
Y Corp. Example
205,000 * 92.3077% = 189,231 allocated to bonds
205,000 * 7.6923% = 15,769 allocated to warrants
Journal entry
Cash 205,000
Discount on bond payable 10,769
Bond Payable 200,000
Paid in capital -Stock Warrants 15,769
3. 90,000 stock rights exercised {10 rights per share} (This comes from #1)
How much cash?
Cash 288,000
9,000 shares for $32 each
Common Stock 9,000
APIC – Common 279,000
9,000 shares of $1 par stock
Journal entry?
Cash 48,000
Paid in capital -Stock Warrants 12,615
Common Stock 1,600
APIC – Common 59,015
Y Corp. Example
5. On December 31st 2017 the firm grants options to purchase 5,000 shares of common stock. On that date the
shares are trading for $31 per share and the strike price of the options is $30 per share. The options vest over the
next calendar year.
On date of grant the options are worth $10 each. Option value
5,000 shares
X $10 per share
Journal entry on December 31st to record grant of options.
None
Compensation expense is measured on date of grate but recognized over the vesting period
Journal entry on December 31st 2018 (after 1 year) to record compensation expense related to the options
◦ Options expire because they do not vest (employee not allowed to exercise them)
20,000 options vest over 2018. Recognize compensation expense December 31st , 2018
◦ 20,000 * $3 per option = $60,000
Value of Options
20,000 options x $3 value = 60,000
o Reduction in EPS results from conversion of other securities into common stock.
o Shareholders want to know the extent of reduction in EPS, if dilution takes place.
EPS
EPS measures entity performance over the reporting period.
Disclosure requirements
◦ Basic EPS in all situations
◦ Diluted EPS when capital structure includes potentially dilutive securities
◦ Must be presented on face of the income statement for both
◦ Numerator (Income) is increased by the after tax interest that would be saved if converted
Basic EPS
◦ Numerator NI – preferred dividend
400 – (2,000x 5%)= 300
◦ Denominator 1,000 shares of common
all year
◦ Basic EPS?
300/1,000 = 0.30 EPS
If converted example 1 - preferred
If preferred stock is converted then 2 effects
◦ More shares of common (200 shares preferred X 20)
◦ No preferred dividends ($100)
Diluted EPS
300 + 100 = 400
◦ Numerator
◦ Diluted EPS?
400/5,000 = 0.08 Diluted EPS
If converted example 1 - Bonds
JJ company has 1,000 shares of common stock, 200, $1000 5% convertible
bonds. The firm has $14,000 of net income and a 40% tax rate. Each bond is
convertible into 50 shares of common stock
Basic EPS
◦ Numerator NI =14,000
Diluted EPS
◦ Number of new shares issued if options exercised 200
◦ Proceeds from strike price 200 x $25 = $5,000
◦ Number of shares repurchased
◦ Net new shares $5,000 / $40 = 125
◦ Diluted EPS
200 – 125 = 75
400/(1,000 + 75) = 0.372
Is the security dilutive?
Divide numerator effect by denominator effect.
If this ratio is less than basic EPS the security is dilutive
Example suppose tax rate is 40%
Suppose X company has Basic EPS of $2.00 per share
The firms also has convertible bonds with a face value of 1,000,000 and an interest rate of 5%.
b. anti-dilutive: Income increases by 30,000 denominator increases by 10,000. If we used this security is would increase EPS.
Diluted EPS = [2,000,000 + 30,000]/[1,000,000 + 10,000] = 2.01
The securities are anti-dilutive so it is not used for diluted EPS
Diluted EPS example from text book
H has net income = 360,000 and 100,000 average shares outstanding. Common stock sold at an
average market price of $15 during the period. Also outstanding were 15,000 warrants that
could be exercised to purchase one share of common stock at $10.
a. Are the warrants dilutive?
If warrants or options are in the money they will be dilutive
b. Compute basic EPS
360,000/100,000=$ 3.60 per share
c. Compute diluted EPS
1. How many new shares? 15,000
2. How much cash will we get? 15,000 x 10 = 150,000
3. How many shares can we buy for $150,000? 150,000/15 = 10,000
4. EPS = 360,000/ (100,000 + 15,000-10,000) = 3.43
Compressive example –
diluted EPS some securities anti-dilutive
V company has
◦ $1,200,000 of net income; 40% income tax rate
◦ 30,000 shares of $100 par value 6% preferred shares
◦ Each Preferred share is convertible into 3 shares of common stock
◦ The par value of common stock outstanding is $6,000,000 and the par value of each share is $10
1,116,000/690,000 = $1.62
What if dilative securities are not outstanding the whole year?
If potentially dilative securities are not outstanding for the entire year, then numerator and
denominator effects are time weighted.
◦ Convertible bond issued after 8 months = outstanding for 1/3rd of the year
◦ + 1/3rd of the numerator effect
◦ +1/3rd of the denominator effect
◦ Actual conversion takes place, then newly issued shares will be outstanding from their date of
issuance and will be included in calculation the numerator effect and denominator affect for
time before conversion took place will be calculated.
◦ The calculation will be the same as assuming conversion on first day of the year