Chapter 21: Dilutive Securities and Earnings Per Share

a type of securities that can be converted or increase the number of common shares outstanding

dilutive securities

convertible debt allows companies to borrow money ______ than without the conversion feature

cheaper

JE to record convertible securities on issuance:

cash

disc/prem on BP

(C) bonds payable

at the time of conversion for convertible securities, we use the ______ _______ ______

book value method

JE to record conversion of bond with a discount:

B/P

(C) disc on B/P

(C) common stock

(C) APIC - common

JE to record conversion of bond with a discount and an additional consideration of cash:

B/P

debt-conversion expense

(C) disc on B/P

(C) cash

(C) common stock

(C) APIC - common

companies should recognize a _____ or ____ when retiring convertible debt the same way they recognize a gain or loss when retiring non-convertible debt

gain or loss

this type of stock includes an option for the holder to convert preferred shares into a fixed number of common shares

convertible preferred stock

convertible preferred stock is generally classified as ______

equity

preferred stock can be classified as debt if it is _________ __________ at a fixed rate on a specific date

mandatorily redeemable

if convertible preferred stock is converted, the value of the conversion is based on the _____ ______ of the preferred stock

book value

JE to record the conversion of convertible preferred stock securities:

preferred stock at par

APIC - preferred

(C) common stock at par

(C) APIC - common

certificates in which the holder is entitled to acquire a stock within a stated period at a certain price

stock warrants

stock warrants are issued by the __________

company

stock options give the holder the option to purchase:

- a specific number of stocks

- at a specific price (exercise price)

- during a specific period

the date employees receive the options

grant date

the period in which the employee performs services

service period

the date that an employee's right to retain the option is no longer contingent on remaining in the service of the employer

vesting date

the date on which the employee exercises the option

exercise date

the date on which the options expire

expiration date

on the grant date, companies must define:

compensation expense

over the employees' service period, the company must:

recognize compensation expense

compensation expense is calculated using the ______ ______ _____ estimated using an _____ ________ ______

fair value method; option pricing model

JE to record compensation expense for stock options:

compensation expense

(C) PIC - stock options

JE to record the expiration of stock options:

PIC - stock options

(C) PIC - expired options

JE to record the exercise of options:

cash

PIC - stock options

(C) common stock at par

(C) APIC - common

cash received =

number of options exercised x exercise price

earnings per share indicates the income earned by each share of ______ _______

common stock

investors use EPS to evaluate _____ _________

firm performance

Basic EPS =

(net income - preferred dividends)/weighted-average common shares outstanding

weighted shares =

total shares outstanding x fraction of year

stock dividends and stock splits are treated as if they occurred at the ____________ of the period

beginning

firms _______ the # of shares outstanding before the dividend or split so that everything is on the same basis

restate

a company has a _______ capital structure if there are no financial instruments that could be converted to common stock and decrease earnings per common share

simple

for a firm with a simple capital structure, only _____ ___ is required on the financial statements

basic EPS

diluted EPS =

Basic EPS - impact of convertibles - impact of options

companies with _________ capital structure report both basic and diluted EPS

complex

the dilutive effect of convertibles is measure by the

if-converted method

the dilutive effect of options/warants is measured by the

treasury stock method

if converted method:

- the denominator (# of shares) is _________ by the new shares that would be created if the bonds were converted

- the number is increased by the _____-____ interest expense that would be saved if the bonds were converted

increased; after-tax

the numerator effect for convertible bonds =

interest expense x (1-tax rate)

preferred stock:

- the denominator will ______ by the new shares that would be created if the preferred stock were converted into common stock

- the numerator will increased by the _________ _______ that would be saved if the preferred stock were converted into common stock

increase; preferred dividends

the treasury stock method assumed that:

- options or warrants are exercised at the beginning of the year

- the company uses the proceeds to purchase treasury stock

treasury stock method:

- the numerator is ____ affected by the exercise

- denominator is increased by the ____ ____ _______ that would be created upon exercise

net new shares

3 step process for calculating net new shares

1. proceeds

2. repurchase amount

3. new new shares

the purpose of EPS it to show the potential _______ in EPS of an assumed conversion or exercise

reduction

the the conversion or exercise does not decrease EPS, then the security is ____-_______

anti-dilutive

stock options and warrants:

- the security will be anti-dilutive if:

exercise price > market price

convertible bonds and preferred stock:

- divide the numerator effect by the denominator effect

- if the ratio is _______ than basic EPS, then the security is anti-dilutive

greater

anti-dilutive securities are not included in

EPS