Transcript Intangible Assets - University of Utah

Dilutive Securities and EPS
ACCTG 5120
David Plumlee
1
Convertible Securities
What two ways of offering
conversion features are available?
Non-separable conversion feature
Detachable warrants
What is the important factor in
determining how to account for these?
Accounting is function of whether the
conversion feature is separable
page2
Non-separable Conversion
Feature
How should securities with non-separable
conversion features be recorded?
Account for these securities as though there was no
conversion feature
How should the conversion of securities with
non-separable conversion features be recorded?
‘Book value’ method
 set-up the stock issued on books
 no gain/loss on transaction
 remove debt from the books
page3
Convertibles Issuance
What is the general form of the JE at issuance?
Bonds Payable (Preferred Stock)
Premium or PIC-PS (Discount)
Common Stock
APIC-Common Stock
DR
CR
XX
DR or CR
XX
XX
NO GAIN OR LOSS RECOGNIZED!
page4
Detachable Warrants
How should securities with detachable warrants
be recorded at issuance?
Account for both securities issued by either
proportional or incremental method
How should securities with detachable warrants
be recorded at conversion?



account for cash received
account for stock issued
remove warrants from books
page5
Warrant JE’s
Issuance
DR
XX
Cash
Bonds Payable /Pref. Stk.
Premium (Discount)/PIC-PS
PIC-Warrants
Conversion
PIC Warrants
Cash
Common Stock
PIC-Common Stock
DR
XX
XX
CR
XX
DR or CR
XX
CR
XX
XX
page6
Introduction to EPS
What is EPS?
EPS 
income
attributab
le to common
common
shareholde
rs
shares
What are the two main categories of EPS?


basic EPS
diluted EPS
FAS 128 replaces
APB #15 and
actually simplifies
computations
required!
page7
Disclosures under FAS 128
What separate EPS categories must be disclosed?

net income
 income from continuing operations
discontinued operations, extraordinary
items and cumulative changes in
accounting policy

page8
What is Simple Capital
Structure?
Simple capital structure includes no
‘potentially dilutive securities’
Report basic EPS only!
page9
What is Complex Capital
Structure?
Includes ‘potentially dilutive securities’
i.e.,
 stock rights, warrants and options
 convertible preferred stock or debt
Report basic and diluted EPS
page10
Diluted EPS is a “worst
case” estimate of EPS
 EPS “as if” all dilutive
securities converted/exercised

Basic (undiluted)
measures what EPS is
currently
undiluted
diluted
spread provides information about capital
structure by disclosing an estimate of
amount of potential dilution that exists
page11
Computing Basic EPS
Income Available to
Common Shareholders’ = Net income- dividend on preferred stock
Common Shares = Weighted average # of shares outstanding
*preferred dividends:
- if non-cumulative-deduct dividends declared only
- if cumulative-deduct current period dividend declared or not
EPS 
NI - dividend
weighted
on pref. stock *
average # shares
page12
Weighted Average # of Shares
How do you calculate weighted average
number of shares?
# of shares weighted by portion of
year outstanding
What do you do about stock splits and stock
dividends?
Adjust retroactively to beginning of the
year earliest period presented
page13
Example
During 2000 Impact,
 Began the year with 120,000 shares outstanding
 Issued 30,000 shares April 1
 Purchased treasury stock of 9,000 shares on
September 1
 Distributed a stock dividend on October 1, and
reissued 1/3 of treasury stock on November 1.
What are the weighted average number of shares
outstanding for 2000?
page14
Weighted average shares
outstanding
Date
1-1
4-1
9-1
10-1
Shares
Outstanding
120,000
Portion
Restate of year(wt)
Weighted
Shares
11-1
Weighted shares outstanding
page15
Weighted average shares
outstanding
Date
1-1
4-1
9-1
10-1
11-1
Shares
Outstanding
120,000
150,000
141,000
155,100
158,400
Portion
Restate of year(wt)
1.1
3/12
1.1
5/12
1.1
1/12
1/12
2/12
Weighted shares outstanding 12/12
Weighted
Shares
33,000
68,750
12,925
12,925
26,400
154,000
page16
Example - Income
They reported earnings of $650,000 for the
year. They had 1000 shares of 10%, $100
par value preferred, cumulative stock
outstanding. Calculate their eps.
page17
Basic earnings per share


Numerator
$650,000 - (100*1000*10%)
=
$640,000
Denominator
154,000
EPS = 640,000/154,000 = $4.16*
*4.1558
page18
Potentially dilutive securities



Convertible debt
Convertible preferred stock
Stock warrants/options


used to acquire stock at a set price
issued with or without other securities
page19
Computing Diluted EPS
1. Begin with basic EPS
2. Identify potentially dilutive securities
3. For each compute dilution ratio
assuming dilution took place
Impact on income available to shareholders
dilution ratio* =
Impact on weighted shares outstanding
*NOT a fraction--a ratio!
page20
Computing Diluted EPS
(continued)
4. Rank from most dilutive (smallest
dilution ratio) to least dilutive (largest
dilution ratio)
5. Add smallest to basic EPS
 add numerator and denominator and
compute “tentative” EPS
 adjust until no additional dilutive
securities are found
page21
Antidilution


Antidilutive securities are securities
whose inclusion in EPS computations
would increase EPS
Should not be considered in computing
diluted EPS
page22
Calculation of Dilution Ratio Convertible Bonds
beg. of yr.
ra tio 
issue date
(1 - t) x in te re s t e x p e n s e
# o f s h a re s x fra c tio n o f y r
page23
Example
Impact has 100 $1,000 bonds that are convertible to
common stock in a 1:20 ratio. Bonds were issued
with a market rate of 10% and were outstanding for
the entire year. The tax rate is 40%. Compute the
dilution ratio.
interest expense
100*$1,000*10% = $10,000
common stock issued 100*20 = 2000 shares
dilution ratio = (1-.40) * 10000 =
2000
6000
2000
page24
Calculate Dilution Ratio - Convertible
Preferred
beg. of yr.
ra tio 
issue date
d iv id e n d s a v in g s
# o f s h a re s x fra c tio n o f y r
page25
Example
Impact has 200 shares of 8% cumulative preferred
stock with a par value of $500 that are convertible to
common stock in a 1:5 ratio. They were outstanding
for the entire year. Tax rate is 40%. Compute the
dilution ratio.
200*$500*8% = $8,000 preferred dividend
200*5 = 1000 shares common stock issued
dilution ratio = 8000
1000
page26
Calculation of Dilution Ratio - Warrants
& Options
beg. of yr.
ra tio 
issue date
0
in c re m e n ta l s h a re s x fra c tio n o f y r
page27
Options/Warrants - Use
Treasury Stock Method
Assume options or warrants are exercised and
company uses $$$ received to repurchase shares
(like treasury stock)
 if option/warrant price is > or = stock price
then there is no dilution (options/warrants are ‘out of the
money’)

if option/warrant price is < or = stock price
then there is dilution (options/warrants are ‘in of the
money’)
page28
How to calculate treasury
stock method


Compute proceeds (cash) from assumed
exercise
Compute # shares assumed repurchased with
proceeds



use average stock price
Compute # shares assumed issued
‘incremental shares’ = number of shares
assumed issued - number of shares assumed
repurchased
page29
Example
Impact has 2000 stock options outstanding for
a full year with a strike price of $30. Their
stock is trading at $50 a share. The tax rate is
40%. Compute the dilution ratio.
Cash received = $30*2000=$60,000
Shares ‘repurchased’ = $60,000/50 = 1200
Shares ‘issued’ = 2,000
‘incremental shares’ = 2,000-1,200=800
Dilution ratio
=
0
800
page30
Calculating Diluted EPS



Basic EPS $640,000/154,000 = $4.1558
Arrange dilution ratios from most dilutive to
least dilutive $0/800; $6000/2000; $8000/1000
Recalculate and compare to basic
$640,000+0
154,000+800
=
$640,000+0+6000
154,000+800+2000
$4.134
(< 4.1558, so dilutive)
=
$4.12
(<4.134, so dilutive)
$640,000+0+6000 +8000 = $4.144
154,000+800+2000+100
(> 4.12, so anti-dilutive)
page31
Stock Options
What is a stock option?
The right to buy a specific number
of shares for certain period of time
at a fixed or determinable price.
What are the critical accounting issues?
Valuation - How should compensation expense be
determined?
Timing - When should expense be recognized?
page32
Dates/terms
What are the important dates for stock options?
Grant date
Date that the option is received
Typically, market price=exercise price
Measurement date
Date that # of shares and
option(purchase) price are known
Often same as grant date
page33
FAS 123
Valuation

Intrinsic value method uses APB 25
Compensation expense = Excess of market price over
option price on measurement date

Fair value method


uses fair value of the option (Black/Scholes option
pricing)
Compensation expense = Estimate of fair value of
options expected to vest
Timing - Recognized when employee performs service
page34
Example of Stock Option
January 1, 2000, Star corporation grants options that
allow execs. to acquire 10 million shares of $1 par
value stock within next 8 years, but not before
December 31, 2003 (vesting date). The exercise
price = market price on date of grant = $35. Fair
value of the options is $8.
 On July 11, 2005, 6 million of the options were
exercised.
 The remaining options expired without being
exercised.
page35
Option example

January 1, 2000
NO ENTRY!
At the end of each of the next four years
(12/31/00; 01; 02;03)


Compensation expense
PIC - stock options
20 M
20 M
page36
Option example


Options exercised on July 11, 2003
Cash (35* 6 M shares)
210 M
Paid in cap -stock options
48 M
Common stock
PIC - excess
Options expire on December 31, 2008
PIC - stock options
32 M
PIC - excess CS
6M
252 M
32 M
page37