With this summary for the IBEB course Intermediate Accounting, you have everything you need to succeed! It includes both content from the book, as well as from lecture slides. Also, the summary provides handy tricks you can use on the exam. (FEB12007X / FEB12007)
Intermediate Financial Accounting All Tutorials 2019
Test bank CHAPTER 11
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Erasmus Universiteit Rotterdam (EUR)
Economie en Bedrijfseconomie
Intermediate accounting (FEB12007X)
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Chapter 16: Dilutive Securities and
EPS
Warrants: traded separately, which gives the holder the right to get specified number of
shares at a predetermined price and date.
- Use with and without method
- 10,000 bonds with detachable warrants, sold for $10.2 million. FC of liability
component = $9,707,852 → fair value of equity component = $492,148
-
- If exercised at $25 (par 5)
-
- If expired:
-
Dilutive securities: convertible securities (options, convertible bonds), that are able to dilute
EPS
- Because if they’re exercised, outstanding shares increase Earnings are diluted
Begin with most dilutive, then work down until not dilutive anymore
Share option: gives employees to buy ordinary shares at a certain price
- Often included in share-based compensation plans, but less and less often
o B/c incentivizes executives to manipulate numbers to get stock price higher
o restricted shares used more often now
2 ways of reporting options given to employees:
1. Intrinsic-value option: a way of reporting the granting of share options to employees
o How much the employee would receive if the option was immediately
exercised
, o Difference between share price and exercise price (usually 0)
2. Fair value method: use option-pricing methods to value the options at date of grant
a. This is the most used / required way
Accounting for Share Compensation:
- Fair value method: calculate total compensation expense using option-pricing
methods
- Allocating expense: allocate the expense in the service period (period between
granting and vesting)
Share compensation example: CEO gets options to buy 2,000 shares ($100 par) on Jan 1
2015, option share price is $6000, current market price is $7000 option-valuation gives
total worth of $22m. Expected period of benefit is 2 years.
- First Entries
o No entry at grant date
o
o (B/c expected period = 2 years divide the expense over the 2 years
- Exercise:if 2,000 of the 10,000 (20%) shares are exercised
o → 20% of the total compensation cost is subtracted from premium
o
o New shares created, but not entered at fair value
- Expiration:if options expire without being exercised
o
o If not exercised: the expenses do NOT change
- Adjustment: can compensation (determined at granting) be changed in the future?
o Service condition: if employee is required to complete a period of service
(until vested) to get the option then company CAN adjust compensation
▪ If CEO leaves after a year: reverse first compensation
, ▪
▪ If executive leaves, and 2000 of 10000 share options are forfeited →
only reverse 20% of the initial entry
● → rest of the years, the entries for expenses will only be 80%
o Market condition: if vesting of option depends on market conditions (e.g.
price) NOT allowed to change compensation (because market conditions
are already reflected in the fair value of option)
Restricted Shares: employee gets shares, but cannot be sold until vesting occurs
- Has entry at grant
- Restricted shares never become completely worthless (unlike an option)
- Result in less dilution to existing shareholders
o Because usually fewer restricted shares are given than options would have
been
- Better aligns employee interest with company interest
Restricted shares example: 1000 restricted shares given, FV is $20, service period is 5
yrs, $1 par
- On grant date:
o
o Unearned compensation is NOT an asset contra equity account
- At the end of each of the 5 years:
o
- What if employee leaves before vesting? reverse all recorded compensation
expense & reverse the shares granted
o
Employee Share-Purchase Plans: employees can buy shares at discounted price, as part
of compensation
- discount should be considered an expense
- Example: market price is $30, employees can buy for $24 expense difference
, -
Earnings Per Share
Earnings per share: income earned by each ordinary share
- If company has discontinued operations loss or gain from discontinued operations
must be shown per share
o E.g.
o
Simple capital structure: consists only of ordinary shares & no shares that can dilute NI per
ord. share
Complex capital structure: if it includes securities that possibly convert into ordinary shares
which would dilute earnings.
- If preference shares cumulative, even if company does not declare dividend, you
should subtract the dividend that normally would be paid out
- Calculating weighted average shares outstanding:
o
- Weighted average shares outstanding with share dividends / stock splits:
o The extra shares will count as if they were there for the entire period up
until that point
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