ACCT 3120 : CH. 19

What 2 things does a company do if it cannot determine the Fair Market Value of both the Bonds and the Stock Warrants

Use the security (the Bond or the Stock Warrant) for which Fair Market Value can be determined. Allocate the remainder of the proceeds from the sale of the security for which the company does not know the Fair Market Value.

Dilutive Securities are debt and equity securities whose assumed exercise or conversion results in a _______ in Earnings Per Share (EPS) because...

reduction (ie. dilution) because in all cases there would be more shares of common stock outstanding

How to calculate the weighted-average number of shares of common stock When stock dividends or stock splits occur, companies need to ....

weight the shares of common stock by the fraction of the period they are outstanding restate the shares outstanding before the Stock Dividends or Stock Splits, including: 1. Restate the prior year weighted-average number of shares outstanding so that EPS for all years would be computed on a comparable basis. 2. If a Stock Dividend or Stock Split occurs AFTER year end, but BEFORE the financial statement are issued, the weighted-average number of shares for all periods would be restated.

Stock Warrants issued with Bonds are long-term options to buy shares of Common Stock in the future at an ___________. 1. What is the life of a stock warrant? 2. Proceeds fro the sale of Bonds with Stock Warrants are allocated between what two securities and when? 3. What are the 2 methods of allocating proceeds between the Bond and Stock Warrant (if the Stock Warrant is "Detachable")

"exercise price" 1. generally 5 years 2. Proceeds from the sale of Bonds with Stock Warrants are allocated between the two securities (the Bond and the Stock Warrant)ONLY IF the Stock Warrant is "DETACHABLE". The allocation is based on the Fair Market Values of the Bond and the Stock Warrant; "FMV" often determined by specialists. 3. Proportional and Incremental method

On January 2, 2018, Sarah Lawrence Co. issued at face value $10,000 of 4% bonds convertible in total into 2,000 shares of Lawrence's common stock. No bonds were converted during 2018. Throughout 2018, Lawrence had 10,000 shares of common stock outstanding. Lawrence's 2016 net income was $2,000. The income tax rate is 40%. No potential common shares other than the convertible bonds were outstanding during 2018. Diluted earnings per share for 2018 would be:

$0.19 slide 66

At December 31, 2018 and 2019, Hathcock Company had outstanding 50 million common shares and 4 million shares of 10%, $10 par cumulative preferred stock. Net income for 2019 was $20 million. No dividends were declared in 2018 or 2019. EPS for 2019 was:

$32 20 -4 / 50 = 16/50 We subtract current year dividends on cumulative preferred stock, even if not declared this period.

On January 1, 2018, Parker and Ryan Insurance Company granted 30,000 stock options to certain executives. The stock options are exercisable no sooner than December 31, 2020, and expire on January 1, 2024. Each stock option can be exercised to acquire one share of $1 par Common Stock for $12. The Black-Scholes option-pricing model estimates the fair value of the stock options to be $5 on the date of grant. The market price of the company's stock was as follows: January 1, 2018 $14 December 31, 2018 15 What amount should Parker and Ryan recognize as compensation expense for 2018?

$50,000 Compensation expense = total compensation ( stock options x fair value of stock option on date of grant) / vesting period Total compensation ($5 × 30,000) = $150,000 Vesting period (3 years) ÷ 3 Annual expense $50,000

Ellen Kelly Inc. had 200,000 shares of $.50 par common stock, 10,000 shares of 5%, $20 par cumulative preferred stock, and 30,000 shares of 5%, $10 par preferred stock convertible into 10,000 common shares. Net income after taxes was $1,500,000. No dividends were declared during the year. Diluted EPS would be:

$7.10 $1,500,000 − (10,000 ×5% ×$20 par) 200,000 + 10,000 shares Even though dividends were not declared, the cumulative preferred stock dividends are subtracted.

To determine the effect of Stock Options and Stock Warrants on Dilutive Earnings Per Share, the dilutive effects of their potential conversion is determined using the "Treasury-Stock Method", which assumes: (2)

(1) The exercise of the Stock Options or Stock Warrants at the beginning of the year (or date of issue if later), and (2) The company uses those proceeds to purchase Common Stock for the treasury at the AVERAGE MARKET PRICE of the Common Stock during the period. ----If the AVERAGE MARKET PRICE < EXERCISE PRICE, the security is "antidilutive" (i.e., STOP). In other words, no one would exercise a Stock Option if they could buy the Common Stock in the open market at less than the Exercise Price.

Complex Capital Structure exists when a company has any of the 4 Dilutive Securities outstanding:

(a) Convertible Bonds or (b) Convertible Preferred Stock (c) Stock Options or (d) Stock Warrants

Sometimes companies will redeem / payoff Convertible Bonds prior to (a) or (b) Is there a difference in the accounting for the early redemption/payoff of Convertible Bonds and Bonds not convertible What is the difference between the cash that the company is paying the Bondholders and the carrying amount (ie. net book value) of the Bonds is reported as either....

(a) their maturity (b) conversion to Common Stock There is no difference in the accounting for the early redemption / payoff of Convertible Bonds and Bonds that are not convertible. a "gain" or "loss" on early redemption in the Income Statement

Stock Warrants

(are equity instruments like Stock Options) are certificates entitling the holder to acquire shares of Common Stock at a certain price ("exercise price" or "strike price")within a stated period. •To make a Bond more attractive, Stock Warrants may be issued with Bonds thus also giving the Bondholder an opportunity to also purchase shares of Common Stock at a "strike" or "exercise" price.

EPS equation

(net income - preferred dividends) / weighted average number of common shares outstanding -If preferred stock is noncumulative preferred dividends only get deducted if declared by BOD -If cumulative preferred stock, whether declared or not we will deduct the current years amount in the numerator

Corbin Company had 100,000 shares of common stock outstanding. Options to purchase 5,000 shares of common stock were outstanding at the beginning of the year. The options can be exercised to purchase stock at $50 per share. The average market price of the stock was $80. The net increase in the dilutive earnings per share denominator is:

1,875 shares

ACCOUNTING FOR STOCK-APPRECIATION RIGHTS (SAR's) 4 charactersitics

1. Company gives an executive the right to receive cash (generally) compensation equal to the share appreciation. 2. Share appreciation is the excess of the market price of the stock at the date of exercise over a pre-established price. 3 .Company may pay the share appreciation in cash, shares, or a combination of both. 4. Accounting for stock-appreciation rights depends on whether the company classifies the rights as equity or as a liability. ** if value of company increases, executives would get a comparable cash basis instead of common stock / stock options ** Seen in privately held companies who don't typically give stock options

Dilutive Securities contain a right to: (2 conversions)

1. Convert convertible bonds or preferred stock into common stock 2. Exercise stock options or stock warrants to obtain shares of common stock

Complex capital structures and dual presentation of EPS require the following additional disclosures in the Notes to the Financial Statements: (5)

1. Description of pertinent rights and privileges of the various securities outstanding. 2. A reconciliation of the numerators and denominators of the basic and diluted EPS computations, including individual income and share amount effects of all securities that affect EPS. 3. The effect given preferred dividends in determining income available to common stockholders in computing basic EPS. 4. Securities that could potentially dilute basic EPS in the future that were excluded in the computation because they were antidilutive. 5. Effect of conversions subsequent to year-end, but before issuing the financial statements.

Steps for computing diluted earnings per share: 3

1. Determine, for each dilutive security, the per share effect assuming exercise/conversion. --ex: slides 102 - 106 2. Rank the results from step 1 from smallest to largest earnings effect per share. ---ex: slides 107 - 110 3. Beginning with the earnings per share based upon the weighted-average of common stock outstanding, recalculate earnings per share by adding the smallest per share effects from step 2. Continue this process so long as each recalculated earnings per share is smaller than the previous amount. ---ex: slides 111-112

Some companies award Stock Options to executive employees to: (2) Stock options granted to key employees have what 4 characteristics

1. Incentivize and motivate employees' performance 2. Retain executives and recruit new talent 1. Are awarded at a specified "Exercise" or "Strike" price (set by the company at the Date of Grant at a price equal to the market price of the Common Stock at that time). 2. Require service by the employee over some period of time, usually 3 to 5 years, termed the Service Period. Stock Options generally Vest to the employees at the end of the Service Period, but could partially Vest throughout the Service Period. 3. If employees exercise the Stock Options, they must pay the company the Strike price of each Stock Option; 1 Stock Option = 1 share of Common Stock 4. The specified time that employees have, generally at the expiration of the Service Period, to exercise the Stock Options is termed the "Exercise Period" (could be months or longer)

Companies classify SARs as liability awards if at the date of exercise, the holder receives a cash payment. To record share-based liability: (3)

1. Measure the fair value of the award at the grant date and accrue compensation over the service period. 2. Remeasure the fair value each reporting period, until the award is settled; adjust the compensation cost each period for changes in fair value prorated for the portion of the service period completed. 3. Once the service period is completed, determine compensation expense each subsequent period by reporting the full change in market price as an adjustment to compensation expense.

A company must disclose the following about each of its Stock Compensation Plans in its Notes to Financial Statements: (4)

1. Nature and extent of such arrangements. --Number of stock options granted, exercisable, exercised,and expired --Vesting/exercise period --Strike/exercise price 2. Effect on the Income Statement of compensation cost. 3. Method of estimating the fair value of the goods or services received, or the fair value of the equity instruments granted (or offered to grant). 4. Cash flow effects.

The IF-CONVERTED METHOD for a Convertible Bond assumes:

1. The conversion occurs at the beginning of the period (or at the time of issuance of the security, if issued during the period), and 2. The elimination of related interest, net of the tax effect (ADD BACK THE INTEREST (net of the tax effect) AS IF THE INTEREST WAS UNPAID). If there are Convertible Bonds or Convertible Preferred Stock, the dilutive effects of potential conversion on EPS using the "IF-CONVERTED METHOD".

On November 1, 2016, the stockholders of Searle Co. approve a plan that grants the Company's 5 executives Stock Options to purchase 2,000 shares each of the Company's $1 par value Common Stock. The Stock Options were granted ("Date of Grant") on January 1, 2017. The expected period of benefit is 2 years ("Service Period"). The executives may exercise the options at any time within the next 10 years ("Exercise Period"). The Strike Price of each Stock Option is $60, and the market price of the Common Stock at the Date of Grant is $70 per share. The fair value of the Stock Options determined using the Black-Scholes Stock Option Pricing Model was $220,000. The Service Period is 2 years and the FMV of the Stock Options at the Grant Date was $220,000. Searle would record the transactions related to these Stock Option contracts as follows: What are the Basic entries to record Stock Compensation Expense at the end of the 2 years

12/31/17: Dr. Stock Compensation Expense 110,000 Cr. Paid-in Capital 110,000 12/31/18: Dr. Stock Compensation Expense 110,000 Cr. Paid in Capital Stock Option 110,000 110,000 = 220,000 / 2

On November 1, 2016, the stockholders of Searle Co. approve a plan that grants the Company's 5 executives Stock Options to purchase 2,000 shares each of the Company's $1 par value Common Stock. The Stock Options were granted ("Date of Grant") on January 1, 2017. The expected period of benefit is 2 years ("Service Period"). The executives may exercise the options at any time within the next 10 years ("Exercise Period"). The Strike Price of each Stock Option is $60, and the market price of the Common Stock at the Date of Grant is $70 per share. The fair value of the Stock Options determined using the Black-Scholes Stock Option Pricing Model was $220,000. If Searle's executives exercise 2,000 of the 10,000 Stock Options (20 percent of the Stock Options) on June 1, 2020, the Company records the following journal entry. What is the Exercise of the Options at the $60 strike price?

1st step = pay the strike price June 1, 2020: Dr. Cash (shares available for purchase x their price per share) (2,000 x 60) 120,000 Dr. Paid-in Capital - Stock Options 44,000 (220,000 x 20%) (FMV of the stock options x % of stock options exercised) Cr. Common Stock 2,000 ( shares available for purchase x their par value )(2,000 x $1) Cr. Paid - in capital in excess of par-common 162,000

On December 31, 2017, Wayne Sparks Company had 600,000 shares of common stock issued and outstanding. Sparks issued a 5% stock dividend on June 30, 2018. On September 30, 2018, 20,000 shares of common stock were reacquired as treasury stock. What is the appropriate number of shares to be used in the basic earnings per share computation for 2018?

625,000 1/1 -6/30 600,000 ×1.05 = 630,000 x 6/12 = 315,000 7/1 -9/30 630,000 x 3/12 = 157,500 10/1 -12/31 610,000 x 3/12 = 152,500 Weighted-Average Common Shares 625,000

Basic v. Diluted EPS

Basic EPS is a factual calculation / number. = (NI - preferred dividends) / WA # shares outstanding Diluted EPS is, however, a "HYPOTHETICAL" calculation / number expressing a "worse case scenario" AS IF the outstanding Dilutive Securities were converted to shares of Common Stock. = basic EPS - impact of convertibles - impact of options, warrants, and other dilutive securities -the company doesn't know if the holders of those potentially Dilutive Securities will convert or exercise them to obtain shares of the Company's Common Stock. Companies will not report diluted EPS if the potentially dilutive securities are antidilutive (i.e., would increase EPS).

Typically independent 3rd party valuation specialists use what pricing model to determine the fair value of Stock Options What 8 characteristics are utilized? (don't have to know all 8 inputs but be familiar)

Black-Scholes Stock Option 1.The company's historical financial performance 2. The company's projected future financial performance 3. Exercise price or "strike price" of the options 4. Expected term of the stock options 5. Current market price of the Common Stock 6. Expected future dividends on the company's stock 7. Expected risk-free rate of return during the term of the stock options 8. Expected volatility of the company's stock

What method do companies use when converting convertible bonds to shares of common stock Is there a gain or loss upon conversion?

Book Value Method •The Convertible Bonds are converted to shares of Common Stock at the Book Value or Carrying Value of the Convertible Bonds, and therefore there is no gain or loss upon conversion of the Convertible Bonds to shares of Common Stock.

Harp had Stock Warrants recorded at $30,600. Assume Harp's bondholders exercised all 1,000 "detachable" Stock Warrants. Each Stock Warrant allowed the holder to buy 1 share of Harp's $1 par-value Common Stock at $25 per share. On the date the Stock Warrants were exercised, Harp's stock was selling for $35 per share. Record the exercise of the "detachable" Stock Warrants. Instead, now assume Harp's bondholders failed to exercise the "detachable" Stock Warrants. Each Stock Warrant had allowed the holder to buy 1 share of Harp's $1 par-value Common Stock at $25 per share. Record the expiration of the "detachable" Stock Warrants.

Dr. APIC -Stock Warrants 30,600 Cr.APIC -Expired Stock Warrants30,600 EXPIRATION = APIC

Moore Corporation has outstanding 2,000, $1,000 bonds, each convertible into 50 shares of $10 par value common stock. Assume Moore wanted to reduce its annual interest cost and agreed to pay the bond holders $70,000 to convert. What would be the journal entry for this?

Dr. Bonds Payable 2,000,000 Cr. Discount on Bonds Payable 30,000 Cr. Common Stock (2,000 x 50 x $10) 1,000,000 Cr. Paid-in Capital in Excess of Par—Common 970,000 Dr. Debt Conversion Expense 70,000 Cr. Cash 70,000

Moore Corporation has outstanding 2,000, $1,000 bonds, each convertible into 50 shares of $10 par value common stock. The bonds are converted on December 31, 2017, when the unamortized discount is $30,000 and the market price of the stock is $21 per share. Prepare the entry to record the conversion of the bonds.

Dr. Bonds Payable 2,000,000 Cr. Discount on Bonds Payable 30,000 Cr. Common Stock (2,000 x 50 x $10) 1,000,000 Paid-in Capital in Excess of Par—Common 970,000

Harp had Stock Warrants recorded at $30,600. Assume Harp's bondholders exercised all 1,000 "detachable" Stock Warrants. Each Stock Warrant allowed the holder to buy 1 share of Harp's $1 par-value Common Stock at $25 per share. On the date the Stock Warrants were exercised, Harp's stock was selling for $35 per share. Record the exercise of the "detachable" Stock Warrants.

Dr. Cash (1,000 x $25)25,000 Dr. APIC -Stock Warrants 30,600 Cr .Common Stock (1,000 x $1)1,000 Cr. APIC -CS54,600

Miller Corporation issued $4,000,000 par value, 7% convertible bonds at 99 for cash. If the bonds had not included the conversion feature, they would have sold for 95. Record the entry at date of issuance.

Dr. Cash 3,960,000 Dr. Discount on Bonds Payable 40,000 Cr. Bonds Payable 4,000,000

Gall Inc. issued 2,000 shares of $10 par value Common Stock upon conversion of 1,000 shares of $50 par value Preferred Stock. The Preferred Stock was originally issued at $60 per share. The Common Stock is trading at $26 per share at the time of conversion. Prepare the entry to record the conversion of the Convertible Preferred Stock to Common Stock: what is the book value associated with this?

Dr. Preferred Stock 50,000 Dr. Paid-in Capital in Excess of Par—Preferred 10,000 Cr. Common Stock (2,000 x $10) 20,000 Cr. Paid-in Capital in Excess of Par—Common 40,000

Companies classify SARs as equity awards if at the date of exercise, the holder receives shares of stock from the company upon exercise. What happens to the holder and at the date of grant?

Holder receives shares in an amount equal to the share-price appreciation(the difference between the market price and the pre-established price). At the date of grant, the company determines a fair value for the SAR and then allocates this amount to compensation expense over the service period of the employees.

On November 1, 2016, the stockholders of Searle Co. approve a plan that grants the Company's 5 executives Stock Options to purchase 2,000 shares each of the Company's $1 par value Common Stock. The Stock Options were granted ("Date of Grant") on January 1, 2017. The expected period of benefit is 2 years ("Service Period"). The executives may exercise the options at any time within the next 10 years ("Exercise Period"). The Strike Price of each Stock Option is $60, and the market price of the Common Stock at the Date of Grant is $70 per share. The fair value of the Stock Options determined using the Black-Scholes Stock Option Pricing Model was $220,000. If Searle's executives fail to exercise the remaining Stock Options before their expiration date, the Company records the following at the date of expiration. What is the recording of the expiration of the stock options? WHY wouldn't the executives exercise their Stock Options?

Jan 1, 2027 Dr. Paid-in Capital - Stock Options 176,000 Cr. Paid-in Capital - Expired Stock Options 176,000 (220,000 x 80%) The "strike price" exceeds the FMV of the common stock = not "in the money" Compensation expense if not reversed when stock options expire

At December 31, 2014, Watson Co. had 500,000 shares of common stock issued and outstanding, 400,000 of which had been issued and outstanding throughout the year and 100,000 of which were issued on October 1, 2014. Net income for the year ended December 31, 2014, was $1,400,000. Additionally, Watson had 8,000 shares of 5%, $100 par value preferred cumulative stock outstanding. What should be Watson's 2014 Earnings Per Common Share, rounded to the nearest penny? Net income attributable to common = Preferred dividend = WASCO= EPS=

Net income attributable to common = 1,400,000 -preferred dividend Preferred dividend = 8,000 x $100 x 5% = $40,000 WASCO= 400,000 x (9/12) + 500,000 x (3/12) = 425,000 EPS= $1,360,000 / 425,000 = $3.20 per share

Sale of Bonds with detachable stock warrants involve: Sale of Bonds with nondetachable stock warrants is considered to involve:

Sale of Bonds with Detachable Stock Warrants involves two securities, therefore the proceeds from the sale of the Bonds and Stock Warrants are allocated between the "Bond" and the "Stock Warrant" based on Fair Market Values. Sale of Bonds with NondetachableStock Warrantsis considered to involve a singlesecurityand therefore the sale of Bonds with NondetachableStock Warrants is entirely recorded as a sale of Bonds(i.e., none of the proceeds are allocated to the Stock Warrants).

EPS flowchart

Simple Capital Structure (Single Presentation of EPS) ---> Compute Income Applicable to Common Stock (Net Income minus Preferred Dividends) ---> Compute Weighted-Average Number of Common Shares Outstanding ---> EPS = Income Applicable to Common Stock / Weighted-Average Number of Common Shares

Simple vs. Complex Structure

Simple Structure--Common Stock; no potentially dilutive securities; report only a single EPS amount at the bottom of the income statement Complex Structure--Includes any of the 4 Dilutive Securities that could dilute Earnings Per Common Share (EPS); require "dual" EPS amounts on income statement if dilutive: (a) Convertible Bonds (b) Convertible Preferred Stock (c) Stock Options (d) Stock Warrants. ----would report basic and dilutive eps -- dilutive = how much EPS would be diluted if securities were excercised

US GAAP requires companies to recognize what type of expense for Stock Options used which method? What are the 3 steps to do this?

Stock Compensation Expense using fair-value methods Step 1 - Use the Black-Scholes Stock Option Pricing Model to determine the fair value of the Stock Options at the Date of Grant. NO Journal Entry! Step 2 - That fair value of the Stock Options is then "charged" / "Debited" to: Dr. Stock Compensation Expense Cr. APIC - Stock Options over the "Service Period" (i.e., period of time, typically 3 to 5 years, that the employee must work to "earn" the Stock Options; the "Service Period" is generally the same as the "Vesting Period"). Step 3 - If the Stock Options are "exercised" at the end of the Service Period or when Vested (if earlier), the employee pays the "Strike Price" (the "Strike Price" is usually set equal to the market price of the Common Stock at the Grant Date to avoid adverse tax consequences).

How are stock options recognized?

Stock Options are "equity instruments" and Stock Compensation Expense is recognized over the Service Period as: Dr. Stock Compensation Expense Cr. Additional Paid-in Capital - Stock Options

how to solve fore income available to common stockholders = numerator of eps

Subtract the current - year preferred stock dividend from net income to arrive at Income available to common stockholders Preferred Stock Dividends are subtracted on Cumulative Preferred Stock (ONLY the current year amount that would accumulate), whether declared or not.

Proportional method to allocate cost between bonds and detachable stock warrants:

The Proportional Method allocates the proceeds from the sale of the Bonds and Detachable Stock Warrants using the proportion of the two amounts, based on their relative Fair Market Values, with FMV often determined by independent valuation specialists.

Companies sometimes offer Bondholders a cash "inducement" or "incentive" called _________, to convert their Convertible Bonds to shares of Common Stock

a sweetner

Illustration: Prior to 2017, Barkley Company issued 40,000 shares of 6% convertible, cumulative preferred stock, $100 par value. Each share is convertible into 5 shares of common stock. Net income for 2017 was $1,200,000. There were 600,000 common shares outstanding during 2017. There were no changes during 2017 in the number of common or preferred shares outstanding. Instructions (a) Compute diluted earnings per share for 2017.

answer on slides 75-78

In 2016, Chirac Enterprises issued, at par, 60, $1,000, 8% bonds, each convertible into 100 shares of common stock. Chirac had revenues of $17,500 and expenses other than interest and taxes of $8,400 for 2017. (Assume that the tax rate is 40%.) Throughout 2017, 2,000 shares of common stock were outstanding; none of the bonds was converted or redeemed. Instructions: (a) Compute diluted earnings per share for 2017. (b) Assume same facts as those for Part (a), except the 60 bonds were issued on September 1, 2017 (rather than in 2016), and none have been converted or redeemed.

answers on slides 68-72

Zambrano Company's net income for 2017 is $40,000. The only potentially dilutive securities outstanding were 1,000 options issued during 2016, each exercisable for one share at $8. None has been exercised, and 10,000 shares of common were outstanding during 2017. The average market price of the stock during 2017 was $20. Instructions (a) Compute diluted earnings per share. (b)Assume the 1,000 options were issued on October 1, 2017 (rather than in 2016). The average market price during the last 3 months of 2017 was $20.

answers slides 83-87

How to account for the issuance/sale of convertible bonds is the same as for.....

as for bonds that are not convertible: Dr. Cash (issuance price times face value) Dr. Discount on Bonds Payable (difference) Cr. Bonds Payable (always issuance price)

When can convertible bonds be converted into shares of common stock and what are 2 characteristics if the bon is converted into common stock

can be converted during some designated time period and at a designated exchange rate that is disclosed in the Bond Indenture (ie. a $1,000 bond = 10 shares of common stock) If a "Convertible Bond" is converted into shares of Common Stock, the: (a) Interest is no longer paid on the Bonds, and (b) the Principal amount of the Bonds is not repaid.

Earnings Per Common Share (EPS) indicates the income earned by each share of _________. What should a company do if the income statement contains discontinued operations

common stock When the Income Statement contains Discontinued Operations, companies should separately disclose Earnings Per Share for Continuing and Discontinued Operations.

Convertible preferred stock includes an option for the holder to...... If the Convertible Preferred Stock is converted to Common Stock what method is used?

convert Convertible Preferred Stock into a predetermined number of shares of Common Stock use the "Book Value Method" (just like the method for the Convertible Bonds) to transfer the carrying value of the Preferred Stock accounts to the Common Stock accounts (no gain or loss is recognized when the Convertible Preferred Stock is converted to Common Stock; it's simply a reclassification between the 2 equity accounts).

Diluted EPS (review figure on slide 59)

is a hypothetical calculation that includes the effect of all Convertible Bonds, Convertible Preferred Stock, Stock Options or Stock Warrants that are outstanding because the company doesn't know if the holders of those potentially Dilutive Securities will convert or exercise them to obtain shares of the Company's Common Stock. Companies will not report diluted EPS if the potentially dilutive securities are antidilutive (i.e., would increase EPS).

Stock Compensation Expense is only recognized...... When employees terminate their employment before the Stock Options vest or are earned, they ______ their Stock Options. When this happens, what is recorded?

over the "service period" for the stock options that vest to the employees forfeit 2 alternatives to account for "forfeitures" of Stock Options: 1. Record the effect of the "forfeitures" as they occur: Dr. Stock Options -Additional Paid-In Capital Cr. Stock Compensation Expense 2. Estimate "forfeitures" and adjust as estimates change: As estimates change, "adjust expense to determine the cumulative expense through the end of the year". Do this by(a)calculating the cumulative Stock Option expense and (b) deduct amounts of Stock Option expense already recorded to determine the current year expense.

The conversion rate on a dilutive security may change during the period in which the security is outstanding. If the conversion rate on a dilutive security changes during the period, the company uses: For Convertible Preferred Stock the company does not subtract preferred stock dividends from net income in computing the numerator (TREAT AS IF UNPAID). Why not?

the most dilutive conversion rate available Because for purposes of computing EPS, it assumes conversion of the Convertible Preferred Stock to outstanding Common Stock (i.e., the Preferred Stock dividends wouldn't be paid).

Why would companies offer an incentive to Bondholders to encourage them to convert their Convertible Bonds into shares of Common Stock? Any "Sweetener" that may be paid is recorded as an....

•The companies would no longer pay interest on the Bonds. •The companies would not have to repay the principal of the Bonds. ...an Expense (perhaps "Debt Conversion Expense") when paid.