Ch 19 Smart Book

The effect of changes in estimated option forfeitures must be recognized

cumulatively in the year the estimate changes.

Contingent issuable shares may be included in the calculation of

diluted EPS.

The incremental effect of convertible preferred stock is determined by dividing Blank______ by Blank______.

dividends that wouldn't be paid; additional common shares from conversion

Basic EPS is determined by dividing

earnings available to common shareholders by weighted-average common shares outstanding.

Which of the following accounting numbers is reported most frequently by the media?

earnings per share

Investors' desire to focus on one number that may summarize a company's performance may explain the importance of

earnings per share.

Compensation plans that are tied to the achievement of certain targets and are used to motivate key employees are referred to as _____ compensation plans.

executive, management, manager, or performance

If the underlying stock pays no dividends, the time value of money component of a stock option is the difference between the Blank______ and its Blank______.

exercise price; discounted present value

Which of the following are among the factors that must be considered in order to estimate the total compensation associated with stock options? (Select all that apply.)

expected term of the option current market price of the stock exercise price of the options

Which of the following are among the factors that must be considered in order to estimate the total compensation associated with stock options? (Select all that apply.)

expected volatility of the stock price expected risk-free rate of return during the option term expected dividends on the underlying stock

Under current GAAP, stock options must be reported in the income statement at

fair value.

Vested restricted stock awards are (Select all that apply.)

included in the denominator of basic EPS. already outstanding.

When the effect of potential common shares is dilutive on EPS for Blank______, it should be included in all components of diluted earnings per share.

income from continuing operations

Yves Company has convertible securities that are dilutive with respect to some components of reported EPS, but are antidilutive to other components. Which financial statement line item should be used to determine whether to include the potential common shares in the calculation of diluted EPS?

income from continuing operations

If convertible bonds are assumed to have been converted, the numerator would be assumed to Blank______ by the Blank______ effect of the interest saved.

increase; after-tax

When the tax benefit derived from nonqualified stock options is less than the amount recognized as a deferred tax asset, the company should recognize the difference by

increasing income tax expense.

When the tax benefit derived from nonqualifying stock options exceeds the amount recognized as a deferred tax asset, the company should recognize the difference by

increasing paid-in capital.

A strategy that simplifies the determination of whether convertible securities are dilutive is to compare their _____ effect on earnings per share.

incremental

The incremental effect of convertible bonds is the after-tax _____ saved divided by the additional common shares from the conversion.

interest

The benefit the holder of an option would realize by exercising the options rather than buying the underlying stock directly is referred to as _____ value.

intrinsic

Which of the following are the essential components of option values? (Select all that apply.)

intrinsic value time value

Diluted EPS should be the

lowest possible EPS.

The value of stock options

must be recognized as an expense.

Which of the following are valid categories of stock option plans for tax purposes? (Select all that apply.)

nonqualified stock option plans incentive stock option plans

An actual conversion of dilutive convertible securities will (Select all that apply.)

not affect the reported amount of diluted EPS. decrease the reported amount of basic EPS.

On January 1, Year 1, Utta Corp. (a calendar-year company) grants 10,000 stock options with a 3-year vesting period to employees. On the grant date, the market price of the $1 par value stock is equal to the exercise price of $20 per share. The estimated value of the options is $6 per option. During Year 4, 9,000 stock options were exercised. In Year 5, the remaining stock options expire. Utta should recognize the expiration by debiting

paid-in capital—stock options for $6,000.

On January 1, Year 1, Utta Corp. (a calendar-year company) grants 10,000 stock options with a 3-year vesting period to employees. On the grant date, the market price of the $1 par value stock is equal to the exercise price of $20 per share. The estimated value of the options is $6 per option. During Year 4, 9,000 stock options were exercised. In Year 5, the remaining stock options expire. Utta should recognize the expiration by debiting

paid-in capital—stock options for $6,000. Reason: 1,000 x $6

A low dividend payout ratio may indicate that the company is

planning to reinvest its earnings.

Securities that may become common shares in the future are considered

potential common shares.

Which of the following are subtracted when determining earnings available to common shareholders?

preferred stock dividends

Muller Company sponsors a performance-based stock option plan. When the options are granted, Muller should recognize related compensation expense if it is _____ that the performance target will be met.

probable or likely

Initially, recognition of compensation expense for performance-based plans requires that the achievement of the target is

probable.

Under a Blank______ stock option incentive plan, the exercise price of stock options must be Blank______ the market price at the grant date.

qualified; equal to

The price-earnings ratio provides an indication of a company's

quality of earnings.

Compensation relating to stock option grants should be

recognized over the service period for which employees receive options.

If share-based awards are contingent on the achievement of specific market conditions, compensation expense is

recognized regardless of whether the conditions are met.

If a company issues non-qualifying stock options to employees, it

recognizes a deferred tax asset related to compensation expense recorded in current period accounting income that is not yet deductible

For the purpose of deriving EPS, securities are considered dilutive if they are capable of

reducing earnings per share.

Klein Corp. includes outstanding stock options in the calculation of current year diluted EPS. The proceeds from this presumed stock issuance are assumed to be utilized to

repurchase as many shares as possible.

Typically stock options are exercisable

several years after the grant date

Stock options are often used as employee incentives; therefore, stock options are typically exercisable

several years after they were granted.

The "if converted method" assumes that convertible securities were converted into common stock at what point?

the beginning of the current period

Stock options are said to be "in the money" if

the current market price of the stock exceeds the option exercise price.

The time between the date that options are granted and the first date they can be exercised is referred to as the _____ period.

vesting

At the beginning of the year, Solen Corp. had 100,000 shares of common stock outstanding. On April 1, the company issued an additional 60,000 shares. Weighted-average shares for the year will be

145,000 Shares Reason: 100,000 + (60,000 x 9/12)

On January 1, Year 1, Muenster Corp. (a calendar-year company) grants 10,000 stock options with a 3-year vesting period to employees. On the grant date, the market price of the $1 par value stock is equal to the exercise price of $20 per share. The estimated value of the options is $4 per option. During Year 4, 8,800 stock options were exercised. In Year 5, the remaining stock options expire. How will the expiration of the stock options affect the company's compensation expense?

Compensation expense will not be affected.

Correctly match each type of stock option plan with the correct tax treatment. Instructions

Incentive stock option plan = The recipient pays taxes only when the shares acquired under the plan are sold. Nonqualified stock option plan = The recipient must pay taxes on the difference between the exercise price and the market price of the stock at the exercise date.

Which of the following plans frequently specify a performance condition or a market condition that must be satisfied before employees are allowed the benefits of the reward? (Select all that apply.)

Other share-based plans Stock option plans

Which of the following factors (each considered independently) will tend to increase the value of stock options? (Select all that apply.)

a longer option term volatility of the stock price increases in the market price of the underlying stock

The journal entry to record unexercised stock options that have been allowed to lapse includes (select all that apply)

credit to paid-in-capital-expiration of stock options debit to paid-in-capital-stock options

The two components of the time value relating to options are the

effect of the time value of money. volatility value.

Munch has $500,000 of convertible 6% preferred stock outstanding. The shares can be converted to 40,000 common shares. Munch's tax rate is 40%. For purposes of determining whether the preferred shares are dilutive, the incremental effect of the preferred shares is:

$0.75 Reason: ($500,000 x 0.06) = $30,000; $30,000/40,000 shares = $0.75

Correctly match each type of stock option plan with the correct tax treatment.

Incentive stock option plan = The employer granting the stock options cannot deduct stock option-related values for tax purposes. Nonqualified stock option plan = The employer granting the stock options can deduct the difference between the exercise and the market price at the exercise date for tax purposes.

Maggie Company issued options valued at $1 million to one of its executives that are contingent on the company achieving a 10% increase in sales revenue within the next 12 months. The company believes that it is possible that this target will be achieved. After 6 months, the company estimates that it is probable that the target will be achieved. Based on this new estimate, the company must

debit compensation expense for $1 million.

Stock options, rights, and warrants must be considered when calculating _____ EPS.

diluted

The time value of money component of stock options is the difference between the exercise price and the

discounted present value minus the present value of expected dividends.

Dividends per common share divided by earnings per share provides an indication of

dividend payout.

When estimates of options forfeitures change, the cumulative effect on compensation is recognized

in current earnings.

When stock options expire, compensation expense

is not affected.

Compensation expense related to share-based awards is recognized regardless of whether the market-related conditions are met because

option-pricing models already implicitly reflect market conditions.

Donald Company grants stock options to certain employees. On the date of grant, Donald should measure total compensation based on

the fair value of the options.

The way we take into account the dilutive effect of stock options is referred to as the _____ stock method.

treasury

Falcon Company grants stock options to its upper and middle management employees. The options vest over a 4-year period, with 25% exercisable after 1 year, 25% after 2 years, another 25% after 3 years, and the remaining 25% after 4 years. This is an example of

graded vesting.

On January 1, Year 1, Utta Corp. (a calendar-year company) grants 10,000 stock options with a 3-year vesting period to employees. On the grant date, the market price of the $1 par value stock is equal to the exercise price of $20 per share. The estimated value of the options is $6 per option. During Year 4, 9,000 stock options were exercised. In Year 5, the remaining stock options expire. When the options expire, Utta should credit

paid-in capital—expired stock options for $6,000. Reason: 1,000 x $6

When a company reacquires its own shares, and weighted-average shares are calculated for the purpose of determining EPS, the reacquired shares that are subtracted from the weighted-average calculation are weighted for the

period that they are not outstanding.

Mueller Company estimates that it is unlikely that a particular executive will achieve a specific performance target. Mueller already recognized compensation expense related to this performance plan. Mueller must _____ the related expense.

reverse or credit

Option values include the following essential components: a(n) _____ value and a(n) _____ value.

Blank 1: intrinsic Blank 2: time

Match the component of the time value relating to options with its definition. Instructions

Intrinsic Value = Benefit the holder would realize by exercising the option rather than buying the stock directly Time Value = Benefit that accrues due to the passage of time Volatility Value = Likelihood that the option holder might benefit from price appreciation

Kilian Company issued stock options on August 1, Year 1. For the purpose of calculating dilutive EPS for the year ended December 31, Year 2, the options should be assumed to have been exercised on

January 1, Year 2.

Which of the following must be presented in the financial statement notes relating to EPS? (Select all that apply.)

Potential common shares not included in diluted EPS. Material subsequent events that would have affected EPS. Adjustments to the numerator for preferred dividends. A reconciliation of the numerator and denominator used for basic EPS to those used for diluted EPS.

Which of the following potential common shares may be included in the calculation of diluted EPS, but not basic EPS?

Stock options Restricted stock Convertible securities Contingent issuable shares

What factor typically determines the accounting treatment for share-based plans?

The type of condition that must be fulfilled by employees of the sponsoring company.

The incremental effect of convertible bonds is the Blank______ interest saved divided by the Blank______ common shares from the conversion.

after-tax; additional

Proceeds under the treasury stock method may include (Select all that apply.)

amounts received under the hypothetical exercising of the options. total compensation from nonvested awards.

Basic EPS represents the income earned by one share of

common stock.

Warrants, options, and rights are antidilutive if the exercise price is

higher than the stocks' average market price.

The goal of diluted EPS is to report the Blank______ potential dilution that might result from the conversion or exercise of securities and equity contracts.

highest

Restricted stock awards are

included in the calculation of EPS if unvested.

The rules surrounding the calculation of earnings-per-share are designed to Blank______ comparability by Blank______ differences in the calculation from one company to the next.

maximize; minimizing

From an accounting perspective, the significance of the stock option vesting period is that it is the time period

over which compensation expense is allocated.

When stock options are allowed to lapse, paid-in capital from stock options should be reclassified as:

paid-in capital from expired stock options

The treasury stock method takes into account the dilutive effect of stock options and assumes that the proceeds from the exercise of options are used to

purchase treasury shares.

When it becomes probable that a performance target will not be met, previously recognized compensation expense must be:

reversed

Pfeffer Company reports net income of $120,000; the company's tax rate is 40%. Throughout the year, 200,000 common shares were outstanding. Pfeffer's basic EPS will be

$0.60 Reason: $120,000/200,000

Kolb Corp. has $1 million face amount, 6% convertible preferred stocks issued at par outstanding. Each $100 par value stock can be converted into 5 shares of common stock. The company's tax rate is 40%. The incremental effect of the convertible preferred stocks on diluted EPS will be

$1.20. Reason: $60,000/50,000 shares

Salt Company reports net income of $360 million; the company's tax rate is 40%. Throughout the year, 200 million common shares were outstanding. Salt's basic EPS will be

$1.80 Reason: $360/200

Adam Company's net income for the year is $100 million. Weighed-average shares are 50 million shares. In addition to common shares, the company also has $50 million par value, 8% cumulative preferred stock outstanding. The company's basic EPS will be

$1.92 Reason: ($100 - $4)/50

Waldemar Company's net income for the year is $300 million. Weighed-average shares are 150 million shares. In addition to common shares, the company also has $100 million par value, 6% cumulative preferred stock outstanding. The company's basic EPS will be

$1.96 Reason: ($300 - $6)/150

Bonnie Inc. has 500, 6%, $1,000 face amount bonds outstanding during the entire year. The bonds were issued at face. Each bond is convertible into 14 shares of common stock. The company's tax rate is 30%. What would be the effect of the assumed conversion on the numerator of diluted EPS?

$21,000 Reason: $1,000 x 500 x 6% x (1 - 0.3)

Fuller Corp. has 10,000 options outstanding that allow employees to purchase each share of stock for $10. The market price of the stock is $14. The intrinsic value of the related options is

$4 per share.

Place the presentation of earnings per share in the correct order.

1. EPS - income from continuing operations 2. EPS - discontinued operations 3. EPS - net income

Pfeffer Company reports net income of $360 million for the year; the company's tax rate is 40%. At the beginning of the year, 200,000 common shares were outstanding. On August 1, the company issued an additional 120,000 shares. Weighted-average shares will be

250,000 Reason: [200,000 + (120,000 x 5/12)]

Salt Company reports net income of $360 million for the year; the company's tax rate is 40%. At the beginning of the year, 200 million common shares were outstanding. On July 1, Salt sold an additional 80 million shares and on October 1 distributed a 10% stock dividend. On December 1, the company reacquired 24 million of its outstanding shares. The company's weighted-average shares for the purpose of calculating basic EPS will be

262 Million Reason: [(200 + [80 x 6/12]) x 1.1] - 24/12

Salt Company reports net income of $360 million for the year; the company's tax rate is 40%. At the beginning of the year, 200 million common shares were outstanding. On July 1, Salt sells an additional 80 million shares. On October 1, the company distributed a 10% stock dividend. The company's weighted-average shares for the purpose of calculating basic EPS will be

264 Million Reason: [200 + (80 x 6/12)] x 1.1

Bonnie Inc. has 500, 6%, $1,000 face amount bonds outstanding during the entire year. The bonds were issued at face. Each bond is convertible into 14 shares of common stock. The company's tax rate is 30%. What would be the effect of the assumed conversion on the denominator of diluted EPS?

7,000 shares would be added. Reason: 500 x 14

Which of the following will qualify a company for having a simple capital structure for the purpose of earnings per share?

A company that has no outstanding securities that could potentially dilute EPS.

Disclosure notes related to EPS should include: (Select all that apply.)

Antidilutive common shares not included in EPS Adjustments to the numerator for preferred dividends Subsequent events that would affect the calculation

Because options are not exercised immediately, their valuation includes a(n) _____ _____ component.

Blank 1: time Blank 2: value

Which of the following strategies will simplify the determination of whether convertible securities are dilutive or antidilutive to EPS?

Comparing the incremental effect of the conversion.

Which of the following stock options is considered "in the money" relating to options with an exercise price of $15 per share?

Current stock price per share is $20.

Which of the following must be presented in a company's financial statements (which include the financial statement notes), assuming that the related financial statement items exist for that company? (Select all that apply.)

EPS—income from continuing operations EPS—discontinued operations EPS—net income

True or false: In calculating diluted EPS,convertible preferred stock is assumed converted only if the stock was issued during an earlier period.

False Reason: It is assumed converted if its conversion were to result in a dilution of EPS.

Katie Company issued stock options on February 1, Year 1. For the purpose of calculating dilutive EPS, the options should be assumed to have been exercised on

February 1, Year 1.

Correctly match the type of vesting of stock options with the correct description. Instructions

Graded vesting = Stock options vest over time. Cliff vesting = Stock options vest all at once.

Which of the following is true with respect to the accounting profession's response to the demand for comparable EPS numbers?

Inconsistencies in calculating EPS have been minimized.

Which of the following statements regarding the prevalence of stock option awards is correct?

Many large and medium-size companies grant stock options.

Which of the following must be presented in the financial statement notes relating to EPS? (Select all that apply.)

Material subsequent events that would have affected EPS. Adjustments to the numerator for preferred dividends. A reconciliation of the numerator and denominator used for basic EPS to those used for diluted EPS. Potential common shares not included in diluted EPS.

Which of the following shares may be included in the calculation of basic EPS?

Outstanding common shares

Which of the following plans frequently specify a performance condition or a market condition that must be satisfied before employees are allowed the benefits of the reward? (Select all that apply.)

Stock option plans Other share-based plans

Which of the following will result in the distribution of additional shares? (Select all that apply.)

Stock splits Stock dividends

What condition must be met to include contingent issuable shares in the calculation of diluted EPS?

The required condition already is being met.

Which of the following scenarios will increase stockholders' equity?

The sale of new shares

Which of the following statements regarding the role of antidilutive securities in the calculation of EPS is correct?

They are ignored when calculating both basic and diluted EPS.

Which of the following is correct regarding stock options and other share-based plans?

They frequently specify a performance or market condition.

Which of the following represent typical goals of executive compensation plans? (Select all that apply.)

To provide compensation to certain employees. To create performance incentives for certain employees.

True or false: Accounting for share-based plans depends on the type of condition that must be fulfilled by the employee to achieve the share-based award.

True

True or false: Stock options have become an integral part of most medium and large companies.

True

True or false: The incremental effect of conversion of preferred stock is calculated as the preferred dividends that would not be paid divided by additional common shares from conversion.

True

Which of the following factors (each considered independently) will tend to lower the value of stock options? (Select all that apply.)

a higher exercise price higher dividends

Horst Company has 50,000 stock options outstanding. The option exercise price is $13 per share, the average market price of the stock was $12 per share during the year, and the end-of-year stock price was $14. For the purpose of calculating EPS, these stock options are

antidilutive.

For the purpose of calculating diluted EPS, convertible preferred stock is

assumed to have already been converted.

In calculating EPS, preferred stock dividends are subtracted from the numerator because EPS represents earnings available to _____ shareholders.

common

Which of the following may result in potential common shares? (Select all that apply.)

convertible preferred stocks convertible bonds

Munster Company issued options to a key executive that are contingent on the company achieving a 10% increase in sales revenue within the next 12 months. The company believes that it is likely that this target will be achieved and accrues $5 million in related compensation expense. After 9 months, the company estimates that it is possible, but not likely that the target will be achieved. Based on this new estimate, the company must

credit compensation expense for $5 million.

On January 1, Year 1, Utta Corp. (a calendar-year company) grants 15,000 stock options with a 3-year vesting period to employees. On the grant date, the market price of the $1 par value stock is equal to the exercise price of $20 per share; the estimated market value of each option is $5. The company's average tax rate is 30%. To reflect the tax effect of these nonqualifying stock options, Utta Corp. should (Select all that apply.)

credit income tax expense for $7,500. debit deferred tax asset for $7,500. Reason: ($5 x 15,000/3) x 0.3

Salt Company reports net income of $360 million for the year; the company's tax rate is 40%. At the beginning of the year, 200 million common shares were outstanding. On July 1, Salt sells an additional 80 million shares. On October 1, the company distributed a 10% stock dividend. Rounding to the nearest cent, the company's basic EPS will be

$1.36. Reason: $360/[(200 + [80 x 6/12]) x 1.1]

When we include options, rights, and warrants in the calculation of diluted EPS, we pretend that the potential increase in shares

has already occurred.

Securities that upon conversion or exercise of potential common shares would increase EPS are referred to as _____ securities.

antidilutive

The price-earnings ratio indicates a company's earnings quality by

indicating the multiple the market is willing to pay for earnings

In calculating diluted EPS under the treasury stock method, one component of the proceeds from the exercise of options include

cash received at exercise

On January 1, Year 1, Utta Corp. (a calendar-year company) grants 10,000 stock options with a 3-year vesting period to employees. On the grant date, the market price of the $1 par value stock is equal to the exercise price of $20 per share. On the date of grant, the estimated value of the options is $6 per option. During Year 4, when the market value of the stock is $30 per share, 9,000 stock options were exercised. Utta Corp. should recognize this event by debiting (Select all that apply.)

paid-in capital—stock options for $54,000. Reason: 9,000 x $6 cash for $180,000.

The value of stock options has a time value component because (Select all that apply.)

the value of the options may change between the date of grant and the time the options are exercised. options do not have to be exercised immediately.

Vogel Corp.'s denominator for calculating diluted EPS is 57,300 weighted-average shares. Included in the denominator were 5,000 shares related to convertible preferred stocks assumed to have been converted. If the convertible preferred stock had actually been converted, the weighted-average shares for purposes of diluted EPS would have been

57,300 shares.

On January 1, Year 1, Utta Corp. (a calendar-year company) grants 10,000 stock options with a 3-year vesting period to employees. On the grant date, the market price of the $1 par value stock is equal to the exercise price of $20 per share. On the date of grant, the estimated value of the options is $6 per option. During Year 4, 9,000 stock options were exercised. Utta Corp. should recognize this event by crediting (Select all that apply.)

common stock for $9,000. Reason: $1 x 9,000 shares paid-in capital in excess of par for $225,000. Reason: $180,000 + $54,000 - $9,000