Chapter 19
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
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.
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.
Which of the following must be presented in the financial statement notes relating to EPS?
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. Material subsequent events that would have affected EPS. Adjustments to the numerator for preferred dividends.
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.
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 shares may be included in the calculation of basic EPS?
Outstanding common shares
Which of the following potential common shares may be included in the calculation of diluted EPS, but not basic EPS?
Restricted stock Contingent issuable shares Convertible securities Stock options
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, 7% convertible bonds issued at par outstanding. Each $1,000 bond can be converted into 40 shares of common stock. The company's tax rate is 40%. The incremental effect of the bonds on diluted EPS will be
$1.05.
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.
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.
Place the presentation of earnings per share in the correct order.
EPS - income from continuing operations EPS - discontinued operations EPS - net income
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?
EPS—net income EPS—discontinued operations EPS—income from continuing operations
The method that assumes that a conversion into common stock occurred at the later of the beginning of the period or the time the convertible security is issued is referred to as the______
If Converted Method
Volatility Value
Likelihood that the option holder might benefit from price appreciation
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 plans frequently specify a performance condition or a market condition that must be satisfied before employees are allowed the benefits of the reward?
Stock option plans Other share-based plans
Cliff vesting
Stock options vest all at once.
Graded vesting
Stock options vest over time.
Disclosure notes related to EPS should include
Subsequent events that would affect the calculation Antidilutive common shares not included in EPS Adjustments to the numerator for preferred dividends
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.
Incentive stock option plan
The employer granting the stock options cannot deduct stock option-related values for tax purposes.
What factors would affect the calculation of diluted EPS if convertible bonds are assumed to have been converted into common stock of the issuing company?
The numerator would reflect the after-tax savings of interest. The denominator would reflect the additional common shares assumed issued.
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.
Incentive stock option plan
The recipient pays taxes only when the shares acquired under the plan are sold.
Which of the following scenarios will increase total assets and equity?
The sale of new 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.
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 statements is correct regarding stock dividends and stock splits?
They represent distributions of additional shares to existing shareholders.
Which of the following represent typical goals of executive compensation plans?
To create performance incentives for certain employees. To provide compensation to certain employees.
The way we take into account the dilutive effect of stock options is referred to as the____________
Treasury Stock Method
Stock options have become an integral part of most medium and large companies.
True
Which of the following factors (each considered independently) will tend to lower the value of stock options? (
a higher exercise price higher dividends
Which of the following factors (each considered independently) will tend to increase the value of stock options?
a longer option term volatility of the stock price increases in the market price of the underlying stock
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
a. $1.80.Reason:$360/200
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
a. 250,000.Reason:[200,000 + (120,000 x 5/12)]
The incremental effect of convertible bonds is the ______ interest saved divided by the ______ common shares from the conversion.
after-tax; additional
Securities that upon conversion or exercise of potential common shares would increase EPS are referred to as________________
antidilutive securities
In calculating diluted EPS under the treasury stock method, one component of the proceeds from the exercise of options include
cash received at exercise
In calculating EPS, preferred stock dividends are subtracted from the numerator because EPS represents earnings available to
common shareholders
Basic EPS represents the income earned by one share of
common stock.
Which of the following may result in potential common shares?
convertible bonds convertible preferred stocks
Which of the following would prevent Norbert Company from having a simple capital structure for the purpose of reporting EPS?
convertible preferred stocks
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.
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.
Basic EPS is determined by dividing
earnings available to common shareholders by weighted-average common shares outstanding.
Investors' desire to focus on one number that may summarize a company's performance may explain the importance of
earnings per share.
If the underlying stock pays no dividends, the time value of money component of a stock option is the difference between the ______ and its ______.
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?
expected risk-free rate of return during the option term expected volatility of the stock price expected dividends on the underlying stock
Under current GAAP, stock options must be reported in the income statement at
fair value.
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.
When we include options, rights, and warrants in the calculation of diluted EPS, we pretend that the potential increase in shares
has already occurred.
When the effect of potential common shares is dilutive on EPS for ______, 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
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.
Which of the following are the essential components of option values?
intrinsic value time value
When stock options expire, compensation expense
is not affected.
Warrants, options, and rights are dilutive if the exercise price is
lower than the stocks' average market price.
Diluted EPS should be the
lowest possible EPS.
Compensation plans that are tied to the achievement of certain targets and are used to motivate key employees are referred to as __________compensation plans.
manangement
Share-based plans typically are grouped into two major categories based on the conditions that must be met by employees in order to receive the benefits of the award. These categories are
market-based plans. performance-based plans.
The rules surrounding the calculation of earnings-per-share are designed to_____________comparability by___________________differences in the calculation from one company to the next.
maximize; minimizing
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?
nonqualified stock option plans incentive stock option plans
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.
The value of stock options has a time value component because
options do not have to be exercised immediately. the value of the options may change between the date of grant and the time the options are exercised.
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.
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.
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.
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.
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
Initially, recognition of compensation expense for performance-based plans requires that the achievement of the target is
probable.
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.
Under a _________stock option incentive plan, the exercise price of stock options must be__________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.
When it becomes probable that a performance target will not be met, previously recognized compensation expense must be:
reversed
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.
Earnings per share is reported very frequently in the financial press because it
tends to summarize the company's performance.
Stock options are said to be "in the money" if
the current market price of the stock exceeds the option exercise price.
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.
Proceeds under the treasury stock method may include
total compensation from nonvested awards. amounts received under the hypothetical exercising of the options.
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
The time between the date that options are granted and the first date they can be exercised is referred to as the
vesting period
The two components of the time value relating to options are the
volatility value. effect of the time value of money.
When stock options are allowed to lapse, paid-in capital from stock options should be reclassified as:
paid-in capital from expired stock options
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
paid-in capital in excess of par for $225,000. common stock for $9,000.
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. 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
paid-in capital—stock options for $54,000. cash for $180,000.
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*($500,000 x 0.06) = $30,000$30,000 / 40,000 shares = 0.75
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.
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.
Time Value
Benefit that accrues due to the passage of time
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.
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.
credit
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
credit income tax expense for $7,500. debit deferred tax asset for $7,500.
The journal entry to record unexercised stock options that have been allowed to lapse includes
credit to paid-in-capital-expiration of stock options debit to paid-in-capital-stock options
Stock options, rights, and warrants must be considered when calculating
diluted EPS
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.
The incremental effect of convertible bonds is the after-tax__________ saved divided by the additional common shares from the conversion
interest
The incremental effect of convertible bonds is the after-tax____________saved divided by the additional common shares from the conversion
interest
In calculating diluted EPS, which of the following restricted stock awards is included in the calculation?
unvested restricted stock awards only
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.
Vested restricted stock awards are
Already outstanding and included in the denominator of basic EPS
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
$1.92Reason:($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
Dividends per common share divided by earnings per share provides an indication of
dividend payout.
Intrinsic Value
Benefit the holder would realize by exercising the option rather than buying the stock directly
The benefit the holder of an option would realize by exercising the options rather than buying the underlying stock directly is referred to as
Blank 1: intrinsic
Option values include the following essential components: a(n)_______ value and a(n) _________value.
Blank 1: intrinsic Blank 2: time
Because options are not exercised immediately, their valuation includes a(n) __________component.
Blank 1: time Blank 2: value
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.
What condition must be met to include contingent issuable shares in the calculation of diluted EPS?
The required condition already is being met.
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
For the purpose of calculating diluted EPS, convertible preferred stock is
assumed to have already been converted.
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
b. 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
c. 264 millionReason:[200 + (80 x 6/12)] x 1.1
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.
An actual conversion of dilutive convertible securities will
decrease the reported amount of basic EPS. not affect the reported amount of diluted EPS.
The incremental effect of convertible preferred stock is determined by dividing ______ by ______.
dividends that wouldn't be paid; additional common shares from conversion
Which of the following are among the factors that must be considered in order to estimate the total compensation associated with stock options?
exercise price of the options expected term of the option current market price of the stock
In calculating diluted EPS,convertible preferred stock is assumed converted only if the stock was issued during an earlier period.
falseReason:It is assumed converted if its conversion were to result in a dilution of EPS.
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 ______ potential dilution that might result from the conversion or exercise of securities and equity contracts.
highest
When estimates of options forfeitures change, the cumulative effect on compensation is recognized
in current earnings.
Restricted stock awards are
included in the calculation of EPS if unvested.
A strategy that simplifies the determination of whether convertible securities are dilutive is to compare their_____________ effect on earnings per share.
incremental
The price-earnings ratio indicates a company's earnings quality by
indicating the multiple the market is willing to pay for earnings