AC311 Chapter 19

Formula for new yearly compensation expense if we record forfeitures only if and when they occur

(Total comp - forfeitures) x (current period/vesting period) - comp from previous years

Formula for new yearly compensation expense if a forfeiture estimate is revised. Why do we use this formula?

(Total comp x [100 - new percentage]%) * (current period/vesting period) - comp from previous years The (total comp x [100 - new percentage]%) quantity reflects the total compensation that will accumulate based on the new forfeiture estimate. The (current period/vesting period) reflects how long it's been since the start of vesting. Then, subtracting out the compensation from previous years lets us determine the amount of compensation that should be recorded just this year.

Formula for yearly compensation expense w/ forfeiture estimate

(Total comp x [100-estimated percentage]%)/vesting period

Formula for basic EPS

(earnings available to common shareholders)/(weighted average # of common shares outstanding)

Simplest situation for basic EPS

(net income)/(common shares outstanding)

How do we calculate net loss per share (formula)?

(net loss - preferred dividends)/weighted average shares outstanding

Balance sheet effects: stock options exercised

- Assets increase - Net increase in SE

Balance sheet and I/S effects: yearly compensation expense for RSU

- No net change to SE (increases and decreases by same amount) - PTI decreases

Balance sheet effects: RSU closed out at end of vesting period

- No net change; SE increase and decrease by same amount

Balance sheet effects: unexercised stock options expire

- No net change; SE increases and decreases by same amount

3 types of potential common shares

1. Convertible bonds 2. Convertible preferred stock 3. Stock options

Two ways to adjust compensation in the case of forfeitures

1. Estimating forfeitures as a percentage; journal entries are adjusted to reflect this starting at the beginning of the vesting period until the end. 2. Adjusting as forfeitures occur

Simple capital structure

A company has no outstanding securities that could potentially dilute EPS (no potential common shares).

Complex capital structure

A company has potential common shares outstanding; companies with complex capital structure must calculate both basic EPS and diluted EPS.

Earnings per share (EPS)

Amount of income earned by a company expressed on a per share basis

What is the primary goal of EPS?

Comparability

Forfeiture estimates lead to what type of adjustment?

Cumulative expense adjustment--an adjustment in which the total amount of expense over the vesting period is adjusted and periodic expense is determined accordingly.

Journal entry: stock options exercised

Dr Cash (exercise price x # options exercised) Dr PIC--stock options (proportion of account balance based on proportion of options exercised) Cr Common stock (par value) Cr APIC--CS (to balance)

Journal entry: yearly compensation expense for RSU

Dr Compensation expense (total comp expense/vesting period) CR PIC--restricted stock

Journal entry: yearly compensation for stock option

Dr Compensation expense (total comp/vesting period) CR PIC--stock options

Journal entry: RSU closed out at end of vesting period

Dr PIC--restricted stock (total compensation amount) Cr Common stock (par value) Dr APIC--CS

Journal entry: unexercised stock options expire

Dr PIC--stock options CR PIC--expiration of stock options

What is basic EPS?

EPS calculation based on the simple capital structure; does not include potential common shares.

When are expenses recognized for stock compensation?

Expenses are recognized throughout the vesting period, NOT when the stock options are exercised or when restricted stock is converted to common stock.

Share-based awards

Forms of payment whose value is dependent on the value of the company's stock. Can be outright awards of shares, stock options, or cash payments tied to market price of shares.

How do we know if potential common shares are antidilutive under the if-converted method?

If incremental EPS for convertible preferred stock or convertible bonds does not bring basic EPS down to its worst case scenario when it's included in the diluted EPS calculation (based on order of entry), it is technically antidilutive.

How do we know if potential common shares are antidilutive under the treasury stock method? Why?

If the number of shares of treasury stock reacquired is greater than the number of stock options/warrants exercised, the shares are antidilutive. This is because the number of outstanding common shares will decrease overall, increasing EPS.

In what years do we apply the formulas for forfeitures (estimate or recording them as they occur)?

In the year the estimate occurs/the year the forfeitures occur AND all years after.

Incremental EPS: treasury stock method for stock warrants or options

Incremental EPS under the treasury stock method will always be zero. Numerator: no change Denominator: add net change in outstanding shares (formula for this on another flashcard)

Stock option plans

Instead of being awarded shares, an employee is given the option to buy shares in the future.

How is the total value of RSUs calculated? (formula)

Market price of shares is used to calculate total value (total compensation expense) Total value = # of shares x market price

Do we include antidilutive securities in diluted EPS?

NO; we ignore them and only include dilutive shares.

Incremental EPS: if-converted method for convertible bonds

Numerator: + (interest savings - tax benefits) Denominator: + # of converted shares

Incremental EPS: if-converted method for convertible preferred stock

Numerator: + pre-conversion preferred dividends Denominator: + # of converted shares

Potential common shares

Securities that are not yet common stock but may become common stock through their exercise/conversion/issuance and therefore dilute EPS.

Restricted stock award

Shares are awarded in the name of the employee, but company might retain physical possession of the shares. Shares are subject to forfeiture by the employee if employment is terminated within some specified number of years from the date of grant; creates incentive to remain with company until shares vest.

What are "out of the money" options? Are they considered in diluted EPS?

Stock options whose exercise price is greater than the average market price. They are not considered in incremental EPS because 1) no one would exercise them in real life, and 2) they would result in a net decrease of common shares outstanding.

What extra information gets added into the basic EPS formula when a company declares preferred dividends?

The amount of preferred dividends gets subtracted from the numerator.

Order of entry for including potential common shares in diluted EPS

The potential common with the lowest incremental EPS should be included in the diluted EPS calculation FIRST; this may cause other potential common shares to become antidilutive. We would thus ignore the newly antidilutive shares and present the worst case scenario.

What extra information gets added into the basic EPS formula when new shares are issued partway through the year?

The quantity (# new shares x proportion of year outstanding) gets added to the denominator of the formula.

What extra information gets added into the basic EPS formula when a company reacquires shares by retiring them or purchasing them as treasury stock?

The quantity (# reacquired shares x proportion of year NOT outstanding) gets subtracted from the denominator.

Restricted stock units (RSUs)

The right of any employee to receive a specified number of shares of company stock; expense is recognized as the recipient satisfies the vesting agreement (OVER TIME). Restricted stock is actually "distributed" as common stock at the end of the vesting period.

How do stock splits from one year affect EPS from the previous year?

The stock splits are applied retroactively to the previous year's EPS when that previous year's EPS is reported in this year's comparative financials.

How do we determine the vesting period for stock options?

The vesting period is the amount of time between the grant date and the approved exercise date.

If preferred dividends are non-cumulative, what will the effect to basic EPS be?

There are 3 possibilities: 1. If no dividends are declared for the year, there is no effect to the calculation. 2. If dividends declared are greater than or equal to yearly preferred dividends, only the yearly preferred dividends are subtracted from the numerator of the basic EPS calculation. 3. If dividends declared are less than yearly preferred dividends, the whole amount of dividends declared are subtracted from the numerator (all of these will go to preferred shareholders).

What types of changes to basic EPS are time-weighted? Which are not?

Time-weighted: new issuance of shares and reacquisition of shares Not time-weighted: stock dividends/stock splits

What is used to calculate total compensation for stock options? (formula)

Total compensation = # of options x estimated FV of each OPTION

What are we trying to reflect to stakeholders when we calculate diluted EPS?

We are trying to show them the WORST CASE SCENARIO.

What should we do if an employee forfeits their RSUs before the end of the vesting period?

We should reverse any journal entries related to the compensation.

If preferred dividends are cumulative, what will the effect to basic EPS always be?

We will always subtract those yearly preferred dividends from the numerator of the basic EPS calculation.

What extra information gets added into the basic EPS formula when a stock dividend or stock split is declared?

Whatever is in the denominator already [shares issued prior to stock split/dividend] gets multiplied by the quantity (1 + decimal equivalent of stock dividend %).

How do we determine which potential common shares are most dilutive?

When comparing potential common shares, whichever has the lowest incremental EPS will be the most dilutive. Since stock options/warrants always have an incremental EPS of 0, those will be the most dilutive as long as they lead to a net increase in outstanding shares (otherwise they are antidilutive). After that, the potential common shares with the next lowest incremental EPS will be the next most dilutive, so on and so forth.

Antidilutive securities

When these potential common shares are exercised/converted, EPS increases rather than decreases.

Formula for net change in outstanding shares from the exercise of stock warrants or options

# shares exercised x exercise price = "_____" "_____" / average market price = # shares reacquired # shares exercised - # shares reacquired = net change in outstanding shares