Chapter 19
The two primary types of restricted stock plans:
(a) Restricted Stock Awards. (b) Restricted Stock Units. •These plans usually are tied to continued employment.
Financial Statement Presentation of Earnings per Share Data
Basic EPS and diluted EPS must be reported separately for income from continuing operations and net income when the income statement includes discontinued operations. Per share amounts for discontinued operations would be disclosed either: •On the face of the income statement or, In the notes to financial statements. For all reporting periods presented in the comparative statements. Businesses without potential common shares present basic EPS only.
Restricted Stock Units (RSUs) Journal Entry
Debit: compensation expense credit: paid-in capital-restricted stock Debit: paid-in capital-restricted stock credit: common stock credit: paid-in capital-excess of par
EPS =
Earnings available to common shareholders ÷Weighted-average number of common shares outstanding
Options, Rights, and Warrants
Give holders the right to exercise their option to purchase common stock, at a specified exercise price. Dilution resulting from the possible exercise should be reflected in the calculation of diluted EPS,but not basic EPS. To include the dilutive effect of a security means to calculate EPS as if the potential increase in shares already has occurred.
Antidilutive Securities
If the effect of the conversion or exercise of potential common shares would be to increase, rather than decrease. Ignoredwhen calculating both basic and diluted EPS. Example: Options, Warrants, Rights
When Potential Common Shares Are Reflected in EPS •Stock options (or warrants, rights) •Restricted stock •Convertible securities (bonds, notes, preferred stock) •Contingently issuable shares
Is the Dilutive Effect Reflected in the Calculation of EPS?* Basic EPS no no no no Is the Dilutive Effect Reflected in the Calculation of EPS?* Diluted EPS yes yes yes yes The effect is not included for any security if its effect is antidilutive. ƗUnless shares are contingent upon some level of performance not yet achieved.
If the target is based on changes in the _______ rather than on performance, compensation is recorded as if there were no _______.
Market Target Compensation expense is recognized regardless of when the market condition is met.
Intrinsic value =
Market price of the shares− Option price at which they can be acquired
How Potential Common Shares Are Reflected in a Diluted EPS Calculation •Stock options (or warrants, rights). •Restricted stock. •Convertible bonds (or notes). •Convertible preferred stock. •Contingently Issuable shares: Issuable when specified conditions are met, and those conditions currently are being met. •Contingently Issuable shares: Issuable when specified conditions are met, and those conditions are not currently being met.
Modification to the Diluted EPS Fractions in Numerator -None -None -Add the Interest (after-tax) that would have been avoided if the debt had been converted. -Do not deduct the dividends that would have been avoided If the preferred stock had been converted. -None -None Modification to the Diluted EPS Fractions in Denominator -Add the shares that would be created by their exercise,* reduced by shares repurchased at the average share price -Add shares that would be created by their vesting,* reduced by shares repurchased at the average share price -Add shares that would be created by the conversion* of the bonds (or notes). -Add shares that would have been created by the conversion* of the preferred stock. -Add shares that are issuable. -None *At the beginning of the year or when potential common shares were Issued, whichever Is later (time-weight the increase in shares if assumed exercised or converted in midyear).
Potential Common Shares
Securities that are not common stock but might become common stockthrough their exercise or conversion (Diluted Earnings per Share)
Convertible Securities
Securities that can be converted into (exchanged for) shares of stock at the option of the holder of the security. •So, convertible securities are potentially dilutive. The potentially dilutive effect of convertible securities is reflected in diluted EPS calculations by pretending they were converted into common stock occurred at the beginning of the period (or at the time the convertible security is issued, if that's later).
Share-Based Compensation
Share-based awards are forms of payment whose value is tied to the market price of the company's stock. Share-based compensation plans include stock award plans,stock option plans,stock appreciation rights (SARs),or one of the several similar plans. The goals are to provide compensation to designated employees, while sometimes providing those employees with a performance incentive.
Increase in shares caused by a stock dividend
Stock dividend or stock split merely increases the number of shares without affecting the firm's assets. Larger number of less valuable shares. Same "pie," more slices.
Plans with Performance or Market Conditions
Stock option plans often specify a performance condition or a market condition that must be satisfied before employees are allowed the benefits of the award. Objective: To provide employees with additional incentive for managerial achievement. An option might not be exercisable until a performance target is met. The way such plans are accounted for depends on whether the condition is: •Performance-based or Market-based.
Restricted Stock Units (RSUs)
The company distributes the shares after the recipient of RSUs satisfies the vesting requirement. The recipient benefits by the value of the shares at the end of the vesting period.
Increase in shares from selling new shares
When new shares are sold, both assets and shareholders' equity are increased by an additional investment in the firm by shareholders. Shareholders' interests in their company's earnings is diluted.
Criteria for the plan being noncompensatory:
a.All employees can participate. b.Employees have no longer than one month after the price is fixed to decide whether to participate. c.The discount is no greater than 5%.
EPS is calculated as if conversion
already had occurred.
Restricted Stock Awards
awarded in the name of the employee shares physical possession might be retained by the company Subject to forfeiture by the employee if employment is terminated within some specified number of years from the date of grant. Not free to sell the shares during the restriction period.
Compensation now is measured as the _____ _____ of the ______ ______ the grant date. We record that amount as _______ ________ over the service period for which employees receive the options. The fair value is __________ by employing a recognized option pricing model.
fair value stock options Compensation expense estimated
The number of reacquired shares is time-weighted for the
fraction of the year they were not outstanding,prior to being subtractedfrom the number of shares outstanding during the period. When a stock distribution (dividend) occurs during the reporting period, any sales or purchases of shares that occur before, but not after,the distribution are increased by the distribution.
Antidilutive vs Dilutive
incremental effect of conversion> basic EPS incremental effect of conversion < basic EPS
The weighted-average number of shares is reduced if
shares are reacquired during the period. Reacquired either as retired shares or as treasury stock
When a senior class of shareholders (like preferred shareholders) is entitled to a specified allocation of earnings (like preferred dividends) these amounts are
subtracted from earnings before calculating earnings per share. We subtract dividends oncumulativepreferred stock, even if not declared this period, the presumption being that the dividends eventually will be paid
If these criteria for the plan being noncompensatory are met
the sales of new shares are recorded as employees buy shares and do not record compensation expense If these criteria for the plan being noncompensatory are not met,the discount to employees is considered to becompensation,and that amount is recorded as expense
Order of Entry for Multiple Convertible Securities
•A convertible security might seem to be dilutive when looked at individually but may be antidilutive when included in combination with other convertible securities. •The earnings per incremental share is used to determine the sequence of including securities' effects. •The securities are included in reverse order, beginning with the lowest incremental effect (that is, most dilutive), followed by the next lowest.
Stock option plans give employees the option to purchase.
•A specified number of shares of the firm's stock. •At a specified exercise price. •During a specified period of time. Historically, options were measured at their intrinsic values.
Earnings per Share (EPS)
•A way of summarizing the performance of business enterprises in a single number. The comparability of EPS numbers is maximized by minimizing the inconsistencies in their calculation from one company to the next.
Benefits to the employees:
•Allow employees to buy shares from their employer without brokerage fees and at a slight discount.
A firm with a complex capital structure reports two EPS calculations:
•Basic EPSignores the dilutive effect of such securities. •Diluted EPS incorporates the dilutive effect of all potential common shares.
An option pricing model takes into accountseveral variables, such as:
•Exercise price of the option. •Expected term of the option. •Current market price of the stock. •Expected dividends. •Expected risk-free rate of return during the term of the option. •Expected volatility of the stock.
Recognition of compensation expense for performance-based options depends:
•Initially on whether it's probable that the performance target will be met and, •Ultimately on whether the performance target actually ismet.
Options, Rights, and Warrants Assumptions:
•Options (or rights, or warrants) were exercised at the beginning of the reporting period, or when the options were issued if that's later. •Cash proceeds from selling the new shares at the exercise price are used to buy back as many shares as possible at the shares' average market price during the year.
Employee Share Purchase Plans
•Permit all employees to buy shares directly from their companyat favorable terms. •Primary intent of these plans is to encourage employee ownership of the company's shares. •Loyalty is enhanced among employee shareholders.
Many companies are moving away from stock options in favor of other forms of share-based compensation.
•Restricted stock awards. •Restricted stock units.
Once the shares vest and the restrictions are lifted, paid-in capital.
•Restricted stock is replaced by common stock and paid-in capital. •Excess of par. Any market price changes that might occur after that don't affect the total compensation.
Effect on EPS calculation:
•Shares are added to the denominator of the EPS fraction. •The preferred dividends in the numerator are not subtracted because those dividends would have been avoided if the preferred stock had been converted.
When we pretend they are converted:
•The denominator of the EPS fraction is increased by the additional common shares that would have been issued upon conversion. •The numerator is increased by the interest (after-tax) on bonds or other debt or the preferred dividends that would have been avoided if the convertible securities had not been outstanding due to having been converted.
When the buyback(average market) price is higher than the exercise price
•The number of shares assumed repurchased is fewer than the number of shares assumed sold. •Shares are sold at the exercise price and repurchased at the market price. •Buying back more shares than were sold. •Produces a net decrease in the number of shares. •EPS would increase,not decrease.
Calculation of EPS becomes more demanding when:
•The number of shares has changed during the reporting period. •The earnings available to common shareholders are diminished by dividends to preferred shareholders. •We attempt to take into accountthe impending effect of potential common shares.
Terms of RSUs vary.
•The recipient sometimes is given the cash equivalent of the number of shares used to value the RSUs. •The terms might stipulate that either the recipient or the company is allowed tochoose whether to settle in stock or cash.
Accounting objective: Share-Based Compensation
•To determine the fair value of the compensation. •To expense that compensation over the periods in which participants perform services.
Complex capital structure
•When any potential common shares are outstanding. Examples of potential common shares: •Convertible bonds. •Convertible preferred stock. •Stock options. •Contingently issuable securities. (Diluted Earnings per Share)
