ACCT405 Chapter 19
JE on Exercise Date (Stock Options)
Dr. Cash (exercise price @ date of grant*options exercised) Dr. Paid-in Capital - stock options (total compensation exp*(no. shares exercised/total shares permitted to purchase)) Cr. Common Stock (no. shares exercised*par val) Cr. Paid-in Capital - excess of par (remainder)
JE on Expiration Date (Stock Options)
Dr. Paid-in Capital - stock options (account balance) Cr. Paid-in Capital - expiration of stock options
Vesting Period
The time between the date options are granted and the first date they can be exercised ~Usually is considered to be the service period over which the compensation expense is reported
Stock Options, Rights, and Warrants
These are similar; each gives its holder the right to exercise their option to purchase common stock, usually at a specified exercise price. ~If this exercise price is higher than the market price, the securities are said to be antidilutive securities, and are excluded from the calculation of diluted EPS. However, if the exercise price is lower than the market price, the securities are dilutive ~We use the treasury stock method to determine the impact of those securities on diluted EPS
Total Compensation Expense (Stock Option Plans)
To calculate, Fair value per option on the grant date*options granted
Vesting
Usually occurs if the employee works specified number of years for the company ~These restrictions give the employee the incentive to remain with the company
Simple Capital Structure
A company is said to have this if it has no outstanding dilutive securities (not common stock, but could potentially become common stock) that could potentially dilute (reduce) EPS. ~Requires that we disclose only basic earnings per share
Convertible Securities
Can be converted into shares of common stock at the option of the holder of the security ~Potentially dilutive ~EPS will be affected if and when such securities are converted and new shares of common stock are issued ~Uses the "if-converted" method when calculating diluted EPS - this determines the impact of these securities on EPS
JE to Record Allocation of Compensation Expense (Stock Options w/ Performance Conditions)
Dr. Compensation Expense (est. total compensation expense/length of vesting period) Cr. Paid-in Capital - stock options (expensed equally over vesting period)
JE at End of Vesting Period (Restricted Stock Award or RSU)
Dr. Paid-in Capital (no. shares granted*current market price) Cr. Common Stock (no. shares granted*par value) Cr. Paid-in Capital - excess of par (to balance)
Stock Option Plans
Employees aren't actually awarded shares of stock but instead are given the option to buy shares in the future They give employees the option to buy a) a specified number of shares of the firm's stock b) at a specified exercise price c) during a specified period of time
Restricted Stock Plans
Executive compensation sometimes includes shares of stock granted to the executive ~These shares are restricted in some way ~Typically, they are tied to continued employment
US GAAP vs IFRS (EPS)
FASB ASC 260 - The denominator for the EPS calculation is the same under both GAAP and IFRS. The numerator still can differ because the components of NI often are different under GAAP and IFRS
Complex Capital Structure
If a firm's capital structure includes securities that could potentially dilute (reduce) EPS (such as convertible securities or stock options), it is classified as this ~A firm with this has to report two EPS calculations
Convertible Securities Impact on Diluted EPS
If the company has convertible securities, there is an impact on both the numerator and the denominator of the diluted EPS equation: ~The denominator of the diluted EPS fraction is increased by additional common shares that would have been issued upon conversion ~The numerator is increased by the interest expense (after-tax) or preferred dividends that would have been avoided if the convertible securities had not been outstanding due to having been converted Dilutive EPS may decrease or increase as a result of the assumed conversion: ~If the diluted EPS decreases, the securities are in fact dilutive and are assumed converted for diluted EPS calculation ~If the diluted EPS increases, the securities are antidilutive and are not considered converted for the diluted EPS calculation (we are trying to show the worst case scenario)
JE to Record Forfeiture (Restricted Stock Award or RSU)
JE at end of each yr within vesting period: Dr. Paid-in Capital - restricted stock Cr. Compensation Expense (total compensation expense/length of vesting period)
Share-Based Compensation
Many compensation plans include one or more types of share-based awards in which the amount of the compensation employees receive is tied to the market price of the company stock ~These include awards of shares of stock and stock options, which create SE ~Company gives employees ownership in company - done in top level management
"If-Converted" Method
Method used when calculating diluted EPS - this determines the impact of convertible securities on EPS ~Assumes the conversion into common stock occurred at the beginning of the period (or at the time the convertible security is issued, if that is later) ~If the convertible shares have been outstanding in prior years, we will assume conversion at the beginning of the current period
JE on Grant Date (Stock Options)
None required - just calculate the fair market value of total options granted
Estimated Total Compensation (Stock Option Plans w/ Performance Conditions)
Number of options expected to vest * fair value
Weighted Average Number of Shares Computation
Outstanding shares at beginning of period* - treasury shares*(fraction of months outstanding)* + treasury shares sold*(fraction of months outstanding)* *multiply by (1+percent of dividend issued) if applicable...only make this adjustment to activities that happened before the dividend was issued...if no dividend was issued, no adjustment is needed!
Restricted Stock
Represents potential common shares ~Their dilutive effect is included in diluted EPS using the treasury method similar as we do for stock options ~These shares are added to the denominator and then reduced by the number of shares that can be bought back with the "proceeds" at the average market price of the company's stock during the year
Accounting for Restricted Stock Awards and Restricted Stock Units
The compensation expense associated with a share of restricted stock award or RSU is the market price of unrestricted shares of the same stock at the date of grant and is accrued as compensation expense over the service period for which participants receive the shares (expense equally over the service period) ~This usually is the period from the date of grant to when restrictions are lifted (the vesting date)
Total Compensation Expense (Restricted Stock Award of RSU)
To calculate, Fair value per share at the date of grant * shares awarded
US GAAP vs IFRS (Stock Option Plans with Graded-Vesting)
Under IFRS, ~the straight-line choice is not permitted (it is permitted under GAAP) ~companies view each vesting group (or tranche) separately, as if it were a separate award ~there's no requirement that the company must recognize at least the amount of the award that has vested by each reporting dates
Restricted Stock Awards
A primary type of restricted stock plan; Shares are actually awarded in the name of the employee, although the company might retain physical possession of the shares. The employee has all rights of a shareholder, subject to certain restrictions ~Subject to forfeiture if the conditions for vesting are not met
JE to Record Purchases of Shares by Employees with Small Discount (Employee Share Purchase Plan)
Dr. Cash (market price of shares*no. shares purchased*1-discount%) Cr. Common Stock (market price of shares*no. shares purchased*1-discount%)
JE to Record Allocation of Compensation Expense (Restricted Stock Award or RSU)
Dr. Compensation Expense (total compensation expense/length of vesting period) Cr. Paid-in Capital - restricted stock (expensed equally over vesting period)
Diluted Earnings Per Share
Incorporates the dilutive effect of potential common shares. The dilutive effect is included essentially by "pretending" the securities already have been exercised, converted, or otherwise transformed into common shares
Basic Earnings Per Share
Net income after taxes, minus certain preferred dividends*, divided by the weighted-average number of common shares outstanding *Current period's cumulative preferred stock dividends (whether declared or not) and noncumulative preferred stock dividends (only if declared) are subtracted from net income ~Ignores the dilutive effect of potential common shares
Dilutive Securities
Securities that are not common stock in form but that enable their holders to obtain common stock upon exercise or conversion and increase the number of outstanding shares ~ex: stock options, convertible bonds, convertible preferred stock
Accounting for Share-Based Compensation
The objective is to record the fair value of the compensation expense over the periods in which related services are performed. ~Meaning we need to (a) determine the fair value of the compensation and (b) expense that compensation over the periods in which participants perform services
Stock Options, Rights, and Warrants Impact on Diluted EPS
Three steps to calculate the hypothetical incremental increase in shares outstanding due to options, rights, and warrants: (1) Determine the new shares from the assumed conversion of the stock options, rights, or warrants (2) Compute the treasury shares purchased with the proceeds received using the following formula: proceeds received from assumed exercise / average market price of stock (3) Compute the incremental shares assumed outstanding as follows: the new shares assumed issued (1) minus the treasury shares assumed to be repurchased with the proceeds (2)
Restricted Stock Units (RSU)
A primary type of restricted stock plan; A right to receive stock awards, the shares are not issued at the time of the grant. Only after the vesting requirements are satisfied, the company issues and distributes the shares ~Subject to forfeiture if the conditions for vesting are not met
JE to Record Purchases of Shares by Employees with Large Discount (Employee Share Purchase Plan)
Dr. Cash (market price of shares*no. shares purchased*1-discount%) Dr. Compensation expense (discount) (market price of shares*no. of shares purchased*discount rate) Cr. Common Stock (market price of shares*no. of shares purchased)
JE to Record Allocation of Compensation Expense (Stock Options)
Dr. Compensation Expense (total compensation expense/length of vesting period) Cr. Paid-in Capital - stock options (expensed equally over vesting period, NOT exercisable period)
JE to Record Change in Estimate of Forfeiture (Stock Options)
Dr. Compensation Expense* Cr. Paid-in Capital - stock options *total compensation expense x (1-forefeiture rate)% x yrs passed since grant date/no yrs in vesting pd - comp exp recorded in previous yrs ***accounted for prospectively - do not change previous years***
Stock Option Plans with Graded-Vesting
If recipients gradually become eligible to exercise their options rather than all at once, the plan is said to have graded vesting. In such case, accounting for compensation expense may be handled in either of two ways: ~View each vesting group (or tranche) separately, as if it were a separate award. Most companies use this approach ~Account for the entire award on straight-line basis over the entire vesting period ~Either way, the company, must recognize at least the amount of the award that has vested by that date
Employee Share Purchase Plans
Permits employees to buy shares of the company's common stock directly from the company under convenient of favorable terms. If such plan satisfies all three conditions below, it is considered noncompensatory and no compensation expense is recorded, instead we simply record the sale of new shares as employees buy those shares: (1) Substantially all full time employees may participate on an equitable basis (2) The discount from market is small (no greater than 5%) (3) Employees have no longer than one month after price is fixed to decide whether to participate ~If such plan does NOT satisfy these three conditions above, it is considered compensatory and requires that the fair value of any discount to be recorded as compensation expense
Accounting for Stock Option Plans
Report compensation expense at the fair value of the options during the period of service for which the compensation is given ~Companies are required to estimate the fair value of these on the grant date. Fair value is estimated using one of several option-pricing models (these are statistical models that use computers to incorporate information about company's stock and the terms of the stock option to estimate the options fair value-considers the exercise price and expected term of the option, the current market price of the underlying stock and its expected volatility, expected dividends, and the expected risk-free rate of return to make the fair value calculation) ~If an employee forfeits a stock option because the employee fails to satisfy a service requirement (e.g., leaves employment), the company should adjust the estimate of compensation expense recorded in the period - prospectively accounted for ~A new standard update: companies can elect to account for forfeitures of stock options or restricted stock when forfeitures actually occur, rather than estimating forfeitures. So rather than recording compensation expense and paid-in capital for the net amount of awards expected to vest, under this election, companies can choose to initially record compensation based on the total amount and then reduce compensation expense and paid-in capital only if and when forfeitures occur. A company must disclose its policy election for forfeitures (estimated or recorded as they occur)
Financial Statement Presentation (Basic & Diluted EPS)
Reported on the face of the I/S for all periods presented ~Companies without potential common shares present basic EPS only Disclosure note should provide additional information including: ~A reconciliation of the numerator and denominator used in the basic EPS computations to the numerator and the denominator used in the diluted EPS computations ~Any adjustments to the numerator for preferred dividends ~Any potential common shares that weren't included because they were antidilutive ~Any transactions that occurred after the end of the most recent period that would materially affect EPS When the I/S includes discontinued operations, EPS data (both basic and diluted) must also be reported separately for income from continuing operations and NI. ~Per share amounts for discontinued operations are disclosed either on the face of the I/S or in the notes to the financial statements
Restricted Stock Impact on Diluted EPS
Restricted shares are added to the denominator and then reduced by the number of shares that can be bought back with the "proceeds" at the average market price of the company's stock during the year Diluted EPS Formula: No change to the numerator/denominator is increased using treasury method ~Since generally employees do not pay anything to acquire the shares of restricted stock, the cash proceeds are zero. However, the total proceeds include the compensation that's not yet expensed. ~Note that only unvested shares are included in the diluted EPS calculation since fully vested shares are actually distributed and already outstanding
Stock Option Plans with Performance or Market Conditions
Some stock option plans are structured so that the stock option award is received only when certain performance or market conditions are met (ex: the options may be exercised only if EPS exceeds $2 or if divisional revenue increases by 5% in three years) ~If an award contains a market condition such as the stock price reaching a specified level, then no special accounting is required. So, the company recognizes compensation expense regardless of when, if ever, the market condition is met ~In some circumstances, compensation from a stock option plan depends on meeting a performance condition such as achieving a certain level of divisional revenue. In this case, compensation expense depends on whether or not we feel it is probable that the performance target will be met.... ....if it is not probable that the condition will be met, compensation is NOT recognized ....if it is probable that the condition will be met, compensation must be recognized ~In some cases, this means that we will have a cumulative amount of compensation to recognize. That is, compensation for the current period plus an adjustment for the periods when we did not recognize compensation
Contingently Issuable Shares
Sometimes an agreement specifies that additional shares of common stock will be issued contingent on the occurrence of some future event. ~At times these are issuable to certain key executives or others in the event a certain level of performance is achieved ~The performance may be related to a desired level on income, a target stock price, or some other measurable activity level ~The most common example is shares that are issued upon reaching some future earnings level ~Because they are potential common shares, they are included in calculating dilutive EPS if... ....These shares are to be issued merely due to the passage of time, or ....If they're based upon some target performance level and that target performance level is already being met (assumed to remain at existing levels until the end of the contingency period) Changes to the Diluted EPS formula: no adjustment to the numerator / denominator is increased for additional shares
Earnings Per Share (EPS
The single accounting number that is reported most frequently in the media and receives by far the most attention by investors and creditors ~Most frequently reported measure of a company's performance ~Reported on the I/S of all publicly traded firms ~Generally, it is simply earnings available to common shareholders divided by the weighted average number of common shares outstanding ~Only financial measure ratio governed by US GAAP
Treasury Stock Method
We 'pretend' that the stock options, rights, and warrants were exercised at the beginning of the period (or at the time they are issued, if later) and any proceeds received from the exercise are used to purchase treasury shares at the average market price per share (we use proceeds to get the shares back) ~The "proceeds received" for the calculation should include: the amount received from the hypothetical exercise of the options and any compensation from the award that has not yet been expensed ~The effect of this is to determine an incremental increase in the number of shares in the denominator of the diluted EPS equation.
Weighted Average Number of Shares
When the number of shares changes during the year, EPS calculations are based on the _________ outstanding during the period. ~New shares issued during s reporting period are time-weighted by the fraction of the period they were outstanding (number of new shares times the number of months that those shares have been outstanding, divided by 12) and then added to the number of shares outstanding at the beginning of the period ~On the contrary, an increase in shares due to a stock dividend or stock split is not time-weighted... ....When stock split or stock dividend occur sometimes during the year we assume these additional shares as a result of stock dividend or split have been outstanding from the beginning of the year ...When reported again in the comparative financial statements, previous years' EPS are restated for comparability ~If common shares are reacquired (as treasury stock or to be retired) the weight-average number of shares is reduced. The number of reacquired shares is time-weighted for the fraction of the period they were not outstanding. The time-weighted shares are then subtracted from the number of shares in the denominator of the EPS fraction ~Not simply just the end of the year common shares ~Only complex if the number of shares changes throughout the year
