final

current requirement to expense employee stock options

-GAAP revision requires fair value accounting for employee stock options, eliminating the intrinsic value approach -requires companies to record the value of their options in their income statements

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.

simple capital structure

-a firm is said to have this if it has no outstanding securities that could potentially dilute (reduce) earnings per share -convertible bonds= referred to as potential common shares -a firm has a simple capital structure if it has no potential common shares -calculation is referred to as basic eps= earnings available to common shareholders/weighted average number of common shares outstanding

restricted stock units

-a right to receive a specified number of shares of company stock -could be in the form of a performance bonus, a signing bonus, or regular compensation -stock isn't received right away, the shares are distributed as the recipient of RSUs satisfies the vesting requirement

convertible securities

-can be converted into (exchanged for) shares of stock at the option of the holder of the security and thus are potentially dilutive -by the converted method, we assume the conversion into common stock occured at the beginning of the period (or at the time the convertible security is issued, if thats later) -we increase the denominator of the EPS fraction by the additional common shares that would have been issued upon conversion, we increase the numerator 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

contingently issuable shares

-considered to be outstanding in the computation of diluted EPS is the target performance level already is being met (assumed to remain at existing levels until the end of the contingency period) -for example, if shares will be issued at a future date if a certain level of income is achieved and that level of income or more was already reported this year, those additional shares are simply added to the denominator of the diluted EPS fraction

share-based compensation

-employee compensation plans frequently include this -awards are forms of payment whose value is dependent on the value of the company's stock -may be outright awards of shares, stock options, or cash payments tied to the market price of shares

stock option plans

-employees aren't actually awarded shares, but rather given the option to buy shares at a specified exercise price within some specified number of years from the date of the grant

restricted stock plans

-executive compensation sometimes includes a grant of shares of stock or the right to receive shares that are restricted in such a way to provide incentive to the recipient -two types are (a) restricted stock awards and (b) restricted stock units

treasury stock method

-for diluted EPS, we assume the proceeds from the excercise of the option were used to reacquire shares of treasury stock at the average market price of the common stock during the reporting period -besides providing comparability, this assumption is plausible because if options were excercised, more shares would be needed to issue to option holders

what happens if RSUs are forefeited?

-if RSUs are forefeited because the employee leaves the company, reverse all previous entries relating to employee -would result in a decrease in compensation expense in the year of forfeiture -the total compensation, adjusted for the forfeited amount, is then allocated over the remaining service period

forfeitures

-if previous experience indicates that a material number of the options will be forefeited before they vest (due to employee turnover or violation of other terms of options), we adjust the amount of compensation recorded (a) by estimating forefeitures or (b) as forfeitures occur -default approach is to estimate the percentage of options that will be forefeited and adjust grant date calculation of the fair value of the options to reflect that expectation

plans with market conditions

-if the award contains a market condition (e.g. a share option with an excercisability requirement based on the stock price reaching a certain level), then no special accounting is required -the fair value estimate of the share option already implicitly reflects market conditions due to the nature of share option pricing models -thus, we recognize compensation expense regardless of when, if ever, the market condition is met

price-earnings ratio

-one way that analysts use EPS data -ratio is simply the market price per share divided by the earnings per share, it measures the market's perception of the quality of a company's earnings by indicating the price multiple the capital market is willing to pay for the company's earnings

employee share purchase plans

-permit all employees to buy shares directly from their company at favorable terms -primary intent of these plans is to encourage employee ownership of the company's shares -employee also benefits because these plans allow employees to buy shares from their employees without brokerage fees and perhaps, at a slight discount -some companies even encourage participation by matching or partially matching employee purchases

dividend payout ratio

-provides an indication of a firm's reinvestment strategy -a low payout ratio suggests that a company is retaining a large portion of earnings for reinvestment in new facilities and other operating needs -low payouts often are found in growth industries and high payouts in mature industries

potential common shares

-securities that, while not being common stock, may become common stock through their exercise, conversion, or issuance and therefore dilute (reduce) earnings per share

restricted stock awards

-shares are awarded in the name of the employee, although the company might retain physical possession of the shares -the compensation associated with a share of restricted stock is the market price at the grant date of an unrestricted share of the same stock -amount is accrued as compensation expense with a credit to paid in capital- restricted stock, over the service period for which participants receive the shares, usually from the date of grant to when restrictions are lifted (vesting date) -once the shares vest and restrictions are lifted, paid in capital- restricted stock is replaced by common stock and paid-in capital- excess of par

earnings per share

-the amount of income earned by a company expressed on a per share basis

what happens when the buyback (average market) price is higher than the exercise price?

-there is a net increase in the number of shares, so earnings per share will decline

convertible securities

-to determine whether convertible securities are dilutive and should be included in a diluted EPS calculation, we can compare the incremental effect of the conversion (expressed as a fraction) with the EPS fraction before the effect of any convertible security is considered -the incremental effect (of conversion) of the bonds is the after-tax interest saved divided by the additional common shares from conversion -the incremental effect (of conversion) of the preferred stock is the dividends that wouldn't be paid divided by the additional common shares from conversion

what is the common goal of share-based compensation plans?

-to provide compensation to designated employees while providing employees with some sort of performance incentive

what happens in an RSU if the employee will receive cash or can elect to receive cash

-we consider the award to be a liability rather than equity -we determine its fair value at the grant date and recognize that amount as compensation expense over the requisite service period consistent with the way we account for restricted stock awards, RSUs, and other share-based compensation -because these plans are considered to be liabilities payable in cash, the credit portion of the entry as we recognize compensation expense each year is to liability- restricted stock

recognizing the fair value of options

-we measure compensation as the fair value of the stock options at the grant date and then record that amount as compensation expense over the service period for which employees receive the options -estimating the fv requires the use of one of several option pricing models, these models assimilate a variety of information about a company's stock and the terms of the stock option to estimate the options fair value. the model should take into account the following: 1. excercise price of the option 2. expected term of the option 3. currrent market price of the stock 4. expected dividends 5. expected risk free rate of return during the term option 6. expected volatility of the stock -the total compensation, as estimated by the options' fair value, is reported as compensation expense over the period of service for which the options are given. Because recipients are normally not allowed to exercise their options for a specified number of years, this delay provides incentive to stay with the company -the time between the date options are granted and the first date they can be exercised is the vesting period and usually is considered to be the service period over which the compensation expense is reported

complex capital structure

-what a firm is said to have if potential common shares are outstanding -a firm with a complex capital structure reports two EPS calculations: basic EPS ignores the dilutive effect of such securities; diluted EPS incorporates the dilutive effect of all potential common shares

plans with performance conditions

-whether we recognize compensation expense for performance based options depends on (a) initially on whether it's probably that the performance target will be met and (b) ultimately on whether the performance target actually is met -if it becomes probable that a performance target will not be met, we reverse any compensation expense already recorded -when we revise our estimate of total compensation because our expectation of probability changes, we record the effect of the change in the current period

what should disclosure notes include pertaining to EPS?

1. a reconciliation of the numerator and denominator used in the diluted EPS computations 2. any adjustments to the numerator for preferred dividends 3. any potential common shares that weren't included because they were antidilutive 4. any transactions that occurred after the end of the most recent period would materially affect earnings per share

an employee share purchase plan is considered noncompensatory as long as:

1. substantially all employees can participate 2. employees have no longer than one month after the price is fixed to decide whether to participate, and 3. the discount is no greater than 5% (or can be justified as reasonable)

for the treasury stock method, "proceeds" include:

1. the amount, if any, received from the hypothetical exercise of options or vesting of restricted stock 2. the total compensation from the award that's not yet expensed

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?

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

antidilutive securities

at times, the effect of the conversion or exercise of potential common shares would be to increase, rather than decrease, EPS. -such securities are ignored when calculating both basic and diluted EPS

what does paid in capital-stock options become when options expire without being excercised

paid in capital-expiration of stock

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

qualified; equal to

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

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

vesting

to become exercisable