Unit 3 - Share Holders' Equity, share-based compensation and Earnings per share
On December 31, Wayne Sparks Company had 600,000 shares of common stock issued and outstanding. Sparks issued a 5% stock dividend on June 30. On September 30 20,000 shares of common stock were reacquired as Treasury stock. What is the appropriate number of shares to be used in the EPS computation?
(600,000 x 1.05) - (20,000 x 3/12) = 625,000
EPS Calculation
(NI-preferred dividends)/ weighted average CS outstanding
Share buybacks
-A corporation might reacquire shares of its stock Viewed as a way to distribute company profits without paying dividends Decreasing the supply of shares in the marketplace supports the price of remaining shares Acquisition of a company's own shares doesn't create an asset Companies buy back shares to offset the increase in shares issued to employees.
Extends our view of income beyond net income reported in an income statement to include four types of gains and losses not included in income statement
1. Net holding gains(losses) on investments 2. Gains (losses) from and amendments to postretirement benefit plans 3. Deferred gains (losses) on derivatives 4. Adjustments from foreign currency translation
Ellen Kelly Inc. had 200000 shares of .50 par common stock, 10,000 shares of 5%, 20 par cumulative preferred stock, and 30000 shares of 5%, 10 par preferred stock convertible into 10,000 common shares. Net Income after taxes was 1500000. No dividends were declared during the year. Diluted EPS would be?
1500000 - (10000 x 5% x 20Par)/200000 + 10000 shares Even though dividends were not declared, the cumulative preferred stock dividends are subtracted.
`On January 2nd, Sarah Lawrence Co. issued at face value 10000 of 4% bonds convertible in total into 2000 shares of lawrence's common stock. No bonds were converted during 2016. Throughout 2016, Lawrence had 10000 shares of common stock outstanding. Lawrence's 2016 net income was 2000. The income tax rate is 40% No potential common shares other than the convertible bonds were outstanding during 2016. Diluted EPS for 2016 would be:
2000 + 400* - (400 x .4)/10000 + 2000 * 10,000 x 4%
At December 31, 2016 and 2017, Hathcock Company had outstanding 50 Million Common Shares and 4 Million shares of 10%, $10 par cumulative preferred stock. Net Income for 2017 was $20 Million. No dividends were declared in 2016 or 2017. EPS for 2017 was?
20Mil NI - 4Mil*/50Mil Shares = 16/50 *10% x 10 Par x 4 Mil Shares We subtract dividends on cumulative preferred stock, even if not declared in this period
Privately Held
A corporation that has only a few stockholders and whose stock is not available for sale to the general public
Stock Dividends
A distribution of Retained earnings to the stockholders in the form of stock Affects neither the assets nor the liabilities of the firm Shareholders' proportional interest in the firm remains unchanged
Employee share purchase plans
A plan through which employees may purchase shares in their employer firm. These often permit all employees to buy shares directly from their company at favorable terms. The primary intent of these plans is to encourage employee ownership of the company's shares. Presumably loyalty is enhanced among employee-shareholders. The employee also benefits because, typically, these plans allow employees to buy shares from their employer without brokerage fees and, perhaps, at a slight discount. Some companies even encourage participation by matching or partially matching employee purchases. As long as substantially all employees can participate, employees have no longer than one month after the price is fixed to decide whether to participate, and the discount is no greater than 5% (or can be justified as reasonable), accounting is straight forward. Simply record the sale of new shares as employees buy shares. If these criteria for the plan being noncompensatory are not met, say the discount is 15%, accounting is similar to other share-based plans and the discount is considered to be compensation and is recorded to compensation expense.
What additional information should disclosure notes have?
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 earnings per share.
Stock Splits
An action by a company that gives stockholders two or more shares of stock for each one they own.
Contingently Issuable Shares
An agreement specifies that additional shares of common stock will be issued. Contingent upon future events - condition/ event is met, now we would include the shares in diluted EPS -Considered to be outstanding in the computation of diluted EPS if the target performance level already is being met
A stock of distribution of 25% or higher can be accounted for in one of two ways:
As a large stock dividend (stock split effected in the form of a stock dividend) As a stock stock split (thus, a 100% stock dividend could be labeled a 2-for-1 stock split and accounted for as such
To include the dilutive effect of a security means to calculate EPS:
As if the potential increase in shares has occured
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
Fractional Shares
Cash payments usually are made when shareholders are entitled to fractions of whole shares Called in "cash in lieu of payments"
Reasons for Stock Dividends
Company tires to give shareholders the illusion that they are receiving a real dividend Merely to enable the corporation to take advantage of the accepted accounting practice of capitalizing retained earnings
Journal entry to record the RSU
Compensation Expense Debit Paid-in Capital - restricted stock
How is target based on changes in the market rather than on performance
Compensation is recorded as if there were not target, and compensation expense is recognized regardless of when the market condition is met
Some examples of potential common shares are:
Convertible bonds, convertible preferred stock, stock options, contingently issuable securities
In 2015, Broyles, Inc. reacquired 3,000 shares of its common stock at $55 per share. in 2016, Broyles, inc. reissued 1000 shares of the stock at $75 per share. Which of the following would be included in the 2016 entry?
Credit treasury stock for $55000
The Model Business Corporation Act
Designed to serve as a guide to states in the development of their corporation statutes Variations among state laws influence GAAP pertaining to shareholders' equity transactions
Property Dividends
Distributions of non-cash assets, recorded at the fair value of the asset. Recognize gain or loss for difference between book and fair value.
How do you calculate the Compensation Expense
Divide the total compensation by the years it will take to vest
Liquidating Dividend
Dividend exceeds the balance in retained earnings, the excess is referred to as a liquidating dividend Any portion of a dividend not representing a distribution of earnings should be debited to additional paid-in capital
Anti-dilutive Securities
Does not affect and is not affected by EPS either basic or diluted
How do you calculate total compensation?
Estimated fair value per option x Options granted
What are some variables that an Option Pricing Model takes into account?
Exercise price of the option, Expected term of the option, current market price of the stock, expected dividends, expected risk free rate of the return during the term of the option, and expected volatility of the stock
How do you calculate RSUs?
Fair value per share x Shares Awarded/Vesting years required
Shared-Based Awards
Forms of payment whose value is tied to the market price of the company's stock
Change in the nature of the shares is reflected in a calculation of EPS by increasing or decreasing the number of shares?
Increasing
Alternative way to determine whether convertible securities are dilutive and should be included in a diluted EPS Calculation:
Incremental Effect of Conversion > basic EPS--->Antidilutive Incremental Effect of Conversion<Basic EPS--->Dilutive
Potential Common Shares -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 Diluted EPS No Yes No Yes No Yes No Yes
What will happen to the par value in a 2-for-1 stock split
It will be reduced by one-half
Corporation characteristics
Limited Liability A corporation is a separate legal entity, responsible for its own debts The owners are not personally liable for debts of a corporation Shareholders' liability is limited to the amounts they invest in the company when they purchase shares Ease of raising capital Corporations sell ownership interest in the form of shares of stock and hence ownership rights are easily transferred
Intrinsic Value =
Market Price of the Shares - Option price at which they can be acquired
What is the stock market reaction to stock distributions
Market price per share will decline in proportion to the increase in the number of shares distributed in a stock dividend Early Rule-makers felt that per share market prices do not adjust in response to an increase in the number of shares Capitalizing retained earnings for a stock dividend artificially reclassifies earned capital as invested capital
Sheddan Co. had 100,000 shares of common stock outstanding. Options to purchase 5000 shares of common stock were outstanding at the beginning of the year. The options can be exercised to purchase stock at 50 per share. The average market price of he stock was 80. The net increase in the dilutive earnings per share denominator is?
New Shares = 5000 Treasury Shares (5000 x 50) / 80 = 3125 Incremental Shares = 1875
What is the accounting treatment for stock splits
No journal entry is required
preferred shares
No voting rights. Similar to note or bond cause pays dividends first. Convertible Preferred Shares convert to fixed number of common stock
Reverse stock split
Occurs when a company decreases its outstanding shares No journal entry is necessary Market price per share theoretically would increase Often done by struggling companies trying to increase the stock price
Where should per share amounts for discontinued operations be disclosed?
On the face of the income statement or in the notes to financial statements.
Volatility value
One popular option pricing model is the black-scholes model which assumes a log-normal distribution This assumption posits that the stock price is as likely to fall by half as it is to double and that large price movements are less likely than small price movements The higher a stock's volatility, the higher the probability of large increases or decrease in market price
Time value
Options also have a time value due to the fact that: The holder of an option doesn't have to pay the exercise price until the option is exercised The market price of the underlying stock may yet rise and create additional intrinsic value The longer the time until expiration, other things being equal, the greater the time value Subdivided into two components: 1. the effects of time value of money and 2. volatility value.
How do you account for Restricted Stock Awards?
Paid-in Capital-Restricted Stock Common Stock Paid-in Capital-Excess of Par
Accounting for Treasury Stock
Purchase of treasury stock is viewed as a temporary reduction of shareholders' equity Cost of acquiring the shares is temporarily debited to the treasury stock account Shares are considered to be issued, but not outstanding Purchase or treasury stock and its subsequent resale is considered to be a single transaction
Restricted Stock Awards and Units in EPS Calculations
Replacing stock options as the share-based compensation plan of choice Represents potential common shares and their dilutive effect in included in diluted EPS The 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 The first component of the proceeds: Usually is absent because employees don't pay to acquire their shares, Unvested restricted stock award shares and RSU shares are included in hypothetical EPS calculations, and fully vested shares are distributed and thus outstanding The second component of the proceeds: The proceeds for the EPS calcuation include the total compensation from the unvested restricted stock that's not yet expensed.
What are some characteristics of retained earnings
Represent a corporation's accumulated, undistributed net income or net loss a more descriptive title would be reinvested earnings
Common shares
Represent an ownership interest in a company, residual claim on firm assets. Includes the right to vote, the right to share in profits when dividends are declared, the right to share in the distribution of assets if the company is liquidated and preemptive right which is the right to maintain one's percentage share of ownership when new shares are issued.
Retained Earnings
Represents earned capital
Cliff Vesting
Requires participants to complete a specific number of years of service with an employer before they get any vested benefits, after which they are 100% vested.
What are the two primary types of restricted stock plans
Restricted stock awards and restricted stock units
How should basic EPS and diluted EPS be reported on financial statements
Separately for income from continuing operations and net income when the income statement includes discontinued operations
The affect on EPS Calculation when a convertible preferred stock:
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.
Treasury Stock
Shares previously sold to shareholders that are bought back by the corporation
Are preferred shares equity or debt?
Somewhat hybrid securities - a cross between equity and debt Equity b/c preferred shareholders receive dividends each year the company pays dividends and Debt b/c the company is obligated to pay cash (or other assets) at a fixed or determinable rate in the future make
Share-based compensation plans include the following:
Stock award plans, stock option plans, stock appreciation rights, or one of the several similar plans
An 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 and a large number of less valuable shares. (same pie more slices)
Resale of Shares
Subsequent sale of shares is recorded exactly like any sale of shares Resale of treasury shares is viewed as the consummation of the single transaction begun when the treasury shares were purchased Allocating the cost of treasury shares occurs when the shares are resold
Graded Vesting
System by which qualified retirement plan participants become incrementally vested over a period of years of service.
What is the accounting objective with share-based compensation plans?
T determine the fair value of the compensation and to expense that compensation over the periods in which participants perform services.
How is compensation presently measured?
The Fair value of the stock options at the grant date
Is stock appreciation rights debt or equity
The accounting treatment depends on whether the award is considered an equity instrument or a liability If the employer can elect to settle in shares of stock rather than cash, the award is considered to be equity If the employee will receive cash or can elect to receive cash, the award is considered to be a liability
When stock is issued in exchange for property the best evidence of fair value might be any of the following EXCEPT:
The average book value of outstanding stock Occasionally, shares are issued for consideration other than cash, maybe services or noncash asset. in those instances, the transaction should be recorded at the fair value of the shares or the noncash consideration, whichever seems more clearly evident. This is consistent with the GAAP rules for any noncash transaction.
Intrinsic Value
The benefit the holder of an option would realize by exercising the option rather than buying the underlying stock directly An option that has an exercise price equal to or exceeding the market price of the underlying stock has zero intrinsic value
What is the affect on EPS when such securities 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.
SARS payable in cash (liability
The fair value of the SARs is estimated and that amount is recognized as compensation expense over the requisite service period The fair value is periodically re-estimated in order to continually adjust the liability (and corresponding compensation) until its paid The periodic expense is the fraction of the total compensation earned to date by recipients of the SARs reduced by any amounts expensed in prior periods.
SARS payable in shares
The fair value of the SARs is estimated at the grant date and accrue that compensation to expense over the service period. The cash settlement of an equity award s considered the repurchase of an equity instrument The total compensation is not revised for subsequent changes in the price of the underlying stock
What are some disadvantages to the corporation entity
The federal government imposes expensive reporting requirements Double taxation
What is the compensation associated with a share of restricted stock
The market price at the grant date of an unrestricted share of the same stock.
When does the calculation of EPS become more demanding?
The number of shares has changed during the reporting period, the earnings available to common shareholders are diminished by dividends to preferred shareholders, and we attempt to take into account the impending effect of potential common shares
Reacquired shares causes:
The weighted average number of shares to reduce, the number of reacquired shares s time-weighted for the fraction of the year they were not outstanding, prior to being subtracted from the number of shares outstanding during the period, and when a stock distribution occurs during the reporting period, any sales or purchases of shares that occur before, but not after, the distribution are increased by the distribution
What is the objective to stock splits?
To induce the per share market price decline that follows The motivation for reducing the per share market price is to increase the stock's marketability by making it attractive to a larger number of potential investors
Paid-in Capital
Total amount of cash and other assets paid in to the corporation by stockholders in exchange for capital stock.
Earnings Available to Common Shareholders
When a senior class of shareholders is entitled to a specified allocation of earnings these amounts are subtracted from earnings before calculating earnings per share
Complex Capital Structure
When any potential common shares are outstanding
An Increase in shares from selling new shares occurs:
When new shares are sold, both assets and shareholders' equity are increased by an additional investment in the firm by shareholders. Shareholders' interest in their company's earnings is diluted
Stock appreciation rights
_________: gives the employee the right to receive compensation based on the increase in the price of the firm's stock over a predetermined amount. Employees have limited downside risk and unlimited upside potential. Since no shares are actually issued, no dilution.
Stock Dividends
additional shares of a company's own stock given to stockholders
Restricted stock awards are:
awarded in the name of the employee and the physical possession be retained by the company are subject to forfeiture by the employee if employee is terminated, and the employee is not free to sell the shares during the restricted period.
Restricted Stock Units
compensation offered by an employer to an employee in the form of company stock (the employee does not receive the stock immediately, but instead receives it according to a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with the employer for a particular length of time)
Restricted Stock units
compensation offered by an employer to an employee in the form of company stock (the employee does not receive the stock immediately, but instead receives it according to a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with the employer for a particular length of time)
Publicly held
corporation that sells stock on the open market
Articles of incorporation
describes the nature of the firm's business activities, the shares to be issued, and the composition of the initial board of directors
Dividends
distribution of the after-tax earnings that are distributed to company's shareholders
Share Appreciation
excess of the market price of the stock at the date of exercise over a pre-established price
Convertible securities
gives bondholder or preferred stockholder the right to exchange the bond or preferred stock for a fixed number of shares of common stock
Comparability of EPS
maximized by minimizing the inconsistencies in their calculation from one company to the next.
Earnings per share
measures the net income earned per share of common stock
Cash Dividends
money paid to stockholders, normally out of the corporation's current earnings or accumulated profits; taxable as income to recipients No legal obligation exists for paying dividends Liability is not recorded until a company;s board of directors votes to declare a dividend
Mandatorily redeemable preferred shares
must be reported in the balance sheet as a liability, not as shareholders' equity
Convertible Preferred Stock
preferred stock that an owner may exchange for a specified number of shares of common stock EPS is calculated as if conversion already occured
Stock Options
rights to buy a certain number of shares of stock at a specified price
Potential Common Shares
securities that can be used by the holder to acquire common stock
par value
the amount that an investor pays to purchase a bond and that will be repaid to the investor at maturity
Hybrid Organizations
these are organizations that include features of a mix of the various basic business organizations (ex: subchapter S corporation, LLC, LLP)