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Chapter 16 Intermediate
Terms in this set (30)
The measure the company uses, that is, income from continuing operations (adjusted for preferred dividends), to determine whether potential common stock is dilutive or antidilutive.
A method of allocating compensation expense over the service period. At the end of each period, total compensation expense reported to date should equal the percentage of the total service period that has elapsed, multiplied by the total estimated compensation cost.
The excess of the market price of the stock at the date of exercise over a pre-established price.
Stock appreciation rights (SARS)
A plan in which the company gives an executive the right to receive compensation equal to the share appreciation.
Securities which, upon conversion or exercise, increase earnings per share (or reduce the loss per share). Companies with complex capital structures will not report diluted EPS if the securities in their capital structure are antidilutive; they will report only the basic EPS number.
The earnings per share for a simple capital structure. A company with a complex capital structure reports both basic EPS and diluted EPS amounts on the face of its income statement.
Complex capital structure
A capital structure that includes securities that could have a dilutive effect on earnings per common share.
Bond that permits its holder to exchange it for ("convert it to") other corporate securities (typically common stock) for a specified period of time after issuance. The sale of a convertible bond is recorded like a straight-debt issue; upon conversion, the company records the securities exchanged for the bond at the carrying amount (book value) of the bond. The company amortizes, either at its maturity or upon conversion, any discount or premium that results from the issuance of the bond.
Convertible preferred stock
Preferred stock that allows stockholders, at their option, to exchange preferred shares for shares of common stock at a predetermined ratio. The convertible preferred stockholder not only enjoys a preferred claim on dividends but also has the option of converting into a common stockholder with unlimited participation in earnings.
Detachable stock warrants
A warrant (option to buy common stock at a fixed price) that can be "detached" from the related security (a bond) and traded as a separate security for a specified period of time. To account for detachable stock warrants, companies separate debt issued with detachable warrants into debt and equity components, using either the proportional method or the incremental method.
The earnings per share for a complex capital structure. Diluted EPS begins with the basic EPS computation but includes the effect of all potential dilutive common shares outstanding during the period. It is computed as income available to common stockholders divided by weighted-average number of shares outstanding, plus the impact of convertibles, options, warrants, and other dilutive securities.
Securities that can be converted to common stock. Upon conversion or exercise by the holder, the dilutive securities reduce (dilute) earnings per share. Companies with dilutive securities report both basic EPS and diluted EPS in their income statements.
Earnings per share
A distilled and important income figure, calculated as net income minus preferred dividends (income available to common stockholders), divided by the weighted-average common shares outstanding. Companies must disclose earnings per share on the face of the income statement.
Fair value method
The amount at which a company can exchange a financial instrument in a current transaction between willing parties. Companies account for expense related to stock options and restricted stock at fair value.
The date at which a company grants stock options to employees. Public companies estimate the options' fair value as of that date, using an option-pricing model and any adjustments needed for unique factors. No adjustments occur after the grant date in response to subsequent changes (up or down) in the stock price.
If Converted method
Method of measuring the dilutive effects of potential conversion on EPS, for companies with securities convertible into common stock. For a convertible bond, this method assumes the conversion of the convertible securities at the beginning of the period and the elimination of related interest, net of tax. The additional shares assumed issued increase the weighted-average number of shares outstanding (the denominator), and the amount of interest expense increases net income (the numerator).
Income available to common stockholders
The numerator used in a basic earnings per share calculation when a company has both common and preferred stock outstanding. Computed as net income minus preferred dividends.
When a company cannot determine the fair value of either the warrants or the bonds, the company uses the security for which it can determine the fair value, and allocates the remainder of the purchase price to the security for which it does not know the fair value.
The offer of additional consideration, to prompt conversion of convertible debt to equity securities.
Intrinsic value method
Method for reporting the granting of stock options. It measures compensation cost as what the holder of the stock option would receive today if the option was immediately exercised. The intrinsic value is the difference between the market price of the stock and the exercise price of the options at the grant date. Use of this approach for most stock-based compensation plans is not allowed under GAAP, which generally requires the fair value method.
Used to account for the proceeds of an issue of detachable warrants, by allocating the proceeds based on the proportion of the following two amounts: (1) the value of the bonds without the warrants, and (2) the value of the warrants.
Restricted stock plans
Restricted-stock plans transfer shares of stock to employees, subject to an agreement that the shares cannot be sold, transferred, or pledged until vesting occurs.
For stock options, the period in which employees perform services, typically represented by the time between the grant date and the vesting date. A company generally determines total compensation cost of the options at the grant date and allocates it as an expense in the periods in which employees perform the services.
Simple capital structure
Capital structure that consists only of common stock and other securities (preferred stock, bonds, warrants) that are not dilutive. A company has a simple capital structure if does not include potential common stock that upon conversion or exercise could dilute earnings per share.
Stock based compensation plans
These plans provide the employee with the opportunity to receive stock if the performance of the company is satisfactory.
Gives key employees the option to purchase common stock at a given price over an extended period of time.
Upon the issue of new stock, the old stockholders generally have the right to purchase newly issued shares in proportion to their holdings, to avoid a dilution of voting rights.
Treasury stock method
Method of measuring the dilutive effects on EPS of stock options and warrants outstanding. This method assumes that a company exercises the options or warrants and uses those proceeds to purchase common stock for the treasury at the average price of common shares during the period. If such purchases result in dilution (assuming the market price of the stock is above the exercise price), the company reports potential common shares in its diluted EPS.
Long-term options, issued with other securities, to buy common stock at a fixed price for a specified period of time (generally 5 years, occasionally 10). Companies account for debt issued with nondetachable warrants as straight debt. To account for detachable stock warrants, companies separate debt issued with detachable warrants into debt and equity components, using either the proportional method or the incremental method.
Weighted average number of shares outstanding
The denominator used in an earnings per share calculation. Companies weight the shares of stock issued or purchased during a period by the fraction of the period they are outstanding, to determine the equivalent number of whole shares outstanding for the year.
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