Sid Glandon, DBA, CPA
Associate Professor of Accounting
The University of Texas at El Paso
1


Provide employee incentives:




Stock award plans
Stock option plans
Stock appreciation rights
Broad-based (noncompensatory plans)
2




Restricted shares are issued as compensation
Compensation expense is recognized over the vesting period
At the end of the vesting period the normal equity accounts are credited for common stock and additional paid-in capital
3

Compensation expense
Account
Paid-in capital, restricted stock
Debit
XXX
Credit
XXX
To record the annual allocation to compensation expense under the stock award plan
Account
Paid-in capital, restricted stock
Common stock
Paid-in capital, excess of par
To record the vesting of stock under the stock award plan
Debit
XXX
Credit
XXX
XXX
4



Important dates



Grant date of options
Vesting date
Exercise date of options
Compensation expense recognized by

Fair value method (SFAS 123)
5

Work
Start Date
Grant Date Vesting
Date
Exercise
Date
Expiration
Date
Options are granted to employee
Date employee can first exercise options
Employee exercises options
Unexercised
Options expire
6










Grant date, January 1, 2001
10,000 options granted
One option = one $1 par value share
Exercise price: $60; Market price: $70
Options exercisable within 10 years
Service period is 2 years
2,000 options exercised on June 1, 2004
8,000 options expired on January 1, 2011
Using an option pricing model the fair value of options is $220,000
7

Date Account
1/1/01 No entry at grant date
Debit Credit
12/31/01 Compensation expense $110,000
Paid-in capital, stock options $110,000
To record the allocation of compensation related to the stock options
12/31/02 Compensation expense
Paid-in capital, stock options
$110,000
$110,000
To record the allocation of compensation related to the stock options
8

Date
6/1/04 Cash
Account
Paid-in capital, stock options
Common stock
Paid-in capital, excess of par
Debit
$120,000
44,000
To record the exercise of 2,000 options at $60 per share
Analysis of paid-in capital, options:
Original compensation expense
Number of options
Compensation per option
Options exercised
Reduction of paid-in capital, options
$220,000
10,000
22
2,000
Credit
$2,000
162,000
$44,000
9

Date Account
1/1/11 Paid-in capital, stock options
Paid-in capital, expired options
To record the expiration of 8,000 stock options
Debit
$176,000
Analysis of paid-in capital, options:
Original compensation expense
Number of options
Compensation per option
Options expired
Reduction of paid-in capital, options
$220,000
10,000
22
8,000
Credit
$176,000
$176,000
10




SARs are designed to mitigate employee cash flow problems in non-qualified plans
Employee gets right to receive any appreciation in share value at exercise date equal to market price

Less pre-established amount
Employee receives cash or stock only for the appreciation
11


Fact Pattern:

SARs program established, January 1, 2001




Exercise period, over next five years


Pre-established price per SAR $10
Number of SARs granted, 10,000
Market prices of stock at December 31,

2001, $13


2002, $17
2003, $15
Service period: 2 years
The SARs are exercised on December 31, 2003
12

Market value of stock
SAR specified price
Difference
Number of SARs shares granted
Total compensation expense
2001
$13
10
3
10,000
30,000
December 31,
2002
$17
10
7
10,000
70,000
2003
$15
10
5
10,000
50,000
Percentage of service completed 50%
Accumulated compensation expense 15,000
100%
70,000
100%
50,000
Recognized in prior years 0 15,000 70,000
Current year compensation expense $15,000 $55,000 ($20,000)
13

Date Account
1/1/01 No entry at grant date
Debit Credit
12/31/01 Compensation expense
Liability for SARs
15,000
15,000
To record compensation expense associated with stock appreciation rights granted in 2001
12/31/02 Compensation expense
Liability for SARs
55,000
55,000
To record compensation expense associated with stock appreciation rights granted in 2001
14

Adjustment to Compensation Expense and Exercise of Stock Appreciation Rights
Date Account
12/31/03 Liability for SARs
Compensation expense
Debit
20,000
Credit
20,000
To record and adjustment to compensation expense associated with stock appreciation rights granted in 2001
12/31/03 Liability for SARs
Cash
50,000
50,000
To record the exercise of SARS at December 31, 2003
15





Most important number in income statement
Dilution of EPS means reduction in EPS
Potential conversion of dilutive securities into common stock
If dilution takes place extent of reduction must be disclosed
16

Net Income less Preferred Dividends
Weighted Average Outstanding Common Shares
17


Fact Pattern:





Beginning balance = 800,000 shares
Issued 100,000 shares on April 1
Reacquired 300,000 shares on July 1
Net income = $1,700,000
Preferred dividends = $250,000
18

Weighted-Average common Shares Outstanding
Description
Beginning balance
Issued shares
Adjusted balance
Reacquired shares
Adjusted balance
Dates
1/1/04
4/1/04
7/1/04
Weighted-average common shares outstanding
Shares
800,000
100,000
900,000
(300,000)
600,000
Fraction of
Year
3/12
3/12
6/12
Weighted
Average
200,000
225,000
300,000
725,000
19

Basic Earnings Per Share
Net income
Less: preferred dividends
Income available for common shareholders
Divided by weighted-average shares
Earnings per share
$1,700,000
250,000
$1,450,000
725,000
$2.00
20




Restatement of weighted shares outstanding before the dividend or split
Deemed to have been outstanding since the beginning of the year
After year end but before issuance of financial statements require restatement to beginning of year
21

Basic EPS with Stock Dividends

Fact Pattern:

Beginning balance = 800,000 shares






Issued 100,000 shares on April 1
Reacquired 300,000 shares on July 1
25% stock dividend on October 1
Issue 120,000 shares on November 1
Net income = $1,500,000
Preferred dividends = $481,125
22

Weighted-Average Common Shares Outstanding
Description
Beginning balance
Issued shares
Adjusted balance
Reacquired shares
Adjusted balance
25% stock dividend
Adjusted balance
Issued shares
Adjusted balance
Dates
1/1/04
4/1/04
7/1/04 (300,000)
10/1/04 150,000
11/1/04 120,000
Weighted-average common shares outstanding
Shares
800,000
100,000
900,000
600,000
750,000
870,000
Restate
Restated
Shares
1.25
1,000,000
Fraction of Weighted
Year Average
3/12 250,000
1.25
1.25
1,125,000
750,000
750,000
870,000
3/12
3/12
1/12
2/12
281,250
187,500
62,500
145,000
926,250
23

Basic EPS with Stock Dividends
Net income
Less: preferred dividends
Income available for common shareholders
Divided by weighted-average shares
Earnings per share
$1,500,000
481,125
$1,018,875
926,250
$1.10
24





Stock options, rights and warrants
Convertible securities

Convertible bonds

Convertible preferred stock
Only dilutive securities are considered
Antidilutive securities are ignored
25




Reduction in EPS if potentially dilutive:

Stock options, rights or warrants

Convertible securities
Assumed exercised or converted at beginning of the year
Two EPS calculations


Basic EPS, and
Diluted EPS
26

Complex Capital Structures: Diluted EPS
Diluted EPS =
Net Income less Preferred Dividends plus Bond Interest
Expense (net of tax) and/or Convertible Preferred Dividends
Weighted Average Number of Common Shares Outstanding
Assuming Maximum Dilution
27




Treasury stock method

Options, Rights and Warrants
If converted method

Convertible Securities
Maximum dilutive conversion rate is used in calculating diluted EPS
28





Options, rights and warrants are included in EPS computations
Assumed exercised at beginning of year
Proceeds from exercise are assumed used to buy back common shares
Exercise price per share must be less than market price per share for dilution
29

•
Fact Pattern:
•
•
•
•
Exercise price = $10 per share
Average market price = $40 per share
1,000 options outstanding and assumed exercised
Additional shares added to weightedaverage common shares outstanding
30

Dilution using the Treasury Stock Method
1,000 Shares assumed issued
Proceeds assumed from options:
Exercise price
Number of optionns outstanding
Assumed proceeds
Assumed number of shares purchased:
Assumed proceeds
Divided by average market price
Assumed number of shares purchased
Dilution (increase in outstanding shares)
$10
1,000
$10,000
$10,000
40
250
750
31




Conversion of securities into common stock is assumed to occur at the beginning of the year
Related interest effect (net of tax) and/or convertible preferred dividends are removed from the calculation of income available to common shares
Weighted average number of shares is increased by additional common shares assumed issued at beginning of year
32


Fact Pattern:





Net income = $500,000
Common shares outstanding = 250,000
$1,000,000 6% convertible bonds
Each $1,000 bond convertible into 25 shares of common stock
Income tax rate = 35%
33

Basic EPA using If-Converted Method
Net income
Common shares outstanding
Basic EPS
$500,000
250,000
$2.00
34

Diluted EPS using If-Converted Method
Adjustment to net income available to common
Net income
Face amount of bonds
Stated interest rate
Interest expense
Less: tax affect
Interest expense net of tax
Adjusted net income
$1,000,000
6%
60,000
21,000
$500,000
39,000
$539,000
Adjustment to common shares outstanding
Common shares outstanding
Shares assumed to be issued:
Number of $1,000 bonds
Conversion ratio
Shares assumed to be issued
Adjusted common shares outstanding
1,000
25
250,000
25,000
275,000
35

Diluted EPS using If-Converted Method
Adjusted net income
Adjusted common shares outstanding
Diluted EPS
$539,000
275,000
$1.96
36


Requires duel presentation


Basic earnings per share
Diluted earnings per share
37