Chapter 16 Dilutive Securities and Earnings per Share This slide deck contains animations. Please disable animations if they cause issues with your device.
Learning Objectives After studying this chapter, you should be able to: 1. Describe the accounting for the issuance, conversion, and retirement of convertible securities. 2. Contrast the accounting for stock warrants and for stock warrants issued with other securities. 3. Describe the accounting and reporting for stock compensation plans.
Accounting for Convertible Debt Two main reasons corporations issue convertibles: 1. To raise equity capital without giving up more ownership control than necessary. 2. Obtain debt financing at cheaper rates. The accounting for convertible debt involves reporting issues at the time of (1) issuance, (2) conversion, and (3) retirement.
Accounting for Convertible Debt At Time of Issuance
Recording convertible bonds follows the method used to record straight debt issues, with any discount or premium amortized over the term of the debt. Global View IFRS requires that the issuer of convertible debt record the liability and equity components separately.
Hilton, Inc. has a $1,000 bond that is convertible into 10 shares of common stock (par value $10). At the time of conversion, the unamortized premium is $50. Hilton records the conversion of the bonds as follows. Bonds Payable 1,000 Premium on Bonds Payable 50 Common Stock Paid-in Capital in Excess of Par—Common
Induced Conversion Illustration: Helloid, Inc. has outstanding $1,000,000 par value convertible debentures convertible into 100,000 shares of $1 par value common stock. Helloid wishes to reduce its annual interest cost. To do so, Helloid agrees to pay the holders of its convertible debentures an additional $80,000 if they will convert. Assuming conversion occurs, Helloid makes the following entry. Debt Conversion Expense 80,000 Bonds Payable 1,000,000 Common Stock (100,000 x $1) 100,000 Paid-in Capital in Excess of Par—Common 900,000 Cash 80,000 LO 1
Convertible Preferred Stock Convertible preferred stock includes an option for the holder to convert preferred shares into a fixed number of common shares. • Classified as part of stockholders’ equity, unless mandatory redemption exists. • No theoretical justification for recognizing a gain or loss when exercised. • Company uses the book value method. LO 1
Convertible Preferred Stock Illustration: Host Enterprises issued 1,000 shares of common stock (par value $2) upon conversion of 1,000 shares of preferred stock (par value $1) that was originally issued for a $200 premium. The entry would be: Convertible Preferred Stock (1,000 × $1) Paid-in Capital in Excess of Par—Preferred Retained Earnings Common Stock (1,000 x $2)
Stock Warrants Warrants are certificates entitling the holder to acquire shares of stock at a certain price within a stated period. Normally arises under three situations: 1. To make the security more attractive. 2. Existing stockholders have a preemptive right to purchase common stock first. 3. To executives and employees as a form of compensation.
Stock Warrants Issued with Other Securities Basically long-term options to buy common stock at a fixed price. • Generally life of warrants is five years, occasionally ten years. • Proceeds allocated between the two securities. • Allocation based on fair market values. • Two methods of allocation: 1) proportional method 2) incremental method LO 2
Proportional Method Illustration: Assume that AT&T’s bonds (par $1,000) sold for 99 without the warrants soon after their issue. The market price of the warrants at that time was $30. (Prior to sale the warrants will not have a fair value.) The allocation relies on an estimate of fair value, generally as established by an investment banker, or on the relative fair value of the bonds and the warrants soon after the company issues and trades them. The price paid for 10,000, $1,000 bonds with the warrants attached was par, or $10,000,000. The following illustration shows the proportional allocation of the bond proceeds between the bonds and warrants. LO 2
Investors Exercise all 1,000 Warrants Assuming investors exercise all 10,000 warrants (one warrant per one share of stock), AT&T makes the following entry. Cash (10,000 x $25) 250,000 Paid-in Capital—Stock Warrants 294,118 Common Stock (10,000 × $5) Paid-in Capital in Excess of Par—Common
What if investors fail to exercise the warrants, AT&T debits Paid-in Capital—Stock Warrants for $294,118 and credits Paidin Capital—Expired Stock Warrants for a like amount. LO 2