CHAPTER 16
Dilutive Securities and Earnings Per Share
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics
Questions
Brief
Exercises
Exercises
Problems
Concepts
for Analysis
1.
Convertible debt
and preference
shares.
1, 2, 3, 4,
5, 6, 7
1, 2, 3
1, 2, 3, 4, 5,
6, 7, 25, 26
1
2.
Warrants and debt.
3, 8, 9
4, 5
7, 8, 9,
10, 29
1
1, 3
3.
Share options,
restricted share.
1, 10, 11,
12, 13,
14, 15
6, 7, 8
11, 12, 13,
14, 15
1, 2, 3
2, 4
4.
Earnings Per Share
(EPS)—terminology.
17, 18, 24
15
6
5.
EPS—Determining
potentially dilutive
securities.
19, 20, 21
12, 13, 14
23, 24, 25,
26, 27, 28
5, 7
6.
share method.
22, 23
27, 29
1, 5, 7
7.
EPS—Weighted-
average computation.
16, 17
10, 11
16, 17, 18,
19, 20, 21,
4, 5, 68
8.
objectives.
24, 25
9, 15
5, 6, 7
9.
EPS—
Comprehensive
calculations.
26
20, 21, 22,
23, 24, 25,
27, 28, 29
4, 6, 7, 8
4, 5
10.
shares.
28
Share appreciation
rights.
16
30, 31
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Brief
Exercises
Exercises
Problems
Concepts
for
Analysis
1, 2, 3
1, 2, 3, 4,
5, 6, 7, 25, 26
1
1
4, 5
7, 8, 9, 10
1
3
6, 7, 8
11, 12,13,
1, 2, 3
1, 2, 3, 4
9, 10,
16, 17, 18,
5, 8
5, 6
12, 13, 14
23, 24, 25,
26, 27, 28, 29
4, 6, 7
1, 5, 6, 7
30, 31
ASSIGNMENT CHARACTERISTICS TABLE
Item
Description
Level of
Difficulty
Time
(minutes)
E16.1
Issuance and repurchase of convertible bonds.
Moderate
10–15
E16.2
Issuance and repurchase of convertible bonds.
Moderate
15–20
E16.3
Issuance and repurchase of convertible bonds.
Moderate
15–20
E16.4
Issuance, conversion, repurchase of convertible bonds.
Moderate
15–20
E16.5
Conversion of bonds.
Simple
15–20
E16.6
Conversion of bonds.
Simple
10–15
E16.7
Issuance and conversion of bonds.
Simple
15–20
E16.8
Issuance of bonds with share warrants.
Simple
10–15
E16.9
Issuance of bonds with share warrants.
Simple
10–15
E16.10
Issuance of bonds with share warrants.
Moderate
15–20
E16.11
Issuance and exercise of share options.
Moderate
15–25
E16.12
Issuance, exercise, and forfeiture of share options.
Moderate
15–25
E16.13
Issuance, exercise, and expiration of share options.
Moderate
15–25
E16.14
Accounting for restricted shares.
Simple
10–15
E16.15
Accounting for restricted shares.
Simple
10–15
E16.16
Weighted-average ordinary shares.
Moderate
15–25
E16.17
EPS: Simple capital structure.
Simple
10–15
E16.18
EPS: Simple capital structure.
Simple
10–15
E16.19
EPS: Simple capital structure.
Simple
10–15
E16.20
EPS: Simple capital structure.
Simple
20–25
E16.21
EPS: Simple capital structure.
Simple
10–15
E16.22
EPS: Simple capital structure.
Simple
10–15
E16.23
EPS with convertible bonds, various situations.
20–25
E16.24
EPS with convertible bonds.
Moderate
15–20
E16.25
EPS with convertible bonds and preference shares.
Moderate
20–25
E16.26
EPS with convertible bonds and preference shares.
Moderate
10–15
E16.27
EPS with options, various situations.
Moderate
20–25
E16.28
EPS with contingent issuance agreement.
Simple
10–15
E16.29
EPS with warrants.
Moderate
15–20
Share-appreciation rights.
Moderate
15–25
Share-appreciation rights.
Moderate
15–25
P16.1
Entries for various dilutive securities.
Moderate
35–40
P16.2
Share-option plan.
Moderate
30–35
P16.3
Share-based compensation.
Moderate
25–30
P16.4
EPS with complex capital structure.
Moderate
30–35
P16.5
Basic EPS: Two-year presentation.
Moderate
30–35
P16.6
Computation of basic and diluted EPS.
Moderate
35–45
P16.7
Computation of basic and diluted EPS.
Moderate
25–35
P16.8
EPS with share dividend and discontinued operations.
30–40
CA16.1
Dilutive securities, EPS.
Moderate
15–20
CA16.2
Ethical issues—compensation plan.
Simple
15–20
Share warrants—various types.
Moderate
15–20
CA16.4
Share compensation plans.
Moderate
25–35
CA16.5
EPS: Preferred dividends, options, and convertible debt.
Moderate
25–35
ANSWERS TO QUESTIONS
1. Securities such as convertible debt or share options are dilutive because their features indicate
2. Corporations issue convertible securities for two reasons. One is to raise equity capital without
giving up more ownership control than necessary. A second reason is to obtain financing at
3. Convertible debt and debt issued with share warrants are similar in that: (1) both allow the issuer
to issue debt at a lower interest cost than would generally be available for straight debt; (2) both
4. The accounting treatment of the €160,000 “sweetener” to induce conversion of the bonds into
ordinary shares represents a departure from IFRS because the IASB views the transaction as the
5. (a) From the point of view of the issuer, the conversion feature of convertible debt results in a
lower cash interest cost than in the case of nonconvertible debt. In addition, the issuer in
planning its long-range financing may view the convertible debt as a means of raising equity
capital over the long term. Thus, if the market value of the underlying shares increases
(b) The purchaser obtains an option to receive either the face amount of the debt upon maturity
or the specified number of shares upon conversion. If the market value of the underlying
shares increases above the conversion price, the purchaser (either through conversion or
Questions Chapter 16 (Continued)
6. The view that separate accounting recognition should be accorded the conversion feature of
convertible debt is based on the premise that there is an economic value inherent in the
conversion feature or call on the ordinary shares and that the value of this feature should be
recognized for accounting purposes by the issuer. It may be argued that the call is not
7. The method used by the company to record the exchange of convertible debentures for ordinary
shares can be supported on the grounds that when the company issued the convertible
debentures, the proceeds could represent consideration received for the shares. Therefore, when
conversion occurs, the book value of the obligation is simply transferred to the shares exchanged
8. Cash ………………………………………………………………………………….. 3,000,000
Bonds Payable ……………………………………………………………… 2,900,000
9. If a corporation decides to issue new shares, the old shareholders generally have the right, referred
to as a share right, to purchase newly issued shares in proportion to their holdings. No entry is
10. Companies are required to use the fair value method to recognize compensation cost. For most
share option plans compensation cost is measured at the grant date and allocated to expense
Questions Chapter 16 (Continued)
11. Cordero would account for the discount as a reduction of the cash proceeds and an increase in
12. The profession recommends that the fair value of a share option be determined on the date on
which the option is granted to a specific individual.
13. IFRS requires that compensation expense be recognized over the service period. Unless
14. Using the fair value approach, total compensation expense is computed based on the fair value
15. The advantages of using restricted shares to compensate employees are: (1) The restricted
16. Weighted-average shares outstanding
Outstanding shares (all year) = ……………………………………….. 400,000
October 1 to December 31 (200,000 X 1/4) = …………………….. 50,000
17. The computation of the weighted-average number of shares requires restatement of the shares
outstanding before the share dividend or split. The additional shares outstanding as a result of a
Questions Chapter 16 (Continued)
18. (a) Basic earnings per share is the amount of earnings for the period available to each
ordinary share outstanding during the reporting period.
(b) A potentially dilutive security is a security which can be exchanged for or converted into
(d) A complex capital structure exists whenever a company’s capital structure includes
dilutive securities.
19. Convertible securities are potentially dilutive securities and part of diluted earnings per share if
20. The concept that a security may be the equivalent of common stock has evolved to meet the
reporting needs of investors in corporations that have issued certain types of convertible securities,
options, and warrants. A potentially dilutive security is a security which is not, in form, common
stock but which enables its holder to obtain common stock upon exercise or conversion. The
21. Convertible securities are considered to be potentially dilutive securities whenever their conversion
22. Under the treasury-share method, diluted earnings per share should be determined as if
outstanding options and warrants were exercised at the beginning of year (or date of issue if
later) and the funds obtained thereby were used to purchase ordinary shares at the average
market price for the period. For example, if a corporation has 10,000 warrants outstanding
Questions Chapter 16 (Continued)
23. Yes, if warrants or options are present, an increase in the market price of the ordinary shares can
increase the number of potentially dilutive ordinary shares by decreasing the number of shares
24. Antidilution is an increase in earnings per share resulting from the assumption that convertible
securities have been converted or that options and warrants have been exercised, or other
shares have been issued upon the fulfillment of certain conditions. For example, an antidilutive
condition would exist when the dividend or interest requirement (net of tax) of a convertible
security exceeds the current EPS multiplied by the number of ordinary shares issuable upon
25. Both basic earnings per share and diluted earnings per share must be presented in a complex
*26. Antidilution when multiple securities are involved is determined by ranking the securities for
maximum possible dilution in terms of per share effect. Starting with the most dilutive, earnings
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 16.1
Cash (£4,000,000 X .99) ……………………………………….. 3,960,000
BRIEF EXERCISE 16.2
Share Premium—Conversion Equity …………………… 20,000
BRIEF EXERCISE 16.3
Share Capital—Preference (1,000 X $50) ………………. 50,000
Share Premium—Conversion Equity
BRIEF EXERCISE 16.4
Cash [2,000 X ($1,000 X 1.01)] ……………………………… 2,020,000
BRIEF EXERCISE 16.5
Cash (3,000 X €1,000 X .98) ………………………………….. 2,940,000
BRIEF EXERCISE 16.6
1/1/19 No entry
12/31/19 Compensation Expense (₤150,000 ÷ 2) ……. 75,000
Share Premium—Share
BRIEF EXERCISE 16.7
1/1/19 Unearned Compensation ……………………….. 130,000
Share Capital—Ordinary
(2,000 X £5) …………………………………. 10,000
BRIEF EXERCISE 16.8
1/1/19 Unearned Compensation ……………………….. 75,000
Share Capital—Ordinary ………………….. 10,000
BRIEF EXERCISE 16.9
€1,000,000 – (100,000 X €2)
= €3.20 per share
250,000 shares
LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: Critical Thinking, AICPA FC: Reporting, AICPA PC: Problem Solving
BRIEF EXERCISE 16.10
Dates
Outstanding
Shares
Outstanding
Fraction
of Year
Weighted
Shares
BRIEF EXERCISE 16.11
(a) (300,000 X 4/12) + (330,000 X 8/12) = 320,000
BRIEF EXERCISE 16.12
Net income ………………………………………………………………………. R$300,000
Adjustment for interest, net of tax [R$64,000 X (1 – .40)] …….. 38,400
BRIEF EXERCISE 16.13
Net income ……………………………………………………………………… €270,000
BRIEF EXERCISE 16.14
Proceeds from assumed exercise of 45,000
options (45,000 X ₺10) ………………………………………………….. ₺450,000
BRIEF EXERCISE 16.15
Earnings per share
Income from continuing operations (€600,000/100,000) ……. € 6.00
*BRIEF EXERCISE 16.16
2019: (5,000 X $4) X 50% = $10,000
SOLUTIONS TO EXERCISES
EXERCISE 16.1 (10–15 minutes)
(a) Present Value of Principal:
(€2,000,000 X .79383) ……………………………………………….. €1,587,660
Present Value of Interest Payments:
(€120,000 X 2.57710) ………………………………………………… 309,252
Present Value of the Liability Component ……………………. €1,896,912
EXERCISE 16.2 (15–20 minutes)
(a) Carrying Value of Bonds, 1-1-19
Carrying Value of Bonds, 1-1-20 ………………………………….. €1,928,665
(b) Share Premium—Conversion Equity …………… 103,088
EXERCISE 16.2 (Continued)
(c) Share Premium—Conversion Equity ……….. 40,000*
Bonds Payable ………………………………………. 1,928,665
Cash …………………………..…………………… 1,940,000
EXERCISE 16.3 (15–20 minutes)
(a) Present Value of Principal:
(¥100,000 X .35218(n = 10, i = 11%)) ………………………… ¥ 35,218
Present Value of Interest Payments:
(¥10,000 X 5.88923(n = 10, i = 11%)) ………………………… 58,892
(b)
Date
Cash
Paid
Interest
Expense
Discount
Amortized
Carrying Value
of Bonds
1/1/19
¥94,110
EXERCISE 16.3 (Continued)
* 10,000 X 5.20637 = ¥ 52,064
100,000 X .58349 = 58,349
¥110,413
Adjustment to equity:
Fair value of convertible bonds
(with both liability and equity) ………………….. ¥112,000
Less: Liability component …………………………. 110,413
EXERCISE 16.4 (15–20 minutes)
(a) Cash ……………………………………………………………….. 60,000
Bonds Payable ………………………………………….. 53,993
Share Premium—Conversion Equity …………… 6,007
EXERCISE 16.4 (Continued)
(d) Computation of gain or loss:
Present value of liability component
at 12/31/21 ………………………………………………. £54,000
Less: Carrying value (from above) …………….. 51,783
Loss …………………………………………………………. £ 2,217
(e) Interest Expense ……………………………………………… 4,074
Bonds Payable ………………………………………………… 926
Cash …………………………..…………………………….. 5,000
EXERCISE 16.5 (15–20 minutes)
(a) Cash (€3,000,000 X .98) …………………………………… 2,940,000
Bonds Payable …………………………………………. 2,655,888
Share Premium—Conversion Equity ………….. 284,112
EXERCISE 16.5 (Continued)
Share Premium—Conversion Equity
EXERCISE 16.6 (10–15 minutes)
Conversion recorded at book value of the bonds:
EXERCISE 16.7 (15–20 minutes)
1. Cash (€10,000,000 X .99) ……………………………….. 9,900,000
2. Cash (€10,000,000 X .98) ……………………………….. 9,800,000
3. Share Premium—Conversion Equity ……………… 200,000
Conversion Expense …………………………………….. 75,000
EXERCISE 16.8 (10–15 minutes)
(a) Cash …………………………………………………………….. 150,000
EXERCISE 16.9 (10–15 minutes)
TOKACHI GROUP
Journal Entry
September 1, 2019
Cash (¥312,000,000 + ¥6,000,000) ………………………… 318,000,000
Bonds Payable …………………………..…………… 290,000,000
Schedule 1
Value of Share Warrants
Sales price (30,000 X ¥10,400) ………………………………………. ¥312,000,000
Schedule 2
Accrued Bond Interest to Date of Sale
Face value of bonds …………………………………………………….. ¥300,000,000
EXERCISE 16.10 (15–20 minutes)
(a) Cash (€3,000,000 X 1.02) ………………………………. 3,060,000
(b) Cash ……………………………………………………………. 3,060,000
Bonds Payable ………………………………………… 2,940,000
EXERCISE 16.11 (15–25 minutes)
1/2/19 No entry (total compensation cost is $600,000)
12/31/19 Compensation Expense …………………………... 300,000
12/31/20 Compensation Expense ……………………………. 300,000
Share Premium—Share Options …………. 300,000
1/3/21 Cash (30,000 X £40) ………………………………….. 1,200,000
Share Premium—Share Options
EXERCISE 16.11 (Continued)
(Note to instructor: The market price of the shares has no relevance in the
prior entry and the following one.)
5/1/21 Cash (10,000 X £40) ………………………………….. 400,000
EXERCISE 16.12 (15–25 minutes)
1/1/19 No entry (total compensation cost is €400,000)
12/31/19 Compensation Expense ……………………………… 200,000
Share Premium—Share Options ………… 200,000
(€400,000 X 1/2) (To recognize
compensation expense for 2019)
12/31/20 Compensation Expense ……………………………… 170,000
Share Premium—Share Options ………… 170,000
(€400,000 X 1/2 X 17/20) (To recognize
compensation expense for 2020)