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 preferred stock.
1, 2, 3, 4,
5, 6, 7
1, 2, 3
1, 2, 3, 4, 5, 6,
24, 25,
2
1
2.
Warrants and debt.
2, 3, 8, 9
4, 5
7, 8, 9
1
1, 3
restricted stock.
12, 13,
14, 15
4.
Earnings Per Share
18, 24
potentially dilutive
securities.
6.
EPS—Treasury stock
method.
22, 23
15
28
5
5, 6
7.
EPS—Weighted-
average computation.
16, 17
10, 11
15, 16, 17,
18, 21
5, 6, 7,
8, 9
8.
EPS—General
objectives.
9, 12
5, 6
calculations.
23, 24, 25, 26,
27, 28
EPS—Contingent
shares.
Stock appreciation
rights.
29, 30
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Questions
Brief
Exercises
Exercises
Problems
Concepts
for
Analysis
1. Describe the
accounting for the
1, 2, 4, 5, 6, 7
1, 2, 3
1, 2, 3, 4, 5,
6
1, 2
CA16-1
CA16-3
2. Contrast the accounting
3, 8, 9
4, 5
1, 7, 8, 9
1
CA16-1,
14, 15
13, 14
CA16-4
3. Describe the
10, 11, 12, 13,
6, 7, 8
10, 11, 12,
1, 3, 4
CA16-2,
4. Compute basic
16, 17
9, 10,
15, 16, 17,
6, 7, 8, 9
CA16-5
5. Compute diluted
18, 19, 20, 21,
13, 14, 15
22, 23, 24,
5, 7, 8
CA16-5,
*6. Explain the accounting
16
29, 30
*7. Compute earnings per
26
ASSIGNMENT CHARACTERISTICS TABLE
Item
Description
Level of
Difficulty
Time
(minutes)
E16.1
Issuance and conversion of bonds.
Simple
15–20
E16.2
Conversion of bonds.
Simple
15–20
E16.3
Conversion of bonds.
10–15
E16.4
Conversion of bonds.
Moderate
15–20
E16.5
Conversion of bonds.
Simple
10–20
E16.6
Conversion of bonds.
Moderate
25–35
E16.7
Issuance of bonds with warrants.
Simple
10–15
E16.8
Issuance of bonds with detachable warrants.
Simple
10–15
E16.9
Issuance of bonds with stock warrants.
Moderate
15–20
E16.10
Issuance and exercise of stock options.
Moderate
15–25
E16.11
Issuance, exercise, and termination of stock options.
Moderate
15–25
E16.12
Issuance, exercise, and termination of stock options.
Moderate
15–25
E16.13
Accounting for restricted stock.
Simple
10–15
E16.14
Accounting for restricted stock.
Simple
10–15
E16.15
Weighted-average number of shares.
Moderate
15–25
E16.16
EPS: Simple capital structure.
Simple
10–15
E16.17
EPS: Simple capital structure.
Simple
10–15
E16.18
EPS: Simple capital structure.
10–15
E16.19
EPS: Simple capital structure.
Simple
20–25
E16.20
EPS: Simple capital structure.
Simple
10–15
E16.21
EPS: Simple capital structure.
10–15
E16.22
EPS with convertible bonds, various situations.
20–25
E16.23
EPS with convertible bonds.
Moderate
15–20
E16.24
EPS with convertible bonds and preferred stock.
Moderate
20–25
E16.25
EPS with convertible bonds and preferred stock.
Moderate
10–15
E16.26
EPS with options, various situations.
Moderate
20–25
E16.27
EPS with contingent issuance agreement.
10–15
E16.28
EPS with warrants.
Moderate
15–20
*E16.29
Stock-appreciation rights.
Moderate
15–25
*E16.30
Stock-appreciation rights.
Moderate
15–25
P16.1
Entries for various dilutive securities.
Moderate
35–40
P16.2
Entries for conversion, amortization, and interest of bonds.
Moderate
45–50
P16.3
Stock option plan.
Moderate
30–35
P16.4
Stock-based compensation.
Moderate
25–30
P16.5
EPS with complex capital structure.
Moderate
30–35
P16.6
Basic EPS: Two-year presentation.
Moderate
30–35
P16.7
Computation of basic and diluted EPS.
Moderate
35–45
P16.8
Computation of basic and diluted EPS.
Moderate
25–35
P16.9
EPS with stock dividend and discontinued operations.
30–40
CA16.1
Warrants issued with bonds and convertible bonds.
Moderate
20–25
CA16.2
Ethical issues—compensation plan.
Simple
15–20
CA16.3
Moderate
15–20
CA16.4
Stock 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 stock 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 stock 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
allow the holders to purchase the issuer’s stock at less than market value if the stock appreciates
sufficiently in the future; (3) both provide the holder the protection of a debt security if the value of
4. The accounting treatment of the $160,000 “sweetener” to induce conversion of the bonds into
common shares represents a departure from GAAP because the FASB views the transaction as
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
Questions Chapter 16 (Continued)
(b) The purchaser obtains an option to receive either the face amount of the debt upon maturity
or the specified number of common shares upon conversion. If the market value of the
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 common stock 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 common
stock can be supported on the grounds that when the company issued the convertible
debentures, the proceeds could represent consideration received for the stock. Therefore, when
conversion occurs, the book value of the obligation is simply transferred to the stock exchanged
8. Cash ………………………………………………………………………………….. 3,000,000
Discount on Bonds Payable …………………………………………………… 100,000
Bonds Payable ……………………………………………………………… 3,000,000
Paid-in Capital—Stock Warrants ……………………………………… 100,000
Questions Chapter 16 (Continued)
9. If a corporation decides to issue new shares of stock, the old stockholders generally have the
right, referred to as a stock right, to purchase newly issued shares in proportion to their holdings.
10. Companies are required to use the fair value method to recognize compensation cost. For most
11. This plan would not be considered compensatory since it meets the conditions of a
noncompensatory plan; i.e., (1) substantially all full-time employees may participate on an
12. The profession recommends that the fair value of a stock option be determined on the date on
which the option is granted to a specific individual.
13. GAAP 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 stock to compensate employees are: (1) The restricted stock
never becomes completely worthless; (2) it generally results in less dilution than stock options;
Questions Chapter 16 (Continued)
16. Weighted-average number of 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 outstanding requires restatement of
the shares outstanding before the stock dividend or split. The additional shares outstanding as a
18. (a) Basic earnings per share is the amount of earnings for the period available to each share
of common stock outstanding during the reporting period.
(b) Potentially dilutive security is a security which can be exchanged for or converted into
common stock and therefore upon conversion or exercise could dilute (or decrease)
19. Convertible securities are potentially dilutive securities and part of diluted earnings per share if
their conversion increases the EPS numerator less than it increases the EPS denominator; i.e.,
Questions Chapter 16 (Continued)
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-stock 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 common stock at the average
23. Yes, if warrants or options are present, an increase in the market price of the common stock can
increase the number of potentially dilutive common 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
Questions Chapter 16 (Continued)
Earnings per share assuming conversion of the bonds:
Net income……………………………………………………………………………………. $10,000
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
per share is reduced until one of the securities maintains or increases earnings per share. When
LO: 7, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 16.1
Cash ………………………………………………………………….. 3,960,000
BRIEF EXERCISE 16.2
Bonds Payable ……………………………………………………. 2,000,000
Discount on Bonds Payable ………………………….. 30,000
BRIEF EXERCISE 16.3
Preferred Stock (1,000 X $50) ………………………………. 50,000
Paid-in Capital in Excess of Par—
BRIEF EXERCISE 16.4
Cash ………………………………………………………………….. 2,020,000
Discount on Bonds Payable
($2,000,000 – $1,940,784) …………………………………. 59,216
BRIEF EXERCISE 16.5
Cash ……………………………………………………………………. 2,020,000
Discount on Bonds Payable
BRIEF EXERCISE 16.6
1/1/20
No entry
12/31/20
BRIEF EXERCISE 16.7
1/1/20
Unearned Compensation ……………………… 130,000
Common Stock (2,000 X $5) …………… 10,000
BRIEF EXERCISE 16.7 (continued)
12/31/21
BRIEF EXERCISE 16.8
1/1/20
Unearned Compensation ……………………….. 75,000
Common Stock …………………………………… 10,000
BRIEF EXERCISE 16.9
BRIEF EXERCISE 16.10
Dates
Outstanding
Shares
Outstanding
Fraction
of Year
Weighted
Shares
1/1–5/1
120,000
4/12
40,000
5/1–7/1
180,000
2/12
BRIEF EXERCISE 16.11
(a) (300,000 X 4/12) + (330,000 X 8/12) = 320,000
BRIEF EXERCISE 16.12
Earnings per share
Income from continuing operations ($600,000/100,000) . $ 6.00
BRIEF EXERCISE 16.13
Net income ……………………………………………………………………… $300,000
Adjustment for interest, net of tax [$40,000* X (1 – .20)] …….. 32,000
BRIEF EXERCISE 16.14
Net income ……………………………………………………………………… $270,000
BRIEF EXERCISE 16.15
Proceeds from assumed exercise of 45,000
options (45,000 X $10) ………………………………………………….. $450,000
*BRIEF EXERCISE 16.16
2020: (5,000 X $4) X .50 = $10,000
SOLUTIONS TO EXERCISES
EXERCISE 16.1 (15–20 minutes)
1. Cash ($20,000,000 X .99) …………………………. 19,800,000
2. Cash ………………………………………………………. 19,600,000
Discount on Bonds Payable ……………………. 1,200,000
Bonds Payable …………………………………. 20,000,000
3. Debt Conversion Expense ………………………. 75,000
Bonds Payable ……………………………………….. 10,000,000
EXERCISE 16.2 (15–20 minutes)
(a) Interest Payable ($200,000 X 2/6) ……………… 66,667
Interest Expense ($200,000 X 4/6) + $2,712 .. 136,045
EXERCISE 16.2 (Continued)
(b) Bonds Payable ……………………………………………. 1,500,000
Discount on Bonds Payable ……………………. 27,458
Common Stock (30,000 X $20) ………………… 600,000
EXERCISE 16.3 (10–20 minutes)
Conversion recorded at book value of the bonds:
Bonds Payable …………………………………………………… 500,000
EXERCISE 16.4 (15–20 minutes)
(a) Cash …………………………………………………………… 10,800,000
Bonds Payable …………………………………….. 10,000,000
EXERCISE 16.4 (Continued)
(b) Bonds Payable …………………………..…………… 3,000,000
Schedule 1
Computation of Unamortized Premium on Bonds Converted
Premium on bonds payable on January 1, 2019 $800,000
Schedule 2
Computation of Common Stock Resulting from Conversion
Number of shares convertible on January 1, 2019:
Number of bonds ($10,000,000 ÷ $1,000) 10,000
EXERCISE 16.5 (10–20 minutes)
Interest Expense ……………………………………………………. 25,640
Bonds Payable ………………………………………………………. 500,000
Discount on Bonds Payable ($10,240 – $640) ……. 9,600
EXERCISE 16.6 (25–35 minutes)
(a) December 31, 2021
Bond Interest Expense …………………………………… 156,000
(b) January 1, 2022
Bonds Payable ………………………………………………. 400,000
Premium on Bonds Payable ……………………………. 6,400*
EXERCISE 16.6 (Continued)
(c) March 31, 2022
Bond Interest Expense ……………………………………. 7,800
Premium on Bonds Payable ……………………………. 200
($6,400 ÷ 8 years) X 3/12
(d) June 30, 2022
Bond Interest Expense ……………………………………. 124,800
Premium on Bonds Payable ……………………………. 3,200
***Total to be paid: ($3,200,000 X .08 ÷ 2) + $8,000 = $136,000
***Original premium $80,000
EXERCISE 16.7 (10–15 minutes)
(a) Basic formulas:
Value of bonds without warrants
X Issue price = Value assigned to bonds
Value of bonds without warrants
+ Value of warrants
Value of bonds without warrants
(b) When the warrants are non-detachable, separate recognition is not
given to the warrants. The accounting treatment parallels that given
convertible debt because the debt and equity element cannot be
separated.