CA 16.7
Dear Mr. Dolan:
I hope that the following brief explanation helps you understand why your warrants were not included in
Rhode’s earnings per share calculations.
However, corporations that have outstanding a variety of other securities—convertible bonds,
convertible preference shares, share options, and share warrants—have a complex capital structure.
Because these securities could be converted to ordinary shares they have a potentially “dilutive” effect
on EPS.
In order not to mislead users of financial information, the accounting profession insists that EPS
If we assume that Rhode exercises 30,000 warrants at $30, the company does not simply add 30,000
shares to ordinary shares outstanding; rather, for diluted EPS, Rhode is assumed to purchase and
retire 36,000 [(30,000 X $30) ÷ $25] treasury shares at $25 with the proceeds. Therefore, if you add the
30,000 exercised warrants to the ordinary shares outstanding and then subtract the 36,000 shares
Sincerely,
Ms. Smart Student
FINANCIAL REPORTING PROBLEM
(a) See note 13.
1. Under M&S’s share-based compensation plan 10,437,215 options
were granted during 2016.
4. The options expire 3 years after the date of grant.
(b)
(In millions—except per share)
2016
2015
Weighted average ordinary shares
1,642.2
1,646.9
Diluted earnings per share
24.8p
29.5p
COMPARATIVE ANALYSIS CASE
(a) adidas pays employees a salary and a cash performance bonus based
on net income. adidas does not have a stock option plan.
(b)
2015
201,536
14,940
2014
208,776
14,940
(c)
Diluted Earnings Per Share
(in millions)
adidas
Puma
ACCOUNTING, ANALYSIS, AND PRINCIPLES
ACCOUNTING
(a) Present value of principal:
(€200,000 X .42241) …………………………………………. € 84,482
Amortization Schedule
Date
Cash Paid
Interest
Expense
(9%)
Discount
Amortized
Carrying Value
of Bonds
1/1/19
€161,494
12/31/19
(b)
Basic EPS
2020
2019
Net income
€30,000
€27,000
Outstanding shares
÷10,000
÷10,000
Basic EPS
€ 3.00
€ 2.70
Diluted EPS
Net income
€30,000
€27,000
Add: Interest savings (see schedule above)
Adjusted net income (1)
€44,763
€41,534
Outstanding shares
Shares upon conversion
Total shares for diluted EPS (2)
Diluted EPS (1) ÷ (2)
ACCOUNTING, ANALYSIS, AND PRICIPLES (Continued)
(c) Conversion Expense (€50 X 200) ………………………… 10,000
ANALYSIS
EPS Presentation
2020
2019
Net income
€30,000
€27,000
Diluted EPS
€ 2.80
€ 2.60
EPS standards are important to analysts who rely on reported earnings per
PRINCIPLES
IFRS for convertible debt primarily differs from U.S. GAAP on convertible
Cash ……………………………………………………………………….. 200,000
Bonds Payable…………………………………………………… 200,000
ACCOUNTING, ANALYSIS, AND PRICIPLES (Continued)
Supporters of the IFRS treatment would argue that separating the bond
issue into liability and equity components provides more representationally
faithful information in the financial statements. That is, the resulting
financial statements do a better job of representing the underlying
economics of the transaction. When bond investors buy bonds with a
RESEARCH CASE
(a) IFRS 2 addresses the accounting for share-based payment
compensation plans.
(b) The objectives for accounting for stock compensation are (as stated by
IFRS 2, paragraph 1): The objective of this IFRS is to specify the
financial reporting by an entity when it undertakes a share-based
(c) When the goods or services received or acquired in a share-based
payment transaction do not qualify for recognition as assets, they shall
be recognised as expenses (par.8).
For equity-settled share-based payment transactions, the entity shall
measure the goods or services received, and the corresponding
RESEARCH CASE (Continued)
Typically, shares, share options or other equity instruments are
granted to employees as part of their remuneration package, in
addition to a cash salary and other employment benefits. Usually, it is
part of basic remuneration, e.g. as an incentive to the employees to
remain in the entity’s employ or to reward them for their efforts in
improving the entity’s performance. By granting shares or share
options, in addition to other remuneration, the entity is paying
additional remuneration to obtain additional benefits. Estimating the
GAAP CONCEPTS and APPLICATION
16.1. Similarities
• U.S. GAAP and IFRS follow the same model for recognizing
share-based compensation: The fair value of shares and options
awarded to employees is recognized over the period to which the
employees’ services relate.
• Although the calculation of basic and diluted earnings per share
Differences
• A significant difference between U.S. GAAP and IFRS is the
accounting for securities with characteristics of debt and equity,
• Related to employee share-purchase plans, these plans under
U.S. GAAP are often considered non-compensatory and therefore
no compensation is recorded. However, certain conditions must
GAAP Concepts and Application (Continued)
• Other EPS differences relate to (1) the treasury-share method and
16.2.
(a) Under IFRS, Norman must “bifurcate” (split out) the equity
component—the value of the conversion option—of the bond issue.
Under IFRS, the convertible bond issue is recorded as follows.
(c) IFRS provides a more faithful representation of the impact of the bond
issue, by recording separately its debt and equity components.
16.3
(a) Account
Current Liabilities $ 554,114
Concepts and Application (Continued)
(b) Sepracor is doing very well. Its ROA and ROE are above the industry
average. However, its debt level is quite high, compared to the
(c) Under IFRS, the debt and equity components of a convertible bond are
separately recorded as liabilities and equity. Assuming a liability
Reclassified:
Account
Current Liabilities $554,114
Convertible Debt 398,020
Total Liabilities 978,313 [$1,228,313 – ($648,020 – $398,020)]