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,
7, 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
14
4.
Earnings Per Share
18, 24
potentially dilutive
securities.
6.
EPS—Treasury stock
method.
22, 23
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.
24, 25
9, 15
5, 6
calculations.
23, 24, 25, 26,
27, 28
10.
EPS—Contingent
shares.
27
Stock appreciation
rights.
16
29, 30
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Questions
Brief
Exercises
Exercises
Problems
Concepts
for
Analysis
1. Describe the
accounting for the
issuance, conversion,
and retirement of
convertible securities.
1, 2, 4, 5
1, 2
1, 2, 3, 4, 5,
6
1, 2
CA16-1
2. Explain the accounting
for convertible
preferred stock.
3
4. Describe the
accounting for stock
compensation plans.
10, 11, 12, 13,
14, 15
6, 7, 8
10, 11, 12,
13, 14
1, 3, 4
CA16-2,
CA16-4
5. Discuss the controversy
involving stock
compensation plans.
7. Compute earnings per
share in a complex
capital structure.
18, 20, 21, 22,
23, 24, 25
12, 13, 14
22, 23, 24,
25, 26, 27,
5, 7, 8
CA16-6
for stock-appreciation
rights plans.
29, 30
share in
a complex situation.
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.
Simple
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
E16-13
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.
Simple
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.
Simple
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
E16-26
EPS with options, various situations.
Moderate
20–25
E16-27
EPS with contingent issuance agreement.
Simple
10–15
E16-28
EPS with warrants.
Moderate
15–20
Stock-appreciation rights.
Moderate
15–25
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 extraordinary items.
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
Stock warrants—various types.
Moderate
15–20
CA16-4
Stock compensation plans.
Moderate
25–35
CA16-5
EPS: Preferred dividends, options, and convertible debt.
Moderate
25–35
SOLUTIONS TO CODIFICATION EXERCISES
CE16-1
Master Glossary
(a) The amount of earnings for the period available to each share of common stock outstanding
during the reporting period.
(d) The date at which an employer and an employee reach a mutual understanding of the key terms
and conditions of a share-based payment award. The employer becomes contingently obligated
on the grant date to issue equity instruments or transfer assets to an employee who renders the
CE16-2
According to FASB ASC 260-10–45-7 (Earnings Per Share—Other Presentation Matters):
EPS data shall be presented for all periods for which an income statement or summary of earnings is
CE16-3
According to FASB ASC 260-10–50-1 (Earnings Per Share—Disclosure):
For each period for which an income statement is presented, an entity shall disclose all of the following:
(a) A reconciliation of the numerators and the denominators of the basic and diluted per-share
computations for income from continuing operations. The reconciliation shall include the individual
CE16-3 (Continued)
(b) The effect that has been given to preferred dividends in arriving at income available to common
stockholders in computing basic EPS.
(c) Securities (including those issuable pursuant to contingent stock agreements) that could
CE16-4
According to FASB ASC 260-10–55-12 (Earnings Per Share—Implementation—Restatement of EPS
Data):
If the number of common shares outstanding increases as a result of a stock dividend or stock split
(see Subtopic 505–20) or decreases as a result of a reverse stock split, the computations of basic and
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
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
the retirement of debt. Therefore, the FASB requires that the “sweetener” of $160,000 be
reported as an expense. It is not an extraordinary loss because it is simply a payment to induce
conversion.
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
(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
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 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
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
stock option plans compensation cost is measured at the grant date and allocated to expense
over the service period, which typically ends on the vesting date.
Questions Chapter 16 (Continued)
11. This plan would not be considered compensatory since it meets the conditions of a
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
otherwise specified, the service period is the vesting period—the time between the grant date
and the vesting date.
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;
and (3) it better aligns the employee incentives with the companies’ incentives.
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
Questions Chapter 16 (Continued)
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.,
the EPS with conversion is less than the EPS before conversion.
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
would decrease earnings per share. If this situation does not result, conversion is not assumed
and only basic EPS is reported.
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
would exist when the dividend or interest requirement (net of tax) of a convertible security exceeds
the current EPS multiplied by the number of common shares issuable upon conversion of the
Questions Chapter 16 (Continued)
Earnings per share assuming conversion of the bonds:
25. Both basic earnings per share and diluted earnings per share must be presented in a complex
capital structure. When irregular items are reported, per share amounts should be shown for
income from continuing operations, income before extraordinary items, and net income.
*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 ………………………………………………………………….. 3,960,000
BRIEF EXERCISE 16-2
Bonds Payable …………………………………………………… 2,000,000
BRIEF EXERCISE 16-3
Preferred Stock (1,000 X $50) …………………………..….. 50,000
BRIEF EXERCISE 16-4
Cash ………………………………………………………………….. 2,020,000
Discount on Bonds Payable
BRIEF EXERCISE 16-5
Cash …………………………..……………………………………….. 2,020,000
Discount on Bonds Payable
BRIEF EXERCISE 16-6
1/1/14 No entry
BRIEF EXERCISE 16-7
1/1/14 Unearned Compensation ……………………… 130,000
Common Stock (2,000 X $5) …………… 10,000
Paid in Capital in Excess of Par—
Common Stock
[($65 – $5) X 2,000] ……………………… 120,000
BRIEF EXERCISE 16-8
1/1/14 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
BRIEF EXERCISE 16-11
BRIEF EXERCISE 16-12
Net income ……………………………………………………………………… $300,000
BRIEF EXERCISE 16-13
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 before extraordinary loss ($600,000/100,000) ….. $ 6.00
Extraordinary loss ($120,000/100,000) ……………………….. 1.20
Net income ($480,000/100,000) ………………………………….. $ 4.80
*BRIEF EXERCISE 16-16
SOLUTIONS TO EXERCISES
EXERCISE 16-1 (15–20 minutes)
1. Cash ($20,000,000 X .99) …………………………. 19,800,000
Discount on Bonds Payable ……………………. 200,000
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
Paid-in Capital in Excess of Par ……………… 872,542*
EXERCISE 16-3 (10–20 minutes)
Conversion recorded at book value of the bonds:
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
Premium on Bonds Payable
(Schedule 1) ………………………………………. 216,000
Schedule 1
Computation of Unamortized Premium on Bonds Converted
Premium on bonds payable on January 1, 2013 $800,000
Schedule 2
Computation of Common Stock Resulting from Conversion
Number of shares convertible on January 1, 2013:
Number of bonds ($10,000,000 ÷ $1,000) 10,000
EXERCISE 16-5 (10–20 minutes)
Interest Expense ……………………………………………………. 25,640
Discount on Bonds Payable …………………………….. 640
be debited for $8,333)
Bonds Payable ………………………………………………………. 500,000
Discount on Bonds Payable ($10,240 – $640) ……. 9,600
*($500,000 – $9,600) – $75,000
EXERCISE 16-6 (25–35 minutes)
(a) December 31, 2015
Bond Interest Expense …………………………………… 156,000
(b) January 1, 2016
Bonds Payable …………………………..………………….. 400,000
Premium on Bonds Payable ……………………………. 6,400
Common Stock ………………………………………… 320,000
EXERCISE 16-6 (Continued)
(c) March 31, 2016
Bond Interest Expense ……………………………………. 7,800
March 31, 2016
Bonds Payable ……………………………………………….. 400,000
Premium on Bonds Payable ……………………………. 6,200
Common Stock ………………………………………… 320,000
(d) June 30, 2016
Bond Interest Expense ……………………………………. 124,800
Premium on Bonds Payable ……………………………. 3,200
***Total to be paid: ($3,200,000 X 8% ÷ 2) + $8,000 = $136,000
***Original premium $80,000
2014 amortization (8,000)
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
Cash ……………………………………………………………… 152,000
Discount on Bonds Payable ……………………………. 40,800
(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.