Intermediate accounting 17e by kieso ch16

Intermediate Accounting
Seventeenth Edition
Kieso ● Weygandt ● Warfield

Chapter 16
Dilutive Securities and
Earnings
per
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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.
4. Compute basic earnings per share.
5. Compute diluted earnings per share.
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Preview of Chapter 16

Dilutive Securities and Earnings Per Share

Dilutive Securities
• Debt and equity
• Convertible debt
• Convertible preferred stock

Stock Warrants
• Warrants and other securities
• Stock rights
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Preview of Chapter 16
Stock Compensation Plans
• Measurement
• Recognition
• Restricted stock
• Employee stock-purchase plans
• Disclosure of compensation plans

Basic Earnings Per Share
• Simple structure
• Comprehensive example
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Preview of Chapter 16

Diluted Earnings Per Share
• Convertible securities
• Options and warrants
• Contingent issues
• Antidilution
• Presentation and disclosure

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Learning Objective 1
Describe the Accounting for the
Issuance, Conversion, and Retirement
of Convertible Securities

LO 1

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Dilutive Securities
Debt and Equity
Should companies report these financial instruments as a
liability or equity.
Stock
Options

LO 1

Convertible
Securities

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Preferred
Stock

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Dilutive Securities

Accounting for Convertible Debt
Convertible bonds can be changed into other corporate
securities during some specified period of time after
issuance.

LO 1

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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.

LO 1

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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.

LO 1

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Accounting for Convertible Debt
At Time of Conversion

Companies use the book value method when converting
bonds.
When the debtholder converts the debt to equity, the
issuing company recognizes no gain or loss upon
conversion.

LO 1

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At Time of Conversion
Illustration

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

LO 1

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100
950
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Accounting for Convertible Debt
Induced Conversion

• Issuer wishes to encourage prompt conversion.
• Issuer offers additional consideration, called a
“sweetener.”
• Sweetener is an expense of the current period.

LO 1

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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

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Accounting for Convertible Debt
Retirement of Convertible Debt

• Recognized same as retiring debt that is not
convertible.
• Difference between the cash acquisition price and
carrying amount should be reported as gain or loss in
the income statement.

LO 1

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Dilutive Securities

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

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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)

LO 1

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1,000
200
800
2,000

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Learning Objective 2
Contrast the Accounting for Stock
Warrants and for Stock Warrants Issued
with Other Securities

LO 2

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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.

LO 2

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Stock Warrants

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

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Stock Warrants

Proportional Method
Determine:

1. value of the bonds without the warrants, and
2. value of the warrants.
The proportional method allocates the proceeds using
the proportion of the two amounts, based on fair values.

LO 2

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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

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Proportional Method

Allocation of Proceeds between Bonds and Warrants

LO 2

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Proportional Method

Allocation of Proceeds between Bonds and Warrants
The bonds sell at a discount. AT&T records the sale as follows.
Cash
Discount on Bonds Payable
Bonds Payable

9,705,882
294,118

10,000,000

In addition, AT&T sells warrants that it credits to paid-in
capital. It makes the following entry.
Cash
Paid-in Capital—Stock Warrants
LO 2

294,118

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294,118
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Proportional Method

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

50,000
494,118

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

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