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FAIS 3 > Ch 16 > Flashcards

Ch 16 Flashcards

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0
Q

How are preferred stock and options classified?

A

As liabilities

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1
Q

Why should companies classify non redeemable shares as equity?

A

Because issuer has no obligation to pay dividends or repurchase
The stock

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2
Q

Dilutive securities

A

Upon exercise may dilute EPS

ex. Convertible securities, options, warrants

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3
Q

Convertible bonds

A

Can be changed into other corporate securities during some

specified period after issuance

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4
Q

Why do corporations issue convertibles? 2 reasons

A

1 raise equity capital

2 obtain debt financing at cheaper rates

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5
Q

The accounting for convertible debt involves reporting issues at 3 times

A

Time of:
1 issuance
2 conversion
3 retirement

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6
Q

IFRS requires that the issuer of convertible debt record the…

A

Liability and equity components separately

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7
Q

Method of recording convertible bonds at time of issuance

A

Follows method used to record straight debt issues, none
Of the proceeds are recorded as equity

Companies amortize to maturity date any discount or premium

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8
Q

Converting bonds into other securities, what method is used to record conversion?

A

Book value method

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9
Q

Book value method

A

Records the securities exchanged for the bond at the carrying
Amount (book value) of the bond

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10
Q

Induce conversion

A

Additional consideration such as cash or common stock, called
A “sweetener”

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11
Q

When do induced conversions occur?

A

When issuer wishes to encourage prompt conversion of its
Convertible debt to equity securities

To reduce interest costs or improve debt to equity ratio

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12
Q

Accounting treatment of induced conversions

A

Expensed in the current period

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13
Q

Retiring convertible debt, what must companies recognize?

A

Companies need to recognize gain or loss on retiring convertible
Debt

in same way they recognize gain or loss in retiring non convertible
Debt

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14
Q

Retirement of debt: reporting differences between cash acquisition price of debt and it’s carrying amount

A

Reported in current income as gain or loss

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15
Q

Convertible preferred stock

A

Includes option for holder to convert preferred shares into fixed
Number of common shares

When convertible preferred stock exercised, company does
Not recognize a gain or loss

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16
Q

Difference between classification of convertible preferred (where no mandatory redemption exists) and convertible bonds

A

Convertible preferred considered part of stockholders equity

Convertible bonds considered liability

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17
Q

What accounting method is used when convertible preferred stock is exercised?

A

Book value method

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18
Q

Warrants

A

Certificates entitling the holder to acquire shares of stock at
Certain price within stated period

Warrants when exercised have dilutive effect on EPS

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19
Q

Difference between convertible securities and stock warrants

A

Upon exercise of warrants holder has to pay certain amount

Of money to obtain shares

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20
Q

3 situations for issuance if warrants or options to buy additional shares

A

1 make security more attractive in deal

2 preemptive right to purchase common stock first

3 executive and employee compensation

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21
Q

Detachable stock warrant

A

Can be separated form stock and traded as separate security

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22
Q

Warrants issued with other securities

A

Long term options to buy common stock at fixed price

Generally life of warrants is 5 years or 10 years

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23
Q

A company should allocate the proceeds from the sale of debt with detachable stock warrants between…

A

The 2 securities

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24
2 methods of allocation between warrants issued with other securities
1 proportional method 2 incremental method
25
Proportional method
Allocates proceeds using proportion of 2 amounts based on fair Values
26
Incremental method
Used when fair value can't be determined Allocates known fair value to security and then allocates purchase Price when fair value is unknown
27
Inseparable feature (convertible security)
Choices are mutually exclusive Holder either converts the bond or redeems cash, but can't Do both
28
Detachable warrants
Involves 2 securities, 1 debt security remains outstanding until Maturity And the other a warrant to purchase common stock This justifies separate accounting treatment
29
Nondetachable warrants
Don't require allocation of proceeds btw/bonds and warrants Similar to convertible bonds, companies record entire proceeds From Nondetachable warrants as debt
30
Preemptive privilege AKA stock right
To purchase newly issued shares in proportion to their holdings
31
What does preemptive privilege/stock right do for existing shareholders?
Saves existing shareholders from suffering a dilution of voting rights without their consent May allow for purchase of stock below its fair value
32
Companies make only a memorandum entry when they...
Issue rights to existing stockholders
33
Stock option
Warrant which gives key employees the option to purchase | common stock at given price over extended period of time
34
Stock based compensation plans
Provide employee opportunity to receive stock if performance | Of company by whatever measure is satisfactory
35
Option expense is much smaller element of compensation relative to restricted stock. 2 major reasons
1 manipulation of accounting numbers by executives to achieve Higher share price to get compensated with options 2 GAAP results in companies recording higher expense when Stock options are granted
36
Grant date
Date you receive options
37
IFRS follows the same model as GAAP for recognizing...
Share based compensation
38
Intrinsic value method (granted stock options)
Measures compensation cost by excess of market price of stock Over its exercise price at grant date Intrinsic value method measures what holder would receive today If option was immediately exercised
39
Intrinsic value
Difference between market price of stock and exercise price | Of options at grant date
40
Fair value method (granted stock options)
Companies use acceptable option-pricing models to value the | Options at date of grant
41
GAAP requires companies recognize compensation cost using...
Fair value method
42
4 major factors of option pricing
1 volatility of underlying stock 2 expected life of options 3 risk-free rate during option life 4 expected dividends during option life
43
2 main accounting issues for stock option plans
1 how to determine compensation expense 2 over what periods to allocate compensation expense
44
Stock options fair value method
Companies compute total compensation expense based on FMV of options expected to vest on date they grant options to Employees
45
Service period AKA Vesting period
Time between grant date and vesting date Periods in which employees perform the service
46
To vest
To earn the rights to Employees award becomes vested at date that the employee's right to receive or retain shares or cash under award no longer Depends on remaining service to employer
47
Restricted stock plans
Transfer shares of stock to employees, subject to agreement that shares can't be sold, transferred or Pledged until vesting occurs
48
3 major advantages of restricted stock plans
1 restricted stock never becomes worthless 2 restricted stock results in less dilution to existing shareholders 3 restricted stock better aligns employee incentives with Companies incentives
49
Restricted stock results in less dilution to existing shareholders
Restricted stock awards usually 1/2 to 1/3 the size of stock options
50
Unearned compensation
Cost of services yet to be performed Not an asset
51
Employee stock-purchase plans (ESPPs)
Generally permit all employees to purchase stock at discounted Price for short period of time
52
What 3 conditions must be satisfied for employee stock purchase plans (ESPPs) to not be considered compensatory?
1 substantially all full time employees may participate on equitable Basis 2 discount from market is 5% or less 3 plan offers no substantive option feature
53
IFRS requires than any discount from market price on stock purchase plans be recorded as...
Compensation expense
54
4 requirements for disclosure of compensation plans
1 nature and terms of plans and how they affect Shareholders 2 effect on income statement of compensation cost 3 method of estimating FMV of goods or services received Or FMV of equity instruments granted 4 cash flow effects from share based payment plans
55
How did companies overstate earnings in the S&P 500 by 10 percent? How did companies resist overstating earnings?
Through use of the intrinsic value method (overstate) Accurately stated through use of fair value method
56
Earnings per share
Indicates income earned by each share of common stock
57
When is a corporations capital structure simple?
When it consists only of common stock or includes no Potential common stock that upon conversion Or exercise could dilute earnings per common share
58
When is a capital structure complex
When it includes securities that could have dilutive effect on EPS
59
Earnings per share for common stock holders (when preferred shares exist) equation
EPS = | net income - preferred dividends)/(weighted avg. # SH. Outstanding
60
If a company declares dividends on preferred stock and a net loss occurs, how does the company compute the loss?
The company adds the preferred dividend to the loss to | Compute the loss per share
61
If the preferred stock is cumulative and the company has net income but declares no dividend in the current year, it...
Subtracts an amount equal to the dividend that should have | Been declared in current year only
62
If preferred stock is cumulative and company reports a net loss, but declares no dividend in current year, it...
Adds an amount equal to the dividend to the net loss
63
Where should dividend in arrears be included in computations?
Dividend in arrears included in previous year's computations
64
Weighted average number of shares outstanding
Period shares are outstanding constitutes basis of per share Amounts reported Companies must weight shares by fraction of period they are Outstanding
65
In determining the restatement of weighted avg. of shares outstanding what is restated?
Stock dividends and stock splits when they occur
66
Issuance or purchase of stock changes the amount of... 2) Are the weighted average of shares restated?
Net assets 2) weighted avg. of shares aren't restated
67
Antidilutive securities
Securities that upon conversion or exercise increase EPS or reduce loss per share
68
Diluted EPS equation
Diluted EPS equation = (Net income - preferred dividends)/(weighted avg. # SH. Outstanding) - impact of convertibles - impact of options, warrants and other dilutive securities
69
If-converted method, how is it used?
How companies measure dilutive effects of potential conversion On EPS
70
If-converted method, for convertible bonds assumes 2 things
1 conversion of convertible securities at beginning of period Or time of issuance 2 elimination of related interest net of tax
71
The additional shares assumed issued...
Increase the denominator (the weighted avg. # of SH.)
72
The amount of interest expense, net if tax associated with potential common shares...
Increases the numerator (net income)
73
Treasury stock method
Used by companies to include options and warrants and their | Equivalents in EPS computations
74
What does the treasury stock method assume .
Options or warrants are exercised at beginning of year/issuance Date And company uses proceeds to purchase common stock for The treasury
75
If the exercise price of the option or warrant is lower than market price of stock...
Dilution occurs
76
If exercise price of an option or warrant is higher than the market price of the stock it...
Reduces number of common shares Its anti dilutive because leads to increase in EPS
77
Contingent shares
In business combinations the acquirer may promise to issue | Additional shares under certain conditions
78
2 conditions for contingent shares
1 passage of time condition Or 2 attainment of certain earnings or market price level
79
When computing diluted EPS, what should a company exclude?
Including any securities that are anti dilutive in the calculation
80
5 additional disclosures in note form that capital structures and dual presentation of EPS require
1 description of pertinent rights and privileges of securities outstanding 2 reconciliation of numerators and denominators of basic and Complex EPS 3 effect from preferred dividends on EPS 4 securities not included in current year that could dilute EPS in Future 5 effect of conversions subsequent to year end but before issuance

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