Accounting for Convertible Debt and Stock Warrants

Accounting for Convertible Debt

• Companies use the book value method when converting bonds.
• When a debt holder converts debt to equity, the issuing company records no gain or loss on conversion.

Stock Warrants

• Stock warrants give investors the option to buy a company's stock at a set price within a specific timeframe.
• Warrants are often included as incentives to entice investors to purchase a company's bonds.
• Investors like warrants because they allow participation in a company's future growth or offer a way to sell the warrants in the market.
• Companies use warrants to reduce financing costs (lower interest rates).

Stock Warrants - Synthetic Convertible Debt Formula

• Debt + Nondetachable Stock Warrants = Synthetic Convertible Debt

Stock Warrants Issued with Other Securities

• When warrants are issued with bonds, they can be detachable or nondetachable.
• Detachable warrants can be sold separately from the bonds.
• Nondetachable warrants can only be sold with the bonds.
• Accounting for nondetachable warrants is similar to convertible bonds; the entire proceeds are recorded as bonds payable.

Dilutive Securities - Convertible Preferred Stock

• Convertible preferred stock allows holders to convert their preferred shares into a set number of common shares.
• Convertible preferred stock is part of stockholders' equity, not liabilities, unless mandatory redemption exists.
• Convertible bonds are liabilities; do not confuse them with convertible preferred stock.

Weighted-Average Shares Outstanding - Stock Dividends & Stock Splits

• When stock dividends or stock splits occur, companies must restate shares outstanding to compute the weighted-average number.
• Companies restate the shares issued from a stock dividend or split, but not the issuance or repurchase for cash.

Stock Warrants - Rights to Subscribe to Additional Shares

• Stock rights give existing stockholders the preemptive right to buy newly issued shares proportionally to their holdings.
• The price of stock rights is typically less than the current market price.
• Companies make a memorandum entry for stock rights; no journal entry is required when issuing rights.

Proportional Method for Detachable Stock Warrants

• Companies use the proportional method to allocate proceeds from the sale of detachable warrants.
• First, determine the fair values of the bonds and warrants separately.
• The allocation is then based on the proportion of each security's fair value.

Weighted-Average Number of Shares Outstanding

• Companies use the weighted-average number of shares outstanding for the period to compute per-share earnings.
• Shares are weighted by the length of time they were outstanding during the accounting period.

Basic Earnings Per Share - Income Statement Components

• When income statements have intermediate components (like discontinued operations), earnings per share must be disclosed for each component.
• Earnings per share should be reported for continuing operations, loss from discontinued operations (net of tax), and net income.

Basic Earnings Per Share - Income Statement Presentation of EPS

• Earnings per share shows the income earned by each common stock share.
• Companies only report earnings per share for common stock.

Basic Earnings Per Share - Preferred Stock Dividends

• To calculate earnings per share, subtract preferred stock dividends from net income.
• Current year preferred dividends are subtracted regardless of whether declared for cumulative preferred stock.

Basic Earnings Per Share - Simple/Complex Capital Structure

• Simple structure: only common stock, no potentially dilutive securities.
• Complex structure: includes securities that can potentially dilute common share earnings per share.
• "Dilutive" means the ability to drop earnings-per-share figures.

Stock Warrants - Allocation Methods

• Companies can use the proportional or incremental methods to allocate proceeds from stock warrant sales.