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Questions and Answers
What determines the earnings per share reported on the income statement?
What determines the earnings per share reported on the income statement?
When calculating earnings available to common stockholders, which of the following is subtracted from net income?
When calculating earnings available to common stockholders, which of the following is subtracted from net income?
What method allocates proceeds based on the proportion of two fair values?
What method allocates proceeds based on the proportion of two fair values?
Which statement is true regarding stock rights issued to existing stockholders?
Which statement is true regarding stock rights issued to existing stockholders?
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In calculating earnings per share for a company with a complex capital structure, which element is considered potentially dilutive?
In calculating earnings per share for a company with a complex capital structure, which element is considered potentially dilutive?
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Which component of income must have earnings per share disclosed separately in the income statement?
Which component of income must have earnings per share disclosed separately in the income statement?
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What does the weighted-average number of shares outstanding represent?
What does the weighted-average number of shares outstanding represent?
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Which of the following statements is false regarding preferred stock dividends?
Which of the following statements is false regarding preferred stock dividends?
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What method do companies use when converting convertible debt to equity?
What method do companies use when converting convertible debt to equity?
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What is a key characteristic of detachable warrants?
What is a key characteristic of detachable warrants?
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Which of the following accurately describes synthetic convertible debt?
Which of the following accurately describes synthetic convertible debt?
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What accounting treatment applies to nondetachable warrants?
What accounting treatment applies to nondetachable warrants?
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Which statement about convertible preferred stock is true?
Which statement about convertible preferred stock is true?
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When companies issue stock dividends, what do they need to do?
When companies issue stock dividends, what do they need to do?
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What right do stockholders gain from a stock right?
What right do stockholders gain from a stock right?
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What is one benefit companies gain by issuing warrants?
What is one benefit companies gain by issuing warrants?
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Study Notes
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.
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Description
This quiz covers key concepts of convertible debt and stock warrants. It explores the book value method for bond conversion, the benefits of stock warrants for investors, and the implications of issuing warrants with other securities. Test your knowledge on these financial instruments and their impact on corporate finance.
