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Dilutive Securities
Securities that are not common stock in form but that enable their holders to obtain common stock upon exercise or conversion.
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What are the primary accounting concerns about Dilutive Securities?
- Accounting for them at the:
- Date of Issuance
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- Date of Exercise or Conversion
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Convertible Bonds
Bonds that may be converted into a specified number of common shares at the bondholders' discretion
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Convertible Preferred Stock
Preferred Stock that may be converted into a specified number of common shares at the PS holders' discretion
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Stock Warrants
Certificates entitling the holder to purchase shares of stock at a specified price within a stated period
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What are the reasons a company would issue Stock Warrants? (3)
1. As an "EQUITY KICKER" to make another security (e.g. debt) more attractive
2. As a PRE-EMPTIVE RIGHT TO PURCHASE additional shares to existing SHs when new stock is issued
3. As COMPENSATION to executives and employees.
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Detachable Stock Warrants
Stock warrants attached to debt that may be separately traded from the debt
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How do warrants differ from convertible securities? (2)
1. Warrants require the holder to pay a certain amount of money to acqure the stock.
2. Warrants often have separate existence. For example, warrants may be attached to debt; however, when the warrants are exercised, the debt remains. Thus, warrants are often traded in their own market.
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Nondetachable stock warrants
warrants that occur when debt is issued with warrants to acquire stock, but the warrants cannot be sold separately from the debt
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Who would companies issue stock warrants to and why would they do it?
They are issued to existing SHs when a company's directors decide to issue new shares of stock. This is done to allow each SH the right to maintain his/her current ownership percentage of the company.
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Can stock warrants be sold in the open market like any other security? If so when is this possible?
Yes, they can, but only during the exercise period.
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How do you record the issuance of stock rights? Also how do you record them if/when they are unexercised?
No entry is made
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Upon exercise of the stock rights, the transactions is recorded _________________________________.
as a straight issuance of stock for cash
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Stock compensation plans (aka stock option plans)
A common form of warrants that arise when a company issues stock options to employees as a form of compensation
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Compensatory Stock Options Plan
A stock options plan designed to compensate a few key employees of the company
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Noncompensatory Stock Options Plan
- employee stock purchase plans (ESPPs)
- A stock options plan designed primarily to raise equity capital and/or entice widespread ownership of the company by its' employees.
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Stock Appreciation Rights
A method of compensating key employees for stock value appreciation whereby the employees receive cash, stock, or a combination of both for the excess of the market price of the stock on the exercise date over a pre-established price.
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Restricted stock plans
A type of plan that provides key executive employees stock as compensation, but the stock cannot be sold or transferred by the employee until vesting occurs.
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How are restricted stock plans and employee stock plans?
In restricted stock plans actual stock is awarded to the employees rather than options to buy the stock.
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When does a Simple Capital Structure exist?
It exists when there AREN'T any potentially dilutive securities that if converted or exercised could dilute (weaken or lessen) earnings per common share or increase a loss per share.
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When does a Complex Capital Structure exist?
It exists when there ARE potentially dilutive securities that if converted or exercised could dilute (weaken or lessen) earnings per common share or increase a loss per share.
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How is EPS computed in a SIMPLE CAPITAL STRUCTURE?
- Net I - Preferred dividends /Weighted Avg. #com.shs OS in yr
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Basic EPS
EPS for a simple capital structure
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Diluted EPS
EPS computed assuming the potentially dilutive securities have been exercised or converted
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Steps in computing Diluted EPS
1. Compoute basic EPS as described.
2. For each potentially dilutive security, compute its incremental effect on EPS as follows:
- numerator adjustment/
- denominator adjustment
3. Rank the incremental effect of the potentially dilutive securities from smallest (most dilutive) to highest (least dilutive).
- 4. Starting with the most dilutive security from the ranking in step 3, add the numerator and denominator adjustments to the basic EPS numerator and denominator and recompute EPS.
- If EPS goes down, repeat this for the next most dilutive security. Continue this process until the inclusion of a potentially dilutive security causes EPS to increase or until all potentially dilutive securities are included in EPS.
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If a company has a complex structure with potentially dilutive securities that are ANTI-DILUTIVE, how would they report EPS?
They would only report Basic EPS
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If a company has a complex structure with potentially dilutive securities that are DILUTIVE or if last years' securities were dilutive, how would they report EPS?
They would report Diluted EPS and Basic EPS in dual presentation comparing the years presented.
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