Chapter 16: 1Q (page 873)
What is meant by a dilutive security?
Dilutive securities are financial instruments-typically warrants, stock options, convertible bonds- which increase the quantity of common shares if exercised. This then "dilutes" the earnings per share.
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CA16-3 WRITING (Stock Warrants—Various Types) For various reasons a corporation may issue warrants to purchase shares of its common stock at specified prices that, depending on the circumstances, may be less than, equal to, or greater than the current market price. For example, warrants may be issued:
1. To existing stockholders on a pro rata basis.
2. To certain key employees under an incentive stock-option plan.
3. To purchasers of the corporation’s bonds.
Instructions
For each of the three examples of how stock warrants are used:
(a) Explain why they are used.
(b) Discuss the significance of the price (or prices) at which the warrants are issued (or granted) in relation to (1) the current market price of the company’s stock, and (2) the length of time over which they can be exercised.
(c) Describe the information that should be disclosed in financial statements, or notes thereto, that are prepared when stock warrants are outstanding in the hands of the three groups listed above
Question: Petrenko Corporation has outstanding 2,000 \(1,000 bonds, each convertible into 50 shares of \)10 par value ordinary shares. The bonds are converted on December 31, 2017. The bonds payable has a carrying value of \(1,950,000 and conversion equity of \)20,000. Record the conversion using the book value method.
IFRS16-3 Norman Co., a fast-growing golf equipment company, uses GAAP. It is considering the issuance of convertible bonds. The bonds mature in 10 years, have a face value of \(400,000, and pay interest annually at a rate of 4%. The equity component of the bond issue has a fair value of \)35,000. Greg Shark is curious as to the difference in accounting for these bonds if the company were to use IFRS.
(a) Prepare the entry to record issuance of the bonds at par under GAAP.
(b) Repeat the requirement for part (a), assuming application of IFRS to the bond issuance.
(c) Which approach provides the better accounting? Explain.
Explain the treasury-stock method as it applies to options and warrants in computing dilutive earnings per share data.
(Issuance, Exercise, and Termination of Stock Options) On January 1, 2018, Titania Inc. granted stock options to officers and key employees for the purchase of 20,000 shares of the company’s \(10 par common stock at \)25 per share. The options were exercisable within a 5-year period beginning January 1, 2020, by grantees still in the employ of the company, and expiring December 31, 2024. The service period for this award is 2 years. Assume that the fair value option-pricing model determines total compensation expense to be \(350,000.On April 1, 2019, 2,000 options were terminated when the employees resigned from the company. The market price of the common stock was \)35 per share on this date.On March 31, 2020, 12,000 options were exercised when the market price of the common stock was $40 per share.
Instructions
Prepare journal entries to record issuance of the stock options, termination of the stock options, exercise of the stock options, and charges to compensation expense, for the years ended December 31, 2018, 2019, and 2020.
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