AK0035

AKUNTANSI KEUANGAN
MENENGAH II
CHAPTER 1
DILUTIVE SECURITIES AND
EARNING PER SHARE

ACCOUNTING PROGRAM
 PREVIEW OF CHAPTER 1

Intermediate Accounting
IFRS 2nd Edition
Kieso, Weygandt, and Warfield
Objectives
After studying this chapter, you should be able to:
1. Describe the accounting for the issuance,
conversion, and retirement of convertible
securities.
2. Explain the accounting for convertible preference
shares.
3. Contrast the accounting for share warrants and for
share warrants issued with other securities.
4. Describe the accounting for share compensation
plans.
Contents
Dilutive Securities and Compensations Plans
Convertible Debt
Convertible Preference Shares
Share Warrant
Accounting for Share Compensation
EPS—Complex Capital Structure
DILUTIVE SECURITIES AND COMPENSATION PLANS

Debt and Equity

Should companies report these instruments as a liability
or equity?

Convertible Preference
Share Options
Securities Shares

LO 1
Convertible Debt

Bonds which can be changed into other corporate

securities are called convertible bonds.

Benefit of a Bond (guaranteed interest and principal)

+
Privilege of Exchanging it for Shares (at the holder’s option)

LO 1
Convertible Debt

Two main reasons corporations issue convertibles:

To raise equity capital without giving up more

ownership control than necessary.

Obtain debt financing at cheaper rates.

LO 1
 Convertible Debt

Accounting for Convertible Debt

Convertible debt is accounted for as a compound instrument.
Companies use the “with-and-without” method to value
compound instruments.

ILLUSTRATION 4-1
Convertible Debt
Components

LO 1
Convertible Debt

Accounting for Convertible Debt

Implementation of the with-and-without approach:
1. First, determine total fair value of convertible debt with both
the liability and equity component.

2. Second, determine liability component by computing net

present value of all contractual future cash flows discounted
at the market rate of interest.

3. Finally, subtract liability component estimated in second

step from fair value of convertible debt (issue proceeds) to
arrive at the equity component.

LO 1
Convertible Debt

Accounting at Time of Issuance

Illustration: Roche Group (CHE) issues 2,000 convertible
bonds at the beginning of 2015. The bonds have a four-year
term with a stated rate of interest of 6 percent and are issued at
par with a face value of €1,000 per bond (the total proceeds
received from issuance of the bonds are €2,000,000). Interest is
payable annually at December 31. Each bond is convertible into
250 ordinary shares with a par value of €1. The market rate of
interest on similar non-convertible debt is 9 percent.

LO 1
 Convertible Debt ILLUSTRATION 4-2
Time Diagram for
Convertible Bond

Accounting at
Time of
Issuance
ILLUSTRATION 4-3
Fair Value of Liability
Component of Convertible Bond

ILLUSTRATION 4-4
Equity Component of
Convertible Bond

LO 1
 Convertible Debt

Accounting at Time of Issuance ILLUSTRATION 4-3

Fair Value of Liability
Component of Convertible Bond

ILLUSTRATION 4-4
Equity Component of
Convertible Bond

Cash 2,000,000
Journal
Entry Bonds Payable 1,805,606
Share Premium—Conversion Equity 194,394

LO 1
Convertible Debt

Settlement of Convertible Bonds

Repurchase at Maturity. If the bonds are not converted at
maturity, Roche makes the following entry to pay off the
convertible debtholders.

Bonds Payable 2,000,000

Cash 2,000,000

NOTE: The amount originally allocated to equity of €194,384 either remains

in the Share Premium—Conversion Equity account or is transferred to the
Share Premium—Ordinary account.

LO 1
Convertible Debt

Settlement of Convertible Bonds

Conversion of Bonds at Maturity. If the bonds are converted at
maturity, Roche makes the following entry.

Share Premium—Conversion Equity 194,394

Bonds Payable 2,000,000
Share Capital—Ordinary 500,000
Share Premium—Ordinary 1,694,394

NOTE: The amount originally allocated to equity of €194,384 is transferred to

the Share Premium—Ordinary account.

LO 1
Convertible Debt

Settlement of Convertible Bonds

ILLUSTRATION 4-5
Conversion of Bonds before Maturity. Convertible Bond
Amortization Schedule

LO 1
Convertible Debt

Settlement of Convertible Bonds

Conversion of Bonds before Maturity. Assuming that Roche
converts its bonds into ordinary shares on December 31, 2016.

Share Premium—Conversion Equity 194,374

Bonds Payable 1,894,464
Share Capital—Ordinary 500,000
Share Premium—Ordinary 1,588,838

NOTE: The amount originally allocated to equity (€194,374) is transferred to

the Share Premium—Ordinary account.

LO 1
Convertible Debt

Induced Conversion
Issuer wishes to encourage prompt conversion.

Issuer offers additional consideration, called a

“sweetener,” to induce conversion.

Sweetener is an expense of the period.

LO 1
Convertible Debt

Induced Conversion
Illustration: Helloid, Inc. has outstanding $1,000,000 par value
convertible debentures convertible into 100,000 ordinary shares
($1 par value). When issued, Helloid recorded Share Premium—
Conversions Equity of $15,000. Helloid wishes to reduce its
annual interest cost. To do so, Helloid agrees to pay the holders
of its convertible debentures an additional $80,000 if they will
convert. Assuming conversion occurs, Helloid makes the
following entry.

LO 1
Convertible Debt

Induced Conversion
Illustration: Helloid makes the following entry.

Conversion Expense 80,000

Share Premium—Conversion Equity 15,000
Bonds Payable 1,000,000
Share Capital—Ordinary 100,000
Share Premium—Ordinary 915,000
Cash 80,000

LO 1
Convertible Preference Shares

Convertible preference shares include an option for the

holder to convert preference shares into a fixed number of
ordinary shares.
Convertible preference shares are reported as part of
equity.

When preference shares are converted or repurchased,

there is no gain or loss recognized.

LO 2
Convertible Preference Shares

Illustration: Morse Company issues 1,000 convertible

preference shares that have a par value of €1 per share. The
shares were issued at a price of €200 per share. The journal
entry to record this transaction is as follows.

Cash (1,000 x €200) 200,000

Share Capital—Preference (1,000 x €1) 1,000
Share Premium—Conversion Equity 199,000

LO 2
Convertible Preference Shares

Illustration: If each share is subsequently converted into 25

each ordinary shares (€2 par value) that have a fair value of
€410,000, the journal entry to record the conversion is as
follows.

Share Capital—Preference 1,000

Share Premium—Conversion Equity 199,000
Share Capital—Ordinary (1,000 x 25 x €2) 50,000
Share Premium—Ordinary 150,000

LO 2
Convertible Preference Shares

Illustration: If the convertible preference shares are

repurchased at their fair value instead of converted, Morse
makes the following entry.

Share Capital—Preference 1,000

Share Premium—Conversion Equity 199,000
Retained Earnings 210,000
Cash 410,000

Any excess paid above the book value of the convertible preference
shares is often debited to Retained Earnings.

LO 2
Share Warrant

Warrants are certificates entitling the holder to acquire

shares at a certain price within a stated period.

Normally arises under three situations:

1. To make the security more attractive.

2. Existing shareholders have a preemptive right to

purchase ordinary shares.

3. To executives and employees as a form of

compensation.

LO 3
Share Warrant

Share Warrants Issued with Other Securities

Warrants issued with other securities are basically long-term
options to buy ordinary shares at a fixed price.
Generally, the life of warrants is five years, occasionally 10
years.

Company should use the with-and-without method to

allocate the proceeds between the two components.

LO 3
Share Warrant

Illustration: At one time, Siemens AG (DEU) issued bonds with

detachable five-year warrants. Assume that the five-year warrants
provide the option to buy one ordinary share (par value €5) at €25.
At the time, an ordinary share of Siemens was selling for
approximately €30. These warrants enabled Siemens to price its
bond offering (with a €10,000,000 face value) at par with an 8¾
percent yield (quite a bit lower than prevailing rates at that time).
In this example, Siemens was able to sell the bonds plus the
warrants for €10,200,000. To account for the proceeds from this
sale, Siemens uses the with-and-without method. Using this
approach, Siemens determines the present value of the future
cash flows related to the bonds, which is €9,707,852.
LO 3
Share Warrant

Illustration: Using this approach, Siemens determines the present

value of the future cash flows related to the bonds, which is
€9,707,852.
The bonds sell at a discount. Siemens records the sale as follows.

Cash 9,705,852
Bonds Payable 9,705,852

In addition, Siemens sells warrants and make the following entry.

Cash 492,148
Share Premium-Share Warrants 492,148

LO 3
Share Warrant

Illustration: Assuming investors exercise all 10,000 warrants (one

warrant per one ordinary share), Siemens makes the following
entry.

Cash (10,000 x €25) 250,000

Share Premium—Share Warrants 492,148
Share Capital—Ordinary (10,000 x €5) 50,000
Share Premium—Ordinary 692,148

LO 3
Share Warrant

Rights to Subscribe to Additional Shares

Share Rights - existing stockholders have the right
(preemptive privilege) to purchase newly issued shares in
proportion to their holdings.
Price is normally less than current market value.

Companies make only a memorandum entry.

LO 3
Share Warrant

Share Compensation Plans

Share Option - gives key employees option to purchase
ordinary shares at a given price over extended period of time.
Effective compensation programs are ones that:
1. Base compensation on performance.
2. Motivate employees.
3. Help retain executives and recruit new talent.
4. Maximize employee’s after-tax benefit and minimize
employer’s after-tax cost.
5. Use performance criteria over which employee has control.
LO 3
Accounting for Share Compensation

Share Option Plans

Two main accounting issues:

1. How to determine compensation expense.

2. Over what periods to allocate compensation expense.

LO 4
Accounting for Share Compensation

Determining Expense
Companies compute total compensation expense
based on the fair value of the options expected to
vest on the date they grant the options to the
employee(s) (i.e., the grant date).

Allocating Compensation Expense

Recognize compensation expense in the periods in
which employees perform the service—the service
period.

LO 4
Accounting for Share Compensation

Illustration: On November 1, 2014, the shareholders of Chen

Company approve a plan that grants the company’s five
executives options to purchase 2,000 shares each of the
company’s ¥100 par value ordinary shares. The company grants
the options on January 1, 2015. The executives may exercise the
options at any time within the next 10 years. The option price per
share is ¥6,000, and the market price of the shares at the date of
grant is ¥7,000 per share. Under the fair value method, the
company computes total compensation expense by applying an
acceptable fair value option-pricing model (such as the Black-
Scholes option-pricing model). To keep this illustration simple, we
assume that the fair value option-pricing model determines Chen’s
total compensation expense to be ¥22,000,000.
LO 4
Accounting for Share Compensation

Basic Entries: Assume that the expected period of benefit is two

years, starting with the grant date. Chen would record the
transactions related to this option contract as follows.

Dec. 31, 2015

Compensation Expense 11,000,000 *
Share Premium—Share Options 11,000,000

Dec. 31, 2016

Compensation Expense 11,000,000
Share Premium—Share Options 11,000,000

* (¥22,000,000 ÷ 2)

LO 4
Accounting for Share Compensation

Employee Stock-Purchase Plans (ESPPs)

Generally permit all employees to purchase shares at a
discounted price for a short period of time.

Considered compensatory and should be recorded as

expense over the service period.

LO 4
Accounting for Share Compensation

Illustration: Masthead Company offers all its 1,000 employees the

opportunity to participate in an employee share-purchase plan.
Under the terms of the plan, the employees are entitled to purchase
100 ordinary shares (par value £1 per share) at a 20 percent
discount. The purchase price must be paid immediately upon
acceptance of the offer. In total, 800 employees accept the offer,
and each employee purchases on average 80 shares. That is, the
employees purchase a total of 64,000 shares. The weighted-
average market price of the shares at the purchase date is £30 per
share, and the weighted-average purchase price is £24 per share.

LO 4
Accounting for Share Compensation

Illustration: The entry to record this transaction is as follows.

Cash (64,000 x £24) 1,536,000

Compensation Expense [64,000 x (£30 - £24)] 384,000
Share Capital—Ordinary (64,000 x £1) 64,000
Share Premium—Ordinary 1,856,000

The IASB indicates that there is no reason to treat broad-based

employee share plans differently from other employee share plans.

LO 4
EPS—Complex Capital Structure

Illustration: Mayfield Corporation has net income of £210,000 for

the year and a weighted-average number of ordinary shares
outstanding during the period of 100,000 shares. The basic earnings
per share is therefore £2.10 (£210,000 4 100,000). The company
has two convertible debenture bond issues outstanding. One is a 6
percent issue sold at 100 (total £1,000,000) in a prior year and
convertible into 20,000 ordinary shares. Interest expense for the
current year related to the liability component of this convertible
bond is £62,000. The other is a 7 percent issue sold at 100 (total
£1,000,000) on April 1 of the current year and convertible into
32,000 ordinary shares. Interest expense for the current year related
to the liability component of this convertible bond is £80,000. The
tax rate is 40 percent.
LO 7
EPS—Complex Capital Structure

Basic EPS

Net income = £210,000

= £2.10
Weighted-average shares = 100,000

LO 7
 EPS—Complex Capital Structure

When calculating Diluted EPS, begin with Basis EPS.

Basic 6% Debentures 7% Debentures
EPS

£210,000 + £62,000 x (1 - .40) +£80,000 x (1 - .40) x 9/12

=
100,000 + 20,000 + 24,000

Basic EPS
= 2.10 Effect on EPS Effect on EPS = 1.50
= 1.86
Diluted EPS = £1.97

LO 7
EPS—Complex Capital Structure

Diluted EPS – Convertible Securities

Other Factors
The conversion rate on a dilutive security may change during the
period in which the security is outstanding. In this situation, the
company uses the most dilutive conversion rate available.

For Convertible Preference Shares the company does not

subtract preference dividends from net income in computing the
numerator. Why not? Because for purposes of computing EPS, it
assumes conversion of the convertible preference shares to
outstanding ordinary shares.

LO 7
EPS—Complex Capital Structure

Illustration (EPS with Preference Shares): On January 1,

2015, Lund Company issued €1,000,000 of 6% convertible
preference shares were issued. Each €100 preference share
is convertible into 5 ordinary shares of Lund. Lund’s net
income in 2015 was €240,000, and its tax rate was 40%. The
company had 100,000 ordinary shares outstanding
throughout 2015.

Instructions: Compute diluted earnings per share for 2015.

LO 7
 EPS—Complex Capital Structure

Illustration: Compute diluted EPS for 2015.

When calculating Diluted EPS, begin with Basis EPS.

Basic EPS

Net income £240,000 – Pfd. Div. £60,000 *

= £1.80
Weighted-average shares = 100,000

* £1,000,000 x 6% = £60,000 dividend

LO 7
 EPS—Complex Capital Structure

Illustration: Compute diluted EPS for 2015.

When calculating Diluted EPS, begin with Basis EPS.

Diluted EPS

£240,000 – £60,000 + £60,000 £240,000

= =
100,000 + 50,000* 150,000

£1.60
Effect on
Basic EPS = 1.80
EPS = 1.20 * (10,000 x 5)

LO 7
 EPS—Complex Capital Structure

Illustration (variation): Assume each share of preferred is

convertible into 3 shares of common stock.

Diluted EPS Basic = Diluted EPS

£240,000 – £60,000 + £60,000 £180,000

= =
100,000 + 30,000* 100,000
Antidilutive
£1.80
Basic EPS = 1.80 Effect on
* (10,000 x 3)
EPS = 2.00
LO 7
References
Sumber:
Intermediate Accounting
IFRS Edition
Kieso, Weygant, Warfield
By
WILEY
Questions & Answers