16-24
4. Describe the accounting for share
compensation plans.
5. Discuss the controversy involving share
compensation plans.
6. Compute earnings per share in a
simple capital structure.
7. Compute earnings per share in a
complex capital structure.
After studying this chapter, you should be able to:
LEARNING OBJECTIVES
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.
16-25
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
16-26
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
16-27
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
16-28
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
16-29
4. Describe the accounting for share
compensation plans.
5. Discuss the controversy involving share
compensation plans.
6. Compute earnings per share in a
simple capital structure.
7. Compute earnings per share in a
complex capital structure.
After studying this chapter, you should be able to:
LEARNING OBJECTIVES
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.
16-30
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
16-31
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
16-32
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.
€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
16-33
Illustration: Using this approach, Siemens determines the present value of the future cash flows related to the bonds, which is
€9,707,852.
Cash 9,705,852
Bonds Payable 9,705,852
LO 3
ILLUSTRATION 16-8 Equity Component of Security Issue
The bonds sell at a discount. Siemens records the sale as follows.
16-34
Illustration: Using this approach, Siemens determines the present value of the future cash flows related to the bonds, which is
€9,707,852.
LO 3
ILLUSTRATION 16-8 Equity Component of Security Issue
Cash 492,148
Share Premium-Share Warrants 492,148
In addition, Siemens sells warrants and make the following entry.
16-35
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
16-36
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
16-37
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.
Share Compensation Plans
LO 3
16-38
The Major Reporting Issue
IASB guidelines requires companies to recognize compensation cost using the fair-value method.
Under the fair-value method
, companies use acceptable option- pricing models to value the options at the date of grant.
LO 3
16-39
4. Describe the accounting for share
compensation plans.
5. Discuss the controversy involving share
compensation plans.
6. Compute earnings per share in a
simple capital structure.
7. Compute earnings per share in a
complex capital structure.
After studying this chapter, you should be able to:
LEARNING OBJECTIVES
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.
16-40
Two main accounting issues:
1. How to determine compensation expense.
2. Over what periods to allocate compensation expense.
Share Option Plans
LO 4
16-41
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 employees 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
16-42
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
16-43
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.
Compensation Expense 11,000,000
Share Premium Share Options
11,000,000 Dec. 31, 2015
¥22,000,000 ÷ 2
Compensation Expense 11,000,000
Share Premium Share Options
11,000,000 Dec. 31, 2016
LO 4
16-44
Exercise.
If Chen’s executives exercise 2,000 of the 10,000 options 20 percent of the options on June 1, 2018 three years
and five months after date of grant, the company records the following journal entry.
Cash
2,000 x ¥6,000
12,000,000 Share Premium
Share Options 4,400,000
Share Capital Ordinary
2,000 x ¥100
200,000 Share Premium
Ordinary 16,200,000
June 1, 2018
LO 4
16-45
Expiration.
If Chen’s executives fail to exercise the remaining share options before their expiration date, the company records
the following at the date of expiration.
Share Premium Share Options
17,600,000 Share Premium
Expired Share Options 17,600,000
Jan. 1, 2025
¥22,000,000 x 80
LO 4
16-46
Adjustment.
Once the total compensation is measured at the date of grant, can it be changed in future periods?
Depends on whether the adjustment is caused by a
service or
market condition .
LO 4
16-47
Restricted Shares
Restricted-share plans transfer shares to employees, subject
to an agreement that the shares cannot be sold, transferred, or pledged until vesting occurs.
Major Advantages:
1. Shares never becomes completely worthless.
2. Shares generally results in less dilution to existing shareholders.
3. Shares better aligns employee incentives with company incentives.
LO 4
16-48
Restricted Shares Example: On January 1, 2015, Ogden Company issues 1,000 restricted shares to its CEO, Christie DeGeorge.
Ogden’s shares have a fair value of 20 per share on January 1, 2015. Additional information is as follows.
Service period related to the restricted shares is five years.
Vesting occurs if DeGeorge stays with the company for a five- year period.
Par value of the stock is 1 per share.
Ogden makes the following entry on the grant date January 1, 2015.
LO 4
16-49
Unearned Compensation 20,000
Share Capital--Ordinary
1,000 x 1
1,000
Share Premium--Ordinary
1,000 x 19
19,000
Unearned Compensation represents the cost of services yet to be performed, which is not an asset. Reported in equity in the statement
of financial position, as a contra equity account
Restricted Shares Example: Ogden makes the following entry on
the grant date January 1, 2015.
LO 4
16-50
Compensation expense 4,000
Unearned compensation 4,000
Ogden records compensation expense of 4,000 for each of the next four years 2016, 2017, 2018, and 2019.
Restricted Shares Example: Record the journal entry at
December 31, 2015, Ogden records compensation expense.
LO 4
16-51
Share Capital--Ordinary 1,000
Share Premium--Ordinary 19,000
Compensation Expense
4,000 x 2
8,000 Unearned Compensation
12,000
Restricted Shares Exam: Assume that DeGeorge leaves on
February 3, 2017before any expense has been recorded during 2017. The entry to record this forfeiture is as follows
LO 4
16-52
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
16-53
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
16-54
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
16-55
Disclosure of Compensation Plans
Company with one or more share-based payment arrangements must disclose:
1. Nature and extent of share-based payment arrangements that existed during the period.
2. How the fair value of the goods and services received, or the fair value of the equity instruments granted during the period,
was determined.
3. Effect of share- based payment transactions on the company’s
net income loss during the period and on its financial position.
LO 4
16-56
4. Describe the accounting for share
compensation plans.
5. Discuss the controversy
