Matt Kacskos is a shareholder of Howat Corporation and has asked you, the firm's accountant, to explain why his employee stock options were not included in diluted EPS. In order to explain this situation, you must briefly explain what dilutive securities are, why they are included in the EPS calculation, and why some securities are antidilutive and therefore are not included in this calculation.
Instructions
(a) Write Kacskos a one-and-a-half page letter explaining why the warrants are not included in the calculation. Use the following data to help you explain this situation.
1. Howat Corporation earned $228,000 during the period, when it had an average of 100,000 common shares outstanding.
2. The common shares sold at an average market price of $25 per share during the period.
3. Also outstanding were 15,000 employee stock options that could be exercised by the holder to purchase one common share at $30 per option.
(b) The IASB proposed in its Exposure Draft issued in 2008 that the year-end price of the shares be used, rather than the average price for the year. Assuming that the year-end market price was $33 per share, would this change your answer in part (a)? Why or why not? (c) Now assume that the company in the past has made a practice of settling the stock options in cash. Consequently, the stock options have been reported as a liability at fair value, with changes in fair value reflected in net earnings. The 2008 Exposure Draft proposes that, if the options are reported at fair value through profit or loss, then these should not be adjusted for in the diluted EPS. Make arguments to support this new proposed treatment.
(d) Stock options (not just employee stock options) are used for various purposes by companies. Briefly explain the business reasons for companies issuing stock options.