_____________________________________________________ Strategic Accounting _____________________________________________________ Exercise 1 Restricted stock award; Kmart Kmart Holding Co. included the following disclosure note in a recent annual report: RESTRICTED STOCK (in part) ……., we issued 111,540 shares of restricted stock at market prices ranging from $23.00 to $29.65. … The restricted stock generally vests over three years, during which time we will recognize total compensation expense of approximately $3 million. Required: 1. Based on the information provided in the disclosure note, determine the weighted average market price of the restricted stock issued. 2. How much compensation expense did Kmart report for the year following the year in which the restricted stock was issued? Exercise 2 Steve Job’s restricted stock; tax effects Apple Inc. provides its executives compensation under a variety of share-based compensation plans including restricted stock awards. The following disclosure note from Apple’s 2007 annual report describes the plan created for the company’s chief executive officer, Steve Jobs: CEO Restricted Stock Award On March 19, 2003, the Company’s Board of Directors granted 10 million shares of restricted stock to the Company’s CEO that vested on March 19, 2006. The amount of the restricted stock award expensed by the Company was based on the closing market price of the Company’s common stock on the date of grant and was amortized ratably on a straight-line basis over the three-year requisite service period. Upon vesting during 2006, the 10 million shares of restricted stock had a fair value of $646.6 million and had grant-date fair value of $7.48 per share. The restricted stock award was net-share settled such that the Company withheld shares with value equivalent to the CEO’s minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. The total shares withheld of 4.6 million were based on the value of the restricted stock award on the vesting date as determined by the Company’s closing stock price of $64.66. The remaining shares net of those withheld were delivered to the Company’s CEO. Total payments for the CEO’s tax obligations to the taxing authorities were $296 million in 2006 and are reflected as a financing activity within the Consolidated Statements of Cash Flows. The net-share settlement had the effect of share repurchases by the Company as it reduced and retired the number of shares outstanding and did not represent an expense to the Company. The Company’s CEO has no remaining shares of restricted stock. Required: 1. How much compensation did Apple record for its CEO related to the restricted stock in its fiscal year ended September 24, 2005? 2. What was the CEO’s combined income tax and employment tax rate that Apple used to determine the shares to be withheld at vesting? 3. From the information provided in the disclosure note, recreate the journal entries Apple used to record compensation expense and its related tax effects on September 24, 2005, the end of the 2005 fiscal year. 4. From the information provided in the disclosure note, recreate the journal entries Apple used to record the vesting of the restricted stock and its related tax effects on March 16, 2006, assuming the remaining compensation expense already has been recorded. Exercise 3 Share-based plans; Cisco Systems Cisco Systems offers its employees a variety of share-based compensation plans including stock options, stock appreciation rights, and restricted stock. The following is an excerpt from a disclosure note from Cisco’s 2007 financial statements: Note 10 Employee Benefit Plans (in part) …., the Company adopted SFAS 123(R), which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors including employee stock options and employee stock purchase rights, based on estimated fair values. Employee share-based compensation expense under SFAS 123(R) was as follows (in millions): Years Ended Total employee share-based compensation expense July 28 2007 $931 July 29 2006 $1,050 July 30 2005 $ — Required: 1. Cisco’s share-based compensation includes stock options, stock appreciation rights, restricted stock awards, and performance-based awards. What is the general financial reporting objective when recording compensation expense for these forms of compensation? 2. Cisco reported share-based expense of $931 million in 2007. Without referring to specific numbers and ignoring other forms of share-based compensation, describe how this amount reflects the value of stock options. Exercise 4 EPS; AAON, Inc. “I guess I’ll win that bet!” you announced to no one in particular. “What bet?” Renee asked. Renee Patey was close enough to overhear you. “When I bought my AAON stock last year Randy insisted it was a mistake, that they were going downhill. I bet him a Coke he was wrong. This press release says earnings are up 11%,” you bragged. Renee was looking over your shoulder now at the article you were pointing at: TULSA, OK -- (MARKET WIRE) -- 11/07/07 -- AAON, Inc. (NASDAQ: AAON) today announced its operating results for the third quarter and ninemonth period ended September 30, 2007. In the quarter, net sales were a record high of $70.9 million, up 11% from $64.2 million during the corresponding period in 2006, and net income equaled the third quarter record level of $5.4 million or $0.28 per share set in the same period a year ago. Per share earnings are on a diluted basis and reflect the threefor-two stock split on August 21, 2007. It was also announced that the Board of Directors has authorized the Company to repurchase up to 10% (approximately 1.8 million shares) of its outstanding common stock. Excerpt from: “AAON Reports Third Quarter Results and Announces New Stock Buyback Plan,” November 11, 2007. “Twenty-eight cents a share, huh?” Renee asked. “How many shares do you have? When do you get the check?” Required: 1. Renee’s questions imply that she thinks you will get cash dividends of 28 cents a share. What does earning per share really tell you? 2. The press release says, “Per share earnings are on a diluted basis and reflect the three-for-two stock split on August 21, 2007.” What does that mean? 3. The press release indicates that AAON may repurchase up to $1.8 million of its stock. Would that reduction in shares be taken into account when EPS is calculated? How? 4. You know from statements AAON mailed you that AAON grants stock options to company executives. If those options are exercised, you know the resulting increase in shares might reduce earnings per share. Is that possibility taken into account when EPS is calculated? Explain. Exercise 5 Reporting EPS; discontinued operations; Alberto-Culver Company The Alberto-Culver Company develops, manufactures, distributes and markets branded beauty care products as well as branded food and household products in the United States and more than 100 other countries.. The following is an excerpt from the comparative income statements (beginning with earnings from continuing operations) from Alberto-Culver’s 2007 annual report ($ in thousands): Earnings from continuing operations Earnings (loss) from discontinued operations, net of income taxes Net earnings 2007 $81,227 2006 79,515 2005 69,839 (2,963 ) 125,806 141,062 $78,264 205,321 210,901 An income statement sometimes includes items that require separate presentation (net of income taxes) within the statement. The two possible “separately reported items” are discontinued operations and extraordinary items. Alberto-Culver reports one of these items. A disclosure note from Alberto-Culver’s 2007 annual report is shown below: Weighted Average Shares Outstanding The following table provides information about basic and diluted weighted average shares outstanding: (shares in thousands) 2007 2006 Basic weighted average shares outstanding 95,896 92,426 Effect of dilutive securities: Assumed exercise of stock options 2,443 1,110 Assumed vesting of restricted stock 237 199 Effect of unrecognized stock-based compensation related to future services (218) (250) Diluted weighted average shares outstanding 98,358 93,485 2005 91,451 1,252 177 (42) 92,838 The computations of diluted weighted average shares outstanding exclude 1.4 million shares in fiscal year 2007, 2.1 million shares in fiscal year 2006 and 38,000 shares in fiscal year 2005 since the options were anti-dilutive. Required: 1. The disclosure note shows adjustments for “assumed exercise of stock options and assumed vesting of restricted stock.” What other adjustments might be needed? Explain why and how these adjustments are made to the weighted-average shares outstanding. 2. The disclosure note indicates that the effect of some of the stock options were not included because they would be antidilutive. What does that mean? Why not include antidilutive securities? 3. Based on the information provided, prepare the presentation of basic and diluted earnings per share for 2007, 2006, and 2005 that Alberto-Culver reports in its 2007 annual report. Exercise 6 Per share data; stock options; antidilutive securities; Sun Microsystems Sun Microsystems, Inc., headquartered in Santa Clara, California, is a prominent provider of products and services for network computing. Sun’s 2007 annual report included the following disclosure note: Computation of Net Income (Loss) per Common Share (in part) Basic net income (loss) per common share is computed using the weightedaverage number of common shares outstanding (adjusted for treasury stock and common stock subject to repurchase activity) during the period. Diluted net income (loss) per common share is computed using the weighted-average number of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares are anti-dilutive when their conversion would increase earnings per share. Dilutive common equivalent shares consist primarily of stock options and restricted stock awards (restricted stock and restricted stock units that are settled in stock). The following table sets forth the computation of basic and diluted income (loss) per share for each of the past three fiscal years (in millions, except per share amounts): Fiscal Years Ended June 30, 2007 2006 2005 Basic earnings per share Net income (loss) Basic weighted average shares outstanding Net Income (loss) per common share-basic Diluted earnings per share Net income (loss) Diluted weighted average shares outstanding Net Income (loss) per common share-diluted $ 473 3,531 $0.13 $ 473 3,606 $0.13 $ (864) 3,437 $(0.25) $(864) 3,437 $(0.25) $ (107) 3,368 $(0.03) $(107) 3,368 $(0.03) For fiscal 2007, we added 75 million common equivalent shares to our basicweighted-average shares outstanding to compute the diluted weightedaverage shares outstanding. We are required to include these dilutive shares in our calculations of net income per share for fiscal 2007 because we earned a profit. If we had earned a profit during fiscal 2006 and 2005, we would have added 25 million and 23 million common equivalent shares, respectively, to our basic weighted-average shares outstanding to compute the diluted weighted-average shares outstanding for these periods. Required: 1. The note indicates that “diluted net income (loss) per common share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period.” What are dilutive common equivalent shares? 2. The note indicates that “For fiscal 2007, we added 75 million common equivalent shares to our basic-weighted-average shares outstanding to compute the diluted weighted-average shares outstanding.” Does that mean Sun had a total of 75 million stock options and restricted shares outstanding? Explain. 3. Sun does not include potential common shares from employee stock options and restricted stock when calculating EPS for fiscal 2006 and 2005. Why not? If Sun had included dilutive potential common shares from employee stock options and restricted stock awards, what would have been the amount of diluted loss per share for fiscal 2006? Exercise 7 EPS; options; restricted stock; additional components for “proceeds” in treasury stock method Witter House is a calendar-year firm with 300 million common shares outstanding throughout 2009 and 2010. As part of its executive compensation plan, at January 1, 2008, the company had issued 30 million executive stock options permitting executives to buy 30 million shares of stock for $10 within the next eight years, but not prior to January 1, 2011. The fair value of the options was estimated on the grant date to be $3 per option. In 2009, Witter House began granting employees stock awards rather than stock options as part of its equity compensation plans and granted 15 million restricted common shares to senior executives at January 1, 2009. The shares vest four years later. The fair value of the stock was $12 per share on the grant date. The average price of the common shares was $12 and $15 during 2009 and 2010, respectively. The stock options qualify for tax purposes as an incentive plan. The restricted stock does not. The company’s net income was $150 million and $160 million in 2009 and 2010, respectively. Its income tax rate is 40%. Required: 1. Determine basic and diluted earnings per share for Witter House in 2009. 2. Determine basic and diluted earnings per share for Witter House in 2010.
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