Stockholders' Equity, Share-Based Compensation, and EPS
What this domain tests
This domain covers common and preferred stock, additional paid-in capital, retained earnings, treasury stock, dividends, stock splits, share-based payment, and basic and diluted EPS under ASC 718, ASC 260, and IAS 33.
Equity
Common stock and additional paid-in capital are recorded at par or stated value plus excess. Treasury stock under the cost method is debited at cost; reissuance above cost credits additional paid-in capital from treasury stock. Cash dividends reduce retained earnings when declared. Stock dividends and stock splits do not change total equity but are applied retroactively to EPS. Property dividends are measured at fair value. Preferred stock may be cumulative, participating, convertible, or callable; mandatorily redeemable preferred stock is classified as a liability.
Share-based compensation
Equity-classified awards are measured at grant-date fair value and recognized over the vesting period. Options are valued using an option-pricing model such as Black-Scholes or a lattice model. Restricted stock is measured at the fair value of the shares. Forfeitures are estimated or recognized when incurred under the entity's policy election. Liability-classified awards are remeasured each period.
EPS
Basic EPS equals net income minus preferred dividends divided by weighted-average common shares. Diluted EPS applies the if-converted method to convertible securities and the treasury stock method to options and warrants. Incremental shares equal options outstanding minus the shares that could be repurchased with exercise proceeds divided by the average market price. Potential shares are included only if dilutive, and multiple securities are ranked from most to least dilutive.
Worked example
Net income is $500,000; preferred dividends are $20,000; weighted-average common shares are 180,000; options for 20,000 shares have a $10 strike price; the average market price is $25. Basic EPS is $480,000 / 180,000 = $2.67. Treasury stock method proceeds are $200,000, repurchasing 8,000 shares; incremental shares are 12,000. Diluted shares are 192,000, and diluted EPS is $480,000 / 192,000 = $2.50.
Traps
Using ending shares instead of a weighted average; forgetting preferred dividends; including antidilutive securities; using the strike price instead of the average market price; failing to restate for stock splits; and remeasuring equity-classified awards at each reporting date.