
Concept explainers
EPS; options; restricted stock; additional components for “proceeds” in
• LO19–1, LO19–2, LO19–4, LO19–8, LO19–11
Witter House is a calendar-year firm with 300 million common shares outstanding throughout 2018 and 2019. As part of its executive compensation plan, at January 1, 2017, 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, 2020. The fair value of the options was estimated on the grant date to be $3 per option.
In 2018, 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, 2018. 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 2018 and 2019, 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 2018 and 2019, respectively. Its income tax rate is 40%.
Required:
1. Determine basic and diluted earnings per share for Witter House in 2018.
2. Determine basic and diluted earnings per share for Witter House in 2019.
(1)
Earnings per share (EPS): The amount of earnings made available to each common share is referred to as earnings per share. Dilutive securities like convertible bonds, convertible preferred stock, and stock options, reduce the EPS by increasing the common shares.
Use the following formula to determine EPS:

Explanation of Solution
Determine basic EPS of W House for the year 2018.
Determine diluted EPS of W House for the year 2018.
Step 1: Compute the total compensation cost of stock options to W House.
Step 2: Compute the compensation expense allocated each year.
Note: Refer to Equation (1) for the value and computation of compensation cost.
Step 3: Compute the value of exercisable options.
Step 4: Compute the hypothetical proceeds of options in 2018.
Note: Refer to Equations (3) and (2) for the value and computation of exercisable options and compensation expense.
Step 5: Compute the number of shares assumed to be reacquired.
Note: Refer to Equation (4) for the value and computation of hypothetical proceeds of options.
Step 6: Compute the total compensation cost of stock awards to W House.
Step 7: Compute the compensation expense allocated each year.
Note: Refer to Equation (6) for the value and computation of compensation cost.
Step 8: Compute the hypothetical proceeds of awards in 2018.
Note: There are no cash proceeds until the completion of the vesting years. Refer to Equation (7) for the value and computation of compensation expense for one year.
Step 9: Compute the number of shares assumed reacquired.
Note: Refer to Equation (8) for the value and computation of hypothetical proceeds of awards.
Step 10: Compute the total weighted average number of common shares.
Details | Number of Shares |
Weighted average number of shares held in 2018 | 300,000,000 |
Number of exercisable options granted as shares | 30,000,000 |
Number of shares assumed reacquired as treasury stock | (27,500,000) |
Number of exercisable awards granted as shares | 15,000,000 |
Number of shares assumed reacquired as treasury stock | (11,250,000) |
Total weighted average number of shares | 306,250,000 shares |
Table (1)
Note: Refer to Equation (5) for the value and computation of number of options assumed reacquired as treasury stock, and Equation (9) for number of awards assumed reacquired as treasury stock.
Step 11: Compute diluted EPS of W House for the year 2018.
Note: Refer to Table (1) for value and computation of weighted average number of common shares outstanding.
(2)

Explanation of Solution
Determine basic EPS of W House for the year 2019.
Determine diluted EPS of W House for the year 2019.
Step 1: Compute the hypothetical proceeds in 2019.
Note: Refer to Equation (3) for the value and computation of exercisable options value. Do not add any compensation expense because options could be exercised after December 31, 2019.
Step 2: Compute the number of shares assumed to be reacquired.
Note: Refer to Equation (10) for the value and computation of hypothetical proceeds of options.
Step 3: Compute the hypothetical proceeds of awards in 2019.
Note: Since the vesting period is 4 years, there are no cash proceeds. Refer to Equation (7) for the value and computation of compensation expense for one year.
Step 4: Compute excess tax benefit per share.
Step 5: Compute the number of shares assumed to be reacquired.
Note: Refer to Equations (12) and (13) for the value and computation of hypothetical proceeds and excess tax benefit.
Step 6: Compute the total weighted average number of common shares.
Details | Number of Shares |
Weighted average number of shares held in 2016 | 300,000,000 |
Number of exercisable options granted as shares | 30,000,000 |
Number of shares assumed reacquired as treasury stock | (20,000,000) |
Number of exercisable awards granted as shares | 15,000,000 |
Number of shares assumed reacquired as treasury stock | (7,200,000) |
Total weighted average number of shares | 317,800,000 shares |
Table (2)
Note: Refer to Equation (11) for the values and computation of number of options assumed reacquired as treasury stock, and Equation (14) for number of awards assumed reacquired as treasury stock.
Step 7: Compute diluted EPS of W House for the year 2019.
Note: Refer to Table (2) for value and computation of weighted average number of common shares outstanding.
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Chapter 19 Solutions
Intermediate Accounting
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