In the video 16.03 - Earnings Per Share: Treasury Stock Method, Roger Philipp, CPA, CGMA, explains the concepts behind the treasury stock method of accounting for dilutive stock options, rights and warrants when calculating diluted earnings per share (EPS), and works through an illustrative example.
Assumption #1 is that anyone with economically advantageous stock options will exercise them all by purchasing shares of common stock at the option price.
Assumption #2 is that the company will then spend the funds gained from the stock option exercise on treasury stock, purchasing it at the average market price. The difference between number of shares of common stock purchased during the option exercise and the common shares repurchased as treasury stock by the company is the incremental number of shares outstanding. This number is added to the denominator, weighted average common shares outstanding, in the diluted EPS calculation.
Finally, in the video lesson, Roger provides a big-picture summary of basic EPS, diluted EPS and the treasury stock method.
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Video Transcript Sneak Peek:
Okay, the third thing I want to look at now is called the Treasury Stock Method. So, with the Treasury Stock Method, this deals with options, rights, warrants. So, this is like a stock option. Let's think about a stock option, if you had a stock option, what happens? Options, warrants, you have these things that allow you to convert it, give money, and get common stock back.
So, if you think about it, what are you giving me? You're giving me money. What am I giving you? Common stock. So whether it's an option, whether it's a right, whether it's a warrant, I've got to look at that and use what we call the Treasury Stock Method.