Question

The "treasury stock" method of calculating shares outstanding for diluted earnings per share is used when?

A. bonds are converted to common stock
B. preferred stock is converted to common stock
C. stock options are exercisable
D. treasury stock has been reissued

Answer 1

The "treasury stock" method of calculating shares outstanding for diluted earnings per share is used when (C) stock options are exercisable.

Step-by-step explanation:

The treasury stock method is employed when calculating diluted earnings per share to account for the potential impact of stock options that are exercisable. It assumes that the proceeds from the exercise of options at the average market price would be used to repurchase common shares in the open market.

This method is particularly relevant when there are outstanding stock options that could potentially be exercised, leading to an increase in the number of common shares. By incorporating the treasury stock method, companies provide a more comprehensive view of their earnings per share, considering the impact of potentially dilutive securities like stock options.

Answer 2

The "treasury stock" method of calculating shares outstanding for diluted earnings per share is used when the stock options are exercisable. Therefore, the correct option is C. stock options are exercisable.

Step-by-step explanation:

The "treasury stock" method is employed to calculate shares outstanding for diluted earnings per share when stock options are exercisable. This approach is crucial in assessing the potential dilution impact of outstanding stock options on a company's earnings per share.

When stock options are exercisable, the treasury stock method assumes that the proceeds received from the exercise of these options are used to buy back common shares at the average market price. This assumption allows for a conservative estimation of the potential increase in the number of outstanding shares if these options were exercised and converted into common shares.

By incorporating the potential impact of the exercise of stock options into the calculation of diluted earnings per share, the treasury stock method adjusts the denominator of the EPS formula. It reflects a more conservative scenario by considering the additional shares that could be issued, thereby providing a more cautious perspective of a company's earnings per share in the event of potential option exercises.

The utilization of the treasury stock method becomes crucial for companies that have outstanding stock options as part of their compensation packages or equity plans. It offers stakeholders, investors, and analysts a comprehensive understanding of the potential impact on earnings per share, ensuring a more transparent financial representation that considers the potential dilution effect of exercisable stock options. Therefore, the correct option is C. stock options are exercisable.