Download - SHARE-BASED COMPENSATION AND EARNINGS PER SHARE Chapter 19 © 2009 The McGraw-Hill Companies, Inc
SHARE-BASED SHARE-BASED COMPENSATION ANDCOMPENSATION ANDEARNINGS PER SHAREEARNINGS PER SHARE
Chapter 19
© 2009 The McGraw-Hill Companies, Inc.
McGraw-Hill /Irwin
Slide 2
Share-Based CompensationShare-Based Compensation
Restricted stock plans Restricted stock plans usually are tied to usually are tied to continued employment of the person continued employment of the person
receiving the award.receiving the award.The compensation associated with a share of The compensation associated with a share of
restricted stock (or nonvested stock) is the restricted stock (or nonvested stock) is the market price at the market price at the grant date grant date of an of an unrestricted share of the same stock. unrestricted share of the same stock.
The amount is accrued as The amount is accrued as compensation compensation expense expense over the service period for which over the service period for which participants receive the shares.participants receive the shares.
Restricted stock plans Restricted stock plans usually are tied to usually are tied to continued employment of the person continued employment of the person
receiving the award.receiving the award.The compensation associated with a share of The compensation associated with a share of
restricted stock (or nonvested stock) is the restricted stock (or nonvested stock) is the market price at the market price at the grant date grant date of an of an unrestricted share of the same stock. unrestricted share of the same stock.
The amount is accrued as The amount is accrued as compensation compensation expense expense over the service period for which over the service period for which participants receive the shares.participants receive the shares.
Stock Award Plans
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Stock Option PlansStock Option Plans
Stock option plansStock option plans give employees the give employees the option to purchase (a) a specified option to purchase (a) a specified numbernumber of shares of the firm's stock, (b) at a of shares of the firm's stock, (b) at a specified specified exercise priceexercise price, (c) during a , (c) during a specified specified period of timeperiod of time. .
The The fair valuefair value is accrued as is accrued as compensation compensation expense over the service periodexpense over the service period for which for which participants receive the options, usually participants receive the options, usually from the date of grant to when the options from the date of grant to when the options become exercisable (the vesting date). become exercisable (the vesting date).
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Slide 4
Expense – The Great DebateExpense – The Great Debate
Historically, options have been measured at Historically, options have been measured at their intrinsic value – the simple difference their intrinsic value – the simple difference
between the market price of the shares and between the market price of the shares and the option price at which they can be the option price at which they can be
acquired. If the market and exercise price acquired. If the market and exercise price are equal on the date of grant, no are equal on the date of grant, no
compensation expense is recognized even compensation expense is recognized even if the options provide executives with if the options provide executives with
substantial income.substantial income.
Historically, options have been measured at Historically, options have been measured at their intrinsic value – the simple difference their intrinsic value – the simple difference
between the market price of the shares and between the market price of the shares and the option price at which they can be the option price at which they can be
acquired. If the market and exercise price acquired. If the market and exercise price are equal on the date of grant, no are equal on the date of grant, no
compensation expense is recognized even compensation expense is recognized even if the options provide executives with if the options provide executives with
substantial income.substantial income.
McGraw-Hill /Irwin
Slide 5
Expense – The Great DebateExpense – The Great Debate
Opposition to a proposed FASB Statement Opposition to a proposed FASB Statement have identified three objections.have identified three objections.
1.1. Options with no intrinsic value at issue Options with no intrinsic value at issue have zero fair value and should have zero fair value and should notnot give give rise to expense recognition.rise to expense recognition.
2.2. It is impossible to measure the fair value of It is impossible to measure the fair value of compensation on the date of grant.compensation on the date of grant.
3.3. Current practices have unacceptable Current practices have unacceptable economic consequences.economic consequences.
Opposition to a proposed FASB Statement Opposition to a proposed FASB Statement have identified three objections.have identified three objections.
1.1. Options with no intrinsic value at issue Options with no intrinsic value at issue have zero fair value and should have zero fair value and should notnot give give rise to expense recognition.rise to expense recognition.
2.2. It is impossible to measure the fair value of It is impossible to measure the fair value of compensation on the date of grant.compensation on the date of grant.
3.3. Current practices have unacceptable Current practices have unacceptable economic consequences.economic consequences.
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Slide 6
Recognizing Fair Value of OptionsRecognizing Fair Value of OptionsAccounting for stock options parallels the accountingAccounting for stock options parallels the accountingfor restricted stock we discussed earlier. We now arefor restricted stock we discussed earlier. We now are
required to estimate the fair value of stock optionrequired to estimate the fair value of stock optionon the grant date.on the grant date.
Accounting for stock options parallels the accountingAccounting for stock options parallels the accountingfor restricted stock we discussed earlier. We now arefor restricted stock we discussed earlier. We now are
required to estimate the fair value of stock optionrequired to estimate the fair value of stock optionon the grant date.on the grant date.
SFAS 123 (revised) requires the use of an option SFAS 123 (revised) requires the use of an option pricing model that deals with the:pricing model that deals with the:1.1. Exercise price of the option.Exercise price of the option.2. Expected term of the option.2. Expected term of the option.3. Current market price of the stock.3. Current market price of the stock.4. Expected dividends.4. Expected dividends.5. Expected risk-free rate of return.5. Expected risk-free rate of return.6. Expected volatility of the stock.6. Expected volatility of the stock.
McGraw-Hill /Irwin
Slide 7
Plans with Performance or Market Plans with Performance or Market ConditionsConditions
In some circumstances, compensation from a stock option plan depends on
meeting a performance targetperformance target. When this is the case, compensation expense
depends on whether or not we feel it is probableprobable that the target performance will
be met.
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Employee Share Purchase PlanEmployee Share Purchase Plan Permit employees to buy shares directly from
their employer. Usually the plan is considered compensatory,
and compensation expense is recorded. Employees may buy 100 shares of no par stock
for $8.50 per share. The current market price is $10.00. The $1.50 discount is recorded as compensation expense:
Description Debit Credit
Cash (100 × $8.50) 850
Compensation expense (100 × $1.50) 150
Common stock (100 × $10.00) 1,000
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Slide 9
Earnings Per Share (EPS)Earnings Per Share (EPS)
Of the myriad facts and figures Of the myriad facts and figures generated by accountants, the single generated by accountants, the single
accounting number that is reported most accounting number that is reported most frequently in the media and receives by frequently in the media and receives by far the most attention by investors and far the most attention by investors and
creditors is creditors is earnings per shareearnings per share..
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Slide 10
Simple Capital Structure(Basic EPS)
Basic Earnings Per ShareBasic Earnings Per Share
Net income (after tax) – Preferred dividends*Weighted average outstanding common stock Net income (after tax) – Preferred dividends*Weighted average outstanding common stock
*Current period’s cumulative preferred stock period’s cumulative preferred stock dividends (whether or not declared) and dividends (whether or not declared) and
noncumulative preferred stock dividends (only if noncumulative preferred stock dividends (only if declared).declared).
*Current period’s cumulative preferred stock period’s cumulative preferred stock dividends (whether or not declared) and dividends (whether or not declared) and
noncumulative preferred stock dividends (only if noncumulative preferred stock dividends (only if declared).declared).
Number of shares outstanding× Number of months outstanding ÷ 12 Weighted average shares outstanding
Number of shares outstanding× Number of months outstanding ÷ 12 Weighted average shares outstanding
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Slide 11
Issuance of New SharesIssuance of New Shares
Date Description No. of Shares1/1 Balance 100,000 4/1 Issued 50,000 10/1 Issued 10,000
Compute the weighted average number of Compute the weighted average number of shares of common stock outstanding.shares of common stock outstanding.
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Slide 12
Issuance of New SharesIssuance of New Shares
Compute the weighted average number of Compute the weighted average number of shares of common stock outstanding.shares of common stock outstanding.
100,000100,000 + [50,000 + [50,000 ×× (9/12)] + [10,000 (9/12)] + [10,000 × (3/12)] = × (3/12)] = 140,000140,000SharesShares
at Jan. 1 at Jan. 1NewNew
SharesSharesNewNew
SharesShares
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Slide 13
Stock Dividends and Stock SplitsStock Dividends and Stock Splits
Common shares issued as part of stock Common shares issued as part of stock dividends and stock splits are treated dividends and stock splits are treated
retroactively as subdivisions of the retroactively as subdivisions of the shares already outstanding at the date shares already outstanding at the date
of the split or dividend.of the split or dividend.
Common shares issued as part of stock Common shares issued as part of stock dividends and stock splits are treated dividends and stock splits are treated
retroactively as subdivisions of the retroactively as subdivisions of the shares already outstanding at the date shares already outstanding at the date
of the split or dividend.of the split or dividend.
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Slide 14
Stock Dividends and Stock SplitsStock Dividends and Stock Splits
Compute the weighted average number of Compute the weighted average number of shares of common stock outstanding.shares of common stock outstanding.
Date Description No. of Shares
1/1 Balance 100,000 4/1 Issued 50,000 5/1 Stock dividend(100%) 150,000
McGraw-Hill /Irwin
Slide 15
Stock Dividends and Stock SplitsStock Dividends and Stock Splits
Compute the weighted-average number of Compute the weighted-average number of shares of common stock outstanding.shares of common stock outstanding.
100,000 100,000 × (2.00) + [50,000 × (2.00) + [50,000 × (9/12) × 2.00]× (9/12) × 2.00] = = 275,000275,000SharesShares
at Jan. 1 at Jan. 1NewNew
SharesShares
Stock dividendStock dividendadjustmentadjustment
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Slide 16
Stock Dividends and Stock SplitsStock Dividends and Stock Splits
Retroactive treatment:Retroactive treatment:
Stock dividend or split Stock dividend or split is treated as is treated as
outstanding from the outstanding from the beginning of the beginning of the
period.period.
Stock dividend or split Stock dividend or split is treated as is treated as
outstanding from the outstanding from the beginning of the beginning of the
period.period.
Stock dividend or split is Stock dividend or split is applied retroactively in applied retroactively in
proportion to the number of proportion to the number of shares outstanding at the shares outstanding at the
time of the dividend or split.time of the dividend or split.
Stock dividend or split is Stock dividend or split is applied retroactively in applied retroactively in
proportion to the number of proportion to the number of shares outstanding at the shares outstanding at the
time of the dividend or split.time of the dividend or split.
New sharesNew sharesissued this period?issued this period?
New sharesNew sharesissued this period?issued this period?
YesYes NoNo
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Slide 17
Reacquired SharesReacquired Shares
The weighted-average number of shares The weighted-average number of shares is reduced by the number of reacquired is reduced by the number of reacquired shares, time-weighted for the shares, time-weighted for the fraction of fraction of
the year they were the year they were notnot outstanding. outstanding.
The weighted-average number of shares The weighted-average number of shares is reduced by the number of reacquired is reduced by the number of reacquired shares, time-weighted for the shares, time-weighted for the fraction of fraction of
the year they were the year they were notnot outstanding. outstanding.
McGraw-Hill /Irwin
Slide 18
Reacquired SharesReacquired Shares
Compute the weighted-average number of Compute the weighted-average number of shares of common stock outstanding.shares of common stock outstanding.
Date Description No. of Shares
1/1 Balance 100,000 4/1 Issued 50,000 5/1 Repurchased shares 12,000
McGraw-Hill /Irwin
Slide 19
Reacquired SharesReacquired Shares
Compute the weighted-average number of Compute the weighted-average number of shares of common stock outstanding.shares of common stock outstanding.
100,000100,000 + [50,000 + [50,000 ×× (9/12)] - [12,000 (9/12)] - [12,000 × (8/12)] = × (8/12)] = 129,500129,500SharesShares
at Jan. 1 at Jan. 1NewNew
SharesSharesTreasuryTreasurySharesShares
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Slide 20
Earnings Available to Common ShareholdersEarnings Available to Common Shareholders
Net incomeLess: Current period’s cumulative preferred stock dividends (whether or not declared)Less: Noncumulative preferred stock dividends (only if
declared)Net income available to common shareholders
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Slide 21
Complex Capital StructureComplex Capital Structure(dual EPS)(dual EPS)
Dilution/Antidilution TestDilution/Antidilution Test
StockStockOptionsOptions
Convertible Convertible securitiessecurities
Treasury stock Treasury stock methodmethod
If-converted If-converted methodmethod
Contingently Contingently issuable issuable sharesshares
Potential Common Shares:Potential Common Shares:•Stock options, rights, and Stock options, rights, and warrants warrants•Convertible bonds and stockConvertible bonds and stock•Contingent common stock Contingent common stock issues issues
Potential Common Shares:Potential Common Shares:•Stock options, rights, and Stock options, rights, and warrants warrants•Convertible bonds and stockConvertible bonds and stock•Contingent common stock Contingent common stock issues issues
Diluted Earnings Per shareDiluted Earnings Per share
May Report Basic and Diluted Earnings Per Share
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Slide 22
Options, Rights, and WarrantsOptions, Rights, and Warrants
ProceedsProceeds
Used toUsed to
Purchase Purchase treasury treasury sharesshares
At At average average market market priceprice
The The treasury stock methodtreasury stock method assumes that proceeds assumes that proceeds
from the exercise of from the exercise of options are used to options are used to
purchase treasury shares. purchase treasury shares. This method usually This method usually
results in a net increase in results in a net increase in shares included in the shares included in the
denominator of the denominator of the calculation of diluted calculation of diluted earnings per share.earnings per share.
The The treasury stock methodtreasury stock method assumes that proceeds assumes that proceeds
from the exercise of from the exercise of options are used to options are used to
purchase treasury shares. purchase treasury shares. This method usually This method usually
results in a net increase in results in a net increase in shares included in the shares included in the
denominator of the denominator of the calculation of diluted calculation of diluted earnings per share.earnings per share.
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Slide 23
Options, Rights, and WarrantsOptions, Rights, and Warrants
Proceeds from assumed exerciseProceeds from assumed exercise
AverageAverage market price of stock market price of stock
Proceeds from assumed exerciseProceeds from assumed exercise
AverageAverage market price of stock market price of stock
Determine new shares from assumed Determine new shares from assumed exercise of stock options.exercise of stock options.
Compute number of shares Compute number of shares repurchased. repurchased.
McGraw-Hill /Irwin
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Options, Rights, and WarrantsOptions, Rights, and Warrants
Determine new shares from assumed Determine new shares from assumed exercise of stock options.exercise of stock options.
Compute shares purchased for the Compute shares purchased for the treasury. treasury.
Compute the incremental shares Compute the incremental shares assumed outstanding.assumed outstanding.
New shares from assumed exercise (1)New shares from assumed exercise (1)
Less: Treasury shares assumed purchasedLess: Treasury shares assumed purchased (2) (2)
Net increase in shares outstanding (3)Net increase in shares outstanding (3)
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Slide 25
Options, Rights, and WarrantsOptions, Rights, and Warrants
When the exercise price When the exercise price exceeds the market exceeds the market
price, the securities are price, the securities are antidilutiveantidilutive..
When the exercise price When the exercise price exceeds the market exceeds the market
price, the securities are price, the securities are antidilutiveantidilutive..
McGraw-Hill /Irwin
Slide 26
Convertible SecuritiesConvertible Securities
The The if-converted methodif-converted method is used for is used for Convertible debt and equity Convertible debt and equity
securities.securities.The method assumes conversion occurs The method assumes conversion occurs as of the as of the beginningbeginning of the period or date of the period or date
ofof issuance issuance, if later., if later.
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Slide 27
Convertible SecuritiesConvertible Securities
The assumed conversion of convertible bonds The assumed conversion of convertible bonds or preferred stock has two effects on dilutive or preferred stock has two effects on dilutive earnings per share:earnings per share:increases the denominator by the number of increases the denominator by the number of
common shares issuable upon conversion,common shares issuable upon conversion,increases the numerator by decreasing increases the numerator by decreasing after-tax after-tax
interest expenseinterest expense on convertible bonds, and on convertible bonds, and dividends on convertible preferred stock.dividends on convertible preferred stock.
The assumed conversion of convertible bonds The assumed conversion of convertible bonds or preferred stock has two effects on dilutive or preferred stock has two effects on dilutive earnings per share:earnings per share:increases the denominator by the number of increases the denominator by the number of
common shares issuable upon conversion,common shares issuable upon conversion,increases the numerator by decreasing increases the numerator by decreasing after-tax after-tax
interest expenseinterest expense on convertible bonds, and on convertible bonds, and dividends on convertible preferred stock.dividends on convertible preferred stock.
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Slide 28
Convertible SecuritiesConvertible Securities
Dilutive earnings per share may decrease or Dilutive earnings per share may decrease or increase after the assumed conversion.increase after the assumed conversion.
If dilutive earnings per share If dilutive earnings per share decreasesdecreases, , the securities are the securities are dilutivedilutive and are and are
assumed assumed convertedconverted..
If dilutive earnings per share If dilutive earnings per share decreasesdecreases, , the securities are the securities are dilutivedilutive and are and are
assumed assumed convertedconverted..
If dilutive earnings per shareIf dilutive earnings per share increases increases, , the securities are the securities are antidilutiveantidilutive and are and are
notnot considered converted. considered converted.
If dilutive earnings per shareIf dilutive earnings per share increases increases, , the securities are the securities are antidilutiveantidilutive and are and are
notnot considered converted. considered converted.
McGraw-Hill /Irwin
Order of Entry for Multiple Convertible Order of Entry for Multiple Convertible SecuritiesSecurities
When a company has more than one When a company has more than one instances of potential common shares, instances of potential common shares,
they are considered for inclusion in they are considered for inclusion in dilutive EPS in sequence from the dilutive EPS in sequence from the most most
dilutive to the least dilutivedilutive to the least dilutive..
When a company has more than one When a company has more than one instances of potential common shares, instances of potential common shares,
they are considered for inclusion in they are considered for inclusion in dilutive EPS in sequence from the dilutive EPS in sequence from the most most
dilutive to the least dilutivedilutive to the least dilutive..
McGraw-Hill /Irwin
Slide 30
Additional EPS IssuesAdditional EPS Issues
Contingent shares are issuable in the Contingent shares are issuable in the future for little or no cash consideration future for little or no cash consideration
upon the satisfaction of certain conditions. upon the satisfaction of certain conditions. Contingently issuable shares are Contingently issuable shares are
considered to be outstanding in the considered to be outstanding in the computation of EPS if the target computation of EPS if the target
performance level already is being met.performance level already is being met.
Contingent shares are issuable in the Contingent shares are issuable in the future for little or no cash consideration future for little or no cash consideration
upon the satisfaction of certain conditions. upon the satisfaction of certain conditions. Contingently issuable shares are Contingently issuable shares are
considered to be outstanding in the considered to be outstanding in the computation of EPS if the target computation of EPS if the target
performance level already is being met.performance level already is being met.
Contingently Issuable SharesContingently Issuable Shares
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Slide 31
Contingently Issuable SharesContingently Issuable Shares
Shares are issued Shares are issued merely due to passage merely due to passage
of time.of time.
Shares are issued Shares are issued merely due to passage merely due to passage
of time.of time.
Some target performance Some target performance level has already been level has already been met and is expected to met and is expected to
continue to the end of the continue to the end of the contingency period.contingency period.
Some target performance Some target performance level has already been level has already been met and is expected to met and is expected to
continue to the end of the continue to the end of the contingency period.contingency period.
Contingent shares are included in dilutive EPS if:
Contingent shares are included in dilutive EPS if:
Example: Additional shares may be Example: Additional shares may be issued based on future earnings. issued based on future earnings.
Example: Additional shares may be Example: Additional shares may be issued based on future earnings. issued based on future earnings.
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Slide 32
SummarySummary
Potential Common Shares Basic EPS Diluted EPS Stock options (or warrants, rights) no yes Convertible securities (bonds, notes, preferred stock) no yes Contingently issuable shares no yes
Dilutive Effect Shown?
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Slide 33
SummarySummary
Potential Common Shares Numerator Denominator
Stock options (or warrants, rights)None
Add incremental shares
Convertible bonds or notes Add after tax interest
Add shares issuable upon
conversion
Convertible preferred Add back dividends declared
Add shares issuable upon
conversion Contingently issuable shares
Conditions being currently met None
Add shares issuable
Conditions not being met None None
Impact
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Slide 34
Financial Statement PresentationFinancial Statement Presentation
Report EPS data separately for:
1. Income from Continuing Operations
2. Separately Reported Items
a) Discontinued Operations
b) Extraordinary Items
3. Net Income
McGraw-Hill /Irwin
Slide 35
Appendix 19A – Option-Pricing TheoryAppendix 19A – Option-Pricing Theory
Intrinsic value Intrinsic value is the benefit the holder of an is the benefit the holder of an option would realize by exercising the option option would realize by exercising the option
rather than buying the underlying stock directly. rather than buying the underlying stock directly. An option that permits an employee to buy $25 An option that permits an employee to buy $25
stock for $10, has an intrinsic value of $15.stock for $10, has an intrinsic value of $15.
Intrinsic value Intrinsic value is the benefit the holder of an is the benefit the holder of an option would realize by exercising the option option would realize by exercising the option
rather than buying the underlying stock directly. rather than buying the underlying stock directly. An option that permits an employee to buy $25 An option that permits an employee to buy $25
stock for $10, has an intrinsic value of $15.stock for $10, has an intrinsic value of $15.
Options have a time Options have a time value because the value because the
holder of an option does holder of an option does not have to pay the not have to pay the
exercise price until the exercise price until the option is exercised.option is exercised.
Options have a time Options have a time value because the value because the
holder of an option does holder of an option does not have to pay the not have to pay the
exercise price until the exercise price until the option is exercised.option is exercised.
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Slide 36
SummarySummary
The fair value of an option is (a) its intrinsic value plus (b) its time value of money plus (c) its volatility component.
The fair value of an option is (a) its intrinsic value plus (b) its time value of money plus (c) its volatility component.
McGraw-Hill /Irwin
Appendix 19B - Stock Appreciation RightsAppendix 19B - Stock Appreciation Rights
The SARs are considered to be equity if the employer can elect to settle in shares of stock.
The amount of compensation is estimated at the grant date as the fair value of the SARs.
This amount is expensed over the service period.
Usually the same as the fair value of a stock option with
similar terms.
McGraw-Hill /Irwin
Stock Appreciation RightsStock Appreciation Rights
The SARs are considered to be a liability if the employee can elect to receive cash upon settlement. In that case, the amount of compensation (and related liability) is estimated each period and continuously adjusted to reflect changes in the fair value of the SARs until the compensation is finally paid.
The current expense (and adjustment to the liability) is the fraction of the total compensation earned to date by recipients of the SARs (based on the elapsed percentage of the service period), reduced by any amounts expensed in prior periods.
McGraw-Hill /Irwin
End of Chapter 19End of Chapter 19
© 2008 The McGraw-Hill Companies, Inc.