In applying the treasury stock method of computing diluted earnings per share, when is it appropriate to use the average market price of common stock during the year as the assumed repurchase price?
A) Always
B) Never
C) When the average market price is higher than the exercise price
D) When the average market price is lower than the exercise price

Question

Quizplus · Accepted Answer

The treasury stock method assumes that if stock options were exercised, the company would use the proceeds to buy back its own shares at the average market price during the year. Therefore, it is appropriate to use the average market price as the assumed repurchase price when it is higher than the exercise price, as this would result in a lower number of shares being issued and a lower dilution of earnings per share. If the average market price is lower than the exercise price, it would not make sense for the company to buy back its own shares at a higher price than the market, so a different method would need to be used to compute diluted earnings per share.

In Applying the Treasury Stock Method of Computing Diluted Earnings