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Chapter 16: 2Q (page 873)
Briefly explain why corporations issue convertible securities.
Corporations issue convertibles for two principal reasons. One is to raise equity capital without surrendering more ownership control than needed and secondly, to give convertibles is to get debt financing at less expensive rates.
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(Issuance, Exercise, and Termination of Stock Options) On January 1, 2018, Titania Inc. granted stock options to officers and key employees for the purchase of 20,000 shares of the company’s \(10 par common stock at \)25 per share. The options were exercisable within a 5-year period beginning January 1, 2020, by grantees still in the employ of the company, and expiring December 31, 2024. The service period for this award is 2 years. Assume that the fair value option-pricing model determines total compensation expense to be \(350,000.On April 1, 2019, 2,000 options were terminated when the employees resigned from the company. The market price of the common stock was \)35 per share on this date.On March 31, 2020, 12,000 options were exercised when the market price of the common stock was $40 per share.
Instructions
Prepare journal entries to record issuance of the stock options, termination of the stock options, exercise of the stock options, and charges to compensation expense, for the years ended December 31, 2018, 2019, and 2020.
(Conversion of Bonds) Vargo Company has bonds payable outstanding in the amount of \(500,000, and the Premium on Bonds Payable account has a balance of \)7,500. Each \(1,000 bond is convertible into 20 shares of preferred stock of parvalue of \)50 per share. All bonds are converted into preferred stock.
Rockland Corporation earned net income of \(300,000 in 2017 and had 100,000 shares of common stock outstanding throughout the year. Also outstanding all year was \)800,000 of 9% bonds, which are convertible into 16,000 shares of common. Rockland’s tax rate is 40%. Compute Rockland’s 2017 diluted earnings per share.
(EPS with Complex Capital Structure) Amy Dyken, controller at Fitzgerald Pharmaceutical Industries, a public company, is currently preparing the calculation for basic and diluted earnings per share and the related disclosure for Fitzgerald’s financial statements. Below is selected financial information for the fiscal year ended June 30, 2017.
FITZGERALD PHARMACEUTICAL INDUSTRIES
SELECTED BALANCE SHEET
INFORMATION
JUNE 30, 2017
Long-term debt
Notes payable, 10% \( 1,000,000
8% convertible bonds payable 5,000,000
10% bonds payable 6,000,000
Total long-term debt \)12,000,000
Shareholders’ equity
Preferred stock, 6% cumulative, \(50 par value,
100,000 shares authorized, 25,000 shares issued
and outstanding \) 1,250,000
Common stock, \(1 par, 10,000,000 shares authorized,
1,000,000 shares issued and outstanding 1,000,000
Additional paid-in capital 4,000,000
Retained earnings 6,000,000
Total shareholders’ equity \)12,250,000
The following transactions have also occurred at Fitzgerald.
1. Options were granted on July 1, 2016, to purchase 200,000 shares at \(15 per share. Although no options were exercised
during fiscal year 2017, the average price per common share during fiscal year 2017 was \)20 per share.
2. Each bond was issued at face value. The 8% convertible bonds will convert into common stock at 50 shares per \(1,000
bond. The bonds are exercisable after 5 years and were issued in fiscal year 2016.
3. The preferred stock was issued in 2016.
4. There are no preferred dividends in arrears; however, preferred dividends were not declared in fiscal year 2017.
5. The 1,000,000 shares of common stock were outstanding for the entire 2017 fiscal year.
6. Net income for fiscal year 2017 was \)1,500,000, and the average income tax rate is 40%.
Instructions
For the fiscal year ended June 30, 2017, calculate the following for Fitzgerald Pharmaceutical Industries.
(a) Basic earnings per share.
(b) Diluted earnings per share.
GROUPWORK (Computation of Basic and Diluted EPS) Charles Austin of the controller’s office of Thompson
Corporation was given the assignment of determining the basic and diluted earnings per share values for the year ending
December 31, 2018. Austin has compiled the information listed below.
1. The company is authorized to issue 8,000,000 shares of \(10 par value common stock. As of December 31, 2017, 2,000,000
shares had been issued and were outstanding.
2. The per share market prices of the common stock on selected dates were as follows.
Price per Share
July 1, 2017 \)20.00
January 1, 2018 21.00
April 1, 2018 25.00
July 1, 2018 11.00
August 1, 2018 10.50
November 1, 2018 9.00
December 31, 2018 10.00
3. A total of 700,000 shares of an authorized 1,200,000 shares of convertible preferred stock had been issued on July 1, 2017.
The stock was issued at its par value of \(25, and it has a cumulative dividend of \)3 per share. The stock is convertible into
common stock at the rate of one share of convertible preferred for one share of common. The rate of conversion is to be
automatically adjusted for stock splits and stock dividends. Dividends are paid quarterly on September 30, December 31,
March 31, and June 30.
4. Thompson Corporation is subject to a 40% income tax rate.
5. The after-tax net income for the year ended December 31, 2018, was \(11,550,000.
The following specific activities took place during 2018.
1. January 1—A 5% common stock dividend was issued. The dividend had been declared on December 1, 2017, to all stockholders
of record on December 29, 2017.
2. April 1—A total of 400,000 shares of the \)3 convertible preferred stock was converted into common stock. The company
issued new common stock and retired the preferred stock. This was the only conversion of the preferred stock during 2018.
3. July 1—A 2-for-1 split of the common stock became effective on this date. The board of directors had authorized the split
on June 1.
4. August 1—A total of 300,000 shares of common stock were issued to acquire a factory building.
5. November 1—A total of 24,000 shares of common stock were purchased on the open market at \(9 per share. These shares
were to be held as treasury stock and were still in the treasury as of December 31, 2018.
6. Common stock cash dividends—Cash dividends to common stockholders were declared and paid as follows.
April 15—\)0.30 per share
October 15—$0.20 per share
7. Preferred stock cash dividends—Cash dividends to preferred stockholders were declared and paid as scheduled.
Instructions
(a) Determine the number of shares used to compute basic earnings per share for the year ended December 31, 2018.
(b) Determine the number of shares used to compute diluted earnings per share for the year ended December 31, 2018.
(c) Compute the adjusted net income to be used as the numerator in the basic earnings per share calculation for the year
ended December 31, 2018.
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