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Chapter 16: Q7P (page 884)

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.

Short Answer

Expert verified

Number of shares used to compute earning per share and diluted earning per share are 4,951,000 and . The total adjusted income is $10, 350,000.

Step by step solution

01

Basic earnings per share

Particular

Date

Outstanding

Beginning Balance

Including 5% Stock Dividend

Jan 1-Apr 1

$2,100,000

Conversion of Preferred Stock

Apr 1- Jan 1

$2,520,000

Stock Split

July 1- Aug 1

$5,040,000

Issue Share of Building

Aug 1- Nov 1

$5,340,000

Purchase of Treasury Stock

Nov 1- Dec 1

$5,316,000

The total number of common shares to compute basic earnings per share is 4,951,000
02

Diluted earnings per share

Particular

Outstanding

Number of shares used to compute basic earnings per share

4,951,000

Convertible Preferred Stock- Still outstanding

630,000

Convertible Preferred Stock- Converted

$210,000

The total number of common shares to compute diluted earnings per share is $5,719,000
03

Adjusted net income

Particular

Amount

Amount

After Tax Net Income

$11,550,000

Preferred Stock Dividend March 31

$525,000

June 30, Sept 30, and Dec 31

$675,000

$1,200,000

Adjusted Net Income

$10,350,000

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Most popular questions from this chapter

Accounting, Analysis, and Principles

On January 1, 2016, Garner issued 10-year, \(200,000 face value, 6% bonds at par. Each \)1,000 bond is convertible into 30 shares of Garner \(2 par value common stock. The company has had 10,000 shares of common stock (and no preferred stock) outstanding throughout its life. None of the bonds have been converted as of the end of 2017. (Ignore all tax effects.)

Accounting

(a) Prepare the journal entry Garner would have made on January 1, 2016, to record the issuance of the bonds.

(b) Garner’s net income in 2017 was \)30,000 and was \(27,000 in 2016. Compute basic and diluted earnings per share for Garner for 2017 and 2016.

(c) Assume that 75% of the holders of Garner’s convertible bonds convert their bonds to stock on June 30, 2018, when Garner’s stock is trading at \)32 per share. Garner pays $50 per bond to induce bondholders to convert. Prepare the journal entry to record the conversion.

Analysis

Show how Garner will report income and EPS for 2017 and 2016. Briefly discuss the importance of GAAP for EPS to analysts evaluating companies based on price-earnings ratios. Consider comparisons for a company over time, as well as comparisons between companies at a point in time.

Principles

In order to converge GAAP and IFRS, the FASB is considering whether the equity element of a convertible bond should be reported as equity. Describe how the journal entry you made in part (a) above would differ under IFRS. In terms of the accounting principles discussed in Chapter 2, what does IFRS for convertible debt accomplish that GAAP potentially sacrifices? What does GAAP for convertible debt accomplish that IFRS potentially sacrifices?

CA16-3 WRITING (Stock Warrants—Various Types) For various reasons a corporation may issue warrants to purchase shares of its common stock at specified prices that, depending on the circumstances, may be less than, equal to, or greater than the current market price. For example, warrants may be issued:

1. To existing stockholders on a pro rata basis.

2. To certain key employees under an incentive stock-option plan.

3. To purchasers of the corporation’s bonds.

Instructions

For each of the three examples of how stock warrants are used:

(a) Explain why they are used.

(b) Discuss the significance of the price (or prices) at which the warrants are issued (or granted) in relation to (1) the current market price of the company’s stock, and (2) the length of time over which they can be exercised.

(c) Describe the information that should be disclosed in financial statements, or notes thereto, that are prepared when stock warrants are outstanding in the hands of the three groups listed above

CA16-4 WRITING (Stock Compensation Plans) The following two items appeared on the Internet concerning the GAAP requirement to expense stock options.

WASHINGTON, D.C.—February 17, 2005 Congressman David Dreier (R–CA), Chairman of the House Rules Committee, and Congresswoman Anna Eshoo (D–CA) reintroduced legislation today that will preserve broad-based employee stock option plans and give investors critical information they need to understand how employee stock options impact the value of their shares.

“Last year, the U.S. House of Representatives overwhelmingly voted for legislation that would have ensured the continued ability of innovative companies to offer stock options to rank-and-file employees,” Dreier stated. “Both the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) continue to ignore our calls to address legitimate concerns about the impact of FASB’s new standard on workers’ ability to have an ownership stake in the New Economy, and its failure to address the real need of shareholders: accurate and meaningful information about a company’s use of stock options.”

In December 2004, FASB issued a stock option expensing standard that will render a huge blow to the 21st century economy,” Dreier said. “Their action and the SEC’s apparent lack of concern for protecting shareholders, requires us to once again take a firm stand on the side of investors and economic growth. Giving investors the ability to understand how stock options impact the value of their shares is critical. And equally important is preserving the ability of companies to use this innovative tool to attract talented employees.”

“Here We Go Again!” by Jack Ciesielski (2/21/2005, http://www.accountingobserver.com/blog/2005/02/here-we-go-again) On February 17, Congressman David Dreier (R–CA), and Congresswoman Anna Eshoo (D–CA), officially entered Silicon Valley’s bid to gum up the launch of honest reporting of stock option compensation: They co-sponsored a bill to “preserve broad-based employee stock option plans and give investors critical information they need to understand how employee stock options impact the value of their shares.” You know what “critical information” they mean: stuff like the stock compensation for the top five officers in a company, with a rigged value set as close to zero as possible. Investors crave this kind of information. Other ways the good Congresspersons want to “help” investors: The bill “also requires the SEC to study the effectiveness of those disclosures over three years, during which time, no new accounting standard related to the treatment of stock options could be recognized. Finally, the bill requires the Secretary of Commerce to conduct a study and report to Congress on the impact of broad-based employee stock option plans on expanding employee corporate ownership, skilled worker recruitment and retention, research and innovation, economic growth, and international competitiveness.”

It’s the old “four corners” basketball strategy: stall, stall, stall. In the meantime, hope for regime change at your opponent, the FASB.

Instructions

(a) What are the major recommendations of the stock-based compensation pronouncement?

(b) How do the provisions of GAAP in this area differ from the bill introduced by members of Congress (Dreier and Eshoo), which would require expensing for options issued to only the top five officers in a company? Which approach do you think would result in more useful information? (Focus on comparability.)

(c) The bill in Congress urges the FASB to develop a rule that preserves “the ability of companies to use this innovative tool to attract talented employees.” Write a response to these Congress-people explaining the importance of neutrality in financial accounting and reporting.

(EPS with Convertible Bonds and Preferred Stock) On January 1, 2017, Crocker Company issued 10-year, \(2,000,000 face value, 6% bonds, at par. Each \)1,000 bond is convertible into 15 shares of Crocker common stock. Crocker’s net income in 2017 was \(300,000, and its tax rate was 40%. The company had 100,000 shares of common stock outstanding throughout 2017. None of the bonds were converted in 2017.

Instructions

(a) Compute diluted earnings per share for 2017.

(b) Compute diluted earnings per share for 2017, assuming the same facts as above, except that \)1,000,000 of 6% convertible preferred stock was issued instead of the bonds. Each $100 preferred share is convertible into 5 shares of Crocker common stock.

GROUPWORK (Entries for Various Dilutive Securities) The stockholders’ equity section of Martino Inc. at the beginning of the current year appears below.

Common stock, \(10 par value, authorized 1,000,000

shares, 300,000 shares issued and outstanding \)3,000,000

Paid-in capital in excess of par—common stock 600,000

Retained earnings 570,000

During the current year, the following transactions occurred.

1. The company issued to the stockholders 100,000 rights. Ten rights are needed to buy one share of stock at \(32. The rights were void after 30 days. The market price of the stock at this time was \)34 per share.

2. The company sold to the public a \(200,000, 10% bond issue at 104. The company also issued with each \)100 bond one detachable stock purchase warrant, which provided for the purchase of common stock at \(30 per share. Shortly after issuance, similar bonds without warrants were selling at 96 and the warrants at \)8.

3. All but 5,000 of the rights issued in (1) were exercised in 30 days.

4. At the end of the year, 80% of the warrants in (2) had been exercised, and the remaining were outstanding and in good standing.

5. During the current year, the company granted stock options for 10,000 shares of common stock to company executives.

The company, using a fair value option-pricing model, determines that each option is worth \(10. The option price is \)30.

The options were to expire at year-end and were considered compensation for the current year.

6. All but 1,000 shares related to the stock-option plan were exercised by year-end. The expiration resulted because one of the executives failed to fulfill an obligation related to the employment contract.

Instructions

(a) Prepare general journal entries for the current year to record the transactions listed above.

(b) Prepare the stockholders’ equity section of the balance sheet at the end of the current year. Assume that retained earnings

at the end of the current year is $750,000.
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