Dilutive Dan Eps

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EXERCISES

DILUTIVES & EPS


Ex. 16-120—Convertible Bonds.
Dahl Co. issued $5,000,000 of 12%, 5-year convertible bonds on December 1, 2006 for $5,020,800 plus
accrued interest. The bonds were dated April 1, 2006 with interest payable April 1 and October 1. Bond
premium is amortized each interest period on a straight-line basis. Dahl Co. has a fiscal year end of
September 30.
On October 1, 2007, $2,500,000 of these bonds were converted into 35,000 shares of $15 par common
stock. Accrued interest was paid in cash at the time of conversion.
Instructions
(a) Prepare the entry to record the interest expense at April 1, 2007. Assume that interest payable was
credited when the bonds were issued (round to nearest dollar).
(b) Prepare the entry to record the conversion on October 1, 2007. Assume that the entry to record
amortization of the bond premium and interest payment has been made.
Solution 16-120
(a) Interest Payable 100,000
Interest Expense 198,400
Premium on Bonds Payable 1,600
Cash 300,000

Calculations:
Issuance price $5,020,800
Par value 5,000,000
Total premium $ 20,800

Months remaining 52
Premium per month $400
Premium amortized (4 × $400) $1,600

(b) Bonds Payable 2,500,000


Premium on Bonds Payable 8,400
Common Stock (35,000 × $15) 525,000
Paid-in Capital in Excess of Par 1,983,400

Calculations:
Premium related to 1/2 of the bonds $10,400 ($20,800 ÷ 2)
Less premium amortized 2,000 [($10,400 ÷ 52) × 10]
Premium remaining $ 8,400
Ex. 16-121—Convertible Bonds.
Linn Co. sold convertible bonds at a premium. Interest is paid on May 31 and November 30. On May 31, after
interest was paid, 100, $1,000 bonds are tendered for conversion into 3,000 shares of $10 par value common
stock that had a market price of $40 per share. How should Linn Co. account for the conversion of the bonds
into common stock under the book value method? Discuss the rationale for this method.

Solution 16-121
To account for the conversion of bonds under the book value method, Bonds Payable should be debited for the
face value, Premium on Bonds Payable should be debited, and Common Stock should be credited at par for
the shares issued. Using the book value method, no gain (loss) on conversion is recorded. The amount to be
recorded for the stock is equal to the book (carrying) value (face value plus unamortized premium) of the
bonds. Paid-in Capital in Excess of Par would be credited for the difference between the book value of the
bonds and the par value of the stock issued. The rationale for the book value method is that the conversion is
the completion of the transaction initiated when the bonds were issued. Since this is viewed as a transaction
with stockholders, no gain (loss) should be recognized.
Ex. 16-122—Convertible Debt and Debt with Warrants (Essay).
What accounting treatment is required for convertible debt? Why? What accounting treatment is required for
debt issued with stock warrants? Why?

Solution 16-122
Convertible debt is treated solely as debt. One reason is that the debt and conversion option are inseparable.
The holder cannot sell one and retain the other. The two choices are mutually exclusive. Another reason is that
the valuation of the conversion option or the debt security without the conversion option is subjective because
these values are not established separately in the marketplace.

When debt is issued with stock warrants, the warrants are given separate recognition. After issue, the debt and
the detachable warrants trade separately. The proceeds may be allocated to the two elements based on the
relative fair values of the debt security without the warrants and the warrants at the time of issuance. The
proceeds allocated to the warrants should be accounted for as paid-in capital.
Ex. 16-123—Stock options.
Prepare the necessary entries from 1/1/07-2/1/09 for the following events using the fair value method. If no
entry is needed, write "No Entry Necessary."
1. On 1/1/07, the stockholders adopted a stock option plan for top executives whereby each might receive
rights to purchase up to 12,000 shares of common stock at $40 per share. The par value is $10 per
share.
2. On 2/1/07, options were granted to each of five executives to purchase 12,000 shares. The options
were non-transferable and the executive had to remain an employee of the company to exercise the
option. The options expire on 2/1/09. It is assumed that the options were for services performed equally in
2007 and 2008. The Black-Scholes option pricing model determines total compensation expense to be
$1,300,000.
3. At 2/1/09, four executives exercised their options. The fifth executive chose not to exercise his options,
which therefore were forfeited.
Solution 16-123
1. 1/1/07
No entry necessary.
2. 2/1/07
No entry necessary.
2/31/07
Compensation Expense 650,000
Paid-in Capital—Stock Options 650,000

12/31/08
Compensation Expense 650,000
Paid-in Capital—Stock Options 650,000
3. 2/1/09
Cash (4 × 12,000 × $40) 1,920,000
Paid-in Capital—Stock Options ($1,300,000 × 4/5) 1,040,000
Common Stock 480,000
Paid-in Capital in Excess of Par 2,480,000

Paid-in Capital—Stock Options 260,000


Paid-in Capital from Expired Stock Options 260,000
Ex. 16-124—Weighted average shares outstanding.
On January 1, 2007, Yarrow Corporation had 1,000,000 shares of common stock outstanding. On March 1, the
corporation issued 150,000 new shares to raise additional capital. On July 1, the corporation declared and
issued a 2-for-1 stock split. On October 1, the corporation purchased on the market 600,000 of its own
outstanding shares and retired them.
Instructions
Compute the weighted average number of shares to be used in computing earnings per share for 2007.

Solution 16-124
Increase Months
(Decrease) Outstanding Outstanding Share Months
Jan. 1 — 1,000,000 2 2/1 4,000,000
March 1 150,000 1,150,000 4 2/1 9,200,000
July 1 1,150,000 2,300,000 3 6,900,000
Oct. 1 (600,000) 1,700,000 3 5,100,000
12 25,200,000
(25,200,000 ÷ 12) 2,100,000
Ex. 16-125—Earnings Per Share. (Essay)
Define the following:
(a) The computation of earnings per common share
(b) Complex capital structure
(c) Basic earnings per share
(d) Diluted earnings per share

Solution 16-125
(a) Earnings per common share is computed by dividing net income less preferred dividends by the
weighted average of common shares outstanding.
(b) A complex capital structure exists when a corporation has convertible securities, options, warrants,
or other rights that upon conversion or exercise could dilute earnings per share.
(c) Basic earnings per share is earnings per share computed based on the common shares
outstanding during the period.
(d) Diluted earnings per share is earnings per share computed based on common stock and all
potentially dilutive common shares that were outstanding during the period.
Ex. 16-126—Earnings per share.
Ramirez Corporation has 400,000 shares of common stock outstanding throughout 2007. In addition, the corporation has
5,000, 20-year, 7% bonds issued at par in 2005. Each $1,000 bond is convertible into 20 shares of common stock after
9/23/08. During the year 2007, the corporation earned $600,000 after deducting all expenses. The tax rate was 30%.
Instructions
Compute the proper earnings per share for 2007.
Solution 16-126
Net income $600,000
Earnings per share: ————————— = ————---- = $1.50
Outstanding shares 400,000
Net income + Interest after taxes
Earnings per share assuming bond conversion: ————————————------------———
Assumed outstanding shares

$600,000 + $245,000
($350,000 × .7 = $245,000); —————————— = $1.69
400,000 + 100,000

Therefore the bonds are antidilutive, and earnings per common share outstanding of $1.50 should be reported.
Note that the convertible security is antidilutive:

Bond interest after taxes $245,000


—————————————--- = ———— = $2.45
Assumed incremental shares 100,000
Ex. 16-127—Diluted earnings per share.
Brewer Company had 400,000 shares of common stock outstanding during the year 2007. In addition, at
December 31, 2007, 90,000 shares were issuable upon exercise of executive stock options which require a $40
cash payment upon exercise (options granted in 2005). The average market price during 2007 was $50.
Instructions
Compute the number of shares to be used in determining diluted earnings per share for 2007.

Solution 16-127
Shares outstanding 400,000
Add: Assumed issuance 90,000
490,000
Deduct: Proceeds/Average market price ($3,600,000 ÷ $50) (72,000)
Number of shares418,000
*Ex. 16-128—Stock
*Ex. 16-128—Stock appreciation
appreciation rights.
rights.
On January
On January 1,
1, 2006,
2006, Rye
Rye Co.
Co. established
established aa stock
stock appreciation
appreciation rights
rights plan
plan for
for its
its executives.
executives. They
They could
could receive
receive cash
cash at
at any
any time
time during
during the
the next
next four
four years
years equal
equal to
to the
the
difference between the market price of the common stock and a preestablished price of $16 on 300,000 SARs. The market price is as follows:
difference between the market price of the common stock and a preestablished price of $16 on 300,000 SARs. The market price is as follows: 12/31/06—$21; 12/31/06—$21;
12/31/07—$18; 12/31/08—$19;
12/31/07—$18; 12/31/08—$19; 12/31/09—$20.
12/31/09—$20. On On December
December 31,31, 2008,
2008, 50,000
50,000 SARs
SARs are
are exercised,
exercised, and
and the
the remaining
remaining SARs
SARs are
are exercised
exercised on
on December
December 31,
31, 2009.
2009.
Instructions
Instructions
(a)
(a) Prepare aa schedule
Prepare schedule that
that shows
shows thethe amount
amount of
of compensation
compensation expense
expense for for each
each of
of the
the four
four years
years starting
starting with
with 2006.
2006.
(b)
(b) Prepare the
Prepare the journal
journal entry
entry at
at 12/31/07
12/31/07 toto record
record compensation
compensation expense.
expense.
(c)
(c) Prepare the
Prepare the journal
journal entry
entry at
at 12/31/09
12/31/09 toto record
record the
the exercise
exercise of
of the
the remaining
remaining SARs.
SARs.

*Solution 16-128
(a) Schedule of Compensation Expense
300,000 SARs
Market Set Value Percent Accrued
Date Price Price of SARs Accrued to Date Expense
12/31/06 $21 $16 $1,500,000 25% $375,000 $375,000
(75,000)
12/31/07 18 16 600,000 50% 300,000 (75,000)
375,000
12/31/08 19 16 900,000 75% 675,000 375,000
325,000
12/31/09 20 16 1,000,000 100% 1,000,000 325,000
($4 × 250,000)

(b) Liability Under Stock Appreciation Plan 75,000


Compensation Expense 75,000
(c) Liability Under Stock Appreciation Plan 1,000,000
Cash 1,000,000
Pr. 16-129—Convertible bonds and stock warrants.
For each of the unrelated transactions described below, present the entry(ies) required to record the bond transactions.
1. On August 1, 2007, Ryan Corporation called its 10% convertible bonds for conversion. The $8,000,000 par bonds were converted into
320,000 shares of $20 par common stock. On August 1, there was $700,000 of unamortized premium applicable to the bonds. The fair market
value of the common stock was $20 per share. Ignore all interest payments.
2. Garnett, Inc. decides to issue convertible bonds instead of common stock. The company issues 10% convertible bonds, par $3,000,000, at
97. The investment banker indicates that if the bonds had not been convertible they would have sold at 94.
3. Lopez Company issues $5,000,000 of bonds with a coupon rate of 8%. To help the sale, detachable stock warrants are issued at the rate of
ten warrants for each $1,000 bond sold. It is estimated that the value of the bonds without the warrants is $4,935,000 and the value of the
warrants is $315,000. The bonds with the warrants sold at 101.

Solution 16-129
1. Bonds Payable 8,000,000
Premium on Bonds Payable 700,000
Common Stock 6,400,000
Paid-in Capital in Excess of Par 2,300,000
2. Cash 2,910,000
Discount on Bonds Payable 90,000
Bonds Payable 3,000,000
3. Cash 5,050,000
Discount on Bonds Payable 253,000
Bonds Payable 5,000,000
Paid-in Capital—Stock Warrants 303,000
($315,000 ÷ $5,250,000 × $5,050,000 = $303,000)
Pr.
Pr. 16-130—Earnings
16-130—Earnings per per share.
share.
Adcock
Adcock Corp.
Corp. had
had $500,000
$500,000 net
net income
income inin 2007.
2007. On
On January
January 1,
1, 2007
2007 there
there were
were 200,000
200,000 shares
shares of
of common
common stock
stock outstanding.
outstanding. On
On April
April 1,
1, 20,000
20,000
shares
shares were issued and on September 1, Adcock bought 30,000 shares of treasury stock. There are 30,000 options to buy common stock at $40
were issued and on September 1, Adcock bought 30,000 shares of treasury stock. There are 30,000 options to buy common stock at $40 a
a
share
share outstanding.
outstanding. The
The market
market price
price of
of the
the common
common stock
stock averaged
averaged $50
$50 during
during 2007.
2007. The
The tax
tax rate
rate is
is 40%.
40%.
During
During 2007,
2007, there
there were
were 40,000
40,000 shares
shares ofof convertible
convertible preferred
preferred stock
stock outstanding.
outstanding. The
The preferred
preferred isis $100
$100 par,
par, pays
pays $3.50
$3.50 a
a year
year dividend,
dividend, and
and is
is
convertible
convertible into
into three
three shares
shares of
of common
common stock.
stock.
Adcock
Adcock issued $2,000,000 of 8% convertible bonds
issued $2,000,000 of 8% convertible bonds at
at face
face value
value during
during 2006.
2006. Each
Each $1,000
$1,000 bond
bond is
is convertible
convertible into
into 30
30 shares
shares of
of common
common stock.
stock.
Instructions
Instructions
Compute
Compute diluted
diluted earnings
earnings per
per share
share for
for 2007.
2007. Complete
Complete the
the schedule
schedule and
and show
show all
all computations.
computations.

Solution 16-130 60,000 120,000


Net Adjust- Adjusted Adjust- Adjusted
Security Income mentNet IncomeShares ment Shares EPS
a
Com. Stock $500,000 $(140,000) $360,000 200,000 5,000 205,000 $1.76
b
Options 360,000 205,000 6,000 211,000 1.71
c
Bonds 360,000 96,000 456,000 211,000 60,000 271,000 1.68
Preferred 456,000 140,000 596,000 271,000 120,000 391,000 1.52
a
20,000 × 3/4 = 15,000
30,000 × 1/3 = (10,000)
5,000 SA
b
30,000
$1,200,000 ÷ $50 = (24,000) (or) [(50 -– 40) ÷ 50] × 30,000 = 6,000 SA
6,000 SA

$96,000 $140,000
c
$2,000,000 × .08 × .6 = $96,000 ———— = $1.60———— = $1.17
60,000 120,000
Pr. 16-131—Basic and diluted EPS.
Assume that the following data relative to Eddy Company for 2007 is available:
Net Income $2,100,000
Transactions in Common Shares Change Cumulative
Jan. 1, 2007, Beginning number 700,000
Mar. 1, 2007, Purchase of treasury shares (60,000) 640,000
June 1, 2007, Stock split 2-1 640,000 1,280,000
Nov. 1, 2007, Issuance of shares 120,000 1,400,000
8% Cumulative Convertible Preferred Stock
Sold at par, convertible into 200,000 shares of common
(adjusted for split). $1,000,000

Stock Options
Exercisable at the option price of $25 per share. Average
market price in 2007, $30 (market price and option price
adjusted for split). 60,000 shares

Instructions
(a) Compute the basic earnings per share for 2007. (Round to the nearest penny.)
(b) Compute the diluted earnings per share for 2007. (Round to the nearest penny.)
Solution 16-131
Computation of weighted average shares outstanding during the year:
January 1 Outstanding 700,000
March 1 Repurchase (5/6 × 60,000) (50,000)
650,000

June 1 2-for-1 split 1,300,000


November 1 Issued (1/6 × 120,000) 20,000
1,320,000

Additional shares for purposes of diluted earnings per share:


Potentially dilutive securities
8% convertible preferred stock 200,000
Stock options
Proceeds from exercise of 60,000 options (60,000 × $25) $1,500,000
Shares issued upon exercise of options 60,000
Less: treasury stock purchasable with proceeds
($1,500,000 ÷ $30) 50,000 10,000
Dilutive securities—additional shares 210,000

$2,100,000 – $80,000
(a) Basic earnings per share: ——————————----------- = $1.53
1,320,000
$2,100,000
(b) Diluted earnings per share: ———–——————-------------- = $1.37
1,320,000 + 210,000
Pr. 16-132—Basic and diluted EPS.
Presented below is information related to Berry Company.
1. Net Income [including an extraordinary gain (net of tax) of $70,000] $230,000
2. Capital Structure
a. Cumulative 8% preferred stock, $100 par,
6,000 shares issued and outstanding $600,000
b. $10 par common stock, 74,000 shares outstanding on January 1.
On April 1, 40,000 shares were issued for cash. On October 1,
16,000 shares were purchased and retired. $1,000,000
c. On January 2 of the current year, Berry purchased Raye Corporation.
One of the terms of the purchase was that if Berry 's net income for the
following year is $2400,000 or more, 50,000 additional shares would
be issued to Raye stockholders next year.
3. Other Information
a. Average market price per share of common stock during entire year $30
b. Income tax rate 30%
Instructions
Compute earnings per share for the current year.
Solution 16-132
Income before extraordinary item $160,000
Less preferred dividends (48,000)
Available to common before extraordinary item 112,000
Add extraordinary gain (net of tax) 70,000
Income available to common $182,000

Weighted average shares outstanding:


January 1 74,000
3/4 × 40,000 30,000
1/4 × 16,000 (4,000)
100,000
Basic earnings per share:
Income before extraordinary item $1.12(a)
Extraordinary item (net of tax) .70(b)
Net income$1.82(c)

Calculations:
$112,000 $70,000 $182,000
(a) ———— (b) ———— (c) ————
100,000 100,000 100,000

Diluted earnings per share:


Income before extraordinary item $ .75(a)
Extraordinary item (net of tax) .46(b)
Net Income$1.21(c)

Calculations:
$112,000 $70,000 $182,000
(a) ———————— (b) ———— (c) ————————
100,000 + 50,000 150,000 100,000 + 50,000

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