16 Dilutive Securities and Earnings per Share PROBLEMS 16
PROBLEMS
P16-1 (LO1,2,3) GROUPWORK (Entries for Various Dilutive Securities) The stockholders’ equity section of Martino Inc. at the beginning of the current year appears below…
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.
P16-2 (L01) EXCEL (Entries for Conversion, Amortization, and Interest of Bonds) Volker Inc. issued $2,500,000 of convertible 10-year bonds on July 1, 2017. The bonds provide for 12% interest payable semiannually on January 1 and July 1. The discount in connection with the issue was $54,000, which is being amortized monthly on a straight-line basis.
The bonds are convertible after one year into 8 shares of Volker Inc.’s $100 par value common stock for each $1,000 of bonds.
On August 1, 2018, $250,000 of bonds were turned in for conversion into common stock. Interest has been accrued monthly and paid as due. At the time of conversion, any accrued interest on bonds being converted is paid in cash.
Instructions
Prepare the journal entries to record the conversion, amortization, and interest in connection with the bonds as of the following dates. (Round to the nearest dollar.)
(a) August 1, 2018. (Assume the book value method is used.)
(b) August 31, 2018.
(c) December 31, 2018, including closing entries for end-of-year.
(AICPA adapted)
P16-3 (L03) EXCEL (Stock-Option Plan) Berg Company adopted a stock-option plan on November 30, 2016, that provided that 70,000 shares of $5 par value stock be designated as available for the granting of options to officers of the corporation at a price of $9 a share. The market price was $12 a share on November 30, 2017.
On January 2, 2017, options to purchase 28,000 shares were granted to president Tom Winter—15,000 for services to be rendered in 2017 and 13,000 for services to be rendered in 2018. Also on that date, options to purchase 14,000 shares were granted to vice president Michelle Bennett—7,000 for services to be rendered in 2017 and 7,000 for services to be rendered in 2018. The market price of the stock was $14 a share on January 2, 2017. The options were exercisable for a period of one year following the year in which the services were rendered. The fair value of the options on the grant date was $4 per option.
In 2018, neither the president nor the vice president exercised their options because the market price of the stock was below the exercise price. The market price of the stock was $8 a share on December 31, 2018, when the options for 2017 services lapsed.
On December 31, 2019, both president Winter and vice president Bennett exercised their options for 13,000 and 7,000 shares, respectively, when the market price was $16 a share.
Instructions
Prepare the necessary journal entries in 2016 when the stock-option plan was adopted, in 2017 when options were granted, in 2018 when options lapsed, and in 2019 when options were exercised.
P16-4 (L03) (Stock-Based Compensation) Assume that Amazon.com has a stock-option plan for top management. Each stock option represents the right to purchase a share of Amazon $1 par value common stock in the future at a price equal to the fair value of the stock at the date of the grant. Amazon has 5,000 stock options outstanding, which were granted at the beginning of 2017. The following data relate to the option grant.
…
Instructions
(a) Prepare the journal entry(ies) for the first year of the stock-option plan.
(b) Prepare the journal entry(ies) for the first year of the plan assuming that, rather than options, 700 shares of restricted stock were granted at the beginning of 2017.
(c) Now assume that the market price of Amazon stock on the grant date was $45 per share. Repeat the requirements for (a) and (b).
(d) Amazon would like to implement an employee stock-purchase plan for rank-and-file employees, but it would like to avoid recording expense related to this plan. Which of the following provisions must be in place for the plan to avoid recording compensation expense?
(1) Substantially all employees may participate.
(2) The discount from market is small (less than 5%).
(3) The plan offers no substantive option feature.
(4) There is no preferred stock outstanding.
P16-5 (L05) GROUPWORK (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.
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.
P16-6 (L04) (Basic EPS: Two-Year Presentation) Melton Corporation is preparing the comparative financial statements for the annual report to its shareholders for fiscal years ended May 31, 2017, and May 31, 2018. The income from operations for the fiscal year ended May 31, 2017, was $1,800,000 and income from continuing operations for the fiscal year ended May 31, 2018, was $2,500,000. In both years, the company incurred a 10% interest expense on $2,400,000 of debt, an obligation that requires interestonly payments for 5 years. The company experienced a loss from discontinued operations of $600,000 on February 2018. The company uses a 40% effective tax rate for income taxes.
The capital structure of Melton Corporation on June 1, 2016, consisted of 1 million shares of common stock outstanding and
20,000 shares of $50 par value, 6%, cumulative preferred stock. There were no preferred dividends in arrears, and the company had not issued any convertible securities, options, or warrants.
On October 1, 2016, Melton sold an additional 500,000 shares of the common stock at $20 per share. Melton distributed a
20% stock dividend on the common shares outstanding on January 1, 2017. On December 1, 2017, Melton was able to sell an additional
800,000 shares of the common stock at $22 per share. These were the only common stock transactions that occurred during the two fiscal years.
Instructions
(a) Identify whether the capital structure at Melton Corporation is a simple or complex capital structure, and explain why.
(b) Determine the weighted-average number of shares that Melton Corporation would use in calculating earnings per share for the fiscal year ended:
(1) May 31, 2017.
(2) May 31, 2018.
(c) Prepare, in good form, a comparative income statement, beginning with income from operations, for Melton Corporation for the fiscal years ended May 31, 2017, and May 31, 2018. This statement will be included in Melton’s annual report and should display the appropriate earnings per share presentations.
(CMA adapted)
P16-7 (L04,5) 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…
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.
P16-8 (L05) (Computation of Basic and Diluted EPS) The information below pertains to Barkley Company for 2018…
Instructions
(a) Compute basic earnings per share for 2018.
(b) Compute diluted earnings per share for 2018.
P16-9 (L04) (EPS with Stock Dividend and Discontinued Operations) Christina Corporation is preparing the comparative financial statements to be included in the annual report to stockholders. Christina employs a fiscal year ending May 31.
Income from operations before income taxes for Christina was $1,400,000 and $660,000, respectively, for fiscal years ended May 31, 2018 and 2017. Christina experienced a loss from discontinued operations of $400,000 on March 3, 2018. A 40% combined income tax rate pertains to any and all of Christina Corporation’s profits, gains, and losses.
Christina’s capital structure consists of preferred stock and common stock. The company has not issued any convertible securities or warrants and there are no outstanding stock options.
Christina issued 40,000 shares of $100 par value, 6% cumulative preferred stock in 2014. All of this stock is outstanding, and no preferred dividends are in arrears.
There were 1,000,000 shares of $1 par common stock outstanding on June 1, 2016. On September 1, 2016, Christina sold an additional 400,000 shares of the common stock at $17 per share. Christina distributed a 20% stock dividend on the common shares outstanding on December 1, 2017. These were the only common stock transactions during the past 2 fiscal years.
Instructions
(a) Determine the weighted-average number of common shares that would be used in computing earnings per share on the current comparative income statement for:
(1) The year ended May 31, 2017.
(2) The year ended May 31, 2018.
(b) Starting with income from operations before income taxes, prepare a comparative income statement for the years ended May 31, 2018 and 2017. The statement will be part of Christina Corporation’s annual report to stockholders and should include appropriate earnings per share presentation.
(c) The capital structure of a corporation is the result of its past financing decisions. Furthermore, the earnings per share data presented on a corporation’s financial statements is dependent upon the capital structure.
(1) Explain why Christina Corporation is considered to have a simple capital structure.
(2) Describe how earnings per share data would be presented for a corporation that has a complex capital structure. (CMA adapted)
