Dilutive Securities and Earnings per Share

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Chapter 16 Dilutive Securities and Earnings per Share

QUESTIONS
1. What is meant by a dilutive security?
2. Briefly explain why corporations issue convertible securities.
3. Discuss the similarities and the differences between convertible debt and debt issued with stock warrants.
4. Bridgewater Corp. offered holders of its 1,000 convertible bonds a premium of $160 per bond to induce conversion into shares of its common stock. Upon conversion of all the bonds, Bridgewater Corp. recorded the $160,000 premium as a reduction of paid-in capital. Comment on
Bridgewater’s treatment of the $160,000 “sweetener.”
5. Explain how the conversion feature of convertible debt has a value (a) to the issuer and (b) to the purchaser.
6. What are the arguments for giving separate accounting recognition to the conversion feature of debentures?
7. Four years after issue, debentures with a face value of $1,000,000 and book value of $960,000 are tendered for conversion into 80,000 shares of common stock immediately after an interest payment date. At that time, the market price of the debentures is 104, and the common stock is selling at $14 per share (par value $10). The company records the conversion as follows.
Bonds Payable 1,000,000
Discount on Bonds Payable 40,000
Common Stock 800,000
Paid-in Capital in Excess of Par—Common Stock 160,000
Discuss the propriety of this accounting treatment.
8. On July 1, 2014, Roberts Corporation issued $3,000,000 of 9% bonds payable in 20 years. The bonds include detachable warrants giving the bondholder the right to purchase for $30 one share of $1 par value common stock at any time during the next 10 years. The bonds were sold for $3,000,000. The value of the warrants at the time of issuance was $100,000.
Prepare the journal entry to record this transaction.
9. What are stock rights? How does the issuing company account for them?
10. Briefly explain the accounting requirements for stock compensation plans under GAAP.
11. Cordero Corporation has an employee stock-purchase plan which permits all full-time employees to purchase 10 shares of common stock on the third anniversary of their employment and an additional 15 shares on each subsequent anniversary date. The purchase price is set at the market price on the date purchased and no commission is charged. Discuss whether this plan would be considered compensatory.
12. What date or event does the profession believe should be used in determining the value of a stock option? What arguments support this position?
13. Over what period of time should compensation cost be allocated?
14. How is compensation expense computed using the fair value approach?
15. What are the advantages of using restricted stock to compensate employees?
16. At December 31, 2014, Reid Company had 600,000 shares of common stock issued and outstanding, 400,000 of which had been issued and outstanding throughout the year and 200,000 of which were issued on October 1, 2014.
Net income for 2014 was $2,000,000, and dividends declared on preferred stock were $400,000. Compute Reid’s earnings per common share. (Round to the nearest penny.)
17. What effect do stock dividends or stock splits have on the computation of the weighted-average number of shares outstanding?
18. Define the following terms.
(a) Basic earnings per share.
(b) Potentially dilutive security.
(c) Diluted earnings per share.
(d) Complex capital structure.
(e) Potential common stock.
19. What are the computational guidelines for determining whether a convertible security is to be reported as part of diluted earnings per share?
20. Discuss why options and warrants may be considered potentially dilutive common shares for the computation of diluted earnings per share.
21. Explain how convertible securities are determined to be potentially dilutive common shares and how those convertible securities that are not considered to be potentially dilutive common shares enter into the determination of earnings per share data.
22. Explain the treasury-stock method as it applies to options and warrants in computing dilutive earnings per share data.
23. Earnings per share can affect market prices of common stock. Can market prices affect earnings per share? Explain.
24. What is meant by the term antidilution? Give an example.
25. What type of earnings per share presentation is required in a complex capital structure?
*26. How is antidilution determined when multiple securities are involved? 

BRIEF EXERCISES


BE16-1 Archer Inc. issued $4,000,000 par value, 7% convertible bonds at 99 for cash. If the bonds had not included the conversion feature, they would have sold for 95. Prepare the journal entry to record the issuance of the bonds.

BE16-2 Petrenko Corporation has outstanding 2,000 $1,000 bonds, each convertible into 50 shares of $10 par value common stock. The bonds are converted on December 31, 2014, when the unamortized discount is $30,000 and the market price of the stock is $21 per share. Record the conversion using the book value approach.

BE16-3 Pechstein Corporation issued 2,000 shares of $10 par value common stock upon conversion of
1,000 shares of $50 par value preferred stock. The preferred stock was originally issued at $60 per share.
The common stock is trading at $26 per share at the time of conversion. Record the conversion of the preferred stock.

BE16-4 Eisler Corporation issued 2,000 $1,000 bonds at 101. Each bond was issued with one detachable stock warrant. After issuance, the bonds were selling in the market at 98, and the warrants had a market price of $40. Use the proportional method to record the issuance of the bonds and warrants.

BE16-5 McIntyre Corporation issued 2,000 $1,000 bonds at 101. Each bond was issued with one detachable stock warrant. After issuance, the bonds were selling separately at 98. The market price of the warrants without the bonds cannot be determined. Use the incremental method to record the issuance of the bonds and warrants.

BE16-6 On January 1, 2014, Barwood Corporation granted 5,000 options to executives. Each option entitles the holder to purchase one share of Barwood’s $5 par value common stock at $50 per share at any time during the next 5 years. The market price of the stock is $65 per share on the date of grant. The fair value of the options at the grant date is $150,000. The period of benefit is 2 years. Prepare Barwood’s journal entries for January 1, 2014, and December 31, 2014 and 2015.

BE16-7 Refer to the data for Barwood Corporation in BE16-6. Repeat the requirements assuming that instead of options, Barwood granted 2,000 shares of restricted stock.

BE16-8 On January 1, 2014 (the date of grant), Lutz Corporation issues 2,000 shares of restricted stock to its executives. The fair value of these shares is $75,000, and their par value is $10,000. The stock is forfeited if the executives do not complete 3 years of employment with the company. Prepare the journal entry (if any) on January 1, 2014, and on December 31, 2014, assuming the service period is 3 years.

BE16-9 Kalin Corporation had 2014 net income of $1,000,000. During 2014, Kalin paid a dividend of $2 per share on 100,000 shares of preferred stock. During 2014, Kalin had outstanding 250,000 shares of common stock. Compute Kalin’s 2014 earnings per share.

BE16-10 Douglas Corporation had 120,000 shares of stock outstanding on January 1, 2014. On May 1, 2014,
Douglas issued 60,000 shares. On July 1, Douglas purchased 10,000 treasury shares, which were reissued on October 1. Compute Douglas’s weighted-average number of shares outstanding for 2014.

BE16-11 Tomba Corporation had 300,000 shares of common stock outstanding on January 1, 2014. On
May 1, Tomba issued 30,000 shares. (a) Compute the weighted-average number of shares outstanding if the
30,000 shares were issued for cash. (b) Compute the weighted-average number of shares outstanding if the
30,000 shares were issued in a stock dividend.

BE16-12 Rockland Corporation earned net income of $300,000 in 2014 and had 100,000 shares of common stock outstanding throughout the year. Also outstanding all year was $800,000 of 10% bonds, which are convertible into 16,000 shares of common. Rockland’s tax rate is 40%. Compute Rockland’s 2014 diluted earnings per share.

BE16-13 DiCenta Corporation reported net income of $270,000 in 2014 and had 50,000 shares of common stock outstanding throughout the year. Also outstanding all year were 5,000 shares of cumulative preferred stock, each convertible into 2 shares of common. The preferred stock pays an annual dividend of $5 per share. DiCenta’s tax rate is 40%. Compute DiCenta’s 2014 diluted earnings per share.

BE16-14 Bedard Corporation reported net income of $300,000 in 2014 and had 200,000 shares of common stock outstanding throughout the year. Also outstanding all year were 45,000 options to purchase common stock at $10 per share. The average market price of the stock during the year was $15. Compute diluted earnings per share.

BE16-15 The 2014 income statement of Wasmeier Corporation showed net income of $480,000 and an extraordinary loss of $120,000. Wasmeier had 100,000 shares of common stock outstanding all year. Prepare
Wasmeier’s income statement presentation of earnings per share.

* BE16-16 Ferraro, Inc. established a stock-appreciation rights (SAR) program on January 1, 2014, which entitles executives to receive cash at the date of exercise for the difference between the market price of the stock and the pre-established price of $20 on 5,000 SARs. The required service period is 2 years. The fair value of the SARs are determined to be $4 on December 31, 2014, and $9 on December 31, 2015. Compute
Ferraro’s compensation expense for 2014 and 2015.


EXERCISES


E16-1 (Issuance and Conversion of Bonds) For each of the unrelated transactions described below, present the entry(ies) required to record each transaction.
1. Grand Corp. issued $20,000,000 par value 10% convertible bonds at 99. If the bonds had not been convertible, the company’s investment banker estimates they would have been sold at 95. Expenses of issuing the bonds were $70,000.
2. Hoosier Company issued $20,000,000 par value 10% bonds at 98. One detachable stock purchase warrant was issued with each $100 par value bond. At the time of issuance, the warrants were selling for $4.
3. Suppose Sepracor, Inc. called its convertible debt in 2014. Assume the following related to the transaction.
The 11%, $10,000,000 par value bonds were converted into 1,000,000 shares of $1 par value common stock on July 1, 2014. On July 1, there was $55,000 of unamortized discount applicable to the bonds, and the company paid an additional $75,000 to the bondholders to induce conversion of all the bonds. The company records the conversion using the book value method.

E16-2 (Conversion of Bonds) Aubrey Inc. issued $4,000,000 of 10%, 10-year convertible bonds on June 1,
2014, at 98 plus accrued interest. The bonds were dated April 1, 2014, with interest payable April 1 and October 1. Bond discount is amortized semiannually on a straight-line basis.
On April 1, 2015, $1,500,000 of these bonds were converted into 30,000 shares of $20 par value common stock. Accrued interest was paid in cash at the time of conversion.
Instructions

(a) Prepare the entry to record the interest expense at October 1, 2014. Assume that accrued interest payable was credited when the bonds were issued. (Round to nearest dollar.)
(b) Prepare the entry(ies) to record the conversion on April 1, 2015. (Book value method is used.)
Assume that the entry to record amortization of the bond discount and interest payment has been made.

E16-3 (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 par value of $50 per share. All bonds are converted into preferred stock.
Instructions

Assuming that the book value method was used, what entry would be made?

E16-4 (Conversion of Bonds) On January 1, 2013, when its $30 par value common stock was selling for $80 per share, Plato Corp. issued $10,000,000 of 8% convertible debentures due in 20 years. The conversion option allowed the holder of each $1,000 bond to convert the bond into five shares of the corporation’s common stock. The debentures were issued for $10,800,000. The present value of the bond payments at the time of issuance was $8,500,000, and the corporation believes the difference between the present value and the amount paid is attributable to the conversion feature. On January 1, 2014, the corporation’s $30 par value common stock was split 2 for 1, and the conversion rate for the bonds was adjusted accordingly. On
January 1, 2015, when the corporation’s $15 par value common stock was selling for $135 per share, holders of 30% of the convertible debentures exercised their conversion options. The corporation uses the straightline method for amortizing any bond discounts or premiums.
Instructions

(a) Prepare in general journal form the entry to record the original issuance of the convertible debentures.
(b) Prepare in general journal form the entry to record the exercise of the conversion option, using the book value method. Show supporting computations in good form.

E16-5 (Conversion of Bonds) The December 31, 2014, balance sheet of Kepler Corp. is as follows.
10% callable, convertible bonds payable (semiannual interest dates April 30 and October 31; convertible into 6 shares of $25 par value common stock per $1,000 of bond principal; maturity date April 30, 2020) $500,000
Discount on bonds payable 10,240 $489,760
On March 5, 2015, Kepler Corp. called all of the bonds as of April 30 for the principal plus interest through
April 30. By April 30, all bondholders had exercised their conversion to common stock as of the interest payment date. Consequently, on April 30, Kepler Corp. paid the semiannual interest and issued shares of common stock for the bonds. The discount is amortized on a straight-line basis. Kepler uses the book value method.
Instructions

Prepare the entry(ies) to record the interest expense and conversion on April 30, 2015. Reversing entries were made on January 1, 2015. (Round to the nearest dollar.)

E16-6 (Conversion of Bonds) On January 1, 2014, Gottlieb Corporation issued $4,000,000 of 10-year, 8% convertible debentures at 102. Interest is to be paid semiannually on June 30 and December 31. Each $1,000 debenture can be converted into eight shares of Gottlieb Corporation $100 par value common stock after
December 31, 2015.
On January 1, 2016, $400,000 of debentures are converted into common stock, which is then selling at $110. An additional $400,000 of debentures are converted on March 31, 2016. The market price of the common stock is then $115. Accrued interest at March 31 will be paid on the next interest date.
Bond premium is amortized on a straight-line basis.
Instructions

Make the necessary journal entries for:
(a) December 31, 2015. (c) March 31, 2016.
(b) January 1, 2016. (d) June 30, 2016.
Record the conversions using the book value method.

E16-7 (Issuance of Bonds with Warrants) Illiad Inc. has decided to raise additional capital by issuing $170,000 face value of bonds with a coupon rate of 10%. In discussions with investment bankers, it was determined that to help the sale of the bonds, detachable stock warrants should be issued at the rate of one warrant for each $100 bond sold. The value of the bonds without the warrants is considered to be $136,000, and the value of the warrants in the market is $24,000. The bonds sold in the market at issuance for $152,000.
Instructions

(a) What entry should be made at the time of the issuance of the bonds and warrants?
(b) If the warrants were nondetachable, would the entries be different? Discuss.

E16-8 (Issuance of Bonds with Detachable Warrants) On September 1, 2014, Sands Company sold at 104
(plus accrued interest) 4,000 of its 9%, 10-year, $1,000 face value, nonconvertible bonds with detachable stock warrants. Each bond carried two detachable warrants. Each warrant was for one share of common stock at a specified option price of $15 per share. Shortly after issuance, the warrants were quoted on the market for $3 each. No fair value can be determined for the Sands Company bonds. Interest is payable on
December 1 and June 1. Bond issue costs of $30,000 were incurred.
Instructions

Prepare in general journal format the entry to record the issuance of the bonds. (AICPA adapted)

E16-9 (Issuance of Bonds with Stock Warrants) On May 1, 2014, Friendly Company issued 2,000 $1,000 bonds at 102. Each bond was issued with one detachable stock warrant. Shortly after issuance, the bonds were selling at 98, but the fair value of the warrants cannot be determined.
Instructions

(a) Prepare the entry to record the issuance of the bonds and warrants.
(b) Assume the same facts as part (a), except that the warrants had a fair value of $30. Prepare the entry to record the issuance of the bonds and warrants.


E16-10 (Issuance and Exercise of Stock Options) On November 1, 2014, Columbo Company adopted a stock-option plan that granted options to key executives to purchase 30,000 shares of the company’s $10 par value common stock. The options were granted on January 2, 2015, and were exercisable 2 years after the date of grant if the grantee was still an employee of the company. The options expired 6 years from date of grant. The option price was set at $40, and the fair value option-pricing model determines the total compensation expense to be $450,000.
All of the options were exercised during the year 2017: 20,000 on January 3 when the market price was $67, and 10,000 on May 1 when the market price was $77 a share.
Instructions

Prepare journal entries relating to the stock option plan for the years 2015, 2016, and 2017. Assume that the employee performs services equally in 2015 and 2016.

E16-11 (Issuance, Exercise, and Termination of Stock Options) On January 1, 2015, 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, 2017, by grantees still in the employ of the company, and expiring December 31, 2021. 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, 2016, 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, 2017, 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, 2015, 2016, and 2017.

E16-12 (Issuance, Exercise, and Termination of Stock Options) On January 1, 2013, Nichols Corporation granted 10,000 options to key executives. Each option allows the executive to purchase one share of
Nichols’ $5 par value common stock at a price of $20 per share. The options were exercisable within a
2-year period beginning January 1, 2015, if the grantee is still employed by the company at the time of the exercise. On the grant date, Nichols’ stock was trading at $25 per share, and a fair value option-pricing model determines total compensation to be $400,000.
On May 1, 2015, 8,000 options were exercised when the market price of Nichols’ stock was $30 per share. The remaining options lapsed in 2017 because executives decided not to exercise their options.
Instructions

Prepare the necessary journal entries related to the stock option plan for the years 2013 through 2017.

E16-13 (Accounting for Restricted Stock) Derrick Company issues 4,000 shares of restricted stock to its CFO, Dane Yaping, on January 1, 2014. The stock has a fair value of $120,000 on this date. The service period related to this restricted stock is 4 years. Vesting occurs if Yaping stays with the company for 4 years. The par value of the stock is $5. At December 31, 2015, the fair value of the stock is $145,000.
Instructions

(a) Prepare the journal entries to record the restricted stock on January 1, 2014 (the date of grant), and December 31, 2015.
(b) On March 4, 2016, Yaping leaves the company. Prepare the journal entry (if any) to account for this forfeiture.

E16-14 (Accounting for Restricted Stock) Tweedie Company issues 10,000 shares of restricted stock to its CFO, Mary Tokar, on January 1, 2014. The stock has a fair value of $500,000 on this date. The service period related to this restricted stock is 5 years. Vesting occurs if Tokar stays with the company until
December 31, 2018. The par value of the stock is $10. At December 31, 2014, the fair value of the stock is $450,000.
Instructions

(a) Prepare the journal entries to record the restricted stock on January 1, 2014 (the date of grant), and December 31, 2015.
(b) On July 25, 2018, Tokar leaves the company. Prepare the journal entry (if any) to account for this forfeiture.

E16-15 (Weighted-Average Number of Shares) Newton Inc. uses a calendar year for financial reporting.
The company is authorized to issue 9,000,000 shares of $10 par common stock. At no time has Newton issued any potentially dilutive securities. Listed below is a summary of Newton’s common stock activities.
Instructions
(a) Compute the weighted-average number of common shares used in computing earnings per common share for 2013 on the 2014 comparative income statement.
(b) Compute the weighted-average number of common shares used in computing earnings per common share for 2014 on the 2014 comparative income statement.
(c) Compute the weighted-average number of common shares to be used in computing earnings per common share for 2014 on the 2015 comparative income statement.
(d) Compute the weighted-average number of common shares to be used in computing earnings per common share for 2015 on the 2015 comparative income statement.
(CMA adapted)

E16-16 (EPS: Simple Capital Structure) On January 1, 2015, Wilke Corp. had 480,000 shares of common stock outstanding. During 2015, it had the following transactions that affected the common stock account.
February 1 Issued 120,000 shares
March 1 Issued a 10% stock dividend
May 1 Acquired 100,000 shares of treasury stock
June 1 Issued a 3-for-1 stock split
October 1 Reissued 60,000 shares of treasury stock
Net income $2,500,000
Preferred stock: 50,000 shares outstanding, $100 par, 8% cumulative, not convertible 5,000,000
Common stock: Shares outstanding 1/1 750,000
Issued for cash, 5/1 300,000
Acquired treasury stock for cash, 8/1 150,000
2-for-1 stock split, 10/1
Instructions

Compute earnings per share.
Instructions

(a) Determine the weighted-average number of shares outstanding as of December 31, 2015.
(b) Assume that Wilke Corp. earned net income of $3,456,000 during 2015. In addition, it had 100,000 shares of 9%, $100 par nonconvertible, noncumulative preferred stock outstanding for the entire year. Because of liquidity considerations, however, the company did not declare and pay a preferred dividend in 2015. Compute earnings per share for 2015, using the weighted-average number of shares determined in part (a).
(c) Assume the same facts as in part (b), except that the preferred stock was cumulative. Compute earnings per share for 2015.
(d) Assume the same facts as in part (b), except that net income included an extraordinary gain of $864,000 and a loss from discontinued operations of $432,000. Both items are net of applicable income taxes. Compute earnings per share for 2015.

E16-17 (EPS: Simple Capital Structure) Ace Company had 200,000 shares of common stock outstanding on December 31, 2015. During the year 2016, the company issued 8,000 shares on May 1 and retired 14,000 shares on October 31. For the year 2016, Ace Company reported net income of $249,690 after a casualty loss of $40,600 (net of tax).
Instructions

What earnings per share data should be reported at the bottom of its income statement, assuming that the casualty loss is extraordinary?

E16-18 (EPS: Simple Capital Structure) Flagstad Inc. presented the following data.
1. Number of common shares issued and outstanding at December 31, 2012 2,000,000
2. Shares issued as a result of a 10% stock dividend on September 30, 2013 200,000
3. Shares issued for cash on March 31, 2014 2,000,000
Number of common shares issued and outstanding at December 31, 2014 4,200,000
4. A 2-for-1 stock split of Newton’s common stock took place on March 31, 2015


E16-19 (EPS: Simple Capital Structure) A portion of the combined statement of income and retained earnings of Seminole Inc. for the current year follows.
At the end of the current year, Seminole Inc. has outstanding 8,500,000 shares of $10 par common stock and 50,000 shares of 6% preferred. On April 1 of the current year, Seminole Inc. issued 1,000,000 shares of common stock for $32 per share to help finance the casualty.
Instructions

Compute the earnings per share on common stock for the current year as it should be reported to stockholders.

E16-20 (EPS: Simple Capital Structure) On January 1, 2014, Lennon Industries had stock outstanding as follows.
6% Cumulative preferred stock, $100 par value, issued and outstanding 10,000 shares $1,000,000
Common stock, $10 par value, issued and outstanding 200,000 shares 2,000,000
To acquire the net assets of three smaller companies, Lennon authorized the issuance of an additional
160,000 common shares. The acquisitions took place as shown below.
On May 14, 2014, Lennon realized a $90,000 (before taxes) insurance gain on the expropriation of investments originally purchased in 2000.
On December 31, 2014, Lennon recorded net income of $300,000 before tax and exclusive of the gain.
Instructions

Assuming a 50% tax rate, compute the earnings per share data that should appear on the financial statements of Lennon Industries as of December 31, 2014. Assume that the expropriation is extraordinary.

E16-21 (EPS: Simple Capital Structure) At January 1, 2014, Langley Company’s outstanding shares included the following.
280,000 shares of $50 par value, 7% cumulative preferred stock
900,000 shares of $1 par value common stock
Net income for 2014 was $2,530,000. No cash dividends were declared or paid during 2014. On February
15, 2015, however, all preferred dividends in arrears were paid, together with a 5% stock dividend on common shares. There were no dividends in arrears prior to 2014.
On April 1, 2014, 450,000 shares of common stock were sold for $10 per share, and on October 1, 2014,
110,000 shares of common stock were purchased for $20 per share and held as treasury stock.
Instructions

Compute earnings per share for 2014. Assume that financial statements for 2014 were issued in March 2015.

E16-22 (EPS with Convertible Bonds, Various Situations) In 2013, Chirac Enterprises issued, at par,
60 $1,000, 8% bonds, each convertible into 100 shares of common stock. Chirac had revenues of $17,500 and Income before extraordinary item $15,000,000
Extraordinary loss, net of applicable income tax (Note 1) 1,340,000
Net income 13,660,000
Retained earnings at the beginning of the year 83,250,000
96,910,000
Dividends declared:
On preferred stock—$6.00 per share $ 300,000
On common stock—$1.75 per share 14,875,000 15,175,000
Retained earnings at the end of the year $81,735,000
Note 1. During the year, Seminole Inc. suffered a major casualty loss of $1,340,000 after applicable income tax reduction of $1,200,000.
Date of Acquisition Shares Issued
Company A April 1, 2014 50,000
Company B July 1, 2014 80,000
Company C October 1, 2014 30,000
expenses other than interest and taxes of $8,400 for 2014. (Assume that the tax rate is 40%.) Throughout
2014, 2,000 shares of common stock were outstanding; none of the bonds was converted or redeemed.
Instructions

(a) Compute diluted earnings per share for 2014.
(b) Assume the same facts as those assumed for part (a), except that the 60 bonds were issued on
September 1, 2014 (rather than in 2013), and none have been converted or redeemed.
(c) Assume the same facts as assumed for part (a), except that 20 of the 60 bonds were actually converted on July 1, 2014.

E16-23 (EPS with Convertible Bonds) On June 1, 2012, Andre Company and Agassi Company merged to form Lancaster Inc. A total of 800,000 shares were issued to complete the merger. The new corporation reports on a calendar-year basis.
On April 1, 2014, the company issued an additional 400,000 shares of stock for cash. All 1,200,000 shares were outstanding on December 31, 2014.
Lancaster Inc. also issued $600,000 of 20-year, 8% convertible bonds at par on July 1, 2014. Each $1,000 bond converts to 40 shares of common at any interest date. None of the bonds have been converted to date.
Lancaster Inc. is preparing its annual report for the fiscal year ending December 31, 2014. The annual report will show earnings per share figures based upon a reported after-tax net income of $1,540,000. (The tax rate is 40%.)
Instructions

Determine the following for 2014.
(a) The number of shares to be used for calculating:
(1) Basic earnings per share.
(2) Diluted earnings per share.
(b) The earnings figures to be used for calculating:
(1) Basic earnings per share.
(2) Diluted earnings per share.
(CMA adapted)

E16-24 (EPS with Convertible Bonds and Preferred Stock) The Simon Corporation issued 10-year, $5,000,000 par, 7% callable convertible subordinated debentures on January 2, 2014. The bonds have a par value of $1,000, with interest payable annually. The current conversion ratio is 14:1, and in 2 years it will increase to 18:1. At the date of issue, the bonds were sold at 98. Bond discount is amortized on a straightline basis. Simon’s effective tax was 35%. Net income in 2014 was $9,500,000, and the company had 2,000,000 shares outstanding during the entire year.
Instructions

(a) Prepare a schedule to compute both basic and diluted earnings per share.
(b) Discuss how the schedule would differ if the security was convertible preferred stock.

E16-25 (EPS with Convertible Bonds and Preferred Stock) On January 1, 2014, 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 2014 was $300,000, and its tax rate was 40%. The company had
100,000 shares of common stock outstanding throughout 2014. None of the bonds were converted in 2014.
Instructions

(a) Compute diluted earnings per share for 2014.
(b) Compute diluted earnings per share for 2014, 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.

E16-26 (EPS with Options, Various Situations) Venzuela Company’s net income for 2014 is $50,000. The only potentially dilutive securities outstanding were 1,000 options issued during 2013, each exercisable for one share at $6. None has been exercised, and 10,000 shares of common were outstanding during 2014.
The average market price of Venzuela’s stock during 2014 was $20.
Instructions

(a) Compute diluted earnings per share. (Round to nearest cent.)
(b) Assume the same facts as those assumed for part (a), except that the 1,000 options were issued on
October 1, 2014 (rather than in 2013). The average market price during the last 3 months of 2014 was $20.

E16-27 (EPS with Contingent Issuance Agreement) Winsor Inc. recently purchased Holiday Corp., a large midwestern home painting corporation. One of the terms of the merger was that if Holiday’s income for 2014 was $110,000 or more, 10,000 additional shares would be issued to Holiday’s stockholders in 2015.
Holiday’s income for 2013 was $120,000.
Instructions

(a) Would the contingent shares have to be considered in Winsor’s 2013 earnings per share computations?
(b) Assume the same facts, except that the 10,000 shares are contingent on Holiday’s achieving a net income of $130,000 in 2014. Would the contingent shares have to be considered in Winsor’s earnings per share computations for 2013?

E16-28 (EPS with Warrants) Howat Corporation earned $360,000 during a period when it had an average of 100,000 shares of common stock outstanding. The common stock sold at an average market price of $15 per share during the period. Also outstanding were 15,000 warrants that could be exercised to purchase one share of common stock for $10 for each warrant exercised.
Instructions

(a) Are the warrants dilutive?
(b) Compute basic earnings per share.
(c) Compute diluted earnings per share.

*E 16-29 (Stock-Appreciation Rights) On December 31, 2010, Beckford Company issues 150,000 stock appreciation rights to its officers entitling them to receive cash for the difference between the market price of its stock and a pre-established price of $10. The fair value of the SARs is estimated to be $4 per SAR on
December 31, 2011; $1 on December 31, 2012; $10 on December 31, 2013; and $9 on December 31, 2014. The service period is 4 years, and the exercise period is 7 years.
Instructions

(a) Prepare a schedule that shows the amount of compensation expense allocable to each year affected by the stock-appreciation rights plan.
(b) Prepare the entry at December 31, 2014, to record compensation expense, if any, in 2014.
(c) Prepare the entry on December 31, 2014, assuming that all 150,000 SARs are exercised.

*E 16-30 (Stock-Appreciation Rights) Capulet Company establishes a stock-appreciation rights program that entitles its new president Ben Davis to receive cash for the difference between the market price of the stock and a pre-established price of $30 (also market price) on December 31, 2010, on 30,000 SARs. The date of grant is December 31, 2010, and the required employment (service) period is 4 years. President Davis exercises all of the SARs in 2016. The fair value of the SARs is estimated to be $6 per SAR on December 31,
2011; $9 on December 31, 2012; $15 on December 31, 2013; $6 on December 31, 2014; and $18 on December
31, 2015.
Instructions

(a) Prepare a 5-year (2011–2015) schedule of compensation expense pertaining to the 30,000 SARs granted president Davis.
(b) Prepare the journal entry for compensation expense in 2011, 2014, and 2015 relative to the 30,000 SARs.

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