DILUTIVE
SECURITIES AND EARNINGS PER SHARE
Ex. 1—Convertible Bonds.
Catt Co. issued P3,000,000 of 12%, 5-year convertible bonds on December 1, 2003 for P3,013,000
plus accrued interest. The bonds were dated April 1, 2003 with interest payable April 1 and
October 1. Bond premium is amortized
each interest period on a straight-line basis. Catt Co. has a fiscal year end
of September 30.
On October 1, 2004 ,
P1,500,000 of these bonds were converted into 21,000 shares of P15 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, 2004 . Assume that interest payable
was credited when the bonds were issued (round to nearest peso).
(b) Prepare
the entry to record the conversion on October 1, 2004 . Assume that the entry to record
amortization of the bond premium and interest payment has been made.
Ex. 2—Stock options.
Prepare the necessary entries from 1/1/03-2/1/05 for the following events
using the fair value method. If no entry
is needed, write "No Entry Necessary."
1. On 1/1/03 , the stockholders adopted a stock option plan for
top executives whereby each might receive rights to purchase up to 10,000
shares of common stock at P40 per share. The par value is P10 per share.
2. On 2/1/03 , options were granted to each of five executives to
purchase 10,000 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 2/1/05 . It is
assumed that the options were for services performed equally in 2003 and 2004.
The Black-Scholes option pricing model determines total compensation expense to
be P1,100,000.
3. At 2/1/05 , four executives exercised their options. The fifth
executive chose not to exercise his options, which therefore were forfeited.
Ex. 3—Weighted average shares outstanding.
On January 1, 2004 ,
Yarrow Corporation had 800,000 shares of common stock outstanding. On March 1, the corporation issued 120,000
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 480,000 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 2004.
Ex. 4—Earnings per share.
Ramirez Corporation has 500,000 shares of common stock outstanding
throughout 2004. In addition, the corporation has 5,000, 20-year, 7% bonds
issued at par in 2002. Each P1,000 bond is convertible into 25 shares of common
stock after 9/23/05 .
During the year 2004, the corporation earned P600,000 after deducting all
expenses. The tax rate was 30%.
Instructions
Compute the proper
earnings per share for 2004.
Ex. 5—Diluted earnings per share.
Brewer Company had 300,000 shares of common stock outstanding during the
year 2004. In addition, at December
31, 2004 , 70,000 shares were issuable upon exercise of executive
stock options which require a P40 cash payment upon exercise (options granted
in 2002). The average market price during 2004 was P50.
Instructions
Compute the number of shares to be used in determining diluted earnings
per share for 2004.
Ex. 6—Stock appreciation rights.
On January 1, 2002 ,
Rye Co. established a stock appreciation rights plan for its executives. They
could receive cash at any time during the next
four years equal to the difference between the market price of the
common stock and a preestablished price of P16 on 240,000 SARs. The market
price is as follows: 12/31/02 —P21;
12/31/03 —P18; 12/31/04 —P19; 12/31/05 —P20. On December 31, 2004 , 50,000
SARs are exercised, and the remaining SARs are exercised on December 31, 2005 .
Instructions
(a) Prepare a
schedule that shows the amount of compensation expense for each of the four
years starting with 2002.
(b) Prepare
the journal entry at 12/31/03
to record compensation expense.
(c) Prepare
the journal entry at 12/31/05
to record the exercise of the remaining SARs.
Ex. 7—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, 2004 , Ryan
Corporation called its 10% convertible bonds for conversion. The P6,000,000 par
bonds were converted into 240,000 shares of P20 par common stock. On August 1,
there was P525,000 of unamortized premium applicable to the bonds. The fair
market value of the common stock was P20 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 P2,000,000, at 97. The investment banker indicates that if the
bonds had not been convertible they would have sold at 94.
3. Gomez
Company issues P3,000,000 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 P1,000
bond sold. It is estimated that the
value of the bonds without the warrants is P2,961,000 and the value of the
warrants is P189,000. The bonds with the warrants sold at 101.
Ex. 8—Earnings per share.
Birney Corp. had P900,000 net income in 2004. On January 1, 2004 there were
220,000 shares of common stock outstanding. On April 1, 20,000 shares were issued
and on September 1, Birney bought 30,000 shares of treasury stock. There are
30,000 options to buy common stock at P40 a share outstanding. The market price
of the common stock averaged P50 during 2004. The tax rate is 40%.
During 2004, there were 20,000 shares of convertible
preferred stock outstanding. The preferred is P100 par, pays P7 a year
dividend, and is convertible into three shares of common stock.
Birney issued P2,000,000 of 8% convertible bonds at face value during
2003. Each P1,000 bond is convertible into 20 shares of common stock.
Instructions
Compute diluted earnings per share for 2004. Complete the
schedule and show all computations.
Net Adjust- Adjusted Adjust- Adjusted
Security Income ment Net Income Shares ment Shares EPS
Ex. 9—Basic and diluted EPS.
Assume that the
following data relative to Eddy Company for 2004 is available:
Net Income P1,400,000
Transactions in Common Shares Change Cumulative
8% Cumulative
Convertible Preferred Stock
Sold at par, convertible into 200,000 shares of common
(adjusted for split). P1,000,000
Stock Options
Exercisable at the option price of P25 per share. Average
market price in 2004, P30 (market price and option price
adjusted for split). 60,000
shares
Instructions
(a) Compute the basic earnings per share for
2004. (Round to the nearest centavo.)
(b) Compute the diluted earnings per share for
2004. (Round to the nearest centavo.)
Ex. 10—Basic and diluted EPS.
Presented below is
information related to Alley Company.
1. Net
Income [including an extraordinary gain (net of tax) of P130,000] P420,000
2. Capital
Structure
a. Cumulative 8% preferred stock, P100 par,
6,000
shares issued and outstanding P600,000
b. P10 par common stock, 84,000 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. P1,000,000
c. On January 2 of the current year, Alley
purchased Raye Corporation.
One
of the terms of the purchase was that if Alley's net income for the
following
year is P400,000 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 P30
b. Income tax rate 30%
Instructions
Compute earnings per
share for the current year.
Ex. 11—Basic and diluted EPS.
The following
information was taken from the books and records of Simonic, Inc.:
1. Net income P 840,000
2. Capital structure:
a. Convertible 6% bonds. Each of the 300, P1,000
bonds is convertible
into
50 shares of common stock at the present date and for the next
10
years. 300,000
b. P10 par common stock, 400,000 shares issued
and outstanding
during
the entire year. 4,000,000
c. Stock warrants outstanding to buy 16,000
shares of common stock
at
P20 per share.
3. Other information:
a. Bonds converted during the year None
b. Income tax rate 30%
c. Convertible debt was outstanding the entire
year
d. Average market price per share of common
stock during the year P32
e. Warrants were outstanding the entire year
f. Warrants exercised during the year None
Instructions
Compute basic and diluted earnings per share.
Solution 16-80
(a) Interest
Payable ............................................................................. 60,000
Interest
Expense ............................................................................ 119,000
Premium
on Bonds Payable .......................................................... 1,000
Cash
................................................................................... 180,000
Calculations:
Issuance
price P3,013,000
Par
value 3,000,000
Total
premium P
13,000
Months
remaining 52
Premium
per month P250
Premium
amortized (4 × P250) P1,000
(b) Bonds
Payable ............................................................................... 1,500,000
Premium
on Bonds Payable .......................................................... 5,250
Common
Stock (21,000 × P15)......................................... 315,000
Paid-in
Capital in Excess of Par ........................................ 1,190,250
Calculations:
Premium
related to 1/2 of the bonds P6,500 (P13,000 ÷ 2)
Less
premium amortized 1,250 [(P6,500
÷ 52) × 10]
Premium
remaining P5,250
Solution 16-93
Basic EPS = P840,000 ÷
400,000 sh. = P2.10
Net Adjust- Adjusted
Adjust- Adjusted Diluted
Security Income ment
Net Income Shares ment Shares EPS
Warrants 840,000 — 840,000 400,000 6,0001 406,000 2.07
Conv. Bonds 840,000 P12,6002 852,600 406,000 15,000 421,000 2.03
16,000
1
320,000
———— = (10,000)
32
6,000 SA
P12,600
2 P300,000 ´ .06 ´ .7 = P12,600 ————
= P.84
15,000
Solution 16-82
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.
Solution 16-83
1. 1/1/03
No entry necessary.
2. 2/1/03
No
entry necessary.
Compensation
Expense ................................................................ 550,000
Paid-in
Capital—Stock Options ......................................... 550,000
12/31/04
Compensation
Expense ................................................................ 550,000
Paid-in
Capital—Stock Options ......................................... 550,000
3. 2/1/05
Cash
(4 × 10,000 × P40) ............................................................... 1,600,000
Paid-in
Capital—Stock Options (P1,100,000 × 4/5) ...................... 880,000
Common
Stock ................................................................. 400,000
Paid-in
Capital in Excess of Par ........................................ 2,080,000
Paid-in
Capital—Stock Options ..................................................... 220,000
Paid-in
Capital from Expired Stock Options ..................... 220,000
Ex. 16-85—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 16-85
(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.
Solution 16-84
Increase Months
(Decrease) Outstanding Outstanding Share Months
Jan. 1 — 800,000 2 2/1 3,200,000
March 1 120,000 920,000 4 2/1 7,360,000
Oct. 1 (480,000) 1,360,000
3 4,080,000
12 20,160,000
(20,160,000
÷ 12) 1,680,000
Solution 16-86
Net income P600,000
Earnings
per share: ————————— = ———— = P1.20
Outstanding
shares 500,000
Net income + Interest after taxes
Earnings
per share assuming bond conversion: ———————————————
Assumed outstanding shares
P600,000 + P245,000
(P350,000 × .7 = P245,000); —————————— = P1.35
500,000 + 125,000
Therefore the bonds are antidilutive, and earnings per
common share outstanding of P1.20 should be reported.
Note that the
convertible security is antidilutive:
Bond interest
after taxes P245,000
—————————————
= ———— = P1.96
Assumed
incremental shares
125,000
Solution 16-87
Shares outstanding 300,000
Add: Assumed issuance 70,000
370,000
Deduct: Proceeds/Average market price (P2,800,000 ÷ P50) (56,000)
Number of shares 314,000
Ex. 16-81—Convertible Bonds.
King Co. sold convertible bonds at a premium. Interest is paid on May 31
and November 30. On May 31, after interest was paid, 100, P1,000 bonds are
tendered for conversion into 3,000 shares of P10 par value common stock that
had a market price of P40 per share. How should King Co. account for the
conversion of the bonds into common stock under the book value method? Discuss
the rationale for this method.
Solution 16-81
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. 16-82—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
16-88
(a) Schedule
of Compensation Expense
240,000 SARs
Market Set Value Percent Accrued
Date Price Price
of SARs Accrued to Date Expense
(60,000)
300,000
220,000
(P4
× 190,000)
*Solution
16-88 (cont.)
(b) Liability
Under Stock Appreciation Plan ........................................ 60,000
Compensation
Expense .................................................... 60,000
(c) Liability
Under Stock Appreciation Plan ........................................ 760,000
Cash
................................................................................... 760,000
Solution 16-89
1. Bonds
Payable .................................................................................. 6,000,000
Premium
on Bonds Payable ............................................................. 525,000
Common
Stock .................................................................... 4,800,000
Paid-in
Capital in Excess of Par ........................................... 1,725,000
2. Cash ................................................................................................. 1,940,000
Discount
on Bonds Payable ............................................................. 60,000
Bonds
Payable ...................................................................... 2,000,000
3. Cash ................................................................................................. 3,030,000
Discount
on Bonds Payable ............................................................. 151,800
Bonds
Payable ...................................................................... 3,000,000
Paid-in
Capital—Stock Warrants .......................................... 181,800
(P189,000
÷ P3,150,000 × P3,030,000 = P181,800)
Solution 16-90
Net
Adjust- Adjusted Adjust- Adjusted
Security Income
ment Net Income Shares ment Shares EPS
Com. Stock P900,000 P(140,000) P760,000 220,000 5,000a 225,000 P3.38
Options 760,000 225,000 6,000b 231,000 3.29
Bonds 760,000 96,000c 856,000 231,000 40,000 271,000 3.16
Preferred 856,000 140,000 996,000 271,000 60,000 331,000 3.01
a 20,000 ×
3/4 = 15,000
30,000
× 1/3 = (10,000)
5,000 SA
b 30,000
P1,200,000
÷ P50 = (24,000) (or) [(50 – 40) ÷ 50] × 30,000 = 6,000
SA
6,000 SA
P96,000 P140,000
c P2,000,000
× .08 × .6 = P96,000 ———— = P2.40 ———— = P2.33
40,000 60,000
Solution 16-91
Computation of
weighted average shares outstanding during the year:
January
1 Outstanding 500,000
March
1 Repurchase (5/6 × 60,000) (50,000)
450,000
June
1 2-for-1 split 900,000
November
1 Issued (1/6 × 120,000) 20,000
920,000
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 × P25) P1,500,000
Shares
issued upon exercise of options 60,000
Less:
treasury stock purchasable with proceeds
(P1,500,000
÷ P30) 50,000
10,000
Dilutive
securities—additional shares 210,000
P1,400,000 – P80,000
(a) Basic earnings per share: —————————— = P1.43
920,000
P1,400,000
(b) Diluted earnings per share: ———–————— = P1.24
920,000
+ 210,000
Solution 16-92
Income before extraordinary item P290,000
Less preferred dividends (48,000)
Available to common before extraordinary item 242,000
Add extraordinary gain (net of tax) 130,000
Income available to common P372,000
Weighted average shares outstanding:
January 1 84,000
3/4 × 40,000 30,000
1/4
× 16,000 (4,000)
110,000
Basic earnings per
share:
Income
before extraordinary item P2.20 (a)
Extraordinary
item (net of tax) 1.18 (b)
Net
income P3.38 (c)
Calculations:
P242,000 P130,000 P372,000
(a) ———— (b) ———— (c) ————
110,000
110,000 110,000
Diluted earnings per
share:
Income
before extraordinary item P1.51 (a)
Extraordinary
item (net of tax) .81 (b)
Net
Income P2.32 (c)
Calculations:
P242,000 P130,000 P372,000
(a) ———————— (b) ———— (c) ————————
110,000 + 50,000 160,000 110,000 +
50,000
