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SOLUTIONS TO EXERCISES

 

EXERCISE 16-4

 

(a)   Cash.......................................................................     10,800,000

                Bonds Payable................................................................                                   10,000,000

                Premium on Bonds Payable........................................                                        800,000

                   (To record issuance of $10,000,000

                    of 8% convertible debentures for

                     $10,800,000. The bonds mature in

                     twenty years, and each $1,000

                     bond is convertible into five shares

                     of $30 par value common stock)

 


EXERCISE 16-4 (Continued)

 

(b)   Bonds Payable......................................................        3,000,000

        Premium on Bonds Payable

            (Schedule 1) ..........................................................           216,000

                Common Stock, $15 par

                    (Schedule 2) ................................................................                                         450,000

                Paid-in Capital in Excess of Par..................................                                      2,766,000

                    (To record conversion of 30% of

                     the outstanding 8% convertible

                     debentures after giving effect to

                     the 2-for-1 stock split)

 

Schedule 1

Computation of Unamortized Premium on Bonds Converted

 

Premium on bonds payable on January 1, 2003                                    $800,000

Amortization for 2003 ($800,000 ÷ 20)                             $40,000

Amortization for 2004 ($800,000 ÷ 20)                             +40,000                 80,000

Premium on bonds payable on January 1, 2005                                      720,000

Bonds converted                                                                                                   30%

Unamortized premium on bonds converted                                            $216,000

Schedule 2

Computation of Common Stock Resulting from Conversion

 

Number of shares convertible on January 1, 2003:

    Number of bonds ($10,000,000 ÷ $1,000)                     10,000

    Number of shares for each bond                                   X      5                 50,000

Stock split on January 1, 2004                                                                    X           2

Number of shares convertible after the stock split                                  100,000

% of bonds converted                                                                                  X      30%

Number of shares issued                                                                                 30,000

Par value/per share                                                                                                $15

Total par value                                                                                               $450,000


EXERCISE 16-8

 

SANDS COMPANY

Journal Entry

September 1, 2004

                                                                                                                                          

 

Cash..................................................................................      4,220,000

Unamortized Bond Issue Costs........................................           30,000

        Bonds Payable (4,000 X $1,000)............................................                                   4,000,000

        Premium on Bonds Payable—Schedule 1..........................                                      136,000

        Paid-in Capital—Stock Warrants—

            Schedule 1.............................................................................                                        24,000

        Bond Interest Expense—Schedule 2...................................                                        90,000

            (To record the issuance of the bonds)

 

Schedule 1

Premium on Bonds Payable and Value of Stock Warrants

Sales price (4,000 X $1,040)                                                                    $4,160,000

Face value of bonds                                                                                   4,000,000

                                                                                                                            160,000

Deduct value assigned to stock warrants

 (4,000 X 2 = 8,000; 8,000 X $3)                                                                      24,000

Premium on bonds payable                                                                    $   136,000

 

Schedule 2

Accrued Bond Interest to Date of Sale

 

Face value of bonds                                                                                 $4,000,000

Interest rate                                                                                                              9%

Annual interest                                                                                           $   360,000

 

Accrued interest for 3 months – ($360,000 X 3/12)                             $     90,000

EXERCISE 16-11

 

1/1/05         No entry

 

12/31/05     Compensation Expense..................................      175,000

                               Paid-in Capital—Stock Options.........................                                175,000

                               ($350,000 X 1/2) (To recognize

                               compensation expense for 2005)

 

4/1/06         Paid-in Capital—Stock Options........................        35,000

                               Compensation Expense.....................................                                 35,000

                               ($350,000 X 2,000/20,000)

                               (To record termination of stock op-

                               tions held by resigned employees)

 

12/31/06     Compensation Expense..................................      175,000

                               Paid-in Capital—Stock Options.........................                                175,000

                               ($350,000 X 1/2) (To recognize

                               compensation expense for 2006)

 

3/31/07       Cash (12,000 X $25)..........................................      300,000

                    Paid-in Capital—Stock Options......................      210,000

                    ($350,000 X 12,000/20,000)

                               Common Stock.....................................................                                120,000

                               Paid-in Capital in Excess of Par........................                                390,000

                               (To record exercise of stock


EXERCISE 16-22 (

 

(a)   Revenues                                                                                                   $17,500

        Expenses:

                Other than interest                                                $8,400                            

                Bond interest (60 X $1,000 X .08)                         4,800                 13,200

        Income before income taxes                                                                     4,300

                Income taxes (40%)                                                                              1,720

        Net income                                                                                                 $  2,580

 

        Diluted earnings per share:

$2,580 + (1–.40)($4,800)

=

$5,460

=                                              $.68

2,000 + 6,000

8,000

(b)   Revenues                                                                                                   $17,500

        Expenses:

                Other than interest                                                $8,400

                Bond interest (60 X $1,000 X .08 X 4/12)             1,600                 10,000

        Income before income taxes                                                                     7,500

                Income taxes (40%)                                                                              3,000

        Net income                                                                                                  $ 4,500

        Diluted earnings per share:

$4,500 + (1–.40)($1,600)

=

$5,460

=                                            $1.37

2,000 + (6,000 X 1/3 yr.)

4,000

(c)   Revenues                                                                                                   $17,500

        Expenses:

                Other than interest                                                $8,400                            

                Bond interest (60 X $1,000 X .08 X 1/2)               2,400

                Bond interest (40 X $1,000 X .08 X 1/2)               1,600                12,400

        Income before income taxes                                                                     5,100

                Income taxes (40%)                                                                              2,040

        Net income                                                                                                 $  3,060

        Diluted earnings per share (see note):

$3,060 + (1–.40)($4,000)

=

$5,460

=       $.68

2,000 + (2,000 X 1/2 yr.) + 4,000 + (2,000 X 1/2)

8,000

Note: The answer is the same as (a). In both (a) and (c), the bonds are assumed converted for the entire year.


 


EXERCISE 16-24 (20-25 minutes)

 

(a)   Net income for year                                                                          $9,500,000

        Add:  Adjustment for interest (net of tax)                                          234,000*

                                                                                                                      $9,734,000

 

        *Maturity value                                                                                  $5,000,000

         Stated rate                                                                                         X           7%

         Cash interest                                                                                        350,000

         Discount amortization [(1.00 – .98) X $5,000,000 X 1/10]                10,000

         Interest expense                                                                                  360,000

         1 – tax rate (35%)                                                                              X           .65

         After-tax interest                                                                              $   234,000

 

         $5,000,000/$1,000 = 5,000 debentures

                Increase in diluted earnings per share denominator:

                        5,000

                      X    18

                      90,000

 

        Earnings per share:

                Basic EPS             $9,500,000 ÷ 2,000,000 = $4.75

                Diluted EPS          $9,734,000 ÷ 2,090,000 = $4.66

 

(b)   If the convertible security were preferred stock, basic EPS would be the same assuming there were no preferred dividends declared or the preferred was noncumulative. For diluted EPS, the numerator would be the net income amount and the denominator would be 2,090,000.

 

 

EXERCISE 16-25 (10-15 minutes)

 

(a)   Net income                                                                                             $300,000

        Add:  Interest savings (net of tax)

            [$120,000 X (1 – .40)]                                                                            72,000

        Adjusted net income                                                                           $372,000

 

        $2,000,000 ÷ $1,000 =                                                               2,000 bonds

                                               X    15

                                               30,000 shares

 

        Diluted EPS: $372,000 ÷ (100,000 + 30,000) = $2.86


EXERCISE 16-25 (Continued)

 

(b)   Shares outstanding                                                                                 100,000

        Add:  Shares assumed to be issued (10,000* X 5)                              50,000

        Shares outstanding adjusted for dilutive securities                        150,000

 

        *$1,000,000 ÷ $100

 

        Diluted EPS: ($300,000 – $0) ÷ 150,000 = $2.00

Note: Preferred dividends are not deducted since preferred stock was assumed converted into common stock.

 

 


EXERCISE 16-27

(a)   The contingent shares would have to be reflected in diluted earnings per share because the earnings level is currently being attained.

 

(b)   Because the earnings level is not being currently attained, contingent shares are not included in the computation of diluted earnings per share.

 

 


SOLUTIONS TO PROBLEMS


PROBLEM 16-2

 

(a)                                           Entries at August 1, 2005

        Bonds Payable..............................................................    150,000

                Discount on Bonds Payable (Schedule 1).....................                                3,032*

                Common Stock (8 X 150 X $100)......................................                           120,000

                Paid-in Capital in Excess of Par.......................................                             26,968**

                      (To record the issuance of 1,200 shares

                      of common stock in exchange for

                      $150,000 of bonds and the write-off of

                      the discount on bonds payable)

 

          *($34,000 X 1/10) X (107/120)

        **($150,000 – $3,032) – $120,000

 

        Interest Payable.................................................................         1,500

                Cash ($150,000 X 12% X 1/12)...........................................                                1,500

(To record payment in cash of interest

accrued on bonds converted as of

August 1, 2005

 

(b)                                     Entries at August 31, 2005

        Bond Interest Expense......................................................           255*

                 Discount on Bonds Payable (Schedule 1).....................................                                   255

                       (To record amortization of one month’s

                       discount on $1,350,000 of bonds)

 

        *($34,000 X 90%) X (1/120)

 

        Bond Interest Expense..................................................       13,500

                 Interest Payable ($1,350,000 X 12% X 1/12)..............................                              13,500

                       (To record accrual of interest for August

                       on $1,350,000 of bonds at 12%)

 

(c)                                   Entries at December 31, 2005

            (Same as August 31, 2005, and the following closing entry)

        Income Summary..........................................................    175,756

                 Bond Interest Expense*.............................................................                            175,756

                       (To close expense account)

 

        *($3,256 + $172,500)

 

 


PROBLEM 16-2 (Continued)

 

Schedule 1

Monthly Amortization Schedule

 

Unamortized discount on bonds payable:

Amount to be amortized over 120 months                                                 $34,000

Amount of monthly amortization ($34,000 ÷ 120)                                           $283

Amortization for 13 months to July 31, 2005 ($283 X 13)                          $3,679

Balance unamortized 7/31/05 ($34,000 – $3,679)                                      $30,321

10% applicable to debentures converted                                                       3,032

Balance August 1, 2005                                                                                  $27,289

Remaining monthly amortization over remaining 107 months                   $255

 

Schedule 2

Interest Expense Schedule

 

Amortization of bond discount charged to bond interest expense in 2005 would be as follows:

        7 months X $283.00                                        $1,981

        5 months X $255.00                                          1,275

                Total                                                           $3,256

 

Interest on Bonds:

12% on $1,500,000                                                                                         $180,000

Amount per month ($180,000 ÷ 12)                                                              $15,000

12% on $1,350,000                                                                                         $162,000

Amount per month ($162,000 ÷ 12)                                                              $13,500

Interest for 2005 would be as follows:

        7 months X $15,000                                                                               $105,000

        5 months X $13,500                                                                                   67,500

                Total                                                                                                 $172,500

 

Total interest

        Amortization of discount                           $    3,256

        Cash interest paid                                        172,500

        Bond interest expense                              $175,756

 


 

PROBLEM 16-3

 

2002. No journal entry would be recorded at the time the stock option plan was adopted. However, a memorandum entry in the journal might be made on November 30, 2002, indicating that a stock option plan had authorized
the future granting to officers of options to buy 70,000 shares of $5 par value common stock at $8 a share.

 

2003                                                January 2

              No entry

 

                                                      December 31

              Compensation Expense.........................................      132,000

                      Paid-in Capital—Stock Options..................................                                132,000

                          (To record compensation expense

                          attributable to 2003—22,000 options

                          at $6 ($14 – $8))

 

2004                                             December 31

              Compensation Expense.........................................      120,000

                      Paid-in Capital—Stock Options..................................                                120,000

                         (To record compensation expense

                         attributable to 2004—20,000 options

                         at $6 ($14 – $8))

 

              Paid-in Capital—Stock Options............................      132,000

                      Paid-in Capital from Expired Stock

                         Options.........................................................................                                132,000

                         (To record lapse of president’s

                         and vice president’s options to buy

                         22,000 shares)

 

(Note to instructor: This entry provides an opportunity to indicate when a credit to compensation expense might result. APB Opinion No. 25, as well as SFAS No. 123, states that if a stock option is not exercised because an employee fails to fulfill an obligation, the estimate of compensation expense recorded in previous periods should be adjusted (as a change in estimate) by decreasing compensation expense in the period of forfeiture and debiting the paid-in capital account.)


PROBLEM 16-3 (Continued)

 

2005                                             December 31

              Cash (20,000 X $8)...................................................      160,000

              Paid-in Capital—Stock Options............................      120,000

                   (20,000 X $6)

                      Common Stock (20,000 X $5)......................................                                100,000

                      Paid-in Capital in Excess of Par.................................                                180,000

                         (To record issuance of 20,000 shares

                         of $5 par value stock upon exercise

                         of options at option price of $8 and a

                         market price of $14 at date of grant)

 


 

PROBLEM 16-4

 

The computation of Dewey Yaeger Pharmaceutical Industries’ basic earnings per share and the diluted earnings per share for the fiscal year ended June 30, 2005, are shown below.

 

(a)

Basic earnings per share

=

Net income – Preferred dividends

Average common shares outstanding

 

 

 

=

$1,500,000 – $106,2501

1,000,000

 

 

 

=

$1,393,750

1,000,000

 

 

 

=

$1.3937 or $1.39 per share

 

       1Preferred dividend = .085 X $1,250,000

                                          = $106,250                        

 

(b)

Diluted earnings per share

=

Net income – Preferred dividends + Interest (net of tax)

Average common shares + Potentially dilutive common shares

 

 

 

=

$1,500,000 – $106,250 + $210,0002

1,000,000 + 250,0003 + 25,0004

 

 

 

=

$1,603,750

1,275,000

 

 

 

=

$1.2578 or $1.26 per share

 

       2Use “if converted” method for 7% bonds

               Adjustment for interest expense (net of tax)

                    ($5,000,000 X .07 X .6)                                                               $210,000

 

       3Shares assumed to be issued if converted

               $5,000,000 ÷ $1,000/bond X 50 shares                                         250,000


PROBLEM 16-4 (Continued)

 

       4Use treasury stock method to determine incremental

           shares outstanding

               Proceeds from exercise of options

                   (100,000 X $15)                                                                         $1,500,000

 

               Shares issued upon exercise of options                                    100,000

               Shares purchasable with proceeds

                   (Proceeds ÷ Average market price)

                   ($1,500,000 ÷ $20)                                                                           75,000

                       Incremental shares outstanding                                             25,000

 


 

PROBLEM 16-6

 

(a)         The number of shares used to compute basic earnings per share is 6,736,000, as calculated below.

 

 

Event

Dates

Outstanding

Shares

Outstanding

 

Restatement

Fraction

of Year

Weighted

Shares

Beginning Balance, including 5% stock dividend

 

 

Jan. 1–Apr. 1

 

 

3,150,000

 

 

2.0

 

 

3/12

 

 

1,575,000

Conversion of preferred stock

 

Apr. 1–July 1

 

3,360,000

 

2.0

 

3/12

 

1,680,000

Stock split

July 1–Aug. 1

6,720,000

 

1/12

560,000

Issued shares for

   building

 

Aug. 1–Nov. 1

 

7,020,000

 

 

3/12

 

1,755,000

Purchase of Treasury

  stock

 

Nov. 1–Dec. 31

 

6,996,000

 

 

2/12

 

1,166,000

Total number of common shares to compute basic earnings per share

6,736,000

 

(b)   The number of shares used to compute diluted earnings per share is 7,891,000, as shown below.

 

        Number of shares to compute basic earnings per

           share                                                                                                    6,736,000

        Convertible preferred stock—still outstanding

           (500,000 X 2 X 1.05)                                                                           1,050,000

        Convertible preferred stock—converted                                                         

           (200,000 X 2 X 1.05 X 3/12)                                                                  105,000

        Number of shares to compute diluted earnings

           per share                                                                                             7,891,000

 

(c)   The adjusted net income to be used as the numerator in the basic earnings per share calculation for the year ended December 31, 2004, is $11,900,000, as computed below.

 

        After-tax net income                                                                        $13,550,000

        Preferred stock dividends

                March 31 (700,000 X $.75)                       $   525,000                                 

                June 30, September 30,

                   and December 31

                   (500,000 X $.75 X 3)                                  1,125,000                1,650,000

        Adjusted net income                                                                        $11,900,000



 

PROBLEM 16-8

 

 

(a)

Weighted Average Shares

 

Before Stock Dividend

After Stock Dividend

Total as of June 1, 2002

1,500,000

1,800,000

Issue of September 1, 2002

   400,000

   480,000

Total as of May 31, 2004

1,900,000

2,280,000

 

 

 

1.   1,800,000 X 3/12 =

 

450,000

      2,280,000 X 9/12 =

 

1,710,000

           Total

 

2,160,000

 

 

 

2.   2,280,000 X 12/12

 

2,280,000

 

(b)                                         CORDELIA CORPORATION

Comparative Income Statement

For the Years Ended May 31, 2004 and 2003

 

2004

2003

Income from operations before income taxes

$1,400,000

$660,000

Income taxes

     560,000

  264,000

Income before extraordinary item

840,000

396,000

Extraordinary item—loss from earthquake, less applicable income taxes of $200,000

 

     300,000

 

               

Net income

$   540,000

$   396,000

 

 

 

Per share of common stock

 

 

          Income before extraordinary item

$.241

$.043

          Extraordinary loss, net of tax

(.13)4

 

 

 

 

Net income

$.112

$.04

 

 

 

 

EPS calculations =

Net income – Preferred dividends

Weighted average common shares

 

Preferred dividends = 50,000 X $100 X .06 = $300,000

 

Extraordinary loss per share calcuation

=

Loss

Weighted average common shares

 

1($840,000 – $300,000) ÷ 2,280,000 = $.24

2($540,000 – $300,000) ÷ 2,280,000 = $.11

3($396,000 – $300,000) ÷ 2,160,000 = $.04

4$300,000 ÷ 2,280,000 = $.13

 

(c)   1.    A corporation’s capital structure is regarded as simple if it consists only of common stock or includes no potentially dilutive securities. Cordelia Corporation has a simple capital structure because it has not issued any convertible securities, warrants, or stock options, and there are no existing rights or securities that are potentially dilutive of its earnings per common share.

 

        2.    A corporation having a complex capital structure would be required to make a dual presentation of earnings per share; i.e., both basic earnings per share and diluted earnings per share. This assumes that the potentially dilutive securities are not antidilutive.

 

               The basic earnings per share computation uses only the weighted av­erage of the common stock outstanding. The diluted earnings per share computation assumes the conversion or exercise of all po­tentially dilutive securities that are not antidilutive.