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.