Test Bank, Intermediate Accounting, 14th ed.
197
 CHAPTER 19 
Earnings Per Share
MULTIPLE CHOICE QUESTIONS
Theory/Definitional Questions
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
Companies required to supply EPS disclosures
Treatment of noncumulative preferred dividends not declared
The earnings per share computation reported on the income statement
Treatment of dividends on cumulative, nonconvertible preferred stock
Items considered when computing diluted EPS
Treatment of a stock dividend issued in mid year
Diluted EPS is based on assumptions about future transactions
Treatment of convertible securities under diluted EPS
True/false statements regarding EPS
Dilution of options and warrants under treasury stock method
Reporting earnings per share information
Using the if-converted method with diluted EPS
Assumptions of if-converted method of EPS computation
Use of the treasury stock method when computing dilutive EPS
Computing EPS for a company having different issues of convertible
securities and/or stock options and warrants
Weighted-average number of shares (midyear events)
EPS figures are reported on the income statement
Purpose of reporting diluted earnings per share
Treatment of interest expense on dilutive convertible debt
Computing diluted EPS for a company with a complex capital structure
Current GAAP for companies with complex capital structures
Current and former GAAP for earnings per share
U.S. GAAP vs. international standards
Basic EPS and APB Opinion No. 15
Stock options, warrants and rights and EPS calculation
Incremental EPS for multiple potential dilutive securities
Presentation of EPS for discontinued operations, extraordinary items,
and cumulative effect of accounting change
198
Chapter 19  Earnings Per Share
Computational Questions
28
Computation of weighted-average number of shares
29
Computation of basic EPS
30
Computation of basic EPS
31
Computation of basic EPS
32
Computation of basic EPS
33
Computation of weighted-average shares for diluted EPS
34
Computation of diluted EPS
35
Computation of diluted EPS
36
Computation of weighted-average shares for diluted EPS
37
Computation of diluted loss per share
38
Computation of shares used for basic and dilutive EPS
39
Computation of weighted-average number of shares for EPS
40
Computation of diluted EPS
41
Computation of diluted EPS
42
Computation of diluted EPS
43
Effect of treasury stock method and warrants on number of shares used
44
Computation of diluted EPS
45
Computation of basic EPS
46
Computation of weighted-average number of shares for diluted EPS
47
Computation of diluted EPS
48
Computation of shares to compute diluted EPS
49
Effect of stock rights on EPS calculation
50
Effect of stock rights on EPS calculation
51
Effect of stock rights on EPS calculation
PROBLEMS
1
2
3
4
5
6
7
8
9
10
11
12
13
14
Computation of weighted-average shares and comparative EPS
Computation of basic EPS with extraordinary items
Computation of dilutive EPS
Computation of basic, dilutive EPS
Computation of basic, dilutive EPS
Computation of weighted-average shares
Computation of simple, dilutive EPS
Computation of simple, dilutive EPS
Computation of basic, dilutive EPS/loss PS
Computation of simple, dilutive EPS
EPS for complex capital structure
Exclusion of nonpublic companies from EPS reporting
EPS and stock price maximization
Interpreting the price/earnings ratio
MULTIPLE CHOICE QUESTIONS
Test Bank, Intermediate Accounting, 14th ed.
199
c
LO2
1. Earnings per share disclosures are required only for
a. companies with complex capital structures.
b. companies that change their capital structures during the reporting
period.
c. public companies.
d. private companies.
c
LO3
2. In computing the earnings per share of common stock, noncumulative
preferred dividends not declared should be
a. deducted from the net income for the year.
b. added to the net income for the year.
c. ignored.
d. deducted from the net income for the year, net of tax.
a
LO8
3. Which earnings per share computation should be reported on the face of
the
income statement?
Basic EPS Diluted EPS
a.
Yes
Yes
b.
Yes
No
c.
No
Yes
d.
No
No
b
LO3
4. When computing earnings per share on common stock, dividends on
cumulative, nonconvertible preferred stock should be
a. deducted from net income only if the dividends were declared or paid in
the current period.
b. deducted from net income regardless of whether the dividends were not
paid or declared in the period.
c. deducted from net income only if net income is greater than the
dividends.
d. ignored.
c
LO5
5. In calculating diluted earnings per share, which of the following should not
be
considered?
a. The weighted average number of common shares outstanding
b. The amount of dividends declared on cumulative preferred shares
c. The amount of cash dividends declared on common shares
d. The number of common shares resulting from the assumed conversion
of debentures outstanding
200
Chapter 19  Earnings Per Share
c
LO3
6. What is the correct treatment of a stock dividend issued in mid year when
computing the weighted-average number of common shares outstanding for
earnings per share purposes?
a.
The stock dividend should be weighted by the length of time that the
additional number of shares are outstanding during the period.
b.
The stock dividend should be included in the weighted-average
number of common shares outstanding only if the additional shares
result in a decrease of 3 percent or more in earnings per share.
c. The stock dividend should be weighted as if the additional shares were
issued at the beginning of the year.
d. The stock dividend should be ignored since no additional capital was
received.
a
7. The EPS computation that is forward-looking and based on assumptions
about
future transactions is
a. diluted EPS.
b. basic EPS.
c. continuing operations EPS.
d. extraordinary EPS.
LO2
a
LO4
b
LO6
8. When computing diluted earnings per share, stock options are
a. recognized only if they are dilutive.
b. recognized only if they are antidilutive.
c. recognized only if they were exercised.
d. ignored.
9. Of the following, select the incorrect statement concerning earnings per
share.
a. During periods when all income is paid out as dividends, earnings per
share and dividends per share under a simple capital structure would be
identical.
b. Under a simple capital structure, no adjustment to shares outstanding is
necessary for a stock split on the last day of the fiscal period.
c. During a period, changes in stock issued or reacquired by a company
may affect earnings per share.
d. During a loss period, the amount of loss attributed to each share of
common stock should be computed.
Test Bank, Intermediate Accounting, 14th ed.
c
LO4
201
10. In applying the treasury stock method of computing diluted earnings per
share,
when is it appropriate to use the average market price of common stock
during the year as the assumed repurchase price?
a. Always
b. Never
c. When the average market price is higher than the exercise price
d. When the average market price is lower than the exercise price
d
LO8
11. Earnings per share information should be reported for all of the following
except
a. continuing operations.
b. extraordinary gain.
c. net income.
d. cash flows from operating activities.
b
LO5
12. When using the if-converted method to compute diluted earnings per share,
convertible securities should be
a. included only if antidilutive.
b. included only if dilutive.
c. included whether dilutive or not.
d. not included.
a
LO5
13. The if-converted method of computing EPS data assumes conversion of
convertible securities at the
a. beginning of the earliest period reported (or at time of issuance, if later).
b. beginning of the earliest period reported (regardless of time of
issuance).
c. middle of the earliest period reported (regardless of time of issuance).
d. ending of the earliest period reported (regardless of time of issuance).
a
14. When computing dilutive EPS, the treasury stock method can be used for
all
of the following except
a. convertible preferred stock.
b. stock warrants.
c. stock options.
d. stock rights.
LO4
202
Chapter 19  Earnings Per Share
a
15. For a company having several different issues of convertible securities
and/or
stock options and warrants, the FASB requires selection of the combination
of securities producing
a. the lowest possible earnings per share.
b. the highest possible earnings per share.
c. the earnings per share figure midway between the lowest possible and
the highest possible earnings per share.
d. any earnings per share figure between the lowest possible and the
highest possible earnings per share.
LO7
a
LO3
16. For purposes of computing the weighted-average number of shares
outstanding during the year, a midyear event that must be treated as
occurring at the beginning of the year is the
a. declaration and issuance of a stock dividend.
b. purchase of treasury stock.
c. sale of additional common stock.
d. issuance of stock warrants.
c
17. Where in the financial statements should basic and complex EPS figures
for
income from continuing operations be reported?
a. In the accompanying notes
b. In management’s discussion and analysis
c. On the income statement
d. On the statement of cash flows
LO8
d
LO2
18. The main purpose of reporting diluted earnings per share is to
a. provide a comparison figure for debt holders.
b. indicate earnings shareholders will receive in future periods.
c. distinguish between companies with a complex capital structure and
companies with a simple capital structure.
d. show the maximum possible dilution of earnings.
b
19. In determining earnings per share, interest expense, net of applicable
income
taxes, on convertible debt which is dilutive should be
a. ignored for diluted earnings per share.
b. added back to net income for diluted earnings per share.
LO5
Test Bank, Intermediate Accounting, 14th ed.
203
c. deducted from net income for diluted earnings per share.
d. none of the above.
d
LO2
b
LO1
20. When computing diluted EPS for a company with a complex capital
structure,
what is the denominator in the computation?
a. Number of common shares outstanding at year-end
b. Weighted-average number of common shares outstanding
c. Weighted-average number of common shares outstanding plus all other
potentially antidilutive securities
d. Weighted-average number of common shares outstanding plus all other
potentially dilutive securities
21. Under current GAAP, a company with a complex capital structure and
potential
earnings per share dilution must present
a. primary and fully diluted earnings per share.
b. basic and diluted earnings per share.
c. basic and primary earnings per share.
d. basic earnings per share and cash flow per share.
c
LO1
22. Under current GAAP, common stock equivalents
a. are considered in calculating basic earnings per share.
b. are considered in calculating primary earnings per share.
c. are not considered in calculating basic earnings per share.
d. are not considered in calculating fully diluted earnings per share.
c
LO1
23. Current U.S. GAAP for earnings per share
a. are not consistent with the standards for earnings per share
promulgated
by the Accounting Standards Board of the United Kingdom.
b. are not consistent with the standards for earnings per share
promulgated by the International Accounting Standards Committee
(IASC).
c. are consistent both with the U.K. and the International Accounting
Standards Committee standards for earnings per share.
d. are unique and are not consistent with the standards promulgated by
the U.K. Accounting Standards Board, the International Accounting
Standards Committee, or any other standard setting body in the world.
204
Chapter 19  Earnings Per Share
d
LO1
24. Under Accounting Principles Board Opinion No. 15, the historical or basic
earnings per share figure for companies with complex capital structures
was
a. always reported as part of primary earnings per share, but not fully
diluted earnings per share.
b. always reported as part of fully diluted earnings per share, but not
primary earnings per share.
c. always disclosed as a separate amount in addition to primary and fully
diluted earnings per share.
d. never disclosed either in primary or fully diluted earnings per share.
c
LO7
25. In calculating earning per share, stock options warrants, and rights are
a. always dilutive.
b. never dilutive.
c. dilutive if the exercise price is less than the average market price of the
common stock.
d. dilutive if the exercise price is more than the average market price of the
common stock.
b
LO7
26. For companies with a complex capital structure, a convertible security is
potentially dilutive if
a. its incremental EPS is greater than basic EPS after considering any
stock options, rights, and warrants.
b. its incremental EPS is less than basic EPS after considering any stock
options, rights, and warrants.
c. its incremental EPS is equal to basic EPS after considering any stock
options, rights, and warrants.
d. its incremental EPS is less than 1.00 after considering any stock
options, rights, and warrants.
c
LO8
27. An entity that reports a discontinued operation, an extraordinary item, or a
cumulative effect of an accounting change shall present basic and diluted
earnings per share amounts for those line items
a. only on the face of the income statement.
b. only in the notes to the financial statements.
c. either on the face of the income statement or in the notes to the
financial statements.
d. only if management chooses to do so as these amounts are note
required to be disclosed either in the financial statements or the notes
thereto.
Test Bank, Intermediate Accounting, 14th ed.
c
LO3
d
LO3
205
28. On December 31, 2002, Superior, Inc. had 600,000 shares of common
stock
issued and outstanding. Superior issued a 10 percent stock dividend on
July 1, 2003. On October 1, 2003, Superior reacquired 48,000 shares of its
common stock and recorded the purchase using the cost method of
accounting for treasury stock. What number of shares should be used in
computing basic earnings per share for the year ended December 31,
2003?
a. 612,000
b. 618,000
c. 648,000
d. 660,000
29. At December 31, 2002, the Murdock Company had 150,000 shares of
common
stock issued and outstanding. On April 1, 2003, an additional 30,000
shares of common stock were issued. Murdock's net income for the year
ended December 31, 2003, was $517,500. During 2003, Murdock declared
and paid $300,000 in cash dividends on its nonconvertible preferred stock.
The basic earnings per common share, rounded to the nearest penny, for
the year ended December 31, 2003, should be
a. $3.00.
b. $2.00.
c. $1.45.
d. $1.26.
d
LO3
30. At December 31, 2003 and 2003, Lapham Corp. had 200,000 shares of
common stock and 20,000 shares of 5 percent, $100 par value cumulative
preferred stock outstanding. No dividends were declared on either the
preferred or common stock in 2003 or 2002. Net income for 2003 was
$1,000,000. For 2003, basic earnings per common share amounted to
a. $5.00.
b. $4.75.
c. $4.50.
d. $4.00.
c
LO3
31. The Thomas Company's net income for the year ended December 31 was
$30,000. During the year, Thomas declared and paid $3,000 in cash
dividends on preferred stock and $5,250 in cash dividends on common
stock. At December 31, 36,000 shares of common stock were outstanding,
206
Chapter 19  Earnings Per Share
30,000 of which had been issued and outstanding throughout the year and
6,000 of which were issued on July 1. There were no other common stock
transactions during the year, and there is no potential dilution of earnings
per share. What should be the year’s basic earnings per common share of
Thomas, rounded to the nearest penny?
a. $0.66
b. $0.75
c. $0.82
d. $0.91
b
LO3
d
LO4
32. Bay Area Supplies had 60,000 shares of common stock outstanding at
January
1. On May 1, Bay Areas Supplies issued 31,500 shares of common stock.
Outstanding all year were 30,000 shares of nonconvertible preferred stock
on which a dividend of $4 per share was paid in December. Net income for
the year was $290,100. Bay Area Supplies should report basic earnings
per share for the year of
a. $1.86.
b. $2.10.
c. $2.84.
d. $3.17.
33. Landrover, Inc. had 150,000 shares of common stock issued and
outstanding
at December 31, 2002. On July 1, 2003, an additional 25,000 shares of
common stock were issued for cash. Landrover also had unexercised stock
options to purchase 20,000 shares of common stock at $15 per share
outstanding at the beginning and end of 2003. The market price of
Landrover's common stock was $20 throughout 2003. What number of
shares should be used in computing diluted earnings per share for the year
ended December 31, 2003?
a. 182,500
b. 180,000
c. 177,500
d. 167,500
Test Bank, Intermediate Accounting, 14th ed.
207
b
LO4
34. Glendale Enterprises had 200,000 shares of common stock issued and
outstanding at December 31, 2002. On July 1, 2003, Glendale issued a 10
percent stock dividend. Unexercised stock options to purchase 40,000
shares of common stock (adjusted for the 2003 stock dividend) at $20 per
share were outstanding at the beginning and end of 2003. The market
price of Glendale's common stock (which was not affected by the stock
dividend) was $25 per share during 2003. Net income for the year ended
December 31, 2003, was $1,100,000. What should be Glendale's 2003
diluted earnings per common share, rounded to the nearest penny?
a. $4.23
b. $4.82
c. $5.00
d. $5.05
b
LO5
35. On January 2, 2002, Worley Co. issued at par $50,000 of 4 percent bonds
convertible, in total, into 5,000 shares of Worley's common stock. No
bonds were converted during 2002. Throughout 2002 Worley had 5,000
shares of common stock outstanding. Worley's 2002 net income was
$5,000. Worley's income tax rate is 40 percent. No potentially dilutive
securities other than the convertible bonds were outstanding during 2002.
Worley's diluted earnings per share for 2002 would be
a. $0.58.
b. $0.62.
c. $0.70.
d. $1.16.
208
Chapter 19  Earnings Per Share
d
36. At December 31, 2002, Dayplanner Inc. had 250,000 shares of common
stock
outstanding. On October 1, 2003, an additional 60,000 shares of common
stock were issued for cash. Dayplanner also had 2,000,000 of 8 percent
convertible bonds outstanding at December 31, 2003, which are convertible
into 50,000 shares of common stock. The bonds are dilutive in the 2003
earnings per share computation. No bonds were issued or converted into
common stock during 2003. What is the number of shares that should be
used in computing diluted earnings per share for the year ended December
31, 2003?
a. 265,000
b. 300,000
c. 310,000
d. 315,000
LO5
b
LO6
c
LO5
37. The JVB Corporation had 200,000 shares of common stock and 10,000
shares
of cumulative, $6 preferred stock outstanding during 2003. The preferred
stock is convertible at the rate of three shares of common per share of
preferred. For 2003, the company had a $60,000 net loss from operations
and declared no dividends. JVB should report 2003 diluted loss per share
of (rounded to the nearest cent)
a. $(0.30).
b. $(0.52).
c. $(0.58).
d. $(0.60).
38. Zacor Incorporated has 2,500,000 shares of common stock outstanding on
December 31, 2002. An additional 500,000 shares of common stock were
issued April 1, 2003, and 250,000 more on July 1, 2003. On October 1,
2003, Zacor issued 5,000, $1,000 face value, 7 percent convertible bonds.
Each bond is convertible into 40 shares of common stock. No bonds were
converted into common stock in 2003. What is the number of shares to be
used in computing basic earnings per share and diluted earnings per share,
respectively?
a. 2,875,000 and 2,925,000
b. 2,875,000 and 3,075,000
c. 3,000,000 and 3,050,000
Test Bank, Intermediate Accounting, 14th ed.
209
d. 3,000,000 and 3,200,000
b
LO3
39. Shoemaker Company had 1,000 common shares issued and outstanding at
January 1. During the year, Shoemaker also had the common stock
transactions listed below.
April 1
Issued 300 previously unissued shares
May 1
Split the stock 2-for-1
June 30
Purchased 100 shares for the treasury
July 30
Distributed a 20 percent stock dividend
December 31 Split the stock 3-for-1
Given this information, what is the weighted-average number of shares that
Shoemaker should use for earnings per share purposes?
a. 2,880
b. 8,640
c. 8,820
d. 9,720
c
LO5
40. During its fiscal year, Richards' Distributing had net income of $100,000 (no
extraordinary items) and 50,000 shares of common stock and 10,000
shares of preferred stock outstanding. Richards declared and paid
dividends of $.50 per share to common and $6.00 per share to preferred.
The preferred stock is convertible into common stock on a share-for-share
basis. For the year, Richards Distributing should report diluted earnings
(loss) per share of
a. $(0.80).
b. $1.00.
c. $1.67.
d. $2.67.
c
41. At December 31, 2002, the Roberts Company had 700,000 shares of
common
210
Chapter 19  Earnings Per Share
LO5
stock outstanding. On September 1, 2003, an additional 300,000 shares of
common stock were issued. In addition, Roberts had $20,000,000 of 8
percent convertible bonds outstanding at December 31, 2002, which are
convertible into 400,000 shares of common stock. No bonds were
converted into common stock in 2003. The net income for the year ended
December 31, 2003, was $6,000,000. Assuming the income tax rate was
40 percent, what should be the diluted earnings per share for the year
ended December 31, 2003?
a. $5.00
b. $5.53
c. $5.80
d. $8.30
c
42. The 2003 net income of Atwater Inc. was $200,000 and 100,000 shares of
its
common stock were outstanding during the entire year. In addition, there
were outstanding options to purchase 10,000 shares of common stock at
$10 per share. These options were granted in 2000 and none had been
exercised by December 31, 2003. Market prices of Atwater's common stock
during 2003 were
January 1.................................................... $20 per share
December 31.............................................. $40 per share
Average Price............................................. $25 per share
LO4
The amount that should be shown as Atwater's diluted earnings per share
for 2003 (rounded to the nearest cent) is
a. $2.00.
b. $1.95.
c. $1.89.
d. $1.86.
d
LO4
43. Warrants exercisable at $20 each to obtain 20,000 shares of common stock
were outstanding during a period when the average and year-end market
price of the common stock was $25. Application of the treasury stock
method for the assumed exercise of these warrants in computing diluted
earnings per share will increase the weighted-average number of
outstanding common shares by
a. 20,000.
b. 16,667.
c. 16,000.
d. 4,000.
Test Bank, Intermediate Accounting, 14th ed.
b
LO6
211
44. The following information relates to the capital structure of Metcalf Corp.:
12/31/02
12/31/03
Outstanding shares:
Common stock..............................................
180,000
180,000
Preferred stock, convertible into 60,000
shares of common.........................................
60,000
60,000
10% convertible bonds, convertible into
40,000 shares of common............................ $2,000,000 $2,000,000
During 2003 Metcalf paid $90,000 in dividends on the preferred stock.
Metcalf's net income for 2003 was $1,960,000 and the income tax rate was
40 percent. For the year ended December 31, 2003, the diluted earnings
per share is
a. $7.29.
b. $7.43.
c. $8.17.
d. $8.29.
a
LO5
45. At December 31, 2002, Lefton, Inc. had 600,000 shares of common stock
outstanding. On April 1, 2003, an additional 180,000 shares of common
stock were issued for cash. Lefton also had $5,000,000 of 8% convertible
bonds outstanding at December 31, 2003, which are convertible into
150,000 shares of common stock. The bonds are dilutive in the 2003 EPS
computation. No bonds were issued or converted into common stock
during 2003. What is the number of shares that should be used in
computing basic earnings per share for 2003?
a. 735,000
b. 780,000
c. 885,000
d. 910,000
212
Chapter 19  Earnings Per Share
c
LO5
46. At December 31, 2002, Lefton, Inc. had 600,000 shares of common stock
outstanding. On April 1, 2000, an additional 180,000 shares of common
stock were issued for cash. Lefton also had $5,000,000 of 8% convertible
bonds outstanding at December 31, 2003, which are convertible into
150,000 shares of common stock. The bonds are dilutive in the 2000 EPS
computation. No bonds were issued or converted into common stock
during 2003. What is the number of shares that should be used in
computing diluted earnings per share for 2003?
a. 735,000
b. 780,000
c. 885,000
d. 910,000
b
47. Datatec, Inc., had 400,000 shares of $20 par common stock and 40,000
shares
of $100 par, 6% cumulative, convertible preferred stock outstanding for the
entire year ended December 31, 2003. Each share of the preferred stock is
convertible into 5 shares of common stock. Datatec's net income for 2003
was $1,680,000. For the year ended December 31, 2003, the diluted
earnings per share is
a. $2.40.
b. $2.80.
c. $3.60.
d. $4.20.
LO5
b
LO5
48. On December 31, 2001, Feterik Company had 7,000 shares of common
stock
issued and outstanding. On April 1, 2002, an additional 1,000 shares of
common stock were issued and on July 1, 500 more shares were issued.
On October 1, 2002, Feterik issued 10, $1,000 maturity value, 8%
convertible bonds. Each bond is convertible into 40 shares of common
stock. No bonds were converted into common stock in 2002. Assuming
there are no antidilutive securities, what is the number of shares Feterik
should use to compute diluted earnings per share for the year ended
December 31, 2002?
a. 7,950
b. 8,100
c. 8,150
d. 8,400
Test Bank, Intermediate Accounting, 14th ed.
213
The following information relates to questions 49-51:
James Corporation currently has stock rights outstanding for 2,000 common
shares. The exercise price of these shares is $20. The options were
issued in January of 2000. The average market price of the related
common stock during the year 2000 was $25. The average market price of
the related common stock during 2001 was $21 and during 2002 was $19.
The company’s fiscal year ends on December 31 of each year.
d
LO7
49. How should these stock rights be treated in earnings per share calculations
for the year ending December 31, 2000?
a. The stock options are antidilutive and should not be included either in
basic and diluted earnings per share.
b. The stock options are dilutive and should be included both in basic and
diluted earnings per share.
c. The stock options are dilutive and should be included both in basic and
diluted earnings per share in the amount of 400 shares.
d. The stock options are dilutive and should be included only in diluted
earnings per share in the amount of 400 shares.
b
50. How should these stock rights be treated in the earnings per share
calculation
for the year ending December 31, 2002?
a. The stock options are antidilutive and should not be included either in
basic or diluted earnings per share.
b. The stock options are dilutive and should be included in diluted
earnings per share in the amount of 95 shares.
c. The stock options are dilutive and should be included in diluted
earnings per share in the amount of 2,000 shares.
d. The stock options are dilutive and should be included in diluted
earnings per share in the amount of 400 shares.
LO7
a
LO7
51. How should these stock rights be treated in the earnings per share
calculation
for the year ending December 31, 2003?
a. The stock options are antidilutive and should not be included with in
basic or diluted earnings per share.
b. The stock options are dilutive and should be included in diluted
earnings per share in the amount of 105 shares.
c. The stock options are dilutive and should be included in diluted
earnings per share in the amount of 2,000 shares.
214
Chapter 19  Earnings Per Share
d. The stock options are dilutive and should be included in diluted
earnings per share in the amount of 400 shares.
PROBLEMS
Problem 1
On December 31, 2001, Jamfest Travel Inc. had 450,000 shares of no-par common
stock issued and outstanding. All shares were sold for $7.50. On June 30, 2002,
the firm issued an additional 135,000 shares for $7 per share. The 2002 income
was $319,200. On September 1, 2003, a 15 percent stock dividend was issued to
all common shareholders. On October 1, 2003, 60,000 shares were reacquired as
treasury shares. Net income in 2003 was $278,063.
(1) Compute the weighted-average number of common shares outstanding for
2002 and 2003 that should be shown on comparative statements at the end of
2003.
(2) Compute the basic earnings per share in 2002 and 2003 to be reported on
comparative statements at the end of 2003.
Solution 1
LO3
(1) 2002: 450,000 x 12/12 x 1.15 = 517,500
135,000 x 6/12 x 1.15 = 77,625
595,125 shares
2003:
585,000 x 12/12 x 1.15 = 672,750
(60,000) x 3/12 = (15,000)
657,750
(2) 2002:
($319,200 / 595,125) =
$.54 (rounded)
2003:
($278,063 / 657,750) =
$.42 (rounded)
Problem 2
The income statement of Micro Computers, Inc. showed the following information
on December 31, 2003.
Income before income tax..................................................... $1,472,000
Income tax expense...............................................................
441,600
Income from continuing operations....................................... $1,030,400
Extraordinary loss (net of tax savings)..................................
(100,000)
Net income............................................................................. $ 930,400
Compute earnings per share figures for common stock under the assumption that
Micro Computer Inc. has
(1) 320,000 shares of $24 par value common stock outstanding.
(2) 9,600 shares of $100, par 8% cumulative preferred stock, and 240,000 shares
of no-par common stock. Dividends are not in arrears.
Note: Assumption (1) is independent of (2).
Solution 2
LO3
(1) EPS--continuing operations
EPS--extraordinary items
EPS
$3.22 *
(.31)**
$2.91 (rounded)
*$1,030,400/320,000 = $3.22
**$(100,000)/320,000 = $(.31)
(2) EPS--continuing operations
EPS--extraordinary items
EPS
$3.97*
(.42)**
$3.55
*[$1,030,400 - ($8.00 x 9,600)] / 240,000 = ($1,030,400 - $76,800) / 240,000 = $3.97
**(100,000) / 240,000 = $(.42)
Problem 3
During 2003, the Ellis Corporation had 370,000 shares of $20 par common stock
outstanding. On January 1, 2003, 2,000, 8 percent bonds were issued with a
maturity value of $1,000 each. To enhance the bond sale, the company offered a
conversion of 50 shares of common stock for each bond at the option of the
purchaser. Net income for 2003 was $464,000. The income tax rate was 30
percent. Compute the diluted earnings per share of common stock.
Solution 3
LO5
Diluted EPS = ($464,000 + $160,000 - $48,000) / (370,000 + 100,000)
= $576,000 / 470,000
= $1.23 (rounded)
Problem 4
During 2003, Wright Corp. had outstanding 125,000 shares of common stock and
7,500 shares of noncumulative, 8 percent, $50 par preferred stock. Each preferred
share is convertible into 8 shares of common stock. In 2003, net income was
$231,500.
(1) Compute basic and diluted earnings per share for 2003 assuming no dividends
were declared or paid.
(2) Compute basic and diluted earnings per share for 2003 assuming dividends
were declared and paid on the preferred stock.
Solution 4
LO3
(1) BEPS
DEPS
(2) BEPS
DEPS
= ($231,500 / 125,000) = $1.85 (rounded)
= $231,500 / [125,000 + (8 x 7,500)]
= $231,500 / 185,000
= $1.25 (rounded)
= ($231,500 - 30,000) / 125,000 = $1.61 (rounded)
= $231,500 / (125,000 + 60,000)
= $231,500 / 185,000
= $1.25 (rounded)
Problem 5
On December 31, 2003, Masters Inc. had outstanding 180,000 shares of common
stock. Net income for 2003 was $285,000. Outstanding options (granted July 1,
2003) to purchase 15,000 shares of common stock at $20 per share had not been
exercised by December 31, 2003. During 2003, market prices for the common
stock were:
July 1, 2003......................................................................
December 31, 2003..........................................................
Average market................................................................
(1) Compute the basic earnings per common share in 2003.
(2) Compute the diluted earnings per common share in 2003.
$18 per share
$32 per share
$25 per share
Solution 5
LO4
(1) BEPS = $285,000 / 180,000
= $1.58 (rounded)
(2) DEPS = $285,000 / [180,000 + ½ (15,000 - 12,000*)]
= $285,000 / 181,500
= $1.57 (rounded)
* $300,000/$25 = 12,000 shares
Problem 6
Data Controls Inc. had 250,000 shares of common stock outstanding at the end of
2001. During 2002 and 2003, the following transactions took place.
2002
March 1
July 24
October 1
December 1
Sold 24,000 shares
Issued a 20 percent stock dividend
Sold 16,000 shares
Purchased 15,000 shares to be held in treasury
2003
June 1
September 1
3-for-1 stock split
Sold 60,000 shares
Data Controls Inc. has a simple capital structure.
Compute the weighted average number of shares for 2002 and 2003 to be used in
the earnings per share computation for comparative financial statements at the end
of 2003.
Solution 6
LO3
2002
January 1
March 1
October 1
December 1
2003
January 1
September 1
250,000 x 12/12 x 1.20 x 3 =
24,000 x 10/12 x 1.20 x 3 =
16,000 x 3/12 x 3 =
(15,000) x 1/12 x 3 =
329,800* x 12/12 x 3 =
60,000 x 4/12 =
900,000
72,000
12,000
(3,750)
980,250
989,400
20,000
1,009,400
*2002
January 1
March 1
July 24
October 1
December 1
Issuance
20% stock dividend
Issuance
Treasury stock
250,000
24,000
54,800
16,000
(15,000)
329,800
Problem 7
The following is a partial balance sheet for Anderson Corp. for the year ended
December 31, 2002.
9 percent Convertible Bonds (issued at par)................................... $1,800,000
Common Stock, 180,000 shares issued and outstanding, $50 par. $9,000,000
(a)
(b)
(c)
(d)
Each $1,000 convertible bond can be converted into 80 shares of
common stock.
On September 1, 2003, one-third of the convertible debt was converted
into common stock.
Anderson reported net income of $1,550,000 in 2003. The income tax
rate was 30 percent.
No other stock transactions took place during 2003.
(1) Compute basic earnings per share for 2003.
(2) Compute diluted earnings per share for 2003.
Solution 7
LO6
(1) BEPS = $1,550,000 / [180,000 + (4/12 x 48,000)]
= $1,550,000 / 196,000
= $7.91 (rounded)
Conversion (600 bonds x 80) = 48,000 shares
(2) DEPS
= $1,550,000 + ($144,000 x 0.7) / 196,000 + 128,000
= $1,650,800 / 324,000
= $5.10
Interest Avoided
$1,200,000 x 9% x 12/12 =
$ 600,000 x 9% x 8/12 =
Equivalent Shares
1,200 bonds x 12/12 x 80 =
600 bonds x 80 x 8/12 =
$108,000
36,000
$144,000
96,000
32,000
128,000
Problem 8
The Stanley Corp. provides the following data for 2003.
Transactions in common stock:
January 1, 2003, beginning balance............................... 300,000 shares
April 1, 2003, issuance.................................................... 100,000 shares
8% $100 par nonconvertible cumulative preferred stock.......
Issued at par
$100,000
6% $100 par convertible cumulative preferred stock.............
Issued at $105
Convertible into 20,000 shares
$200,000
Stock options..........................................................................
Option price......................................................................
Average market................................................................
Year-end market...............................................................
60,000 shares
$25
$35
$40
The net income for 2003 is $2,300,000. The company's tax rate is 30 percent. No
conversions or options were exercised during 2003.
(1) Compute basic earnings per share.
(2) Compute diluted earnings per share.
Solution 8
LO9
(1) BEPS
(2) DEPS
= ($2,300,000 - $8,000 - $12,000) / [300,000 + 9/12 (100,000)]
= $2,280,000 / 375,000
= $6.08
= ($2,300,000 - $8,000) / (375,000 + 20,000 + 60,000 - 42,857)
= $2,292,000 / 412,143
= $5.56
Options = 60,000 x $25 = $1,500,000
$1,500,000/$35 = 42,857
Problem 9
At December 31, 2002, Rollins Inc. had 400,000 shares of common stock
outstanding. The company also had 40,000 shares of $7 convertible preferred
stock. Each share is convertible into 4 shares of common stock. (Dividends were
declared and paid.)
Transactions during 2003:
July 1, 2003
July 8, 2003
September 1, 2003
October 1, 2003
Sold 200,000 shares
Declared 100% stock dividend
Sold 120,000 shares
Purchased 60,000 shares to be held in treasury
Rollins Inc. reported a loss of $670,000 for 2003.
(1) Compute basic earnings (loss) per share.
(2) Compute diluted earnings (loss) per share.
Solution 9
LO6
Weighted-average computation:
January 1, 2003
400,000 x 12/12 x 2 = 800,000
July 1, 2003
200,000 x 6/12 x 2 = 200,000
September 1, 2003
120,000 x 4/12
= 40,000
October 1, 2003
(60,000) x 3/12
= (15,000)
1,025,000
(1) BEPS
= [$(670,000) - $280,000] / 1,025,000
= ($950,000) / 1,025,000
= $(.93)
(2) DEPS
= $(670,000) / (1,025,000 + 160,000)
= $(670,000) / 1,185,000
= $(.57) *
*The convertible preferred stock is antidilutive. Rollins would report a loss per
common share of $.93 for 2000.
Problem 10
During all of 2002, Dawson Manufacturing Company had 950,000 shares of
common stock outstanding. On June 30, 2002, the company issued 10,000 7
percent convertible bonds at par. The maturity value of each bond is $1,000. Each
bond is convertible into 20 shares of common stock. None were converted during
2002.
Dawson also had 60,000 stock warrants outstanding for all of 2002. The option
price is $10 per share. The market price of the common stock was $40 on
December 31, 2002, and the average market price for 2002 was $30.
Dawson reported a net income of $3,650,000 for 2002. Assume the company had
a 40 percent income tax rate.
(1) Compute the basic earnings per share.
(2) Compute diluted earnings per share.
Solution 10
LO9
(1) BEPS
= $3,650,000 / 950,000
= $3.84 (rounded)
(2) DEPS
= ($3,650,000 + 350,000 - 140,000) / [950,000 + 6/12 (200,000) +
(60,000 - 20,000)]
= $3,860,000 / 1,090,000
= $3.54 (rounded)
Bonds--dilutive:
($10,000,000 x .07 x .60) / (10,000 x 20) = $2.10
$2.10 < $3.84
Incremental shares = 10,000 x 20 = 200,000
Interest avoided = $10,000,000 x 7% x 6/12 = $350,000
Tax savings on interest = $350,000 x 0.40 = $140,000
Stock options--dilutive
Proceeds $10 x 60,000 = $600,000
$600,000 / $30 = 20,000 shares
Incremental shares = 60,000 - 20,000 = 40,000
Problem 11
At December 21, 2002, EMD Company had 500,000 shares of common stock
outstanding. EMD sold 50,000 shares on October 1, 2003. Net income for 2003
was $2,417,875; the income tax rate was 30%. In addition, EMD had the following
debt and equity securities on its books on December 31, 2002:
(a) 18,000 shares of $100 par, 12% cumulative preferred stock.
(b) 28,000 shares of $100 par, 10% cumulative preferred stock, par $100, sold at
110. Each share of preferred stock is convertible into 2 shares of common
stock.
(c) $2,000,000 face value of 9% bonds sold at par.
(d) $3,000,000 face value of 7% convertible bonds sold to yield 8%. Unamortized
bond discount is $100,000 at December 31, 2002. Each $1,000 bond is
convertible into 20 shares of common stock.
Options to purchase 10,000 shares of common stock were issued May 1, 2003.
Exercise price is $30 per share; market value at date of option was $29; average
market value May 1 to December 31, 2003, was $40.
Compute the earnings per share amounts for the year ended December 31, 2003.
Solution 11
LO9
1. Computation of basic earnings per share:
Net income..................................................................
Less: Dividends on cumulative preferred stock:
18,000 x $100 x .12............................................$216,000
28,000 x $100 x .10............................................
496,000
Net income identified with common stock..........................
$1,921,875
Weighted average number of shares:
Jan. 1 to Oct. 1 (500,000 x ¾)....................................
375,000
Oct. 1 to Dec. 31 (550,000 x ¼).................................
137,500
Total....................................................................
512,500
Basic earnings per share....................................................
$3.75
2.
Computation of diluted earnings per share:
Test for dilution of convertible securities:
$2,417,875
280,000
Net Income
Number of
Incremental
7% Convertible bonds..........................
10% Convertible preferred stock..........
Impact
$168,000 *
280,000
Shares
60,000
56,000
EPS
$2.80
5.00
$3,000,000 x .08 x .70 = $168,000; effective interest is amount charged to
interest expense, not interest paid.
Since only the convertible bonds are less than the basic earnings per share of
$3.75, only the convertible bonds are potentially dilutive.
*
Net
Description
Income
Basic earnings per share $1,921,875
May 1, 2003, options as
if exercised May 1, 2003:
Number of shares
assumed issued: 10,000
Number of treasury
shares (10,000 x
$30)  $40
(7,500)
$1,921,875
7% convertible
bonds
168,000
Diluted earnings
per share
$2,089,875
Number of
Shares
2,500
Part of
Year
8/12
Weighted
Average
512,500
EPS
$3.75
1,667
514,167
$3.74
60,000
574,167
$3.64
Problem 12
Statement of Financial Accounting Standards No. 128, “Earnings Per Share,”
requires
that earnings per share figures be presented only by companies with
publicly held
common stock or potential common stock.
List arguments for and against the exclusion of nonpublic companies from the
requirement of reporting earnings per share.
Solution 12
LO8
Perhaps the major argument for not requiring earnings per share for nonpublic
enterprises relates to the issue of standards overload. Authoritative accounting
pronouncements have increased both in quantity and complexity. Managers of
small companies believe that the cost of complying with complex standards
exceeds the value of the benefits derived from the information disclosed under
these standards. Small firms having limited resources cannot afford the enormous
cost of complying with complex and costly standards that require information of
questionable value.
A major argument for requiring earnings per share information even for nonpublic
companies is the fact that many enterprises exempted from the requirement are
neither small nor closely held. Many nonpublic enterprises are large and complex
entities whose financial reports are widely distributed. Such enterprises may be in
direct competition with enterprises whose securities are traded in public markets.
Suspension of the requirement for reporting earnings per share for some
enterprises in an industry, but not for others, is not sustainable solely on the basis
of differences in form of ownership. Arguments regarding the cost and benefits of
pronouncements are problematical because costs of applying a standard may be
identified, but valuing the benefits derived is difficult. The increasing complexity of
business transactions suggests that the statement reader should be provided with
as much information as possible in order to make an informed decision about the
financial condition of the enterprise and the integrity and stewardship of
management. If the standards relating to earnings per share and other matters are
complex, it is only because the standards are reflecting the complexity of the
transactions.
Problem 13
You are an independent CPA and have just acquired a new client, A. Dunn
Manufacturing Company. The president of the company recently read an article
advising a firm’s management team to seek to maximize the long-run value of the
firm’s stock. The article mentioned profit maximization, earnings per share, and the
role of these two factors in stock price maximization. The president wants your
advice on how the choice of inventory cost flow methods (e.g., FIFO vs. LIFO)
relates to profit maximization, earnings per share, and stock price maximization.
Solution 13
LO8
The objective of a firm is not to maximize earnings per share or the accounting
definition of profit. The correct objective is to maximize shareholder wealth, which
is the price per share that is equivalent to the discounted cash flows of the firm.
Maximizing earnings per share may actually result in a reduction in cash flows. For
example, earnings per share during a period of rising prices would be higher for a
firm that adopts FIFO inventory accounting rather than LIFO. FIFO matches older,
lower costs against current revenues, resulting in a higher net income and higher
earnings per share. LIFO would produce lower net income and earnings per share
because more recent, higher costs are matched against current revenues.
Nevertheless, FIFO is the wrong choice in a period of rising prices because it
minimizes cash flow by maximizing taxes. LIFO should be chosen because it
provides higher cash flows as a result of reducing income and thus reducing taxes.
Since shareholders are concerned about discounted cash flow, they will assign a
higher value to the shares of a company that uses LIFO accounting.
Problem 14
The price-earnings ratio frequently is used by analysts and investors for evaluating
stock prices because it relates the earnings of the business to the current market
price
of the stock. The ratio is computed by dividing the market price per share by the
earnings per share before extraordinary items.
Explain how the price-earnings ratio should be interpreted, including any problems
associated with the interpretation of the ratio.
Solution 14
LO8
A stock selling at a high price-earnings ratio generally is regarded favorably by
analysts. A high ratio shows that investors believe that the firm has good growth
opportunities and that the firm’s earnings are relatively safe. The lower risk of the
earnings lowers the discount rate used in discounting future earnings to the
present thus raising the present value of these discounted future cash flows and
raising the stock price as a result. Nonetheless, a firm could have a high priceearnings ratio, not because stock price is high, but because earnings are low.
A major problem with the price-earnings ratios is the use of earnings per share in
the denominator. Earnings per share reflect the somewhat arbitrary choices of
accounting principles used to determine earnings. A firm’s reported earnings could
be changed substantially by the adoption of more conservative or less conservative
accounting procedures. An additional problem with the price-earnings ratio is that
only at the end of the fiscal year are the numerator and denominator measured as
of the same date. The price-earnings ratio often is computed during the year using
the earnings per share amount from the most recent financial statements or by
using a moving quarterly average.
CHAPTER 19 -- QUIZ A
Name _________________________
Section ________________________
T F
1. When the market price of stock options, warrants, and rights is higher than
the current option price, exercise might occur; therefore, there is potential
dilution from these securities and they would be included in the computation
of diluted earnings per share.
T F
2. In order to compute diluted earnings per share when convertible debt exists,
adjustments must be made both to net income (numerator) and to the number
of shares of common stock outstanding (denominator).
T F
3. When a company has only common stock outstanding, but there are
convertible securities, stock options, warrants, or other rights outstanding, it
is never classified as a company with a simple capital structure.
T F
4. The term “complex capital structure” describes a company with outstanding
stock options, warrants, convertible securities, etc., which are materially
dilutive.
T F
5. When earnings per share are diluted as a result of the inclusion of
outstanding options and warrants, the average market price of the common
stock at the end of the period is used in computing the number of shares
assumed to be reacquired.
T F
6. Nonconvertible preferred stock is excluded from consideration in the
determination of basic earnings per share during periods where dividends on
preferred stock are declared.
T F
7. Retroactive treatment of common stock dividends and splits is required for all
periods' earnings per share data presented in the financial statements.
T F
8. If preferred stock dividends are cumulative, the full amount of the annual
dividends should be deducted from net income in the determination of basic
earnings per share, whether or not the dividends have been declared.
T F
9. Any security whose exercise or conversion would increase earnings per
share or reduce loss per share are referred to as antidilutive securities.
T F 10. When a convertible bond is included in the determination of diluted earnings
per share, net income is adjusted by adding back the interest expense, and
the
number of shares of common stock outstanding is increased by the number
of shares that would have been issued upon conversion.
226
CHAPTER 19 -- QUIZ B
A.
B.
C.
D.
E.
F.
G.
Name _________________________
Section ________________________
Incremental shares
Dilutive securities
Treasury stock method
Basic earnings per share
Simple capital structure
If-converted method
Antidilutive security
H.
I.
J.
K.
Primary earning per share
Convertible securities
Complex capital structure
Diluted earnings
Select the term that best fits each of the following definitions and descriptions. Indicate
your answer by placing the appropriate letter in the space provided
____ 1. Securities whose assumed exercise or conversion results in a reduction in
earnings per share or an increase in loss per share.
____ 2. Securities, such as bonds and preferred stock, whose terms permit the holder
to change the investment into the common stock.
____ 3. Used to adjust the earnings per share computation to consider the impact of
the possible conversion of convertible securities.
____ 4. A company having only common or common and preferred stock.
____ 5. A company with potential earnings per share dilution.
____ 6. The number of shares issued upon exercising an option or warrant less the
assumed number of shares reacquired after applying the treasury stock
method of stock reacquisition.
____ 7. Securities whose assumed conversion or exercise results in an increase in
earnings per share or a decrease in a loss per share.
____ 8. The amount of earnings attributable to each share of common stock
outstanding, including common stock equivalents. This amount is no longer
reported under FASB Statement No. 128.
____ 9. A method of recognizing the use of proceeds that would be obtained upon
exercise of options and warrants in computing earnings per share.
____ 10. Net income divided by weighted-average number of shares outstanding.
227
CHAPTER 19 -- QUIZ SOLUTIONS
Quiz A
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
T
T
F
T
F
F
T
T
T
F
Quiz B
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
B
I
F
E
J
A
G
H
C
D
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