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CHAPTER 18
QUESTIONS
1. Earnings per share information is used by
investors to evaluate the results of operations of a business and estimate future
earnings. Because earnings are an important determinant of the market price of a
companys common stock, the EPS measurement will aid the investor in determining the attractiveness of an investment in a
companys stock.
2. Earnings per share data have the same limitations that any income figure has under
current generally accepted accounting principles. The alternative methods available
for computing net income sometimes make
comparison among companies difficult, and
the condensed EPS figure does not remove
this difficulty. In some cases, the existence
of EPS data even increases the lack of
comparability because EPS information is
frequently disclosed separately from any
note disclosure describing the accounting
methods employed.
7. The two-class method is a technique for allocating earnings per share to two different
classes of stock that both have ownership
privileges. The two-class method is used
when a company has two classes of common stock with different dividend rights or
when a company has participating preferred stock in addition to its common
stock.
8. Dilution of EPS refers to the effect that certain types of securitieswhose terms enable their holders to acquire common
shareswill have on EPS data if these securities are converted into common stock. If
in a complex capital structure, conversion
of convertible securities or exercise of options, warrants, or rights would reduce the
EPS from what it would have been using
only common shares outstanding, dilution
of EPS has occurred.
805
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806
Chapter 18
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Chapter 18
807
PRACTICE EXERCISES
PRACTICE 181 SHARES OUTSTANDING: ISSUANCE AND REACQUISITION
Period
Jan. 1Apr. 1
Apr. 1Aug. 1
Aug. 1Dec. 31
Total
Fraction of
the Year
3/12
4/12
5/12
Shares
Outstanding
200,000
260,000
160,000
Weighted-Average
Shares
50,000
86,667
66,667
203,334
Fraction of
the Year
2/12
3/12
3/12
4/12
Shares
Adjustment
Outstanding
Factor
150,000
2.0 1.20
300,000
1.20
345,000
1.20
414,000
1.00
Weighted-Average
Shares
60,000
90,000
103,500
138,000
391,500
When the preferred stock is not cumulative, an adjustment is made to basic EPS
only for preferred dividends declared during the year.
Basic EPS = $220,000/100,000 common shares = $2.20 per share
2.
When the preferred stock is cumulative, an adjustment is made to basic EPS for
all preferred dividends whether they are declared during the year or not.
Preferred dividends = 30,000 shares
$100 par
5% = $150,000
Fraction of
the Year
3/12
4/12
5/12
Shares
Adjustment
Outstanding
Factor
200,000
2.0
260,000
2.0
520,000
1.0
$50 par
Weighted-Average
Shares
100,000
173,333
216,667
490,000
8% = $80,000
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808
Chapter 18
0.80
Allocation of undistributed earnings .............................. $ 108,000
$432,000
Number of shares ............................................................. 100,000
320,000
Undistributed earnings per share ................................... $
1.08
$
1.35
The basic earnings per share amounts are computed and reported as follows:
Participating
Preferred
Common
Stock
Stock
Distributed earnings .........................................................
$1.40
$1.00
Undistributed earnings ....................................................
1.08
1.35
Basic earnings per share .................................................
$2.48
$2.35
PRACTICE 186 DILUTED EPS AND STOCK OPTIONS
1.
$10) = $500,000
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Chapter 18
809
$10) = $500,000
$10) = $500,000
$10) = $500,000
(4/12) =
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810
Chapter 18
$100 par
5% = $50,000
If the preferred shares had been converted at the beginning of the year:
40,000 additional common shares (10,000 4) would have been outstanding.
The $50,000 in preferred dividends would have been available to all common
stockholders.
Preliminary diluted EPS calculation: $400,000/(100,000 + 40,000) = $2.86 per
share
Conversion of these preferred shares would decrease earnings per share ($2.86
< $3.50). Thus, they are dilutive and are included in the calculation of diluted
EPS. In addition, it is likely that the preferred shareholders would give up their
preferred dividends of $5.00 ($100 0.05) per share to join the common stockholders and earn $14.00 per share (basic EPS of $3.50 4 converted shares).
Diluted EPS = $2.86 per share
2.
If the preferred shares had been converted at the beginning of the year:
10,000 additional common shares (10,000 1) would have been outstanding.
The $50,000 in preferred dividends would have been available to all common
stockholders.
Preliminary diluted EPS calculation: $400,000/(100,000 + 10,000) = $3.64 per
share
Conversion of these preferred shares would increase earnings per share ($3.64
> $3.50). Thus, they are antidilutive and are ignored in the calculation of diluted
EPS. In addition, it is unlikely that the preferred shareholders would give up
their preferred dividends of $5.00 ($100 0.05) per share to get one share and
join the common stockholders who are earning basic EPS of $3.50 per share.
Diluted EPS = Basic EPS = $3.50 per share
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Chapter 18
811
$100 par
5% = $50,000
If the preferred shares had been converted on February 1 when they were issued:
45,833 additional common shares [10,000 5 (11/12)] would have been outstanding.
The $50,000 in preferred dividends would have been available to all common
stockholders.
Preliminary diluted EPS calculation: $400,000/(100,000 + 45,833) = $2.74 per
share
Conversion of these preferred shares would decrease earnings per share ($2.74
< $3.50). Thus, they are dilutive and are included in the calculation of diluted
EPS. In addition, it is likely that the preferred shareholders would give up their
preferred dividends of $5.00 ($100 0.05) per share to join the common stockholders and earn $17.50 per share (basic EPS of $3.50 5 converted shares).
Diluted EPS = $2.74 per share
2.
If the preferred shares had been converted on February 1 when they were issued:
9,167 additional common shares [10,000 1 (11/12)] would have been outstanding.
The $50,000 in preferred dividends would have been available to all common
stockholders.
Preliminary diluted EPS calculation: $400,000/(100,000 + 9,167) = $3.66 per share
Conversion of these preferred shares would increase earnings per share ($3.66
> $3.50). Thus, they are antidilutive and are ignored in the calculation of diluted
EPS. In addition, it is unlikely that the preferred shareholders would give up
their preferred dividends of $5.00 ($100 0.05) per share to get one share and
join the common stockholders who are earning basic EPS of $3.50 per share.
Diluted EPS = Basic EPS = $3.50 per share
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812
Chapter 18
If the convertible bonds had been converted at the beginning of the year:
5,000 additional common shares (100 50) would have been outstanding.
The $7,000 in after-tax interest would have been available to all common
stockholders.
Preliminary diluted EPS calculation: ($100,000 + $7,000)/(50,000 + 5,000) = $1.95
per share
Conversion of these bonds would decrease earnings per share ($1.95 < $2.00).
Thus, they are dilutive and are included in the calculation of diluted EPS.
Diluted EPS = $1.95 per share
2.
If the convertible bonds had been converted at the beginning of the year:
2,000 additional common shares (100 20) would have been outstanding.
The $7,000 in after-tax interest would have been available to all common
stockholders.
Preliminary diluted EPS calculation: ($100,000 + $7,000)/(50,000 + 2,000) = $2.06
per share
Conversion of these bonds would increase earnings per share ($2.06 > $2.00).
Thus, they are antidilutive and are not included in the calculation of diluted EPS.
Diluted EPS = Basic EPS = $2.00 per share
If the convertible bonds had been converted on October 1 when they were issued:
2,500 additional common shares [100 100 (3/12)] would have been outstanding.
The $1,750 in after-tax interest would have been available to all common
stockholders.
Preliminary diluted EPS calculation: ($100,000 + $1,750)/(50,000 + 2,500) = $1.94
per share
Conversion of these bonds would decrease earnings per share ($1.94 < $2.00).
Thus, they are dilutive and are included in the calculation of diluted EPS.
Diluted EPS = $1.94 per share
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Chapter 18
813
If the convertible bonds had been converted on October 1 when they were issued:
375 additional common shares [100 15 (3/12)] would have been outstanding.
The $1,750 in after-tax interest would have been available to all common
stockholders.
Preliminary diluted EPS calculation: ($100,000 + $1,750)/(50,000 + 375) = $2.02
per share
Conversion of these bonds would increase earnings per share ($2.02 > $2.00).
Thus, they are antidilutive and are not included in the calculation of diluted EPS.
Diluted EPS = Basic EPS = $2.00 per share
2.
Incremental impact is less than the basic EPS ($2.80 < $3.00), so the convertible
bonds are dilutive.
3.
4.
Incremental impact is greater than the basic EPS ($3.73 > $3.00), so the convertible bonds are antidilutive.
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814
Chapter 18
PRACTICE 1813 BASIC AND DILUTED EPS AND ACTUAL CONVERSION OF STOCK
OPTIONS
1.
Period
Jan. 1Apr. 1
Apr. 1Dec. 31
Total
Fraction of
the Year
3/12
9/12
Shares
Outstanding
100,000
140,000
Weighted-Average
Shares
25,000
105,000
130,000
(3/12) = 3,333
Fraction of
the Year
8/12
4/12
Shares
Outstanding
200,000
225,000
$100 par
Weighted-Average
Shares
133,333
75,000
208,333
0.05 = $25,000
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Chapter 18
815
PRACTICE 1815 BASIC AND DILUTED EPS AND ACTUAL CONVERSION OF CONVERTIBLE BONDS
1.
Period
Jan. 1Aug. 1
Aug. 1Dec. 31
Total
Fraction of
the Year
7/12
5/12
Shares
Outstanding
100,000
120,000
Weighted-Average
Shares
58,333
50,000
108,333
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816
Chapter 18
$10) = $400,000
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Chapter 18
817
2.
$10) =
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818
Chapter 18
2.
$10) =
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Chapter 18
819
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820
Chapter 18
Basic EPS
$ 1.92
(0.50)
(0.35)
$ 1.07
Diluted EPS
$ 1.68
(0.44)
(0.31)
$ 0.94*
Period
Jan. 1June 1
June 1Dec. 1
Dec. 1Dec. 31
Total
Fraction of
the Year
5/12
6/12
1/12
Shares
Adjustment
Outstanding
Factor
100,000
2.0
125,000
2.0
250,000
1.0
Weighted-Average
Shares
83,333
125,000
20,833
229,166
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Chapter 18
821
2.0
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822
Chapter 18
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Chapter 18
823
EXERCISES
1821.
Jan. 1 to Feb. 1
76,000 1/12 3*
1.20 =
Feb. 1 to May 1
124,000 3/12 3
1.20 =
May 1 to Aug. 1
104,000 3/12 3
1.20 =
Aug. 1 to Sept. 1 124,800 1/12 3
=
Sept. 1 to Nov. 1 139,800 2/12 3
=
Nov. 1 to Dec. 31 419,400 2/12
=
Weighted-average number of shares
outstanding .........................................................
*3-for-1 stock split
1822.
22,800
111,600
93,600
31,200
69,900
69,900
Increase/Decrease
in No. of Shares
(76,000 + 48,000)
(124,000 20,000)
(104,000 1.20)
(124,800 + 15,000)
(139,800 2)
399,000
1823.
110,000
357,500
182,250
649,750
546,750
224,750
771,500
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824
1823.
1824.
Chapter 18
(Concluded)
Computation of weighted-average shares:
Jan. 1 to Feb. 1 220,000 2 (stock split) 1.10 (stock
dividend) 1/12...............................................
Feb. 1 to Apr. 1 260,000 2 (stock split) 1.10 (stock
dividend) 2/12...............................................
Apr. 1 to July 1 257,000 2 (stock split) 1.10 (stock
dividend) 3/12...............................................
July 1 to Dec. 31 (514,000 + 15,000) 1.10 (stock
dividend) 6/12...............................................
Weighted-average shares 2013..........................................................
*Rounded.
2013
Computation of earnings:
Income before income taxes ........................................................
Less: Income taxes (30%) ............................................................
Net income ....................................................................................
Less: Preferred dividend ..............................................................
Net income identified with common stock ..................................
40,333*
95,333*
141,350
290,950
567,966
$ 636,400
190,920
$ 445,480
70,000
$ 375,480
5.36
$ 419,000
125,700
$ 293,300
70,000
$ 223,300
$ 42,000
12,600
29,400
$ 252,700
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Chapter 18
825
1824. (Concluded)
Computation of weighted-average number of shares:
100,000 4/12 = 33,333
120,000 8/12 = 80,000
113,333
Basic EPS:
Income before extraordinary items ($223,300/113,333)
Extraordinary gain ($29,400/113,333) .......................
Net income ($252,700/113,333)..................................
$1.97
0.26
$2.23
a
$ 1.05*
(0.21)
$ 0.84
b
$ 0.75
(0.21)
$ 0.54
*$21,000/20,000 = $1.05
1826.
a. After-tax interest:
$500,000 0.075 = $37,500; $37,500
Contribution per share:
$24,375/12,500 shares (500 bonds
c
$ 0.60**
(0.21)
$ 0.39
$21,000
6,000
$15,000
$15,000
3,000
$12,000
0.65* = $24,375
25 shares per bond) = $1.95
The contribution is greater than the $1.54 basic EPS; therefore, the bond
conversion is antidilutive.
*The after-tax rate: 100% 35% tax rate = 65%
b. Contribution per share:
30,000 shares $6 per share = $180,000; $180,000/90,000 shares
(30,000 preferred shares 3 shares of common for each preferred
share) = $2.00
The contribution is greater than the $1.54 basic EPS; the security is antidilutive.
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826
Chapter 18
1826. (Concluded)
c. The average market price exceeds the exercise price; assumed conversion
is dilutive.
d. After-tax interest:
$800,000 0.11 = $88,000; $88,000
Contribution per share:
$57,200/20,000 shares (800 bonds
0.65 = $57,200
25 shares per bond) = $2.86
The contribution is greater than the $1.54 basic EPS; the convertible bonds
are antidilutive.
e. Contribution per share:
$1,000,000 0.07 = $70,000; $70,000/50,000 shares (10,000
5) = $1.40
The contribution is less than the $1.54 basic EPS; the security is dilutive.
1827.
1828.
55,000
12,000
9,000
3,000
58,000
$ 560,000
28,000
40,000
28,000
12,000
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Chapter 18
1829.
827
Basic EPS:
Net income ..............................................................
Number of common shares outstanding ...............
Basic EPS ................................................................
Diluted EPS:
Net income ..............................................................
Add interest on convertible bonds, net
of taxes:
Interest, $45,000 0.09 .....................................
Less: Income taxes of 30% ...............................
Adjusted net income ...............................................
1830.
$ 75,000
10,000
$ 7.50
$ 75,000
$4,050
1,215
2,835
$ 77,835
10,000
14,000
$5.56
4,000
Basic EPS:
Income before extraordinary gain
($199,800/100,000) ..............................................
Extraordinary gain ($43,520/100,000)...................
Net income ............................................................
*Rounded down.
Diluted EPS:
Income before extraordinary gain ..........................
Add interest on convertible bonds, net
of taxes:
Interest ($800,000 0.05) ..................................
Less: Income taxes (30%) .................................
Adjusted income before extraordinary gain
Actual number of shares outstanding ...................
Additional shares assumed issued on
conversion (50 800) ...........................................
Total shares for computing diluted EPS ...............
Diluted EPS:
Income before extraordinary gain
($227,800/140,000) ...........................................
Extraordinary gain ($43,520/140,000) ................
Net income ..........................................................
$2.00
0.43*
$2.43
$ 199,800
$ 40,000
12,000
28,000
$ 227,800
100,000
40,000
140,000
$1.63
0.31
$1.94
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828
1831.
Chapter 18
180,000
$(1.56)
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Chapter 18
1832.
829
Basic EPS:
Net income ....................................................................................
$950,000
266,667*
212,500
125,000
227,500
831,667
831,667
120,000
240,000
1,191,667*
$1.09
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830
1833.
Chapter 18
1. The books of Yorke Corporation reflect a complex capital structure because convertible bonds are outstanding and dilution would result from
their conversion.
2. Complex capital structures require two EPS figures. Basic EPS is based on
actual income and actual shares outstanding. Diluted EPS is based on
common stock outstanding and all dilutive convertible securities, stock options, warrants, or rights.
Each EPS figure (basic and diluted) should be shown for income before
below-the-line items and for below-the-line items separately, with a total
EPS for net income.
Step 1Basic EPS:
Computation of earnings:
Income before extraordinary loss ......................................
Less: Dividends on preferred stock ..................................
Income before extraordinary loss identified with
common stock .................................................................
Extraordinary loss, net of taxes .........................................
Net income identified with common stock ........................
$715,000
35,000
$680,000
(16,000)
$664,000
33,250
99,750
185,500
Basic EPS:
Income before extraordinary loss ($680,000/185,500) ......
Extraordinary loss ($16,000/185,500) ................................
Net income ..........................................................................
$ 3.67
(0.09)
$ 3.58
52,500
EPS
Impact
$1.12
Number
of
Ordinary
Shares
EPS
185,500
$3.67
25,000
210,500
$3.36
Extraordinary
Loss
$(16,000)
$(16,000)
Extraordinary
Net
Loss
Income
EPS
EPS
$(0.09)
$3.58
$(0.08)
$3.28*
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Chapter 18
1834.
831
$760,000
96,000
$664,000
$2.46
Number of
Shares
48,000
26,000
Incremental
EPS
Impact
$2.00
1.82
Because both convertible securities are lower than basic EPS, they are both
potentially dilutive. Whether the securities are actually dilutive depends on the
comparison with the recomputed EPS, as shown in step 3.
*24,000 $4 = $96,000
Description
Basic EPS ..................................
Stock options:
Number of shares
assumed issued ..................
Number of treasury shares
assumed repurchased
(32,000 $12)/$18................
Incremental shares ...................
7.5% convertible bonds ............
Convertible preferred stock .....
Diluted EPS ...............................
Net
Income
$664,000
Number
of
Shares
270,000
$664,000
47,250
$711,250
96,000
$807,250
10,667
280,667
26,000
306,667
48,000
354,667
EPS
$2.46
32,000
(21,333)
10,667
2.37
2.32
2.28
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832
Chapter 18
PROBLEMS
1835.
Dates
Issued
Shares
Stock
Dividend
Stock
Split
Portion
of Year
Weighted
Average
2013
Jan. 1 to Mar. 31
50,000
1.05
4.0
3/12
=
52,500
Mar. 31Sale
10,000
Mar. 31 to July 31
60,000
1.05
4.0
4/12
=
84,000
July 31Stock Div.
3,000
July 31 to Nov. 1
63,000
4.0
3/12
=
63,000
Nov. 1Sale
12,000
Nov. 1 to Dec. 31
75,000
4.0
2/12
=
50,000
Weighted-average number of shares .............................................. 249,500
Dates
Issued
Shares
Stock
Dividend
Stock
Split
Portion
of Year
Weighted
Average
2014
Jan. 1 to Feb. 28
75,000
4.0
2/12
=
50,000
Feb. 28T stock
purchase
(8,000)
Feb. 28 to Apr. 30
67,000
4.0
2/12
=
44,667
Apr. 30Split
201,000
Apr. 30 to Nov. 1
268,000
6/12
= 134,000
Nov. 1T stock sale
5,000
Nov. 1 to Dec. 31
273,000
2/12
=
45,500
Weighted-average number of shares .............................................. 274,167
1836.
1. Number of shares of stock outstanding .......................................................
Income from continuing operations..............................................................
Extraordinary loss ..........................................................................................
Net income ......................................................................................................
Basic EPS:
Continuing operations ($930,000/250,000) ...............................................
Extraordinary loss [$(80,000)/250,000] .....................................................
Net income ($850,000/250,000)..................................................................
2. Number of common shares expressed as weighted-average
number of shares:
Jan. 1 to Apr. 30160,000 4/12 ..............................................................
May 1 to Sept. 30220,000 5/12 .............................................................
Oct. 1 to Dec. 31250,000 3/12 ..............................................................
Basic EPS:
Continuing operations ($930,000/207,500) ...................................................
Extraordinary loss [$(80,000)/207,500]..........................................................
Net income per common share ($850,000/207,500)...................................
*Basic EPS numbers do not sum to the total because of rounding.
250,000
$930,000
(80,000)
$850,000
$ 3.72
(0.32)
$ 3.40
53,333
91,667
62,500
207,500
$ 4.48
(0.39)
$ 4.10*
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Chapter 18
833
1836. (Concluded)
3. Same answer as (1). The July 1, 2013, 25% stock dividend increased the number of
shares outstanding from 200,000 to 250,000. Stock dividends retroactively affect the
shares and thus are assumed outstanding the entire year.
1837.
Great Northern Inc.
Computations for Basic Earnings per ShareSimple Structure
December 31, 2014
Weighted-average number of shares for 2013:
Issued
Stock
Stock
Portion
Weighted
Dates
Shares
Dividend
Split
of Year
Average
2013
Jan. 1 to May 1
32,500
1.08
2.0
4/12
=
23,400
May 1Sale
4,500
May 1 to Aug. 1
37,000
1.08
2.0
3/12
=
19,980
Aug. 1Stock div.
2,960
Aug. 1 to Dec. 31
39,960
2.0
5/12
=
33,300
Weighted-average number of shares ..................................................
76,680
Computation of earnings for 2013:
Income before extraordinary gain.......................................................................
Less: Preferred stock dividend ($67,500 0.12) ................................................
Income before extraordinary gain identified with common stock ....................
Extraordinary gain ...............................................................................................
Net income identified with common stock ......................................................
$ 316,200
8,100
$ 308,100
12,500
$ 320,600
$4.02
0.16
$4.18
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834
Chapter 18
1837. (Concluded)
Computation of earnings for 2014:
Retained earningsDecember 31, 2014 .......................................................
Less: Retained earningsDecember 31, 2013.............................................
Increase in retained earnings ........................................................................
Add dividends in 2014:
Preferred shares ...............................................................
$ 9,900*
Common shares ................................................................
163,240
Net income, 2014 ............................................................................................
Add extraordinary loss ..................................................................................
Income before extraordinary loss .................................................................
Less: Preferred stock dividend .....................................................................
Income before extraordinary loss identified with common stock ..............
Basic EPS, 2014:
Income before extraordinary loss ($256,980/81,853) ...................................
Extraordinary loss [$(19,000)/81,853]............................................................
Net income ($237,980/81,853) .....................................................................
*$82,500 0.12 = $9,900
$ 471,200
396,460
$ 74,740
173,140
$ 247,880
19,000
$ 266,880
9,900
$ 256,980
$ 3.14
(0.23)
$ 2.91
1838.
Basic EPS:
Net income ......................................................................................................
Less: Preferred dividend ($9 5,000) ...........................................................
Net income identified with common stock ................................................
$ 500,000
45,000
$ 455,000
175,000
$2.60
Diluted EPS:
Income (see above for basic EPS) ................................................................
$455,000
175,000
12,387
187,387
$2.43
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Chapter 18
835
1839.
1. Basic EPS:
Net income for 2013:
Operating revenue ..............................................................................
Less: Operating expenses .................................................................
Income from operations before taxes ...............................................
Less: Income taxes (35%) ..................................................................
Net income .......................................................................................
$ 1,460,000
790,000
$ 670,000
234,500
$ 435,500
34,000
$12.81
2. Diluted EPS:
Net income to be used in computing diluted EPS:
Net income ..........................................................................................
$435,500
34,000
2,077
36,077
$12.07
Basic EPS:
Income before extraordinary gain ..............................................................
Extraordinary gainnet of taxes ...............................................................
Net income ..............................................................................................
$ 142,400
21,000
$ 163,400
16,667
8,833
25,500
1840.
$5.58
0.82
$6.41*
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836
Chapter 18
1840. (Concluded)
Diluted EPS:
Net income (see above for basic EPS)..........................................................
Weighted-average number of shares outstanding at Dec. 31, 2013 ...........
Incremental shares:
On assumed exercise of options:
Outstanding all year .............................................................. 2,500
Outstanding to Sept. 1, 2013 (1,500 8/12) ......................... 1,000
3,500
$163,400
25,500
1,909
27,409
$5.20
0.77
$5.96*
1841.
1. Basic EPS:
Weighted-average shares outstanding:
Dates
Jan. 1 to Aug. 31
Aug. 31 to Dec. 31
Shares
110,000
140,000
Months
Outstanding
8/12
4/12
=
=
Weighted
Average
73,333
46,667
120,000
$ 540,000
120,000
$
4.50
EPS Impact
$1.40
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Chapter 18
837
1841. (Concluded)
Net income .................................................................................................
Add interest savings on assumed conversion:
Interest prior to conversion ($1,000,000 0.06 8/12) ...... $40,000
Less: Income taxes (30%) ...................................................
12,000
Number of shares used in computing diluted EPS:
Number of shares for basic EPS ..........................................................
Incremental shares issued on assumed conversion (30,000 8/12) .
Shares used in computing diluted EPS ...............................................
Diluted EPS ($568,000/140,000).................................................................
2. Basic loss per share:
Net loss.......................................................................................................
Weighted-average number of shares outstanding [See (1)] ...................
Loss per share [$(220,000)/120,000] .........................................................
Diluted loss per share assuming conversion of 10-year debentures:
Net loss.......................................................................................................
Add interest savings on assumed conversion [See (1)] .........................
Shares used in computing diluted loss per share [See (1)] ....................
Diluted loss per share [$(192,000)/140,000] .............................................
$ 540,000
28,000
$ 568,000
120,000
20,000
140,000
$4.06
$ (220,000)
120,000
$
(1.83)
$ (220,000)
28,000
$ (192,000)
140,000
$
(1.37)
Because diluted loss per share assuming conversion is less than basic loss per
share, convertible securities are antidilutive, and the $1.83 loss per share would be
the only reported EPS on the income statement. Conversion always causes antidilution when losses occur.
1842.
1. Basic EPS:
Net income .................................................................................................
Less: Dividends on preferred stock (12,000 $6) ...................................
Net income applicable to common stock ..............................................
Weighted-average shares outstanding:
Jan. 1 to Sept. 1220,000 8/12 ..........................................................
Sept. 1 to Dec. 31310,000 4/12 ........................................................
Basic EPS ($848,000/250,000) ...................................................................
$ 920,000
72,000
$ 848,000
146,667
103,333
250,000
$3.39
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838
Chapter 18
1842. (Concluded)
2. Diluted EPS:
Test for dilution on convertible bonds:
Interest, net of tax, per $1,000 bond ($1,000 0.10 0.70) .....
Number of shares ......................................................................
Incremental EPS ($70/50) ..........................................................
$ 70.00
50.00
$ 1.40 (dilutive)
$ 848,000
250,000
56,000
$ 904,000
7,353
257,353
40,000
297,353
$3.04
Because the exercise price for the warrants is greater than the average market
price of the stock for the year ($36 > $34), the warrants are antidilutive.
1843.
Step 1Basic EPS:
Net income as reported ............................................................
$ 12,750,000
Less: Preferred dividends paid:
June 30 (1,400,000 $0.50) .................................................. $ 700,000
Sept. 30 (1,400,000 $0.50) ..................................................
700,000
Dec. 31 (650,000 $0.50) ......................................................
325,000
1,725,000
Net income less preferred dividends .......................................
$ 11,025,000
Shares outstanding at December 31, 2013 ..............................
Less: Shares issued on conversion of preferred stock
(750,000 2) ............................................................................
Shares outstanding at Jan. 1, 2013 ..........................................
Computation of weighted-average number of shares:
Jan. 1 to Oct. 1 ...................................................... = 7,300,000
Oct. 1 to Nov. 1 ............. 7,300,000 + 2(150,000) = 7,600,000
Nov. 1 to Dec. 31 .......... 7,600,000 + 2(600,000) = 8,800,000
Weighted-average number of shares ..................................
Basic EPS ($11,025,000/7,575,000) ...........................................
8,800,000
1,500,000
7,300,000
9/12
1/12
2/12
5,475,000
633,333
1,466,667
7,575,000
$1.46
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Chapter 18
839
1843. (Concluded)
Step 2Determine whether convertible securities are dilutive:
Net Income
Impact
$ 1,725,000
1,260,000
Number of
Shares
1,825,000*
1,200,000**
Incremental
EPS
Impact
$0.95
1.05
Because both convertible securities are lower than basic EPS, they are both potentially dilutive. Whether the securities are actually dilutive depends on the comparison
with the recomputed EPS, as shown in step 3.
*(1,400,000 2) 6/12 = 1,400,000
(1,250,000 2) 1/12 = 208,333
(650,000
2) 2/12 = 216,667
1,400,000 + 208,333 + 216,667 = 1,825,000
1844.
Net Income
$11,025,000
Number of
Shares
7,575,000
$11,025,000
1,725,000
$12,750,000
1,260,000
$14,010,000
100,000
7,675,000
1,825,000
9,500,000
1,200,000
10,700,000
EPS
$1.46
500,000
(400,000)
100,000
1.44
1.34
1.31
$ 1,985,000
$ 240,000
250,000
490,000
$ 1,495,000
240,000
100,000
340,000
$4.40
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840
Chapter 18
1844. (Concluded)
Computation of diluted EPS:
Test for dilution of convertible securities:
Net Income
Number of Incremental
Impact
Shares
EPS
7% Convertible bonds..................................... $122,200*
55,000
$2.22
10% Convertible preferred stock....................
250,000
75,000
3.33
*$2,350,000 0.08 0.65 = $122,200; effective interest is amount charged to interest
expense, not paid interest.
Because each security is less than the $4.40 basic EPS, they are both pote ntially
dilutive. Whether the securities are actually dilutive depends on the comparison
with the recomputed EPS, as shown below.
Net
Number of
Description
Income
Shares
Basic EPS ................................... $1,495,000
May 1, 2014, options as if
exercised May 1, 2014:
Number of shares
assumed issued ....... 20,000
Number of treasury
shares
[(20,000 $20)/$25]... (16,000)
4,000
$1,495,000
7% Convertible bonds ..............
122,200
$1,617,200
10% Convertible preferred
stock .......................................
250,000
Diluted EPS ...............................
$1,867,200
Part of
Year
Weighted
Average
340,000
8/12
2,667
342,667
55,000
397,667
EPS
$4.40
4.36
4.07
75,000
472,667
3.95
$1.49
1845.
Diluted EPS:
Test for dilution of convertible bonds:
Increase in
Net Income
10-yr., 6% convertible bonds...................
$23,400*
20-yr., 7% convertible bonds......................
50,400
25-yr., 10% convertible bonds.................
56,700**
Increase in
Number of
Shares
66,000
54,000
32,400
Incremental
EPS
$0.35
0.93
1.75
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Chapter 18
841
1845. (Concluded)
COMPUTATIONS:
*$600,000 0.065
Net
Income
$1,315,000
23,400
$1,338,400
50,400
$1,388,800
56,700
$1,445,500
Number
of Shares
880,000
66,000
946,000
54,000
1,000,000
32,400
1,032,400
Incremental
EPS
$1.49
1.41
1.39
1.40
1.39*
*The 25-yr. bonds are antidilutive and therefore are not included in the computation of diluted EPS.
2. Basic EPS assuming conversion of 10-year, 6% bonds on
July 1, 2014:
Net income in (1) ..................................................................................
Add interest savings after conversion
($600,000 0.065 6/12) 0.60 ........................................................
New net income ...................................................................................
$ 1,315,000
880,000
33,000
913,000
$1.45
11,700
$ 1,326,700
Net
Income
$1,326,700
Number
of Shares
913,000
11,700
$1,338,400
50,400
$1,388,800
33,000
946,000
54,000
1,000,000
Incremental
EPS
$1.45
1.41
1.39*
*The 25-yr. bonds would still be antidilutive because the diluted calculations are
the same whether conversion of the 10-year bonds occurs or not.
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842
Chapter 18
1846.
$ 2,300,000
77,000
$ 2,223,000
Portion
Weighted
of Year
Average
4/12 =
403,333
3/12
341,000
2/12
227,333
2/12
251,167
1/12
129,415
1,352,248
$1.64
=
=
121,000
107,250
228,250
=
=
$ 86,625
26,469
$ 113,094
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Chapter 18
843
1846. (Concluded)
=
=
137,940
42,148
180,088
Net Income
$2,223,000
Number
of Shares
1,352,248
EPS
$1.64
$2,223,000
63,414
1,415,662
1.57
$2,223,000
12,931
1,428,593
1.56
77,000
$2,300,000
228,250
1,656,843
1.39
113,094
$2,413,094
180,088
1,836,931
1.31
154,000
(90,586)
63,414
110,000
(97,069)
12,931
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844
Chapter 18
CASES
Discussion Case 1847
The EPS data are limited for comparison purposes because (1) the number of shares outstanding for
each organization may differ, (2) the accounting principles followed by each may differ, (3) the assumptions supporting the EPS computation may not reflect the actual actions of the firm, and (4) each firm may
or may not have similar dilutive securities. The EPS is a result of dividing income available to common
shareholders by the weighted-average number of common shares outstanding for the period. There is no
reason to suggest that the capitalization of one corporation will be the same as anothers capitalization.
The capitalization of an organization reflects its objectives and the result of current and past activity, as
well as future expectations.
2013
$ 6,500,000
500,000
$ 6,000,000
1,800,000
$ 4,200,000
400,000
$ 3,800,000
2012
$ 7,000,000
2011
$7,500,000
$ 7,000,000
2,100,000
$ 4,900,000
400,000
$ 4,500,000
$ 7,500,000
2,250,000
$ 5,250,000
800,000
$ 4,450,000
800,000
1,000,000
1,000,000
4.75
4.50
4.45
Farnsworth Company was able to maintain and even increase EPS while operating income declined because in 2012 it retired 50% of the preferred stock (50,000 shares), which eliminated $400,000 of required dividends that would now be available to common stockholders. In 2013, EPS was increased by
borrowing money, which in part was used to retire 200,000 shares of common stock. The increase in interest expense of $350,000 after taxes was more than offset by the retirement of 200,000 shares of
common stock. The case illustrates how a company can increase EPS despite declining operating income.
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Chapter 18
845
Case 1851
1.
This question is a simple mathematical exercise to demonstrate that the difficult part of computing EPS is
not dividing the numerator by the denominator but rather determining what the numerator and the denominator are. Disney reported net income for 2009 of $3,307 million. This net income was divided by the
average diluted shares outstanding of 1,875 million to yield diluted earnings per share of $1.76.
2.
Dividing $648 million by 1,875 million average shares outstanding results in an average dividend paid per
share (loosely) of $0.35 per share. Disneys dividend payout ratio for 2009 was 20% (dividends per share
divided by earnings per share).
3.
The most recent Disney stock split was in June 1998 when Disney effected a 3-for-1 stock split. Whenever a stock split occurs, the stockholders equity and per-share values are restated to give retroactive
recognition to the stock split in prior periods.
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846
Chapter 18
Case 1852
The objective of this assignment is to cause students to think about why the FASB must work with the
IASB in developing accounting standards. Students should also consider why the FASB must be very
careful when working with the IASB in that it (the FASB) does not compromise U.S. GAAP in the spirit of
international harmonization.
Because the economy is now global, money can be raised in capital markets around the world. If the U.S.
capital markets require the use of U.S. GAAP and U.S. GAAP places an unreasonable burden on companies, those companies can raise their needed funds elsewhere. Thus, the FASB must seek international harmonization of accounting standards to ensure that U.S. capital markets remain as viable players
in financing the global economy.
However, if the FASB compromises the rigor of its standards in an effort to appeal to the international
community, the result may be that domestic U.S. investors will get lower-quality financial statement information.
As described in the text, the SEC is now seriously considering accepting International Financial Reporting
Standards (IFRS) for use by U.S. companies. A key reason that this is under consideration is that the
FASB and the IASB have worked jointly to develop a commonly accepted, high-quality set of standards.
Case 1853
This ethical dilemma presents students with the problem of trying to defend the FASBs position against
another viable alternative. The FASB elected to compute and provide to financial statement users the most
conservative diluted EPS figure. The FASB could have selected the managers position as well. But the fact
remains that the FASB did not choose the managers position. If the manager insists on computing EPS
using a method that is not in accordance with GAAP, external auditors would be forced to issue a qualified
audit opinion. In that qualified opinion, the auditors would have to specifically state the reason for the qualification, thereby revealing the managers purpose in using the different method for computing EPS.
Case 1854
Solutions to this problem can be found on the Instructors CD-ROM or downloaded from the Web at
www.cengage.com/accounting/stice.