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Chapter 16: 6Q (page 873)
What are the arguments for giving separate accounting recognition to the conversion feature of debentures?
The arguments for giving separate accounting recognition to the change element of debentures is that there is an economic value intrinsic in conversion feature.
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DiCenta Corporation reported net income of \(270,000 in 2017 and had 50,000 shares of common stock outstanding throughout the year. Also outstanding all year were 5,000 shares of cumulative preferred stock, each convertible into 2 shares of common. The preferred stock pays an annual dividend of \)5 per share. DiCenta鈥檚 tax rate is 40%. Compute DiCenta鈥檚 2017 diluted earnings per share.
EPS: Simple Capital Structure) On January 1, 2018, Wilke Corp. had 480,000 shares of common stock outstanding. During 2018, it had the following transactions that affected the common stock account.
February 1 Issued 120,000 shares
March 1 Issued a 10% stock dividend
May 1 Acquired 100,000 shares of treasury stock
June 1 Issued a 3-for-1 stock split
October 1 Reissued 60,000 shares of treasury stock
Instructions
(a) Determine the weighted-average number of shares outstanding as of December 31, 2018.
(b) Assume that Wilke Corp. earned net income of \(3,456,000 during 2018. In addition, it had 100,000 shares of 9%, \)100 par nonconvertible, noncumulative preferred stock outstanding for the entire year. Because of liquidity considerations, however, the company did not declare and pay a preferred dividend in 2018. Compute earnings per share for 2018, using the weighted-average number of shares determined in part (a).
(c) Assume the same facts as in part (b), except that the preferred stock was cumulative. Compute earnings per share for 2018.
(d) Assume the same facts as in part (b), except that net income included a loss from discontinued operations of $432,000 (net of tax). Compute earnings per share for 2018.
GROUPWORK (Computation of Basic and Diluted EPS) Charles Austin of the controller鈥檚 office of Thompson
Corporation was given the assignment of determining the basic and diluted earnings per share values for the year ending
December 31, 2018. Austin has compiled the information listed below.
1. The company is authorized to issue 8,000,000 shares of \(10 par value common stock. As of December 31, 2017, 2,000,000
shares had been issued and were outstanding.
2. The per share market prices of the common stock on selected dates were as follows.
Price per Share
July 1, 2017 \)20.00
January 1, 2018 21.00
April 1, 2018 25.00
July 1, 2018 11.00
August 1, 2018 10.50
November 1, 2018 9.00
December 31, 2018 10.00
3. A total of 700,000 shares of an authorized 1,200,000 shares of convertible preferred stock had been issued on July 1, 2017.
The stock was issued at its par value of \(25, and it has a cumulative dividend of \)3 per share. The stock is convertible into
common stock at the rate of one share of convertible preferred for one share of common. The rate of conversion is to be
automatically adjusted for stock splits and stock dividends. Dividends are paid quarterly on September 30, December 31,
March 31, and June 30.
4. Thompson Corporation is subject to a 40% income tax rate.
5. The after-tax net income for the year ended December 31, 2018, was \(11,550,000.
The following specific activities took place during 2018.
1. January 1鈥擜 5% common stock dividend was issued. The dividend had been declared on December 1, 2017, to all stockholders
of record on December 29, 2017.
2. April 1鈥擜 total of 400,000 shares of the \)3 convertible preferred stock was converted into common stock. The company
issued new common stock and retired the preferred stock. This was the only conversion of the preferred stock during 2018.
3. July 1鈥擜 2-for-1 split of the common stock became effective on this date. The board of directors had authorized the split
on June 1.
4. August 1鈥擜 total of 300,000 shares of common stock were issued to acquire a factory building.
5. November 1鈥擜 total of 24,000 shares of common stock were purchased on the open market at \(9 per share. These shares
were to be held as treasury stock and were still in the treasury as of December 31, 2018.
6. Common stock cash dividends鈥擟ash dividends to common stockholders were declared and paid as follows.
April 15鈥擻)0.30 per share
October 15鈥�$0.20 per share
7. Preferred stock cash dividends鈥擟ash dividends to preferred stockholders were declared and paid as scheduled.
Instructions
(a) Determine the number of shares used to compute basic earnings per share for the year ended December 31, 2018.
(b) Determine the number of shares used to compute diluted earnings per share for the year ended December 31, 2018.
(c) Compute the adjusted net income to be used as the numerator in the basic earnings per share calculation for the year
ended December 31, 2018.
(Stock-Based Compensation) Assume that Amazon.com has a stock-option plan for top management. Each
stock option represents the right to purchase a share of Amazon \(1 par value common stock in the future at a price equal to the
fair value of the stock at the date of the grant. Amazon has 5,000 stock options outstanding, which were granted at the beginning
of 2017. The following data relate to the option grant.
Exercise price for options \)40
Market price at grant date (January 1, 2017) \(40
Fair value of options at grant date (January 1, 2017) \)6
Service period 5 years
Instructions
(a) Prepare the journal entry(ies) for the first year of the stock-option plan.
(b) Prepare the journal entry(ies) for the first year of the plan assuming that, rather than options, 700 shares of restricted
stock were granted at the beginning of 2017.
(c) Now assume that the market price of Amazon stock on the grant date was $45 per share. Repeat the requirements for
(a) and (b).
(d) Amazon would like to implement an employee stock-purchase plan for rank-and-file employees, but it would like to
avoid recording expense related to this plan. Which of the following provisions must be in place for the plan to avoid
recording compensation expense?
(1) Substantially all employees may participate.
(2) The discount from market is small (less than 5%).
(3) The plan offers no substantive option feature.
(4) There is no preferred stock outstanding
Financial Statement Analysis Case
Ragatz, Inc.
Ragatz, Inc., a drug company, reported the following information. The company prepares its financial statements in accordance with GAAP.
2017 (000) | |
Current liabilities | \(554,114 |
Convertible subordinated debts | 648,020 |
Total liabilities | 1,228,313 |
Stockholder鈥檚 equity | 176,413 |
Net income | 58,333 |
Analysts attempting to compare Ragatz to drug companies that issue debt with detachable warrants may face a challenge due to differences in accounting for convertible debt.
Instructions
(a) Compute the following ratios for Ragatz, Inc. (Assume that year-end balances approximate annual averages.)
(1) Return on assets.
(2) Return on common stock equity.
(3) Debt to assets ratio.
(b) Briefly discuss the operating performance and financial position of Ragatz. Industry averages for these ratios in 2017 were ROA 3.5%; return on equity 16%; and debt to assets 75%. Based on this analysis, would you make an investment in the company鈥檚 5% convertible bonds? Explain.
(c) Assume you want to compare Ragatz to an IFRS company like Merck (which issues nonconvertible debt with detachable warrants). Assuming that the fair value of the equity component of Ragatz鈥檚 convertible bonds is \)150,000, how would you adjust the analysis above to make valid comparisons between Ragatz and Merck?
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