Intermediate Accounting Chapter 16 CPA Exam Practice: Dilutive Securities & Earnings Per Share

Bondholders of Balm Co. converted their bonds into 90,000 shares of $5 par value common stock. In Balm's accounting records, the bonds had a par value of $775,000 and unamortized discount of $23,000 at the time of conversion. What amount of additional paid-in capital from the conversion should Balm record?

A. $348,000

B. $798,000

C. $302,000

D. $325,000

C. $302,000

$302,000 is correct. Without fair value information, the book value method of allocating the bond carrying value to the owners' equity accounts must be used. The carrying value of the bond issue is $752,000 ($775,000 - $23,000). Of that amount, $450,000 is first allocated to the common stock account at par value (90,000 shares issued x $5). The remainder, or $302,000 ($752,000 - $450,000) is allocated to additional paid in capital.

Which of the following is generally associated with the terms of convertible debt securities?

A. An initial conversion price that is less than the market value of the common stock at time of issuance.

B. A feature to subordinate the security to nonconvertible debt.

C. An interest rate that is lower than nonconvertible debt.

D. A noncallable feature.

C. An interest rate that is lower than nonconvertible debt.

An interest rate that is lower than nonconvertible debt is correct because convertible debt generally will have an interest rate that is lower than nonconvertible debt.

The proceeds from a bond issued with detachable stock purchase warrants should be accounted for

A. Entirely as bonds payable.

B. Entirely as stockholders' equity.

C. Partially as unearned revenue, and partially as bonds payable.

D. Partially as stockholders' equity, and partially as bonds payable.

D. Partially as stockholders' equity, and partially as bonds payable.

Partially as stockholders' equity, and partially as bonds payable is correct. Bonds issued with stock purchase warrants are, in substance, composed of two elements, a debt element and a stockholders' equity element. Per ASC Topic 470, proceeds from bonds issued with detachable stock purchase warrants should be allocated between the bonds and the warrants on the basis of their relative fair market values. Detachable warrants are traded separately from the debt and have an available fair market value. The amount allocated to the warrants should be accounted for as stockholders' equity with the remainder allocated to bonds payable.

A restricted stock award was granted at the beginning of 2015 calling for 3,000 shares of stock to be awarded to executives at the beginning of 2019. The fair value of one option was $20 at grant date. During 2017, 100 shares were forfeited because an executive left the firm.

What amount of compensation expense is recognized for 2017?

A. $15,000

B. $14,500

C. $13,500

D. $14,000

C. $13,500

$13,500 is correct. Total compensation expense at grant date is $60,000 (3,000 x $20). The service period is four years (2015-2018). Annual expense recognized is $15,000 ($60,000/4).Through 2016, a total of $30,000 of compensation expense is recognized. After the forfeit, only 2,900 shares remain to be awarded. Annual compensation expense for the remaining two years before considering forfeited shares is therefore $14,500 [(2,900 x $20)/4]. The expense for the two years associated with the 100 shares forfeited is $1,000 [(100 x $20)/2]. For 2017, subtracting the reversal of the $1,000 yields $13,500 as the final amount of expense to be recognized. Another way to calculate the $14,500 is: ($60,000 original total compensation expense - $30,000 expense for 15 and 16 - $1,000 expense for 17 and 18 on forfeited shares)/2.

A company had the following outstanding shares as of January 1, year 2:

Preferred stock, $60 par, 4%, cumulative 10,000 shares

Common stock, $3 par 50,000 shares

On April 1, year 2, the company sold 8,000 shares of previously unissued common stock. No dividends were in arrears on January 1, year 2, and no dividends were declared or paid during year 2. Net income for year 2 totaled $236,000. What amount is basic earnings per share for the year ended December 31, year 2?

A. $4.07

B. $4.21

C. $3.66

D. $3.79

D. $3.79

$3.79 is correct. Basic EPS = Net Income - Preferred Dividends / Weighted shares outstanding. The numerator is $236,000 - preferred dividends [($60 x 10,000) x .04 = 24,000] = $212,000. The denominator is 50,000 (12/12) + 8,000 (9/12) = 56,000 shares. $212,000 / 56,000 = $3.786 or $3.79.

Chape Co. had the following information related to common and preferred shares during the year:

Common shares outstanding, 1/1 700,000

Common shares repurchased, 3/31 20,000

Conversion of preferred shares, 6/30 40,000

Common shares repurchased, 12/1 36,000

Chape reported net income of $2,000,000 at December 31. What amount of shares should Chape use as the denominator in the computation of basic earnings per share?

A. 684,000

B. 700,000

C. 702,000

D. 740,000

C. 702,000

702,000 is correct. Weighted average shares outstanding are weighted by the number of months the shares were outstanding during the year. The easiest way to do this is to take each change in common stock and multiply by the number of months remaining - add the shares that increased shares outstanding and subtract shares that reduced shares outstanding.

Shares Months Wtd avg

700,000

12/12 700,000

-20,000

9/12 -15,000

+40,000

6/12 +20,000

-36,000

1/12 -3,000

702,000

A firm has basic earnings per share (BEPS) of $1.29. If the tax rate is 30%, which of the following securities would be dilutive?

A. Six percent, $100 par cumulative convertible preferred stock, issued at par, with each preferred share convertible into four shares of common stock.

B. Seven percent convertible bonds, issued at par, with each $1,000 bond convertible into 40 shares of common stock.

C. Cumulative 8%, $50 par preferred stock.

D. Ten percent convertible bonds, issued at par, with each $1,000 bond convertible into 20 shares of common stock.

B. Seven percent convertible bonds, issued at par, with each $1,000 bond convertible into 40 shares of common stock.

Seven percent convertible bonds, issued at par, with each $1,000 bond convertible into 40 shares of common stock is correct. This security is dilutive. The numerator effect is $49 saving in interest ($1,000 x .07 x (1-.3)), and the denominator effect is 40 more shares outstanding. 49 / 40 = $1.225, which is less than the BEPS of $1.29, so the security is dilutive.

On January 2, 2017, Morey Corp. granted Dean, its president, 20,000 stock appreciation rights for past services. Those rights are exercisable immediately and expire on January 1, 2020.

On exercise, Dean is entitled to receive cash for the excess of the stock's market price on the exercise date over the market price on the grant date. Dean did not exercise any of the rights during 2017. The market price of Morey's stock was $30 on January 2, 2017 and $45 on December 31, 2017.

As a result of the stock appreciation rights, Morey should recognize compensation expense for 2017 of

A. $100,000.

B. $300,000.

C. $600,000.

D. $0.

B. $300,000.

$300,000 is correct. The 2017 compensation expense for these stock-appreciation rights equals: (number of shares) x (ending market price - grant-date market price) = 20,000($45 - $30) = $300,000. The rights are immediately vested, because they can be exercised immediately. Therefore, the entire $300,000 amount is recognized as expense in 2017. Changes in market price in future years, before the rights are exercised, are recognized on a current and prospective basis (change in estimate).

During the current year, Comma Co. had outstanding: 25,000 shares of common stock, 8,000 shares of $20 par, 10% cumulative preferred stock, and 3,000 bonds that are $1,000 par and 9% convertible. The bonds were originally issued at par, and each bond was convertible into 30 shares of common stock. During the year, net income was $200,000, no dividends were declared, and the tax rate was 30%.

What amount was Comma's basic earnings per share for the current year?

A. $7.36

B. $8.00

C. $7.55

D. $3.38

A. $7.36

$7.36 is correct. One year of preferred stock dividends is subtracted from income in the numerator of EPS because the stock is cumulative. The amount of dividends declared does not affect the calculation. The bonds are not relevant because basic EPS does not assume conversion of the bonds. The calculation is: Basic EPS = [$200,000 - (8,000 x $20 x .10)]/25,000 = ($200,000 - $16,000)/25,000 = $7.36.