16
Dilutive CHAPTER Securities and Earnings Per Share
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics 1. 2. 3. Convertible debt and preferred stock. Warrants and debt. Stock options, restricted stock. Earnings Per Share (EPS)terminology. EPSDetermining potentially dilutive securities. EPSTreasury stock method. EPSWeightedaverage computation. EPSGeneral objectives. EPSComprehensive calculations. EPSContingent shares. Stock appreciation rights. 16 Questions 1, 2, 3, 4, 5, 6, 7, 28 2, 3, 8, 9 1, 10, 11, 12, 13, 14, 15 17, 18, 24 19, 20, 21 Brief Exercises 1, 2, 3 4, 5 6, 7, 8 Exercises 1, 2, 3, 4, 5, 6, 7, 24, 25, 7, 8, 9, 28 10, 11, 12, 13, 14 1, 3, 4 Problems 2 Concepts for Analysis 1 1, 3 2, 4
4. 5.
15 12, 13, 14 22, 23, 27
6 5, 7
6. 7. 8. 9.
22, 23 15, 16 24, 25 10, 11 9, 15
28 15, 16, 17, 18, 21 5, 6, 7, 8, 9
5, 7
5, 6, 7 19, 20, 21, 22, 23, 24, 26, 27, 28 27 29, 30 7, 8, 9
10. *11.
*This material is dealt with in an Appendix to the chapter.
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16-1
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives 1. Describe the accounting for the issuance, conversion, and retirement of convertible securities. 2. Explain the accounting for convertible preferred stock. 3. Contrast the accounting for stock warrants and for stock warrants issued with other securities. 4. Describe the accounting for stock compensation plans under generally accepted accounting principles. 5. Discuss the controversy involving stock compensation plans. 6. Compute earnings per share in a simple capital structure 7. Compute earnings per share in a complex capital structure. *8. Explain the accounting for stock-appreciation rights plans. *9. Compute earnings per share in a complex situation. 9, 10, 11, 15 12, 13, 14 16 15, 16, 17, 18, 19, 20, 21 22, 23, 24, 25, 26, 27, 28 29, 30 6, 9 5, 7, 8 Brief Exercises 1, 2 Exercises 2, 3, 4, 5, 6 Problems 1, 2
3 4, 5 6, 7, 8
24, 25 1, 7, 8, 9 10, 11, 12, 13, 14 1 1, 3, 4
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ASSIGNMENT CHARACTERISTICS TABLE
Ite m E16-1 E16-2 E16-3 E16-4 E16-5 E16-6 E16-7 E16-8 E16-9 E16-10 E16-11 E16-12 E16-13 E16-14 E16-15 E16-16 E16-17 E16-18 E16-19 E16-20 E16-21 E16-22 E16-23 E16-24 E16-25 E16-26 E16-27 E16-28 *E16-29 *E16-30 P16-1 P16-2 P16-3 P16-4 P16-5 P16-6 P16-7 P16-8 P16-9 CA16-1 CA16-2 CA16-3 CA16-4 CA16-5 CA16-6 CA16-7 Description Level of Difficul ty Simple Simple Simple Moderate Simple Moderate Simple Simple Moderate Moderate Moderate Moderate Simple Simple Moderate Simple Simple Simple Simple Simple Simple Complex Moderate Moderate Moderate Moderate Simple Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Complex Moderate Simple Moderate Moderate Moderate Moderate Moderate Time (minut es) 1520 1520 1015 1520 1020 2535 1015 1015 1520 1525 1525 1525 1015 1015 1525 1015 1015 1015 2025 1015 1015 2025 1520 2025 1015 2025 1015 1520 1525 1525 3540 4550 3035 2530 3035 3035 3545 2535 3040 2025 1520 1520 2535 2535 2535 2535 16-3
Issuance and conversion of bonds. Conversion of bonds. Conversion of bonds. Conversion of bonds. Conversion of bonds. Conversion of bonds. Issuance of bonds with warrants. Issuance of bonds with detachable warrants. Issuance of bonds with stock warrants. Issuance and exercise of stock options. Issuance, exercise, and termination of stock options. Issuance, exercise, and termination of stock options. Accounting for restricted stock. Accounting for restricted stock. Weighted-average number of shares. EPS: Simple capital structure. EPS: Simple capital structure. EPS: Simple capital structure. EPS: Simple capital structure. EPS: Simple capital structure. EPS: Simple capital structure. EPS with convertible bonds, various situations. EPS with convertible bonds. EPS with convertible bonds and preferred stock. EPS with convertible bonds and preferred stock. EPS with options, various situations. EPS with contingent issuance agreement. EPS with warrants. Stock-appreciation rights. Stock-appreciation rights. Entries for various dilutive securities. Entries for conversion, amortization, and interest of bonds. Stock option plan. Stock-based compensation. EPS with complex capital structure. Basic EPS: Two-year presentation. Computation of basic and diluted EPS. Computation of basic and diluted EPS. EPS with stock dividend and extraordinary items. Warrants issued with bonds and convertible bonds. Ethical issuescompensation plan. Stock warrantsvarious types. Stock compensation plans. EPS: Preferred dividends, options, and convertible debt. EPS concepts and effect of transactions on EPS. EPS, antidilution.
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SOLUTIONS TO CODIFICATION EXERCISES
CE16-1
Master Glossary (a) The amount of earnings for the period available to each share of common stock outstanding during the reporting period. A reduction in EPS resulting from the assumption that convertible securities were converted, that options or warrants were exercised, or that other shares were issued upon the satisfaction of certain conditions. A security that gives the holder the right to purchase shares of common stock in accordance with the terms of the instrument, usually upon payment of a specified amount. The date at which an employer and an employee reach a mutual understanding of the key terms and conditions of a share-based payment award. The employer becomes contingently obligated on the grant date to issue equity instruments or transfer assets to an employee who renders the requisite service. Awards made under an arrangement that is subject to shareholder approval are not deemed to be granted until that approval is obtained unless approval is essentially a formality (or perfunctory), for example, if management and the members of the board of directors control enough votes to approve the arrangement. Similarly, individual awards that are subject to approval by the board of directors, management, or both are not deemed to be granted until all such approvals are obtained. The grant date for an award of equity instruments is the date that an employee begins to benefit from, or be adversely affected by, subsequent changes in the price of the employers equity shares. Paragraph 718-10-25-5 provides guidance on determining the grant date. See Service Inception Date.
(b)
(c)
(d)
CE16-2
According to FASB ASC 260-10-45-7 (Earnings Per ShareOther Presentation Matters): EPS data shall be presented for all periods for which an income statement or summary of earnings is presented. If diluted EPS data are reported for at least one period, they shall be reported for all periods presented, even if they are the same amounts as basic EPS. If basic and diluted EPS are the same amount, dual presentation can be accomplished in one line on the income statement.
CE16-3
According to FASB ASC 260-10-50-1 (Earnings Per ShareDisclosure): For each period for which an income statement is presented, an entity shall disclose all of the following: (a) A reconciliation of the numerators and the denominators of the basic and diluted per-share computations for income from continuing operations. The reconciliation shall include the individual income and share amount effects of all securities that affect earnings per share (EPS). Example 2 (see paragraph 260-10-55-51) illustrates that disclosure. (See paragraph 260-10-45-3.) An entity is encouraged to refer to pertinent information about securities included in the EPS computations that is provided elsewhere in the financial statements as prescribed by Subtopic 505-10.
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(b)
The effect that has been given to preferred dividends in arriving at income available to common stockholders in computing basic EPS.
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CE16-3 (Continued)
(c) Securities (including those issuable pursuant to contingent stock agreements) that could potentially dilute basic EPS in the future that were not included in the computation of diluted EPS because to do so would have been antidilutive for the period(s) presented. Full disclosure of the terms and conditions of these securities is required even if a security is not included in diluted EPS in the current period.
CE16-4
According to FASB ASC 260-10-55-12 (Earnings Per ShareImplementationRestatement of EPS Data): If the number of common shares outstanding increases as a result of a stock dividend or stock split (see Subtopic 505-20) or decreases as a result of a reverse stock split, the computations of basic and diluted EPS shall be adjusted retroactively for all periods presented to reflect that change in capital structure . If changes in common stock resulting from stock dividends, stock splits, or reverse stock splits occur after the close of the period but before issuance of the financial statements, the per-share computations for those and any prior-period financial statements presented shall be based on the new number of shares. If per-share computations reflect such changes in the number of shares, that fact shall be disclosed.
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ANSWERS TO QUESTIONS
1. Securities such as convertible debt or stock options are dilutive because their features indicate that the holders of the securities can become common shareholders. When the common shares are issued, there will be a reductiondilutionin earnings per share. Corporations issue convertible securities for two reasons. One is to raise equity capital without giving up more ownership control than necessary. A second reason is to obtain financing at cheaper rates. The conversion privilege attracts investors willing to accept a lower interest rate than on a straight debt issue. Convertible debt and debt issued with stock warrants are similar in that: (1) both allow the issuer to issue debt at a lower interest cost than would generally be available for straight debt; (2) both allow the holders to purchase the issuers stock at less than market value if the stock appreciates sufficiently in the future; (3) both provide the holder the protection of a debt security if the value of the stock does not appreciate; and (4) both are complex securities which contain elements of debt and equity at the time of issue. Convertible debt and debt with stock warrants are different in that: (1) if the market price of the stock increases sufficiently, the issuer can force conversion of convertible debt into common stock by calling the issue for redemption, but the issuer cannot force exercise of the warrants; (2) convertible debt may be essentially equity capital, whereas debt with stock warrants is debt with the additional right to acquire equity; and (3) the conversion option and the convertible debt are inseparable and, in the absence of separate transferability, do not have separate values established in the market; whereas debt with detachable stock warrants can be separated into debt and the right to purchase stock, each having separate values established by the transactions in the market. 4. The accounting treatment of the $160,000 sweetener to induce conversion of the bonds into common shares represents a departure from GAAP because the FASB views the transaction as the retirement of debt. Therefore, the FASB requires that the sweetener of $160,000 be reported as an expense. It is not an extraordinary loss because it is simply a payment to induce conversion. (a) From the point of view of the issuer, the conversion feature of convertible debt results in a lower cash interest cost than in the case of nonconvertible debt. In addition, the issuer in planning its long-range financing may view the convertible debt as a means of raising equity capital over the long term. Thus, if the market value of the underlying common stock increases sufficiently after the issue of the debt, the issuer will usually be able to force conversion of the convertible debt into common stock by calling the issue for redemption. Under the market conditions, the issuer can effectively eliminate the debt. On the other hand, if the market value of the common stock does not increase sufficiently to result in the conversion of the debt, the issuer will have received the benefit of the cash proceeds to the scheduled maturity dates at a relatively low cash interest cost. (b) The purchaser obtains an option to receive either the face amount of the debt upon maturity or the specified number of common shares upon conversion. If the market value of the underlying common stock increases above the conversion price, the purchaser (either through conversion or through holding the convertible debt containing the conversion option) receives the benefits of appreciation. On the other hand, should the value of the underlying company stock not increase, the purchaser could nevertheless expect to receive the principal and (lower) interest.
2.
3.
5.
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16-7
Questions Chapter 16 (Continued) 6. The view that separate accounting recognition should be accorded the conversion feature of convertible debt is based on the premise that there is an economic value inherent in the conversion feature or call on the common stock and that the value of this feature should be recognized for accounting purposes by the issuer. It may be argued that the call is not significantly different in nature from the call contained in an option or warrant and its issue is thus a type of capital transaction. The fact that the conversion feature coexists with certain senior security characteristics in a complex security and cannot be physically separated from these elements or from the instrument does not constitute a logical or compelling reason why the values of the various elements should not receive separate accounting recognition. The fact that the eventual outcome of the option granted the purchaser of the convertible debt cannot be determined at date of issuance is not relevant to the question of effectively reflecting in the accounting records the various elements of the complex document at the date of issuance. The conversion feature has a value at date of issuance and should be recognized. Moreover, the difficulties of implementation are not insurmountable and should not be relied upon to govern the conclusion. The method used by the company to record the exchange of convertible debentures for common stock can be supported on the grounds that when the company issued the convertible debentures, the proceeds could represent consideration received for the stock. Therefore, when conversion occurs, the book value of the obligation is simply transferred to the stock exchanged for it. Further justification is that conversion represents a transaction with stockholders which should not give rise to a gain or loss. On the other hand, recording the issue of the common stock at the book value of the debentures is open to question. It may be argued that the exchange of the stock for the debentures completes the transaction cycle for the debentures and begins a new cycle for the stock. The consideration or value used for this new transaction cycle should then be the amount which would be received if the debentures were sold rather than exchanged, or the amount which would be received if the related stock were sold, whichever is more clearly determinable at the time of the exchange. This method recognizes changes in values which have occurred and subordinates a consideration determined at the time the debentures were issued. 8. Cash................................................................................................. Discount on Bonds Payable............................................................. Bonds Payable.......................................................................... Paid-in CapitalStock Warrants.............................................. Value of bonds with warrants Value of warrants Value of bonds without warrants $3,000,000 100,000 $2,900,000 3,000,000 100,000 3,000,000 100,000
7.
In this case, the incremental method is used since no separate value is given for the bonds without the warrants. 9. If a corporation decides to issue new shares of stock, the old stockholders generally have the right, referred to as a stock right, to purchase newly issued shares in proportion to their holdings. No entry is required when rights are issued to existing stockholders. Only a memorandum entry is needed to indicate that the rights have been issued. If exercised, the corporation simply debits Cash for the proceeds received, credits Common Stock for the par value, and any difference is recorded with a credit to Paid-in Capital in Excess of Par. Companies are required to use the fair value method to recognize compensa tion cost. For most stock option plans compensation cost is measured at the grant date and allocated to expense over the service period, which typically ends on the vesting date.
10.
16-8
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Questions Chapter 16 (Continued) 11. This plan would not be considered compensatory since it meets the conditions of a noncompensatory plan; i.e., (1) substantially all full-time employees may participate on an equitable basis, (2) the discount from market price is small, and (3) the plan offers no substantive option feature. The profession recommends that the fair value of a stock option be determined on the date on which the option is granted to a specific individual. At the date the option is granted, the corporation foregoes the alternative of selling the shares at the then prevailing price. The market price on the date of grant may be presumed to be the value which the employer had in mind. It is the value of the option at the date of grant, rather than the grantors ultimate gain or loss on the transaction, which for accounting purposes constitutes whatever compensation the grantor intends to pay. 13. GAAP requires that compensation expense be recognized over the service period. Unless otherwise specified, the service period is the vesting periodthe time between the grant date and the vesting date. Using the fair value approach, total compensation expense is computed based on the fair value of the options on the date the options are granted to the employees. Fair value is estimated using an acceptable option pricing model (such as the Black-Scholes option-pricing model). The advantages of using restricted stock to compensate employees are: (1) The restricted stock never becomes completely worthless; (2) it generally results in less dilution than stock options; and (3) it better aligns the employee incentives with the companies incentives. Weighted-average shares outstanding Outstanding shares (all year) =........................................................ October 1 to December 31 (200,000 X 1/4) =.................................. Weighted average............................................................................ Net income............................................................................................... Preferred dividends.................................................................................. Income available to common stockholders.............................................. Earnings per share = 17. $1,600,000 450,000 = $3.56
12.
14.
15.
16.
400,000 50,000 450,000 $2,000,000 400,000 $1,600,000
The computation of the weighted-average number of shares requires restatement of the shares outstanding before the stock dividend or split. The additional shares outstanding as a result of a stock dividend or split are assumed to have been outstanding since the beginning of the year. Shares outstanding prior to the stock dividend or split are adjusted so that these shares are stated on the same basis as shares issued after the stock dividend/split. (a) Basic earnings per share is the amount of earnings for the period available to each share of common stock outstanding during the reporting period. (b) A potentially dilutive security is a security which can be exchanged for or converted into common stock and therefore upon conversion or exercise could dilute (or decrease) earnings per share. Included in this category are convertible securities, options, warrants, and other rights. (c) Diluted earnings per share is the amount of earnings for the period available to each share of common stock outstanding and to each share that would have been outstanding assuming the issuance of common shares for all dilutive potential common shares outstanding during the reporting period.
18.
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16-9
Questions Chapter 16 (Continued) (d) A complex capital structure exists whenever a companys capital structure includes dilutive securities. (e) Potential common stock is not common stock in form but does enable its holders to obtain common stock upon exercise or conversion. 19. Convertible securities are potentially dilutive securities and part of diluted earnings per share if their conversion increases the EPS numerator less than it increases the EPS denominator; i.e., the EPS with conversion is less than the EPS before conversion. The concept that a security may be the equivalent of common stock has evolved to meet the reporting needs of investors in corporations that have issued certain types of convertible securities, options, and warrants. A potentially dilutive security is a security which is not, in form, common stock but which enables its holder to obtain common stock upon exercise or conversion. The holders of these securities can expect to participate in the appreciation of the value of the common stock resulting principally from the earnings and earnings potential of the issuing corporation. This participation is essentially the same as that of a common stockholder except that the security may carry a specified dividend yielding a return different from that received by a common stockholder. The attractiveness to investors of this type of security is often based principally upon this potential right to share in increases in the earnings potential of the issuing corporation rather than upon its fixed return or upon other senior security characteristics. In addition, the call characteristic of the stock options and warrants gives the investor potential control over a far greater number of shares per dollar of investment than if the investor owned the shares outright. Convertible securities are considered to be potentially dilutive securities whenever their conversion would decrease earnings per share. If this situation does not result, conversion is not assumed and only basic EPS is reported. Under the treasury-stock method, diluted earnings per share should be determined as if outstanding options and warrants were exercised at the beginning of year (or date of issue if later) and the funds obtained thereby were used to purchase common stock at the average market price for the period. For example, if a corporation has 10,000 warrants outstanding exercisable at $54, and the average market price of the common stock during the reported period is $60, the $540,000 which would be realized from exercise of warrants and issuance of 10,000 shares would be an amount sufficient to acquire 9,000 shares; thus, 1,000 shares would be added to the outstanding common shares in computing diluted earnings per share for the period. However, to avoid an incremental positive effect upon earnings per share, options and warrants should enter into the computation only when the average market price of the common stock exceeds the exercise price of the option or warrant. Yes, if warrants or options are present, an increase in the market price of the common stock can increase the number of potentially dilutive common shares by decreasing the number of shares repurchasable. In addition, an increase in the market price of common stock can increase the compensation expense reported in a stock-appreciation rights plan. This would decrease net income and, consequently, earnings per share. Antidilution is an increase in earnings per share resulting from the assumption that convertible securities have been converted or that options and warrants have been exercised, or other shares have been issued upon the fulfillment of certain conditions. For example, an antidilutive condition would exist when the dividend or interest requirement (net of tax) of a convertible security exceeds the current EPS multiplied by the number of common shares issuable upon conversion of the security. This may be illustrated by assuming a company in the following situation: Net income................................................................................................................ Outstanding shares of common stock...................................................................... 6% Bonds payable (convertible into 5,000 shares of common stock)...................... Tax rate..................................................................................................................... Basic earnings per share = $10,000/20,000 shares = $.50 $ 10,000 20,000 $100,000 40%
20.
21.
22.
23.
24.
16-10
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Questions Chapter 16 (Continued) Earnings per share assuming conversion of the bonds: Net income........................................................................................................ Bond interest (net of tax) = (1 .40) ($100,000 X .06)..................................... Adjusted net income......................................................................................... Earnings per share assuming conversion = $13,600 20,000 + 5,000 = $.54
$10,000 3,600 $13,600
This antidilutive effect occurs because the bond interest (net of tax) of $3,600 is greater than the current EPS of $.50 multiplied by the number of shares issuable upon conversion of the bonds (5,000 shares). 25. Both basic earnings per share and diluted earnings per share must be presented in a complex capital structure. When irregular items are reported, per share amounts should be shown for income from continuing operations, income before extraordinary items, and net income. The primary iGAAP reporting standards related to financial instruments, including dilutive securities is IAS 39 Financial Instruments: Recognition and Measurement. The accounting for various forms of stock-based compensation under iGAAP is found in IFRS 2 Share-Based Payment. This standard was recently amended, resulting in significant convergence between iGAAP and U.S. GAAP in this area. The iGAAP standard addressing accounting and reporting for earnings per share computations in IAS 33 Earnings per Share. iGAAP and U.S. GAAP are substantially the same in the accounting for dilutive securities, stockbased compensation, and earnings per share. For example, both iGAAP and U.S. GAAP follow the same model for recognizing stock-based compensation. That is, the fair value of shares and options awarded to employees is recognized over the period to which the employees services relate. The main differences concern (1) the accounting for convertible debt. Under U.S. GAAP all of the proceeds of convertible debt are recorded as long term debt. Under iGAAP, convertible bonds are bifurcated, or separated into the equity componentthe value of the conversion optionof the bond issue and the debt component; (2) a minor differences in EPS reportingthe FASB allows companies to rebut the presumption that contracts that can be settled in either cash or shares will be settled in shares. iGAAP requires that share settlement must be used in this situation; (3) other EPS differences relate to the treasury stock method and how the proceeds from extinguishment of a liability should be accounted for and how to make the computation for the weighted-average of contingently issuable shares. 28. (a) Norman makes the following entry to record the issuance under U.S. GAAP. Cash................................................................................................................ Bonds payable........................................................................................... 400,000 400,000
26.
27.
(b) Under iGAAP, Norman must bifurcate (split out) the equity componentthe value of the conversion optionof the bond issue. Under iGAAP, the convertible bond issue is recorded as follows. Cash................................................................................................................ Discount on Bonds Payable............................................................................ Bonds Payable........................................................................................... Paid-in CapitalConvertible Bonds........................................................... (c) 400,000 35,000 400,000 35,000
iGAAP provides a more faithful representation of the impact of the bond issue, by recording separately its debt and equity components. However, there are concerns about reliability of the models used to estimate the equity portion of the bond issue.
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16-11
Questions Chapter 16 (Continued) 29. The FASB has been working on a standard that will likely converge to iGAAP in the accounting for convertible debt. Similar to the FASB the IASB is examining the classification of hybrid securities; the IASB is seeking comment on a discussion document similar to the FASB Preliminary Views document: Financial Instruments with Characteristics of Equity. It is hoped that the boards will develop a converged standard in this area. While U.S. GAAP and iGAAP are similar as to the presentation of EPS, the Boards have been working together to resolve remaining differences related to earnings per share computations. Antidilution when multiple securities are involved is determined by ranking the securities for maximum possible dilution in terms of per share effect. Starting with the most dilutive, earnings per share is reduced until one of the securities maintains or increases earnings per share. When an increase in earnings per share occurs, the security that causes the increase in earnings per share is excluded. The previous computation therefore provided the maximum dilution.
*30.
16-12
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SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 16-1 Cash............................................................................... Discount on Bonds Payable........................................ Bonds Payable...................................................... 3,960,000 40,000 4,000,000
BRIEF EXERCISE 16-2 Bonds Payable.............................................................. Discount on Bonds Payable................................ Common Stock (2,000 X 50 X $10)...................... Paid-in Capital in Excess of Par.......................... 2,000,000 30,000 1,000,000 970,000
BRIEF EXERCISE 16-3 Preferred Stock (1,000 X $50)...................................... Paid-in Capital in Excess of ParPreferred Stock ($60 $50) X 1,000......................................... Common Stock (2,000 X $10)............................... Paid-in Capital in Excess of Par Common Stock ($60 X 1,000) (2,000 X $10)............................ 50,000 10,000 20,000
40,000
BRIEF EXERCISE 16-4 Cash................................................................................ Discount on Bonds Payable ($2,000,000 $1,940,784).......................................... Bonds Payable....................................................... Paid-in CapitalStock Warrants......................... FMV of bonds (2,000 X $1,000 X .98)........................... FMV of warrants (2,000 X $40)..................................... Aggregate FMV.............................................................. Allocated to bonds ($1,960/$2,040 X $2,020,000)....... Allocated to warrants ($80/$2,040 X $2,020,000)....... 2,020,000 59,216 2,000,000 79,216 $1,960,000 80,000 $2,040,000 $1,940,784 79,216 $2,020,000
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16-13
BRIEF EXERCISE 16-5 Cash............................................................................ Discount on Bonds Payable [$2,000,000 X (1 .98)]........................................... Bonds Payable................................................... Paid-in CapitalStock Warrants...................... *$2,000,000 X (1.01 .98) 2,020,000 40,000 2,000,000 60,000*
BRIEF EXERCISE 16-6 1/1/10 12/31/10 No entry Compensation Expense......................... Paid-in CapitalStock Options........................................ Compensation Expense......................... Paid-in CapitalStock Options........................................ 75,000 75,000 75,000 75,000
12/31/11
BRIEF EXERCISE 16-7 1/1/10 Unearned Compensation....................... Common Stock (2,000 X $5)........... Paid in Capital in Excess of Par [($65 $5) X 2,000]....................... Compensation Expense......................... Unearned Compensation............... Compensation Expense......................... Unearned Compensation............... 130,000 10,000 120,000 65,000 65,000 65,000 65,000
12/31/10
12/31/11
16-14
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BRIEF EXERCISE 16-8 1/1/10 Unearned Compensation............................... Common Stock........................................... Paid-in Capital in Excess of Par................ Compensation Expense................................. Unearned Compensation ($75,000 3)..... 75,000 10,000 65,000 25,000 25,000
12/31/10
BRIEF EXERCISE 16-9 $1,000,000 (100,000 X $2) = $3.20 per share 250,000 shares BRIEF EXERCISE 16-10 Dates Outstanding 1/15/1 5/17/1 7/110/1 10/112/31 Shares Outstanding 120,000 180,000 170,000 180,000 Fraction of Year 4/12 2/12 3/12 3/12 Weighted Shares 40,000 30,000 42,500 45,000 157,500
BRIEF EXERCISE 16-11 (a) (300,000 X 4/12) + (330,000 X 8/12) = 320,000 (b) 330,000 (The 30,000 shares issued in the stock dividend are assumed outstanding from the beginning of the year.)
BRIEF EXERCISE 16-12 Net income..................................................................................... Adjustment for interest, net of tax [$80,000 X (1 .40)]........... Adjusted net income.................................................................... Weighted average number of shares adjusted for dilutive securities (100,000 + 16,000)...................................... Diluted EPS....................................................................................
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$300,000 48,000 $348,000 116,000 $3.00
16-15
BRIEF EXERCISE 16-13 Net income.................................................................................... Weighted average number of shares adjusted for dilutive securities (50,000 + 10,000)................................. Diluted EPS................................................................................... $270,000 60,000 $4.50
BRIEF EXERCISE 16-14 Proceeds from assumed exercise of 45,000 options (45,000 X $10)............................................................. Shares issued upon exercise..................................................... Treasury shares purchasable ($450,000 $15)........................ Incremental shares...................................................................... Diluted EPS = $300,000 = 200,000 + 15,000
$450,000 45,000 30,000 15,000 $1.40
BRIEF EXERCISE 16-15 Earnings per share Income before extraordinary loss ($600,000/100,000)..... Extraordinary loss ($120,000/100,000)............................... Net income ($480,000/100,000)...........................................
$ 6.00 (1.20) $ 4.80
*BRIEF EXERCISE 16-16 2010: 2011: (5,000 X $4) X 50% = $10,000 (5,000 X $9) $10,000 = $35,000
16-16
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
SOLUTIONS TO EXERCISES
EXERCISE 16-1 (1520 minutes) 1. Cash ($10,000,000 X .99)................................ Discount on Bonds Payable.......................... Bonds Payable......................................... Unamortized Bond Issue Costs..................... Cash.......................................................... 2. Cash................................................................. Discount on Bonds Payable.......................... Bonds Payable......................................... Paid-in CapitalStock Warrants............ Value of bonds plus warrants ($10,000,000 X .98) Value of warrants (100,000 X $4) Value of bonds 3. 9,900,000 100,000 10,000,000 70,000 70,000 9,800,000 600,000 10,000,000 400,000
$9,800,000 400,000 $9,400,000 75,000 10,000,000 55,000 1,000,000 8,945,000* 75,000
Debt Conversion Expense............................. Bonds Payable................................................ Discount on Bonds Payable................... Common Stock......................................... Paid-in Capital in Excess of Par............. Cash.......................................................... *[($10,000,000 $55,000) $1,000,000]
EXERCISE 16-2 (1520 minutes) (a) Interest Payable ($150,000 X 2/6).................. Interest Expense ($150,000 X 4/6) + $2,032.... Discount on Bonds Payable................... Cash ($3,000,000 X 10% 2)................... Calculations: Par value Issuance price Total discount $3,000,000 2,940,000 $ 60,000
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50,000 102,032 2,032 150,000
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 16-2 (Continued) Months remaining Discount per month ($60,000 118) Discount amortized (4 X $508) 118 $508 $2,032 1,000,000 18,305 600,000 381,695*
(b) Bonds Payable...................................................... Discount on Bonds Payable.......................... Common Stock (30,000 X $20)....................... Paid-in Capital in Excess of Par.................... *($1,000,000 $18,305) $600,000 Calculations: Discount related to 1/3 of the bonds ($60,000 X 1/3) Less: Discount amortized [($60,000 118) X 10 X 1/3] Unamortized bond discount EXERCISE 16-3 (1015 minutes) Conversion recorded at book value of the bonds: Bonds Payable.............................................................. Premium on Bonds Payable........................................ Preferred Stock (400 X 20 X $50)......................... Paid-in Capital in Excess of ParPreferred Stock................................................. EXERCISE 16-4 (1520 minutes) (a) Cash........................................................................ Bonds Payable............................................... Premium on Bonds Payable......................... (To record issuance of $10,000,000 of 8% convertible debentures for $10,600,000. The bonds mature in twenty years, and each $1,000 bond is convertible into five shares of $30 par value common stock) $20,000 1,695 $18,305
400,000 6,000 400,000 6,000
10,600,000 10,000,000 600,000
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 16-4 (Continued) (b) Bonds Payable................................................ Premium on Bonds Payable (Schedule 1) ................................................ Common Stock, $15 par (Schedule 2) ........................................ Paid-in Capital in Excess of Par............ (To record conversion of 20% of the outstanding 8% convertible debentures after giving effect to the 2-for-1 stock split) Schedule 1 Computation of Unamortized Premium on Bonds Converted Premium on bonds payable on January 1, 2010............ Amortization for 2010 ($600,000 20)............................. Amortization for 2011 ($600,000 20)............................. Premium on bonds payable on January 1, 2012............ Bonds converted............................................................... Unamortized premium on bonds converted................... Schedule 2 Computation of Common Stock Resulting from Conversion Number of shares convertible on January 1, 2010: Number of bonds ($10,000,000 $1,000)...................................................... 10,000 Number of shares for each bond................................ X 5 50,000 Stock split on January 1, 2011........................................ X 2 Number of shares convertible after the stock split...... 100,000 % of bonds converted...................................................... X 20% Number of shares issued................................................ 20,000 Par value/per share.......................................................... $15 Total par value.................................................................. $300,000 $600,000 $30,000 30,000 60,000 540,000 20% $108,000 2,000,000 108,000 300,000 1,808,000
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-19
EXERCISE 16-5 (1020 minutes) Interest Expense............................................................... Discount on Bonds Payable [$10,240 64 = $160; $160 X 4]........................... Cash (10% X $600,000 X 1/2)................................... (Assumed that the interest accrual was reversed as of January 1, 2011; if the interest accrual was not reversed, interest expense would be $20,640 and interest payable would be debited for $10,000) Bonds Payable.................................................................. Discount on Bonds Payable ($10,240 $640)....... Common Stock ($25 X 6 X 600)............................... Paid-in Capital in Excess of Par............................. *($600,000 $9,600) $90,000 30,640 640 30,000
600,000 9,600 90,000 500,400*
EXERCISE 16-6 (2535 minutes) (a) December 31, 2010 Bond Interest Expense............................................ Premium on Bonds Payable ($60,000 X 1/20).................................................... Cash ($3,000,000 X 8% X 6/12)........................ January 1, 2011 Bonds Payable.......................................................... Premium on Bonds Payable.................................... Common Stock [8 X $100 X ($600,000/$1,000)].................... Paid-in Capital in Excess of Par...................... Total premium ($3,000,000 X .02) Premium amortized ($60,000 X 2/10) Balance Bonds converted ($600,000 $3,000,000) Related premium ($48,000 X 20%)
16-20
117,000 3,000 120,000
(b)
600,000 9,600 480,000 129,600
$60,000 12,000 $48,000 20% 9,600
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 16-6 (Continued) (c) March 31, 2011 Bond Interest Expense............................................ Premium on Bonds Payable ($9,600 8 years) X 3/12..................................... Bond Interest Payable ($600,000 X 8% X 3/12)................................. March 31, 2011 Bonds Payable.......................................................... Premium on Bonds Payable.................................... Common Stock................................................. Paid-in Capital in Excess of Par...................... Premium as of January 1, 2011 for $600,000 of bonds $9,600 8 years remaining X 3/12 Premium as of March 31, 2011 for $600,000 of bonds (d) $9,600 (300) $9,300 70,200 1,800 12,000 84,000* 11,700 300 12,000 600,000 9,300 480,000 129,300
June 30, 2011 Bond Interest Expense............................................ Premium on Bonds Payable.................................... Bond Interest Payable ($600,000 X 8% X 1/4)***....................................... Cash................................................................... [Premium to be amortized: ($60,000 X 60%) X 1/20 = $1,800, or $28,800** 16 (remaining interest and amortization periods) = $1,800]
*Total to be paid:($1,800,000 X 8% 2) + $12,000 = $84,000 **Original premium 2009 amortization 2010 amortization Jan. 1, 2011 write-off Mar. 31, 2011 amortization Mar. 31, 2011 write-off $60,000 (6,000) (6,000) (9,600) (300) (9,300) $28,800
***Assumes interest accrued on March 31. If not, debit Bond Interest Expense for $82,200.
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-21
EXERCISE 16-7 (1015 minutes) (a) Basic formulas:
Value of bonds without warrants X Issue price = Value assigned to bonds Value of bonds without warrants + Value of warrants Value of warrants X Issue price = Value assigned to warrants Value of bonds without warrants + Value of warrants $136,000 $136,000 + $24,000
X $150,000 = $127,500
Value assigned to bonds
$24,000 X $150,000 = $22,500 $136,000 + $24,000 $150,000
Value assigned to warrants Total
Cash........................................................................... Bonds Payable......................... ($175,000 $127,500) Bonds Payable.................................................. Paid-in CapitalStock Warrants....................
150,000Discount on 47,500 175,000 22,500
(b) When the warrants are non-detachable, separate recognition is not given to the warrants. The accounting treatment parallels that given convertible debt because the debt and equity element cannot be separated. The entry if warrants were non-detachable is: Cash........................................................................... Discount on Bonds Payable.................................... Bonds Payable.................................................. 150,000 25,000 175,000
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 16-8 (1015 minutes) JACOB COMPANY Journal Entry September 1, 2010 Cash ($3,120,000 + $60,000 $30,000).................... Unamortized Bond Issue Costs............................... Bonds Payable (3,000 X $1,000)....................... Premium on Bonds PayableSchedule 1....... Paid-in CapitalStock Warrants Schedule 1...................................................... Bond Interest ExpenseSchedule 2............... (To record the issuance of the bonds) Schedule 1 Premium on Bonds Payable and Value of Stock Warrants Sales price (3,000 X $1,040)....................................................... $3,120,000 Face value of bonds.................................................................... 3,000,000 120,000 Deduct value assigned to stock warrants (3,000 X 2 = 6,000; 6,000 X $3).................................................. 18,000 Premium on bonds payable....................................................... $ 102,000 Schedule 2 Accrued Bond Interest to Date of Sale Face value of bonds.................................................................... Interest rate.................................................................................. Annual interest............................................................................ Accrued interest for 3 months ($240,000 X 3/12).................. EXERCISE 16-9 (1520 minutes) (a) Cash ($3,000,000 X 1.02)............................ Discount on Bonds Payable [(1 .98) X $3,000,000]............................ Bonds Payable....................................... Paid-in CapitalStock Warrants......... *$3,060,000 ($3,000,000 X .98) 3,060,000 60,000 3,000,000 120,000* $3,000,000 8% $ 240,000 $ 60,000 3,150,000 30,000 3,000,000 102,000 18,000 60,000
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-23
EXERCISE 16-9 (Continued) (b) Market value of bonds without warrants ($3,000,000 X .98)................................................. Market value of warrants (3,000 X $20).................. Total market value....................................................
$2,940,000 $3,000,000 $60,000 X $3,060,000 = $ 61,200 Value assigned to warrants $3,000,000 $3,060,000 Total X $3,060,000 = $2,998,800 Value assigned to bonds
$2,940,000 60,000 $3,000,000
Cash........................................................................... Discount on Bonds Payable................................... Bonds Payable..................................................... Paid-in CapitalStock Warrants.......................
3,060,000 1,200 3,000,000 61,200
EXERCISE 16-10 (1525 minutes)1/2/10........................ No entry (total compensation cost is $600,000)12/31/10Compensation Expense 300,000 Paid-in CapitalStock Options........... 300,000 [To record compensation expense for 2010 (1/2 X $600,000)]12/31/11Compensation Expense 300,000........................................................... Paid-in CapitalStock Options ................................................... 300,000 [To record compensation expense for 2011 (1/2 X $600,000)] 1/3/12 Cash (30,000 X $40)...................................... Paid-in CapitalStock Options ($600,000 X 30,000/40,000)........................ Common Stock (30,000 X $10)............. Paid-in Capital in Excess of Par.......... (To record issuance of 30,000 shares of $10 par value stock upon exercise of options at option price of $40) 1,200,000 450,000 300,000 1,350,000
16-24
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 16-10 (Continued) (Note to instructor:The market price of the stock has no relevance in the prior entry and the following one.) 5/1/12 Cash (10,000 X $40)............................................. Paid-in CapitalStock Options ($600,000 X 10,000/40,000)............................. Common Stock............................................ Paid-in Capital in Excess of Par................. (To record issuance of 10,000 shares of $10 par value stock upon exercise of options at option price of $40) 400,000 150,000 100,000 450,000
EXERCISE 16-11 (1525 minutes) 1/1/10 12/31/10 No entry (total compensation cost is $400,000) Compensation Expense..................................... Paid-in CapitalStock Options.............. ($400,000 X 1/2) (To recognize compensation expense for 2010) Paid-in CapitalStock Options......................... Compensation Expense ($200,000 X 3,000/20,000)..................... (To record termination of stock options held by resigned employees) Compensation Expense..................................... Paid-in CapitalStock Options.............. ($400,000 X 1/2 X 17/20) (To recognize compensation expense for 2011) Cash (12,000 X $25)............................................. Paid-in CapitalStock Options ($400,000 X 12,000/20,000).............................. Common Stock......................................... Paid-in Capital in Excess of Par............. (To record exercise of stock options) 200,000 200,000
4/1/11
30,000 30,000
12/31/11
170,000 170,000
3/31/12
300,000 240,000 120,000 420,000
Note: There are 5,000 options unexercised as of 3/31/12 (20,000 3,000 12,000).
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-25
EXERCISE 16-12 (1525 minutes) 1/1/09 12/31/09 No entry (total compensation cost is $450,000) Compensation Expense............................... Paid-in CapitalStock Options ($450,000 X 1/2)................................ Compensation Expense............................... Paid-in CapitalStock Options........... Cash (9,000 X $20)........................................ Paid-in CapitalStock Options................... Common Stock (9,000 X $5)................. Paid-in Capital in Excess of Par.......... *($450,000 X 9,000/10,000) 1/1/13 Paid-in CapitalStock Options................... Paid-in Capital from Expired Stock Options ($450,000 $405,000)......... EXERCISE 16-13 (1015 minutes) (a) 1/1/10 Unearned Compensation................................ Common Stock (4,000 X $5)............................ Paid-in Capital Excess of Par..................... 45,000 45,000 120,000 20,000 100,000 30,000 30,000 20,000 100,000 60,000 60,000 225,000 225,000 225,000 225,000 180,000 405,000* 45,000 540,000
12/31/10 5/1/11
12/31/11 Compensation Expense.................................. Unearned Compensation ($120,000 4)........... (b) 3/4/12 Common Stock................................................. Paid-in Capital Excess of Par......................... Unearned Compensation............................ Compensation Expense (2 X $30,000).......
EXERCISE 16-14 (1015 minutes) (a) 1/1/10 Unearned Compensation................................ Common Stock ($10 X 10,000)........................ Paid-in Capital in Excess of Par................ 500,000 100,000 400,000 100,000 100,000
12/31/11 Compensation Expense ($500,000 5).......... Unearned Compensation..................................
16-26
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 16-14 (Continued) (b) 7/25/14 Common Stock................................................. Paid-in Capital in Excess of Par..................... Compensation Expense.............................. 100,000 400,000 500,000
EXERCISE 16-15 (1525 minutes)(a)............... 2,640,000 shares Jan. 1, 2010Sept. 30, 2010 (2,400,000 X 9/12).................... Retroactive adjustment for stock dividend............. Jan. 1, 2010Sept. 30, 2010, as adjusted................. Oct. 1, 2010Dec. 31, 2010 (2,640,000 X 3/12)..........
1,800,000 X 1.10 1,980,000 660,000 2,640,000 Another way to view this transaction is that the 2,400,000 shares at the beginning of the year must be restated for the stock dividend regardless of where in the year the stock dividend occurs. (b) 4,140,000 shares..................................................................... Jan. 1, 2011 Mar. 31, 2011 (2,640,000 X 3/12).................................................... 660,000 Apr. 1, 2011Dec. 31, 2011 (4,640,000 X 9/12).......... 3,480,000 4,140,000 (c) 8,280,000 shares..................................................................... 2011 weightedaverage number of shares............................................................. previously computed ...................................................................... 4,140,000 Retroactive adjustment for stock split..................... X 2 8,280,000 (d) 9,280,000 shares Jan. 1, 2012Mar. 31, 2012 (4,640,000 X 3/12)................ 1,160,000 Retroactive adjustment for stock split........................... X 2 Jan. 1, 2012Mar. 31, 2012, as adjusted......................... 2,320,000 Apr. 1, 2012Dec. 31, 2012 (9,280,000 X 9/12)............... 6,960,000 9,280,000 Another way to view this transaction is that the 4,640,000 shares at the beginning of the year must be restated for the stock split regardless of where in the year the stock split occurs.
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-27
EXERCISE 16-16 (1015 minutes) (a)
Event Beginning balance Issued shares Stock dividend Reacquired shares Stock split Reissued shares Dates Outstanding Jan. 1Feb. 1 Feb. 1Mar. 1 Mar. 1May 1 May 1June 1 June 1Oct. 1 Oct. 1Dec. 31 Shares Outstanding 480,000 600,000 720,000 620,000 1,860,000 1,920,000 Restatement 1.2 X 3.0 1.2 X 3.0 3.0 3.0 Fraction of Year 1/12 1/12 2/12 1/12 4/12 3/12 Weighted Shares 144,000 180,000 360,000 155,000 620,000 480,000 1,939,000
Weighted-average number of shares outstanding
(b) (c)
Earnings Per Share =
$3,256,000 (Net Income) 1,939,000 (Weighted-Average Shares) $3,256,000 $900,000 1,939,000
= $1.68
Earnings Per Share =
= $1.22
(d) Income from continuing operationsa............ discontinued operationsb...................................... before extraordinary item...................................... gainc ................................................................ .44 Net income....................................................... extraordinary gain.................................................. Add loss from discontinued operations..... Income from continuing operations............
a
$1.46Loss from (.22) Income 1.24Extraordinary Net income $1.68 a $3,256,000 Deduct (864,000) 432,000 $2,824,000
$2,824,000 = $1.46 1,939,000 $(432,000) 1,939,000 $864,000 1,939,000 = $(.22)
b
c
= $.44
16-28
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 16-17 (1015 minutes) Dates Shares Event Outstanding Outstanding Beginning balance Jan. 1May 1 210,000 Issued shares May 1Oct. 31 218,000 Reacquired shares Oct. 31Dec. 31 204,000 Weighted-average number of shares outstanding Fraction of Year 4/12 6/12 2/12 Weighted Shares 70,000 109,000 34,000 213,000
Income per share before extraordinary item ($229,690 + $40,600 = $270,290; $270,290 213,000 shares)......................................................... Extraordinary loss per share, net of tax ($40,600 213,000)...................................................................... Net income per share ($229,690 213,000)..................................
$1.27 (.19) $1.08
EXERCISE 16-18 (1015 minutes)
Event Dates Outstanding Shares Outstanding Restatement 2 2 2 Fraction of Year 4/12 3/12 5/12 Weighted Shares 400,000 450,000 625,000 1,475,000
Beginning balance Jan. 1May 1 600,000 Issued shares May 1Aug. 1 900,000 Reacquired shares Aug. 1Dec. 31 750,000 Weighted-average number of shares outstanding
Net income...................................................................................... Preferred dividend (50,000 X $100 X 8%)......................................
$2,200,000 (400,000) $1,800,000
Net income applicable to common stock = $1,800,000 = $1.22 Weighted-average number of shares outstanding 1,475,000
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-29
EXERCISE 16-19 (2025 minutes) Earnings per share of common stock: Income before extraordinary loss*........................................ Extraordinary loss, net of tax**............................................. Net income***.......................................................................... Income data: Income before extraordinary item......................................... Deduct 6% dividend on preferred stock............................... Common stock income before extraordinary item............. Deduct extraordinary loss, net of tax................................... Net income available for common stockholders................. Dates Outstanding Shares Outstanding Fraction of Year
$1.89 (.17) $1.72
$15,000,000 300,000 14,700,000 1,340,000 $13,360,000 Weighted Shares 1,750,000 6,000,000 7,750,000
January 1April 1 7,000,000 3/12 April 1December 31 8,000,000 9/12 Weighted-average number of shares outstanding *$14,700,000 7,750,000 shares = $1.89 per share (income before extraordinary loss) **$1,340,000 7,750,000 shares = ($.17) per share (extraordinary loss net of tax) ***$13,360,000 7,750,000 shares = $1.72 per share (net income)
EXERCISE 16-20 (1015 minutes) Income before income tax and extraordinary items................... Income taxes................................................................................... Income before extraordinary item................................................. Extraordinary gain, net of applicable income tax of $36,000..... Net income....................................................................................... Per share of common stock: Income before extraordinary item*........................................ Extraordinary gain, net of tax**.............................................. Net income***........................................................................... $300,000 120,000 180,000 54,000 $234,000
$.41 .18 $.59
16-30
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 16-20 (Continued) Dates Outstanding Shares Outstanding Fraction of Year Weighted Shares 50,000 65,000 85,000 92,500 292,500
January 1April 1 200,000 3/12 April 1July 1 260,000 3/12 July 1Oct. 1 340,000 3/12 Oct. 1Dec. 31 370,000 3/12 Weighted-average number of shares outstanding
$300,000 income tax of $120,000 preferred dividends of $60,000 (6% of $1,000,000) = $120,000 (income available to common stockholders)
***$120,000 292,500 shares = $.41 per share (income before extraordinary gain) ***$54,000 292,500 shares = $.18 per share (extraordinary gain, net of tax) ***$174,000 292,500 shares = $.59 per share (net income)
EXERCISE 16-21 (1015 minutes) Dates Outstanding Jan. 1April 1 April 1Oct. 1 Oct. 1Dec. 31 Shares Outstanding 800,000 1,250,000 1,140,000 Fraction of Year 3/12 6/12 3/12 Weighted Shares 200,000 625,000 285,000
Event Beginning balance Issued shares Reacquired shares
Weighted-average number of shares outstanding unadjusted............................................................................. Stock dividend, 2/15/11.................................................... Weighted-average number of shares outstanding adjusted................................................................................. Net income...................................................... Preferred dividend (280,000 X $50 X 7%)..... Earnings per share for 2010:
Net income applicable to common stock Weighted-average number of common shares outstanding = $1,850,000 1,165,500
1,110,000 1.05 1,165,500
$2,830,000 (980,000) $1,850,000
= $1.59
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-31
EXERCISE 16-22 (2025 minutes) (a) Revenues Expenses: Other than interest........................................... Bond interest (75 X $1,000 X .08)................... Income before income taxes.................................. Income taxes (40%)......................................... Net income............................................................... $17,500 $8,400 6,000 14,400 3,100 1,240 $ 1,860
Diluted earnings per share: $1,860 + (1 .40)($6,000) = $5,460 = $.57 2,000 + 7,500 9,500 (b) Revenues.................................................................. $17,500 Expenses:................................................................. Other than interest $8,400 ...................................................................Bond interest (75 X $1,000 X .08 X 4/12)......................................................... 2,000 10,400 Income before income taxes.................................. 7,100 Income taxes (40%)......................................... 2,840 Net income............................................................... $ 4,260 Diluted earnings per share: $4,260 + (1 .40)($2,000) = $5,460 = $1.21 2,000 + (7,500 X 1/3 yr.) 4,500 (c) Revenues.................................................................. $17,500 Expenses:................................................................. Other than interest $8,400 ...................................................................Bond interest (75 X $1,000 X .08 X 1/2)........................................................... 3,000 Bond interest (50 X $1,000 X .08 X 1/2)................. 2,000 13,400 Income before income taxes.................................. 4,100 Income taxes (40%)......................................... 1,640 Net income............................................................... $ 2,460 Diluted earnings per share (see note): $2,460 + (1 .40)($5,000) = $5,460 = $.57 2,000 + (2,500 X 1/2 yr.) + 5,000 + (2,500 X 1/2) 9,500 Note: The answer is the same as (a). In both (a) and (c), the bonds are assumed converted for the entire year.
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 16-23 (1520 minutes)(a) shares for basic earnings per share. Dates Outstanding Shares Outstanding Fraction of Year
1. Number Weighted Shares 200,000 1,050,000 1,250,000
of
Jan. 1April 1 800,000 3/12 April 1Dec. 1 1,400,000 9/12 Weighted-average number of shares outstanding OR Number of shares for basic earnings per share: Initial issue of stock............................................ April 1, 2011 issue (3/4 X 600,000)..................... Total............................................................... 2. Number of shares for diluted earnings per share: Dates Outstanding Shares Outstanding Fraction of Year
800,000 shares 450,000 shares 1,250,000 shares
Weighted Shares 200,000 350,000 712,000 1,262,000
Jan. 1April 1 800,000 3/12 April 1July 1 1,400,000 3/12 July 1Dec. 31 1,424,000* 6/12 Weighted-average number of shares outstanding *1,400,000 + [($600,000 1,000) X 40] (b) 1. Earnings for basic earnings per share: After-tax net income..................................... Earnings for diluted earnings per share: After-tax net income..................................... Add back interest on convertible bonds (net of tax): Interest ($600,000 X .08 X 1/2)...................... Less income taxes (40%)............................. Total................................................................
$1,540,000
2.
$1,540,000
$24,000 $1,554,400
[Note 9,600
14,400 to instructor: In this problem, the earnings per share computed for basic earnings per share is $1.23 ($1,540,000 1,250,000) and the diluted earnings per share is $1.23 (technically $1.232). As a result, only one earnings per share number would be presented.]
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-33
EXERCISE 16-24 (2025 minutes) (a) Net income for year................................................................... Add: Adjustment for interest (net of tax)............................... $7,500,000 187,200* $7,687,200 $4,000,000 X 7% 280,000 8,000 288,000 X .65 $ 187,200
*Maturity value........................................................................... Stated rate................................................................................. Cash interest............................................................................. Discount amortization [(1.00 .98) X $4,000,000 X 1/10]...... Interest expense....................................................................... 1 tax rate (35%)...................................................................... After-tax interest....................................................................... $4,000,000/$1,000 = 4,000 debentures Increase in diluted earnings per share denominator: 4,000 X 18 72,000 Earnings per share: Basic EPS Diluted EPS
$7,500,000 2,000,000 = $3.75 $7,687,200 2,072,000 = $3.71
(b) If the convertible security were preferred stock, basic EPS would be the same assuming there were no preferred dividends declared or the preferred was noncumulative. For diluted EPS, the numerator would be the net income amount of $7,500,000 and the denominator would be 2,072,000.
EXERCISE 16-25 (1015 minutes) (a) Net income.................................................................................. Add: Interest savings (net of tax) [$180,000 X (1 .40)]........................................................ Adjusted net income.................................................................. $3,000,000 $1,000 = 3,000 bonds X 15 45,000 shares Diluted EPS:$348,000 (100,000 + 45,000) = $2.40 $240,000 108,000 $348,000
16-34
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
EXERCISE 16-25 (Continued) (b) Shares outstanding.................................................................... Add: Shares assumed to be issued (10,000* X 5).................. Shares outstanding adjusted for dilutive securities.............. *$1,000,000 $100 Diluted EPS:($240,000 $0) 150,000 = $1.60 Note: Preferred dividends are not deducted since preferred stock was assumed converted into common stock. 100,000 50,000 150,000
EXERCISE 16-26 (2025 minutes) (a) Shares assumed issued on exercise....................................... Proceeds (1,000 X $8 = $8,000)Less: Treasury shares purchased ($8,000/$20)......................................................................................... Incremental shares............................................................ $40,000 Diluted EPS = = $3.77 (rounded) 10,000 + 600 (b) Shares assumed issued on exercise....................................... Proceeds = $8,000Less: Treasury shares purchased ($8,000/$20) 400
Diluted 1,000 400 600
Diluted 1,000
600
X 3/12
Incremental shares..................................................................... Diluted EPS = $40,000 = $3.94 (rounded) 10,000 + 150
150
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-35
EXERCISE 16-27 (1015 minutes) (a) The contingent shares would have to be reflected in diluted earnings per share because the earnings level is currently being attained. (b) Because the earnings level is not being currently attained, contingent shares are not included in the computation of diluted earnings per share.
EXERCISE 16-28 (1520 minutes) (a) The warrants are dilutive because the option price ($10) is less than the average market price ($15). Incremental shares = $15 $10 X 30,000 = $15 OR Proceeds from assumed exercise: (30,000 warrants X $10 exercise price).......................... Treasury shares purchasable with proceeds: ($300,000 $15 average market price).......................... Incremental shares issued: (30,000 shares issued less 20,000 purchased)............. (b) Basic EPS = $2.60 ($260,000 100,000 shares) (c) Diluted EPS = $2.36 ($260,000 110,000 shares) $300,000 20,000 10,000 Diluted
10,000
16-36
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
*EXERCISE 16-29 (1525 Minutes)
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-36
(a)
Fair Value $4
Schedule of Compensation Expense Stock Appreciation Rights
Cumulative Compensation Recognizable $480,000 Percentage Accrued 25% Compensation Accrued to Date $ 120,000 (60,000) Expense 2008 $120,00 0 Expense 2009 Expense 2010 Expense 2011
Date 12/31/08
$(60,000 ) $930,000 $90,000
12/31/09 12/31/10 12/31/11
1 11 9
120,000 1,320,000 1,080,000
50% 75% 100%
60,000 930,000 990,000 90,000 $1,080,000
(b) Compensation Expense............................................................... Liability Under Stock Appreciation Plan.............................. (c) Liability Under Stock Appreciation Plan..................................... Cash (120,000 X $9)................................................................
90,000 90,000 1,080,000 1,080,000
16-37
*EXERCISE 16-30 (1525 Minutes)
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
(a)
Schedule of Compensation Expense Stock Appreciation Rights
Compensation Fair Value $6 Cumulative Compensation Recognizable $240,000 Percentage Accrued 25% Accrued to Date $ 60,000 120,000 Expense 2009 $60,00 0 Expense 2010 Expense 2011 Expense 2012 Expense 2013
Date 12/31/09
$120,00 0 $270,00 0 $(130,000 ) $400,00 0
12/31/10
9
360,000
50%
180,000 270,000 450,000 (130,000) 320,000 400,000 $720,000
16-37
12/31/11
15
600,000
75%
12/31/12
8
320,000
100%
12/31/13
18
720,000
(b) 2009 Compensation Expense...................................................................... Liability Under Stock Appreciation Plan..................................... 2012 Liability Under Stock Appreciation Plan............................................ Compensation Expense...............................................................
60,000 60,000
130,000 130,000
TIME AND PURPOSE OF PROBLEMS
Problem 16-1 (Time 3540 minutes) Purposeto provide the student with an opportunity to prepare entries to properly account for a series of transactions involving the issuance and exercise of common stock rights and detachable stock warrants, plus the granting and exercise of stock options. The student is required to prepare the necessary journal entries to record these transactions and the stockholders equity section of the balance sheet as of the end of the year. Problem 16-2 (Time 4550 minutes) Purposeto provide the student with an understanding of the entries to properly account for convertible debt. The student is required to prepare the journal entries to record the conversion, amortization, and interest in connection with these bonds on specified dates. Problem 16-3 (Time 3035 minutes) Purposeto provide the student with an understanding of the entries to properly account for a stock-option plan over a period of years. The student is required to prepare the journal entries when the stock-option plan was adopted, when the options were granted, when the options were exercised, and when the options expired. Problem 16-4 (Time 2530 minutes) Purposeto provide the student with an understanding of the entries to properly account for a stock option and restricted stock plan. The student is asked to identify the important features of an employee stockpurchase plan. Problem 16-5 (Time 3035 minutes) Purposeto provide the student with an understanding of the effect options and convertible bonds have on the computation of the weighted-average number of shares outstanding with regard to basic EPS and diluted EPS. Preferred stock dividends must also be computed. Problem 16-6 (Time 3035 minutes) Purposeto provide the student with an understanding of the proper computation of the weighted-average number of shares outstanding for two consecutive years. The student is also asked to determine whether the capital structure presented is simple or complex. A two-year comparative income statement with appropriate EPS presentation is also required. Problem 16-7 (Time 3545 minutes) Purposeto provide the student with an opportunity to calculate the number of shares used to compute basic and diluted earnings per share which is complicated by a stock dividend, a stock split, and several issues of common stock during the year. To be determined are the number of shares to compute basic EPS, the number of shares to compute diluted EPS, and the numerator for computing basic EPS. Problem 16-8 (Time 2535 minutes) Purposeto provide the student with a problem with multiple dilutive securities which must be analyzed to compute basic and diluted EPS. Problem 16-9 (Time 3040 minutes) Purposeto provide the student with an opportunity to calculate the weighted-average number of common shares for computing earnings per share and to prepare a comparative income statement including earnings per share data. In addition, the student explains a simple capital structure and the earnings per share presentation for a complex capital structure.
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-39
SOLUTIONS TO PROBLEMS
PROBLEM 16-1
(a) 1. 2.
Memorandum entry made to indicate the number of rights issued. Cash.................................................................... Discount on Bonds Payable*........................... Bonds Payable........................................... Paid-in CapitalStock Warrants**.......... **Allocated to Bonds: $96 X $208,000 = $192,000; $96 + $8 Discount = $200,000 $192,000 = $8,000 **Allocated to Warrants: $8 X $208,000 = $16,000 $96 + $8 208,000 8,000 200,000 16,000
3.
Cash*.................................................................. Common Stock (9,500 X $10)................... Paid-in Capital in Excess of Par.............. *[(100,000 5,000) rights exercised] *[(10 rights/share) X $32 = $304,000
304,000 95,000 209,000
4.
Paid-in CapitalStock Warrants ($16,000 X 80%)............................................ Cash*.................................................................. Common Stock (1,600 X $10)................... Paid-in Capital in Excess of Par.............. *.80 X $200,000/$100 per bond = 1,600 *warrants exercised; 1,600 X $30 = $48,000
12,800 48,000 16,000 44,800
16-40
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
PROBLEM 16-1 (Continued) 5. Compensation Expense*.................................. Paid-in CapitalStock Options............... *$10 X 10,000 options = $100,000 6. For options exercised: Cash (9,000 X $30)............................................. Paid-in CapitalStock Options (90% X $100,000)........................................... Common Stock (9,000 X $10)................... Paid-in Capital in Excess of Par.............. For options lapsed: Paid-in CapitalStock Options....................... Compensation Expense*.......................... 100,000 100,000
270,000 90,000 90,000 270,000
10,000 10,000
*(Note to instructor:This entry provides an opportunity to indicate that a credit to Compensation Expense occurs when the employee fails to fulfill an obligation, such as remaining in the employ of the company. Conversely, if a stock option lapses because the stock price is lower than the exercise price, then a credit to Paid-in CapitalExpired Stock Options occurs.) (b) Stockholders Equity: Paid-in Capital: Common Stock, $10 par value, authorized 1,000,000 shares, 320,100 shares issued and outstanding........................... Paid-in Capital in Excess of Par*............... Paid-in CapitalStock Warrants*.............. Retained Earnings............................................... Total Stockholders Equity.........................
$3,201,000 1,123,800 3,200
$4,328,000 750,000 $5,078,000
*These two accounts often are combined into one category called Additional Paid-in Capital, for financial reporting purposes.
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-41
PROBLEM 16-1 (Continued) Calculations: Common Stock At beginning of year........................ From stock rights (entry #3)........... From stock warrants (entry #4)...... From stock options (entry #6)........ Total.......................................... 300,000 shares 9,500 shares 1,600 shares 9,000 shares 320,100 shares Paid-in Capital in Excess of Par $ 600,000 209,000 44,800 270,000 $1,123,800
16-42
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
PROBLEM 16-2
(a)
Entries at August 1, 2011 Bonds Payable........................................................... Discount on Bonds Payable (Schedule 1)....... Common Stock (8 X 250 X $100)...................... Paid-in Capital in Excess of Par....................... (To record the issuance of 2,000 shares of common stock in exchange for $250,000 of bonds and the write-off of the discount on bonds payable) *($54,000 X 1/10) X (107/120) **($250,000 $4,815) $200,000 Interest Payable......................................................... Cash ($250,000 X 12% X 1/12)........................... (To record payment in cash of interest accrued on bonds converted as of August 1, 2011)
250,000 4,815* 200,000 45,185**
2,500 2,500
(b)
Entries at August 31, 2011 Bond Interest Expense............................................. Discount on Bonds Payable (Schedule 1)...... (To record amortization of one months discount on $2,250,000 of bonds) *($54,000 X 90%) X (1/120) Bond Interest Expense............................................. Interest Payable ($2,250,000 X 12% X 1/12).... (To record accrual of interest for August on $2,250,000 of bonds at 12%)
405* 405
22,500 22,500
(c)
Entries at December 31, 2011 (Same as August 31, 2011, and the following closing entry) Income Summary....................................................... 292,675 Bond Interest Expense (schedule 2)............... (To close expense account)
292,675
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16-43
PROBLEM 16-2 (Continued) Schedule 1 Monthly Amortization Schedule Unamortized discount on bonds payable: Amount to be amortized over 120 months...................................... Amount of monthly amortization ($54,000 120)........................... Amortization for 13 months to July 31, 2011 ($450 X 13)............... Balance unamortized 7/31/11 ($54,000 $5,850)............................ 10% applicable to debentures converted........................................ Balance August 1, 2011..................................................................... Remaining monthly amortization over remaining 107 months..... Schedule 2 Interest Expense Schedule Amortization of bond discount charged to bond interest expense in 2011 would be as follows: 7 months X $450................................... $3,150 5 months X $405................................... 2,025 Total............................................... $5,175 Interest on Bonds: 12% on $2,500,000.............................................................................. Amount per month ($300,000 12)................................................... 12% on $2,250,000.............................................................................. Amount per month ($270,000 12)................................................... Interest for 2011 would be as follows: 7 months X $25,000.................................................................... 5 months X $22,500.................................................................... Total...................................................................................... Total interest Amortization of discount..................... Cash interest paid................................ Bond interest expense......................... $54,000 $ 450 $ 5,850 $48,150 4,815 $43,335 $ 405
$300,000 $ 25,000 $270,000 $ 22,500 $175,000 112,500 $287,500
$
5,175 287,500 $292,675
16-44
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
PROBLEM 16-3
2009
No journal entry would be recorded at the time the stock option plan was adopted. However, a memorandum entry in the journal might be made on November 30, 2009, indicating that a stock option plan had authorized the future granting to officers of options to buy 70,000 shares of $5 par value common stock at $9 a share. January 2 No entry December 31 Compensation Expense..................................... Paid-in CapitalStock Options................. (To record compensation expense attributable to 201022,000 options at $4)
2010
88,000 88,000
2011
December 31 Compensation Expense..................................... Paid-in CapitalStock Options................. (To record compensation expense attributable to 201120,000 options at $4) Paid-in CapitalStock Options......................... Paid-in Capital from Expired Stock Options..................................................... (To record lapse of presidents and vice presidents options to buy 22,000 shares)
80,000 80,000
88,000 88,000
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16-45
PROBLEM 16-3 (Continued) 2012 December 31 Cash (20,000 X $9).............................................. Paid-in CapitalStock Options (20,000 X $4)................................................... Common Stock (20,000 X $5)..................... Paid-in Capital in Excess of Par................ (To record issuance of 20,000 shares of $5 par value stock upon exercise of options at option price of $9)
180,000 80,000 100,000 160,000
16-46
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
PROBLEM 16-4
(a)
1/1/10 12/31/10
No entry Compensation Expense ($6 X 5,000 5)....... Paid-in CapitalStock Options............. 6,000 6,000
(b)
1/1/10
Unearned Compensation ($40 X 700)............ 28,000 Common Stock ($1 X 700)..................... Paid-in Capital in Excess of Par............ Compensation Expense ($28,000 5)........... Unearned Compensation....................... 5,600
700 27,300
12/31/10
5,600
(c)
No change for part (a), unless the fair value of the options change. For part (b): 1/10/10 Unearned Compensation ($45 X 700)............ Common Stock ($1 X 700)..................... Paid in Capital in Excess of Par............ Compensation Expense ($31,500 5)........... Unearned Compensation....................... 31,500 700 30,800 6,300 6,300
12/31/10
(d)
Numbers (1) substantially all employees may participate; (2) The discount from market is small (less than 5%); and (3) The plan offers no substantive option feature, are the three criteria that must be met for an employee stock-purchase plan to be non-compensatory. The fourth provisionthere is no preferred stock outstandingis irrelevant.
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-47
PROBLEM 16-5
The computation of Fitzgerald Pharmaceutical Industries basic earnings per share and the diluted earnings per share for the fiscal year ended June 30, 2010, are shown below. (a) Basic earnings per share = = = Net income Preferred dividends Average common shares outstanding $1,500,000 $75,0001 1,000,000 $1,425,000 1,000,000
= $1.425 or $1.43 per share
1
Preferred dividend = .06 X $1,250,000 = $75,000
Net income Preferred dividends + Interest (net of tax) (b) Diluted earnings per share = Average common shares + Potentially dilutive common shares = = $1,500,000 $75,000 + $240,0002 1,000,000 + 250,0003 + 50,0004 $1,665,000 1,300,000
= $1.2808 or $1.28 per share
2
Use if converted method for 8% bonds Adjustment for interest expense (net of tax) ($5,000,000 X .08 X .6)............................................... Shares assumed to be issued if converted $5,000,000 $1,000/bond X 50 shares.........................
$240,000
3
250,000
16-48
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
PROBLEM 16-5 (Continued)
4
Use treasury stock method to determine incremental shares outstanding Proceeds from exercise of options (200,000 X $15)............................................................ Shares issued upon exercise of options..................... Shares purchasable with proceeds (Proceeds Average market price) ($3,000,000 $20)....................................................... Incremental shares outstanding...........................
$3,000,000 200,000
150,000 50,000
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-49
PROBLEM 16-6
(a) Melton Corporation has a simple capital structure since it does not have any potentially dilutive securities. (b) The weighted-average number of shares that Melton Corporation would use in calculating earnings per share for the fiscal years ended May 31, 2010, and May 31, 2011, is 1,600,000 and 2,200,000 respectively, calculated as follows:
Event Beginning balance New Issue Dates Outstanding June 1Oct. 1 Oct. 1May 31 Dates Outstanding June 1Dec. 1 Dec. 1May 31 Shares Outstanding 1,000,000 1,500,000 Shares Outstanding 1,800,000 2,600,000 Restatement 1.20 1.20 Fraction of Year 4/12 8/12 Weighted Shares 400,000 1,200,000 1,600,000
Event Beginning balance New Issue
Restatement
Fraction Weighted of Year Shares 6/12 6/12 900,000 1,300,000 2,200,000
(c)
MELTON CORPORATION Comparative Income Statement For Fiscal Years Ended May 31, 2010 and 2011 2010 2011 $2,500,000 240,000 2,260,000 904,000 1,356,000 360,000 $ 996,000 $.593 .164 $.435
Income from operations......................................... Interest expense1..................................................... Income before taxes................................................ Income taxes at 40%............................................... Income before extraordinary item......................... Extraordinary loss, net of income taxes of $240,000................................................. Net income............................................................... Earnings per share: Income before extraordinary loss.................. Extraordinary loss........................................... Net income.......................................................
$1,800,000 240,000 1,560,000 624,000 936,000
$ 936,000 $.552 $.55
16-50
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
PROBLEM 16-6 (Continued)
1
Interest expense
= $2,400,000 X .10 = $240,000 (Net income Preferred dividends) Weighted-Average Number of Common Shares ($936,000 $60,000*) 1,600,000
2
Earnings per share = =
= $.55 per share
*Preferred
dividends = (No. of Shares X Par Value X Dividend %) = (20,000 X $50 X .06) = $60,000 per year ($1,356,000 $60,000) 2,200,000
3
Earnings per share =
= $.59 per share Extraordinary Item Weighted-Average Common Shares $360,000 2,200,000
4
Earnings per share = =
= $.16 per share Net Income Preferred Dividends Weighted-Average Common Shares $996,000 $60,000 2,200,000
5
Earnings per share = =
= $.43
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16-51
PROBLEM 16-7
(a) The number of shares used to compute basic earnings per share is 4,951,000, as calculated below.
Dates Shares Fraction Event Outstanding Outstanding Restatement of Year Beginning Balance, including 5% stock dividend Jan. 1Apr. 1 2,100,000 2.0 3/12 Conversion of preferred stock Apr. 1July 1 2,520,000 2.0 3/12 Stock split July 1Aug. 1 5,040,000 1/12 Issued shares for building Aug. 1Nov. 1 5,340,000 3/12 Purchase of Treasury stock Nov. 1Dec. 31 5,316,000 2/12 Total number of common shares to compute basic earnings per share Weighted Shares
1,050,000 1,260,000 420,000 1,335,000 886,000 4,951,000
(b) The number of shares used to compute diluted earnings per share is 5,791,000, as shown below. Number of shares to compute basic earnings per share.................................................................................. Convertible preferred stockstill outstanding (300,000 X 2 X 1.05) ......................................................... Convertible preferred stockconverted (400,000 X 2 X 1.05 X 3/12)............................................... Number of shares to compute diluted earnings per share........................................................................... 4,951,000 630,000 210,000 5,791,000
(c) The adjusted net income to be used as the numerator in the basic earnings per share calculation for the year ended December 31, 2011, is $10,350,000, as computed below. After-tax net income............................................. Preferred stock dividends March 31 (700,000 X $.75)............................ June 30, September 30, and December 31 (300,000 X $.75 X 3).................................... Adjusted net income............................................ $11,550,000 $525,000
675,000
1,200,000 $10,350,000
16-52
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
PROBLEM 16-8
(a)
Basic EPS =
$1,200,000 ($4,000,000 X .06) 600,000*
= $1.60 per share *$6,000,000 $10 (Net income Preferred dividends) + Interest savings (net of tax) = Average common shares + Potentially dilutive common shares = = $1,200,000 $240,000a + $96,000b 600,000 + 15,000c + 60,000d $1,056,000 675,000
(b)
Diluted EPS
= $1.56 per share
a
Preferred stock is not assumed converted since conversion would be antidilutive. That is, conversion of the preferred stock increases the numerator $240,000 ($4,000,000 X .06) and the denominator 120,000 shares [(4,000,000 100) X 3] $2,000,000 X .08 X (1 .40)
b
c
Market price Option price X Number of options = incremental shares Market price $25 $20 X 75,000 = 15,000 $25
d
($2,000,000 $1,000) X 30 shares/bond
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
16-53
PROBLEM 16-9
(a)
Weighted-Average Shares Before Stock Dividend 1,000,000 400,000 1,400,000 After Stock Dividend 1,200,000 480,000 1,680,000 300,000 1,260,000 1,560,000 1,680,000
Total as of June 1, 2009 Issue of September 1, 2009 Total as of May 31, 2011 1. 1,200,000 X 3/12 = 1,680,000 X 9/12 = Total 2. 1,680,000 X 12/12 (b)
AGASSI CORPORATION Comparative Income Statement For the Years Ended May 31, 2011 and 2010 2011 $1,400,000 560,000 840,000 240,000 $ 600,000 2010 $660,000 264,000 396,000
Income from operations before income taxes. . . Income taxes.......................................................... Income before extraordinary item....................... Extraordinary itemloss from earthquake, less applicable income taxes of $160,000....... Net income............................................................. Per share of common stock................................. Income before extraordinary item.................... Extraordinary loss, net of tax............................ Net income.............................................................
$396,000
$.351 (.14)4 $.212
$.103 $.10
16-54
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
PROBLEM 16-9 (Continued) EPS calculations = Net income Preferred dividends Weighted-average common shares
Preferred dividends = 40,000 X $100 X .06 = $240,000 Extraordinary loss per share calcuation
1 2
=
Loss Weighted-average common shares
($840,000 $240,000) 1,680,000 = $.35 ($600,000 $240,000) 1,680,000 = $.21 3 ($396,000 $240,000) 1,560,000 = $.10 4 $240,000 1,680,000 = $.14 (c) 1. A corporations capital structure is regarded as simple if it consists only of common stock or includes no potentially dilutive securities. Agassi Corporation has a simple capital structure because it has not issued any convertible securities, warrants, or stock options, and there are no existing rights or securities that are potentially dilutive of its earnings per common share. A corporation having a complex capital structure would be required to make a dual presentation of earnings per share; i.e., both basic earnings per share and diluted earnings per share. This assumes that the potentially dilutive securities are not antidilutive. The basic earnings per share computation uses only the weightedaverage of the common stock outstanding. The diluted earnings per share computation assumes the conversion or exercise of all potentially dilutive securities that are not antidilutive.
2.
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16-55
TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 16-1 (Time 2025 minutes) Purposeto provide the student with an understanding of the underlying rationale behind the accounting treatments for the issuance of convertible bonds versus the situation when the debt instrument and the warrants are separable. The student is required to describe the differences that exist in accounting for the original proceeds of these two types of issuances, and the arguments which have been presented in support of these differences. This case also requires the interpretation of a situation involving an issuance of long-term notes and warrants, and the preparation of the necessary journal entry. CA 16-2 (Time 1520 minutes) Purposeto provide the student with an opportunity to discuss the ethical issues related to an earningsbased compensation plan. CA 16-3(Time 1520 minutes) Purposeto provide the student with an understanding of the proper accounting and conceptual merits for the issuance of stock warrants to three different groups: existing stockholders, key employees, and purchasers of the companys bonds. This problem requires the student to explain and discuss the reasons for using warrants, the significance of the price at which the warrants are issued (or granted) in relation to the current market price of the companys stock, and the necessary information that should be disclosed in the financial statements when stock warrants are outstanding for each of the groups. CA 16-4 (Time 2535 minutes) Purposeto provide the student with an opportunity to respond to a contrary view of the FASBs standard on Accounting for Stock-Based Compensation, and to defend the concept of neutrality in financial accounting and reporting. CA 16-5 (Time 2535 minutes) Purposeto provide the student with an understanding of how earnings per share is affected by preferred dividends and convertible debt. The student is required to explain how preferred dividends and convertible debt are handled for EPS computations. The student is also required to explain when the treasury stock method is applicable in EPS computations. CA 16-6 (Time 2535 minutes) Purposeto provide the student with some familiarity with the applications dealing with earnings per share. The student is required to explain the general concepts of EPS in regard to a specific capitalization structure, and to discuss the proper treatment, if any, that should be given to a list of items in computing earnings per share of common stock for financial statement reporting. CA 16-7 (Time 2535 minutes) Purposeto provide the student with an opportunity to articulate the concepts and procedures related to antidilution. Responses are provided in a written memorandum.
16-56
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 16-1
(a) 1. When the debt instrument and the option to acquire common stock are inseparable, as in the case of convertible bonds, the entire proceeds of the bond issue should be allocated to the debt and the related premium or discount accounts. When the debt and the warrants are separable, the proceeds of their sale should be allocated between them. The basis of allocation is their relative fair values. As a practical matter, these relative values are usually determined by reference to the price at which the respective instruments are traded in the open market. Thus, if the debt alone would bring six times as much as would the stock warrants if sold separately, one-seventh of the total proceeds should be apportioned to the warrants and sixsevenths to the debt securities. That portion of the proceeds assigned to the warrants should be accounted for as paid-in capital. The result may be that the debt is issued at a reduced premium or at a discount. 2. In the case of convertible debt there are two principal reasons why all the proceeds should be ascribed to the debt. First, the option is inseparable from the debt. The investor in such securities has two mutually exclusive choices: be a creditor and later receive cash for the security; or give up all rights as a creditor and become a stockholder. There is no way to retain one right while selling the other. Second, the valuation of the conversion option or the debt security without the conversion option presents practical problems. For example, in the absence of separate transferability, no separate market values are established and the only values which could be assigned to each would be subjective. Separability of the debt and the warrants and the establishment of a market value for each results in an objective basis for allocating proceeds to the two different equitiescreditors and stockholdersinvolved. 3. Arguments have been advanced that accounting for convertible debt should be the same as for debt issued with detachable stock purchase warrants. Convertible debt has features of debt and stockholders equity, and separate recognition should be given to those characteristics at the time of issuance. Difficulties encountered in separating the relative values of the features are not insurmountable and, in any case, should not result in a solution which ignores the problem. In effect, the company is selling a debt instrument and a call on its stock. Coexistence of the two features in one instrument is no reason why each cannot receive its proper accounting recognition. The practical difficulties of estimation of the relative values may be overcome with reliable professional advice. Allocation is a well-recognized accounting technique and could be applied in this case once reliable estimates of the relative values are known. If the convertible feature was added in order to sell the security at an acceptable price, the value of the convertible option is obviously material and recognition is essential. The question of whether or not the purchaser will exercise the option is not relevant to reflecting the separate elements at the time of issuance. 20,040,000 3,960,000 18,000,000 6,000,000
(b)
Cash............................................................................................... Discount on Bonds Payable ($18,000,000 X 22%)........................ Bonds Payable........................................................................ Paid-in CapitalStock Warrants ($23 $18) X 1,200,000....
To record issuance of bonds at 22% discount with options to buy 1,200,000 shares of the companys $10 par common stock at a price of $5 a share below the current market value. Debt matures in ten years in equal annual installments of $1,800,000 and warrants, if not exercised, lapse as bonds mature.
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
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CA 16-2
(a) Devers recognizes that altering the estimate will benefit Adkins and other executive officers of the company. Current stockholders and investors will be forced to pay out the bonuses, with the altered estimate as a critical factor. The accountants decision should not be based on the existence of the compensation plan. Adkinss request should be denied.
(b) (c)
CA 16-3
(a) 1. The objective of issuing warrants to existing stockholders on a pro-rata basis is to raise new equity capital. This method of raising equity capital may be used because of preemptive rights on the part of a companys stockholders and also because it is likely to be less expensive than a public offering. The purpose of issuing stock warrants to certain key employees, usually in the form of a nonqualified stock option plan, is to increase their interest in the long-term growth and income of the company and to attract new management talent. Also, this issuance of stock warrants to key employees under a stock-option plan frequently constitutes an important element in a companys executive compensation program. Though such plans result in some dilution of the stockholders equity when shares are issued, the plans provide an additional incentive to the key employees to operate the company efficiently. Warrants to purchase shares of its common stock may be issued to purchasers of a companys bonds in order to stimulate the sale of the bonds by increasing their speculative appeal and aiding in overcoming the objection that rising price levels cause money invested for long periods in bonds to lose purchasing power. The use of warrants in this connection may also permit the sale of the bonds at a lower interest cost. Because the purpose of issuing warrants to existing stockholders is to raise new equity capital, the price specified in the warrants must be sufficiently below the current market price to reasonably assure that they will be exercised. Because the success of the offering depends entirely on the current market price of the companys stock in relation to the exercise price of the warrants, and because the objective is to raise capital, the length of time over which the warrants can be exercised is very short, frequently 60 days. Warrants may be offered to key employees below, at, or above the market price of the stock on the day the rights are granted except for incentive stock-option plans. If a stock-option plan is to provide a strong incentive, warrants that can be exercised shortly after they are granted and expire, say, within two or three years, usually must be exercisable at or near the market price at the date of the grant. Warrants that cannot be exercised for a number of years after they are granted or those that do not lapse for a number of years after they become exercisable may, however, be priced somewhat above the market price of the stock at the date of the grant without eliminating the incentive feature. This does not upset the principal objective of stock option plans, heightening the interest of key employees in the long-term success of the company. Income tax laws impose no restrictions on the exercise price of warrants issued to purchasers of a companys bonds. The exercise price may be above, equal to, or below the current market price of the companys stock. The longer the period of time during which the warrant can be exercised, however, the higher the exercise price can be and still stimulate the sale of the bonds because of the increased speculation appeal. Thus, the significance of the length of time over which the warrants can be exercised depends largely on the exercise price (or prices). A low exercise price in combination with a short exercise period can be just as successful as a high exercise price in combination with a long exercise period.
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
2.
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CA 16-3 (Continued)
(c) 1. Financial statement information concerning outstanding stock warrants issued to a companys stockholders should include a description of the stock being offered for sale, the option price, the time period during which the rights may be exercised, and the number of rights needed to purchase a new share. Financial statement information concerning stock warrants issued to key employees should include the following: status of these plans at the end of each period presented, including the number of shares under option, options exercised and forfeited, the weighted average option prices for these categories, the weighted average fair value of options granted during the year, and the average remaining contractual life of the options outstanding. Financial statement disclosure of outstanding stock warrants that have been issued to purchasers of a companys bonds should include the prices at which they can be exercised, the length of time they can be exercised, and the total number of shares that can be purchased by the bondholders.
2.
3.
CA 16-4
(a) In 2004, a new GAAP rule was issued related to stock compensation plans. Generally, the rule indicates that employee stock options be treated like all other types of compensation and that their value be included in financial statements as part of the costs of employee services. The rule requires that all types of stock options be recognized as compensation based on the fair value of the options. Fair value for public companies would be estimated using an option-pricing model. No adjustments after the grant date would be made for changes in the stock priceeither up or down. For both public and nonpublic companies, the value of the award would be charged to expense over the period in which employees provide the related service, which is generally considered the vesting period. Expense is recognized over the service period with adjustment (reversal) of expense for options that do not vest, if employees do not meet the service requirement. (b) According to Ciesielskis commentary, the bill in Congress would only record expense for the options granted to the top five executives. They also are recommending that the SEC conduct further study of the issue and therefore delay the implementation of the new standard. From a comparability standpoint, it is highly unlikely that recording expense on only some options would result in useful information. It will be difficult to compare compensation costs (and income) for companiessome that use stock options extensively and some that pay their employees with cash. Here is an excerpt from a presentation given by Dennis Beresford on the concept of neutrality, which says it well. The FASB often hears that it should take a broader view, that it must consider the economic consequences of a new accounting standard. The FASB should not act, critics maintain, if a new accounting standard would have undesirable economic consequences. We have been told that the effects of accounting standards could cause lasting damage to American companies and their employees. Some have suggested, for example, that recording the liability for retiree health care or the costs for stock-based compensation will place U.S. companies at a competitive disadvantage. These critics suggest that because of accounting standards, companies may reduce benefits or move operations overseas to areas where workers do not demand the same benefits. These assertions are usually combined with statements about desirable goals, like providing retiree health care or creating employee incentives.
(c)
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CA 16-4 (Continued)
There is a common element in those assertions. The goals are desirable but the means require that the Board abandon neutrality and establish reporting standards that conceal the financial impact of certain transactions from those who use financial statements. Costs of transactions exist whether or not the FASB mandates their recognition in financial statements. For example, not requiring the recognition of the cost of stock options or ignoring the liabilities for retiree health care benefits does not alter the economics of the transactions. It only withholds information from investors, creditors, policy makers, and others who need to make informed decisions and, eventually, impairs the credibility of financial reports. One need only look to the collapse of the thrift industry to demonstrate the consequences of abandoning neutrality. During the 1970s and 1980s, regulatory accounting principles (RAP) were altered to obscure problems in troubled institutions. Preserving the industry was considered a greater good. Many observers believe that the effect was to delay action and hide the true dimensions of the problem. The public interest is best served by neutral accounting standards that inform policy rather than promote it. Stated simply, truth in accounting is always good policy. Neutrality does not mean that accounting should not influence human behavior. We expect that changes in financial reporting will have economic consequences, just as economic consequences are inherent in existing financial reporting practices. Changes in behavior naturally follow from more complete and representationally faithful financial statements. The fundamental question, however, is whether those who measure and report on economic events should somehow screen the information before reporting it to achieve some objective. In FASB Concepts Statement No. 2, Qualitative Characteristics of Accounting Information (paragraph 102), the Board observed: Indeed, most people are repelled by the notion that some big brother, whether government or private, would tamper with scales or speedometers surreptitiously to induce people to lose weight or obey speed limits or would slant the scoring of athletic events or examinations to enhance or decrease someones chances of winning or graduating. There is no more reason to abandon neutrality in accounting measurement. The Board continues to hold that view. The Board does not set out to achieve particular economic results through accounting pronouncements. We could not if we tried. Beyond that, it is seldom clear which result we should seek because our constituents often have opposing viewpoints. Governments, and the policy goals they adopt, frequently change.
CA 16-5
(a) Dividends on outstanding preferred stock must be subtracted from net income or added to net loss for the period before computing EPS on the common shares. This generalization will be modified by the various features and different requirements preferred stock may have with respect to dividends. Thus, if preferred stock is cumulative, it is necessary to subtract its current dividend requirements from net income (or to add them to net loss) regardless of whether or not the preferred dividends were actually declared. Where the preferred shares are noncumulative, only preferred dividends actually declared during the current period need be subtracted from net income (or added to net loss) to arrive at the income to be used in EPS calculations. In case the preferred shares are convertible into common stock, when assuming conversion, dividend requirements on the preferred shares are not deducted from net income. This applies when testing for potential dilution to determine whether or not the diluted EPS figures for the period are lower than earnings per common share figures.
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CA 16-5 (Continued)
(b) When options and warrants to buy common stock are outstanding and their exercise price (i.e., proceeds the corporation would derive from issuance of common stock pursuant to the warrants and options) is less than the average price at which the company could acquire its outstanding shares as treasury stock, the treasury stock method is generally applicable. In these circumstances, existence of the options and warrants would be dilutive. However, if the exercise price of options and warrants exceeded the average price of the common stock, the cash proceeds from their assumed exercise would provide for repurchasing more common shares than were issued when the warrants were exercised, thereby reducing the number of shares outstanding. In these circumstances assumed exercise of the warrants would be antidilutive, so exercise would not be presumed for purposes of computing diluted EPS. In arriving at the calculation of diluted EPS where convertible debentures are assumed to be converted , their interest (net of tax) is added back to net income as the numerator element of the EPS calculation while the weighted-average number of shares of common stock into which they would be convertible is added to the shares outstanding to arrive at the denominator element of the calculation.
(c)
CA 16-6
(a) Earnings per share, as it applies to a corporation with a capitalization structure composed of only one class of common stock, is the amount of earnings applicable to each share of common stock outstanding during the period for which the earnings are reported. The computation of earnings per share should be based on a weighted average of the number of shares outstanding during the period with retroactive recognition given to stock splits or reverse splits and to stock dividends. The computation should be made for income from continuing operations, income before extraordinary items, and net income. Companies that report a discontinued operation, or an extraordinary item, should present per share amounts for those line items either on the face of the income statement or in the notes to the financial statements. Treatments to be given to the listed items in computing earnings per share are: 1. Outstanding preferred stock with a par value liquidation right issued at a premium, although affecting the determination of book value per share, will not affect the computation of earnings per share for common stock except with respect to the dividends as discussed in 4. below. The exercise of a common stock option results in an increase in the number of shares outstanding, and the computation of earnings per share should be based on the weightedaverage number of shares outstanding during the period. The exercise of a stock option by the grantee does not affect earnings, but any compensation to the officers from the granting of the options would reduce net income and earnings per share. The replacement of a machine immediately prior to the close of the current fiscal year will not affect the computation of earnings per share for the year in which the machine is replaced. The number of shares remains unchanged and since the old machine was sold for its book value, earnings are unaffected. Dividends declared on preferred stock should be deducted from income from continuing operations, income before extraordinary items, and net income before computing earnings per share applicable to the common stock and other residual securities. If the preferred stock is cumulative, this adjustment is appropriate whether or not the amounts of the dividends are declared or paid. Acquiring treasury shares will reduce the weighted-average number of shares outstanding used in the EPS denominator. 16-61
(b)
2.
3.
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Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
CA 16-6 (Continued)
6. When the number of common shares outstanding increases as a result of a 2-for-1 stock split during the year, the computation should be based on twice the number of weighted average shares outstanding prior to the stock split. Retroactive recognition should be given for all prior years presented. The existence of a provision for a contingent liability on a possible lawsuit created out of retained earnings will not affect the computation of earnings per share since the appropriation of retained earnings does not affect net income or the number of shares of stock outstanding.
7.
CA 16-7
Dear Mr. Dolan: I hope that the following brief explanation helps you understand why your warrants were not included in Rhodes earnings per share calculations. Earnings per share (EPS) provides income statement users a quick assessment of the earnings that were generated for each common share outstanding over a given period. When a company issues only common and preferred stock, it has a simple capital structure; consequently, the only ratio needed to calculate EPS is the following: (Net Income Preferred Dividends) Average Number of Common Shares Outstanding However, corporations that have outstanding a variety of other securitiesconvertible bonds, convertible preferred stock, stock options, and stock warrantshave a complex capital structure. Because these securities could be converted to common stock, they have a potentially dilutive effect on EPS. In order not to mislead users of financial information, the accounting profession insists that EPS calculations be conservative. Thus, a security which might dilute EPS must be figured into EPS calculations as though it had been converted into common stock. Basic EPS assumes a weighted-average of common stock outstanding while diluted EPS assumes that any potentially dilutive security has been converted. Some securities, however, might actually inflate the EPS figure rather than dilute it. These securities are considered antidilutive and are excluded from the EPS computation. Take, for example, your warrants. The computations below provide a good example of how options and warrants are treated in diluted EPS. In these computations, we assume that Rhode will purchase treasury stock using the proceeds from the exercise of your warrants. If we assume that Rhode exercises 30,000 warrants at $30, the company does not simply add 30,000 shares to common stock outstanding; rather, for diluted EPS, Rhode is assumed to purchase and retire 36,000 [(30,000 X $30) $25] shares of treasury stock at $25 with the proceeds. Therefore, if you add the 30,000 exercised warrants to the common stock outstanding and then subtract the 36,000 shares presumably purchased, the number of shares outstanding would be reduced to 94,000 (100,000 + 30,000 36,000). Because the ratios denominator would be reduced by this inclusion, it would cause the ratio to increase, which defeats the purpose of the assumed exercise. These warrants are considered antidilutive and, therefore, are not included in EPS calculations. This explanation should address any concerns you may have had about the use of your warrants in EPS calculations. If you have any further questions, please call me. Sincerely, Ms. Smart Student Accountant 16-62
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
FINANCIAL REPORTING PROBLEM
(a) 1. Under P&Gs stock-based compensation plan (Note 8), 33,091,000 options were granted during 2007. At June 30, 2007, 257,171,000 options were exercisable by eligible managers. In 2007, 37,658,000 options were exercised at an average price of $37.77. The options granted since September 2002 will expire 10 years from the date of grant. The accounts to which the proceeds from these option exercises are credited are Common Stock and Additional Paid-in Capital. The number of outstanding options at June 30, 2007, is 355,006,000 at an average exercise price of $46.10. 2007 3,398.6 $3.04 2006 3,285.9 $2.64 2005 2,737.1 $2.53
2.
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(b)
(In millionsexcept per share) Weighted average common shares Diluted earnings per share
(c) P&G maintains the Procter & Gamble Profit Sharing Trust (Trust) and Employee Stock Ownership Plan (ESOP) to provide a portion of the funding for its defined benefit pension plan.
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COMPARATIVE ANALYSIS CASE
(a) Coca-Cola sponsors restricted stock award plans, and stock option plans. PepsiCo grants stock options to employees under three different incentive plansthe SharePower Stock Option Plan, the Long-Term Incentive Plan, and the Stock Option Incentive Plan. (b) Options outstanding at year-end 2007 (c) Options granted during 2007 (d) Options exercised during 2007 (e) Average exercise price during 2007 (f) Weighted-Average Number of Shares (in millions) Coca-Cola PepsiCo 2007 2,331 1,658 2006 2,350 1,687 2005 2,393 1,706 Diluted Earnings Per Share (in millions) Coca-Cola PepsiCo 2007 $2.57 $3.41 2006 $2.16 $3.34 2005 $2.04 $2.39 Coca-Cola 182,000,000 Coca-Cola 41,000,000 Coca-Cola 31,000,000 Coca-Cola $46.79 PepsiCo 108,808,000 PepsiCo 11,671,000 PepsiCo 28,116,000 PepsiCo $39.34
(g)
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FINANCIAL STATEMENT ANALYSIS CASE
(a) By adopting the disclosure option of SFAS No. 123, Kellogg was not recognizing expense for the cost of stock options. When it adopts SFAS No. 123(R), Kellogg will take the disclosed expense out of the notes and record it as an expense. Based on 2004 data, this will result in a $30.4 million ($890.6 $860.2) or 3.4% reduction in reported net income. The balance sheet effect of adopting the new standard will be to reduce retained earnings by the additional compensation expense, which will be offset by the increase in additional paid-in capital. (b) The earnings per share adjustment for options only affects the denominator of earnings per share. Thus, EPS is overstated by the amount of the omitted compensation expense in the numerator. For Kellogg, 2004 EPS would have been $0.07 per share lower ($2.14 $2.07), if Kellogg would have reflected the cost of stock-based compensation on both the numerator and the denominator of EPS.
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INTERNATIONAL REPORTING CASE
(a) Account 2007 Current Liabilities 554,114 Convertible Debt 648,020 Total Liabilities 1,228,313 Stockholders Equity 176,413 Net Income 58,333 Return on Assets 4.15% = Net Income/ Total Assets Return on Stockholders Equity 33.07% = Net Income/Stockholders Equity Debt to Assets Ratio 87.44% = Total Debt/ Total Assets (b) Sepracor is doing very well. Its ROA and ROSE are above the industry average. However, its debt level is quite high, compared to the industry. This may suggest it is a riskier investment and may require a higher rate of return than the 5% coupon. Investors likely were attracted to the convertible bonds due to the possibility that Sepracors stock price will increase, and they can cash in on these gains when they convert to common stock. (c) Under IFRS, the debt and equity components of a convertible bond are separately recorded as liabilities and stockholders equity. Assuming an equity component of $150,000, for the Sepracor bonds, the following adjusted amounts would be used in the analysis. Since Bayer, if it had convertible bonds, would allocate the bond amount between debt and equity, the same should be done for Sepracor to make their ratios comparable. Reclassified: Account 2007 Current Liabilities 554,114 Convertible Debt 498,020 Total Liabilities 1,078,313 Stockholders Equity 326,413 Net Income 58,333 Return on Assets Return on Stockholders Equity Debt to Assets Ratio 4.15% = Net Income/ Total Assets 17.9% = Net Income/Stockholders Equity 76.8% = Total Debt/ Total Assets
The adjustment results in Sepracor reporting a higher level of stockholders equity and less debt. Although Sepracor reports the same ROA, but lower ROSE, the debt to assets ratio is in line with the industry level, suggesting
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Sepracor may not be as risky as the earlier analysis suggests. The 5% rate may be about right.
Copyright 2010 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 13/e, Solutions Manual(For Instructor Use Only)
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PROFESSIONAL RESEARCH: FASB CODIFICATION
(a) (b) The accounting for stock compensation is addressed in the FASB Codification at FASB ASC 718-10 (Compensation-Stock Compensation). According to FASB ASC 718-10-10 (CompensationStock Compensation, Overall, Objectives), the objective of accounting for transactions under share-based payment arrangements with employees is to recognize in the financial statements the employee services received in exchange for equity instruments issued or liabilities incurred and the related cost to the entity as those services are consumed. This Topic uses the terms compensation and payment in their broadest senses to refer to the consideration paid for employee services. In sub-section 10-2, fair value is established as the measurement objective in accounting for sharebased payment arrangements and requires all entities to apply a fair-value-based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee stock ownership plans. (c) See FASB ASC 718-50-25. 25-1 An employee share-purchase plan that satisfies all of the following criteria does not give rise to recognizable compensation cost (that is, the plan is noncompensatory): 1. The plan satisfies either of the following conditions: (a) The terms of the plan are no more favorable than those available to all holders of the same class of shares. Note that a transaction subject to an employee share-purchase plan that involves a class of equity shares designed exclusively for and held only by current or former employees or their beneficiaries may be compensatory depending on the terms of the arrangement. (b) Any purchase discount from the market price does not exceed the per-share amount of share issuance costs that would have been incurred to raise a significant amount of capital by a public offering. A purchase discount of 5 percent or less from the market price shall be considered to comply with this condition without further justification. A purchase discount greater than 5 percent that cannot be justified under this condition results in compensation cost for the entire amount of the discount. Note that an entity that justifies a purchase discount in excess of 5 percent shall reassess at least annually, and no later than the first share purchase offer during the fiscal year, whether it can continue to justify that discount pursuant to this paragraph. 2. Substantially all employees that meet limited employment qualifications may participate on an equitable basis. 3. The plan incorporates no option features, other than the following: (a) Employees are permitted a short period of timenot exceeding 31 daysafter the purchase price has been fixed to enroll in the plan. (b) The purchase price is based solely on the market price of the shares at the date of purchase, and employees are permitted to cancel participation before the purchase date and obtain a refund of amounts previously paid (such as those paid by payroll withholdings).
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PROFESSIONAL SIMULATION
Explanation (a) The controllers computations were not correct in that the straight arithmetic average of the common shares outstanding at the beginning and end of the year was used. The weighted-average number of shares outstanding may be computed as follows: Dates Outstanding Shares Outstanding Fraction of Year Weighted Shares 963,750 172,500 100,000 1,236,250 $3,374,960 $3,374,960 = $2.73 1,236,250
Jan. 1Oct. 1 1,285,000 9/12 Oct. 1Dec. 1 1,035,000 2/12 Dec. 1Dec. 31 1,200,000 1/12 Weighted-average number of shares outstanding Net income for year Earnings per share =
Financial Statements (b) Basic earnings per share = $3,374,960 = $2.73 1,236,250 Diluted earnings per share = $3,374,960 = $2.56 1,320,250*
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PROFESSIONAL SIMULATION (Continued)
Schedule A *Computation of weighted-average number of shares adjusted for dilutive securities Average number of shares under options outstanding................ Option price per share...................................................................... Proceeds upon exercise of options................................................ Market price of common stock: Average....................................................................................... Treasury shares that could be repurchased with proceeds ($1,400,000 $25)......................................................... Excess of shares under option over treasury shares that could be repurchased (140,000 56,000)........................... Incremental shares............................................................................ Average number of common shares outstanding......................... Weighted-average number of shares adjusted for dilutive securities.......................................................................... 140,000 X $10 $1,400,000 $25 56,000 84,000 84,000 1,236,250 1,320,250
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