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Chapter 16: Q24E (page 880)

(EPS with Convertible Bonds and Preferred Stock) The Simon Corporation issued 10-year, \(5,000,000 par, 7% callable convertible subordinated debentures on January 2, 2017. The bonds have a par value of \)1,000, with interest payable annually. The current conversion ratio is 14:1, and in 2 years it will increase to 18:1. At the date of issue, the bonds were sold at 98. Bond discount is amortized on a straight-line basis. Simon鈥檚 effective tax was 35%. Net income in 2017 was $9,500,000, and the company had 2,000,000 shares outstanding during the entire year.

Instructions

(a) Prepare a schedule to compute both basic and diluted earnings per share.

(b) Discuss how the schedule would differ if the security was convertible preferred stock

Short Answer

Expert verified
  1. Basic Earnings Per share $4.75 and Diluted Earnings Per share $4.66
  2. In case of basic earnings per sharethere will be no change. In case of Diluted Earnings Per share there will be changes.

Step by step solution

01

Computation of Basic and Diluted Earnings per share-

Net Income for year (A)

$9,500,000

Add: Adjustment for interest (net of tax)

$234,000

Income for diluted earnings per share (B)

$9,734,000

Number of shares for Basic EPS (C)

2,000,000

Add: Shares by conversion (($5,000,000/$1,000) x 18))

90,000

Number of shares for Diluted EPS (D)

2,090,000

Basic Earnings Per share (A / C)

$4.75

Diluted Earnings Per share (B / D)

$4.66

Calculation of after tax interest:

Maturity Value

$5,000,000

Rate

7%

Cash Interest

$350,000

Discount amortization [(1.00-.98) *$5,000,000*1/10]

10,000

Interest expense

$360,000

  1. Tax rate (1-35%)

0.65

After tax interest

$234,000

02

The schedule would differ if the security was convertible preferred stock-

b. On the off chance that the convertible securities were preferred stock, basic earnings per share would be a similar accepting there were no preferred dividends announced or the preferred was noncumulative. For diluted Earnings per share, the numerator would be the overall net income amount will be $9,500,000 and the denominator would be 2,090,000.

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Most popular questions from this chapter

(Conversion of Bonds) Vargo Company has bonds payable outstanding in the amount of \(500,000, and the Premium on Bonds Payable account has a balance of \)7,500. Each \(1,000 bond is convertible into 20 shares of preferred stock of parvalue of \)50 per share. All bonds are converted into preferred stock.

Bedard Corporation reported net income of \(300,000 in 2017 and had 200,000 shares of common stock outstanding throughout the year. Also outstanding all year were 45,000 options to purchase common stock at \)10 per share. The average market price of the stock during the year was $15. Compute diluted earnings per share.

Question: (Conversion of Bonds) On January 1, 2017, Gottlieb Corporation issued \(4,000,000 of 10-year, 8% convertible debentures at 102. Interest is to be paid semi-annually on June 30 and December 31. Each \)1,000 debenture can be converted into eight shares of Gottlieb Corporation \(100 par value common stock after December 31, 2018. On January 1, 2019, \)400,000 of debentures are converted into common stock, which is then selling at \(110. An additional \)400,000 of debentures are converted on March 31, 2019. The market price of the common stock is then $115. Accrued interest at March 31 will be paid on the next interest date. Bond premium is amortized on a straight-line basis.

Make the necessary journal entries for:

(a) December 31, 2018. (c) March 31, 2019.

(b) January 1, 2019. (d) June 30, 2019.

Record the conversions using the book value method

EXCEL (Stock-Option Plan) Berg Company adopted a stock-option plan on November 30, 2016, that provided that 70,000 shares of \(5 par value stock be designated as available for the granting of options to officers of the corporation at a price of \)9 a share. The market price was \(12 a share on November 30, 2017.

On January 2, 2017, options to purchase 28,000 shares were granted to president Tom Winter鈥�15,000 for services to be rendered in 2017 and 13,000 for services to be rendered in 2018. Also on that date, options to purchase 14,000 shares were granted to vice president Michelle Bennett鈥�7,000 for services to be rendered in 2017 and 7,000 for services to be rendered in 2018. The market price of the stock was \)14 a share on January 2, 2017. The options were exercisable for a period of one year following the year in which the services were rendered. The fair value of the options on the grant date was \(4 per option.

In 2018, neither the president nor the vice president exercised their options because the market price of the stock was below the exercise price. The market price of the stock was \)8 a share on December 31, 2018, when the options for 2017 services lapsed.

On December 31, 2019, both president Winter and vice president Bennett exercised their options for 13,000 and 7,000 shares, respectively, when the market price was $16 a share.

Instructions

Prepare the necessary journal entries in 2016 when the stock-option plan was adopted, in 2017 when options were granted, in 2018 when options lapsed, and in 2019 when options were exercised.

Question: . Mae Jong Corp. issues \(1,000,000 of 10% bonds payable which may be converted into 10,000 shares of \)2 par value ordinary shares. The market rate of interest on similar bonds is 12%. Interest is payable annually on December 31, and the bonds were issued for total proceeds of $1,000,000. In accounting for these bonds, Mae Jong Corp. will:

(a) first assign a value to the equity component, then determine the liability component.

(b) assign no value to the equity component since the conversion privilege is not separable from the bond.

(c) first assign a value to the liability component based on the face amount of the bond.

(d) use the 鈥渨ith-and-without鈥� method to value the compound instrument.
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