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Chapter 16: Q24Q (page 874)
What is meant by the term antidilution? Give an example.
Anti-dilution refers to the increment in earnings per share, resulting due to exercise of convertible security, options or warrants.
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(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
CA16-3 WRITING (Stock Warrants鈥擵arious Types) For various reasons a corporation may issue warrants to purchase shares of its common stock at specified prices that, depending on the circumstances, may be less than, equal to, or greater than the current market price. For example, warrants may be issued:
1. To existing stockholders on a pro rata basis.
2. To certain key employees under an incentive stock-option plan.
3. To purchasers of the corporation鈥檚 bonds.
Instructions
For each of the three examples of how stock warrants are used:
(a) Explain why they are used.
(b) Discuss the significance of the price (or prices) at which the warrants are issued (or granted) in relation to (1) the current market price of the company鈥檚 stock, and (2) the length of time over which they can be exercised.
(c) Describe the information that should be disclosed in financial statements, or notes thereto, that are prepared when stock warrants are outstanding in the hands of the three groups listed above
(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.
Issuance and Exercise of Stock Options) On November 1, 2017, Columbo Company adopted a stock-option plan that granted options to key executives to purchase 30,000 shares of the company鈥檚 \(10 par value common stock. The options were granted on January 2, 2018, were exercisable 2 years after the date of grant if the grantee was still an employee of the company. The options expired 6 years from date of grant. The option price was set at \)40, and the fair value option-pricing model determines the total compensation expense to be \(450,000.All of the options were exercised during the year 2020: 20,000 on January 3 when the market price was \)67, and 10,000 on May 1 when the market price was $77 a share.
Instructions
Prepare journal entries relating to the stock option plan for the years 2018, 2019, and 2020. Assume that the employee performsservices equally in 2018 and 2019.
(EPS with Convertible Bonds and Preferred Stock) On January 1, 2017, Crocker Company issued 10-year, \(2,000,000 face value, 6% bonds, at par. Each \)1,000 bond is convertible into 15 shares of Crocker common stock. Crocker鈥檚 net income in 2017 was \(300,000, and its tax rate was 40%. The company had 100,000 shares of common stock outstanding throughout 2017. None of the bonds were converted in 2017.
Instructions
(a) Compute diluted earnings per share for 2017.
(b) Compute diluted earnings per share for 2017, assuming the same facts as above, except that \)1,000,000 of 6% convertible preferred stock was issued instead of the bonds. Each $100 preferred share is convertible into 5 shares of Crocker common stock.
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