Question

(EPS with Stock Dividend and Discontinued Operations) Christina Corporation is preparing the comparative financial statements to be included in the annual report to stockholders. Christina employs a fiscal year ending May 31.

Income from operations before income taxes for Christina was \(1,400,000 and \)660,000, respectively, for fiscal years ended May 31, 2018 and 2017. Christina experienced a loss from discontinued operations of \(400,000 on March 3, 2018. A 40% combined income tax rate pertains to any and all of Christina Corporation’s profits, gains, and losses.

Christina’s capital structure consists of preferred stock and common stock. The company has not issued any convertible securities or warrants and there are no outstanding stock options.

Christina issued 40,000 shares of \)100 par value, 6% cumulative preferred stock in 2014. All of this stock is outstanding, and no preferred dividends are in arrears.

There were 1,000,000 shares of \(1 par common stock outstanding on June 1, 2016. On September 1, 2016, Christina sold an additional 400,000 shares of the common stock at \)17 per share. Christina distributed a 20% stock dividend on the common shares outstanding on December 1, 2017. These were the only common stock transactions during the past 2 fiscal years.

Instructions

(a) Determine the weighted-average number of common shares that would be used in computing earnings per share on the current comparative income statement for:

(1) The year ended May 31, 2017.

(2) The year ended May 31, 2018.

(b) Starting with income from operations before income taxes, prepare a comparative income statement for the years ended May 31, 2018 and 2017. The statement will be part of Christina Corporation’s annual report to stockholders and should include appropriate earnings per share presentation.

(c) The capital structure of a corporation is the result of its past financing decisions. Furthermore, the earnings per share data presented on a corporation’s financial statements is dependent upon the capital structure.

(1) Explain why Christina Corporation is considered to have a simple capital structure.

(2) Describe how earnings per share data would be presented for a corporation that has a complex capital structure.

Short answer

(a) Weighted average shares:

2017:1,560,000

2018:1,680,000

(b) Net income:

2017:$396,000

2018:$600,000

(c) (1) Yes, the capital structure of the company is simple.

(2) Companies with complex capital structures must report basic and dilutive earnings per share.

Step-by-step solution

Definition of Capital Structure

The combination of different sources of funds used to finance the company and its operation is known as capital structure. Such structure includes the equity and debt sources of funds used by the business entity.

Calculation of weighted average shares

For the year ending 31 May 2017

Date	Weight	/	12	X	Number of shares outstanding	=	Weighted average shares
1 June	3	/	12	X	1,200,000	=	300,000
1 Sep	9	/	12	X	1,680,000	=	1,260,000
							1,560,000

For the year ending 31 May 2018:

Date	Weight	/	12	X	Number of shares outstanding	=	Weighted average shares
1 June	12	/	12	X	1,680,000	=	1,680,000

Working note:

Weighted average shares

	Before stock dividend	After stock dividend
Total as of 1 June 2016	1,000,000	1,200,000
Issue on 1 September 2016	400,000	480,000
Total on 31 May 2018	1,400,000	1,680,000

Comparative income statement for the year 2017 and 2018

Particular	2018	2017
Income from operation before income tax	$1,400,000	$660,000
Less: income taxes	(560,000)	(264,000)
Income from continuing operations	840,000	396,000
Less: Loss from discontinuing operation net of applicable income tax	(240,000)	(0)
Net income	$600,000	$396,000
Earnings per share
Income from continuing operations net of preferred dividend	$0.35 $\left(\frac{\$840,000-\$240,000}{1,680,000}\right)$	$0.10 $\left(\frac{\$396,000-\$240,000}{1,560,000}\right)$
Less: Discontinued operation	$\left(\frac{\$240,000}{1,680,000}\right)$ ($0.14)
Net income	$0.21	$0.10

Working note: Calculation of preferred dividend

$\begin{array}{rcl}\mathbf{Preferred}\mathbf{}\mathbf{dividend}& \mathbf{=}& \mathbf{Preferred}\mathbf{}\mathbf{shares}\mathbf{}\mathbf{outstanding}\mathbf{\times }\mathbf{Par}\mathbf{}\mathbf{value}\mathbf{\times }\mathbf{Dividend}\mathbf{}\mathbf{rate}\\ & \mathbf{=}& \mathbf{40}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{\$}\mathbf{100}\mathbf{\times }\mathbf{6}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{240}\mathbf{,}\mathbf{000}\end{array}$

Capital structure of the business entity

1. The company’s capital structure is simple because the business entity does not issue any options, convertible securities, or warrants. The business entity has issued common stock and preferred shares that do not create a complex capital structure.
2. Companies with a complex capital structure will present the earnings per share in two categories: basic earnings per share and dilutive earnings per share.

Basic earnings per share consider only weighted average shares of common stock. At the same time, dilutive earnings per share consider all options and weighted average shares of common stock.