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(EPS with Convertible Bonds) On June 1, 2015, Andre Company and Agassi Company merged to form Lancaster Inc. A total of 800,000 shares were issued to complete the merger. The new corporation reports on a calendar-year basis.On April 1, 2017, the company issued an additional 400,000 shares of stock for cash. All 1,200,000 shares were outstanding on December 31, 2017.Lancaster Inc. also issued \(600,000 of 20-year, 8% convertible bonds at par on July 1, 2017. Each \)1,000 bond converts to 40shares of common at any interest date. None of the bonds have been converted to date.Lancaster Inc. is preparing its annual report for the fiscal year ending December 31, 2017. The annual report will show earnings per share figures based upon a reported after-tax net income of $1,540,000. (The tax rate is 40%.)

Instructions

Determine the following for 2017.

(a) The number of shares to be used for calculating:

(1) Basic earnings per share.

(2) Diluted earnings per share.

(b) The earnings figures to be used for calculating:

(1) Basic earnings per share.

(2) Diluted earnings per share

Short Answer

Expert verified

a.

(1) Basic earnings per share= 1,100,000

(2) Diluted earnings per share= 1,112,000

b.

(1) Basic earnings per share= $1,540,000

(2) Diluted earnings per share= $1,554,400

Step by step solution

01

a. Computation of no shares to be used for calculation:

1.

Jan 1 – Apr, 800,000 shares x 3/12

200,000

Apr 1- Dec,1200,000 shares x 9/12

900,000

1,100,000

2.

Jan 1 - Apr 80,000 share x 3/12

200,000

Apr 1-Jul,1200,000 x 3/12

300,000

Jul 1-Dec,1224,000 x 6/12

612,000

1,112,000

02

 Computation of earnings figure to be used:

Income for basic earnings per share equals $1,540,000, and for diluted per share equals$1,554,400.

After tax Net Income

$1,540,000

Add: Interest savings ($600,000 x 0.08 x½)

$24,000

Less: Lost tax benefit ($24,000 x 0.40)

($9,600)

Adjusted net income

$1,554,400

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Most popular questions from this chapter

Financial Statement Analysis Case

Ragatz, Inc.

Ragatz, Inc., a drug company, reported the following information. The company prepares its financial statements in accordance with GAAP.

2017 (000)

Current liabilities

\(554,114

Convertible subordinated debts

648,020

Total liabilities

1,228,313

Stockholder’s equity

176,413

Net income

58,333

Analysts attempting to compare Ragatz to drug companies that issue debt with detachable warrants may face a challenge due to differences in accounting for convertible debt.

Instructions

(a) Compute the following ratios for Ragatz, Inc. (Assume that year-end balances approximate annual averages.)

(1) Return on assets.

(2) Return on common stock equity.

(3) Debt to assets ratio.

(b) Briefly discuss the operating performance and financial position of Ragatz. Industry averages for these ratios in 2017 were ROA 3.5%; return on equity 16%; and debt to assets 75%. Based on this analysis, would you make an investment in the company’s 5% convertible bonds? Explain.

(c) Assume you want to compare Ragatz to an IFRS company like Merck (which issues nonconvertible debt with detachable warrants). Assuming that the fair value of the equity component of Ragatz’s convertible bonds is \)150,000, how would you adjust the analysis above to make valid comparisons between Ragatz and Merck?

(EPS with Options, Various Situations) Venzuela Company’s net income for 2017 is \(50,000. The only potentially dilutive securities outstanding were 1,000 options issued during 2016, each exercisable for one share at \)6. None has been exercised, and 10,000 shares of common were outstanding during 2017. The average market price of Venzuela’s stock during 2017 was \(20.

Instructions

(a) Compute diluted earnings per share. (Round to nearest cent.)

(b) Assume the same facts as those assumed for part (a), except that the 1,000 options were issued on October 1, 2017 (rather than in 2016). The average market price during the last 3 months of 2017 was \)20.

(Warrants Issued with Bonds and Convertible Bonds) Incurring long-term debt with an arrangement whereby lenders receive an option to buy common stock during all or a portion of the time the debt is outstanding is a frequent corporate financing practice. In some situations, the result is achieved through the issuance of convertible bonds; in others, the debt instruments and the warrants to buy stock are separate.

Instructions

(a) (1) Describe the differences that exist in current accounting for original proceeds of the issuance of convertible bonds and of debt instruments with separate warrants to purchase common stock.

(2) Discuss the underlying rationale for the differences described in (a)(1) above.

(3) Summarize the arguments that have been presented in favor of accounting for convertible bonds in the same manner as accounting for debt with separate warrants.

(b) At the start of the year, Huish Company issued \(18,000,000 of 12% bonds along with detachable warrants to buy 1,200,000 shares of its \)10 par value common stock at \(18 per share. The bonds mature over the next 10 years, starting one year from date of issuance, with annual maturities of \)1,800,000. At the time, Huish had 9,600,000 shares of common stock outstanding. The company received $20,040,000 for the bonds and the warrants. For Huish Company, 12% was a relatively low borrowing rate. If offered alone, at this time, the bonds would have sold in the market at a 22% discount. Prepare the journal entry (or entries) for the issuance of the bonds and warrants for the cash consideration received.

CA16-6 WRITING (EPS, Antidilution) Brad Dolan, a stockholder of Rhode Corporation, has asked you, the firm’s accountant, to explain why his stock warrants were not included in diluted EPS. In order to explain this situation, you must briefly explain what dilutive securities are, why they are included in the EPS calculation, and why some securities are antidilutive and thus not included in this calculation.

Rhode Corporation earned \(228,000 during the period, when it had an average of 100,000 shares of common stock outstanding. The common stock sold at an average market price of \)25 per share during the period. Also outstanding were 30,000 warrants that could be exercised to purchase one share of common stock at $30 per warrant.

Instructions

Write Mr. Dolan a 1–1.5-page letter explaining why the warrants are not included in the calculation.

Where can authoritative IFRS be found related to dilutive securities, stock-based compensation, and earnings per share?

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