Question

(Basic EPS: Two-Year Presentation) Melton Corporation is preparing the comparative financial statements for the annual report to its shareholders for fiscal years ended May 31, 2017, and May 31, 2018. The income from operations for thefiscal year ended May 31, 2017, was \(1,800,000 and income from continuing operations for the fiscal year ended May 31, 2018, was \)2,500,000. In both years, the company incurred a 10% interest expense on \(2,400,000 of debt, an obligation that requires interestonly payments for 5 years. The company experienced a loss from discontinued operations of \)600,000 on February 2018. The company uses a 40% effective tax rate for income taxes.

The capital structure of Melton Corporation on June 1, 2016, consisted of 1 million shares of common stock outstanding and 20,000 shares of \(50 par value, 6%, cumulative preferred stock. There were no preferred dividends in arrears, and the company had not issued any convertible securities, options, or warrants.

On October 1, 2016, Melton sold an additional 500,000 shares of the common stock at \)20 per share. Melton distributed a 20% stock dividend on the common shares outstanding on January 1, 2017. On December 1, 2017, Melton was able to sell an additional 800,000 shares of the common stock at $22 per share. These were the only common stock transactions that occurred during the two fiscal years.

Instructions

(a) Identify whether the capital structure at Melton Corporation is a simple or complex capital structure and explain why.

(b) Determine the weighted-average number of shares that Melton Corporation would use in calculating earnings per share for the fiscal year ended: (1) May 31, 2017. (2) May 31, 2018.

(c) Prepare, in good form, a comparative income statement, beginning with income from operations, for Melton Corportion for the fiscal years ended May 31, 2017, and May 31, 2018. This statement will be included in Melton’s annual report and should display the appropriate earnings per share presentations.

Short answer

(a) Simple capital structureis the capital structure of Melton Corporation.

(b) Weighted Average no of shares:May 31, 2017-1,600,000; May 31, 2018 – 2,200,000

(c) Earnings Per Share:

EARNINGS PER SHARE:
Income before extraordinary loss	$0.55	$0.59
Extraordinary loss	0	$0.16
Net Income	$0.55	$0.43

Step-by-step solution

Meaning of Simple Capital Structure

An organization with a simple capital structure has no protections remarkable that might potentially dilute the value of its earnings per share. It implies that its capital structure incorporates common and non-convertible preferred stock.

a. Identification

(a) The capital structure of Melton Corporation is considered a simple capital structure because it does not have any convertible securities

 Step 3: b. Calculation of weighted average number of shares 

For the year ended May 31, 2017

	Date Outstanding	Shares Outstanding	Restatement	Fraction of year	Weighted shares
Beginning Balance	June 1- Oct 1	1,000,000	1.2	4/12	400,000
New Issue	Oct 1- May 31	1,500,000	1.2	8/12	1,200,000
					1,600,000

Note: Shares outstanding between Oct 1 to May 31 are 1,500,000, i.e.,

$\mathbf{(}\mathbf{1}\mathbf{,}\mathbf{000}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{500}\mathbf{,}\mathbf{000}\mathbf{)}$

For the year ended May 31, 2018

	Date Outstanding	Shares Outstanding	Restatement	Fraction of year	Weighted shares
Beginning Balance	June 1- Oct 1	1,800,000		6/12	900,000
New Issue	Oct 1- May 31	2,600,000		6/12	1,300,000
					2,200,000

c. preparinga comparative income statement

MELTON CORPORATION
Comparative Income Statement for fiscal year ended May 31, 2020, and 2021
	2017	2018
Income from Operations	$1,800,000	$2,500,000
Less: Interest expense	(240,000)	(240,000)
Income tax before tax	1,560,000	2,260,000
Less: Income tax 40%	(624,000)	(904,000)
Income before extraordinary items	936,000	1,356,000
Less: Extraordinary loss (600,000-40%)	0	(360,000)
Net Income	$936,000	$996,000
EARNINGS PER SHARE:
Income before extraordinary loss [(Income before extraordinary items - Preferred dividend)/Average outstanding shares]	$0.55	$0.59
Extraordinary loss [(Extraordinary loss - Preferred dividend)/Average outstanding shares]	0	(0.16)
Net Income [(Net Income- Preferred dividend)/Average outstanding shares]	$0.55	$0.43

Working note:

Computation of preferred dividend

$\begin{array}{c}\mathbf{P}\mathbf{r}\mathbf{e}\mathbf{f}\mathbf{e}\mathbf{r}\mathbf{e}\mathbf{d}\mathbf{}\mathbf{d}\mathbf{i}\mathbf{v}\mathbf{i}\mathbf{d}\mathbf{e}\mathbf{n}\mathbf{d}\mathbf{=}\mathbf{S}\mathbf{h}\mathbf{a}\mathbf{r}\mathbf{e}\mathbf{s}\mathbf{\times }\mathbf{P}\mathbf{r}\mathbf{i}\mathbf{c}\mathbf{e}\mathbf{}\mathbf{p}\mathbf{e}\mathbf{r}\mathbf{}\mathbf{s}\mathbf{h}\mathbf{a}\mathbf{r}\mathbf{e}\mathbf{\times }\mathbf{R}\mathbf{a}\mathbf{t}\mathbf{e}\mathbf{}\mathbf{o}\mathbf{f}\mathbf{}\mathbf{d}\mathbf{i}\mathbf{v}\mathbf{i}\mathbf{d}\mathbf{e}\mathbf{n}\mathbf{d}\\ \mathbf{=}\mathbf{20}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{\$}\mathbf{50}\mathbf{\times }\mathbf{6}\mathbf{\%}\\ \mathbf{=}\mathbf{\$}\mathbf{60}\mathbf{,}\mathbf{000}\end{array}$