Chapter 16: Question 17 (page 874)
What effect do stock dividends or stock splits have on the computation of the weighted-average number of shares outstanding?
The computation of the weighted-average number of offers outstanding requires repetition of the shares outstanding before the stock split or dividend.
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Earnings per share can affect market prices of common stock. Can market prices affect earnings per share? Explain.
Tomba Corporation had 300,000 shares of common stock outstanding on January 1, 2017. On May 1, Tomba issued 30,000 shares. (a) Compute the weighted-average number of shares outstanding if the 30,000 shares were issued for cash. (b) Compute the weighted-average number of shares outstanding if the 30,000 shares were issued in a stock dividend.
Accounting, Analysis, and Principles
On January 1, 2016, Garner issued 10-year, \(200,000 face value, 6% bonds at par. Each \)1,000 bond is convertible into 30 shares of Garner \(2 par value common stock. The company has had 10,000 shares of common stock (and no preferred stock) outstanding throughout its life. None of the bonds have been converted as of the end of 2017. (Ignore all tax effects.)
Accounting
(a) Prepare the journal entry Garner would have made on January 1, 2016, to record the issuance of the bonds.
(b) Garner’s net income in 2017 was \)30,000 and was \(27,000 in 2016. Compute basic and diluted earnings per share for Garner for 2017 and 2016.
(c) Assume that 75% of the holders of Garner’s convertible bonds convert their bonds to stock on June 30, 2018, when Garner’s stock is trading at \)32 per share. Garner pays $50 per bond to induce bondholders to convert. Prepare the journal entry to record the conversion.
Analysis
Show how Garner will report income and EPS for 2017 and 2016. Briefly discuss the importance of GAAP for EPS to analysts evaluating companies based on price-earnings ratios. Consider comparisons for a company over time, as well as comparisons between companies at a point in time.
Principles
In order to converge GAAP and IFRS, the FASB is considering whether the equity element of a convertible bond should be reported as equity. Describe how the journal entry you made in part (a) above would differ under IFRS. In terms of the accounting principles discussed in Chapter 2, what does IFRS for convertible debt accomplish that GAAP potentially sacrifices? What does GAAP for convertible debt accomplish that IFRS potentially sacrifices?
Briefly discuss the convergence efforts that are under way by the IASB and FASB in the area of dilutive securities and earnings per share.
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.
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