Chapter 16, Problem 22P

1. and 2.

To determine

Calculate the basic earnings per share and diluted earnings per share.

Explanation of Solution

Calculate the basic earnings per share and diluted earnings per share.

(Figure 1)

Working notes:

(1) Calculate the numerator for the basic earnings per share:

$\begin{array}{c}\text{Numerator earnings per share = Net income }-\left[\begin{array}{l}\text{Preferred dividend for 7\%+}\\ \text{Preferred dividend for 8\%}\end{array}\right]\\ =\$130,400-\left[(1000\times \$100\times 7\%)+\left(800\times \$100\times 8\%\right)\right]\\ =\$130,400-\left[7,000+\$6,400\right]\\ =\$117,000\end{array}$

(2) Calculate the number of shares used in computing the basic earnings per share:

(Figure 2)

(3) Calculate the increase in the share options:

$\begin{array}{c}\begin{array}{l}\text{Increase in the }\\ \text{share options}\end{array}\}\text{=}\left(\begin{array}{l}\text{Number of }\\ \text{shares issued }\end{array}\right)-\left[\frac{\left(\left(\begin{array}{l}\text{Number of }\\ \text{shares acquired}\end{array}\right)\times \left[\begin{array}{l}\text{Stock pric per share+}\\ \text{ Share option per share}\end{array}\right]\right)}{\text{Average per share}}\right]\\ =3,000-\left[\frac{3,000\times \left(\$20+\$4\right)}{\$30}\right]\\ =3,000-2,400\\ =600\end{array}$

(4) Calculate the impact of 8% preferred on diluted earnings per share and ranking:

$\begin{array}{c}\begin{array}{l}\text{8\% preferred on diluted}\\ \text{ earnings per share }\end{array}\}\text{=}\frac{\left(\text{Value of preferred stock}\right)\times \text{Percent of dividend }}{\left(\begin{array}{l}\text{Number of shares }\\ \text{outstanding}\\ \text{ in common stock}\end{array}\right)+\left(\begin{array}{l}\text{Additional shares on }\\ \text{bonds that are convertible }\end{array}\right)}\\ =\frac{\$80,000\times 8\%}{800\times 1.7}\\ =\frac{\$6,400}{1,360}\\ =\$4.71\end{array}$

(5) Calculate the impact of 9.6% bonds on diluted earnings per share and ranking:

$\begin{array}{c}\text{Diluted earnings per share =}\frac{\left(\begin{array}{l}\left\{\text{Net income obtained on 10}\text{.2\% bonds+Discount }\right\}\times \\ \text{Corporation income tax rate}\end{array}\right)}{\left(\begin{array}{l}\text{Number of shares of bonds}\\ \text{ convertible into common stock }\end{array}\right)}\\ =\frac{\left(\left\{\$100,000\times 9.6\%+\$300\right\}\right)\times \left(1-30\%\right)}{100\times 22}\\ =\frac{\$9,900\times 0.7}{2,200}\\ =\frac{\$6,930}{2,200}\end{array}$

$\text{ =3}\text{.15}$

Note:

• The Company has occurred loss form the discontinuing operations, the impact of the convertible security is compared with earnings per share that is related to income from continuing operations.
• The percentage of stock dividend that is required to identify the assumed shared outstanding is ascertained using below formula :

           $\begin{array}{c}\text{Total percent of stock dividend = 1+ Percent of stock dividend}\\ \text{=1+}1\text{0\%}\\ \text{=1}\text{.10}\end{array}$

3.

To determine

Identify whether basic or diluted earnings per share will be reported by the Company R on its 2016 income statement.

Explanation of Solution

The Company R must report an amount of (6) $4.23 as basic earnings per share and (7) $4.05 as diluted earnings per share in its 2016 income statement.

Working notes:

(6) Calculate the basic earnings per share after deducting loss from discontinuing operations:

$\begin{array}{c}\begin{array}{l}\text{Basic earnings per }\\ \text{share after deducting}\\ \text{loss from }\\ \text{discontinuing operations}\end{array}\}=\left(\begin{array}{l}\text{Basic earnings}\\ \text{ per share}\end{array}\right)-\left[\frac{\text{Loss from discontinued operations}}{\text{Weighted averages shares outstanding}}\right]\\ =\$4.62-\left[\frac{\$10,000}{25,300}\right]\\ =\$4.62-\$0.39\\ =\$4.23\end{array}$

(7) Calculate the basic earnings per share after deducting loss from discontinuing operations:

$\begin{array}{c}\begin{array}{l}\text{Diluted earnings per }\\ \text{share after deducting }\\ \text{loss from }\\ \text{discontinuing operations}\end{array}\}=\left(\begin{array}{l}\text{Diluted earnings }\\ \text{per share}\end{array}\right)-\left[\frac{\text{Loss from discontinued operations}}{\text{Weighted averages shares outstanding}}\right]\\ =\$4.41-\left[\frac{\$10,000}{28,100}\right]\\ =\$4.41-\$0.36\\ =\$4.05\end{array}$

Notes to financial statement:

Note 1: Basic earnings per share of the company are based on average common shares outstanding; 7% and 8% preferred dividends are deducted from net income to ascertain the earnings available to common shareholders. Diluted earnings per share are obtained from 600 shares of stock options and 2,200 shares of bonds that are convertible. Diluted earnings available to common shareholders are assumed to have no interest expense of $6,930 on the converted bonds.