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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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The controller of Red Lake Corporation has requested assistance in determining income, basic earnings per share, and diluted earnings per share for presentation on the company’s income statement for the year ended September 30, 2020. As currently calculated, Red Lake’s net income is $540,000 for fiscal year 2019-2020.

Your working papers disclose the following opening balances and transactions in the company’s capital stock accounts during the year:

  1. 1. Common stock (at October 1, 2019, stated value $10, authorized 300,000 shares; effective December 1, 2019, stated value $5, authorized 600,000 shares):

    Balance, October 1, 2019—issued and outstanding 60,000 shares

    December 1, 2019—60,000 shares issued in a 2-for-l stock split

    December 1, 2019—280,000 shares (stated value $5) issued at $39 per share

  2. 2. Treasury stock—common:

    March 3, 2020—purchased 40,000 shares at $38 per share

    April 1, 2020—sold 40,000 shares at $40 per share

  3. 3. Noncompensatory stock purchase warrants, Series A (initially, each warrant was exchangeable with $60 for 1 common share; effective December 1, 2019, each warrant became exchangeable for 2 common shares at $30 per share):

    October 1, 2019—25,000 warrants issued at $6 each

  4. 4. Noncompensatory stock purchase warrants, Series B (each warrant is exchangeable with $40 for 1 common share): April 1, 2020—20,000 warrants authorized and issued at $10 each
  5. 5. First mortgage bonds, 5½%, due 2029 (nonconvertible; priced to yield 5% when issued): Balance October 1, 2019—authorized, issued, and outstanding—the face value of $1,400,000
  6. 6. Convertible debentures, 7%, due 2036 (initially, each $1,000 bond was convertible at any time until maturity into 20 common shares; effective December 1, 2019, the conversion rate became 40 shares for each bond): October 1, 2019—authorized and issued at their face value (no premium or discount) of $2,400,000

The following table shows the average market prices for the company’s securities during 2019-2020:

Chapter 16, Problem 25P, The controller of Red Lake Corporation has requested assistance in determining income, basic

*$Adjusted for stock split

Required:

Prepare a schedule computing:

  1. 1. the basic earnings per share
  2. 2. the diluted earnings per share that should be presented on Red Lake’s income statement for the year ended September 30, 2020

A supporting schedule computing the numbers of shares to be used in these computations should also be prepared. Assume an income tax rate of 30%.

1. and 2.

To determine

Compute the schedule showing the basic earnings per share and diluted earnings per share.

Explanation

Earnings per share (EPS):

The amount of net income available to each shareholder per common share outstanding is referred to as earnings per share (EPS).

(Figure 1)

Working notes:

(1) Calculate the numerator value for the diluted earnings per share:

ParticularsAmount in $Amount in $
Net income 540,000
Interest  on bonds ($2,400,000×7%)168,000 
Less: Corporate income tax ($168,000×30%)50,400 
Interest, net of tax effect 117,600
Numerator value for the diluted earnings per share 657,600

(Table 1)

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

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