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DILUTIVE SECURITIES AND EARNINGS PER SHARE

MULTIPLE CHOICEDilutive SecuritiesConceptual


1. Convertible bonds
a. have priority over other indebtedness.
b. are usually secured by a first or second mortgage.
c. pay interest only in the event earnings are sufficient to cover the interest.
d. may be exchanged for equity securities.

2. The conversion of bonds is most commonly recorded by the


a. incremental method.
b. proportional method.
c. market value method.
d. book value method.

3. Gains or losses on the early extinguishment of convertible debt should be considered an


a. extraordinary item.
b. ordinary item.
c. unusual item.
d. none of these.

4. The conversion of preferred stock may be recorded by the


a. incremental method.
b. book value method.
c. market value method.
d. par value method.

5. When the cash proceeds from a bond issued with detachable stock warrants exceeds the
sum of the par value of the bonds and the fair market value of the warrants, the excess
should be credited to
a. additional paid-in capital from stock warrants.
b. retained earnings.
c. a liability account.
d. premium on bonds payable.

6. Proceeds from an issue of debt securities having stock warrants should not be allocated
between debt and equity features when
a. the market value of the warrants is not readily available.
b. exercise of the warrants within the next few fiscal periods seems remote.
c. the allocation would result in a discount on the debt security.
d. the warrants issued with the debt securities are nondetachable.

7. Stock warrants outstanding should be classified as


a. liabilities.
b. reductions of capital contributed in excess of par value.
c. assets.
16 - 2 Test Bank for Intermediate Accounting, Eleventh Edition

d. none of these. Es addition contributed capital


Dilutive Securities and Earnings per Share 16 - 3

8. The date on which to measure the compensation element in a stock option granted to a
corporate employee ordinarily is the date on which the employee
a. is granted the option.
b. has performed all conditions precedent to exercising the option.
c. may first exercise the option.
d. exercises the option.

9. Compensation expense resulting from a compensatory stock option plan is generally


a. recognized in the period of exercise.
b. recognized in the period of the grant.
c. allocated to the periods benefited by the employee's required service.
d. allocated over the periods of the employee's service life to retirement.

10. The date on which total compensation expense is computed in a stock option plan is the date
a. of grant.
b. of exercise.
c. that the market price coincides with the option price.
c. that the market price exceeds the option price.

11. Which of the following is not a characteristic of a noncompensatory stock purchase plan?
a. It is open to almost all full-time employees.
b. The discount from market price is small.
c. The plan offers no substantive option feature.
d. All of these are characteristics.

*12. Under the intrinsic value method, compensation expense resulting from an incentive stock
option is generally
a. not recognized because no excess of market price over the option price exists at the
date of grant.
b. recognized in the period of the grant.
c. allocated to the periods benefited by the employee's required service.
d. recognized in the period of exercise.

*13. An executive compensation plan in which the executive may receive compensation in
cash, shares of stock, or a combination of both, is known as ______________ plan.
a. a nonqualified stock option
b. a performance-type
c. a stock appreciation rights
d. both a performance-type and a stock appreciation rights

*14. A corporation should record no compensation expense for which of the following types of
executive compensation plans?
a. Stock appreciation rights
b. Nonqualified stock option plans
c. Incentive stock option plans
d. Compensation expense should be recorded for all of these.

*15. The payment to executives from a performance-type plan is never based on the
a. market price of the common stock.
b. return on assets (investment).
c. return on common stockholders' equity.
d. sales.
16 - 4 Test Bank for Intermediate Accounting, Eleventh Edition

MULTIPLE CHOICEDilutive SecuritiesComputational


16. Klugg Co. has $5,000,000 of 8% convertible bonds outstanding. Each $1,000 bond is
convertible into 30 shares of $30 par value common stock. The bonds pay interest on
January 31 and July 31. On July 31, 2004, the holders of $1,500,000 bonds exercised the
conversion privilege. On that date the market price of the bonds was 105 and the market
price of the common stock was $36. The total unamortized bond premium at the date of
conversion was $350,000. Klugg should record, as a result of this conversion, a
a. credit of $255,000 to Paid-in Capital in Excess of Par.
b. credit of $225,000 to Paid-in Capital in Excess of Par.
c. credit of $105,000 to Premium on Bonds Payable.
d. loss of $15,000.

17. On July 1, 2004, an interest payment date, $120,000 of Stark Co. bonds were converted
into 1,800 shares of Stark Co. common stock each having a par value of $45 and a
market value of $54. There is $4,800 unamortized discount on the bonds. Using the book
value method, Stark would record
a. no change in paid-in capital in excess of par.
b. a $7,200 increase in paid-in capital in excess of par.
c. a $14,400 increase in paid-in capital in excess of par.
d. a $9,600 increase in paid-in capital in excess of par.

18. Peters Corporation had two issues of securities outstanding: common stock and an 8%
convertible bond issue in the face amount of $12,000,000. Interest payment dates of the
bond issue are June 30th and December 31st. The conversion clause in the bond
indenture entitles the bondholders to receive forty shares of $20 par value common stock
in exchange for each $1,000 bond. On June 30, 2004, the holders of $1,800,000 face
value bonds exercised the conversion privilege. The market price of the bonds on that
date was $1,100 per bond and the market price of the common stock was $35. The total
unamortized bond discount at the date of conversion was $750,000. In applying the book
value method, what amount should Peters credit to the account "paid-in capital in excess
of par," as a result of this conversion?
a. $247,500.
b. $120,000.
c. $1,080,000.
d. $540,000.
Dilutive Securities and Earnings per Share 16 - 5

Use the following information for questions 19 through 21.

Gomez Corporation issued $9,000,000 of 7%, ten-year convertible bonds on July 1, 2004 at 96.1
plus accrued interest. The bonds were dated April 1, 2004 with interest payable April 1 and
October 1. Bond discount is amortized semiannually on a straight-line basis. On April 1, 2005,
$1,800,000 of these bonds were converted into 500 shares of $20 par value common stock.
Accrued interest was paid in cash at the time of conversion.

19. If "interest payable" were credited when the bonds were issued, what should be the
amount of the debit to "interest expense" on October 1, 2004?
a. $193,500.
b. $202,500.
c. $211,500.
d. $405,000.

20. What should be the amount of the unamortized bond discount on April 1, 2005 relating to
the bonds converted?
a. $70,200.
b. $64,800.
c. $35,100.
d. $66,600.

21. What was the effective interest rate on the bonds when they were issued?
a. 7%
b. Above 7%
c. Below 7%
d. Cannot determine from the information given.

22. In 2003, Singer, Inc., issued for $103 per share, 40,000 shares of $100 par value
convertible preferred stock. One share of preferred stock can be converted into three
shares of Singer's $25 par value common stock at the option of the preferred stockholder.
In August 2004, all of the preferred stock was converted into common stock. The market
value of the common stock at the date of the conversion was $30 per share. What total
amount should be credited to additional paid-in capital from common stock as a result of
the conversion of the preferred stock into common stock?
a. $680,000.
b. $520,000.
c. $1,000,000.
d. $1,120,000.

23. On December 1, 2004, Gentry Company issued at 103, six hundred of its 9%, $1,000
bonds. Attached to each bond was one detachable stock warrant entitling the holder to
purchase 10 shares of Gentry's common stock. On December 1, 2004, the market value
of the bonds, without the stock warrants, was 95, and the market value of each stock
purchase warrant was $50. The amount of the proceeds from the issuance that should be
accounted for as the initial carrying value of the bonds payable would be
a. $580,920.
b. $587,100.
c. $600,000.
d. $618,000.
16 - 6 Test Bank for Intermediate Accounting, Eleventh Edition

24. On March 1, 2004, Winn Corporation issued $600,000 of 8% nonconvertible bonds at 104,
which are due on February 28, 2024. In addition, each $1,000 bond was issued with 25
detachable stock warrants, each of which entitled the bondholder to purchase for $50 one
share of Winn common stock, par value $25. The bonds without the warrants would
normally sell at 95. On March 1, 2004 the fair market value of Winns common stock was
$40 per share and the fair market value of the warrants was $2.00. What amount should
Winn record on March 1, 2004 as paid-in capital from stock warrants?
a. $21,600.
b. $25,200.
c. $31,200.
d. $30,000.

25. During 2004, Dexter Company issued at 104 eight hundred, $1,000 bonds due in ten
years. One detachable stock warrant entitling the holder to purchase 15 shares of
Dexters common stock was attached to each bond. At the date of issuance, the market
value of the bonds, without the stock warrants, was quoted at 96. The market value of
each detachable warrant was quoted at $40. What amount, if any, of the proceeds from
the issuance should be accounted for as part of Dexters stockholders' equity?
a. $0.
b. $32,000.
c. $33,280.
d. $31,616.

26. On April 7, 2004, Lampe Corporation sold a $5,000,000, twenty-year, 8 percent bond
issue for $5,300,000. Each $1,000 bond has two detachable warrants, each of which
permits the purchase of one share of the corporation's common stock for $30. The stock
has a par value of $25 per share. Immediately after the sale of the bonds, the
corporation's securities had the following market values:
8% bond without warrants $1,008
Warrants 21
Common stock 28
What accounts should Lampe credit to record the sale of the bonds?
a. Bonds Payable $5,000,000
Premium on Bonds Payable 194,000
Paid-in CapitalStock Warrants 106,000
b. Bonds Payable $5,000,000
Premium on Bonds Payable 40,000
Paid-in CapitalStock Warrants 210,000
c. Bonds Payable $5,000,000
Premium on Bonds Payable 88,000
Paid-in CapitalStock Warrants 212,000
d. Bonds Payable $5,000,000
Premiums on Bonds Payable 300,000
Dilutive Securities and Earnings per Share 16 - 7

Use the following information for questions 27 and 28.

On May 1, 2004, Kiley Co. issued $800,000 of 7% bonds at 103, which are due on April 30, 2014.
Twenty detachable stock warrants entitling the holder to purchase for $40 one share of Kileys
common stock, $15 par value, were attached to each $1,000 bond. The bonds without the
warrants would sell at 96. On May 1, 2004, the fair value of Kileys common stock was $35 per
share and of the warrants was $2.

27. On May 1, 2004, Kiley should credit Paid-in Capital from Stock Warrants for
a. $30,720.
b. $32,000.
c. $32,960.
d. $56,000.

28. On May 1, 2004, Kiley should record the bonds with a


a. discount of $32,000.
b. discount of $8,960.
c. discount of $8,000.
d. premium of $24,000.

29. On July 4, 2004, Linn Company issued for $2,100,000 a total of 20,000 shares of $100
par value, 7% noncumulative preferred stock along with one detachable warrant for each
share issued. Each warrant contains a right to purchase one share of Linn $10 par value
common stock for $15 per share. The stock without the warrants would normally sell for
$2,050,000. The market price of the rights on July 1, 2004, was $2.50 per right. On
October 31, 2004, when the market price of the common stock was $19 per share and the
market value of the rights was $3.00 per right, 8,000 rights were exercised. As a result of
the exercise of the 8,000 rights and the issuance of the related common stock, what
journal entry would Linn make?
a. Cash ................................................................................. 120,000
Common Stock ........................................................ 80,000
Paid-in Capital in Excess of Par .............................. 40,000
b. Cash . ................................................................................. 120,000
Paid-in CapitalStock Warrants ......................................... 20,000
Common Stock ........................................................ 80,000
Paid-in Capital in Excess of Par .............................. 60,000
c. Cash ................................................................................ 120,000
Paid-in CapitalStock Warrants ......................................... 50,000
Common Stock ........................................................ 80,000
Paid-in Capital in Excess of Par .............................. 90,000
d. Cash ................................................................................. 120,000
Paid-in CapitalStock Warrants ......................................... 30,000
Common Stock ........................................................ 80,000
Paid-in Capital in Excess of Par .............................. 70,000

30. Windom Corp. on January 1, 2001, granted stock options for 100,000 shares of its $10 par
value common stock to its key employees. The market price of the common stock on that
date was $23 per share and the option price was $20. The Black-Scholes option pricing
model determines total compensation expense to be $600,000. The options are exercisable
beginning January 1, 2004, provided those key employees are still in Windoms employ at
the time the options are exercised. The options expire on January 1, 2005.
16 - 8 Test Bank for Intermediate Accounting, Eleventh Edition

On January 1, 2004, when the market price of the stock was $29 per share, all 100,000
options were exercised. The amount of compensation expense Windom should record for
2003 under the fair value method is
a. $0.
b. $100,000.
c. $200,000.
d. $300,000.

31. On December 31, 2004, Heerey Company granted some of its executives options to
purchase 60,000 shares of the company's $50 par common stock at an option price of $60
per share. The Black-Scholes option pricing model determines total compensation expense
to be $1,200,000. The options become exercisable on January 1, 2005, and represent
compensation for executives' past and future services over a three-year period beginning
January 1, 2005. What is the impact on Heerey's total stockholders' equity for the year
ended December 31, 2004, as a result of this transaction under the fair value method?
a. $1,200,000 decrease
b. $400,000 decrease
c. $0
d. $400,000 increase

32. On June 30, 2001, Trane Corporation granted compensatory stock options for 50,000
shares of its $20 par value common stock to certain of its key employees. The market
price of the common stock on that date was $36 per share and the option price was $30.
The Black-Scholes option pricing model determines total compensation expense to be
$600,000. The options are exercisable beginning January 1, 2004, provided those key
employees are still in Tranes employ at the time the options are exercised. The options
expire on June 30, 2005.
On January 4, 2004, when the market price of the stock was $42 per share, all 50,000
options were exercised. What should be the amount of compensation expense recorded
by Trane Corporation for the calendar year 2003 using the fair value method?
a. $0.
b. $240,000.
c. $300,000.
d. $600,000.

33. In order to retain certain key executives, Staley Corporation granted them incentive stock
options on December 31, 2003. 30,000 options were granted at an option price of $35 per
share. Market prices of the stock were as follows:
December 31, 2004 $46 per share
December 31, 2005 51 per share
The options were granted as compensation for executives' services to be rendered over a
two-year period beginning January 1, 2004. The Black-Scholes option pricing model
determines total compensation expense to be $300,000. What amount of compensation
expense should Staley recognize as a result of this plan for the year ended December 31,
2004 under the fair value method?
a. $150,000.
b. $300,000.
c. $330,000.
d. $1,050,000.
Dilutive Securities and Earnings per Share 16 - 9

34. Logan, Inc. had 120,000 shares of treasury stock ($10 par value) at December 31, 2003,
which it acquired at $11 per share. On June 4, 2004, Logan issued 60,000 treasury shares
to employees who exercised options under Logan's employee stock option plan. The
market value per share was $13 at December 31, 2003, $15 at June 4, 2004, and $18 at
December 31, 2004. The stock options had been granted for $12 per share. The cost
method is used. What is the balance of the treasury stock on Logan's balance sheet at
December 31, 2004?
a. $420,000.
b. $540,000.
c. $660,000.
d. $720,000.

Use the following information for questions 35 through 37.

On January 1, 2003, Neeley, Inc. established a stock appreciation rights plan for its executives. It
entitled them to receive cash at any time during the next four years for the difference between the
market price of its common stock and a pre-established price of $20 on 100,000 SARs. Current
market prices of the stock are as follows:
January 1, 2003 $35 per share
December 31, 2003 38 per share
December 31, 2004 30 per share
December 31, 2005 33 per share

Compensation expense relating to the plan is to be recorded over a four-year period beginning
January 1, 2003.

*35. What amount of compensation expense should Neeley recognize for the year ended
December 31, 2003?
a. $300,000.
b. $450,000.
c. $375,000.
d. $1,800,000.

*36. What amount of compensation expense should Neeley recognize for the year ended
December 31, 2004?
a. $0.
b. $50,000.
c. $500,000.
d. $250,000.

*37. On December 31, 2005, 16,000 SARs are exercised by executives. What amount of
compensation expense should Neeley recognize for the year ended December 31, 2005?
a. $475,000.
b. $325,000.
c. $975,000.
d. $130,000.
16 - 10 Test Bank for Intermediate Accounting, Eleventh Edition

MULTIPLE CHOICEDilutive SecuritiesCPA Adapted


38. On January 2, 2002, Boles Co. issued 10-year convertible bonds at 105. During 2004,
these bonds were converted into common stock having an aggregate par value equal to
the total face amount of the bonds. At conversion, the market price of Boles common
stock was 50 percent above its par value. On January 2, 2002, cash proceeds from the
issuance of the convertible bonds should be reported as
a. paid-in capital for the entire proceeds.
b. paid-in capital for the portion of the proceeds attributable to the conversion feature and
as a liability for the balance.
c. a liability for the face amount of the bonds and paid-in capital for the premium over the
face amount.
d. a liability for the entire proceeds.

39. Kane Co. issued bonds with detachable common stock warrants. Only the warrants had a
known market value. The sum of the fair value of the warrants and the face amount of the
bonds exceeds the cash proceeds. This excess is reported as
a. Discount on Bonds Payable.
b. Premium on Bonds Payable.
c. Common Stock Subscribed.
d. Paid-in Capital in Excess of ParStock Warrants.

40. On January 1, 2004, Cater Corp. granted an employee an option to purchase 10,000
shares of Cater's $5 par value common stock at $20 per share. The Black-Scholes option
pricing model determines total compensation expense to be $220,000. The option
became exercisable on December 31, 2005, after the employee completed two years of
service. The market prices of Cater's stock were as follows:
January 1, 2004 $30
December 31, 2005 50
For 2005, Cater should recognize compensation expense under the fair value method of
a. $150,000.
b. $50,000.
c. $110,000.
d. $0.
Dilutive Securities and Earnings per Share 16 - 11

*41. On January 2, 2004, for past services, Simon Corp. granted Ken Otto, its president,
30,000 stock appreciation rights that are exercisable immediately and expire on January
2, 2005. On exercise, Otto is entitled to receive cash for the excess of the market price of
the stock on the exercise date over the market price on the grant date. Otto did not
exercise any of the rights during 2004. The market price of Simon's stock was $30 on
January 2, 2004, and $45 on December 31, 2004. As a result of the stock appreciation
rights, Simon should recognize compensation expense for 2004 of
a. $0.
b. $150,000.
c. $450,000.
d. $900,000.

MULTIPLE CHOICEEarnings Per ShareConceptual


42. With respect to the computation of earnings per share, which of the following would be
most indicative of a simple capital structure?
a. Common stock, preferred stock, and convertible securities outstanding in lots of even
thousands
b. Earnings derived from one primary line of business
c. Ownership interest consisting solely of common stock
d. None of these

43. In computing earnings per share for a simple capital structure, if the preferred stock is
cumulative, the amount that should be deducted as an adjustment to the numerator
(earnings) is the
a. preferred dividends in arrears.
b. preferred dividends in arrears times (one minus the income tax rate).
c. annual preferred dividend times (one minus the income tax rate).
d. none of these.

44. In computations of weighted average of shares outstanding, when a stock dividend or


stock split occurs, the additional shares are
a. weighted by the number of days outstanding.
b. weighted by the number of months outstanding.
c. considered outstanding at the beginning of the year.
d. considered outstanding at the beginning of the earliest year reported.

45. What effect will the acquisition of treasury stock have on stockholders' equity and earnings
per share, respectively?
a. Decrease and no effect
b. Increase and no effect
c. Decrease and increase
d. Increase and decrease
16 - 12 Test Bank for Intermediate Accounting, Eleventh Edition

46. When computing diluted earnings per share, convertible bonds are
a. ignored.
b. assumed converted whether they are dilutive or antidilutive.
c. assumed converted only if they are antidilutive.
d. assumed converted only if they are dilutive.

47. Dilutive convertible securities must be used in the computation of


a. basic earnings per share only.
b. diluted earnings per share only.
c. diluted and basic earnings per share.
d. none of these.

48. In computing earnings per share, the equivalent number of shares of convertible preferred
stock are added as an adjustment to the denominator (number of shares outstanding). If
the preferred stock is cumulative, which amount should then be added as an adjustment
to the numerator (net earnings)?
a. Annual preferred dividend
b. Annual preferred dividend times (one minus the income tax rate)
c. Annual preferred dividend times the income tax rate
d. Annual preferred dividend divided by the income tax rate

49. In the diluted earnings per share computation, the treasury stock method is used for
options and warrants to reflect assumed reacquisition of common stock at the average
market price during the period. If the exercise price of the options or warrants exceeds the
average market price, the computation would
a. fairly present diluted earnings per share on a prospective basis.
b. fairly present the maximum potential dilution of diluted earnings per share on a
prospective basis.
c. reflect the excess of the number of shares assumed issued over the number of shares
assumed reacquired as the potential dilution of earnings per share.
d. be antidilutive.

50. In applying the treasury stock method to determine the dilutive effect of stock options and
warrants, the proceeds assumed to be received upon exercise of the options and warrants
a. are used to calculate the number of common shares repurchased at the average
market price, when computing diluted earnings per share.
b. are added, net of tax, to the numerator of the calculation for diluted earnings per
share.
c. are disregarded in the computation of earnings per share if the exercise price of the
options and warrants is less than the ending market price of common stock.
d. none of these.

51. When applying the treasury stock method for diluted earnings per share, the market price
of the common stock used for the repurchase is the
a. price at the end of the year.
b. average market price.
c. price at the beginning of the year.
d. none of these.
Dilutive Securities and Earnings per Share 16 - 13

52. Antidilutive securities


a. should be included in the computation of diluted earnings per share but not basic
earnings per share.
b. are those whose inclusion in earnings per share computations would cause basic
earnings per share to exceed diluted earnings per share.
c. include stock options and warrants whose exercise price is less than the average
market price of common stock.
d. should be ignored in all earnings per share calculations.

*53. Assume there are two dilutive convertible securities. The one that should be used first to
recalculate earnings per share is the security with the
a. greater earnings adjustment.
b. greater earnings adjustment per share adjustment.
c. smaller earnings adjustment.
d. smaller earnings adjustment per share adjustment.

MULTIPLE CHOICEEarnings Per ShareComputational


54. Jett Corp. had 600,000 shares of common stock outstanding on January 1, issued
900,000 shares on July 1, and had income applicable to common stock of $1,260,000 for
the year ending December 31, 2004. Earnings per share of common stock for 2004 would
be
a. $2.10.
b. $1.00.
c. $1.20.
d. $1.40.

55. At December 31, 2004, Marshall Company had 500,000 shares of common stock issued
and outstanding, 400,000 of which had been issued and outstanding throughout the year
and 100,000 of which were issued on October 1, 2004. Net income for the year ended
December 31, 2004, was $765,000. What should be Marshall's 2004 earnings per
common share, rounded to the nearest penny?
a. $1.53
b. $1.90
c. $1.80
d. $1.70

56. Loeb Co. had 800,000 shares of common stock outstanding on January 1, issued 112,000
shares on May 1, purchased 56,000 shares of treasury stock on September 1, and issued
48,000 shares on November 1. The weighted average shares outstanding for the year is
a. 845,333.
b. 864,000.
c. 882,667.
d. 901,333.
16 - 14 Test Bank for Intermediate Accounting, Eleventh Edition

57. On January 2, 2004, Tyler Co. issued at par $10,000 of 6% bonds convertible in total into
1,000 shares of Tyler's common stock. No bonds were converted during 2004. Throughout
2004, Tyler had 2,000 shares of common stock outstanding. Tyler's 2004 net income was
$6,000, and its income tax rate is 30%. No potentially dilutive securities other than the
convertible bonds were outstanding during 2004. Tyler's diluted earnings per share for
2004 would be (rounded to the nearest penny)
a. $2.00.
b. $2.14.
c. $2.20.
d. $3.21.

58. At December 31, 2003, Olsen Company had 600,000 shares of common stock
outstanding. On October 1, 2004, an additional 120,000 shares of common stock were
issued. In addition, Olsen had $5,000,000 of 6% convertible bonds outstanding at
December 31, 2003, which are convertible into 270,000 shares of common stock. No
bonds were converted into common stock in 2004. The net income for the year ended
December 31, 2004, was $1,500,000. Assuming the income tax rate was 30%, the diluted
earnings per share for the year ended December 31, 2004, should be (rounded to the
nearest penny)
a. $2.72.
b. $2.00.
c. $1.90.
d. $1.67.

59. On January 2, 2004, Carr Co. issued at par $450,000 of 9% convertible bonds. Each
$1,000 bond is convertible into 30 shares. No bonds were converted during 2004. Carr
had 50,000 shares of common stock outstanding during 2004. Carr's 2004 net income
was $240,000 and the income tax rate was 30%. Carr's diluted earnings per share for
2004 would be (rounded to the nearest penny)
a. $4.06.
b. $4.55.
c. $4.80.
d. $5.37.

60. At December 31, 2003, Lowen Co. had 800,000 shares of common stock outstanding. In
addition, Lowen had 300,000 shares of preferred stock which were convertible into
500,000 shares of common stock. During 2004, Lowen paid $600,000 cash dividends on
the common stock and $400,000 cash dividends on the preferred stock. Net income for
2004 was $3,400,000 and the income tax rate was 40%. The diluted earnings per share
for 2004 is (rounded to the nearest penny)
a. $1.86.
b. $2.62.
c. $3.76.
d. $4.26.
Use the following information for questions 61 and 62.

Fairly Co. had 200,000 shares of common stock, 20,000 shares of convertible preferred stock,
and $1,000,000 of 10% convertible bonds outstanding during 2004. The preferred stock is
convertible into 40,000 shares of common stock. During 2004, Fairly paid dividends of $1.20 per
share on the common stock and $4.00 per share on the preferred stock. Each $1,000 bond is
convertible into 45 shares of common stock. The net income for 2004 was $800,000 and the
income tax rate was 30%.
Dilutive Securities and Earnings per Share 16 - 15

61. Basic earnings per share for 2004 is (rounded to the nearest penny)
a. $2.94.
b. $3.22.
c. $3.35.
d. $3.60.

62. Diluted earnings per share for 2004 is (rounded to the nearest penny)
a. $2.77.
b. $2.81.
c. $3.05.
d. $3.33.

63. Young, Incorporated, has 4,000,000 shares of common stock outstanding on December
31, 2003. An additional 1,000,000 shares of common stock were issued on April 1, 2004,
and 500,000 more on July 1, 2004. On October 1, 2004, Young issued 25,000, $1,000
face value, 8% convertible bonds. Each bond is convertible into 20 shares of common
stock. No bonds were converted into common stock in 2004. What is the number of
shares to be used in computing basic earnings per share and diluted earnings per share,
respectively?
a. 5,000,000 and 5,000,000
b. 5,000,000 and 5,125,000
c. 5,000,000 and 5,500,000
d. 5,500,000 and 6,500,000

64. Keene Co. has 2,000,000 shares of common stock outstanding on December 31, 2003.
An additional 100,000 shares are issued on April 1, 2004, and 240,000 more on
September 1. On October 1, Keene issued $3,000,000 of 9% convertible bonds. Each
$1,000 bond is convertible into 40 shares of common stock. No bonds have been
converted. The number of shares to be used in computing basic earnings per share and
diluted earnings per share on December 31, 2004 is
a. 2,155,000 and 2,155,000.
b. 2,155,000 and 2,185,000.
c. 2,155,000 and 2,275,000.
d. 2,540,000 and 2,660,000.
16 - 16 Test Bank for Intermediate Accounting, Eleventh Edition

65. At December 31, 2003, Stine Company had 2,000,000 shares of common stock
outstanding. On January 1, 2004, Stine issued 500,000 shares of preferred stock which
were convertible into 1,000,000 shares of common stock. During 2004, Stine declared and
paid $1,800,000 cash dividends on the common stock and $600,000 cash dividends on
the preferred stock. Net income for the year ended December 31, 2004, was $6,000,000.
Assuming an income tax rate of 30%, what should be diluted earnings per share for the
year ended December 31, 2004? (Round to the nearest penny.)
a. $1.80
b. $2.00
c. $3.00
d. $2.80

66. Dryer Company had 300,000 shares of common stock issued and outstanding at
December 31, 2003. During 2004, no additional common stock was issued. On January 1,
2004, Dryer issued 400,000 shares of nonconvertible preferred stock. During 2004, Dryer
declared and paid $240,000 cash dividends on the common stock and $200,000 on the
nonconvertible preferred stock. Net income for the year ended December 31, 2004, was
$1,280,000. What should be Dryer's 2004 earnings per common share, rounded to the
nearest penny?
a. $1.55
b. $2.80
c. $3.60
d. $4.26

67. At December 31, 2003, Bacon Company had 1,200,000 shares of common stock
outstanding. On September 1, 2004, an additional 400,000 shares of common stock were
issued. In addition, Bacon had $10,000,000 of 6% convertible bonds outstanding at
December 31, 2003, which are convertible into 800,000 shares of common stock. No
bonds were converted into common stock in 2004. The net income for the year ended
December 31, 2004, was $3,750,000. Assuming the income tax rate was 30%, what
should be the diluted earnings per share for the year ended December 31, 2004, rounded
to the nearest penny?
a. $1.76
b. $2.81
c. $1.95
d. $2.04

68. Gregg Company has 3,000,000 shares of common stock outstanding on December 31,
2003. An additional 250,000 shares of common stock were issued on July 1, 2004, and
500,000 more on October 1, 2004. On April 1, 2004, Gregg issued 10,000, $1,000 face
value, 8% convertible bonds. Each bond is convertible into 40 shares of common stock.
No bonds were converted into common stock in 2004. What is the number of shares to be
used in computing basic earnings per share and diluted earnings per share, respectively,
for the year ended December 31, 2004?
a. 3,250,000 and 3,550,000
b. 3,250,000 and 3,250,000
c. 3,250,000 and 3,650,000
d. 3,750,000 and 4,050,000
Dilutive Securities and Earnings per Share 16 - 17

Use the following information for questions 69 and 70.

Information concerning the capital structure of Regan Corporation is as follows:


December 31,
2004 2003
Common stock 150,000 shares 150,000 shares
Convertible preferred stock 15,000 shares 15,000 shares
9% convertible bonds $3,000,000 $3,000,000

During 2004, Regan paid dividends of $1.00 per share on its common stock and $2.50 per share
on its preferred stock. The preferred stock is convertible into 30,000 shares of common stock.
The 9% convertible bonds are convertible into 75,000 shares of common stock. The net income
for the year ended December 31, 2004, was $500,000. Assume that the income tax rate was
30%.

69. What should be the basic earnings per share for the year ended December 31, 2004,
rounded to the nearest penny?
a. $2.22
b. $2.43
c. $3.17
d. $3.33

70. What should be the diluted earnings per share for the year ended December 31, 2004,
rounded to the nearest penny?
a. $2.67
b. $2.45
c. $2.36
d. $1.96

71. Warrants exercisable at $20 each to obtain 70,000 shares of common stock were
outstanding during a period when the average market price of the common stock was $25.
Application of the treasury stock method for the assumed exercise of these warrants in
computing diluted earnings per share will increase the weighted average number of
outstanding shares by
a. 70,000.
b. 56,000.
c. 14,000.
d. 17,500.

72. Edson Corporation had 400,000 shares of common stock outstanding at December 31,
2004. In addition, it had 120,000 stock options outstanding, which had been granted to
certain executives, and which gave them the right to purchase shares of Edson's stock at
an option price of $37 per share. The average market price of Edson's common stock for
2004 was $50. What is the number of shares that should be used in computing diluted
earnings per share for the year ended December 31, 2004?
a. 400,000
b. 442,163
c. 488,800
d. 431,200
16 - 18 Test Bank for Intermediate Accounting, Eleventh Edition

MULTIPLE CHOICEEarnings Per ShareCPA Adapted


73. Dolan, Inc., had 700,000 shares of common stock issued and outstanding at December
31, 2003. On July 1, 2004, an additional 50,000 shares of common stock were issued for
cash. Dolan also had unexercised stock options to purchase 40,000 shares of common
stock at $15 per share outstanding at the beginning and end of 2004. The average market
price of Dolan's common stock was $20 during 2004. What is the number of shares that
should be used in computing diluted earnings per share for the year ended December 31,
2004?
a. 725,000
b. 735.000
c. 760,000
d. 765,000

74. Reese Co. had 300,000 shares of common stock issued and outstanding at December 31,
2003. No common stock was issued during 2004. On January 1, 2004, Reese issued
200,000 shares of nonconvertible preferred stock. During 2004, Reese declared and paid
$125,000 cash dividends on the common stock and $100,000 on the preferred stock. Net
income for the year ended December 31, 2004 was $775,000. What should be Reese's
2004 earnings per common share?
a. $2.59
b. $2.25
c. $2.16
d. $1.84

75. At December 31, 2004 and 2003, Glass Corp. had 120,000 shares of common stock and
10,000 shares of 5%, $100 par value cumulative preferred stock outstanding. No
dividends were declared on either the preferred or common stock in 2004 or 2003. Net
income for 2004 was $400,000. For 2004, earnings per common share amounted to
a. $3.33.
b. $2.92.
c. $2.50.
d. $1.67.

76. Quinn Co. had 2,400,000 shares of common stock outstanding on January 1 and
December 31, 2004. In connection with the acquisition of a subsidiary company in June
2003, Quinn is required to issue 100,000 additional shares of its common stock on July 1,
2005, to the former owners of the subsidiary. Quinn paid $300,000 in preferred stock
dividends in 2004, and reported net income of $5,100,000 for the year. Quinn's diluted
earnings per share for 2004 should be
a. $2.13.
b. $2.04.
c. $2.00.
d. $1.92.
77. When computing diluted earnings per share, convertible securities are
a. ignored.
b. recognized only if they are dilutive.
c. recognized only if they are antidilutive.
d. recognized whether they are dilutive or antidilutive.
Dilutive Securities and Earnings per Share 16 - 19

78. In determining diluted earnings per share, dividends on nonconvertible cumulative


preferred stock should be
a. disregarded.
b. added back to net income whether declared or not.
c. deducted from net income only if declared.
d. deducted from net income whether declared or not.

79. The if-converted method of computing earnings per share data assumes conversion of
convertible securities as of the
a. beginning of the earliest period reported (or at time of issuance, if later).
b. beginning of the earliest period reported (regardless of time of issuance).
c. middle of the earliest period reported (regardless of time of issuance).
d. ending of the earliest period reported (regardless of time of issuance).
16 - 20 Test Bank for Intermediate Accounting, Eleventh Edition

PROBLEMS

Pr. 16-89Convertible bonds and stock warrants.


For each of the unrelated transactions described below, present the entry(ies) required to record
the bond transactions.
1. On August 1, 2004, Ryan Corporation called its 10% convertible bonds for conversion. The
$6,000,000 par bonds were converted into 240,000 shares of $20 par common stock. On
August 1, there was $525,000 of unamortized premium applicable to the bonds. The fair
market value of the common stock was $20 per share. Ignore all interest payments.
2. Garnett, Inc. decides to issue convertible bonds instead of common stock. The company
issues 10% convertible bonds, par $2,000,000, at 97. The investment banker indicates that if
the bonds had not been convertible they would have sold at 94.
3. Gomez Company issues $3,000,000 of bonds with a coupon rate of 8%. To help the sale,
detachable stock warrants are issued at the rate of ten warrants for each $1,000 bond sold. It
is estimated that the value of the bonds without the warrants is $2,961,000 and the value of
the warrants is $189,000. The bonds with the warrants sold at 101.
Dilutive Securities and Earnings per Share 16 - 21

Pr. 16-90Earnings per share.


Birney Corp. had $900,000 net income in 2004. On January 1, 2004 there were 220,000 shares
of common stock outstanding. On April 1, 20,000 shares were issued and on September 1, Birney
bought 30,000 shares of treasury stock. There are 30,000 options to buy common stock at $40 a
share outstanding. The market price of the common stock averaged $50 during 2004. The tax
rate is 40%.

During 2004, there were 20,000 shares of convertible preferred stock outstanding. The preferred
is $100 par, pays $7 a year dividend, and is convertible into three shares of common stock.

Birney issued $2,000,000 of 8% convertible bonds at face value during 2003. Each $1,000 bond
is convertible into 20 shares of common stock.

Instructions
Compute diluted earnings per share for 2004. Complete the schedule and show all computations.

Net Adjust- Adjusted Adjust- Adjusted


Security Income ment Net Income Shares ment Shares EPS
16 - 22 Test Bank for Intermediate Accounting, Eleventh Edition

Pr. 16-91Basic and diluted EPS.


Assume that the following data relative to Eddy Company for 2004 is available:
Net Income $1,400,000

Transactions in Common Shares Change Cumulative


Jan. 1, 2004, Beginning number 500,000
Mar. 1, 2004, Purchase of treasury shares (60,000) 440,000
June 1, 2004, Stock split 2-1 440,000 880,000
Nov. 1, 2004, Issuance of shares 120,000 1,000,000
8% Cumulative Convertible Preferred Stock
Sold at par, convertible into 200,000 shares of common
(adjusted for split). $1,000,000
Stock Options
Exercisable at the option price of $25 per share. Average
market price in 2004, $30 (market price and option price
adjusted for split). 60,000 shares

Instructions
(a) Compute the basic earnings per share for 2004. (Round to the nearest penny.)
(b) Compute the diluted earnings per share for 2004. (Round to the nearest penny.)

Pr. 16-92Basic and diluted EPS.


Presented below is information related to Alley Company.

1. Net Income [including an extraordinary gain (net of tax) of $130,000] $420,000

2. Capital Structure
a. Cumulative 8% preferred stock, $100 par,
6,000 shares issued and outstanding $600,000

b. $10 par common stock, 84,000 shares outstanding on January 1.


On April 1, 40,000 shares were issued for cash. On October 1,
16,000 shares were purchased and retired. $1,000,000

c. On January 2 of the current year, Alley purchased Raye Corporation.


One of the terms of the purchase was that if Alley's net income for the
following year is $400,000 or more, 50,000 additional shares would
be issued to Raye stockholders next year.

3. Other Information
a. Average market price per share of common stock during entire year $30
b. Income tax rate 30%

Instructions
Compute earnings per share for the current year.
Dilutive Securities and Earnings per Share 16 - 23

Pr. 16-93Basic and diluted EPS.


The following information was taken from the books and records of Simonic, Inc.:

1. Net income $ 840,000

2. Capital structure:
a. Convertible 6% bonds. Each of the 300, $1,000 bonds is convertible
into 50 shares of common stock at the present date and for the next
10 years. 300,000

b. $10 par common stock, 400,000 shares issued and outstanding


during the entire year. 4,000,000

c. Stock warrants outstanding to buy 16,000 shares of common stock


at $20 per share.

3. Other information:
a. Bonds converted during the year None
b. Income tax rate 30%
c. Convertible debt was outstanding the entire year
d. Average market price per share of common stock during the year $32
e. Warrants were outstanding the entire year
f. Warrants exercised during the year None

Instructions
Compute basic and diluted earnings per share.