PROBLEM 16-1 (Continued)
Calculations:
Common Stock
Paid-in Capital
in Excess of Par
At beginning of year …………………..
300,000 shares
$ 600,000
From stock rights (entry #3) ……….
From stock warrants (entry #4) …..
Total …………………………………..
320,100 shares
$1,123,800
PROBLEM 16-2
(a) Entries at August 1, 2013
Bonds Payable ………………………………………………… 250,000
Discount on Bonds Payable (Schedule 1) …… 4,815*
Common Stock (8 X 250 X $100) ………………… 200,000
*($54,000 X 1/10) X (107/120)
**($250,000 – $4,815) – $200,000
Interest Payable ………………………………………………. 2,500
Cash ($250,000 X 12% X 1/12) ……………………. 2,500
(To record payment in cash of interest
accrued on bonds converted as of
August 1, 2013)
*($54,000 X 90%) X (1/120)
Interest Expense ……………………………………………… 22,500
Interest Payable ($2,250,000 X 12% X 1/12) … 22,500
(To record accrual of interest for August
on $2,250,000 of bonds at 12%)
PROBLEM 16-2 (Continued)
Schedule 1
Monthly Amortization Schedule
Unamortized discount on bonds payable:
Amount to be amortized over 120 months ………………………………. $54,000
Amount of monthly amortization ($54,000 ÷ 120) …………………….. $ 450
Schedule 2
Interest Expense Schedule
Amortization of bond discount charged to bond interest expense in 2013 would
be as follows:
7 months X $450 …………………………. $3,150
5 months X $405 …………………………. 2,025
Total ……………………………………. $5,175
Interest on Bonds:
12% on $2,500,000 …………………………………………………………………. $300,000
PROBLEM 16-3
2011 No journal entry would be recorded at the time the stock option plan
was adopted. However, a memorandum entry in the journal might be
made on November 30, 2011, indicating that a stock option plan had
authorized the future granting to officers of options to buy 70,000
shares of $5 par value common stock at $9 a share.
2013 December 31
Compensation Expense …………………………….. 80,000
Paid-in Capital—Stock Options …………… 80,000
(To record compensation expense
attributable to 2013—20,000
options at $4)
2014 December 31
Cash (20,000 X $9) …………………………..………… 180,000
Paid-in Capital—Stock Options
PROBLEM 16-4
(a) 1/1/12 No entry
12/31/12 Compensation Expense ($6 X 5,000 ÷ 5) …… 6,000
Paid-in Capital—Stock Options ………… 6,000
(c) No change for part (a), unless the fair value of the options change.
For part (b):
1/10/12 Unearned Compensation ($45 X 700) ……….. 31,500
Common Stock ($1 X 700) ………………… 700
Paid in Capital in Excess of Par—
Common Stock …………………………….. 30,800
PROBLEM 16-5
The computation of Fitzgerald Pharmaceutical Industries’ basic earnings per
share and the diluted earnings per share for the fiscal year ended June 30,
2012, are shown below.
=
$1.425 or $1.43 per share
1Preferred dividend = .06 X $1,250,000
= $75,000
=
2Use “if converted” method for 8% bonds
Adjustment for interest expense (net of tax)
($5,000,000 X .08 X .6) ……………………………………… $240,000
3Shares assumed to be issued if converted
$5,000,000 ÷ $1,000/bond X 50 shares …………………… 250,000
PROBLEM 16-5 (Continued)
4Use treasury stock method to determine incremental
shares outstanding
Proceeds from exercise of options
(200,000 X $15) …………………………………………………. $3,000,000
PROBLEM 16-6
(a) Melton Corporation has a simple capital structure since it does not have
any potentially dilutive securities.
(c) MELTON CORPORATION
Comparative Income Statement
For Fiscal Years Ended May 31, 2012 and 2013
2012
2013
Income from operations ……………………………………
$1,800,000
$2,500,000
Interest expense1 ……………………………………………..
240,000
240,000
Income before taxes …………………………………………
1,560,000
2,260,000
Income taxes at 40% …………………………………………
624,000
904,000
Income before extraordinary item ………………………
Net income ……………………………………………………….
$ 936,000
$ 996,000
Earnings per share:
Income before extraordinary loss ……………….
Extraordinary loss ……………………………………..
Net income ………………………………………………..
PROBLEM 16-6 (Continued)
*Preferred dividends = (No. of Shares X Par Value X Dividend %)
= (20,000 X $50 X .06)
= $60,000 per year
3Earnings per share
=
($1,356,000 – $60,000)
2,200,000
=
$0.59 per share
4Earnings per share
=
=
5Earnings per share
=
Net Income – Preferred Dividends
Weighted-Average Common Shares
=
$996,000 – $60,000
2,200,000
=
$0.43
PROBLEM 16-7
(a) The number of shares used to compute basic earnings per share is
4,951,000, as calculated below.
Event
Dates
Outstanding
Shares
Outstanding
Restatement
Fraction
of Year
Weighted
Shares
Issued shares for
building
Total number of common shares to compute basic earnings per share
4,951,000
(b) The number of shares used to compute diluted earnings per share is
5,791,000, as shown below.
Number of shares to compute
basic earnings per share …………………………... 4,951,000
Convertible preferred stock—
still outstanding (300,000 X 2 X 1.05) …………. 630,000
Convertible preferred stock—
PROBLEM 16-8
=
$1.60 per share
*$6,000,000 ÷ $10
(Net income – Preferred dividends) +
=
$1.56 per share
aPreferred stock is not assumed converted since conversion would be
antidilutive. That is, conversion of the preferred stock increases the
numerator $240,000 ($4,000,000 X .06) and the denominator 120,000 shares
[(4,000,000 ÷ 100) X 3]
b$2,000,000 X .08 X (1 – .40)
PROBLEM 16-9
(a)
Weighted-Average Shares
Before Stock
Dividend
After Stock
Dividend
Total as of June 1, 2011
1,000,000
1,200,000
Issue of September 1, 2011
400,000
480,000
Total as of May 31, 2013
1,400,000
1,680,000
Total
1,560,000
1,680,000
(b) AGASSI CORPORATION
Comparative Income Statement
For the Years Ended May 31, 2013 and 2012
2013
2012
Income from operations before income taxes …..
$1,400,000
$660,000
Income taxes ………………………………………………….
560,000
264,000
Income before extraordinary item ……………………
840,000
396,000
Net income …………………………………………………….
$ 600,000
$396,000
Per share of common stock
Income before extraordinary item …………………
Extraordinary loss, net of tax ……………………….
Net income …………………………………………………….
PROBLEM 16-9 (Continued)
EPS calculations =
Net income – Preferred dividends
Weighted-average common shares
Preferred dividends = 40,000 X $100 X .06 = $240,000
(c) 1. A corporation’s capital structure is regarded as simple if it consists
only of common stock or includes no potentially dilutive securities.
Agassi Corporation has a simple capital structure because it has not
issued any convertible securities, warrants, or stock options, and
there are no existing rights or securities that are potentially dilutive of
its earnings per common share.
TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 16-1 (Time 20–25 minutes)
Purpose—to provide the student with an understanding of the underlying rationale behind the accounting
treatments for the issuance of convertible bonds versus the situation when the debt instrument and the
warrants are separable. The student is required to describe the differences that exist in accounting for the
original proceeds of these two types of issuances, and the arguments which have been presented in
support of these differences. This case also requires the interpretation of a situation involving an issuance
of long-term notes and warrants, and the preparation of the necessary journal entry.
CA 16-2 (Time 15–20 minutes)
Purpose—to provide the student with an opportunity to discuss the ethical issues related to an earnings–based
compensation plan.
CA 16-3 (Time 15–20 minutes)
Purpose—to provide the student with an understanding of the proper accounting and conceptual merits for
the issuance of stock warrants to three different groups: existing stockholders, key employees, and
purchasers of the company’s bonds. This problem requires the student to explain and discuss the reasons
for using warrants, the significance of the price at which the warrants are issued (or granted) in relation to
the current market price of the company’s stock, and the necessary information that should be disclosed in
the financial statements when stock warrants are outstanding for each of the groups.
CA 16-4 (Time 25–35 minutes)
Purpose—to provide the student with an opportunity to respond to a contrary view of the FASB’s standard
on “Accounting for Stock–Based Compensation,” and to defend the concept of neutrality in financial
accounting and reporting.
CA 16-5 (Time 25–35 minutes)
Purpose—to provide the student with an understanding of how earnings per share is affected by preferred
dividends and convertible debt. The student is required to explain how preferred dividends and convertible
debt are handled for EPS computations. The student is also required to explain when the “treasury stock
method” is applicable in EPS computations.
CA 16-6 (Time 25–35 minutes)
Purpose—to provide the student with some familiarity with the applications dealing with earnings per share.
The student is required to explain the general concepts of EPS in regard to a specific capitalization
structure, and to discuss the proper treatment, if any, that should be given to a list of items in computing
earnings per share of common stock for financial statement reporting.
CA 16-7 (Time 25–35 minutes)
Purpose—to provide the student with an opportunity to articulate the concepts and procedures related to
antidilution. Responses are provided in a written memorandum.
SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 16-1
(a) (1) When the debt instrument and the option to acquire common stock are inseparable, as in the
case of convertible bonds, the entire proceeds of the bond issue should be allocated to the debt
and the related premium or discount accounts.
(2) In the case of convertible debt there are two principal reasons why all the proceeds should be
ascribed to the debt. First, the option is inseparable from the debt. The investor in such
securities has two mutually exclusive choices: be a creditor and later receive cash for the
(3) Arguments have been advanced that accounting for convertible debt should be the same as for
debt issued with detachable stock purchase warrants. Convertible debt has features of debt and
stockholders’ equity, and separate recognition should be given to those characteristics at the
time of issuance. Difficulties encountered in separating the relative values of the features are
not insurmountable and, in any case, should not result in a solution which ignores the problem.
CA 16-2
(a) Devers recognizes that altering the estimate will benefit Adkins and other executive officers of the
company. Current stockholders and investors will be forced to pay out the bonuses, with the altered
estimate as a critical factor.
CA 16-3
(a) 1. The objective of issuing warrants to existing stockholders on a pro-rata basis is to raise new
equity capital. This method of raising equity capital may be used because of preemptive rights
on the part of a company’s stockholders and also because it is likely to be less expensive than
a public offering.
2. The purpose of issuing stock warrants to certain key employees, usually in the form of a non-
qualified stock option plan, is to increase their interest in the long-term growth and income of
3. Warrants to purchase shares of its common stock may be issued to purchasers of a company’s
bonds in order to stimulate the sale of the bonds by increasing their speculative appeal and
aiding in overcoming the objection that rising price levels cause money invested for long
2. Warrants may be offered to key employees below, at, or above the market price of the stock on
the day the rights are granted except for incentive stock-option plans. If a stock-option plan is to
provide a strong incentive, warrants that can be exercised shortly after they are granted and
expire, say, within two or three years, usually must be exercisable at or near the market price at
the date of the grant. Warrants that cannot be exercised for a number of years after they are
granted or those that do not lapse for a number of years after they become exercisable may,
however, be priced somewhat above the market price of the stock at the date of the grant
without eliminating the incentive feature. This does not upset the principal objective of stock
option plans, heightening the interest of key employees in the long-term success of the
company.
3. Income tax laws impose no restrictions on the exercise price of warrants issued to purchasers
of a company’s bonds. The exercise price may be above, equal to, or below the current market
CA 16-3 (Continued)
(c) 1. Financial statement information concerning outstanding stock warrants issued to a company’s
2. Financial statement information concerning stock warrants issued to key employees should
include the following: status of these plans at the end of each period presented, including the
3. Financial statement disclosure of outstanding stock warrants that have been issued to
CA 16-4
(a) In 2004, FASB issued an accounting standard related to stock compensation plans.
Generally, the rule indicates that employee stock options be treated like all other types of compensa-
tion and that their value be included in financial statements as part of the costs of employee services.
The rule requires that all types of stock options be recognized as compensation based on the fair
of the issue and therefore delay the implementation of the new standard. From a comparability
standpoint, it is highly unlikely that recording expense on only some options would result in useful
information. It will be difficult to compare compensation costs (and income) for companies—some
that use stock options extensively and some that pay their employees with cash.
(c) Here is an excerpt from a presentation given by Dennis Beresford on the concept of neutrality, which
CA 16-4 (Continued)
There is a common element in those assertions. The goals are desirable but the means require that
the Board abandon neutrality and establish reporting standards that conceal the financial impact of
certain transactions from those who use financial statements. Costs of transactions exist whether or
not the FASB mandates their recognition in financial statements. For example, not requiring the
than promote it. Stated simply, truth in accounting is always good policy.
Neutrality does not mean that accounting should not influence human behavior. We expect that
changes in financial reporting will have economic consequences, just as economic consequences
are inherent in existing financial reporting practices. Changes in behavior naturally follow from more
complete and representationally faithful financial statements. The fundamental question, however, is
whether those who measure and report on economic events should somehow screen the information
before reporting it to achieve some objective. In FASB Concepts Statement No. 2, Qualitative
Characteristics of Accounting Information (paragraph 102), the Board observed:
CA 16-5
(a) Dividends on outstanding preferred stock must be subtracted from net income or added to net loss for
the period before computing EPS on the common shares. This generalization will be modified by the
various features and different requirements preferred stock may have with respect to dividends. Thus, if
CA 16-5 (Continued)
(b) When options and warrants to buy common stock are outstanding and their exercise price (i.e.,
proceeds the corporation would derive from issuance of common stock pursuant to the warrants
and options) is less than the average price at which the company could acquire its outstanding
CA 16-6
(a) Earnings per share, as it applies to a corporation with a capitalization structure composed of only one
class of common stock, is the amount of earnings applicable to each share of common stock
(1) Outstanding preferred stock with a par value liquidation right issued at a premium, although
affecting the determination of book value per share, will not affect the computation of earnings
per share for common stock except with respect to the dividends as discussed in 4. below.
(2) The exercise of a common stock option results in an increase in the number of shares
outstanding, and the computation of earnings per share should be based on the weighted–
average number of shares outstanding during the period. The exercise of a stock option by the
grantee does not affect earnings, but any compensation to the officers from the granting of the
options would reduce net income and earnings per share.
CA 16-6 (Continued)
(6) When the number of common shares outstanding increases as a result of a 2-for-1 stock split
(7) The existence of a provision for a contingent liability on a possible lawsuit created out of
CA 16-7
Dear Mr. Dolan:
I hope that the following brief explanation helps you understand why your warrants were not included in
Rhode’s earnings per share calculations.
In order not to mislead users of financial information, the accounting profession insists that EPS calculations
be conservative. Thus, a security which might dilute EPS must be figured into EPS calculations as though
it had been converted into common stock. Basic EPS assumes a weighted-average of common stock
outstanding while diluted EPS assumes that any potentially dilutive security has been converted.
Some securities, however, might actually inflate the EPS figure rather than dilute it. These securities are
considered antidilutive and are excluded from the EPS computation. Take, for example, your warrants. The
computations below provide a good example of how options and warrants are treated in diluted EPS. In
these computations, we assume that Rhode will purchase treasury stock using the proceeds from the