Financial Accounting: Liabilities & Equities (FA3) Exam Review

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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc. Part 10: Module 9 –Earnings per share Blueprint: 6-9% a. At December 31, 2003, Bob Co. has share options outstanding that permit the holders to acquire a total of 100,000 common shares at a price of $20 per share. The options can be exercised at any time between January 1, 2005 and December 31, 2008, at which latter time they expire. The average common share price during 2003 was $30, and the yearend price was $25. Because of the options, how would the denominator of the diluted EPS change in the December 31, 2003 financial statements? 1) No change as the options are not yet exercisable 2) Increase by 20,000 shares 3) Increase by 33,333 shares 4) Increase by 100,000 shares a. 3 100,000 x $20 = $2,000,000; $2,000,000 / $30 = 66,667; 100,000 issue – 66,667 retired = 33,333 net increase Question 4 (13 marks) Below is information from the December 31, 2006 balance sheet for NG Co. Bonds payable — $500,000 par value, 7%, maturing December 31, 2015, each $1,000 bond is convertible into 30 common shares at the holder’s option (net) $ 450,000 Preferred shares — $2, no par value, cumulative, convertible at 1 preferred share for 2 common shares - 14,000 shares outstanding 210,000 Contributed capital — common share options outstanding 70,000 Common stock conversion rights — 7% bonds 30,000 Common shares — no-par value, 320,000 shares outstanding 800,000 Additional information 1. There are no dividends in arrears at the beginning of the year. No dividends have been declared for 2006. 2. Net income for 2006 is $1,263,000; includes $38,000 interest expense for the 7% bonds. 3. Income tax rate is 40%. 4. Bonds, options, and preferred shares were outstanding for the entire year. 5. The stock options are noncompensatory and are convertible into a total of 80,000 common shares at an exercise price of $32.30. The average share price during the year was $34. 6. No other common share transactions occurred during the year. Required 10 a. Calculate basic and diluted earnings per share (EPS) for the year ended December 31, 2006. 3 b. Assume that one-half of the stock options were exercised on January 1, 2007. Prepare the journal entry(ies) to record the exercise of stock options. 22
FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc. 10 a. Basic EPS Basic EPS Net income $ 1,263,000 (1) Preferred dividends (14,000 × 2) (28,000) Net income available to common shareholders $ 1,235,000 (1) Weighted average common shares outstanding 320,000 $3.86 (3) Individual calculations: Net Income Shares EPS 7% Bonds [38,000 × (1 – 0.4)] $ 22,800 (500,000 / 1,000 × 30) 15,000 1.52 Preferred shares 28,000 (14,000 × 2) 28,000 1.00 Options: Cash = (80,000 × $32.30) = $2,584,000/$34 = 76,000 buy back. 80,000 issue – 76,000 retired = 4,000 net increase in new shares. Diluted EPS Basic $ 1,235,000 320,000 $ 3.86 Options (1.5) Shares issued 4,000 (1/2) 1,235,000 324,000 3.81 (1) Preferred shares 28,000 28,000 (1/2) 1,263,000 352,000 3.59 (1) Bonds 22,800 15,000 (1/2) Diluted EPS $ 1,285,800 367,000 $ 3.50 Note: 1.5 marks for determining order of dilution 3 b. (1) Cash (80,000 × 1/2 × 32.30)..................................................1,292,000 (1) Contributed capital — Options (70,000 × 1/2)...........................35,000 (1) Common shares ..................................................................... 1,327,000 23
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Financial Accounting: Liabilities & Equities (FA3) Exam Review

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