CHAPTER 16

Dilutive Securities and Earnings Per Share

OPTIONAL ASSIGNMENT CHARACTERISTICS TABLE

Item Description
BE16-4 Issuance of bonds with warrants.
BE16-8 Accounting for restricted stock.
BE16-12 EPS with convertible bonds.
BE16-13 EPS with convertible preferred stock.
BE16-14 EPS with stock options.

E16-1 Issuance & conversion of bonds.

E16-4 Conversion of bonds.
E16-5 Conversion of bonds (assume reversing JE NOT made).
E16-7 Issuance of bonds with warrants.
E16-8 Issuance of bonds with detachable warrants.
E16-10 Issuance and exercise of stock options.
E16-11 Issuance, exercise, and termination of stock options.
E16-14 Accounting for restricted stock.
E16-17 EPS: Simple capital structure.
E16-18 EPS: Simple capital structure.
E16-21 EPS: Simple capital structure.
E16-22 EPS with convertible bonds (a. only).
E16-24 EPS with convertible bonds and preferred stock.
E16-28 EPS with stock warrants.

P16-3 Stock option plan.

P16-6 Basic EPS: Two-year income statement presentation.
P16-8 EPS with complex capital structure.
 CH 16 Optional Homework, P ag e |1

BRIEF EXERCISE 16-4

Cash ($2,000,000 x 1.01) ................................................................................. 2,020,000

Discount on Bonds Payable ($2,000,000 – $1,940,784) ................................... 59,216
Bonds Payable (2,000 x $1,000) ............................................................. 2,000,000
Paid-in Capital—Stock Warrants ............................................................. 79,216

FV of bonds ($2,000,000 X .98) = $1,960,000 + FV of warrants (2,000 X $40) = $80,000 = Total $2,040,000

Allocated to bonds (1,960/2,040 X $2,020,000) ................................................ $1,940,784

Allocated to warrants (80/2,040 X $2,020,000).................................................. 79,216

BRIEF EXERCISE 16-8

1/1/12 Unearned Compensation .............................................................. 75,000

Common Stock ................................................................... 10,000
Paid-in Capital in Excess of Par--Common ....................... 65,000

12/31/12 Compensation Expense ($75,000 / 3)........................................... 25,000

Unearned Compensation ................................................... 25,000

BRIEF EXERCISE 16-12

Basic EPS = $300,000 / 100,000 shares = $3.00

If-converted impact of bonds:

Numerator: [$800,000 x 10% = $80,000 x (1 – .40)] = $48,000; Denominator: 16,000 shares

Diluted EPS = ($300,000 + $48,000) / (100,000 + 16,000) = $3.00

Dilutive? $3.00 = $3.00, bonds are NOT dilutive  report only single EPS of $3.00

BRIEF EXERCISE 16-13

Basic EPS = ($270,000 − $25,000*) / 50,000 shares = $5.40

* preferred dividends (subtract since cumulative) = (5,000 x $5)

If-converted impact of preferred stock: Numerator: $25,000; Denominator: 5,000 x 2 = 10,000 shares

Diluted EPS = ($270,000 − $25,000 + $25,000) / (50,000 + 10,000) = $270,000 / 60,000 shares = $4.50

Dilutive? Yes since $4.50 < $5.40  report both Basic and Diluted EPS

BRIEF EXERCISE 16-14

Options are dilutive since $10 option price < $15 market price

Treasury stock method impact of options:

Numerator: $0
Denominator: shares issued 45,000
shares reacquired (45,000 x $10 = $450,000 / $15) (30,000)
incremental shares outstanding 15,000

Diluted EPS = $300,000 / (200,000 + 15,000) = $300,000 / 215,000 shares = $1.40

 CH 16 Optional Homework, P ag e |2

EXERCISE 16-1

1. Cash ($10,000,000 X .99) .............................................................. 9,900,000

Discount on Bonds Payable ........................................................... 100,000
Bonds Payable ..................................................................... 10,000,000

Unamortized Bond Issue Costs ...................................................... 70,000

Cash ..................................................................................... 70,000

2. Cash ($10,000,000 x .98) .............................................................. 9,800,000

Discount on Bonds Payable ($10,000,000 − $9,400,000*) ............ 600,000
Bonds Payable ..................................................................... 10,000,000
Paid-in Capital—Stock Warrants (100,000 x $4) ................. 400,000

* Amount allocated to bonds = $9,800,000 − $400,000 = $9,400,000

3. Bonds Payable ............................................................................... 10,000,000

Discount on Bonds Payable ................................................. 55,000
Common Stock (1,000,000 x $1) .......................................... 1,000,000
Paid-in Capital in Excess of Par--Common .......................... 8,945,000

Debt Conversion Expense ............................................................. 75,000

Cash ..................................................................................... 75,000

EXERCISE 16-4

(a) Cash ...................................................................................................... 10,600,000

Bonds Payable ............................................................................. 10,000,000
Premium on Bonds Payable ......................................................... 600,000

(b) Bonds Payable ($10,000,000 x 20%) ............................................. 2,000,000

Premium on Bonds Payable ($540,000* x 20%) ........................... 108,000
Common Stock (20,000** x $15) ........................................ 300,000
Paid-in Capital in Excess of Par--Common ......................... 1,808,000

* Total balance of premium on Jan. 1, 2014 = [$600,000 − ($600,000 / 20 x 2 years)] = $540,000

** Number of bonds converted = ($2,000,000 / $1,000) ......................... 2,000 bonds

Number of shares per bond (5 x 2 to adjust for stock split) ................. x 10 shares per bond
Number of shares issued ..................................................................... 20,000

EXERCISE 16-5

Note: monthly S-L amortization of discount = $10,240 / 64 remaining months to maturity = $160 per month

Interest entry (assuming NO reversing entry was made):

Interest Payable ($600,000 x 10% x 6/12 x 2/6) .................................................... 10,000

Interest Expense .................................................................................................... 20,640
Discount on Bonds Payable ($160 X 4) ...................................................... 640
Cash ($600,000 X 10% X 6/12) .................................................................. 30,000

Conversion entry:

Bonds Payable ....................................................................................................... 600,000

Discount on Bonds Payable ($10,240 – $640) ........................................... 9,600
Common Stock (600 x 6 x $25) ................................................................... 90,000
Paid-in Capital in Excess of Par--Common ................................................. 500,400
 CH 16 Optional Homework, P ag e |3

EXERCISE 16-7

(a) Cash .......................................................................................................... 150,000

Discount on Bonds Payable ($175,000 – $127,500) .................................. 47,500
Bonds Payable ................................................................................. 175,000
Paid-in Capital—Stock Warrants ...................................................... 22,500

Total FV = $136,000 bonds + $24,000 warrants = $160,000

Allocated to bonds = [$150,000 x (136 / 160)] = $127,500

Allocated to warrants = [$150,000 x (24 / 160)] = $22,500

(b) No separate recognition is given to the warrants if they are nondetachable. The entry is:

Cash .......................................................................................................... 150,000

Discount on Bonds Payable ........................................................................ 25,000
Bonds Payable ................................................................................. 175,000

EXERCISE 16-8

Cash [($3,000,000 x 1.04) = $3,120,000 + $60,000] .................................... 3,180,000

Bonds Payable (3,000 X $1,000) ....................................................... 3,000,000
Premium on Bonds Payable ($3,102,000* − $3,000,000) ................. 102,000
Paid-in Capital—Stock Warrants [(3,000 x 2 = 6,000 x $3)] .............. 18,000
Interest Expense ($3,000,000 x 8% x 3/12) ....................................... 60,000

* amount allocated to bonds = $3,120,000 − $18,000 allocated to warrants = $3,102,000

Unamortized Bond Issue Costs ................................................................ 30,000

Cash .............................................................................................. 30,000

EXERCISE 16-10

1/2/12 No entry (total FV = $600,000)

12/31/12 Compensation Expense ($600,000 / 2 yrs) ................................ 300,000

Paid-in Capital—Stock Options........................................ 300,000

12/31/13 Compensation Expense .............................................................. 300,000

Paid-in Capital—Stock Options........................................ 300,000

1/3/14 Cash (30,000 X $40) ................................................................... 1,200,000

Paid-in Capital—Stock Options ($600,000 X 30,000/40,000) ..... 450,000
Common Stock (30,000 X $10) ........................................ 300,000
Paid-in Capital in Excess of Par--Common ...................... 1,350,000

5/1/14 Cash (10,000 X $40) ............................................................................ 400,000

Paid-in Capital—Stock Options ($600,000 X 10,000/40,000) .............. 150,000
Common Stock (10,000 x $10) .................................................. 100,000
Paid-in Capital in Excess of Par--Common ............................... 450,000
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EXERCISE 16-11

1/1/12 No entry (total FV = $400,000)

12/31/12 Compensation Expense ($400,000 / 2 years) ...................................... 200,000

Paid-in Capital—Stock Options ............................................ 200,000

4/1/13 Paid-in Capital—Stock Options ............................................................ 30,000

Compensation Expense ($200,000 X 3,000/20,000) ........... 30,000

12/31/13 Compensation Expense ($400,000 X 17,000/20,000 / 2 years) .......... 170,000

Paid-in Capital—Stock Options ........................................... 170,000

3/31/14 Cash (12,000 X $25) ............................................................................ 300,000

Paid-in Capital—Stock Options ($340,000 X 12,000/17,000) .............. 240,000*
Common Stock (12,000 x $10) ............................................. 120,000
Paid-in Capital in Excess of Par--Common .......................... 420,000

* or = ($400,000 x 12,000/20,000)

EXERCISE 16-14

(a) 1/1/12 Unearned Compensation................................................................. 500,000

Common Stock (10,000 x $10) ................................................. 100,000
Paid-in Capital in Excess of Par--Common .............................. 400,000

12/31/13 Compensation Expense ($500,000 / 5) ........................................... 100,000

Unearned Compensation ............................................................ 100,000

(b) 7/25/16 Common Stock ................................................................................ 100,000

Paid-in Capital in Excess of Par—Common .................................... 400,000
Unearned Compensation (balance) ................................ 100,000
Compensation Expense ($100,000 x 4 years) ................ 400,000

EXERCISE 16-17

Earnings per common share (a):

Income before extraordinary item (b) ............................................................................... $1.27
Extraordinary loss (c) ....................................................................................................... (.19)
Net income (d) .................................................................................................................. $1.08

(a) Weighted average number of shares outstanding:

Dates Shares Fraction Weighted
Event Outstanding Outstanding Restatement of Year Shares
Beginning balance Jan. 1–May 1 210,000 4/12 70,000
Issued shares May 1–Oct. 31 218,000 6/12 109,000
Reacquired shares Oct. 31–Dec. 31 204,000 2/12 34,000
Weighted-average number of shares outstanding 213,000

(b) income before extraordinary item = $229,690 + $40,600 extraordinary loss = $270,290
EPS = ($270,290 − $0) / 213,000 shares = $1.27

(c) extraordinary loss EPS = $(40,600) / 213,000 = $(.19)

(d) net income EPS = ($229,690 − $0) / 213,000 = $1.08

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EXERCISE 16-18

Dates Shares Fraction Weighted

Event Outstanding Outstanding Restatement of Year Shares
Beginning balance Jan. 1–May 1 600,000 2 4/12 400,000
Issued shares May 1–Aug. 1 900,000 2 3/12 450,000
Reacquired shares Aug. 1–Oct. 1 750,000 2 2/12 250,000
2-for-1 stock split Oct. 1–Dec. 31 1,500,000 3/12 375,000
Weighted-average number of shares outstanding 1,475,000

Earnings per share = ($2,200,000 − $400,000*) / 1,475,000 shares = $1.22

* preferred dividend (whether or not paid since stock is cumulative) = [($100 x 8%) = $8 x 50,000]

EXERCISE 16-21

Dates Shares Fraction Weighted

Event Outstanding Outstanding Restatement of Year Shares
Beginning balance Jan. 1–Apr. 1 800,000 3/12 200,000
Issued shares Apr. 1–Oct. 1 1,250,000 6/12 625,000
Reacquired shares Oct. 1–Dec. 31 1,140,000 3/12 285,000
Weighted-average number of shares outstanding 1,110,000
adjustment for stock dividend in 2013 (before statements issued) X 1.05
Adjusted weighted-average number of shares outstanding 1,165,500

* shares issued for stock dividend = 800,000 x 5% = $40,000

Earnings per share = ($2,830,000 − $980,000*) / 1,165,500 shares = $1.59

* preferred dividends = $50 x 7% = $3.50 x 280,000 = $980,000

EXERCISE 16-22 (a. only)

(a) Revenues $17,500

Expenses:
Other than interest ........................................................................... $8,400
Interest expense (75 X $1,000 X 8%) ............................................. 6,000 14,400
Income before income taxes ...................................................................... 3,100
Income taxes (40%) ........................................................................ 1,240
Net income ................................................................................................. $ 1,860

Basic EPS: $1,860 / 2,000 shares = $.93

If-converted impact of bonds:

Numerator: [$6,000 x (1 – .40)] = $3,600
Denominator: 75 bonds x 100 = 7,500 shares

Diluted EPS = ($1,860 + $3,600) / (2,000 + 7,500) = $5,460 / 9,500 = $.57

Dilutive? Yes since $.57 < $.93  report dual EPS numbers for Basic and Diluted EPS
 CH 16 Optional Homework, P ag e |6

EXERCISE 16-24

(a) Basic EPS = $7,500,000 / 2,000,000 shares = $3.75

If-converted impact of bonds:

Numerator: [$288,000 x (1 – .35)] = $187,200
Denominator: $4,000,000 ÷ $1,000 = 4,000 bonds x 18 (max) = 72,000 shares

* interest expense = $4,000,000 x 7% = $280,000 + $8,000** = $288,000

** discount = $4,000,000 x .02 = $80,000 / 10 years = $8,000

Diluted EPS = ($7,500,000 + $187,200) / (2,000,000 + 72,000) = $7,687,200 / 2,072,000 = $3.71

Dilutive? Yes, since $3.71 < $3.75  report dual EPS numbers for Basic and Diluted EPS

(b) If the convertible security were preferred stock:

Basic EPS would be $3.75 (assuming either no preferred dividends declared or P/S is noncumulative)
Diluted EPS would be $7,500,000 / 2,072,000 = $3.62 (assuming same conversion ratio)

EXERCISE 16-28

(a) Yes, the warrants are dilutive since $10 exercise price < $15 market price

(b) Basic EPS = $260,000 / 100,000 shares = $2.60

(c) Treasury stock method impact of warrants:

Numerator: $0
Denominator: shares issued (30,000 x 1) 30,000
shares reacquired (30,000 x $10 = $300,000 / $15) (20,000)
incremental shares outstanding 10,000

Diluted EPS = $260,000 / (100,000 + 10,000) = $260,000 / 110,000 shares = $2.36

PROBLEM 16-3

2011 November 30: No journal entry would be recorded at the time the stock option plan was adopted.

2012
Jan. 2 No entry (total FV = 28,000 + 14,000 = 42,000 options X $4 = 168,000).

Dec. 31 Compensation Expense [(15,000 + 7,000) = 22,000 options X $4] 88,000

Paid-in Capital—Stock Options ................................................ 88,000

2013
Dec. 31 Compensation Expense [(13,000 + 7,000) = 20,000 options X $4] 80,000
Paid-in Capital—Stock Options ................................................ 80,000

Paid-in Capital—Stock Options .......................................................... 88,000

Paid-in Capital—Expired Stock Options ................................... 88,000

2014
Dec. 31 Cash (20,000 X $9) ............................................................................ 180,000
Paid-in Capital—Stock Options (20,000 X $4) ................................... 80,000
Common Stock (20,000 X $5) .................................................. 100,000
Paid-in Capital in Excess of Par--Common .............................. 160,000
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PROBLEM 16-6

(a) Melton Corporation has a simple capital structure since there are no potentially dilutive securities.

(b)
FYE May 31, 2012 Dates Shares Fraction Weighted
Event Outstanding Outstanding Restatement of Year Shares
Beginning balance June 1–Oct. 1 1,000,000 1.20 4/12 400,000
Issued shares Oct. 1–Jan. 1 1,500,000 1.20 3/12 450,000
20% stock dividend* Jan. 1–May 31 1,800,000 5/12 750,000
Weighted-average number of shares outstanding 1,600,000

* shares issued for stock dividend = 1,500,000 x 20% = 300,000

FYE May 31, 2013 Dates Shares Fraction Weighted

Event Outstanding Outstanding Restatement of Year Shares
Beginning balance June 1–Dec. 1 1,800,000 6/12 900,000
Issued shares Dec. 1–May 31 2,600,000 6/12 1,300,000
Weighted-average number of shares outstanding 2,200,000

(c) MELTON CORPORATION

Income Statement
For Fiscal Years Ended May 31, 2012 and 2013
2012 2013
Income from operations ................................................................................ $1,800,000 $2,500,000
Interest expense (a) ...................................................................................... 240,000 240,000
Income before taxes ...................................................................................... 1,560,000 2,260,000
Income taxes (40%) ...................................................................................... 624,000 904,000
Income before extraordinary item ................................................................. 936,000 1,356,000
Extraordinary loss, net of income taxes of $240,000 .................................... (360,000)
Net income .................................................................................................... $ 936,000 $ 996,000

Earnings per share:

Income before extraordinary item (b) ................................................. $.55 $.59
Extraordinary loss (c) ......................................................................... (.16)
Net income (d) .................................................................................... $.55 $.43

(a) $2,400,000 X .10 = $240,000

(b) 2012: ($936,000 − $60,000*) / 1,600,000 shares 2013: ($1,356,000 − $60,000*) / 2,200,000 shares
* preferred dividends = ($50 x 6%) = $3 x 20,000 shares = $60,000
(c) 2013: $360,000 / 2,200,000 shares
(d) 2012: ($936,000 − $60,000) / 1,600,000 shares 2013: ($996,000 − $60,000) / 2,200,000 shares

PROBLEM 16-8

($1,200,000 – $240,000*)
(a) Basic EPS = = $1.60
600,000**

* # shares P/S = $4,000,000 / $100 = 40,000; dividend = $100 x 6% = $6 x 40,000 = $240,000

** $6,000,000 / $10 = 600,000 shares

(b) Incremental impacts of potentially dilutive securities:

Convertible Bonds:
Numerator: [$160,000* X (1 – .40)] = $96,000
Denominator: $2,000,000 / $1,000 = 2,000 bonds X 30 = 60,000 shares

* interest expense (no prem/disc) = $2,000,000 x 8% = $160,000

 CH 16 Optional Homework, P ag e |8

Convertible Preferred Stock:

Numerator: $240,000
Denominator: $4,000,000 / $100 = 40,000 x 3 = 120,000 shares

Options (dilutive since $20 option price < $25 market price):
Numerator: $0
Denominator: Shares issued 75,000
Shares reacquired (75,000 X $20 = $1,500,000 / $25) ..... (60,000)
Incremental shares outstanding .................................................... 15,000

Dilution/Antidilution Check:

Security Ratio Result Rank (1= most dilutive)

Convertible bonds $96,000 / 60,000 = $1.60 2
Convertible preferred stock $240,000 / 120,000 = $2.00 3
Stock options $0 / 15,000 = $0 1

1. Options:

($1,200,000 – $240,000) $960,000

Recalculated EPS: = = $1.56
(600,000 + 15,000) 615,000

Dilutive? Yes, since $1.56 < $1.60  continue

2. Convertible Bonds:

($960,000 + $96,000) $1,056,000

Recalculated EPS: = = $1.56
(615,000 + 60,000) 675,000

Dilutive? No, since $1.56 not < $1.56  STOP! Do not assume conversion of bonds or preferred stock
since they are antidilutive (the recalculated EPS with the bonds is $1.564 vs. $1.561 with the options)

Presentation of EPS on Income Statement:

Earnings per common share:

Basic $1.60
Diluted $1.56