Earnings Per Share
Easy Practice Test
Intermediate Accounting 2
Easy Practice Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. When a company’s preferred shares are non cumulative and a dividend is not declared, basic earnings per share is computed with
a. a deduction from net income for the stated preferred dividends
b. an addition to net income for the stated preferred dividends
c. a deduction from net income for the amount expected to be declared in the following year
d. net income is not adjusted for the stated preferred dividend
Answer
D. This is the only instance where the stated preferred dividend is not subtracted from net income. Non cumulative means that dividend will not be paid in the future if it is not declared during the current year. The payment will not be made to preferred shareholders and should not be deducted from net income.
2. Which of the following is always true relative to earnings per share?
a. Earnings per share will never be a negative amount.
b. Earnings per share is always one amount representing net income
c. The company must report earnings per share for continuing operations and all items reported after continuing operations
d. All companies, public, private, and non profit must report earnings per share
Answer
C. FASB requires earnings per share be reported for continuing operations, discontinued operations, extraordinary items, accounting changes, and net income (b.). Earnings per share will be negative when the company incurs a loss (a.). Only public companies are required to report earnings per share (d.).
3. When a company declares a stock split
a. the number of shares outstanding does not change
b. the number of shares issued is decreased
c. the number of shares issued and outstanding is increased
d. total shareholder’s equity increases
Answer
C. A stock split increases the number of shares issued and outstanding. Par value and fair market value per share decrease. The total value (book value and fair market value) of the company does not change because of the stock split. No entry is made and total stockholder’s equity does not change.
4. When computing weighted average shares, a stock dividend is treated as if it were declared and paid
a. at the end of the current year
b. on the date it was paid
c. at the beginning of the subsequent year
d. at the beginning of the current year
Answer
D. Stock dividends are treated retroactively as if they occurred at the beginning of the current year.
5. A company with a complex capital structure must have how many convertible securities?
a. at least one
b. at least two
c. three or more
d. five or more
Answer
A. A company that has at least one convertible security or common stock equivalent is considered to have a complex capital structure. A simple capital structure has no common stock equivalents.
6. The computation of basic earnings per share does not consider
a. outstanding common shares
b. cumulative preferred stock dividends declared
c. non convertible preferred stock dividends declared
d. none of the above
Answer
D. All of the items listed are considered in computing basic earnings per share. Weighted average common shares outstanding are used in the computation. All preferred stock dividends declared are deducted from net income. Only non cumulative, not declared is not subtracted from net income.
7. What method is used to account for stock options when computing diluted earnings per share?
a. if converted method
b. treasury stock method
c. option method
d. diluted method
Answer
B. The treasury stock method is used to account for stock options when computing diluted earnings per share. The options are assumed exercised with the cash assumed to be used to purchase treasury shares at the average fair market value during the period.
8. When a bond is nonconvertible, the calculation of which of the following is impacted?
a. basic earnings per share
b. diluted earnings per share
c. both basic and diluted earnings per share
d. neither basic or diluted earnings per share
Answer
D. A nonconvertible bond does not change net income or weighted average shares outstanding when computing basic or diluted earnings per share.
9. The amount of preferred dividends deducted from net income in the basic earnings per share computation is computed as
a. total par value x the standard discount rate
b. total preferred shares x par value per share
c. total preferred shares x par value per share x stated rate
d. par value per share x stated rate
Answer
C. The preferred dividend is computed as total par value (number of shares x par value per share) x the stated annual %. Only dividends that may be declared are deducted from net income.
10. The computation of diluted earnings per share assumes that cash received from the exercise of stock options is used to purchase common stock at
a. fair market value at the end of the year
b. book value at the end of the year
c. average fair market value during the period
d. average book value during the period
Answer
C. The cash is assumed to be used to purchase treasury stock at average fair market value during the period.
11. At the end of the prior year, the corporation had 500,000 $1 par value shares authorized, 260,000 shares issued. During the current year the corporation had the following transactions that changed the number of outstanding shares:
| February 28th: Issued 50,000 shares June 1st: Declared and paid a 25% stock dividend November 1st: Purchased 5,000 shares as treasury stock |
Net income for the current year was $240,000. The company declared and paid a dividend on 7% non cumulative nonconvertible preferred stock with a total par value of $250,000.
The company had 30,000 stock options with an exercise price of $18 outstanding during the current year. The average fair market value of the company’s common stock during the current year was $23.
A. Compute weighted average outstanding common shares for the current year
B. Compute basic earnings per share for the current year
C. Determine the quantity of additional shares from the assumed exercise of options
D. Compute diluted earnings per share for the current year
Answer
A.
| 1/1 to 2/27 260,000 x 1.25 x 2/12 = 54,167 2/28 to 5/31 310,000 x 1.25 x 3/12 = 96,875 6/1 to 10/31 387,500 x 5/12 = 161,458 11/1 to 12/31 382,500 x 2/12 = 63,750 Weighted Average 376,250 |
Begin a new row every time the number of shares change
Multiply: the shares on the row by the amount of time in months the shares were outstanding divided by 12 months
B.
| 240,000 – 17,500 = 222,500 = $0.59 376,250 |
$250,000 x 7% = 17,500 preferred dividend
Declared is subtracted
C.
|
Options: Shares Issued 30,000 = Net Shares Added 6,522 |
Option:
Determine the amount of cash that would be received upon exercise and use that cash to purchase shares at the average FMV during the period.
Subtract the shares repurchased from shares issued to get the net to add to weighted average shares
D.
Copy the basic EPS calculation and adjust:
| 240,000 – 17,500 = 222,500 = $0.58 376,250 + 6,522 = 382,772 |
The preferred shares are non-convertible. The dividend is subtracted in diluted
Add the net shares that would be issued assuming exercise of the options
12. On December 31st of the prior year, the corporation had 400,000 $1 par value shares authorized, 180,000 shares issued and outstanding. During the current year the corporation had the following transactions that changed the number of outstanding shares:
| March 15th: Issued 20,000 shares June 15th: Declared and paid a 2:1 stock split December 1st: Retired 5,000 shares of common stock |
Net income for the current year was $345,000. The company did not declare a dividend on 5% cumulative nonconvertible preferred stock with a total par value of $50,000. The tax rate is 32%.
$200,000 par value convertible bonds with an effective rate of 5% were outstanding during the entire year. The bonds are convertible into 200 shares of common stock for each $1,000 bond.
A. Compute weighted average outstanding common shares for the current year
B. Compute basic earnings per share for the current year
C. Determine the interest saved and shares added with the assumed conversion of the convertible bonds.
D. Compute diluted earnings per share for the current year
Answer
A. Weighted Average Shares Outstanding:
| 1/1 to 3/14 180,000 x 2 x 2.5 / 12 = 75,000 3/15 to 6/14 200,000 x 2 x 3 / 12 = 100,000 6/15 to 12/1 400,000 x 5.5 /12 = 183,333 12/1 to 12/31 395,000 x 1 / 12 = 32,917 Total Weighted Average 391,250 |
Begin a new row with the number of shares outstanding every time the
number of shares outstanding changes
The 2:1 split must be retroactive to the beginning of the year, multiply each line above the split by 2
Multiply by: the quantity of months the company had this number of shares / 12
B.
345,000 – 2,500 = 342,500 = $0.88
391,250
$50,000 x 5% = 2,500 preferred dividends are not declared
The preferred stock is cumulative, always subtract the cumulative dividend
C.
200,000 x 5% = 10,000 x (1-.32) = 6,800 interest saved
200,000 / 1,000 = 200 bonds x 200 shares per bond = 40,000 shares issued
D.
| 345,000 – 2,500 + 6,800 = 349,300 = $0.81 391,250 + 40,000 = 431,250 |
Add the interest saved to net income
Add the shares issued assuming conversion to weighted average shares
Subtract the preferred dividend because preferred stock is nonconvertible
A. Compute weighted average outstanding common shares for the current year
B. Compute basic earnings per share for the current year
C. Compute diluted earnings per share for the current year
Answer
A.
| 1/1 to 2/28 100,000 x 2 x 2/12 = 33,333 3/1 to 12/31 200,000 x 10/12 = 166,667 Weighted Average 200,000 |
B.
| 400,000 – 60,000 = 340,000 = $1.70 200,000 |
10,000 shares x $100 par = $1,000,000 total par x 6% = 60,000 dividend
Preferred shares are noncumulative – dividends were declared, subtract dividend
C.
| 400,000 – 0 = 400,000 = $1.65 200,000 + 42,000 = 242,000 |
Preferred shares: 10,000 x 4.2 per share = 42,000 common shares on assumed conversion; add shares to weighted average shares