Earnings Per Share
Medium Practice Test
Intermediate Accounting 2
Medium Practice Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. Reporting earnings per share follows which accounting principle/assumption?
a. comparability
b. materiality
c. entity
d. conservatism
Answer
A. Earnings per share allows for comparability from one period to the next.
2. Earnings per share is required to be reported on the income statement by
a. publicly traded companies only
b. private companies only
c. both public and private companies
d. it is not required
Answer
A. Only publicly traded companies must report earnings per share at the bottom of the income statement. This is a Securities Exchange Commission requirement.
3. When computing basic earnings per share, cumulative preferred dividends that were not declared during the current year should be
a. ignored
b. subtracted from net income
c. added to net income
d. it depends on the company’s intent to declare the following year
Answer
B. Cumulative preferred dividends that were not declared this year may be declared in the future and should be subtracted from net income in the current period.
4. Basic earnings per share is computed using a weighted average number of shares that includes
a. potential shares issued if a contingency is met
b. current outstanding common shares only
c. current issued common shares only
d. potential shares that will be issued upon conversion of a stock equivalent
Answer
B. Basic earnings per share uses weighted average shares as they were actually outstanding during the period. Outstanding is used. Issued is not used; treasury stock held by the company is not included when computing earnings per share. Contingent shares or potentially issued shares are not included in basic.
5. When computing weighted average shares, common shares retired are
a. subtracted from shares issued and added to shares outstanding
b. subtracted from shares outstanding
c. added to shares authorized
d. none of the above
Answer
B. Shares that are retired are no longer issued or outstanding and are not included in weighted average shares outstanding. Retired shares are deducted from shares outstanding.
6. The assumed conversion of a convertible bond impacts the diluted earnings per share computation by changing
a. net income
b. weighted average common shares
c. both a. and b.
d. neither a. or b.
Answer
C. Assuming the conversion, net income is increased by interest saved net of tax and shares are increased.
7. Stock options differ from other common stock equivalents because they
a. impact total assets of the company when exercised
b. do not change total stockholder’s equity of the company
c. decrease weighted average shares outstanding
d. change total liabilities of the company
Answer
A. The company receives cash upon exercise which increases assets. The company does not increase assets with other common stock equivalents. All common stock equivalents have the potential to change stockholder’s equity. A stock option does not impact liabilities and convertible bonds do impact liabilities.
8. Anti-dilutive typically means
a. basic earnings per share is greater than diluted earnings per share
b. all stock equivalents are always anti-dilutive
c. diluted earnings per share is less than basic earnings per share
d. diluted earnings per share is greater than basic earnings per share
Answer
D. Anti-dilutive means dilutive earnings per share is greater than basic earnings per share. This is not allowed and the security that created the anti-dilutive situation must be removed from the diluted computation. It may only take one anti-dilutive security to make earnings per share anti-dilutive.
9. Earnings per share is always increased when
a. stock options are exercised
b. convertible bonds are converted into common shares
c. the company purchases treasury stock
d. none of the above always increases earnings per share
Answer
C. Purchasing treasury stock decreases outstanding shares which increases earnings per share. Stock options exercised and converting bonds into common shares increases outstanding shares which will decrease earnings per share.
10. Diluted earnings per share is a representation of
a. earnings per common share given all authorized shares are issued
b. earnings per common share given all currently issued common stock equivalents are converted at the beginning of the period
c. earnings per common share given all potentially issued common stock equivalents are converted at the beginning of the period
d. earnings per share given all contingently issued shares are issued at the end of the period
Answer
B. Diluted earnings per share is a lowest earnings per share scenario which shows what earnings per share would be if all common stock equivalents would have been converted to common shares at the beginning of the year.
1) issued 70,000 shares of stock on April 1st,
2) issued 50,000 shares of stock on August 1st and
3) paid a 30% stock dividend on November 1st.
The company also had the following convertible securities:
Stock options granted 2 years ago, all outstanding:
70,000 shares with an exercise price of $15 per share.
The company’s average market price during the current year was $17 per share. The December 31 FMV was $20 per share.
Convertible bonds, face value of $400,000, coupon rate of 4%.
The bonds are convertible to 0.2 shares of common stock for each $1 face value.
Convertible cumulative preferred stock, 1,000 shares $100 par, paying a 5% dividend. The preferred stock is convertible into 22 shares of common stock for each preferred share. The dividend was declared during the current year.
Net income for the current year was $600,000 and the tax rate was 40%.
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 3/31 800,000 x 1.3 x 3/12 = 260,000 4/1 to 7/31 870,000 x 1.3 x 4/12 = 377,000 8/1 to 10/31 920,000 x 1.3 x 3/12 = 299,000 11/1 to 12/31 1,196,000 x 2/12 = 199,333 Weighted Average =1,135,333 |
B.
600,000 – 5,000 = 595,000 = $0.52
1,135,333
Preferred dividend: 1,000 shares x $100 par x 5% = $5,000
C.
60,000 – 0 + 9,600
1,135,333 +8,236 + 80,000 + 22,000
69,600 = $0.06
1,245,569
Options
Options: Shares Issued 70,000
x Exercise Price 15
= Cash received 1,050,000
/ average FMV 17
= Shares Repurchased (61,764)
= Net Shares Added 8,236
Bonds:
$400,000 x 4% = 16,000 x (1 – 0.40) = 9,600 interest saved
400,000 x 0.2 = 80,000 shares issued on conversion
Preferred Stock
1,000 shares x 22 shares issued for each = 22,000 common shares issued on conversion
No dividend is paid if there are no shares because they were converted to common shares
Stock options granted 3 years prior: 60,000 shares with an exercise price of $25 per share. The average market price during the current year was $24 per share, and the December 31st, closing price was $20 per share.
Convertible bonds; face value of $400,000, coupon rate of 2%. The bonds are convertible to 190 shares of common stock for each $1,000 face value of the bond.
Convertible preferred stock; 10,000 shares at $75 par, 9% stated dividend; non cumulative. The preferred stock is convertible to 3.1 shares of common stock per preferred share. No preferred dividends were declared during the current year.
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 3/31 2,000,000 x 3/2 x 3/12 = 750,000 4/1 to 5/31 2,390,000 x 3/2 x 2/12 = 597,500 6/1 to 9/29 2,340,000 x 3/2 x 4/12 = 1,170,000 9/30 to 12/31 3,510,000 x 3/12 = 877,500 Weighted Average = 3,395,000 |
B.
225,000 – 0 = 225,000 = $0.07
3,395,000
Preferred is noncumulative, not declared; do not subtract
C.
225,000 – 0 + 4,800
3,395,000 + 76,000 + 31,000
229,800 = $0.07
3,502,000
Diluted can be equal to basic, but not greater
Options
|
Options: Shares Issued 60,000 = Net Shares Added (2,500) Anti-dilutive – don’t include |
When the exercise price is higher than average fair market value the employee will not exercise; therefore, don’t assume exercise
Bonds:
$400,000 x 2% = 8,000 x .60 = 4,800 interest saved
400,000 /1,000 = 400 x 190 each = 76,000 issued on conversion
Preferred Stock
10,000 shares x 3.1 shares issued for each
= 31,000 common shares on conversion
13. On December 31st of the prior year the company’s balance sheet was as follows:
| Preferred Stock, $100 par value, 5%, 20,000 shares issued and outstanding | $2,000,000 |
| Common Stock, $0.01 par value, 500,000 shares authorized, 300,000 shares issued and outstanding | $ 3,000 |
| Paid in Capital – Common Stock | $ 1,347,000 |
The following transactions occurred during the current year: On November 1, the company issued a 3:1 stock split; On December 1st, the company issued 100,000 shares of common stock. On January 2, the company issued 10,000 shares of preferred stock. Net Income for the current year was $800,000. The preferred stock is cumulative and the dividend was not declared. The tax rate was 30%. The company had the following convertible securities:
Stock options granted on June 1st of the current year: 60,000 shares with an exercise price of $14 per share. Average market price was $19 and the year end closing stock price was $21.
Convertible bonds, face value of $400,000, coupon rate of 6%. Convertible into 75 shares for each $1,000 of face value. The bonds were issued in the prior year.
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 10/31 300,000 x 3 x 10/12 = 750,000 11/1 to 11/30 900,000 x 1/12 = 75,000 12/1 to 12/31 1,000,000 x 1/12 = 83,333 Weighted Average = 908,333 |
B.
| 800,000 – 150,000 = 650,000 = $0.72 908,333 |
Preferred is cumulative, subtract even if not declared
$100 x 30,000 x 5% = 150,000 preferred dividends
(20,000 beginning + 10,000 issued = 30,000 shares)
C.
| 800,000 – 150,000 + 16,800 = 666,800 = $0.70 908,333 + 9,211 + 30,000 = 947,544 |
Options
|
Options: Shares Issued 60,000 = Net Shares 15,790 |
Bonds:
$400,000 x 6% = 24,000 x .70 = 16,800 interest saved
400,000 /1,000 = 400 x 75 each = 30,000 issued on conversion
Preferred Stock
The preferred stock is nonconvertible since you have no conversion information
The dividend is subtracted because conversion is not possible for a nonconvertible.