c16BExercises.

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B EXERCISES

1 3 E16-1B (Issuance and Conversion of Bonds) For each of the unrelated transactions described below,
present the entry(ies) required to record each transaction.
1. Luther Corp. issued $50,000,000 par value 8% convertible bonds at 102. If the bonds had not been
convertible, the company’s investment banker estimates they would have been sold at par. Ex-
penses of issuing the bonds were $750,000.
2. Luther Corp. issued $35,000,000 par value 12% bonds at 101. One detachable stock purchase war-
rant was issued with each $1,000 par value bond. At the time of issuance, the warrants were sell-
ing for $6.50.
3. On October 31, 2014, Luther Corp. called its 10% convertible debentures for conversion. The
$60,000,000 par value bonds were converted into 600,000 shares of $1 par value common stock. On
October 31, there was $155,000 of unamortized premium applicable to the bonds, and the com-
pany paid an additional $355,000 to the bondholders to induce conversion of all the bonds. The
company records the conversion using the book value method.

1 E16-2B (Conversion of Bonds) Telta Inc. issued $15,000,000 of 12%, 40-year convertible bonds on
November 1, 2014, at 97 plus accrued interest. The bonds were dated July 1, 2014, with interest payable
January 1 and July 1. Bond discount (premium) is amortized semiannually on a straight-line basis.
On July 1, 2015, one-half of these bonds were converted into 60,000 shares of $1 par value common
stock. Accrued interest was paid in cash at the time of conversion.
Instructions
(a) Prepare the entry to record the interest expense at December 31, 2014. Assume that accrued inter-
est payable was credited when the bonds were issued. (Round to nearest dollar.)
(b) Prepare the entry(ies) to record the conversion on July 1, 2015. (Book value method is used.) As-
sume that the entry to record amortization of the bond discount and interest payment has been
made.
1 E16-3B (Conversion of Bonds) Zotar Company has bonds payable outstanding in the amount of
$5,600,000, and the Premium on Bonds Payable account has a balance of $150,000. Each $1,000 bond is
convertible into 10 shares of common stock with a par value of $1 per share. All bonds are converted into
common stock.
Instructions
Assuming that the book value method was used, what entry would be made?
1 E16-4B (Conversion of Bonds) On July 1, 2013, when its $1 par value common stock was selling for
$66 per share, Indy Hotels Corp. issued $25,000,000 of 6% convertible debentures due in 10 years. The
conversion option allowed the holder of each $1,000 bond to convert the bond into 10 shares of the cor-
poration’s common stock. The debentures were issued for $26,500,000. The corporation believes the dif-
ference between the par value and the amount paid is attributable to the conversion feature. On January
1, 2014, the corporation’s common stock was split 2 for 1, and the conversion rate for the bonds was ad-
justed accordingly. On January 1, 2015, when the corporation’s $0.50 par value common stock was sell-
ing for $38 per share, holders of 10,000 of the convertible debentures exercised their conversion options.
The corporation uses the straight-line method for amortizing any bond discounts or premiums.
Instructions
(a) Prepare in general journal form the entry to record the original issuance of the convertible
debentures.
(b) Prepare in general journal form the entry to record the exercise of the conversion option, using the
book value method. Show supporting computations in good form.
1 E16-5B (Conversion of Bonds) The December 31, 2013, balance sheet of West Word Corp. is as follows.
12% callable, convertible bonds payable (semiannual interest
dates June 30 and December 31; convertible into 15 shares of $10
par value common stock per $1,000 of bond principal; maturity
date June 30, 2027) $2,500,000
Premium on bonds payable 110,050 $2,610,050

On April 15, 2014, West Word Corp. called all of the bonds as of May 31, 2014 for the principal plus in-
terest through May 31. By May 31, one-half of the bondholders had exercised their conversion to com-
mon stock as of the interest payment date. Consequently, on May 31, West Word Corp. paid the interest
1
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2 • Chapter 16 Dilutive Securities and Earnings per Share

due to all bondholders, issued shares of common stock for one-half of the bonds, and paid cash to retire
the remainder of the bonds. The premium is amortized on a straight-line basis and West Word uses the
book value method.

Instructions
Prepare the entry(ies) to record the interest expense, conversion, and call on May 31, 2014. (Round to the
nearest dollar.)

1 E16-6B (Conversion of Bonds) On January 1, 2012, Desert Windows Corporation issued $1,000,000 of
15-year, 12% convertible debentures at 110. Interest is to be paid semiannually on June 30 and December
31. Each $1,000 debenture can be converted into four shares of Desert Windows Corporation $5 par value
common stock after December 31, 2013.
On January 1, 2014, $400,000 of the debentures is converted into common stock, which is then selling
at $300. An additional $400,000 of the debentures is converted on May 31, 2014. The market price of the
common stock is then $310. Accrued interest at May 31 will be paid on the next interest date.
Bond premium is amortized on a straight-line basis.

Instructions
Make the necessary journal entries for:
(a) December 31, 2013. (c) May 31, 2014.
(b) January 1, 2014. (d) June 30, 2014.
Record the conversions using the book value method.

3 E16-7B (Issuance of Bonds with Warrants) MagTech Inc. requires funding to build a new factory and
has decided to raise the additional capital by issuing $850,000 face value of bonds with a coupon rate of
10%. In discussions with investment bankers, it was determined that to help the sale of the bonds, de-
tachable stock warrants should be issued at the rate of 5 warrants for each $1,000 bond sold. The value
of the bonds without the warrants is considered to be $775,000, and the value of the warrants in the mar-
ket is $75,000. The bonds sold in the market at issuance for $825,000.

Instructions
(a) What entry should be made at the time of the issuance of the bonds and warrants?
(b) If the warrants were nondetachable, would the entries be different? Discuss.

3 E16-8B (Issuance of Bonds with Detachable Warrants) On December 1, 2014, Universal Coat Company
sold 10,000 of its 10%, 15-year, $1,000 face value, nonconvertible bonds with detachable stock warrants at
102. Each bond carried three detachable warrants. Each warrant was for one share of common stock at a
specified option price of $27 per share. Shortly after issuance, the warrants were quoted on the market
for $2.50 each. No market value can be determined for the Universal Coat Company bonds. Interest is
payable on December 1 and June 1. Bond issue costs of $65,000 were incurred.

Instructions
Prepare in general journal format the entry to record the issuance of the bonds.
(AICPA adapted)

3 E16-9B (Issuance of Bonds with Stock Warrants) On May 31, 2014, Core Company issued 1,000, 14%,
10-year $1,000 bonds at 105. Each bond was issued with one detachable stock warrant. Shortly after is-
suance, the bonds were selling at 102, but the market value of the warrants cannot be determined.

Instructions
(a) Prepare the entry to record the issuance of the bonds and warrants.
(b) Assume the same facts as part (a), except that the warrants had a fair value of $8. Prepare the en-
try to record the issuance of the bonds and warrants.

4 E16-10B (Issuance and Exercise of Stock Options) On July 1, 2014, Allied Material Company adopted a
stock option plan that granted options to key executives to purchase 100,000 shares of the company’s $1
par value common stock. The options were granted on January 1, 2015, and were exercisable 3 years af-
ter the date of grant if the grantee was still an employee of the company. The options expired 4 years
from date of grant. The option price was set at $66, and the fair value option pricing model determines
the total compensation expense to be $660,000.
All of the options were exercised February 1, 2018, when the market price was $78 a share.

Instructions
Prepare journal entries relating to the stock option plan for the years 2014 through 2018. Assume that the
employee performs services equally in 2015, 2016, and 2017.
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B Exercises • 3

4 E16-11B (Issuance, Exercise, and Termination of Stock Options) On January 1, 2014, EZ Inc. granted
stock options to officers and key employees for the purchase of 250,000 shares of the company’s $1 par
common stock at $86 per share. The options were exercisable within a 5-year period beginning January
1, 2016, by grantees still in the employ of the company, and expiring December 31, 2018. The service pe-
riod for this award is 2 years. Assume that the fair value option pricing model determines total compen-
sation expense to be $1,250,000.
On July 1, 2014, 20,000 option shares were terminated when the employees resigned from the com-
pany. The market value of the common stock was $88 per share on this date.
On March 31, 2016, 130,000 option shares were exercised when the market value of the common stock
was $91 per share.

Instructions
Prepare journal entries to record issuance of the stock options, termination of the stock options, exercise
of the stock options, and charges to compensation expense, for the years ended December 31, 2014, 2015,
and 2016.

4 E16-12B (Issuance, Exercise, and Termination of Stock Options) On July 1, 2013, Hooker Financial Cor-
poration granted 50,000 options to key executives. Each option allows the executive to purchase one share
of Hooker’s $1 par value common stock at a price of $58 per share. The options were exercisable within
a 2-year period beginning July 1, 2015, if the grantee is still employed by the company at the time of the
exercise. On the grant date, Hooker’s stock was trading at $50 per share, and a fair value option-pricing
model determines total compensation to be $350,000.
On July 1, 2015, 35,000 options were exercised when the market price of Hooker’s stock was $65 per
share. The remaining options lapsed in 2015 because executives decided not to exercise their options.

Instructions
Prepare the necessary journal entries related to the stock option plan for the years 2013 through 2017.

4 E16-13B (Accounting for Restricted Stock) Holt Company issues 10,000 shares of restricted stock to its
new CEO, on January 1, 2014. The stock has a fair value of $260,000 on this date. The service period re-
lated to this restricted stock is 5 years. Vesting occurs if the CEO stays with the company for 5 years. The
par value of the stock is $1. At December 31, 2015, the fair value of the stock is $180,000.

Instructions
(a) Prepare the journal entries to record the restricted stock on January 1, 2014 (the date of grant) and
December 31, 2015.
(b) On February 22, 2016, the CEO leaves the company. Prepare the journal entry (if any) to account
for this forfeiture.

4 E16-14B (Accounting for Restricted Stock) Lawson Company issues 50,000 shares of restricted stock to
its CFO, on January 1, 2014. The stock has a fair value of $1,100,000 on this date. The service period re-
lated to this restricted stock is 4 years. Vesting occurs if CFO stays with the company for 4 years. The par
value of the stock is $1. At December 31, 2014, the fair value of the stock is $1,750,000.

Instructions
(a) Prepare the journal entries to record the restricted stock on January 1, 2014 (the date of grant) and
December 31, 2015.
(b) On August 1, 2017, the CFO leaves the company. Prepare the journal entry (if any) to account for
this forfeiture.

6 E16-15B (Weighted-Average Number of Shares) Keynote Inc. uses a calendar year for financial re-
porting. The company is authorized to issue 20,000,000 shares of $1 par common stock. At no time has
Keynote issued any potentially dilutive securities. Listed below is a summary of Keynote’s common stock
activities.

1. Number of common shares issued and outstanding at December 31,

2012 and 2011 5,000,000
2. Shares issued for cash on March 31, 2013 1,000,000
3. A 2-for-1 stock split of Keynote’s common stock took place on August 31, 2013.
4. Shares issued as a result of a 30% stock dividend on June 30, 2014 3,600,000

Instructions
(a) Compute the weighted-average number of common shares used in computing earnings per com-
mon share for 2012 on the 2013 comparative income statement.
(b) Compute the weighted-average number of common shares used in computing earnings per com-
mon share for 2013 on the 2013 comparative income statement.
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4 • Chapter 16 Dilutive Securities and Earnings per Share

(c) Compute the weighted-average number of common shares to be used in computing earnings per
common share for 2013 on the 2014 comparative income statement.
(d) Compute the weighted-average number of common shares to be used in computing earnings per
common share for 2014 on the 2014 comparative income statement.
(CMA adapted)

6 E16-16B (EPS: Simple Capital Structure) On January 1, 2014, Vermont Maple Corp. had 2,650,000 shares
of common stock issued and outstanding. During 2014, it had the following transactions that affected the
common stock account.

Mar. 1 Issued 250,000 shares in exchange for land

Apr. 1 Acquired 200,000 shares of treasury stock
July 1 Issued a 20% stock dividend
Sept. 1 Reissued 240,000 shares of treasury stock
(adjusted for 20% stock dividend)
Oct. 1 Issued a 2-for-1 stock split

Instructions
(a) Determine the weighted average number of shares outstanding as of December 31, 2014.
(b) Assume that Vermont Maple Corp. earned net income of $8,352,000 during 2014. In addition, it
had 200,000 shares of 9%, $100 par value nonconvertible, cumulative preferred stock outstanding
for the entire year. Because of liquidity considerations, however, the company did not declare and
pay a preferred dividend in 2013 or 2014. Compute earnings per share for 2014, using the weighted-
average number of shares determined in part (a).
(c) Assume the same facts as in part (b), except that the preferred stock was noncumulative. Compute
earnings per share for 2014.
(d) Assume the same facts as in part (b), except that net income included a loss from discontinued op-
erations of $500,000, net of $300,000 in income taxes. Compute earnings per share for 2014.
6 E16-17B (EPS: Simple Capital Structure) SCR Company had 600,000 shares of common stock outstand-
ing on December 31, 2013. During the year 2014 the company acquired and then retired 15,000 shares on
April 1 and issued 50,000 shares on July 31. For the year 2012 SCR Company reported net income of
$982,500, after an extraordinary gain of $300,000 (net of tax).

Instructions
What earnings per share data should be reported at the bottom of its income statement?
6 E16-18B (EPS: Simple Capital Structure) NuCorp presented the following data.

Net income $ 5,800,000

Bonds: 10%, $750,000 par value 738,500
Preferred stock: 100,000 shares outstanding,
$100 par, 8% cumulative, not convertible 10,000,000
Common stock: Shares outstanding 1/1 500,000
Issued for cash, 4/1 800,000
Issued 40% stock dividend, 10/1

Instructions
Compute earnings per share.
6 E16-19B (EPS: Simple Capital Structure) Selected financial information of Gray Plains Inc. for the cur-
rent year follows.

Income before extraordinary item $ 53,500,000

Extraordinary gain, net of applicable
income tax 6,250,000
Net income 59,750,000
Retained earnings at the beginning of the year 268,450,000
328,200,000
Dividends declared:
On preferred stock $ 2,000,000
On common stock—$1 per share 21,500,000 23,500,000
Retained earnings at the end of the year $304,700,000

Note 1. During the year, Gray Plains Inc. took advantage of the current interest rates and called
$125 million of long-term debt. The early retirement resulted in a gain of $10,000,000 before
applicable taxes of $3,750,000.
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B Exercises • 5

At the end of the current year, Gray Plains Inc. has outstanding 21,500,000 shares of $1 par common
stock and 200,000 shares of 10%, $100 par preferred. There were no changes in shares outstanding dur-
ing the year.

Instructions
Compute the earnings per share on common stock for the current year as it should be reported to stock-
holders.
6 E16-20B (EPS: Simple Capital Structure) On January 1, 2014, Bio Industries had stock outstanding as
follows.
8% Noncumulative preferred stock, $100 par value,
issued and outstanding 250,000 shares $25,000,000
Common stock, $1 par value, issued and
outstanding 600,000 shares 600,000

To acquire the net assets of three smaller companies, Bio issued an additional 600,000 common shares.
The acquisitions took place as follows.
Date of Acquisition Shares Issued
MicroBio February 1, 2014 200,000
BioTech June 1, 2014 80,000
SuperBio November 1, 2014 320,000

On December 31, 2014, Bio recorded net income of $9,862,000 before taxes. No dividends on the com-
mon or preferred were declared during 2014.

Instructions
Assuming a 40% tax rate, compute the earnings per share data that should appear on the financial state-
ments of Bio Industries as of December 31, 2014.

6 E16-21B (EPS: Simple Capital Structure) At January 1, 2014, JR Company’s outstanding shares included
the following.
200,000 shares of $100 par value, 6% cumulative preferred stock (issued on January 1, 2012)
600,000 shares of $1 par value common stock

Net income for 2014 was $2,689,000. No cash dividends were declared or paid during 2012 or 2013. On
March 31, 2014, all preferred dividends in arrears for 2012 and 2013 were paid. Then, on July 1, 2014, the com-
pany declared and distributed a 10% stock dividend on common shares. On February 1, 2015, the company
declared and paid the 2014 preferred dividend, and a $0.10 per share cash dividend on the common shares.
On March 1, 2014, 800,000 shares of common stock were sold for $3 per share, and on October 1, 2014,
50,000 shares of common stock held as treasury stock were sold for $4 per share.

Instructions
Compute earnings per share for 2014. Assume that financial statements for 2014 were issued in March 2015.

7 E16-22B (EPS with Convertible Bonds, Various Situations) At the beginning of 2014, Florida Rock
Industries had 25,000 shares of common stock issued and outstanding and 500 $1,000, 6% bonds, each
convertible into 10 shares of common stock. During 2014, Florida Rock had revenues of $156,500 and ex-
penses other than interest and taxes of $104,000. Assume that the tax rate is 40%. None of the bonds was
converted or redeemed.

Instructions
(a) Compute diluted earnings per share for 2014.
(b) Assume the same facts as those assumed for part (a), except that the 500 bonds were issued on
September 1, 2014 (rather than in a prior year), and none have been converted or redeemed.
(c) Assume the same facts as assumed for part (a), except that 100 of the 500 bonds were actually con-
verted on July 1, 2014.

7 E16-23B (EPS with Convertible Bonds) Penguin Ice Inc. was formed on June 30, 2011, through the merger
of Penguin Corp. and Ice Inc. Penguin Ice issued a total of 2,500,000 shares of common stock to owners
of the merged companies. The new company had the following transactions during 2014.
On April 1, 2014, the company issued an additional 500,000 shares of stock for cash.
On July 1, 2014, Penguin Ice issued $1 million of 15-year, 6% convertible bonds at par. Each $1,000 bond
converts to 25 shares of common at any interest date. None of the bonds have been converted to date.
Penguin Ice is preparing its annual report for the fiscal year ending December 31, 2014, and will re-
port after-tax net income of $13,600,000. The tax rate is 40%.
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6 • Chapter 16 Dilutive Securities and Earnings per Share

Instructions
Determine the following for 2014.
(a) The number of shares to be used for calculating:
(1) Basic earnings per share.
(2) Diluted earnings per share.
(b) The earnings figures to be used for calculating:
(1) Basic earnings per share.
(2) Diluted earnings per share.
(CMA adapted)

2 7 E16-24B (EPS with Convertible Bonds and Preferred Stock) Richie Candy Corporation issued 20-year,
$10,000,000 face value, 9% convertible debentures on January 1, 2011. The bonds have a par value of $1,000,
with interest payable semiannually. The initial conversion ratio is 10:1, and in 3 years it will increase to
12:1. At the date of issue, the bonds were sold at 105. Bond premium is amortized on a straight-line ba-
sis. Richie Candy’s effective tax was 40%. Net income in 2014 was $26,860,000, and the company had
12,800,000 common shares issued and outstanding during the entire year.

Instructions
(a) Prepare a schedule to compute both basic and diluted earnings per share.
(b) Discuss how the schedule would differ if the security was convertible preferred stock.

2 7 E16-25B (EPS with Convertible Bonds and Preferred Stock) On January 1, 2014, Yellow Car Company
issued 15-year, $50,000,000 face value, 4% bonds, at par. Each $1,000 bond is convertible into 20 shares of
Yellow Car common stock. None of the bonds were converted in 2014. Yellow Car’s net income in 2014
was $8,680,000, and its tax rate was 30%. The company had 2,650,000 shares of common stock issued and
outstanding throughout 2014.

Instructions
(a) Compute diluted earnings per share for 2014.
(b) Compute diluted earnings per share for 2014, assuming the same facts as above, except that
$50,000,000 of 6% convertible preferred stock was issued instead of the bonds. Each $100 preferred
share is convertible into 2 shares of Yellow Car common stock.

7 E16-26B (EPS with Options, Various Situations) Backhome Company’s net income for 2014 is $650,000,
and 86,000 shares of common were issued and outstanding during 2014. The only potentially dilutive se-
curities outstanding were 25,000 executive stock options issued during 2014, each exercisable for one share
at $20.50; none of these have been exercised. The average market price of Backhome’s stock during 2014
was $26.

Instructions
(a) Compute diluted earnings per share. (Round to nearest cent.)
(b) Assume the same facts as those assumed for part (a), except that 10,000 additional options were
issued on October 1, 2014, with an exercise price of $27 (the market price of the common stock on
that date). The average market price during the last 3 months of 2014 was $29.50.

7 E16-27B (EPS with Contingent Issuance Agreement) Fremantle Brewing Inc. recently purchased
Perth Corp. One of the terms of the merger was that if Perth’s income for 2015 was $500,000 or more,
100,000 additional shares would be issued to Perth’s stockholders in 2016. Perth’s income for 2014 was
$480,000.

Instructions
(a) Would the contingent shares have to be considered in Fremantle’s 2014 earnings per share
computations?
(b) Assume the same facts, except that Perth’s income for 2014 was $510,000. Would the contingent
shares have to be considered in Fremantle’s earnings per share computations for 2014?

7 E16-28B (EPS with Warrants) Gila Corporation earned $2,650,000 during 2014. The company had an
average of 520,000 shares of common stock outstanding. The average market price of common stock was
$32 per share during the year. The company also had 50,000 warrants outstanding, of which two war-
rants could be exercised to purchase one share of common stock for $30 in total.

Instructions
(a) Are the warrants dilutive?
(b) Compute basic earnings per share.
(c) Compute diluted earnings per share.
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B Exercises • 7

8 *E16-29B (Stock Appreciation Rights) On December 31, 2012, SuperTex Company issues 250,000 stock
appreciation rights to its officers entitling them to receive cash for the difference between the market price
of its stock and a pre-established price of $50. The market price fluctuates as follows: 12/31/13—$51;
12/31/14—$48; 12/31/15—$56; 12/31/16—$54. The service period is 4 years and the exercise period is
7 years.

Instructions
(a) Prepare a schedule that shows the amount of compensation expense allocable to each year affected
by the stock appreciation rights plan.
(b) Prepare the entry at December 31, 2016, to record compensation expense, if any, in 2016.
(c) Prepare the entry on December 31, 2016, assuming that all 250,000 SARs are exercised.

8 *E16-30B (Stock Appreciation Rights) Olympia Company establishes a stock appreciation rights pro-
gram that entitles its new CEO to receive cash for the difference between the market price of the stock
and a pre-established price of $20 (also market price) on December 31, 2013, on 50,000 stock appreci-
ation rights. The date of grant is December 31, 2010, and the required employment (service) period is
3 years. The CEO exercises all of the SARs on December 31, 2013. The market value of the stock fluc-
tuates as follows: $19 on December 31, 2014; $23 on December 31, 2015; and $25 on December 31, 2016.

Instructions
(a) Prepare a 3-year (2014–2016) schedule of compensation expense pertaining to the 50,000 SARs
granted the CEO.
(b) Prepare the journal entry for compensation expense in 2014, 2015, and 2016 relative to the 50,000 SARs.
(c) Prepare the entry for the exercise of the SARs on December 31, 2016.
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