SOLUTIONS TO FXEKCISES St Ex. 15-2 Ex. 15-9 2 Extinordinary item None Tressury stock a not an eset; treprasénts shares that have been reacquirag by ths company, not shares that have not yet been Iecued.) © Stock divide d Cuawulative otfeet of an necounting change © Prior period adjustment f 9 ars.) Fle imlio (Market price civided by earnings par sl Discontinuad oparations (Shewing the discontinued operations in ® separate waction of the income statement permits development of the subtotal, Incomo from Continys ing Operations.) hy Fully ditutoci nings por share SUNSPORTS, INC. Income Statement For ihe Year Ended December 31, 1 Nol saios . ae : $9,800,000 Costs and expensos (including applicable Income taxes) 8, Income Wwam conitrulng operations. ‘$1,200,000 Discontinued oporations: Operating loss from Lonnts shops (nat of income tax benefit). a $192,000 Loss on sala of tennis shops (nat of Income taxes) 348,000 _(540,000) Net income .... Earnings per share: Earnings from continuing operations ($1,200,000 + 150,000 shares) Loss from discontinued operations Not oarnings ($660,000 ~ 150,000 share: UNION CHEMICAL Income Statement For the Year Ended December, 31, 19_ HOt SNOB nner se Loss: Costs and expenses (Including income taxes)... Income before extraordinary items. Extingrdinary gain, net of income taxes... Net income, Enmings per share of common stock: Earnings batore extraordinary Mems ($940,000 + 500,000 shares) Extraordinary gainBs. 15-5 Ex. 15-6 Ex 18-7 oy Net Income = Shares outstanding throughout yoor $4,300,000 Earnings per share ($6,300,000 « 1,009 1,000,000 $6.30 Not Income rae Weighted-average number of a1 $6,300,000 1,000,000 x %»_ 1,200,000 shares x 34, Earnings per sha Mae 3 “0 Net Income... a eon Shares outstanding following 20% stock dividend. Gee Earnings per share ($6,300,000 . 1,200,000 shares). hoe Net income (all applicable to common stock)... Sharep of common stock outstanding throughout yoar, Earnings per share ($2,550,000 . 31 100,000 shares) Net Income. een $2,550,000 Less: Preferred’stock dividand (200,000 x 9% x $100) ... 1,600,000 Earnings avaliable for common stock .. $750,000 ‘Shares of common stock outstanding throughout year.. 300,000 Earnings per share ($750,000 + 300,000 shars).. $2.50 \ 1990 1909 1988 Earnings per share 20. seecentronesennecoane, $2.35 $1.52 (1) $1.11 (2) (1) $3.03 originally reported, divided by 2 (twice as many shares) (2) $2.22 originally reported, divided by 2 + , hould be Following the stock dividend, the earnings per share of earlier periods st fetroactively restated to reflect the increased number of shares. In the ce situation, each “new” share (after the 100% stock dividend) Is equal to only ¥2 of a 1990 share, if the earnings of each 1990 share are allocated among the sien es shares, each new share is viewed as having earned '4 of the original amount ($3. + 2= $1.52; $2.22 +2 = $1.11). 1001987 Earnings per share. ‘so. $305 $2.23(1) (1) $6.69 originally reported, divided by 3 (3 times as many shares) Following the stock split, the earnings por share of earlier periods should Pcie tively restated to reflect the Increased number of shares, In the Métck & Co. ‘each “new” share (after the 3-for.mu tse o acum: tasued an ackinional 600,000 saree of capital stock tn & ene crack apin, Put value reduced trom $10 per share to $5 per share {600,000 June 1 Retained Eamings ——— 600,000 Aug. 1 Retained Eamings ———- 950,000 ‘Stock Dividend to Be Distributed ‘Additions: Paid-in Copital: Stock ; 700,000 Dividends eee To recont declaration of a 5% stuck dividend consisting of 50,000 shares of $5 par value comaon stock Amount of retained earnings transterred to permanent capltal is based on market prica c! $19 a share. Sept. 10 Stock Dividend to Be Distributed... Common StOCk nnn To record disiribution of a stock dividend of 50,000 shares. 250,000 ~ consisting of 525,000 shares of $5 par value ‘common stock. ‘& 1575.00 shares _ 527200 + 500,000 + 50,000 + 525,000 = 1,575,000 © Sper valve per share ($10 to Sper valve. par reduced ; uced to $5 par due to 2-for-1 stock split £159 The markat n tak value of the total Tarreytown's shares outstanding Is $5,280,000 (80,000 Since ‘new shares has no effect on the not assets of thewr" ‘1511 @ Feb. 10 Treasury Stock 435,000 Cash ence ; © Purchased 14,500 shares of treasury stock at $30 ee por share, June 4 Cash... — Treasury Stock ws Additional Peid-in Capital: Treasury Stock Transactions... Sold 6,000 shaves of reas $180,000, for $33 per shar 198,000 100,000 ne . 18,000 lury slock, coat Dec, 22 Cash = Additional Peitin Capital: Treasury Stock ‘Transactions... : ‘Treasury Stock Sold 4,000 shares of Wweasury stock, cot $120,000, for $28 per share, 112,0v0 8,000 126,000 Restriction of retained earnings for treasury stock owned ot yeur-end; $135,000 (4,500 shares ett owned x $30 par share cost) After a stock sput, >smings per share are expressed in terms of the “new” shares, Therefore, a S-for-1 stock aplit wil cause. Garnings per share figures to be restated at % of their former amounts. Realization of a gain trom any source increases net earnings per share. {As this gain telates to discontinued operations, however, it would not increase tne per-share ‘eamings trom continuing operations.) ‘A change in depreciation methods is regarded as » change in accounting principle. ‘Achange from an accelerated depreciation to the atraight-line method normally would Involve @ large debit to the Accumulated Depreciation account, es stated in the ‘exerciee. The Income siaiement, however, would contain a credit tem representing the cumulative effect of the change. (This credit is actually a recovery of — or feduction in — the cumulative depreciation expense recorded in past years.) As the cumulative affect of the change Is included In net income and Is a credit, it would increase net sarnings per share. (I would have no atlect, however, upon per-share before extrecrdinary tema and the cumulative effect of an accounting itdenda delyred er pido nok sta no ha datrmation of nat even, ‘Theretore, the declaration andlor payment of a dividend on common stock has mo effect upon earnings per share. Earnings per share are resied to refiet the increased number of shares resulting eee cause & proportionate reduc- per: Feporied pedgrarpleee thalisls stock opin) berlods, as well as in the current period. Aquisition of treasury shares reduces the numbe: tof " — i opin ‘Shares currently oulstandingix 15-12 > © Feren Balance sheet (also 6! Statement of retained earnings (also statement of stockholders’ equity) This information is not included in any formal financial statement — it is quoted daity I. {n publications such as The Wall Street Journal . tained earnings (also statement of stockholders’ equity). Statement of Income statement. Statement of stockholders’ equity Income statement. This Information may be reported in the annual report, but it is not @ required disciosure in any formal financial statement. It is also reported by investors’ services. This information may be included In the annual report but it is not a required disc:osure in Unancial statements. It is reported by Investors’ services ana w t._ financial pages of most newspapers. Balance sheet (Treasury Stock amount deducted In the stockholders’ equity section) ‘and also the statement of stockholders’ equity.= 15A-1 Gulf Coast Airlines per share of comi mings from continuing eperal ni ‘disconiInued oper jied net earings por shar ers on ase ie prolitablity of the motels is not relevant as these motel are owned by Gull Coss! ‘Airlines.0 Minutes, Medium 15A-2 Academic Testing Services, Ine. Vax benefit) ‘cumulative effect of jamings per sharo: ynings from coniInulng operations 0,000 — $250,000") + 300,000 shares) ‘diacontInued operations ($450,000 + 300,000 shares) (93 belore extraordinary item and cumulative elfect of ‘accounting change [($2,500,000 - $250,000 preferred dividends) + [300,000 shares} Extraordinary lors ($760,000 + 300,000 shares) julailve eflect of ateounting change ($135,000 ~ 300,000 Ket earrings (7, = $250,000 preferred dividends) + 300,000 shares] “Preferred dividends: 40,000 shares x $6.25 = $250,000- / ~ 15A-2 Academic Testing Services, Inc. (concluded) ua esa aden doctored during 1884 (ats given) a8: Prelerred stock dividend (40,000 shares x $6.25 per share) —— Cash dividends Number of common share Out nding thro ind per common share ($675,000 » 200,000 shares): ~KELCER INTERIONS -T Income Staterseot { 5 For the Yoar Endee December 31, 1994 =e co lo} 0.09 ojojo| 4 0,0 0}0,0)— nage - he ctot TosS on discontinued operations (het cl com’ tax Bene ltS(| say esbotal ef esuninind nese (at mane wap ‘cumulanve 200,006 shares) 9 Principle15A: Keller interiors (concluded) Net income (from part #) Subtotal ss? Dividends Retained earnings, December 31,1994. EEE (cess of issuance as ® part of additio th ‘$0-called gain on sale of treasury stock and the value of common stock Issued should be reported in the balance she : ee eerste = SS) oe bd ie Recta ae ee i— At Recovery Sciences, Ine, ‘Number of Shares ] outstanaing Note to Instructor: Net income actually Increases book value throughout the year, not merely on the date: which net Income Is closed Into retained earnings. upon y20 Minutes, Medium GRANITE HILLS CORPORATION 1 5A-~5 Statement of Stock ° * For the Year Ended December ving Granite Hills CoFPoration CG: — Teter ! Capital Stock || Additional is “k = Treasury _| Sto€Khoiders' __ S10 Par Vatue| (Pi oon | ee aul ees January olincome tax benefit) Pitti i 25/2/3000) 1S 'a7/4 see SY r Lt et ont “*¢a00RRRSb Mites, Sty 10A~§ OverNight Letter ‘Sold 76% sharos of ~~ ~“‘Transactions ‘Treasury Stock —__ Additional Pak $44 per share. = ay = me = xT rate r br ined Earnings C "300,000 outstanding ahi $1. To be distribute ‘at June 15.. 7 [on June 20 10 stdekholders of record] DEK Dividend To Be Disiibuted ar Capital Stock — as + Issued 19,000 shares of ividend declared June 1. si 3 de ional Pald‘n Capi: Treasury Stock Tra _ Treasury Stock ngactlonape LSA: ¢t Letter (concluded) 083: Treasury stock, 1,400 Total stockholders" equity “Computation of rotalned vamings at bec Retained earnings at beginning ot your Add: Net income fo. year aE eT Mnnnaee! ia ¢ Computation of maximum legal cash dividend par share at Ga Dec. 31, 1994: — ‘earnings at Dec. 31, 1994 Ei Lass: Resirietion of retained earnings for Weasury clock owned ap ; Unrestricted retained earnings rr 53 [3/916/6/010) Number of shares of capital stock ouisianding (401,000 shares Ct Issued, ml is 1,400 'S held Tn treasury) ele Maxi legal cash divid dper ire ($3, divided ry 399,600 shares) 2 ed“a = LoA-7t Mandella Corporation ‘Common S10 issued, of ,000 shares ~ 10,000 ‘sl 0% = tal stock dividend ( cs MANDELLA CORPORATION Stockholders’ December 31, 1994 non stock, $5 par, 1,000,000 share sued and outstanding/1) shares authorized, 328 000 shares Nal: 'S]iry tems _ = ‘propriation loss (net of Income tax benel”s) ie 18 ($2,900,000 ~ 500,000 shares) ‘operations ($1,080,000 + 500, ‘share: befor raordinary items ($1,820,000 + 500,000) | | Extraordinary loss ($720,000 + 500,000} ie ed i ‘Net earnings ($1,100,000 + 500,000) 20 b Estimated net earnings per share next year: igs per share trom continuing operallons ___Esilmated Increase ($5.80 x 5%) Esllmated earnings per share next year CCM stejos ~The profitably (or loss) of the chain of restaurants will have no effect upon Sea Quest's earnings In future period. i gtI5B-2 © Synthetic Genetics, Ine, + 400,000 shares) im ‘Cumulative effect of accounting change ($140,000 + 400,000 shares) ‘Net earnings [($ 1,980,000 — $400,000) + 400,000 shares}Sem tRetio Ge SYNTHETIC GENET} ics, Statement of Retnined (ear Ender Doce: ‘As restated 7 ee S (aggregate) —___————— Relained earnings, = s FS 7 BSC STaR oT eoomeT eae — ed In 7. (dat given) a end (50,000 shares XOX X $10 par valve] —— fash dvidends to common stockhokiens ISB-2 (concluded) [mumber of Common shares Outstandin, throughout 1994 = Fer common share ($800,000 400,000 shares) — ow en eee5 1s 2 i Outstanding ‘Share — a per share cosh dividend || {21 f]0/0/0/0) ‘Balance $41 1]9[0[0{0}0} Bi a|3|80) Apr. 20__Capltal stock eplit 2 tor 1 T Balance ——__ fs4irf8(00, DOU alt{90) June 11 Acquired 2,000 shares of treasury Stock at cost of $56.60 per share Belance 7616 alte July 21 Relssued 2,000 shares of treasury | La 60 per: 2) OO) 010) a} 1010) u 7/8) 7 a a) t Note to Instructor: Net Income actually increases book value throughout the year, date that net Income Is closed Into retained earthgs. not merely upon the= l i me 47013 Souja yeirceg orpred| (orrea 404 $3) a fore ios “CE ‘be. 7 OMT ong 1388 470% saoroneoea To = ger ‘Dwi uosau THI None‘Yoretord payment of cash dividend dectar odin = prlor year ($1.50 x 260,000 shares). “Siock Dividend te Be Distributed | July [75 pe meon Sa tea (000 shares of common stock as 10% stod easury Stock [iL _tash [Purchases asury stock, wi 522 pe share: Craik ees Summary15B-6 Cornish Productions, Ine. (concluded) Stockholders’ Equity I For the Voor Decomber 31, 104 444] | $1/4)3,0}0'0}0) uthorzed, t wued, of which, 2,000 are tld In the treasury itt (a | dellctetl { Hitt do { | t { fat alojotor $620,400, a Nolo aiolo1o HY t } [ | Hr sitios eal el ET ‘earnings are restricted to the Of treasury stock owned. Ai Dec. jainied earnings Is restricted for thle rei OL available for dividends.| | | 2 {Ht A it a t'0}0,0 e2000g- € Comment on total dividends paid on common stock: Although the cash dividend declared remained unchanged ot $1.50 per s Geclared increased from $390,000 to $426, Outstanding at the date the current year 2,000 shares held in treasury = 24,000 additional shares outstandin, femalned unchanged, individual stockholders Of the 10% stock dividend distribution, ire, the totel cash dividends 000. This Increase was caused by an additlc;al 24,000 shares 's Cash dividend was: declare (26,000-share stock dividend - 19). Even though the dividend rate Tecelved 10% more In cash dividenas In the current yeara » 50 Minutes, Strong . 15B-7 Performance, Ing, + + is ity: as a Tommon siock, $10 par, 160,000 shares, Issued — ‘BEG shares, of which 10,000 are held inthe (reasury (1 jonal paid-in capital: “From ssuane= ot common stork (2) Siock d. lends (3) folal paid-in capital ngs) PERFORMANCE, ING. Stockholders’ Equity December 31, 1994 ve jock, $2.50 par, authorized 600,000 shares, Tssued and outstanding 376,000 shares (1) rpald-in capital: S From Issuance of common stock Tom. “fifate 7lotolo} ‘3 ~ Retained earnings (3) 2 2 Total stockholders‘ equity : rH anes 00 shares @ $2.50 par value t TT (2)_10,000 shares x ($52 reissuance price - $45 cost) « $70,000 rc i nad nana, Dee. 31,889 ee Eero a alal 17|3)3)010) ) iia Case 15-1 20 Minutes, Easy Unusual Events in Published Financial Statements @ _ Both the operating loss from the noncual minerals activities and the loss on disposal shouki be classified In ARCO’s Incomw statement as “discontinued operations” and should be shown separately from the results of ARCO’s ongoing business operations. These losses qualify for this separate treatment because the discontinued activities represented an entire identifiable “segivent™ of ARCO's business operations. Achange in the ostimated useful life of depreciable assets is a change In estimate, not a change In sccounting Principle. Changes In estimate affect only the current year and future years; the cumulative effect of such ‘changes upon prior years Is not computed. On the other had, hed American Alrlines changed the method used In computing ‘expense, the cumulative effect of such a change In accounting principle depreciation would be shown In the income statement In the year of the change. The explosion of a chemical plant meets the criteria for classification as an extraordinary Inas. These criteria ‘sre (1) material in amount, (2) unt:eual In nature, end (3) not expected to recut In the foreseeable future. @ Acchange in the method used to depreciate assets Is @ change in sccounting principle. Thoretore, the Cumulative effect of this change upon the net income of prior periods (a $175 milliof reduction) would appedr 8S a separate ltom In AT&T's income statement in the year of the change. @ Thecriteria for classification as an extraordinary ttem are (1) material In dollar amount, (2) unusuel in nature, and (3) not expected to recur In the foreseeable future. Condemnations of assets by governmental authorities Generally are viewed as meeting these criteria. Therefore, the $10 million gain woukl be classified as an ‘extraordinary item in Georgia Pacific's income statement.1 25 Minutes, Easy uae 4 Care 15.5 Squibb’s Extraordinary He a @ Not Income for 1966 is not affectod by the roctassification of the ioss from the Calogory Of extrmordingy ordinary. in either ceso, ths rct Income is reduced by the amount of the loss. sification, Extraordingny Hems was reduced $69 million as 8 result cf the rec! b Income before oxt:20rina whereas ordinary losses are deducted Inariving losses are deducted aftar the computation of this sub at Income before Extiaordinary toms, € Reclassification of this loss will reduce Income from contlauing operations. “Ordinary” operating loses relating to ongoing oper: in arriving at Income from continuing operations, whereas extraordinary losses are de: ination of this subtotal. lassification. When a company reports an extra. ordinary Item, tha price-cart 9 merket price of the stock by the per-shary earings byfore extraocdinary items. As explained in psrt 8, rectassification of Squibb’s $58 million loss wit reduce income before extraordinary Itoms, Thus, the reclassification a'so will reduce the per-share earnings before extrsordinar, itoms. ents ware inno wey aflocted by the Improper classification of this loss in the 1986 Therefore, there is no nead jor Squibb to sake any adjustment to its 1987 financial d The priceernings ratio © The 1967 financi financial statements. f — Theabllity of a comy of unrestricted r ordinary rather than extraordinary. Tharetare, ractas sification ability to pay cash dividends. ha company's cash position and the emount Hectod by reclassification of tha loss as 'S .0SS has no direct effect upon Squibb’s20 Minutes, Medium 2 It Midwestern $1,300,000 opvrating loss the salo. Other ttoms In the 1993 would have been $4,700; Continuing Ope: approximately $4,815, $2,000,000 In 1994, Midwestern Cc c¢ Givon that the basobei! teem was $4,815,000 In 1994, assuming that tt ($4,500,000 x 1.07 = $4,815,000). The operating loss incurred had not sold the baseball team st tha end of 1995 for the year. However, the company would Income statement would not heve heen attected. (000 less than was octually reported, oF $2,600 by tine basebal! y $1,300,000. m9 sold 3, Micwestem ,0 profitabiiity of the con‘inuing newspaper min 1893 indicates that! s7penses wore $32, a excoeded Its net revenue b or $30,990,000. - amounted to $1 300,000 less, Life without Baseball would hava incurred the team's $2,600,000). In 1993, Midwostern’s newspaper business earned 35 , 000, as shown by the subtol rations. if the profitability of those op 5 by 7% In 1994, they will eam $4,500,000 x 1.07 = $4,015,00° ould be expected to earn a wid earn @ net income of approximately case 15-3 Income trom still owned. and lost im thet yess. operations Increases by 7% of tax ettects) he team's exper:ses' (net 200,000, the net Fr enue must have30 Minutes, Strong oe % case 15ng 4 Pick @ Numi, converted. tt is important to recognize that futly diluted earnings represent 2 hypothetical case. The convertible securities have not actually been converted Into common shares as of the close of the current year, The total dollar amount of the company’s extraordinary loss can be uted from the earnings per share Information as follows: : eee $3.00)... share x3 e esis memny scorn si0ch would bs $08 por r share. When & company’s Income statemont Includes an éxtraordinary Item, the price-earnings ratios shown in newspapers are based upon primary earnings betore extraordinary items ($5.90 x 10 « 569) @ (1) $9.02 ($8.20 x 110%) Only the continuing operations will be earning revenue and expenses next year, and the extraordinary Item isnot expected to recur, Therefore, the starting point for projecting future net earnings sind be from sontiuing operations. Since both reverue and sxpensaa are expectad to increase by 10% earnings J8 per snare also should increase 10%. _ OF $748 (86.30 x 110%) The fully diluted earnings per share statistics show the effect that conversion of all of the convertible preferred stock into common shares would have had upon this year's eafnings. Earnings per share from Continuing operations would have been only $6.80, rather than $8.20. Thus, $6.80 per stare becomes the logical st eri eepoglanrecepdreicnidice a mee ‘expected to rise by 10% over those of the current year,s = case 155 35 Minutes, Strong i . +. But What Does It All Mean? ‘a Beginning ot year: 79,395,732 shares outstanding (82,080,998 issued — 4,593,664 held In treasury) y (83,980,306 Issued — 6,221,061 1 hares) End of year: 78,767,415 shares outstanding (63,980,306 yronsury shares) {$95,200,000 tota! dividend declared on commen stock. 79,333,333 approximate “umber of shares entitled to $1.20 per share dividend ($95,200,000 - $1.20 per share) ‘This answor appeers reasonable, since the number of common shares ounstanding ranged from 79,305,732 * at the beginning of the your to 78,767,415 at yearend. We cannot determine precisely the number of shares receiving eect quarterly dividend of 30 cents Ler share, but the 79,333,333 approximate figure for the overslt $1.20 annual dividend appears compallble with the beginning and ending actual figures. ‘The stock Issued during the year for the stock option plans consisted of treasury shares, not newly Issued shares. The Treasury Stock account I$ 5°“ te account for repurchases of a corporation's stock, as well as the reissuance of treasury shares. When stock ls repurchased and subsequently relesued, the Common Stock account Is not aff sury Stock sccount, a @ $20.89 average cost per share of treasury stock at the beginning of the year (6132,90G,.¥ ictal cost + 4,595,654 treasury shares) @ The aggregate reissue price for the treasury shares must have been lower than the cost to acquire those treasury shares, since the Additional Pald-in Capital account was reduced by the relssuance of the treasury stock. The cost of the treasury shares raissued was $16,700,000; the relesue price for the treasury shares must have been $15,300,000 to cause $1,400,000 reduction In Additional Pald-in Capital, {$55.79 averase ~ost per share for treasury stock acquired during the current year {gregats cost + 1,220,700 shares repurchased) © Earnings per share: Divide by the welghted-average number of shares outstanding throughout the year, Book value per share: Divide by the actual number of shares outstandi: ee ing as of the specific date (usually a ane.