Chapter 19 Share-Based Compensation and Earnings per Share
True/False Questions
1. The current FASB standard requires using intrinsic value accounting for employee stock options.
Answer: False Learning Objective: 2 Level of Learning: 1
2. Current year stock dividends and splits require retroactive restatement of EPS for all prior years presented in comparative financial statements.
Answer: True Learning Objective: 7 Level of Learning: 1
3. Compensation expense must be adjusted during the service period to reflect changes in the fair value of options caused by changes in the market price of the underlying shares.
Answer: False Learning Objective: 2 Level of Learning: 2
4. Stock options will be dilutive and included in the calculation of dilutive EPS if the exercise price is greater than the average market value of the stock.
Answer: False Learning Objective: 9 Level of Learning: 2
5. Dilutive convertible bonds affect both the numerator and the denominator in computing diluted EPS.
Answer: True Learning Objective: 10 Level of Learning: 1
6. If previous experience indicates that a material number of stock options will be forfeited before they vest, the fair value estimate of the options on the grant date should be adjusted to reflect that expectation.
Answer: True Learning Objective: 2 Level of Learning: 1
7. Except for tax considerations the potentially dilutive effect of convertible preferred stock is handled in EPS calculations in much the same way as convertible debt.
Answer: True Learning Objective: 10 Level of Learning: 1
8. No time weighting of contingently issuable shares is required when computing basic EPS.
Answer: True Learning Objective: 11 Level of Learning: 1
9. If a company's capital structure includes convertible bonds, diluted EPS might be reduced even if the bonds are not actually converted during the year.
Answer: True Learning Objective: 10 Level of Learning: 2
10. If a company reports an extraordinary gain, EPS must be disclosed on the face of the income statement for both income from ordinary continuing operations and net income.
Answer: True Learning Objective: 12 Level of Learning: 1
Matching Pair Questions
Use the following to answer questions 11-15:
11-15. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.
Terms:
A. Complex capital structure
B. Contingently issuable shares
C. Convertible bonds
D. Convertible preferred stock dividends
E. Diluted EPS
F. If converted method
G. Price-earnings ratio
H. Simple capital structure
I. Stock dividends and splits
J. Treasury stock method
Phrases:
11. ____ Add after-tax interest to EPS numerator.
12. ____ Applies to both convertible debt and convertible equity securities.
13. ____ Approximation of EPS assuming potential common shares became common stock.
14. ____ Assumption used for options, rights, and warrants.
15. ____ Dual presentation of EPS does not apply.
Answer: 11-C; 12-F; 13-E; 14-J; 15-H
Use the following to answer questions 16-20:
16-20. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.
Terms:
A. Contingently issuable shares
B. Convertible bonds
C. Convertible preferred stock dividends
D. Diluted EPS
E. If converted method
F. Price-earnings ratio
G. Stock dividends and splits
H. Times interest earned multiple
I. Treasury stock method
J. Undeclared preferred dividends
Phrases:
16. ____ Expresses the market value of a stock as a multiple of EPS.
17. ____ Factored into EPS if the stock is cumulative.
18. ____ Handled retroactively in computing current and prior years' EPS.
19. ____ Omitted from the EPS numerator under the if converted approach.
20. ____ Included in diluted EPS when performance criterion is met.
Answer: 16-F; 17-J; 18-G; 19-C; 20-A
Use the following to answer questions 21-25:
21-25. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.
Terms:
A. Antidilutive security
B. Basic EPS
C. Convertible bonds
D. Dividend payout ratio
E. Earnings available to common shareholders
F. Issuance of new shares
G. Multiple convertible securities
H. Options, rights, and warrants
I. Preferred dividends
J. Preferred dividends
Phrases:
21. ____ Need to be ranked high to low in terms of dilutive effect.
22. ____ No dilution considered.
23. ____ Tends to be low for growth companies.
24. ____ The numerator in the EPS formula.
25. ____ The treasury stock method is used.
Answer: 21-G; 22-B; 23-D; 24-E; 25-H
Use the following to answer questions 26-30:
26-30. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.
Terms:
A. Antidilutive security
B. Basic EPS
C. Convertible bonds
D. Contingently issuable shares
E. Earnings available to common shareholders
F. Issuance of new shares
G. Multiple convertible securities
H. Options, rights, and warrants
I. Preferred dividends
J. Reacquired shares
Phrases:
26. ____ Potentially dilutive debt.
27. ____ Time-weighted decrease in the basic EPS denominator.
28. ____ Time-weighted increase in the basic EPS denominator.
29. ____ Decrease in the EPS numerator.
30. ____ Does not affect and is not affected by EPS calculations.
Answer: 26-C; 27-J; 28-F; 29-I; 30-A
Use the following to answer questions 31-35:
31-35. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.
Terms:
A. Bonuses
B. Expired options
C. Grant date
D. Option exercise date
E. Option exercise price
F. Performance condition plans
G. Stock option
H. SARs
I. Stock volatility
J. Vesting period
Phrases:
31. ____ A right to buy shares of stock in the future.
32. ____ Shares given for achieving financial goals.
33. ____ Benefit period over which stock option compensation expense is spread.
34. ____ Paid-in capital effectively renamed under the fair value approach.
35. ____ Expensed as compensation in the period earned.
Answer: 31-G; 32-F; 33-J; 34-B; 35-A
Use the following to answer questions 36-40:
36-40. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.
Terms:
A. Bonuses
B. Expired options
C. Grant date
D. Option exercise date
E. Option exercise price
F. Performance condition plans
G. Stock option
H. SARs
I. Stock volatility
J. Vesting period
Phrases:
36. ____ Require(s) liability recognition if the employee can elect to receive cash or stock.
37. ____ Date on or after which employees can buy stock with options.
38. ____ Date on which options are awarded.
39. ____ An important factor in option pricing models.
40. ____The amount paid to convert the option into stock.
Answer: 36-H; 37-D; 38-C; 39-I; 40-E
Multiple Choice Questions
41. The single accounting number in the annual report that receives the most attention by investors is:
A) Total revenue.
B) Book value per share.
C) Equity per share.
D) Earnings per share.
Answer: D Learning Objective: 12 Level of Learning: 1
42. A primary goal of earnings per share determination is:
A) Conservatism.
B) Comparability.
C) Materiality.
D) Objectivity.
Answer: B Learning Objective: 12 Level of Learning: 1
43. ABC declared and paid cash dividends in January of the current year to its common shareholders. The dividend:
A) Will be added to the numerator of the earnings per share fraction for the current year.
B) Will be added to the denominator of the earnings per share fraction for the current year.
C) Will be subtracted from the numerator of the earnings per share fraction for the current year.
D) Has no effect on the earnings per share for the coming year.
Answer: D Learning Objective: 5 Level of Learning: 2
44. The reporting of earnings per share is required only for:
A) Private companies.
B) Companies with complex capital structures.
C) Publicly traded corporations.
D) Medium-sized and large corporations.
Answer: C Learning Objective: 12 Level of Learning: 1
45. When a company's only potential common shares are convertible bonds:
A) Diluted EPS will be greater if the bonds are actually converted than if they are not converted.
B) Diluted EPS will be smaller if the bonds are actually converted than if the bonds are not converted.
C) Diluted EPS will be the same whether or not the bonds are converted.
D) The effect of conversion on diluted EPS cannot be determined without additional information.
Answer: C Learning Objective: 6 Level of Learning: 2
46. If convertible bonds were issued at a discount, when computing diluted EPS, the amortization of the bond discount:
A) Will have no effect.
B) Will decrease the numerator.
C) Will increase the numerator.
D) May increase or decrease the numerator, depending on the amortization method used.
Answer: C Learning Objective: 10 Level of Learning: 2
47. XYZ paid $10,000 in dividends in January of the current year to its preferred shareholders. The preferred stock is nonconvertible and noncumulative. The dividend:
A) Will be added to the denominator of the earnings per share fraction for the current year.
B) Will be added to the numerator of the earnings per share fraction for the current year.
C) Will be subtracted from the numerator of the earnings per share fraction for the current year.
D) May not affect earnings per share depending on the declaration date.
Answer: D Learning Objective: 10 Level of Learning: 2
48. When computing earnings per share, noncumulative preferred dividends not declared should be:
A) Ignored.
B) Deducted from earnings for the year.
C) Added to earnings for the year.
D) Deducted, net of tax effect, from earnings for the year.
Answer: A Learning Objective: 8 Level of Learning: 1
49. When computing earnings per share, cumulative preferred dividends not declared should be:
A) Deducted from earnings for the year.
B) Deducted, net of tax effect, from earnings for the year.
C) Added to earnings for the year.
D) Ignored.
Answer: A Learning Objective: 8 Level of Learning: 1
50. Basic earnings per share is computed using:
A) The actual number of common shares outstanding at the end of the year.
B) A weighted-average of preferred and common shares.
C) The number of common shares outstanding plus common stock equivalents.
D) Weighted-average common shares outstanding for the year.
Answer: D Learning Objective: 6 Level of Learning: 1
51. Which of the following is a correct statement concerning earnings per share?
A) Earnings per share can never be a negative number.
B) Earnings per share must be reported for all corporations.
C) If a company has an extraordinary loss, at least two EPS amounts must be reported.
D) Reported earnings per share is the result of dividing weighted-average shares by net income.
Answer: C Learning Objective: 12 Level of Learning: 1
52. When a company's income statement includes an extraordinary gain, the company should report per share information on:
-
Net Income
Extraordinary Gain
A)
Yes
No
B)
Yes
Yes
C)
No
No
D)
No
Yes
Answer: B Learning Objective: 12 Level of Learning: 1
53. When a company's income statement includes discontinued operations and a gain on the sale of machinery, the company should report per share information on:
-
Net income
Discontinued operations
Gain on sale of machinery
A)
Yes
No
No
B)
Yes
Yes
No
C)
Yes
No
Yes
D)
Yes
Yes
Yes
Answer: B Learning Objective: 12 Level of Learning: 1
54. The result of a stock split is:
A) A larger number of more valuable shares.
B) An increase in corporate assets.
C) An increase in shareholders' equity.
D) A larger number of less valuable shares.
Answer: D Learning Objective: 7 Level of Learning: 1
55. When computing diluted earnings per share, which of the following will be omitted from the calculation?
A) Dividends paid on common stock.
B) The weighted average common shares.
C) The effect of stock splits.
D) The number of common shares represented by stock purchase warrants.
Answer: A Learning Objective: 6 Level of Learning: 1
56. When computing diluted earnings per share, stock options:
A) Are included if they are antidilutive.
B) Should be ignored.
C) Are included if they are dilutive.
D) Increase the numerator while not affecting the denominator.
Answer: C Learning Objective: 9 Level of Learning: 2
57. Basic and diluted earnings per share data are required to be reported:
A) In footnotes to the financial statements.
B) Only if they add to the relevance of the income statement.
C) In the summary section of the annual report.
D) On the face of the income statement.
Answer: D Learning Objective: 12 Level of Learning: 2
58. Which of the following will require a recalculation of weighted-average shares outstanding for all years presented?
A) Stock dividends and stock splits.
B) Stock dividends but not stock splits.
C) Stock splits but not stock dividends.
D) Stock rights.
Answer: A Learning Objective: 9 Level of Learning: 2
59. All other things equal, what is the effect on earnings per share when a corporation acquires shares of its own stock on the open market?
A) Decrease.
B) No effect if the shares are held as treasury shares.
C) Increase only if the shares are considered to be retired.
D) Increase.
Answer: D Learning Objective: 7 Level of Learning: 2
60. If a stock dividend were distributed, when calculating the current year's EPS, the shares distributed are treated as having been issued:
A) At the end of the year.
B) At the beginning of the year.
C) On the declaration date.
D) On the date of distribution.
Answer: B Learning Objective: 7 Level of Learning: 2
61. If a stock split occurred, when calculating the current year's EPS, the shares are treated as issued:
A) At the end of the year.
B) On the first day of the next fiscal year.
C) At the beginning of the year.
D) On the date of distribution.
Answer: C Learning Objective: 7 Level of Learning: 1
62. The adjustment to the weighted-average shares for retired shares is the same as for issuing new shares except:
A) The shares are deducted rather than added.
B) The shares are added rather than deducted.
C) The shares are treated as being acquired at the end of the year.
D) The shares are treated as being acquired at the beginning of the year.
Answer: A Learning Objective: 6 Level of Learning: 2
63. Preferred dividends are subtracted from earnings when computing earnings per share whether or not the dividends are declared or paid if the preferred stock is:
A) Callable.
B) Convertible.
C) Participating.
D) Cumulative.
Answer: D Learning Objective: 8 Level of Learning: 2
64. Preferred dividends would not be subtracted from earnings when computing earnings per share in a year when the dividends are not declared if the preferred stock is:
A) Noncumulative.
B) Convertible.
C) Participating.
D) Cumulative.
Answer: A Learning Objective: 8 Level of Learning: 2
65. How many types of potential common shares must a corporation have in order to be said to have a complex capital structure?
A) 3.
B) 2.
C) 1.
D) 0.
Answer: C Learning Objective: 5 Level of Learning: 1
66. Which of the following is not a potential common stock?
A) Convertible preferred stock.
B) Convertible bonds.
C) Stock rights.
D) Participating preferred stock.
Answer: D Learning Objective: 5 Level of Learning: 1
67. Basic earnings per share ignores:
A) All potential common shares.
B) Some potential common shares, but not others.
C) Dividends declared on noncumulative preferred stock.
D) Stock splits.
Answer: A Learning Objective: 5 Level of Learning: 1
68. Stock options, rights, and warrants are different from convertible securities in that they:
A) Typically increase cash upon exercise.
B) Usually reduce total assets upon exercise.
C) Often reduce liabilities upon exercise.
D) Normally increase retained earnings upon exercise.
Answer: A Learning Objective: 9 Level of Learning: 1
69. Stock options do not affect the calculation of:
A) Diluted EPS.
B) Weighted-average common shares.
C) The denominator in the diluted EPS fraction.
D) Basic EPS.
Answer: D Learning Objective: 9 Level of Learning: 2
70. The calculation of diluted earnings per share assumes that stock options were exercised and that the proceeds were used to:
A) Buy common stock as an investment.
B) Retire preferred stock.
C) Buy treasury stock.
D) Increase net income.
Answer: C Learning Objective: 9 Level of Learning: 2
71. The calculation of diluted earnings per share assumes that stock options were exercised and that the proceeds were used to buy treasury stock at:
A) The end-of-year market price.
B) The average market price during the period.
C) The purchase price stated on the options.
D) The stock's par value.
Answer: B Learning Objective: 9 Level of Learning: 1
72. When we assume conversion of convertible bonds, the numerator is increased by:
A) The amount of after-tax interest.
B) The gross amount of interest.
C) The weighted-average interest.
D) The amount of cash paid during the current year for interest.
Answer: A Learning Objective: 10 Level of Learning: 1
73. When we take into account the dilutive effect of stock options, rights, and warrants in the calculation of EPS, the method used is called the:
A) Optional method.
B) If converted method.
C) Dilution method.
D) Treasury stock method.
Answer: D Learning Objective: 9 Level of Learning: 1
74. When we take into account the dilutive effect of convertible securities in the calculation of EPS, the method used is called the:
A) Treasury stock method.
B) If converted method.
C) Optional method.
D) Dilution method.
Answer: B Learning Objective: 10 Level of Learning: 1
75. Nonconvertible bonds affect the calculation of:
A) Basic earnings per share.
B) Diluted earnings per share.
C) Both A and C.
D) None of the above is correct.
Answer: D Learning Objective: 5 Level of Learning: 2
76. A simple capital structure might include:
A) Stock rights.
B) Convertible bonds.
C) Nonconvertible preferred stock.
D) Stock purchase warrants.
Answer: C Learning Objective: 5 Level of Learning: 1
77. In computing diluted earnings per share, the treasury stock method is used for:
A) Stock warrants.
B) Stock splits.
C) Reverse stock splits.
D) Convertible preferred stock.
Answer: A Learning Objective: 9 Level of Learning: 1
78. When several types of potential common shares exist, the one that enters the computation of diluted EPS first is the one with the:
A) Highest incremental effect.
B) Higher numerator.
C) Median incremental effect.
D) Lowest incremental effect.
Answer: D Learning Objective: 5 Level of Learning: 1
79. Contingently issuable shares may be included in:
A) Basic EPS.
B) Diluted EPS.
C) Both A and C.
D) None of the above is correct.
Answer: B Learning Objective: 11 Level of Learning: 1
80. Which of the following results in increasing basic earnings per share?
A) Paying more than carrying value to retire outstanding bonds.
B) Issuing cumulative preferred stock.
C) Purchasing treasury stock.
D) All of the above decrease basic earnings per share.
Answer: C Learning Objective: 5 Level of Learning: 1
81. The most important accounting objective for executive stock options is:
A) Measuring and reporting the amount of compensation expense during the service period.
B) Measuring their fair value for balance sheet purposes.
C) To disclose increases or decreases in the stock options held at the end of each accounting period.
D) None of the above is correct.
Answer: A Learning Objective: 2 Level of Learning: 1
82. Executive stock options should report as compensation expense:
A) Using the intrinsic value method.
B) Using the fair value method.
C) Using either the fair value method or the intrinsic value method.
D) Only on rare occasions.
Answer: B Learning Objective: 2 Level of Learning: 1
83. Which of the following statements is true regarding SARS payable in cash?
A) Any change in estimated total compensation is recorded as a prior adjustment.
B) The total amount of compensation is not known for certain until the date the SAR is exercised.
C) The liability is adjusted only to reflect each additional year of service.
D) None of the above is correct.
Answer: B Learning Objective: 3 Level of Learning: 2
84. The compensation associated with a share of restricted stock under a stock award plan is:
A) The market price of a share of similar fixed income securities.
B) The market price of an unrestricted share of the same stock.
C) The book value of an unrestricted share of the same stock.
D) The book value of a share of similar stock.
Answer: B Learning Objective: 1 Level of Learning: 1
85. If restricted stock is forfeited because an employee leaves the company, the appropriate accounting procedure is to:
A) Reverse related entries made previously.
B) Do nothing.
C) Prepare correcting entries.
D) Record an income item.
Answer: A Learning Objective: 2 Level of Learning: 2
86. Under the fair value approach for recognizing compensation under a stock option plan, unanticipated forfeitures are treated as:
A) A change in accounting principle.
B) A loss.
C) An income item.
D) A change in estimate.
Answer: D Learning Objective: 2 Level of Learning: 2
Use the following to answer questions 87-88:
During 2006, Falwell Inc. had 500,000 shares of common stock and 50,000 shares of 6% cumulative preferred stock outstanding. The preferred stock has a par value of $100 per share. Falwell did not declare or pay any dividends during 2006.
Falwell's net income for the year ended December 31, 2006, was $2.5 million. The income tax rate is 40%. Falwell granted 10,000 stock options to its executives on January 1 of this year. Each option gives its holder the right to buy 20 shares of common stock at an exercise price of $29 per share. The market price of the common stock averaged $30 per share during 2006, and the price on 12/31/06 was $33.
87. What is Falwell's basic earnings per share for 2006, rounded to the nearest cent?
A) $3.14
B) $4.40
C) $5.00
D) None of the above is correct.
Answer: B Learning Objective: 9 Level of Learning: 3
Rationale:
net preferred income dividends $2,500,000 - (50,000 x $100 x 6%) $2,200,000
—————————————————— = ——————— = $4.40/share
500,000 500,000 shares common shares
88. What is Falwell's diluted earnings per share for 2006, rounded to the nearest cent?
A) $3.14
B) $4.90
C) $4.34
D) Cannot determine from the given information.
Answer: C Learning Objective: 9 Level of Learning: 3
Rationale:
The computation (in $ 000's) is as follows:
net preferred income dividends $2,500,000 - (50,000 x $100 x 6%) $2,200,000
—————————————————— = ——————— = $4.34/share
500,000 + 6,667 * 506,667 shares
common shares net shares added from
on 1/1/06 conversion of options
*10,000 options x 20 shares/option = 200,000 shares;
Proceeds = 200,000 x $29 = $5,800,000
$5,800,000 / $30 per share = 193,333 shares of treasury stock
Net shares added = 200,000 - 193,444 = 6,667
Use the following to answer questions 89-90:
During 2006, Angel Corporation had 900,000 shares of common stock and 50,000 shares of 6% preferred stock outstanding. The preferred stock does not have cumulative or convertible features. Angel declared and paid cash dividends of $300,000 and $150,000 to common and preferred shareholders, respectively, during 2006.
On January 1, 2005, Angel issued $2,000,000 of convertible 5% bonds at face value. Each $1,000 bond is convertible into 5 common shares.
Angel's net income for the year ended December 31, 2006, was $6 million. The income tax rate is 20%.
89. What is Angel's basic earnings per share for 2006, rounded to the nearest cent?
A) $5.29
B) $5.57
C) $6.50
D) None of the above is correct.
Answer: C Learning Objective: 5 Level of Learning: 3
Rationale: The basic EPS is $6.50.
The computation is as follows:
net preferred income dividends $6,000,000 - 150,000 $5,850,000
—————————————————— = ——————— = $6.50/share
900,000 900,000 shares common shares
90. What will Angel report as diluted earnings per share for 2006, rounded to the nearest cent?
A) $6.43
B) $6.25
C) $6.22
D) None of the above is correct.
Answer: D Learning Objective: 10 Level of Learning: 3
Rationale:
net preferred after-tax income dividends interest savings $6,000,000 - 150,000 + $80,000* $5,930,000
————————————————————— = ——————— = $6.52/share**
900,000 + (2,000 x 5) 910,000 shares shares conversion at Jan. 1 of bonds
* (2,000,000 x 5%) = $100,000 in interest; $100,000 x 20% = $20,000 in tax savings
So after-tax interest cost = $80,000.
**Because, this increases EPS, it is antidilutive. Only $6.50 basic EPS will be reported.
Use the following to answer questions 91-93:
Wilson Inc. developed a business strategy that used stock options as a major compensation incentive for is top executives. On 1/1/05, 20 million options were granted, each giving the executive owning them the right to acquire five $1 par value common shares. The exercise price is the market price on the grant date—$10 per share. Options vest on 1/1/07. They cannot be exercised before that date and will expire on 12/31/10. The fair value of the 20 million options, estimated by an appropriate option pricing model, is $40 per option.
91. Wilson's compensation expense in 2005 for these stock options was:
A) $0
B) $200 million
C) $800 million
D) None of the above is correct.
Answer: B Learning Objective: 2 Level of Learning: 3
Rationale:
The computation is as follows:
Estimated value of the options at January 1, 2005:
$40 estimated fair value/option x 20 million options granted = $800 million fair value of options
Fair value is spread over four years of vesting period at $200 million/year.
92. On March 1, 2009, when the market price of Wilson's stock was $14 per share, 3 million of the options were exercised. The journal entry to record this would include:
A) A debit to paid-in capital – stock options for $42 million.
B) A credit to paid-in capital (excess of par) for $285 million
C) A credit to common stock for $75 million
D) All of the above are correct.
Answer: B Learning Objective: 2 Level of Learning: 3
Rationale:
The computation is as follows:
Cash: 3 million options x 5 shares/option x $10/share = $150 million
Paid-in Capital - stock options: 3 million options x $40/option) = $120 million
Common stock: 15 million shares x $1 par/share = $15 million
Paid-in capital in excess of par (to balance) = $285 million
93. Assume that all compensation expense from the stock options granted by Wilson has already been recorded. Further assume that 200,000 options expire without being exercised in 2010? The journal entry to record this would include:
A) Debit to paid-in capital - stock options for $8 million.
B) A debit to common stock for $5 million.
C) A debit to paid-in capital - expiration of stock options for $8 million.
D) None of the above is correct.
Answer: A Learning Objective: 2 Level of Learning: 3
Rationale: This is 200,000 options that had been recorded by credits to paid-in capital - stock options for $8 million, i.e., 200,000 options x $40 option. This is reversed at expiration.
Use the following to answer questions 94-95:
Pastore Inc. granted options for one million shares of its $1 par common stock at the beginning of the current year. The exercise price is $35 per share, which was also the market value of the stock on the grant date. The fair value of the options was estimated at $8 per option.
94. What would be the total compensation indicated by these options?
A) $3 million.
B) $27 million.
C) $ 8 million.
D) $35 million.
Answer: C Learning Objective: 2 Level of Learning: 3
Rationale: 1,000,000 x $8 = $8,000,000
95. If the options have a vesting period of five years, what would be the balance in "Paid-in Capital-Stock Options" three years after the grant date?
A) A credit of $4.8 million.
B) A credit of $16.2 million.
C) A debit of $4.8 million.
D) A debit of $16.2 million.
Answer: A Learning Objective: 2 Level of Learning: 3
Rationale: 1,000,000 x $8 x 3/5 = $4,800,000
Use the following to answer questions 96-99:
Wall Drugs offered an incentive stock option plan to its employees. On January 1, 2006, options were granted for sixty thousand $1 par common shares. The exercise price equals the $5 market price of the common stock on the grant date. The options cannot be exercised before January 1, 2009, and expire December 31, 2010. Each option has a fair value of $1 based on an option pricing model.
96. What is the total compensation cost for this plan?
A) $0.
B) $60,000.
C) $240,000.
D) $300,000.
Answer: B Learning Objective: 2 Level of Learning: 3
Rationale: 60,000 x $1 = $60,000
97. Which is the correct entry to record compensation expense for the year 2006?
-
A)
Compensation expense
12,000
Paid-in capital-stock options
12,000
B)
Compensation expense
20,000
Common stock
20,000
C)
Compensation expense
20,000
Paid-in capital-stock options
20,000
D)
Compensation expense
80,000
Paid-in capital-stock options
80,000
Answer: C Learning Objective: 2 Level of Learning: 3
Rationale: (60,000 x $1)/3 = $20,000
98. Which is the correct entry to record the exercise of 90% the options on April 15, 2009, when the market price of the stock was $8?
-
A)
Cash
270,000
Paid-in capital-stock options
54,000
Common stock
60,000
Paid-in capital—excess of par
264,000
B)
Cash
378,000
Paid-in capital-stock options
54,000
Common stock
54,000
Paid-in capital—excess of par
378,000
C)
Cash
270,000
Paid-in capital-stock options
54,000
Compensation expense
108,000
Common stock
54,000
Paid-in capital—excess of par
378,000
D)
Cash
270,000
Paid-in capital-stock options
54,000
Common stock
54,000
Paid-in capital—excess of par
270,000
Answer: D Learning Objective: 2 Level of Learning: 3
Rationale:
-
Cash (60,000 x 90% x $5)
270,000
Paid-in-capital – stock options
($60,000 x 90%)
54,000
Common stock (60,000 x 90% x $1)
54,000
Paid-in-capital-excess of par
270,000
99. What is the entry to record the expiration of 10% of the options on December 31, 20010?
-
A)
Paid-in capital-stock options
6,000
Paid-in capital—expiration to stock options
6,000
B)
Paid-in capital-stock options
6,000
Retained earnings
6,000
C)
Paid-in capital-stock options
6,000
Compensation expense
6,000
D)
Stock options receivable
30,000
Common stock
6,000
Paid-in capital—excess of par
27,000
Answer: A Learning Objective: 2 Level of Learning: 3
Rationale:
60,000 x $1 x 10% = $6,000
When unexercised options expire, the paid-in capital is renamed.
100. On December 31, 2005, Albacore Company had 300,000 shares of common stock issued and outstanding. Albacore issued a 10% stock dividend on June 30, 2006. On September 30, 2006, 12,000 shares of common stock were reacquired as treasury stock. What is the appropriate number of shares to be used in the basic earnings per share computation for 2006?
A) 303,000.
B) 342,000.
C) 312,000.
D) 327,000.
Answer: D Learning Objective: 2 Level of Learning: 3
Rationale: (300,000 x 1.10) (12,000 x 3/12) = 327,000
101. On December 31, 2005, Beta Company had 300,000 shares of common stock issued and outstanding. Beta issued a 5% stock dividend on June 30, 2006. On September 30, 2006, 40,000 shares of common stock were reacquired as treasury stock. What is the appropriate number of shares to be used in the basic earnings per share computation for 2006?
A) 315,000.
B) 307,500.
C) 305,000.
D) 267,500.
Answer: C Learning Objective: 7 Level of Learning: 3
Rationale: (300,000 x 1.05) (40,000 x 3/12) = 305,000
102. On December 31, 2005, the Bennett Company had 100,000 shares of common stock issued and outstanding. On July 1, 2006, the company sold 20,000 additional shares for cash. Bennett's net income for the year ended December 31, 2006 was $650,000. During 2006, Bennett declared and paid $89,000 in cash dividends on its nonconvertible preferred stock. What is the 2006 basic earnings per share?
A) $5.91.
B) $5.61.
C) $5.10.
D) None of the above is correct.
Answer: C Learning Objective: 7 Level of Learning: 3
Rationale:
103. On December 31, 2005, the Frisbee Company had 250,000 shares of common stock issued and outstanding. On March 31, 2006, the company sold 50,000 additional shares for cash. Frisbee's net income for the year ended December 31, 2006 was $700,000. During 2006, Frisbee declared and paid $80,000 in cash dividends on its nonconvertible preferred stock. What is the 2006 basic earnings per share?
A) $2.16.
B) $3.50.
C) $3.10.
D) $2.80.
Answer: A Learning Objective: 6 Level of Learning: 3
Rationale:
104. Flyaway Travel Company reported net income for 2006 in the amount of $90,000. During 2006, Flyaway declared and paid $2,125 in cash dividends on its nonconvertible preferred stock. Flyaway also paid $10,000 cash dividends on its common stock. Flyaway had 40,000 common shares outstanding from January 1 until 10,000 new shares were sold for cash on April 1, 2006. What is the 2006 basic earnings per share?
A) $1.85.
B) $1.64.
C) $1.76.
D) None of the above is correct
Answer: A Learning Objective: 6 Level of Learning: 3
Rationale:
105. Getaway Travel Company reported net income for 2006 in the amount of $50,000. During 2006, Getaway declared and paid $2,000 in cash dividends on its nonconvertible preferred stock. Getaway also paid $10,000 cash dividends on its common stock. Getaway had 40,000 common shares outstanding from January 1 until 10,000 new shares were sold for cash on July 1, 2006. A 2-for-1 stock split was granted on July 5, 2006. What is the 2006 basic earnings per share?
A) $.42.
B) $.47.
C) $.53.
D) $.56.
Answer: C Learning Objective: 7 Level of Learning: 3
Rationale:
106. Baldwin Company had 40,000 shares of common stock outstanding on January 1, 2006. On April 1, 2006 the company issued 20,000 shares of common stock. The company had outstanding stock options for 10,000 shares exercisable at $10 that had not been exercised by its executives. The end-of-year market price of common stock was $11 while the average price for the year was $12. What number of shares of stock should be used in computing diluted earnings per share?
A) 65,000.
B) 56,667.
C) 55,000.
D) 61,667.
Answer: B Learning Objective: 9 Level of Learning: 3
Rationale:
40,000 + (20,000 x 9/12) + (10,000 8,333*) = 56,667
*(10,000 x $10)/$12 = 8,333
107. Blue Cab Company had 50,000 shares of common stock outstanding on January 1, 2006. On April 1, 2006, the company issued 20,000 shares of common stock. The company had outstanding stock options for 5,000 shares exercisable at $10 that had not been exercised by its executives. The end-of-year market price of common stock was $11 while the average price for the year was $12. The company reported net income in the amount of $269,915 for 2006. What is the diluted earnings per share?
A) $3.60.
B) $4.10.
C) $4.50.
D) $3.81.
Answer: B Learning Objective: 9 Level of Learning: 3
Rationale:
*(5,000 x $10)/$12 = 4,167 from option, plus 50,000 + (20,000 x 9/12).
108. Purple Cab Company had 50,000 shares of common stock outstanding on January 1, 2006. On April 1, 2006, the company issued 20,000 shares of common stock. The company had outstanding stock options for 5,000 shares exercisable at $10 that had not been exercised by its executives. The end-of-year market price of common stock was $11 while the average price for the year was $12. The company reported net income in the amount of $269,915 for 2006. What is the basic earnings per share?
A) $4.10.
B) $3.86.
C) $3.60.
D) $4.15.
Answer: D Learning Objective: 9 Level of Learning: 3
Rationale: $269,915 / (50,000 + (20,000 x 9/12)) = $4.15
109. Burnet Company had 30,000 shares of common stock outstanding on January 1, 2006. On April 1, 2006, the company issued 15,000 shares of common stock. The company had outstanding stock options for 5,000 shares exercisable at $10 that had not been exercised by its executives. The end-of-year market price of common stock was $8 while the average for the year was $9. The company reported net income in the amount of $189,374 for 2006. What is the effect of the options?
A) The options are antidilutive.
B) The options will dilute EPS by $.09 per share.
C) The options will dilute EPS by $.33 per share.
D) The options will dilute EPS by $.17 per share.
Answer: A Learning Objective: 9 Level of Learning: 3
Rationale: Market price is less than exercise price, so the options are ignored when computing EPS.
110. At December 31, 2006, Hansen Corporation had 50,000 shares of common stock and 5,000 shares of 6%, $100 par cumulative preferred stock outstanding. No dividends were declared or paid in 2006. Net income was reported as $200,000. What is basic EPS?
A) $4.00.
B) $3.40.
C) $3.64.
D) $4.02.
Answer: B Learning Objective: 8 Level of Learning: 3
Rationale:
Use the following to answer questions 111-112:
Rudyard Corporation had 100,000 shares of common stock and 10,000 shares of 8%, $100 par convertible preferred stock outstanding during the year. Net income for the year was $400,000 and dividends were paid to both common and preferred shareholders. Rudyard's effective tax rate is 40%. Each share of preferred stock is convertible into 5 shares of common.
111. What is Rudyard's basic EPS?
A) $2.13.
B) $4.80.
C) $4.00.
D) $3.20.
Answer: D Learning Objective: 8 Level of Learning: 3
Rationale:
112. What is Rudyard's diluted EPS?
A) $2.13
B) $2.67
C) $3.20
D) $4.80
Answer: B Learning Objective: 10 Level of Learning: 3
Rationale:
113. Dulce Corporation had 200,000 shares of common stock outstanding during the current year. At the beginning of the year, options for 10,000 shares of common stock were granted with an exercise price of $20. The average market price of the common stock during the year was $25. Net income was $4 million. What is diluted EPS?
A) $20.00.
B) $19.80.
C) $19.23.
D) $18.18.
Answer: B Learning Objective: 9 Level of Learning: 3
Rationale:
*(10,000 x $20)/$25 = 8,000
114. Cracker Company had 2 million shares of common stock outstanding all through 2005. On April 1, 2006, an additional 100,000 shares were sold and issued. On September 30, 2006, Cracker declared a 2-for-1 stock split. Net income in 2006 and 2005 was $10 million and $8 million, respectively. On the 2006, comparative financial statements, EPS would be reported as follows:
-
2006 EPS
2005 EPS
A)
$2.41
$2.00
B)
$2.41
$4.00
C)
$4.82
$4.00
D)
$4.82
$2.00
Answer: A Learning Objective: 7 Level of Learning: 3
Rationale:
2005: $8,000,000/(2,000,000 x 2) = $2.00
2006: $10,000,000/[(2,000,000 x 2) + (100,000 x 9/12 x 2) = $2.41
115. Dublin Inc. had the following common stock record during the current calendar year:
-
Outstanding - beginning of year
2,000,000
Additional shares issued 6/30
100,000
Additional shares issued 9/30
100,000
A 10% stock dividend was paid on December 1. What is the number of shares to be used in computing basic EPS?
A) 2,075,000.
B) 2,282,500.
C) 2,475,000.
D) 2,620,000.
Answer: B Learning Objective: 7 Level of Learning: 3
Rationale: [2,000,000 + (100,000 x 6/12) + (100,000 x 3/12)] x 1.10 = 2,282,500
116. During the current year, East Corporation had 2 million shares of common stock outstanding. Two thousand, $1,000, 8% convertible bonds were issued at face amount at the beginning of the year. East reported income before tax of $3 million and net income of $1.8 million for the year. Each bond is convertible into ten shares of common stock. What is diluted EPS?
A) $.90.
B) $.95.
C) $.89.
D) $.94.
Answer: D Learning Objective: 10 Level of Learning: 3
Rationale:
*($3-$1.8)/$3 = 40%
117. Morrison Corporation had the following common stock record during the current calendar year:
-
Outstanding - January 1
2,000,000
Additional shares issued 3/31
100,000
Distributed a 10% stock dividend on 6/30
Additional shares issued 9/30
100,000
What is the number of shares to be used in computing basic EPS?
A) 2,000,000.
B) 2,200,000.
C) 2,307,500.
D) 2,310,000.
Answer: C Learning Objective: 7 Level of Learning: 3
Rationale: ($2,000,000 x 1.10) + (100,000 x 9/12 x 1.10) + (100,000 x 3/12) = 2,307,500