CHAPTER 16. Retained Earnings and Earnings per Share CONTENT ANALYSIS OF END-OF-CHAPTER ASSIGNMENTS. 1 Easy 5 Analytic Measurement Comprehension

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1 16-1 CONTENT ANALYSIS OF END-OF-CHAPTER ASSIGNMENTS CHAPTER 16 Retained Earnings and Earnings per Share NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY 16-1 Dividend Dates Four important dates for recording the cash dividend; journal entry 16-2 Ex-Dividend Date Difference between exdividend date and date of record 16-3 Participating Preferred Stock Definitions of fully participating and partially participating preferred stock 16-4 Property Dividend Method of recording property dividend 16-5 Stock Dividends Difference between an ordinary and special stock dividend 16-6 Small and Large Stock Dividends Small stock dividend and large stock dividends and the differences in recording them 16-7 Liquidating Dividend Differences in accounting for liquidating dividend and normal cash dividend 16-8 Error Correction Correcting errors from previous years 16-9 Retained Earnings Restrictions Reasons for restricting retained earnings TIME EST. AACSB AICPA BLOOM S 1 Easy 5 Analytic Measurement Comprehension 1 Easy 5 Analytic Measurement Comprehension 1 Easy 5 Analytic Measurement Comprehension 1 Easy 5 Analytic Measurement Comprehension 1 Easy 5 Analytic Measurement Comprehension 1 Easy 5 Analytic Measurement Comprehension 1 Easy 5 Analytic Measurement Comprehension 2 Easy 5 Analytic Measurement Comprehension 2 Easy 5 Analytic Measurement Comprehension

2 16-2 NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY Statement of Shareholders' Equity Comprehensive Income Statement of Retained Earnings Changes included in the statement of shareholder's equity Items included in accumulated other comprehensive income Format of statement; two common elements of statement of retained earnings Capital Structure Definition of simple capital structure Basic EPS Computation of basic EPS for firm with simple capital structure EPS Computation of weighted average number of shares for computation of EPS Stock Dividends and Splits Complex Capital Structure Complex Capital Structure and EPS Treasury Stock Method Dates of stock dividends and splits considered to be issued for computing EPS Identification of securities found in a complex capital structure Identification of EPS computed by a company with a complex capital structure Computation of diluted EPS under the treasury stock method TIME EST. AACSB AICPA BLOOM S 3 Easy 5 Analytic Measurement Comprehension 3 Easy 5 Analytic Measurement Comprehension 3 Easy 5 Analytic Measurement Comprehension 4 Easy 5 Analytic Measurement Comprehension 4 Easy 5 Analytic Measurement Comprehension 4 Easy 5 Analytic Measurement Comprehension 4 Easy 5 Analytic Measurement Comprehension 5 Easy 5 Analytic Measurement Comprehension 5 Easy 5 Analytic Measurement Comprehension 5 Easy 5 Analytic Measurement Comprehension

3 16-3 NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY Convertible Securities Convertible stocks and and EPS bonds; determination of impact and ranking; computations Disclosures Disclosures associated with basic and diluted earnings per share Dilutive Shares: U.S. GAAP and IFRS Extraordinary Items, EPS, and IFRS M16-1 Prior Period Adjustments EPS computed under U.S. GAAP standards and IFRS standards IFRS treatment of extraordinary items and IFRS Reflection of prior period adjustments in the financial statements M16-2 Shareholders' Equity Effect of cash and stock dividends on shareholders equity M16-3 Retained Earnings Dividend transactions and balance of retained earnings M16-4 Stock Split Effect of stock split on additional paid-in capital and retained earnings M16-5 Shareholders' Equity Dividend transactions, treasury stock transactions and balance of shareholder's equity M16-6 Weighted Average Shares Computation of weighted average number of shares for computation of EPS TIME EST. AACSB AICPA BLOOM S 5 Easy 5 Analytic Measurement Comprehension 5 Easy 5 Analytic Reporting Comprehension 5 Easy 5 Analytic Measurement Comprehension 5 Easy 5 Analytic Measurement Comprehension 2 AICPA Easy 5 Analytic Reporting Comprehension 1, 3 AICPA Easy 5 Analytic Measurement Application 3 AICPA Easy 5 Analytic Measurement Application 3 AICPA Moderate 10 Analytic Measurement Application 3 AICPA Moderate 10 Analytic Measurement Application 4 AICPA Easy 5 Analytic Measurement Comprehension

4 16-4 NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY M16-7 Basic EPS Preferred stock dividends and its effect on basic EPS M16-8 Capital Structure and Effect of cash and stock EPS dividends on EPS M16-9 Dilutive Securities and EPS M16-10 Dilutive Securities and EPS RE16-1 Preferred Stock Dividends RE16-2 Property Dividend RE16-3 Stock Dividend RE16-4 Stock Dividend RE16-5 Retained Earnings RE16-6 Prior Period Adjustments RE16-7 Weighted Average Shares RE16-8 Basic EPS Effect of dilutive securities on basic and diluted EPS Effect of dilutive securities on diluted EPS Computation of dividend distribution to fully participating stock Journal entries to record declaration of property dividend Journal entries to record declaration of stock dividend Journal entries to record declaration of stock dividend Effect of common stock dividend on retained earnings balance Correction of error as prior period adjustment Calculation of weighted average shares outstanding for use in computing EPS Calculation of weighted average shares outstanding for use in computing EPS TIME EST. AACSB AICPA BLOOM S 4 AICPA Easy 5 Analytic Measurement Comprehension 4 AICPA Moderate 15 Analytic Measurement Application 5 AICPA Moderate 10 Analytic Measurement Application 5 AICPA Easy 5 Analytic Measurement Application 1 Easy 10 Analytic Measurement Application 1 Easy 10 Analytic Measurement Application 1 Easy 10 Analytic Measurement Application 1 Moderate 10 Analytic Measurement Application 3 Moderate 10 Analytic Measurement Application 2 Moderate 15 Analytic Measurement Application 4 Moderate 10 Analytic Measurement Application 4 Moderate 10 Analytic Measurement Application

5 16-5 NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY RE16-9 Diluted EPS RE16-10 Diluted EPS Compensatory share options and their effect on the number of shares outstanding for computing diluted EPS Convertible preferred stock and its effect on diluted EPS RE16-11 Diluted EPS Convertible bonds and its effect on diluted EPS RE16-12 Basic and Diluted EPS Computation of basic and diluted EPS E16-1 Various Dividends Journal entries for payment of cash, property, and stock dividends; next level E16-2 Dividends Participating, nonparticipating, partially participating preferred stock; cumulative, noncumulative; arrears; compute amounts to be paid; compute dividend yields; next level E16-3 Various Dividends Journal entries for payment of cash, property, and stock dividends E16-4 Stock Dividend Journal entries on the date of declaration and the date of issuance for large and small stock dividends; shareholders equity presentation TIME EST. AACSB AICPA BLOOM S 5 Moderate 10 Analytic Measurement Application 5 Moderate 10 Analytic Measurement Application 5 Moderate 10 Analytic Measurement Application 5 Moderate 10 Analytic Measurement Application 1 Moderate 10 Analytic Measurement Application 1 Moderate 15 Analytic Measurement Application 1 Moderate 10 Analytic Reporting Application 1 Easy 15 Analytic Measurement Application

6 16-6 NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY E16-5 Stock Dividend Comparison E16-6 Prior Period Adjustments Comparison of the impact of a small stock dividend and a large stock dividend on the shareholders equity section of the balance sheet; next level Corrections to retained earnings, preparation of the statement of retained earnings E16-7 Restrictions Disclose bond and treasury stock restrictions E16-8 Retained Earnings Statement E16-9 Retained Earnings Statement Prior period adjustments, cash and stock dividends, stock retirement, acquisition of treasury stock Prior period adjustments, cash and stock dividends, stock retirement, acquisition of treasury stock E16-10 Shareholders Equity Balance sheet preparation; preferred, common, treasury stock E16-11 Changes in Shareholders Equity E16-12 Weighted Average Shares Given the prior year-end balance sheet and a list of transactions, prepare a statement of shareholders equity; compute return on shareholders equity Stock dividend, stock split, reacquisition TIME EST. AACSB AICPA BLOOM S 1 Easy 10 Analytic Measurement Analysis 2 Moderate 15 Analytic Measurement Analysis 3 Easy 10 Analytic Measurement Analysis 3 Moderate 15 Analytic Reporting Analysis 3 Moderate 15 Analytic Reporting Analysis 3 Moderate 15 Analytic Reporting Analysis 3 Moderate 15 Analytic Measurement Analysis 4 Moderate 15 Analytic Measurement Analysis

7 16-7 NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY TIME EST. AACSB AICPA BLOOM S E16-13 Weighted Average Shares Stock dividend, reacquisition 4 Moderate 15 Analytic Measurement Analysis E16-14 Earnings per Share Weighted average shares; nonconvertible preferred dividends; price/earnings ratio 4 Easy 15 Analytic Reporting Analysis E16-15 Earnings per Share Weighted average shares; use 4 Moderate 15 Analytic Reporting Analysis EPS to calculate net income; next level E16-16 Weighted Average Shares Calculation of weighted average shares, treasury stock, stock dividends E16-17 Comparative EPS Weighted average shares, stock split, stock dividend, comparative analysis E16-18 Basic EPS Weighted average shares; nonconvertible preferred dividends; compute price/earnings ratio E16-19 Basic EPS Weighted average shares; stock dividend, nonconvertible preferred stock, income statement presentation E16-20 Earnings Per Share Disclosure E16-21 Impact on EPS and Rankings E16-22 Convertible Preferred Stock, Convertible Bonds, and EPS Weighted average shares, income statement presentation, discontinued operations, extraordinary items Convertible stocks and bonds, computation of impact and ranking of securities Weighted average shares; diluted EPS calculation; next level 4 Easy 15 Analytic Measurement Analysis 4 Easy 15 Analytic Measurement Analysis 4 Easy 15 Analytic Measurement Analysis 4 Easy 15 Analytic Reporting Analysis 4 Easy 15 Analytic Reporting Analysis 5 Moderate 15 Analytic Measurement Analysis 5 Moderate 15 Analytic Measurement Analysis

8 16-8 NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY E16-23 Share Options and EPS E16-24 Convertible Preferred Stock and EPS E16-25 Convertible Bonds and EPS E16-26 Convertible Bonds and EPS E16-27 Convertible Securities and EPS E16-28 Convertible Securities and EPS Share options; compute diluted EPS; IFRS discussion; next level Weighted average shares; diluted EPS calculation Weighted average shares; diluted EPS calculation Weighted average shares; diluted EPS calculation Convertible preferred stocks and bonds; diluted EPS calculation; individual dilution; income statement and disclosure Convertible preferred stocks and bonds; diluted EPS calculations; individual dilution; income statement presentation TIME EST. AACSB AICPA BLOOM S 5 Easy 10 Analytic Measurement Analysis 5 Moderate 15 Analytic Measurement Analysis 5 Moderate 15 Analytic Measurement Analysis 5 Moderate 15 Analytic Measurement Analysis 5 Moderate 15 Analytic Reporting Analysis 5 Moderate 15 Analytic Reporting Analysis P16-1 Dividends Fully participating, partially participating, nonparticipating preferred stock; cumulative, noncumulative; computation of amounts to be paid 1 Moderate 35 Analytic Measurement Application P16-2 Dividends Nonparticipating, noncumulative preferred stock; fully participating, cumulative; five years net income or loss given; worksheet to show maximum amount available for cash dividends 1 AICPA Moderate 25 Analytic Measurement Analysis

9 16-9 NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY P16-3 Corrections, Dividends, Retained Earnings Statement Cash and stock dividends; corrections; retirement; prior period adjustment; journal entries; statement of retained earnings P16-4 Corrections Account analysis with correcting journal entries; preparation of corrected shareholders equity section P16-5 Stock Dividends, Splits Small and large stock dividends, cash (normal and liquidating) and property dividends, stock split; journal entries; shareholders equity presentation P16-6 Retained Earnings Statement P16-7 Comprehensive: Retained Earnings and Shareholders Equity P16-8 Comprehensive: Retained Earnings and Shareholders Equity Restrictions, stock retirement, stock split, stock and cash dividends, prior period adjustment, reissuance of treasury stock Preparation of retained earnings statement and shareholders equity section of balance sheet Preparation of retained earnings statement and shareholders equity section of balance sheet 1, 2 TIME EST. AACSB AICPA BLOOM S Moderate 25 Analytic Measurement Analysis 2 Challenging 40 Analytic Measurement Synthesis 3 Moderate 40 Analytic Measurement Analysis 1, 2, 3 Moderate 35 Analytic Measurement Analysis 1, AICPA Moderate 40 Analytic Measurement Analysis 2, 3 1, AICPA Moderate 40 Analytic Measurement Analysis 2, 3

10 16-10 NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY P16-9 Comprehensive: Shareholders Equity P16-10 Comprehensive: Shareholders Equity Journal entries; reacquisition, reissuance, retirement; cost method for treasury stock; donation; dividends; statement of shareholders equity; balance sheet disclosure with related notes Journal entries; reissuance of treasury stock; share option plan; donation; dividends; statement of shareholders equity; balance sheet disclosure with related notes; return on shareholders equity P16-11 Shareholders Equity Share option plan; employee share purchase plan; preparation of shareholders equity section with related notes P16-12 Comprehensive: Liabilities and Shareholders Equity P16-13 Comprehensive: Shareholders Equity Preparation of long-term liabilities and shareholders equity sections of balance sheet; computation of interest expense Determine amounts of prior period adjustment, cash dividends (preferred and common), property dividends, common shares issued, treasury stock, and EPS numerator 1, 2, 3 1, 2, 3 Challenging 45 Analytic Challenging 45 Analytic TIME EST. AACSB AICPA BLOOM S Measurement Synthesis Measurement Synthesis 3 AICPA Moderate 40 Analytic Measurement Analysis 1, AICPA Moderate 40 Analytic Measurement Analysis 2, 3 1, AICPA Moderate 40 Analytic Measurement Analysis 2, 3

11 16-11 NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY P16-14 Comprehensive: Dividends P16-15 Comprehensive: Dividends P16-16 Comprehensive: Retained Earnings, Journal Entries, and Statement Cash, stock, and property dividends; stock split; reacquisition; journal entries; shareholders equity presentation Cash, stock, and property dividends; reacquisition; stock split; journal entries; shareholders equity presentation Stock retirement, stock dividend, reacquisition, restrictions, cash dividends, prior period adjustments P16-17 Ratio Analysis Earnings with simple capital structure, calculation of dividend yield P16-18 Income Statement and Basic EPS P16-19 Comparative Income Statements and Basic EPS Preparation of multiple-step income statement; results of discontinued operations, extraordinary gain Preparation of multiple-step income statement; P/E ratio; next level P16-20 Earnings per Share Preparation of basic and diluted EPS; understand how this would change under IFRS; next level P16-21 Impact on EPS, Rankings, and Computations Convertible stocks and bonds; determination of impact and ranking; computations 1, 3 1, 3 1, 2, 3 TIME EST. AACSB AICPA BLOOM S Moderate 35 Analytic Measurement Analysis Moderate 35 Analytic Measurement Analysis Challenging 40 Analytic Measurement Synthesis 4 Easy 15 Analytic Measurement Application 4 Challenging 50 Analytic Reporting Synthesis 4 Challenging 35 Analytic Measurement Synthesis 5 Moderate 25 Analytic Measurement Analysis 4, 5 Challenging 35 Analytic Measurement Synthesis

12 16-12 NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY P16-22 Comprehensive: EPS P16-23 Convertible Securities and Earnings per Share P16-24 Comprehensive: EPS Weighted average shares, stock split, share options, convertible stocks; income statement disclosure; IFRS discussion Weighted average shares, stock dividends, share options, convertible stocks and bonds; extraordinary loss; basic and diluted EPS; income statement disclosures Weighted average shares, stock dividends, share options, convertible stocks and bonds; extraordinary loss; basic and diluted EPS; income statement disclosures P16-25 EPS Weighted average shares, stock split, reacquisition, stock warrants, convertible stocks and bonds; basic and diluted EPS; income statement presentation P16-26 EPS Weighted average shares, share options, stock warrants, convertible bonds; basic and diluted EPS C16-1 Dividends and Journal Entries Three important dates in recording cash dividends to shareholders; journal entries 4, 5 4, 5 4, 5 4, 5 4, 5 TIME EST. AACSB AICPA BLOOM S Moderate 35 Analytic Measurement Analysis Challenging 35 Analytic Challenging 35 Analytic Measurement Synthesis Measurement Synthesis AICPA Moderate 35 Analytic Measurement Analysis AICPA Moderate 35 Analytic Measurement Analysis 1 AICPA Moderate 20 Analytic Measurement Analysis

13 16-13 NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY C16-2 Stock Dividends and Splits Stock splits in the form of a dividend; differences between stock split effected in the form of a dividend and an ordinary stock dividend C16-3 Earnings per Share Preferred stock dividends and its effect on basic EPS; convertible bonds and diluted EPS computation C16-4 Complex Capital Structure C16-5 Dividends and Treasury Stock C16-6 Convertible Securities C16-7 Share Options and EPS C16-8 Analyzing Coca- Cola's Retained Earnings and EPS C16-9 Ethics and EPS Adjustment Define complex capital structure and related disclosures Accounting for cash and stock dividends; accounting for treasury stock The effect on diluted EPS of dilutive and antidilutive securities Share option plans and effect on diluted EPS Using real company annual reports; retained earnings and EPS Ethics; allowance for doubtful accounts; EPS; next level C16-10 Researching GAAP Using the FASB Codification System TIME EST. AACSB AICPA BLOOM S 1 AICPA Moderate 20 Analytic Measurement Analysis 4, 5 AICPA Moderate 20 Analytic Measurement Analysis 5 AICPA Moderate 20 Analytic Measurement Analysis 1 AICPA Moderate 20 Analytic Measurement Analysis 5 AICPA Moderate 20 Analytic Measurement Analysis 5 AICPA Moderate 20 Analytic Measurement Analysis Moderate 20 Analytic Measurement Analysis Moderate 20 Analytic Measurement Analysis Moderate 20 Analytic Measurement Analysis

14 ANSWERS TO GOT IT? 16-1 The four important dates are (1) the declaration date, (2) the ex-dividend date, (3) the date of record, and (4) the date of payment. On the declaration date, the corporation makes a journal entry to reduce retained earnings and establish the liability. No journal entry is made on the ex-dividend date; this is the date the stock stops selling with attached dividends. A memorandum entry is made on the date of record indicating that shareholders of record on that date are entitled to the dividend. On the date of payment, the Cash account is reduced and the liability eliminated On the ex-dividend date, the security stops selling with dividends attached. The ex-dividend date is the second business day before the date of record. On the date of record, the company examines the shareholder roles to determine who holds the stock and who will receive the dividend. Because it takes three business days for stock trades to be recorded, the date of record provides shareholders who owned the stock on the day prior to the ex-dividend date and who should receive the dividend Shareholders of fully participating preferred stock share with the common shareholders in any extra dividends. These extra dividends are distributed proportionally based on the respective total par value of each class of stock. Shareholders of partially participating preferred stock are limited in their participation to a fixed rate (based on their respective par value) or amount per share A property dividend is considered a nonreciprocal nonmonetary exchange where the corporation gives up an asset and receives no asset or service in return. The exchange is recorded at its fair value. Consequently, on the declaration date, a corporation first writes up or down the property (for example, stock held in another company) to be used in the dividend to its fair value on that date and recognizes a gain or loss. It then makes a second entry to reduce retained earnings and establish the dividend liability An ordinary stock dividend consists of the issuance of the same class of stock (i.e., common on common) for the dividend. A special stock dividend involves the distribution of a different class of stock (i.e., preferred on common) for the dividend A small stock dividend is one that presumably has a small decrease in market value of the stock. A stock dividend of less than 20% to 25% of the previously outstanding shares is considered a small stock dividend. A stock dividend involving a greater percentage distribution of shares is considered a large stock dividend. Neither a small nor a large stock dividend affects total shareholders equity, although each affects the components of shareholders equity. In the case of a small stock dividend, a corporation transfers an amount equal to the fair value of the newly issued shares from retained earnings to contributed capital on the date of declaration. For a large stock dividend, a corporation transfers an amount equal to the par value of the shares from retained earnings to contributed capital on the date of declaration

15 16-7 A liquidating dividend is treated as a return of contributed capital, whereas a normal cash dividend is treated as a reduction in retained earnings A corporation treats a correction of a material error made in a previous year as a prior period adjustment. The asset or liability account balance is corrected and retained earnings is increased or decreased for the amount of the error. Any related effect on income taxes is similarly recorded. The corporation reports the effect of the error (net of income taxes) on its current year s statement of retained earnings as an adjustment to the beginning retained earnings balance, as previously reported A corporation may restrict its retained earnings to meet legal requirements (e.g., treasury stock), to meet contractual restrictions (e.g., bond provisions), or because of discretionary actions (e.g., self-insurance). It reports a restriction in an explanatory note to its financial statements GAAP requires a corporation to disclose the separate changes in all its shareholders equity accounts as well as the changes in the number of shares of capital stock. Typically, the corporation will summarize these changes in its statement of changes in shareholders equity. This statement frequently will include the changes in retained earnings. Examples of changes included are the issuance of capital stock, the issuance and exercise of share options, transactions involving treasury stock, net income, and dividends A corporation might include in the Accumulated Other Comprehensive Income section of its shareholders equity the following items (amounts accumulated to date): 1. Unrealized increases (gains) or decreases (losses) in the fair value of investments in available-for-sale securities. 2. Translation adjustments from converting the financial statements of a company s foreign operations to U.S. dollars. 3. Certain gains and losses on certain types of derivative financial instruments that are designated as cash flow hedges. 4. Certain pension plan gains, losses, and prior service cost adjustments The suggested format is shown below. The two most common elements are net income and dividends. Beginning retained earnings, as previously reported Plus (minus): Prior period (and retrospective) adjustments (net of income tax effect) Adjusted beginning retained earnings Plus (minus): Net income (loss) Minus: Dividends (specifically identified, including per share amounts) Reductions due to retirement or reacquisition of capital stock Reductions due to conversion of bonds or preferred stock Ending retained earnings A simple capital structure is one that consists only of common stock outstanding (or also has nonconvertible preferred stock outstanding)

16 16-14 For a corporation with a simple capital structure, basic earnings per share is computed by dividing net income (less preferred dividends) by the weighted average number of common shares outstanding during the period The weighted average number of shares is the equivalent whole shares of common stock outstanding during the period. It is calculated by starting with the actual number of common shares outstanding at the beginning of the period and multiplying this layer of shares by the fraction of the year it is outstanding until more common stock is issued or reacquired. These new shares are added to the existing number of shares, and the new layer is multiplied by the fraction of the year it is outstanding. This process is continued for all the issuances during the year. The resulting equivalent whole units for all of the layers are added to determine the weighted average number of common shares for the period For computing earnings per share, stock dividends and splits do not affect the company s net assets. The company gives retroactive recognition to these events for all comparative income statements that it presents. That is, regardless of when they were actually issued, stock dividends and splits are assumed to have occurred at the beginning of the earliest period for which comparative financial statements are presented. This assumption enables a corporation to express all comparative earnings per share figures in terms of its most recent capital structure Several securities such as share options and warrants, convertible preferred stock and convertible bonds, participating securities and two-class stocks, and contingent shares might be found in the complex capital structure of a corporation The two earnings per share amounts generally reported by a corporation with a complex capital structure are basic earnings per share and diluted earnings per share. Besides common shares outstanding, diluted earnings per share include all dilutive potential common shares (options and warrants, convertible preferred stock, and convertible bonds) The treasury stock method is used to determine the change in the number of shares for a corporation s diluted earnings per share calculations when the corporation has share options and warrants. The increase in the denominator is the difference between the assumed shares issued and the assumed shares reacquired (using the average market price) under the arrangements To develop the ranking, the if-converted method is used. First, the impact of the conversion of each convertible security upon earnings per share is computed. This impact is calculated by dividing the increase in the numerator (that is, the savings in preferred dividends or interest expense) by the increased number of common shares issuable upon conversion. Second, the ranking is developed with the convertible security having the lowest (and, therefore, most dilutive) numerical value impact on diluted earnings per share listed first and the remaining securities listed in sequential order according to the magnitude of their impact on diluted earnings per share. The dilutive securities are then sequentially entered into the diluted earnings per share calculation according to the ranking

17 16-21 The additional disclosures made by a corporation in the notes to its financial statements include a schedule identifying and reconciling the numerators and denominators on which both basic and diluted earnings per share figures are calculated. In addition, the schedule includes the amount of preferred dividends deducted to determine the income available to common shareholders, the potential common shares that were not included in diluted EPS because they were antidilutive, and a description of any material impact on the common shares outstanding after the close of the accounting period but before the issuance of the financial report Under IFRS, if a company has potentially dilutive stock options, it will use the treasury stock method to determine the dilutive effect of these options. However, IFRS do not require a company to include any unrecognized compensation cost in the assumed proceeds from issuing the stock. Under U.S. GAAP, any unrecognized compensation cost is added to the assumed proceeds from issuing the stock which, in turn, decreases the incremental number of shares in the denominator of the EPS calculation. The exclusion of the unrecognized compensation cost under IFRS would result in lower earnings per share amounts being reported under IFRS relative to U.S. GAAP Even though the loss is unusual and infrequent, IFRS do not have the concept of extraordinary items. Therefore, Hoke Company would make no EPS disclosure related to this loss. ANSWERS TO MULTIPLE-CHOICE 1. c 3. a 5. a 7. b 9. c 2. b 4. c 6. d 8. d 10. a SOLUTIONS TO REVIEW EXERCISES RE16-1 Preferred Common 10% dividend to preferred (on $22,000 par) $2,200 Common dividend (equal to 10% of $66,000 par) $ 6,600 Extra dividend proportionate to par values: Total to allocate $14,000 Allocated ($2,200 + $6,600) (8,800) Remainder (1/4 to preferred, 3/4 to common) $ 5,200 1,300 3,900 Dividends to each class of stock $3,500 $10,500 RE16-2 Investment in Available-for-Sale Securities ($67,000 $58,000)... 9,000 Gain on Disposal of Investments... 9,000 Retained Earnings... 67,000 Property Dividends Payable... 67,

18 Chapter 16 ANSWERS TO MULTIPLE CHOICE 1. c Common Stock: (.05 x 300,000 X $10 par value) = $150,000 APinC: Common Stock = (.05 x 300,000 X ($20 $10)) = $150,000 RE:($800,000 + $900,000 + $ 1,000,000 + $1,100,000) + (.05 x 300,000 X $20) = $4,100, b 3. a ($840,000 $260,000 $60,000) = $520, c 5. a ((200,000 x $15) + $750,000 $380,000 $48,000 $32,000) 6. d 7. b 8. d ($780,000 $40,000) / 110,000 = $ c Basic: 2,500,000 x 3/12 + 3,000,000 x 3/12 + 3,250,000 x 6/12 = 3,000,000 FD: 3,000,000 + ((5,000 x 20) x 3/12) = 3,050, a ((($970,000 + ($180,000 x (1.3))) / (90, , ,000) = $7.83

19 RE16-3 Retained Earnings ($30 5,000) ,000 Common Stock to Be Distributed... 50,000* Additional Paid-in Capital from Stock Dividend ,000 *Calculation: 10% 50,000 = 5,000 shares issued for stock dividend; 5,000 $10 = $50,000 RE16-4 Retained Earnings ($10 par 25,000) ,000* Common Stock to Be Distributed ,000 *Calculation: 50% 50,000 = 25,000 shares issued for stock dividend; 25,000 $10 = $250,000 RE16-5 Retained earnings, January 1 $122,250 Plus: Net income 95,400 Minus: Dividends (32,000) Retained earnings, December 31 $185,650 RE16-6 Retained Earnings... 40,000 Interest Payable... 40,000 Income Tax Refund Receivable... 12,000 Retained Earnings... 12,000 RE16-7 Months Shares Shares Fraction of Equivalent Are Outstanding Outstanding Year Outstanding = Whole Units January June 10,000 6/12 = 5,000 July August 15,000 2/12 = 2,500 September December 14,400 4/12 = 4,800 12,300 RE16-8 Net Income $13,000 Preferred dividends (4,000) Earnings and shares $ 9,000/4,500 shares = $2.00 Basic earnings per share 16-18

20 RE16-9 Shares issued from assumed exercise... 4,000 Shares assumed reacquired: Proceeds Average Market Price per Share = 4,000 ($12 + $1) $20 = $52,000 $20 = (2,600) Assumed increment in common shares for computing diluted earnings per share... 1,400 RE16-10 Security 9% Preferred stock RE16-11 Impact $5,625 4,500 = $1.25 Security 9% Bonds RE16-12 Impact $6,300 2,500 = $2.52 Earnings Shares Earnings Explanation (Adjustments) (Adjustments) = per share Basic earnings per share $12,500 4,000 = $3.13 Basic Savings in dividends* 2,500 Increment in shares 2,500 Diluted earnings and shares $15,000 6,500 = $2.31 Diluted *Calculation: Security Preferred $2, Impact = $2,500 2,500 = $1.00 SOLUTIONS TO EXERCISES E Feb. 2 Dividends Payable: Preferred... 4,000 Dividends Payable: Common... 40,000 Cash... 44,

21 E16-1 (concluded) Mar. 5 Investment in Man Company Bonds... 6,000 Gain on Disposal of Investments... 6,000 Retained Earnings... 31,000 Property Dividend Payable... 31,000 Apr. 5 Property Dividend Payable... 31,000 Investment in Man Company Bonds... 31,000 July 6 Retained Earnings*... 48,000 Dividends Payable: Preferred... 4,000 Dividends Payable: Common... 44,000 *Preferred: 1,000 shares $4.00 = $ 4,000 Common: 40,000 shares $1.10 = $44,000 Aug. 17 Dividends Payable: Preferred... 4,000 Dividends Payable: Common... 44,000 Cash... 48,000 Oct. 15 Retained Earnings*... 17,600 Common Stock to Be Distributed... 8,000 Additional Paid-in Capital from Stock Dividend... 9,600 *40,000 shares 2% $22 per share Dec. 3 Common Stock to Be Distributed... 8,000 Common Stock, $10 par... 8,000 E Retained Earnings*... 52,960 Dividends Payable: Preferred... 4,000 Dividends Payable: Common... 48,960 *Preferred: 1,000 shares $4.00 = $ 4,000 Common: 40,800 shares $1.20 = $48, Preferred Common a. Preferred dividend (2, $100) $20,000 Remainder to common ($80,000 $20,000) $60,000 Total $20,000 $60,000 b. Dividends in arrears (2 2, $100) $40,000 Current preferred dividend (2, $100) 20,000 Remainder to common ($80,000 $60,000) $20,000 Total $60,000 $20,

22 E16-2 (concluded) c. Dividends in arrears (1 2, $100) $20,000 Current preferred dividends 20,000 Common proportional share ( ,000 $10) $30,000 Remainder shared* ($80,000 $70,000) 4,000 6,000 Total $44,000 $36,000 2,000 $100 *Preferred: $10,000 extra dividend = $4,000 (2,000 $100) + (30,000 $10) Common: $10,000 extra dividend $300,000 = $6,000 $500,000 Dividends per Share 2. Dividend Yield = Market Price per Share Preferred stock: $20,000/2,000 $125 = $10 $125 = 8% Common stock: $60,000/30,000 $20 = $2 $20 = 10% E (1) Retained Earnings... 15,000 Dividends Payable... 15,000 Dividends Payable... 15,000 Cash... 15,000 (2) Retained Earnings (15, $17)... 12,750 Common Stock to Be Distributed... 12,750 Common Stock to Be Distributed... 12,750 Common Stock, no par... 12,750 (3) Investment in Ostend Bonds ($13,000 $9,000)... 4,000 Gain on Disposal of Investment... 4,000 Retained Earnings... 13,000 Property Dividends Payable... 13,000 Property Dividends Payable... 13,000 Investment in Ostend Bonds... 13,000 (4) Retained Earnings... 12,000 Dividends Payable: Scrip... 12,000 Interest Expense ($12, /12)... 1,320 Dividends Payable: Scrip... 12,000 Cash... 13,

23 E16-3 (concluded) (5) Retained Earnings (15,000 $0.70)... 10,500 Contributed Capital Distributed as a Liquidating Dividend (15,000 $0.30)... 4,500 Dividends Payable... 15,000 Dividends Payable... 15,000 Cash... 15, (1) Current assets $ 45,000 Current liabilities $ 30,000 Investment in Ostend bonds 9,000 Common stock, no par 150,000 Fixed assets (net) 200,000 Retained earnings 74,000 $254,000 $254,000 (2) Current assets $ 60,000 Current liabilities $ 30,000 Investment in Ostend bonds 9,000 Common stock, no par 162,750 Fixed assets (net) 200,000 Retained earnings 76,250 $269,000 $269,000 (3) Current assets $ 60,000 Current liabilities $ 30,000 Fixed assets (net) 200,000 Common stock, no par 150,000 $260,000 Retained earnings ($89,000 $13,000 + $4,000 gain) 80,000 $260,000 (4) Current assets $ 46,680 Current liabilities $ 30,000 Investment in Ostend bonds 9,000 Common stock, no par 150,000 Fixed assets (net) 200,000 Retained earnings $255,680 ($89,000 $12,000 $1,320 interest) 75,680 $255,680 (5) Current assets $ 45,000 Current liabilities $ 30,000 Investment in Ostend bonds 9,000 Common stock, no par 150,000 Fixed assets (net) 200,000 Contributed capital $254,000 distributed as a liquidating dividend (4,500) Retained earnings 78,500 $254,

24 E % stock dividend (a) Retained Earnings (25, $30)... 45,000 Common Stock to Be Distributed... 15,000 Additional Paid-in Capital from Stock Dividend... 30,000 (b) Common Stock to Be Distributed... 15,000 Common Stock, $10 par... 15,000 (c) Common stock, $10 par $265,000 Additional paid-in capital on common stock 150,000 Additional paid-in capital from stock dividend 30,000 Retained earnings 155,000 $600, % stock dividend E and 2. (a) Retained Earnings (25, $10) ,000 Common Stock to Be Distributed ,000 (b) Common Stock to Be Distributed ,000 Common Stock, $10 par ,000 (c) Common stock, $10 par $350,000 Additional paid-in capital on common stock 150,000 Retained earnings 100,000 $600,000 Shareholders Equity (1) (2) Common stock, $10 par... $ 460,000 $ 520,000 Additional paid-in capital on common stock , ,000 Total contributed capital... $1,404,000 $1,320,000 Retained earnings... 1,096,000 a 1,180,000 b Total shareholders equity... $2,500,000 $2,500,000 a $1,096,000 = $1,300,000 ($34 40,000 shares 0.15) b $1,180,000 = $1,300,000 ($10 40,000 shares 0.30) 3. Retained earnings are reduced more by a small stock dividend than by a large stock dividend. From a theoretical standpoint, this might have been avoided by (1) using the adjusted market price after the dividends had been declared for both sizes of dividends or (2) recording the dividends like a stock split

25 E (1) Accumulated Depreciation... 15,000 Retained Earnings... 15,000 Retained Earnings ($15, )... 4,500 Income Taxes Payable on Prior Earnings... 4,500 (2) Retained Earnings... 4,000 Interest Payable... 4,000 Income Taxes Payable on Prior Earnings... 1,200 Retained Earnings ($4, )... 1, SCOBIE COMPANY Statement of Retained Earnings For Year Ended December 31, 2016 E16-7 Retained earnings, as previously reported, January 1, $142,400 Prior period adjustments: Correction of overstatement in 2015 depreciation (net of $4,500 income taxes)... 10,500 Correction of understatement in 2015 interest (net of $1,200 income tax credit)... (2,800) Adjusted retained earnings, January 1, $150,100 Add: Net income... 60,000 $210,100 Less: Cash dividends... (13,000) Retained earnings, December 31, $197,100 Shareholders Equity (in part) Retained earnings (see Note 1)... $400,000 Notes to 2016 Financial Statements Note 1: Retained earnings are restricted in the amount of $20,000 as a result of a contractual agreement in connection with the issuance of 12%, 5-year, $100,000 bonds. This restriction will increase by $20,000 each year until the maturity date. Additionally, retained earnings has been restricted in the amount of $15,000, the cost of the treasury stock that it currently holds

26 E ROLT COMPANY Statement of Retained Earnings For Year Ended December 31, 2016 Retained earnings, as previously reported, January 1, $120,000 Add: Correction due to understatement of previous income (net of $4,200 income taxes)... 9,800 Adjusted retained earnings, January 1, $129,800 Add: Net income... 80,000 $209,800 Less: Cash dividends... $13,000 Stock dividends... 17,000 Reduction due to retirement of preferred stock... 10,000* (40,000) Retained earnings, December 31, 2016 (see Note A)... $169,800 *1,000($120 $110) 2. Note A: Retained earnings are restricted in the amount of $20,000, the cost of the common shares being held as treasury stock. E CASTILLO COMPANY Statement of Retained Earnings For Year Ended December 31, 2016 Retained earnings, as previously reported, January 1, $206,000 Less: Correction of overstatement of previous net income (net of $5,400 income tax credit)... (12,600) Adjusted retained earnings, January 1, $193,400 Add: Net income... 58,000 $251,400 Less: Cash dividends... $ 9,000 Stock dividends... 6,000 Reduction due to retirement of preferred stock... 40,000* (55,000) Retained earnings, December 31, 2016 (see Note A)... $196,400 *2,000($150 $130) 2. Note A: Retained earnings are restricted in the amount of $14,000, the cost of the common shares being held as treasury stock

27 E16-10 HERRERA MANUFACTURING CORPORATION Shareholders Equity December 31, 2016 Contributed Capital: Preferred stock, $50 par (6,000 shares authorized, issued, and outstanding)... $300,000 Common stock, $5 par (30,000 shares authorized, 15,000 shares issued of which 500 shares are being held as treasury stock)... 75,000 Additional paid-in capital: On preferred stock ,000 a On common stock ,000 b From treasury stock... 2,500 c Total contributed capital... $752,500 Retained earnings (see Note A)... 16,000 Accumulated other comprehensive income (loss): Unrealized decrease in value of available-for-sale securities... (2,500) Total contributed capital, retained earnings, and accumulated other comprehensive income... $766,000 Less: Treasury stock at cost (500 common shares at $18)... (9,000) Total Shareholders Equity... $757,000 Notes to Financial Statements Note A: Retained earnings are restricted in the amount of $9,000, the cost of the treasury stock. a ($70 $50) 6,000 b ($22 $5) 15,000 c ($23 $18)

28 16-27 E FLORES DESIGN COMPANY Statement of Shareholders Equity For Year Ended December 31, 2016 Preferred Stock Common Stock Additional Paid-in Capital Shares Shares Par Shares Par Preferred Common Treasury Retained Treasury Issued Issued Value Issued Value Stock Stock Stock Earnings (cost) Balances, 1/1/2016 1,250 $125,000 15,000 $150,000 $55,000 $105,000 $ 0 $ 78,000 $(4,200) Issued preferred stock ,000 16,000 a Issued common stock 3,000 30,000 21,000 b Reacquired treasury stock (3,000) Reissued treasury stock 750 c 3,500 Net income 46,500 Dividends (25,000) Balances, 12/31/2016 1,500 $150,000 18,000 $180,000 $71,000 $126,000 $750 $ 99,500 $(3,700) a ($164 $100) 250 b ($17 $10) 3,000 c ($17 $14) Return on shareholders equity = = Net income Average shareholders' equity $46,500 ($623,550* + $508,800)/2 = $46,500 $566,175 = 8.2% *$150,000 + $180,000 + $71,000 + $126,000 + $750 + $99,500 $3,700 = $623,550

29 E Actual Assumed Fraction Equivalent Shares Shares of the year Whole Outstanding Outstanding outsanding Units 220, = 506,000 2/12 = 84, , = 609,500 3/12 = 152, ,750 2 = 609,500 1/12 = 50, ,750 2 = 629,500 2/12 = 104, ,500 = 629,500 2/12 = 104, ,500 = 534,500 1/12 = 44, ,500 = 579,500 1/12 = 48,292 Weighted average shares outstanding , ,500 E16-13 Actual Assumed Fraction Equivalent Shares Shares of the year Whole Outstanding Outstanding outsanding Units 20, = 44,000 3/12 = 11,000 25, = 55,000 2/12 = 9,167 29, = 63,800 4/12 = 21,267 63,800 1,000 = 62,800 2/12 = 10,467 62, ,000 = 63,800 1/12 = 5,317 Weighted average shares outstanding... 57,218 Note to Instructor: Students may mistakenly add the 10% stock dividend to the 200% stock split and multiply the initial issuance by 210% (instead of the correct 220%). E Guthrie has a simple capital structure. 2. Actual Assumed Fraction Equivalent Shares Shares of the year Whole Outstanding Outstanding outsanding Units 50, = 75,000 2/12 = 12,500 60, = 90,000 1/12 = 7,500 58, = 87,000 4/12 = 29,000 59, = 88,500 1/12 = 7,375 88,500 = 88,500 4/12 = 29,500 Weighted average shares outstanding 85, Basic EPS = $225,000/85,875 = $2.62 E16-15 Basic earnings per share = (Net income $96,000)/300,000 = $1.25 Solve for net income = $471,

30 E This is a simple capital structure because there are no dilutive securities. The preferred stock is not convertible into common stock. 2. Actual Assumed Fraction Equivalent Shares Shares of the year Whole Outstanding Outstanding outsanding Units 50, = 75,000 2/12 = 12,500 60, = 90,000 1/12 = 7,500 58, = 87,000 4/12 = 29,000 59, = 88,500 1/12 = 7,375 88,500 = 88,500 4/12 = 29,500 Weighted average shares outstanding 85,875 E annual report: 2016 basic earnings per share: $ computations: $5,125 10,250* = $0.50 * 9,000 7/12 = 5,250 12,000 5/12 = 5,000 10, annual report: 2017 basic earnings per share: $ basic earnings per share: $ computations: $16,400 27,333* = $0.60 * 12, /12 = 4,000 14, /12 = 23,333 27, computations: $5,125 20,500* = $0.25 * 9, /12 = 10,500 or 10,250 (from Requirement 1) 12, /12 = 10, = 20,500 20, annual report: 2018 basic earnings per share: $ basic earnings per share: $ basic earnings per share: $

31 2018 computations: $23,520 33,600* = $0.70 *28, /12 = 33, computations: $16,400 32,800* = $0.50 * 12, /12 = 4,800 or 27,333 (from Requirement 2) 14, /12 = 28, = 32,800 32, computations: $5,125 24,600* = $0.21 * 9, /12 = 12,600 or 20,500 (from Requirement 2) 12, /12 = 12, = 24,600 24,600 E $29,975 $10,000 a 8,500 b a 10% ($100 1,000) = $2.35 b 7,000 3/12 = 1,750 9,000 9/12 = 6,750 8, Price/earnings ratio = 7.4 times = Market price per common share Earnings per share $17.50 $2.35 E $27,760 $6,000 13,600* = $1.60 Basic earnings per share $29,936 $6,000 13,600* = $1.76 Basic earnings per share related to income before extraordinary items * 10, = 12,000 4/12 = 4,000 12, = 14,400 8/12 = 9,600 13, Income before extraordinary items $ 1.76 Extraordinary loss (0.16) Net income (see Note A) $ Note A: Preferred dividends of $6,000 were deducted from income before extraordinary items and net income to determine earnings available to common shareholders. Each earnings per share figure is based upon 13,600 weighted average common shares outstanding

32 E Actual Fraction Equivalent Shares of the year Whole Outstanding outsanding Units 160,000 6/12 = 80, ,000 6/12 = 120,000 Weighted average shares outstanding 200,000 Required EPS figures for 2016: EPS Income from continuing operations before income taxes $680,000 Income tax expense 204,000 Income from continuing operations $476,000 $2.32 a Discontinued operations: Loss on disposal of division, less tax of $18,000 (36,000) (0.18) b Income before extraordinary item $440,000 $2.14 c Extraordinary gain, less tax of $25,000 80, d Net income $520,000 $2.54 e a ($476,000 $12,000)/200,000 b $36, ,000 c ($440,000 $12,000) 200,000 d $80, ,000 e ($520,000 $12,000) 200, If the preferred stock is cumulative, the dividend for the current period should be deducted even if it has not been declared, because preferred stockholders must receive that dividend at some time in the future before common stockholders can receive a dividend. However, if the preferred stock is not cumulative, the dividend should be deducted only if it has been declared. E % preferred stock: $200,000 $19,000 = = $2.26 2, , % bonds: (0.11 $220,000) (1 0.3) $16,940 = = $ , % preferred stock: 0.08 $150,000 $12,000 = = $2.11 1, , % bonds: 9.0% bonds: [(0.10 $100,000) + $6,000/20] (1 0.3) $7,210 = = $ ,500 [(0.09 $200,000) $16,000/25] (1 0.3) $12,152 = = $ ,

33 E16-21 (concluded) 2. Security Impact Ranking 9.5% preferred $ % bonds $ % preferred $ % bonds $ % bonds $ E Weighted Time Shares Average Jan. 1 May 1 4/12 24,000 8,000 May 1 Sept. 30 5/12 27,000 11,250 Sept. 30 Dec. 31 3/12 29,000 7,250 Weighted average shares outstanding... 26, Basic earnings per share = ($72,500 $10,625)/26,500 = $ Diluted earnings per share = {$72, [$13,750 (1 0.3)]}/(26, , ,000) Diluted earnings per share = $2.11 Incremental earnings per share: Bonds: [$13,750 (1 0.3)]/5,000 = $1.93 Preferred: $10,625/7,500 = $ Basic EPS Income from continuing operations $ 90,500 $ 3.01 Loss from discontinued operations 18,000 (0.68) Net income $ 72,500 $ 2.33 E Diluted EPS: $36,000 30, * = $1.17 *Issued 4,000 Reacquired: 4,000 ($32 + $3) $45 = (3,111) Increment Under IFRS, Marion Company would not include the unrecognized compensation cost in the assumed proceeds from issuing the shares under the treasury stock method. Therefore, the earnings per share would be $1.16 (instead of $1.17) as shown below. Diluted EPS: $36,000 30, ,156* = $1.16 *Issued 4,000 Reacquired: 4,000 $32 $45 = (2,844) Increment 1,

34 E16-24 Earnings Shares Earnings Explanation (Adjustments) (Adjustments) = per Share Basic earnings and shares $39,000 a 12,000 b = $3.25 Basic Preferred dividend savings 4,800 c Increment in common shares 3,000 d Diluted earnings and shares $43,800 15,000 = $2.92 Diluted a $39,000 = $43,800 $4,800 ( $100) preferred dividends b 10,000 6/12 = 5,000 14,000 6/12 = 7,000 12,000 c $4,800 (600 5) = $1.60 < $3.25; individually dilutive d E Basic EPS: $44,000 10,000 = $4.40 per share Diluted EPS: Interest = ($400,000 8%) (1 0.3) = $22,400 Additional shares = $400,000 $1, = 9,600 Diluted EPS = ($44,000 + $22,400)/(10, ,600) = $ Antidilutive securities are those whose inclusion would cause EPS to increase rather than decrease. For convertible bonds, the if-converted method alters both the numerator and the denominator of EPS. Therefore, it is possible that the inclusion of a security in the calculation would cause EPS to increase. Antidilutive securities are not included in the calculation because the diluted EPS figure is intended to present the most diluted earnings per share amount. E16-26 Earnings Shares Earnings Explanation (Adjustments) (Adjustments) = per Share Basic earnings and shares $79,200 18,000 a = $4.40 Basic Bond interest expense savings b 3,920 c Increment in common shares 2,000 d Diluted earnings per share $83,120 20,000 = $4.16 Diluted a 15,000 4/12 = 5,000 19,500 8/12 = 13,000 18,000 b [($80, ) (1 0.3)] (80 25) = $1.96 < $4.40; individually dilutive c ($80, ) (1 0.3) d