Question

As auditor for Checkem & Associates, you have been assigned to review Cullumber Corporation’s calculation of earnings per share for the current year. The controller, Mac Taylor, has supplied you with the following calculations:

Net income $3,538,109

Common shares issued and outstanding:

Beginning of year 1,374,960

End of year 1,200,000

Average 1,242,500

Earnings per share: $3,374,960/1,242,500= $2.72 per share

You have gathered the following additional information:

1. The only equity securities are the common shares.

2. There are no options or warrants outstanding to purchase common shares.

3. There are no convertible debt securities.

4. Activity in common shares during the year was as follows:

Outstanding, Jan. 1 1,285,000

Shares acquired, Oct. 1 (250,000)

1,035,000

Shares issued, Dec. 1 165,000

Outstanding, Dec. 1,200,000

Instructions

a) Based on the information, of you agree with the controllers calculation of earnings per share for the year? If disagree, provide revised calculation

b) Assume the same facts except that call options had also been issued for 140,000 common shares at $10 per share. These options were outstanding at the beginning of the year and none had been exercised or cancelled during the year. the average market price of the common shares during the year was $20 and the ending market price was $25. prepare a calculation of earnings per share.

Answer 1

a.
The earnings per share calculated by controller is not correct as controller has considered average share outstsanding for EPS calculation instead of weighted average number of shares.
The revised calculation for earnings per share is shown below.
Earnings per share	Net income/Weighted average number of shares outstanding
Calculation of weighted average number of shares outstanding
Particulars	No of shares outstanding	Number of month outstanding	Weighted average
Beginning shares	1285000	12 months	1,285,000	1285000*(12/12)
Shares repurchased	-250000	-3 months	(62,500)	-250000*(3/12)
New shares reissued	165000	1 month	13,750	165000*(1/12)
		Total weighted average shares	1,236,250
Calculation of earnings per share
Earnings per share	3538109/1236250
Earnings per share	$2.86
Thus, earnings per share is $2.86.
b.
In this case the call options issued for lower than market share price of $25 are dilutive in nature and therefore in this case diluted EPS will have to be calculated.
Calculation of increase in number of shares due to call option.
Proceeds received from exercise of option	$1,400,000	140000*10
No of shares repurchased	56,000	1400000/25
Increase in number of shares	84000	140000-56000
Calculation of diluted earnings per share
Diluted earnings per share	3,538,109/(1,236,250+84,000)
Diluted earnings per share	$2.68
Thus, the options would decrease the EPS to $2.68.