Question

As an inducement to enter a lease, Owl Co., a lessor, granted Fox, Inc., a lessee, twelve months of free rent under a four-year operating lease. The lease, effective on January 1, 2018, provides for monthly rental payments to begin January 1, 2019. Fox made the first rental payment on December 30, 2018. In its 2018 income statement, what rental revenue should Owl report?

One-fourth of the total cash to be received over the life of the lease.

One-third of the total cash to be received over the life of the lease.

Zero.

Cash received during 2016.

Owl Co. has 300,000 common shares, 60,000 common stock options, and 15,000 shares of $100, 4% cumulative preferred stock, all of which were outstanding during 2018. The stock options exercise price is $30 and the average market price is $40 during 2018. Also, Owl has net income of $600,000 and declared no dividends in 2018. What is Basic & Diluted EPS?

Basic EPS $1.80 & Diluted EPS $1.90

Basic EPS $1.80 & Diluted EPS $1.71

Basic EPS $2.00 & Diluted EPS $1.71

Basic EPS $2.00 & Diluted EPS $1.67

Answer 1

Answer to first question is ZERO. The rent that is paid on Dec 30, 2018 is actually for the year starting Jan 1, 2019. This means it is an 'advance payment' in 2018 for using an asset in 2019. Going by the matching concept of revenue recognition, this would not be recorded in income statement. It would rather be recorded on balance sheet - on asset side as 'Cash' and on liabilities side as 'Unearned rent' for 2018 and would be recognized in income statement of 2019.

Second question. Basic EPS = $1.8, Diluted EPS = $1.71

Outstanding Common Shares = 300,000

Number of Preferred Shares =    15,000

Preferred Dividend per share (@4% per $100 price) = 4

Total Preferred Dividends = 15,000*4 = 60,000

Net Income = 600,000

Net Income Less Preferred Dividends = 540,000

Basic EPS = Net Income Less Preferred Dividend/Number of Outstanding Common Shares

Basic EPS = 540,000 / 300,000 = $1.8

Diluted EPS = Net Income Less Preferred Dividend/(Number of Outstanding Common Shares + Diluted Shares)

Amount Paid to exercise options = Options Issued * Exercise Price per Share = 60,000 * 30 = 1,800,000

Value of options in current shares = Amount paid to exercise options / Current Share price = 1,800,000/40 = 45,000

Diluted shares = Options issued – value of options in current shares = 60,000 – 45,000 = 15,000

Diluted EPS = 540,000/(300,000 + 15,000) = $1.71