Question

Problem Facts Information related to the Sosa Company for the year 2020: Common Stock As of the end of 2020, Sosa had 240,000 shares of common stock outstanding. The shares are due to the following common stock transactions:  January 1, 2020 – 100,000 shares of common stock outstanding  April 1, 2020 – issued an additional 50,000 shares for cash  July 1, 2020 - issued a 2 for 1 stock split  September 1, 2020 – purchased 60,000 shares for treasury stock Preferred Stock As of the end of 2020, Sosa had 30,000 shares of 6%, $10 par value, cumulative, convertible preferred stock outstanding. The stock had been outstanding all year and the conversion ratio was each share of preferred stock is convertible into 3 shares of common stock. Bonds Payable As of the end of 2020, Sosa had $800,000, 7% bonds payable outstanding. The bonds had been outstanding for the entire year and each $1,000 bond was convertible into 10 shares of common stock. Options Sosa also had 10,000 common stock options outstanding all year. Each option allowed the holder to purchase 1 share of Sosa’s common stock for $45. During 2020, the average market price of Sosa’s common stock was $48 per share. Additional Information Sosa’s 2020 net income was $580,000, and the company’s income tax rate was 34%. REQUIRED 1. Compute the weighted average number of common shares Sosa will use to compute basic earnings per share. (5 points) 2. Compute 2020 basic earnings per share (3 points) 3. Identify which of the potentially dilutive securities (preferred stock, bonds, options) are dilutive (support must be shown to receive credit for this question) (8 points) 4. Compute diluted earnings per share (4 points) Check Figures:

Basic EPS = $2.20

Diluted EPS = $1.68

Answer 1

1. Weighted Number of Equity Shares :

Numbers of days the shares are outstanding

Number of days in the period

Total Months in a year 12

S.No	Date	Particular	Shares	Cumulative Shares	No of Months Outstanding (Current date – date of next transactions)	Calculation	Weighted Number of shares
1	Jan 1, 2020	Outstanding at the beginning	100,000	100,000	3 Months	100000*3/12	25000
2	Apr 1, 2020	Issued	50000	150000	3 Months	150000*3/12	37500
3	July 1, 2020	Issued for stock split (150000*2/1)	300000	450000	2 Months	450000*2/12	75000
4	Sept 1, 2020	Purchased	-60000	390000	4 Months	390000*4/12	130000
Total							267500

267500 Weighted Number of common shares will use to calculate basic earnings per share.

2.Earnings Per Share (EPS) :

Net profit or loss attributable to ordinary shareholders during a period / by the weighted average number of ordinary shares in issue during the period.

Net profit or loss attributable to ordinary shareholders during a period =

Net Profit after tax – Preference Dividend

S.No	Particulars	Amount in $
1	Net Income	580000
2	Less: Income Tax @ 34%	-197200
	Net Profit After Tax	382800
3	Less : Preference Dividend (30000*10*6%)	-18000
	Net profit or loss attributable to ordinary shareholders during a period	364800

Weighted average number of ordinary shares in issue during the period: 267500

EPS = 364800/267500

= $ 1.36

3. Increase in earnings attributable to equity shareholders on conversion of potential equity shares

Particulars	Increase In Earning (1)	Increase in Number of Equity Shares (2)	Earnings per Incremental share (3) = (1)/(2)
Preferred Stock	=30000*6*10% $18000	=30000*3 90000	0.2
Bonds Payable	=$800000*7% $56000	=800000*10/1000 8000	7
Options	Nil	=10000*(48-45)/48 625	NIL

Options are most dilutive as their earnings per incremental share is NIL, then followed by Preferred stock 0.2 and then Bonds Payable 7.0

4.Dilutive Earnings Per Share

Dilutive EPS = (Total Income –Preferred Dividend)/(Outstanding shares+ Diluted Shares)

For the purpose of computation of diluted EPS, Options will be considered first, Preferred Stock being second most dilutive will be considered next and thereafter Bonds payable will be considered

Particulars	Net Profit Attributable to Equity Shareholders $	No of Equity Shares	Net Profit Attributable per share $	Remark
As reported 31.12.2020	364800	267500	1.364	EPS
Options	0	625
Total	364800	268125	1.361	Diluted EPS
Preferred Stock	18000	90000
Total	382800	358125	1.67	Diluted EPS
Bonds Payable	56000	8000
Total	438800	366125	1.198	Anti-Diluted EPS

Since Diluted earnings per share is increased when taking the Bonds payable into account ( $1.67 to 1.198), the Bonds payable are anti-dilutive and are ignored in the calculation of diluted earnings per share for the year ended 2020.

Therefore diluted earnings per share for the year 2020 is $ 1.67

50.