Question

Richmond Co. sold convertible bonds at a premium. Interest is paid on May 31 and November 30. On May 31, after interest was paid, 100, $1,000 bonds are tendered for conversion into 3,000 shares of $10 par value ordinary shares that had a market price of $40 per share.

Discuss the accounting treatment, if any, that should be given to each of the following items in computing earnings per share of ordinary shares for financial statement reporting.

a)      Outstanding preference shares issued at a premium with a par value liquidation right.                                                                                                       

b)      The exercise at a price below market value but above book value of an ordinary share option issued during the current fiscal year to officers of the corporation.

c)      The replacement of a machine immediately prior to the close of the current fiscal year at a cost 20% above the original cost of the replaced machine. The new machine will perform the same function as the old machine that was sold for its book value.     

d)      The declaration of current dividends on cumulative preference shares.

e)      The acquisition of some of the corporation's outstanding ordinary shares during the current fiscal year. The shares were classified as treasury shares.

f)       A 2-for-1 share split of ordinary shares during the current fiscal year.

g)      A provision created out of retained earnings for a contingent liability from a possible lawsuit.    

Answer 1

1. Preference shares have been issued at part value. Any dividend distribution right of the prefrence shares holders shall reduce the earnings available for the shareholders and hence EPS shall reduce.

2. Exercise of shares by the officers of the corporation shall increase the number of wieghted average shares outstanding during the year while at the same time there shall be no increas in earnings. And hence EPS shall reduce.

3. Replacement of the old machine with new machine shall increase the depreciation expenses and hence, earnings shall also reduce. And hence EPS shall reduce.

4. The declaration of dividends shall reduce the earnings available for the shareholders and hence EPS shall reduce.

5. Buy back of shares during the year shall reduce the number of shares weighted outstanding during the year and hence shall increase the EPS>

6. A 2-1 split shall increase the shall increase the number of wieghted average shares outstanding during the year while at the same time there shall be no increas in earnings. And hence EPS shall reduce.

7. Creation of contingent liability for a lawsuit from retained earnings shall not have any effect on EPS as EPS is computed on the current period outstanding and not on retained earnings.