Question

A portion from the Balance Sheet of Strange Limited is included below:

Strange Limited

Statement of Financial Position (Partial)

At December 31, 2017

Long-term debt
Notes payable, 10%	$ 5,000,000
4% convertible bonds payable	2,000,000
6% convertible bonds payable	3,000,000
Total long-term debt	$10,000,000
Shareholders’ equity
$0.68 cumulative, no par value, convertible preferred shares (unlimited number of shares authorized, 600,000 shares issued and outstanding)	$ 3,000,000
Common shares, no par value (8,000,000 shares authorized, 3,000,000 shares issued and outstanding)	25,000,000
Contributed surplus	200,000
Retained earnings	7,000,000
Total shareholders’ equity	35,200,000

Additional notes are provided below:

Options were granted/written in 2016 that give the holder the right to purchase 100,000 common shares at $8 per share. The average market price of the company’s common shares during 2017 was $14 per share. The options expire in 2025 and no options were exercised in 2017.

The 4% bonds were issued in 2016 at face value. The 6% bonds were issued on June 1, 2017 at face value. Each bond has a face value of $1,000 and is convertible into 100 common shares.

The convertible preferred shares were issued at the beginning of 2017. Each share of preferred is convertible into one common share.

The average income tax rate is 25%.

The common shares were outstanding during the entire year

Preferred dividends were not declared in 2017.

Net income was $2.5 million in 2017.

No bonds or preferred shares were converted during 2017.

Required: ***********

1. Calculate basic earnings per share for 2017.

2. Calculate diluted earnings per share for 2017. For simplicity, ignore the requirement to record the debt and equity components of the bonds separately.

Answer 1

1. Calculation of Basic earnings per share:-

Basic Earnings per share = (Net income available to shareholders - preference dividend) / No. of outstanding shares

= ( $2,500,000(1-0.25) - $600000(0.68) ) / 3,000,000

= (1,875,000 - 408,000) / 3,000,000

= 0.489 per share.

2. Calculation of Diluted earnings per share:-

Diluted earnings per share = (Net income available to shareholders - preference dividend) / No. of Diluted shares outstanding

Calculation of number of shares issued during the year:-

options issued = 100,000

Amount to be paid = 100,000 * $8 = $800,000

Value in current shares = Amount to be to options / current market price

= $800,000 / $14 = 57143

Diluted shares = 100,000 - 57143 = 42857shares

No. of convertible preference shares = 600,000 * 1 = 600,000 shares

NO.of 4% bonds = 2,000,000 / 1000 = 2000 bonds

No. of shares for 4% bonds = 2000 * 100 = 200,000 shares.

No. of 6% bonds = 3,000,000 / 1000 = 3000 bonds

No. of shares for 6% bonds = 3000 * 100 * 7/12 = 175000shares

Total no.of shares outstanding diluted = 3,000,000 + 600,000 + 200,000 + 175,000 = 3,975,000shares

Diluted earnings per share = $1,467,000 / 3,975,000 = $0.369 per share