Question

Following are separate income statements for Austin, Inc., and its 80 percent owned subsidiary, Rio Grande Corporation as well as a consolidated statement for the business combination as a whole.

	Austin				Rio Grande				Consolidated
Revenues	$	(739,000	)		$	(526,000	)		$	(1,265,000	)
Cost of goods sold		413,000				313,000				726,000
Operating expenses		114,000				83,000				235,000
Equity in earnings of Rio Grande		(70,000	)
Individual company net income	$	(282,000	)		$	(130,000	)
Consolidated net income									$	(304,000	)
Noncontrolling interest in consolidated net income										(22,000	)
Consolidated net income attributable to Austin									$	(282,000	)

Additional Information

• Annual excess fair over book value amortization of $38,000 resulted from the acquisition.
• The parent applies the equity method to this investment.
• Austin has 60,000 shares of common stock and 7,000 shares of preferred stock outstanding. Owners of the preferred stock are paid an annual dividend of $60,000, and each share can be exchanged for six shares of common stock.
• Rio Grande has 33,000 shares of common stock outstanding. The company also has 8,000 stock warrants outstanding. For $15, each warrant can be converted into a share of Rio Grande’s common stock. Austin holds half of these warrants. The price of Rio Grande’s common stock was $20 per share throughout the year.
• Rio Grande also has convertible bonds, none of which Austin owned. During the current year, total interest expense (net of taxes) was $35,000. These bonds can be exchanged for 14,000 shares of the subsidiary’s common stock.

Determine Austin’s basic and diluted EPS. (Round your final answers to 2 decimal places.)

Answer 1

Computation of Austin's Basic and Diluted eps

The question relates to eps computation in variable interest entity. Here, interests are made in each other company and various forms and hence, EPS needs to be computed carefully.

Basic EPS—Austin, Inc.	Amount ($)
Consolidated net income to parent	282,000
Austin’s preferred dividends	-60,000
Earnings applicable to Austin’s basic EPS	222,000
Austin's outstanding common shares	60000
Basic earnings per share ($222,000 ÷ 60,000)	3.7
Diluted EPS—Austin, Inc.
Subsidiary earnings and shares for Austin’s diluted EPS calculation:
Rio Grande net income after amortization (130,000 -38,000)	92,000
Interest saved assuming conversion of bonds net of taxes	35000
Net income applicable to diluted EPS	127000
Shares outstanding	33000
Assumed conversion of warrants	8000
Assumed treasury stock acquisition using proceeds from warrant conversion ([8,000 × $15] ÷ $20)	-6000
Assumed conversion of bonds	14000
Subsidiary shares applicable to diluted EPS	49000
Shares controlled by parent (33,000* 80% plus 75% (15/20) of increment created by warranties i.e. 6000 = 33000 * 80%+4500	30900
Portion owned by parent (30900 ÷ 49000)	63.06%
Net income applicable to parent—diluted EPS
Austin’s income and shares for diluted EPS calculation (127000*63.06%)	80086
Austin’s separate net income	212000
Net income of Rio Grande to parent (computed above)	80086
Preferred dividends (assumed converted)	0
Earnings applicable to diluted EPS (212000+80086)	292086
Austin's outstanding common shares	60000
Assumed conversion of preferred stock (7000*6)	42000
Shares applicable to diluted EPS	102000
Diluted earnings per share (292086/102000)	2.86