Question

Chapter 19- Earnings per Share 95. A company with a simple capital structure would include which of the following in the computation of earnings per share? A) Convertible securities Number of shares of nonconvertible cumulative preferred shares C) Dividends on nonconvertible cumulative preferred shares D) Dividends on common shares B) Number Ans: C Difficulty: Medium Level of Learning: Knowledge Topic: LO2 96. DCE had 900 common shares outstanding on January 1, 20x3, issued 600 shares on May 1 and had income applicable to common shares of $5.200 for the year ending December 31, 20x3. Earnings per common share for 20x3 would be: A) $5.78 B) $4.00 C) $3.60 D) $3.46 Ans: B Difficulty: Medium Level of Learning: Application Topic: LO2 97. In determining basic earnings per share, the annual dividend on nonconvertible cumulative preferred shares should be: A) Added back to net income whether declared or not. B) Disregarded. C) Deducted from net income only if declared. D) Deducted from net income whether declared or not Ans: D Difficulty: Medium Level of Learning: Knowledge Topic: LO2 98. In determining basic earnings per share, the annual dividend on convertible cumulative preferred shares, which are not a dilutive convertible security, should be: A) Added back to net income whether declared or not. B) Disregarded. C) Deducted from net income only if declared. D) Deducted from net income whether declared or not. AD Dificulty: Medium Level of Learning: Knowledge Topic: 102

Answer 1

95 Computing of earning per share requires to reduce all income that is to be paid to outsiders. Non convertible cumulative preference shares requires payment to be made every year. Such payment is to be made irrespective of declaration since it is cumulative. Also, preference share holders are outsiders and not owners of the company. Earning per share is calculated for owners and hence any payment made to outsiders is to be reduced and dividends on non convertible cumulative preferred shares should be reduced while calculating earning per share. OPTIONC 96 Outstanding shares as on Jan 1 = 900 shares 600 shares are issued on 1st May which means proportionate shares outstanding on 31st Dec = 600 * 8 months / 12 months proportionate shares outstanding on 31st Dec = 400 shares Shares issued on 1 may are outstanding for period of 8 months as on 31st Dec, ie, year end Total Earnings = $5,200 Total Shares = 900 + 400 = 1,300 shares Earning Per Share = 5,200 / 1,300 = $4 per share OPTION B 97 Basic Earning per share is attributable to owners, ie, equity shareholders of the company. Any payment to outsiders is to be reduced while determining the same. Dividend on non convertible cumulative preference shares is dividend which is to be paid to preference shareholders which wont get converted to equity shares and such dividend is to be paid irrespective of declaration since it is cumulative. Hence, to be reduced. OPTION D 98 Basic earnings are earnings attributable to shareholders and dilutive earnings are also earnings of shareholders but holders fall in earning due to exercise of conversion option. Cumulative convertible preference shares means shareholders who can exercise the conversion option and because of whom earnings will reduce. If earnings increase because of conversion they are anti dilutive but still not considered under basic earnings per share. Hence, dividend on cumulative non convertible preference shares is to be reduced while calculating basic earnings even if they are not dilutive. OPTION D