Question 1

For purposes of computing the weighted-average number of shares outstanding during the year, a midyear event that must be treated as occurring at the beginning of the year is the

Accepted Answer

The declaration and issuance of a stock dividend must be treated as occurring at the beginning of the year for purposes of computing the weighted-average number of shares outstanding during the year. This is because a stock dividend increases the number of shares outstanding and therefore affects the calculation of earnings per share (EPS) for the entire year.

Question 2

When computing diluted earnings per share, stock options are

Accepted Answer

When computing diluted earnings per share, stock options are recognized only if they are dilutive. Dilutive stock options have the potential to decrease earnings per share by increasing the number of shares outstanding. Therefore, they are included in the calculation of diluted earnings per share. Conversely, antidilutive stock options are not included in the calculation, as they do not have a significant impact on earnings per share.

Question 3

The EPS computation that is forward-looking and based on assumptions about future transactions is

Accepted Answer

Diluted EPS takes into account potential dilution from options, warrants, and convertible securities, which are forward-looking assumptions about future transactions. Basic EPS only uses outstanding common shares and does not consider the impact of potential dilution. Continuing operations EPS and extraordinary EPS are not forward-looking computations, as they deal with past or current events.

Question 4

When using the if-converted method to compute diluted earnings per share, convertible securities should be

Accepted Answer

The if-converted method assumes that all convertible securities are converted into common shares, and then computes the diluted EPS based on the increased number of shares outstanding. Therefore, convertible securities should be included in the calculation only if they are dilutive, meaning they would decrease EPS if converted. If the securities are antidilutive, meaning they would increase EPS if converted, they should not be included in the calculation.

Question 5

When computing dilutive EPS, the treasury stock method can be used for all of the following except

Accepted Answer

Convertible preferred stock is not included in the treasury stock method for computing dilutive EPS because it is considered to be a form of debt, not equity.

Question 6

The if-converted method of computing EPS data assumes conversion of convertible securities at the

Accepted Answer

The if-converted method assumes conversion of convertible securities at the beginning of the earliest period reported (or at time of issuance, if later). This is because the calculation of EPS is based on the shares outstanding during the period, and the conversion of convertible securities would affect the number of shares outstanding at the beginning of the period. Therefore, it is appropriate to assume conversion at the beginning of the earliest period reported.

Question 7

In calculating diluted earnings per share, which of the following should not be considered?

Accepted Answer

The amount of cash dividends declared on common shares should not be considered in calculating diluted earnings per share. Diluted earnings per share is calculated by assuming the conversion of all dilutive securities, such as convertible bonds or stock options, into common shares. The weighted average number of common shares outstanding and the number of common shares resulting from the assumed conversion of debentures outstanding should be included in the calculation. The amount of dividends declared on cumulative preferred shares should also be considered, as they have the potential to reduce the earnings available to common shareholders. However, the amount of cash dividends declared on common shares is not relevant to the calculation of diluted earnings per share.

Question 8

The main purpose of reporting diluted earnings per share is to

Accepted Answer

The main purpose of reporting diluted earnings per share is to show the maximum possible dilution of earnings. This provides investors with a more conservative view of earnings potential if all potentially dilutive securities were to be exercised or converted.

Question 9

Under current GAAP, a company with a complex capital structure and potential earnings per share dilution must present

Accepted Answer

Under current GAAP, a company with a complex capital structure and potential earnings per share dilution must present basic and diluted earnings per share. Basic earnings per share is calculated by dividing the net income attributable to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution of other securities, such as convertible bonds or stock options. Therefore, presenting both basic and diluted earnings per share gives a more comprehensive picture of a company's financial performance.

Question 10

Earnings per share disclosures are required only for

Accepted Answer

Earnings per share disclosures are required for public companies as per Generally Accepted Accounting Principles (GAAP) in the United States. Private companies are not required to disclose earnings per share unless they are issuing securities to outside investors. The requirement is not based on the complexity of the company's capital structure or changes made to it during the reporting period.

Question 11

In applying the treasury stock method of computing diluted earnings per share, when is it appropriate to use the average market price of common stock during the year as the assumed repurchase price?

Accepted Answer

The treasury stock method assumes that if stock options were exercised, the company would use the proceeds to buy back its own shares at the average market price during the year. Therefore, it is appropriate to use the average market price as the assumed repurchase price when it is higher than the exercise price, as this would result in a lower number of shares being issued and a lower dilution of earnings per share. If the average market price is lower than the exercise price, it would not make sense for the company to buy back its own shares at a higher price than the market, so a different method would need to be used to compute diluted earnings per share.

Question 12

In determining earnings per share, interest expense, net of applicable income taxes, on convertible debt which is dilutive should be

Accepted Answer

Interest expense on convertible debt is considered a dilutive factor as it represents potential additional shares being issued upon conversion. Therefore, it should be added back to net income for diluted earnings per share calculations.

Question 13

Earnings per share information should be reported for all of the following except

Accepted Answer

Earnings per share information is not relevant to cash flows from operating activities. It is typically calculated using net income from continuing operations and/or extraordinary items.

Question 14

When computing diluted EPS for a company with a complex capital structure, what is the denominator in the computation?

Accepted Answer

When computing diluted EPS for a company with a complex capital structure, the denominator in the computation is the weighted-average number of common shares outstanding plus all other potentially dilutive securities. This includes any securities that could potentially dilute the value of existing shares, such as stock options, convertible bonds or preferred shares that can be converted into common shares.

Question 15

For a company having several different issues of convertible securities and/or stock options and warrants, the FASB requires selection of the combination of securities producing

Accepted Answer

The FASB requires the selection of the combination of securities producing the lowest possible earnings per share (EPS) to ensure a conservative approach in financial reporting, which provides a worst-case scenario to investors regarding dilution of EPS due to convertible securities and/or stock options and warrants.

Question 16

When computing earnings per share on common stock, dividends on cumulative, nonconvertible preferred stock should be

Accepted Answer

Dividends on cumulative, nonconvertible preferred stock should be deducted from net income regardless of whether the dividends were declared or paid in the period. This is because, in the case of cumulative preferred stock, dividends accumulate if not paid out, and they must be paid before any dividends can be distributed to common shareholders. This affects the earnings available to common shareholders, which is why it's deducted in the computation of earnings per share (EPS) for common stock.

Question 17

Where in the financial statements should basic and complex EPS figures for income from continuing operations be reported?

Accepted Answer

Basic and complex EPS figures for income from continuing operations should be reported on the income statement. Basic EPS is typically listed before any potential dilution, while complex EPS takes into account the dilutive effects of things like stock options and convertible securities. The accompanying notes and management's discussion and analysis may provide more detail and explanation, but the actual EPS figures should be reported on the income statement. The statement of cash flows is not relevant for EPS figures.

Question 18

Of the following, select the incorrect statement concerning earnings per share.

Accepted Answer

The answer of Of the following, select the incorrect statement...

Question 19

In computing the earnings per share of common stock, noncumulative preferred dividends not declared should be

Accepted Answer

Noncumulative preferred dividends not declared are not considered as an expense and therefore should be ignored in computing the earnings per share of common stock. These dividends are not owed to the preferred shareholders and do not affect the earnings available to the common shareholders.

Question 20

What is the correct treatment of a stock dividend issued in mid-year when computing the weighted-average number of common shares outstanding for earnings per share purposes?

Accepted Answer

The correct treatment of a stock dividend issued in mid-year when computing the weighted-average number of common shares outstanding for earnings per share purposes is to weight it as if the additional shares were issued at the beginning of the year. This is because the shares are considered outstanding for the entire period, not just the time since they were issued. Therefore, the total number of shares outstanding is increased, and the weighted-average number of common shares outstanding must reflect this by including the additional shares as if they were outstanding for the entire period.

Quiz 18: Earnings Per Share