[Anonymous]

A company had the following outstanding shares as of January 1, Year 2:

Preferred stock, $60 par, 4%, cumulative

10,000 shares

Common stock, $3 par

50,000 shares

On April 1, Year 2, the company sold 8,000 shares of previously unissued common stock. No dividends were in arrears on January 1, Year 2, and no dividends were declared or paid during year 2. Net income for Year 2 totaled $236,000. What amount is basic earnings per share for the year ended December 31, Year 2?

a.

$3.79

b.

$4.21

c.

$4.07

d.

$3.66

Explanation

Choice “a” is correct. Basic earnings per share is calculated using the following formula:

Income available to common shareholders

Weighted average number of common shares outstanding

Step 1: The first step is to compute the income available to common shareholders. This amount is net income of $236,000 less dividends accumulated in the period on cumulative preferred stock, regardless of whether or not the dividends have been paid. For this company, income available to common shareholders is $236,000 less $24,000 (4% × $60 × 10,000) = $212,000.

Step 2: The second step is to compute the weighted average number of common shares outstanding. This would be calculated as follows:

Shares outstanding at the beginning of the period

50,000 shares

Shares sold on April 1, Year 2 on a weighted basis (8,000 × 9/12)

6,000 shares

Weighted average number of common shares outstanding for the entire period

56,000 shares

Step 3: Step 3 is the calculation of the basic earnings per share, which is $212,000 / 56,000 shares = $3.79.

Choices “d”, “c”, and “b” are incorrect based on the above explanation.

My question is why do we consider the 8,000 shares that were unissued. Doesn’t unissued mean not outstanding. And we need only the outstanding shared issued to calculate the weighted average number of common share outstanding? Please explain.

[mccaberp]

@buyr13

The previously unissued stock is issued in April meaning that it becomes outstanding as of April of that year (it's outstanding for 9/12 of the year.) You factor this into the calculation of Weighted Average Common Shares Outstanding as follows:

50,000 * 3/12 = 12,500

+8,000

58,000 * 9/12 = 43,500

56,000 = WACSO

Net Income available to common stock holders:

10,000 * 60 * .04 = 24,000 (preferred dividends accumulated)

Net Income = $236,000

Net INcome available to common stock holders = 236,000 – 24,000 = 212,000

212,000 / 56,000 = 3.785

AUD: Pass
REG: Pass
BEC: Pass
FAR: Pass

First try CPA. Thank god. God bless America.

[mdlynch3]

The shares were PREVIOUSLY unissued. Once sold, they become issued and outstanding and need to be included in the EPS calculation.

Good luck studying!

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[juuustin]

mcca has it right. The question doesn't say how much of the stock is still unissued. It is saying that 8,000 shares were unissued at January 1, but then in April the board decided to sell the shares to raise capital. Since they were only outstanding for 9 months, they must be weighted accordingly.

MD Candidate: 10/1/14

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BEC - 89 (4/19/15)
AUD - 98 (5/30/15)

Ethics - 100

Experience - In Progress!

[Anonymous]

Yeah, I read it wrong..thanks a lot!

[Author]

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