# Intermediate Accounting Exercise Computation of Net Income Intermediate Accounting III ACCTG 303 Section A

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```					                               Intermediate Accounting III
ACCTG 303 Section A

Winter 2005                                  Instructor J.B. Paperman

Midterm Exam 2
February 22, 2005

Name: ____________________________

INSTRUCTIONS:

a)   This exam is closed book. You may use one double-sided sheet of notes. You may
use a calculator to assist in computations.

b)   You must complete this exam on your own. No assistance is allowed except that
provided by the instructor.

c)   If you feel there is ambiguity in a problem, state your assumptions clearly.

d)   The exam has 9 pages in total and 14 questions with 100 points.

1
Multiple Choice (3pts each) – Circle the MOST correct answer

1. Direct costs incurred to sell stock such as underwriting costs
should be accounted for as
1. a reduction of additional paid-in capital.
2. an expense of the period in which the stock is issued.
3. an intangible asset.
a. 1
b. 2
c. 3
d. 1 or 3

A – The only method allowed now is to net it against the issue costs, 3 and 2
were allowed in the past but not any more.

2. "Gains" on sales of treasury stock (using the cost method) should
be credited to
a. paid-in capital from treasury stock.
b. capital stock.
c. retained earnings.
d. other income.

A – Gains go into APIC-TS, losses come out of it if available, otherwise out of
RE, but all “gains” go here.

3. Which of the following best describes a possible result of treasury
stock transactions by a corporation?
a. May increase but not decrease retained earnings.
b. May increase net income if the cost method is used.
c. May decrease but not increase retained earnings.
d. May decrease but not increase net income.

C – Never affects income so b and d are out, and gains go into APIC –TS so a is
out.

4. Which of the following statements about property dividends is not
true?
a. A property dividend is usually in the form of securities
of other companies.
b. A property dividend is also called a dividend in kind.
c. The accounting for a property dividend should be based on
the carrying value (book value) of the nonmonetary assets
transferred.
d. All of these statements are true.

C – Based on market value rather than carrying value.

2
5. The declaration and issuance of a stock dividend larger than 25% of
the shares previously outstanding
a. increases common stock outstanding and increases total stock-
holders' equity.
b. decreases retained earnings but does not change total stock-
holders' equity.
c. may increase or decrease paid-in capital in excess of par but
does not change total stockholders' equity.
d. increases retained earnings and increases total stockholders'
equity.

B – stock dividends never change total SE so a and d are out, just transfers
from RE to CS and APIC-CS so B is correct.

3
6. Proceeds from an issue of debt securities having stock warrants
should NOT be allocated between debt and equity features when
a. the market value of the warrants is not readily available.
b. exercise of the warrants within the next few fiscal periods seems
remote.
c. the allocation would result in a discount on the debt security.
d. the warrants issued with the debt securities are non-detachable.

D – If detachable allocate, in non-detachable ignore.

7. In computing earnings per share for a simple capital structure,
if the preferred stock is cumulative, the amount that should be
deducted as an adjustment to the numerator (earnings) is the
a. preferred dividends in arrears.
b. preferred dividends in arrears times (one minus the income tax
rate).
c. annual preferred dividend times (one minus the income tax rate).
d. none of these.

D – for cumulative preferred always deduct one year’s dividend.

8. In the diluted earnings per share computation, the treasury stock
method is used for options and warrants to reflect assumed
reacquisition of common stock at the average market price during the
period. If the exercise price of the options or warrants exceeds the
average market price, the computation would
a. fairly present diluted earnings per share on a prospective basis.
b. fairly present the maximum potential dilution of diluted earnings
per share on a prospective basis.
c. reflect the excess of the number of shares assumed issued over
the number of shares assumed reacquired as the potential dilution
of earnings per share.
d. be antidilutive.

D – If the exercise price is greater then the use of the options and subsequent
repurchase would actually reduce the number of shares rather than increase them
so it would be anti-dilutive.

4
9. (16 points) Gagne Company's balance sheet shows:
Common stock, \$20 par                    \$3,000,000
Paid-in capital in excess of par          1,050,000
Retained earnings                           750,000

INSTRUCTIONS
Record the following transactions by the cost method and the par
method.
(a) Bought 4,000 shares of its common stock at \$29 a share.
(b) Sold 2,000 treasury shares at \$30 a share.
(c) Sold 800 shares of treasury stock at \$26 a share.

Cost Method
(a) Treasury Stock ..........................     116,000
Cash ..................................               116,000

(b) Cash ....................................      60,000
Treasury Stock ........................                58,000
Paid-in Capital from Treasury Stock ...                 2,000

(c) Cash ....................................      20,800
Paid-in Capital from Treasury Stock .....       1,600
Retained Earnings .......................         800
Treasury Stock ........................                23,200

Par-Value Method
(a) Treasury Stock ..........................     80,000
Paid-in Capital from Common Stock .......     28,000
Retained Earnings .......................      8,000
Cash ..................................              116,000

(b) Cash ....................................      60,000
Treasury Stock ........................                40,000
Paid-in Capital from Common Stock .....                20,000

(c) Cash ....................................      20,800
Treasury Stock ........................                16,000
Paid-in Capital from Common Stock .....                 4,800

5
10. (10 points) The stockholders' equity section of Knott Corporation
shows the following on December 31, 2004:

Preferred stock 5%, \$100 par, 4,000 shares
outstanding                                          \$   400,000
Common stock \$10 par, 60,000 shares outstanding            600,000
Paid-in capital in excess of par                           200,000
Retained earnings                                          110,000

Total stockholders' equity                          \$1,310,000

INSTRUCTIONS
Assuming that all of the company's retained earnings are to be paid
out in dividends on 12/31/04 and that preferred dividends were last
paid on 12/31/02, show how much the preferred and common
stockholders should receive if the preferred stock is cumulative.

Preferred     Common       Total

Dividends in arrears (5% of
\$400,000)                       \$20,000     \$          \$ 20,000
Current year's dividends           20,000      70,000      90,000
Total                             \$40,000     \$54,000    \$110,000

6
11. (10 points) On January 1, 2004, Yarrow Corporation had 800,000 shares
of common stock outstanding. On March 1, the corporation issued
120,000 new shares to raise additional capital. On July 1, the
corporation declared and issued a 2-for-1 stock split. On October 1,
the corporation purchased on the market 480,000 of its own outstanding
shares and retired them.

INSTRUCTIONS
Compute the weighted average number of shares to be used in
computing earnings per share for 2004.

(Increase)                  Months                 Share
(Decrease)   Outstanding   Outstanding   Split     Months

Jan. 1                    800,000         2         2/1    3,200,000
March 1    120,000        920,000         4         2/1    7,360,000
July 1     920,000      1,840,000         3                5,520,000
Oct. 1    (480,000)     1,360,000         3                4,080,000

12                20,160,000

(20,160,000/12)               1,680,000

7
12. (20 points) At the end of 1997, the records of Wittink Corporation
reflected the following:

Common Stock, no-par, 50,000 shares issued and outstanding as of 1/1/97.
20,000 shares issued on 7/1/97. Stock split 2 for 1, issued on
12/1/97.
Preferred Stock, 5%, par \$10, non-convertible, cumulative, non-
participating, 10,000 shares issued and outstanding for all of 1997.
Bonds payable, 8%, 200 bonds issued 1/1/97 at par value. Each \$1,000
bond was initially convertible into 30 shares of common, adjusted to
60 shares of common following the 12/1/97 stock split.
Stock rights, rights for 15,000 shares of common at \$30/share were
outstanding at the beginning of the year, adjusted to 30,000 shares at
\$15 following the 12/1/97 stock split.
Net Income for 1997, \$120,000
Average Tax rate 30%
Average Market price of common stock, \$25 (adjusted for split)
No preferred dividends were declared or paid in 1997.

a) Calculate the weighted average number of shares outstanding for 1997.

(Increase)                   Months                Share
(Decrease)    Outstanding   Outstanding   Split    Months

Jan. 1                     50,000         6         2/1     600,000
July 1     20,000          70,000         6         2/1     840,000

12                1,440,000

(1,440,000/12)                 120,000

b) Calculate Simple Earnings Per Share for 1997.
Because no dividends were declared only cumulative preferred dividends
are subtracted from Net income.

Simple EPS = (\$120,000 – 5%*\$10*10,000)/120,000 = \$115,000/120,000
= \$0.96 per share

c) Calculate the dilution ratios for all potentially dilutive securities.
Convertible bond: Income effect 8%*\$1000*200*(1-30%) = \$11,200
Shares effect 60*200 = 12,000 shares
Dilution ratio = 11,200/12,000 = 0.93
Stock Rights: exercise price is \$15 which is less than market price so
they are dilutive.
Options exercised: issue 30,000 shares for \$450,000 (\$15*30,000)
Repurchase 450,000/25 = 18,000 shares
Net increase of 30,000 – 18,000 = 12,000 shares

8
Ratio = 0/12,000 = 0
d) Determine Diluted Earnings Per Share for 1997.
Rank based on dilution ratios from lowest to highest, rights then
bonds.

First check rights, since 0 is less than .96 we add them
New EPS = (115,000+0)/(120,000+12,000) = .87

Next check bonds, since 0.93 is more than .87 we stop

Diluted EPS = \$0.87 per share

9
13. (10 points) Fry Corporation has 10,000 shares of \$10 par common stock
outstanding on 1/1/98. On 3/1/98 the Board of Directors declared a
\$0.20 per share cash dividend. The date of record for the dividend is
3/25/98 and the dividend will be paid on 4/1/98. On 6/1/98 the Board
of Directors declared a 10% stock dividend. The date of record for
this dividend will be 6/25/98 and the new stock will be issued on
7/1/98. The stock price on 7/2/98 was \$35 per share. Assume Fry
Corporation has enough Retained Earnings so that neither dividend is a
liquidating dividend.

a) Prepare the journal entries necessary to record the cash dividend
(Show the dates for each journal entry).

3/1/98 declared
Dividends (RE)                  2,000
Dividends Payable                      2,000

3/25/98 record
No entry, just compile lists of owners

4/1/98 payment
Dividend Payable                2,000
Cash                                   2,000

b) Prepare the journal entries necessary to record the stock dividend.

6/1/98 declared
Typically no entry but could do:
Dividends (RE)                  10,000
Stock Dividend Distributable           10,000 (is a contra equity)

6/25/98 record
No entry, just compile list of owners

7/1/98
If no entry on 6/1/98
Dividends (RE)                  35,000
Common Stock                           10,000
APIC – CS                              25,000

If entry on 6/1/98 was made
Dividends (RE)                  25,000
Stock Dividend Distributable    10,000
Common Stock                           10,000
APIC – CS                              25,000

10
14. (10 points) On January 1, 2006, Goldingay Corp. granted a compensatory
stock option of 1,000 shares of common stock (par \$1) to Executive
Jessie with an exercise price of \$10 and expiration of 12/31/2016. The
option was for services between 2006 and 2011 (5 years). The market
price per share on the date of grant (January 1, 2006) was \$18; the
fair market value of the option was estimated at \$25,000:

a) Assume that Goldingay follows the revision to FAS 123 to report stock
option plans. Give the required entries to record granting the option
and any required entries for year-end 2006.

No entry on grant date – fair value determined = 25,000 to expense

12/31/06 amortize the fair value over the 5 year vesting period
Compensation Expense             5,000
Stock Options (in APIC)                 5,000

Would repeat every year through 2011

b) On 12/31/2012 Jessie exercises the options when the market value of
the stock is \$25. Give the required entry to record this transaction.

Cash                            10,000
Stock Options                   25,000
Common Stock                            1,000
APIC – CS                              34,000

11

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