ExpertHard1 markMultiple Choice
CPA · Question 05 · Area I: Financial Reporting
TechSol Inc. has 100,000 shares of common stock outstanding throughout Year 1. Net income was $400,000. The company also had the following instruments outstanding all year:<br/><br/>- 10,000 shares of 6% Cumulative Preferred Stock, $100 par. Dividends were NOT declared.<br/>- 5,000 stock options with an exercise price of $20. The average market price was $25.<br/><br/>What is the Diluted Earnings Per Share (EPS) for Year 1?
TechSol Inc. has 100,000 shares of common stock outstanding throughout Year 1. Net income was $400,000. The company also had the following instruments outstanding all year:<br/><br/>- 10,000 shares of 6% Cumulative Preferred Stock, $100 par. Dividends were NOT declared.<br/>- 5,000 stock options with an exercise price of $20. The average market price was $25.<br/><br/>What is the Diluted Earnings Per Share (EPS) for Year 1?
Answer options:
A.
$3.37
B.
$3.40
C.
$3.96
D.
$4.00
How to approach this question
1. Calculate Basic EPS Numerator (NI - Preferred Divs). Note: Cumulative preferred divs are deducted even if not declared. 2. Calculate Diluted Denominator using Treasury Stock Method for options. 3. Divide.
Full Answer
A.$3.37✓ Correct
A
1. **Basic EPS Numerator:**<br/> Net Income: $400,000<br/> Less: Preferred Dividends (10,000 shares * $100 * 6%): $60,000 (Deduct because it's Cumulative, even if not declared).<br/> Numerator = $340,000.<br/><br/>2. **Denominator (Shares):**<br/> Basic Shares: 100,000<br/> Options (Treasury Stock Method):<br/> Proceeds = 5,000 * $20 = $100,000.<br/> Shares repurchased = $100,000 / $25 avg price = 4,000 shares.<br/> Incremental shares = 5,000 issued - 4,000 repurchased = 1,000.<br/> Diluted Denominator = 100,000 + 1,000 = 101,000.<br/><br/>3. **Diluted EPS:**<br/> $340,000 / 101,000 = $3.366... -> Round to $3.37.
Common mistakes
Not deducting undeclared cumulative dividends; using ending market price instead of average for options; adding full option shares without treasury stock repurchase.
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