DILUTIVE SECURITIES AND EARNINGS PER SHARE

Question 1

IFRS requires that convertible debt be separated into its liability and equity components for accounting purposes.

Answer 1

TRUE

Question 2

Companies recognize a gain or loss on the conversion of convertible debt before maturity.

Answer 2

FALSE

Question 3

When an issuer offers some form of additional consideration (a sweetener) to encourage of its convertible debt, it reports the sweetener as a current period expense.

Answer 3

TRUE

Question 4

The issuer of convertible preference shares uses the fair value method to record the conversion of the shares.

Answer 4

FALSE

Question 5

Companies recognize a gain or loss when shareholders exercise convertible preference shares.

Answer 5

FALSE

Question 6

A company should allocate the proceeds from the sale of debt with detachable share warrants between the two securities based on there fair values.

Answer 6

TRUE

Question 7

Non-detachable warrants, unlike detachable warrants, are not considered a compound instrument for accounting purposes.

Answer 7

FALSE

Question 8

The intrinsic value of a share option is the difference between the market price of the shares and the exercise price of the options at the grant date.

Answer 8

TRUE

Question 9

Under the fair value method, companies compute total compensation expense based on the fair value of options on the date of exercise.

Answer 9

FALSE

Question 10

The service period in share option plans is the time between the grant date and the vesting date.

Answer 10

TRUE

Question 11

If an employee fails to exercise a share option before its expiration date, the company should decrease compensation expense.

Answer 11

FALSE

Question 12

If a service condition exists, the company is not permitted to adjust the estimate of compensation expense.

Answer 12

FALSE

Question 13

If preference shares are cumulative and no dividends are declared, the company subtracts the current year preference dividend in computing earnings per share.

Answer 13

TRUE

Question 14

When share dividends or share splits occur, companies must restate the shares outstanding after the share dividend or split, in order to compute the weighted-average number of shares.

Answer 14

FALSE

Question 15

If a share dividend occurs after year-end, but before the financial statements, are authorized for issuance, a company must restate the weighted-average number of shares outstanding for the year.

Answer 15

TRUE

Question 16

If a share dividend occurs after year-end, but before the financial statements, are authorized for issuance, a company must restate the weighted-average number of shares outstanding for the year.

Answer 16

FALSE

Question 17

When a company has a complex capital structure, it must report both basic and diluted earnings per share.

Answer 17

TRUE

Question 18

In computing diluted earnings per share, share options are considered dilutive when their option price is greater than the market price.

Answer 18

FALSE

Question 19

The number of contingent shares to be included in diluted earnings per share is based on the number of shares that would be issuable as if the end of the period were the end of the contingency period.

Answer 19

TRUE

Question 20

A company should report per share amounts for income from continuing operations, but not for discontinued operations.

Answer 20

TRUE

Question 21

Convertible bonds

a. have priority over other indebtedness.
b. are usually secured by a first or second mortgage.
c. pay interest only in the event earnings are sufficient to cover the interest.
d. may be exchanged for equity securities.

Answer 21

may be exchanged for equity securities.

Question 22

The conversion of bonds is most commonly recorded by the

a. incremental method.
b. proportional method.
c. fair value method.
d. book value method.

Answer 22

book value method.

Question 23

When a bond issuer offers some form of additional consideration (a “sweetener”) to induce conversion, the sweetener is accounted for as a(n)

a. equity item.
b. expense.
c. loss.
d. None of these are correct.

Answer 23

expense.

Question 24

Corporations issue convertible debt for two main reasons. One is the desire to raise equity capital that, assuming conversion, will arise when the original debt is converted. The other is

a. the ease with which convertible debt is sold even if the company has a poor credit rating.
b. the fact that equity capital has issue costs that convertible debt does not.
c. that many corporations can obtain financing at lower rates.
d. that convertible bonds will always sell at a premium.

Answer 24

that many corporations can obtain financing at lower rates.

Question 25

When convertible debt is not converted at maturity

a. a gain or loss is recorded for the difference between the book value of the debt and the present value of the cash flows.
b. the amount originally allocated to equity is recorded as a gain on retirement.
c. the amount allocated to the equity component at the issuance date is recorded as a loss on retirement.
d. the carrying value of the bond equals its face value and it is removed from the books

Answer 25

the carrying value of the bond equals its face value and it is removed from the books

Question 26

Convertible bonds

a. Are separated into the bond component and the expense component.
b. Allow a company to issue debt financing at cheaper rates.
c. Are separated into their components based on relative fair values.
d. All of these answer choices are correct.

Answer 26

Allow a company to issue debt financing at cheaper rates.

Question 27

Mae Jong Corp issues $1,000,000 of 10% bonds payable which may be converted into 10,000 shares of $2 par value ordinary shares. The market rate of interest on similar bonds is 12%. Interest is payable annually on December 31, and the bonds were issued for total proceeds of $1,000,000. In accounting for these bonds, Mae Jong Corp. will

a. First assign a value to the equity component, then determine the liability component.
b. Assign no value to the equity component since the conversion privilege is not separable from the bond.
c. First assign a value to the liability component based on the face amount of the bond.
d. Use the “with-and-without” method to value the compound instrument.

Answer 27

Use the “with-and-without” method to value the compound instrument.

Question 28

Convertible preference shares

a. Are compound instruments with both a liability and an equity component.
b. Include an option for the holder to convert preference shares into a fixed number of ordinary shares.
c. Use the “with-and-without” method to value the compound instrument.
d. All of these answer choices are correct.

Answer 28

Include an option for the holder to convert preference shares into a fixed number of ordinary shares.

Question 29

The conversion of preference shares into ordinary shares requires that any excess of the par value of the ordinary shares issued over the carrying amount of the preference shares being converted should be

a. reflected currently in income.
b. reflected currently in other comprehensive income.
c. treated as a prior period adjustment.
d. treated as a direct reduction of retained earnings.

Answer 29

treated as a direct reduction of retained earnings.

Question 30

The conversion of preference shares may be recorded by the

a. incremental method.
b. book value method.
c. market value method.
d. par value method

Answer 30

book value method.

Question 31

When the cash proceeds from bonds issued with detachable share warrants exceed the fair value of the bonds without the warrants, the excess should be credited to

a. Share Premium—Ordinary.
b. Retained Earnings.
c. A share liability account.
d. Share Premium-Share Warrants.

Answer 31

Share Premium-Share Warrants.

Question 32

Proceeds from an issue of debt securities having share warrants should not be allocated between debt and equity features when

a. the fair value of the warrants is not readily available.
b. exercise of the warrants within the next few fiscal periods seems remote.
c. the warrants issued with the debt are non-detachable.
d. Proceeds should be allocated between debt and equity for all of these.

Answer 32

Proceeds should be allocated between debt and equity for all of these.

Question 33

A corporation issues bonds with detachable warrants. The amount to be recorded as share premium is preferably

a. zero.
b. calculated as the excess of the proceeds over the face value of the bonds.
c. equal to the market value of the warrants.
d. calculated as the excess of the proceeds over the fair value of the bonds.

Answer 33

equal to the market value of the warrants.

Question 34

The distribution of share rights to existing ordinary shareholders will increase share premium at the
Date of Issuance Date of Exercise
of the Rights of the Rights
a. Yes Yes
b. Yes No
c. No Yes
d. No No

Answer 34

No
Yes

Question 35

The major difference between convertible debt and share warrants is that upon exercise of the warrants

a. the shares are held by the company for a defined period of time before they are issued to the warrant holder.
b. the holder has to pay a certain amount of cash to obtain the shares.
c. the shares involved are restricted and can only be sold by the recipient after a set period of time.
d. no share premium can be a part of the transaction.

Answer 35

the holder has to pay a certain amount of cash to obtain the shares.

Question 36

According to IFRS, a company makes only a memorandum entry when

a. companies give warrants to executives and employees as a form of compensation.
b. companies include warrants to make a security more attractive.
c. companies issue rights to existing shareholders.
d. All of these answer choices are correct.

Answer 36

companies issue rights to existing shareholders.

Question 37

According to IFRS, once the total compensation is measured at the date of grant

a. it can be changed in future periods related to a change in market conditions.
b. it can be changed to reflect the rise or fall in the market price of the company’s ordinary shares.
c. a company is permitted to adjust the number of share options expected to the actual number of instruments vested.
d. All of these answer choices are correct.

Answer 37

a company is permitted to adjust the number of share options expected to the actual number of instruments vested.

Question 38

Restricted shares

a. better align the employee incentives with the companies’ incentives.
b. result in less dilution to existing shareholders.
c. never become completely worthless.
d. All of these choices are correct.

Answer 38

All of these choices are correct.

Question 39

Which of the following is not a characteristic of a non-compensatory stock option plan?

a. Substantially all full-time employees may participate on an equitable basis.
b. The plan offers no substantive option feature.
c. Unlimited time period permitted for exercise of an option as long as the holder is still employed by the company.
d. Discount from the market price of the stock no greater than would be reasonable in an offer of stock to stockholders or others.

Answer 39

Unlimited time period permitted for exercise of an option as long as the holder is still employed by the company.

Question 40

The date on which to measure the compensation element in a share option granted to a corporate employee ordinarily is the date on which the employee

a. is granted the option.
b. has performed all conditions precedent to exercising the option.
c. may first exercise the option.
d. exercises the option.

Answer 40

is granted the option.

Question 41

Compensation expense resulting from a compensatory share option plan is generally

a. recognized in the period of exercise.
b. recognized in the period of the grant.
c. allocated to the periods benefited by the employee’s required service.
d. allocated over the periods of the employee’s service life to retirement.

Answer 41

allocated to the periods benefited by the employee’s required service.

Question 42

The date on which total compensation expense is computed in a share option plan is the date
a. of grant.
b. of exercise.
c. that the market price coincides with the option price.
d. that the market price exceeds the option price.

Answer 42

of grant.

Question 43

Employee share purchase plans (ESPP)

a. Permit all employees to purchase shares at a discounted price.
b. Are generally considered noncompensatory and result in no compensation expense being recorded.
c. Distribute restricted shares to employees for a short period of time.
d. All of these answer choices are correct regarding ESPP.

Answer 43

Permit all employees to purchase shares at a discounted price.

Question 44

In accounting for share-appreciation rights plans, compensation expense is generally

a. not recognized because no excess of market price over the option price exists at the date of grant.
b. recognized in the period of the grant.
c. allocated over the service period of the employees.
d. recognized in the period of exercise.

Answer 44

allocated over the service period of the employees.

Question 45

For share appreciation rights that are a liability award, the measurement date for computing compensation is the date

a. the rights mature.
b. the share’s price reaches a predetermined amount.
c. of grant.
d. of exercise.

Answer 45

of exercise.

Question 46

An executive pays no taxes at time of exercise in a(an)

a. share appreciation rights plan.
b. incentive share option plan.
c. nonqualified share option plan.
d. Taxes would be paid in all of these.

Answer 46

incentive share option plan.

Question 47

A company estimates the fair value of SARs, using an option-pricing model, for

a. share-based equity awards.
b. share-based liability awards.
c. both equity awards and liability awards.
d. neither equity awards or liability awards.

Answer 47

both equity awards and liability awards.

Question 48

On January 2, 2015, Farr Co. issued 10-year convertible bonds at 105. During 2017, these bonds were converted into ordinary shares having an aggregate par value equal to the total face amount of the bonds. At conversion, the market price of Farr’s shares was 50 percent above its par value. On January 2, 2015, cash proceeds from the issuance of the convertible bonds should be reported as

a. share capital for the entire proceeds.
b. share premium for the portion of the proceeds attributable to the conversion feature and as a liability for the balance.
c. a liability for the entire proceeds.
d. a liability for the present value of the bonds and share premium for the amount over the bonds present value.

Answer 48

a liability for the present value of the bonds and share premium for the amount over the bonds present value.

Question 49

Lang Co. issued bonds with detachable ordinary share warrants. Only the bonds had a known fair value. The cash proceeds exceed the fair value of the bonds. This excess is reported as

a. Share Premium—Share Warrants.
b. Share Premium—Ordinary.
c. Bonds Payable.
d. Share Premium—Conversion Equity

Answer 49

Share Premium—Share Warrants.

Question 50

With respect to the computation of earnings per share, which of the following would be most indicative of a simple capital structure?

a. Ordinary shares, preference shares, and convertible securities outstanding in lots of even thousands
b. Earnings derived from one primary line of business
c. Ownership interest consisting solely of ordinary shares
d. None of these answers are correct

Answer 50

Ownership interest consisting solely of ordinary shares

Question 51

In computing earnings per share for a simple capital structure, if the preference shares are cumulative, the amount that should be deducted as an adjustment to the numerator (earnings) is the

a. preference dividends in arrears.
b. preference dividends in arrears times (one minus the income tax rate).
c. annual preference dividend times (one minus the income tax rate).
d. None of these answers are correct.

Answer 51

None of these answers are correct

Question 52

In computations of weighted average of shares outstanding, when a share dividend or stock split occurs, the additional shares are

a. weighted by the number of days outstanding.
b. weighted by the number of months outstanding.
c. considered outstanding at the beginning of the year.
d. considered outstanding at the beginning of the earliest year reported.

Answer 52

considered outstanding at the beginning of the earliest year reported.

Question 53

What effect will the acquisition of treasury shares have on shareholders’ equity and earnings per share, respectively?

a. Decrease and no effect
b. Increase and no effect
c. Decrease and increase
d. Increase and decrease

Answer 53

Decrease and increase

Question 54

Due to the importance of earnings per share information, it is required to be reported by all
Public Companies Nonpublic Companies
a. Yes Yes
b. Yes No
c. No No
d. No Yes

Answer 54

YES
NO

Question 55

A convertible bond issue should be included in the diluted earnings per share computation as if the bonds had been converted into ordinary shares, if the effect of its inclusion is

	Dilutive	Antidilutive a.		Yes	Yes b.		Yes	No c.		No	Yes d.		No	No

Answer 55

YES
NO

Question 56

When computing diluted earnings per share, convertible bonds are

a. ignored.
b. assumed converted whether they are dilutive or antidilutive.
c. assumed converted only if they are antidilutive.
d. assumed converted only if they are dilutive.

Answer 56

assumed converted only if they are dilutive

Question 57

Dilutive convertible securities must be used in the computation of

a. basic earnings per share only.
b. diluted earnings per share only.
c. diluted and basic earnings per share.
d. None of these answers are correct.

Answer 57

diluted earnings per share only.

Question 58

In computing earnings per share, the equivalent number of shares of convertible preference shares are added as an adjustment to the denominator (number of shares outstanding). If the preference shares are cumulative, which amount should then be added as an adjustment to the numerator (net earnings)?

a. Annual preference dividend
b. Annual preference dividend times (one minus the income tax rate)
c. Annual preference dividend times the income tax rate
d. Annual preference dividend divided by the income tax rate

Answer 58

Annual preference dividend

Question 59

In the diluted earnings per share computation, the treasury share method is used for options and warrants to reflect assumed reacquisition of ordinary shares 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.

Answer 59

be antidilutive.

Question 60

In applying the treasury share method to determine the dilutive effect of share options and warrants, the proceeds assumed to be received upon exercise of the options and warrants

a. are used to calculate the number of ordinary shares repurchased at the average market price, when computing diluted earnings per share.
b. are added, net of tax, to the numerator of the calculation for diluted earnings per share.
c. are disregarded in the computation of earnings per share if the exercise price of the options and warrants is less than the ending market price of ordinary shares.
d. None of these answers are correct.

Answer 60

are used to calculate the number of ordinary shares repurchased at the average market price, when computing diluted earnings per share.

Question 61

When applying the treasury share method for diluted earnings per share, the market price of the ordinary shares used for the repurchase is the

a. price at the end of the year.
b. average market price.
c. price at the beginning of the year.
d. None of these answers are correct.

Answer 61

average market price.

Question 62

Antidilutive securities

a. should be included in the computation of diluted earnings per share but not basic earnings per share.
b. are those whose inclusion in earnings per share computations would cause basic earnings per share to exceed diluted earnings per share.
c. include share options and warrants whose exercise price is less than the average market price of ordinary shares.
d. should be ignored in all earnings per share calculations.

Answer 62

should be ignored in all earnings per share calculations.

Question 63

Assume there are two dilutive convertible securities. The one that should be used first to recalculate earnings per share is the security with the

a. greater earnings adjustment.
b. greater earnings effect per share.
c. smaller earnings adjustment.
d. smaller earnings effect per share.

Answer 63

smaller earnings effect per share.