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11. The following information is available on a company for the current year. Net income $1,000,000 Average number of common shares outstanding 100,000 Details of convertible securities outstanding: Convertible preferred shares outstanding 2,000 o dividend/share $10 o each preferred is convertible into 5 shares of common stock Convertible bonds, $100 face value per bond $80,000 o 8% coupon o each bond is convertible into 25 shares of common stock Corporate tax rate 40% The company’s diluted EPS is closest to: A. $7.57. B. $7.69. C. $7.72.

Ans: C. Since both the preferred shares and bonds are dilutive, they should both be converted to calculate the diluted EPS. Diluted EPS is the lowest value. $7.72 has calculated in the following table. Basic EPS Diluted EPS: Bond converted Diluted EPS: Preferred converted Diluted EPS: Both converted Net Income $1,000,000 $1,000,000 $1,000,000 $1,000,000 Preferred Dividends $(20,000) $(20,000) After-tax cost of interest .08 x 80,000 x (1-.40) $3,840 $3,840 Numerator $980,000 $983,840 $1,000,000 $1,003,840 Average common shares outstanding 100,000 100,000 100,000 100,000 Preferred converted 10,000 10,000 Bond converted 20,000 20,000 Denominator 100,000 120,000 110,000 130,000 EPS $9.80 $8.20 $9.09 $7.72

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12. During 2010, Company A sold a piece of land with a cost of $6 million to Company B for $10 million. Company B made a $2 million down payment with the remaining balance to be paid over the next 5 years. It has been determined that there is significant doubt about the ability and commitment of the buyer to complete all payments. Company A would most likely report a profit in 2010 of: A. $4 million using the accrual method. B. $0.8 million using the installment method. C. $2 million using the cost recovery method.

Ans: B. An installment sale occurs when a firm finances a sale and payments are expected to be received over an extended period. If collectability is certain, revenue is recognized at the time of sale using the normal revenue recognition criteria. If collectability cannot be reasonably estimated, the installment method is used. Under installment method, profit is recognized as cash is collected. Profit reported in 2010 is: x2=0.8million A is incorrect. It has been determined that there is significant doubt about the ability and commitment of the buyer to complete all payments. Normal revenue recognition method cannot be used here. C is incorrect.Cost recovery method could be used in this case, but the reported profit would be $0. Because under the cost recovery method, profit is recognized only when cash collected exceeds costs incurred.

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13. The table below shows changes to the number of common shares outstanding for a company during 2012: 1 January 600,000 shares outstanding 1 June 60,000 shares issued 1 August 2 for 1 stock split 31 December 480,000 shares outstanding To calculate earnings per share for 2012, the company’s weighted average number of shares outstanding is closest to: A. 215,000. B. 420,000. C. 430,000.

Ans: C. The weighted average number of shares outstanding is time weighted: 5/12 of the year there were 180,000 shares, and 7/12 of the year there were 240,000 (180,000+60,000) on a pre-split basis; the stock split is treated retroactively to the start of the year. [(180,000 x 5/12) + (240,000 x 7/12)] x 2 = 430,000

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14. A company entered into a three-year construction project with a total contract price of $5.3 million and an expected total cost of $4.4 million. The following table provides cash flow information relating to the contract: All figures in $ Year 1 Year 2 Year 3 Costs incurred and paid 600,000 3,000,000 800,000 Amounts billed and payments received 1,200,000 2,800,000 1,300,000 If the company uses the percentage-of-completion method, the amount of revenue (in $) recognized in Year 2 will be closest to: A. 2,800,000. B. 3,372,727. C. 3,616,636.

Ans: C. The revenue reported is equal to the percentage of the contract that is completed in that period, where percentage completion is based on costs. In Year 2, the percent completed is $3,000,000/$4,400,000 = 68.2%, resulting in 68.2% x 5,300,000 = 3,616,636 revenue being recognized.

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15. A company, with a tax rate of 40%, sold a capital asset with a net book value of $500,000 for $570,000 during the year. Which of the following amounts (in $) will most likely be reported on its income statement for the year related to the asset sale?

A. 42,000

B. 70,000

C. 570,000

  
  Ans: B.

The disposition of a capital asset is reported as a net gain or loss ($570,000 – $500,000 = $70,000) on the income statement before tax affects.

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16. A company reported net income of $400,000 for the year. At the end of the year, the company had an unrealized gain of $50,000 on its available-for-sale securities, an unrealized gain of $40,000 on held-to-maturity securities and an unrealized loss of $100,000 on its portfolio of held-for-trading securities. The company’s comprehensive income (in $) for the year is closest to:

A. 350,000.

B. 390,000.

C. 450,000.

  
  Ans: C.

Comprehensive Income = Net Income + Other Comprehensive Income = NI + OCI

Other Comprehensive Income will include unrealized gains or losses on available for sale securities. Net Income includes unrealized gains or losses in trading securities, while securities classified as held to maturity are maintained at historical cost and therefore the unrealized gains won’t impact comprehensive income.

OCI = $50,000; Comprehensive Income = NI + OCI = $400,000 + $50,000=$450,000

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17. According to International Financial Reporting Standards which of the following is one of the conditions that must be met for revenue recognition to occur?

A. Costs can be reliably measured

B. Payment has been partially received

C. Goods have been delivered to the customer

  
  Ans: A.

The IASB’s conditions that must be met include that the costs incurred can be reliably measured, there is assurance of payment, not necessarily an actual receipt of any payment, and that the significant risks and rewards of ownership have been transferred, which is normally (but not always) when the goods have been delivered.

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18. A company had 100,000 common shares outstanding on 1 January 2012. The company has no plans to issue additional shares or purchase treasury shares during the year, but is planning either a two-for-one stock split or a 100 percent stock dividend on 1 July. The number of shares used to determine earnings per share at 31 December 2012, will be closest to:

A. 200,000 for both the stock split and the stock dividend.

B. 200,000 for the stock split and 150,000 for the stock dividend.

C. 150,000 for the stock split and 200,000 for the stock dividend.

  
  Ans: A.

Stock dividends and stock splits are treated in the same way for purposes of determining weighted average number of shares outstanding; the adjustment in the number of shares is made as if the stock split or dividend occurred at the beginning of the year.

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19. Which of the following transactions will most likely result in a decrease in a company’s current ratio? The:

A. recording of a warranty expense.

B. recording of revenue before cash is received.

C. payment of a property insurance policy for the following year.

  
  Ans: A.

The recording of a warranty expense will create a warranty liability and the resulting increase in current liabilities will decrease the current ratio.

  

B is incorrect. Recording the revenue will increase the CA while having no affect on the CL, so the current ratio will increase.

  

C is incorrect. The payment of a property insurance policy for the following year has no effect both on CA or Cl, so current ratio stays the same.

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20. A company has just completed the sale of a tract of land for €3.5 million which was originally acquired at a cost of €2.0 million. The purchaser made a down-payment of €200,000 with the remainder to be paid in equal installments over the next 10 years. A short time after the sale, significant doubt arose about the purchaser’s ability to meet the future obligations for the land purchase. When compared to the cost recovery method of revenue recognition, the profit (in €) that the company will recognize in the year of the sale under the installment method is most likely to be higher by:

A. 85,714.

B. 114,286.

C. 150,000.

  
  Ans: A.

Under the installment method, the portion of the total profit of the sale (3.5 – 2.0 = 1.5) that is recognized in each period is determined by the percentage of the total sales price for which the seller has received cash, which is €1.5/€3.5 x €200,000 = €85,714; under the cost recovery method, no profit is recognized until the cash amounts received have exceed the seller’s cost of the property.