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31. The following information was obtained from a company’s 10-k. Number of shares outstanding, June 30, 20x2 1,500,000 Issuance of shares, September 30, 20x2 1,000,000 Repurchase of shares, December 31, 20x2 500,000 Stock split, March 31, 20x3 3-for-1 Firm’s weighted average number of shares outstanding for the one-year period ended June 30,20x3 is closest to: A. 3,000,000. B. 4,500,000. C. 6,000,000. D.

Ans: C. The weighted average number of shares outstanding is time weighted: 3/12 of the year there were 1,500,000 shares, 3/12 of the year there were 2,500,000 (1,500,000+1,000,000),3/12 of the year there were 2,000,000 (1,500,000+1,000,000-500,000) on a pre-split basis (the stock split is treated retroactively to the start of the year), and 3/12 of the year there were 6,000,000 (=2,000,000 x 3) Weighted average number of shares outstanding for the one-year period: [(1,500,000 x 3/12) + (2,500,000 x 3/12)+(2,000,000 x 2/12)] x 3+6,000,000 x 3/12= 6,000,000

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32. An analyst gathered the following information about a company: Shares of common stock 1,000,000 Net income for the year $1,500,000 Par value of convertible bonds with a 4% coupon rate $10,000,000 Par value of cumulative preferred stock with a 7% dividend rate $2,000,000 Tax rate 30% The bonds were issued at par and can be converted into 300,000 common shares. All securities were outstanding for the entire year. Diluted earnings per share for the company are closest to: A. $1.05. B. $1.26. C. $1.36.

Ans: B. Basic EPS Diluted EPS: Bond converted Net Income $1,500,000 $1,500,000 Preferred Dividends $(140,000) $(140,000) After-tax cost of interest .04 x 10,000,000 x (1-0.30) $280,000 Numerator $1,360,000 $1,640,000 Average common shares outstanding 1,000,000 1,000,000 Preferred converted Bond converted 300,000 Denominator 100,000 1,300,000 EPS $1.36 $1.26

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33. Income statements for two companies (A and B) and the common-sized income statement for the industry are provided below: All $ figures in ‘000s Company A Company B Industry Sales $10,500 $8,250 100.00% COGS 6,353 5,239 62.8% SG&A 2,625 2,021 24.8% Interest expense 840 536 7.0% Pretax earnings 683 454 5.4% Taxes 205 145 1.7% Net earnings $478 $309 3.7% The best conclusion an analyst can make is: A. Company B’s interest rate is lower than the industry average. B. Both companies’ tax rates are higher than the industry average. C. Company A earns a higher gross margin than both Company B and the industry.

Ans: C. Company A Company B Industry Sales 100.00% 100.00% 100.00% COGS 60.5% 63.5% 62.8% Gross margin 39.5% 36.5% 37.2% Company A earns a higher gross margin than both Company B and the industry. A is incorrect. The interest rate is not a function of sales and cannot be analyzed on a common sized income statement. B is incorrect. Tax rates are determined based on taxes ÷ pretax earnings, not as a percentage of sales (as shown in common sized analysis). Company A Company B Industry Pretax earnings 6.5% 5.5% 5.4% Taxes 2.0% 1.8% 1.7% Tax rate = taxes ÷ pretax earnings 30% 32% 32% The tax rates for the companies are not higher than the industry.

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34. The following information is available for Ajax Company’s most recent fiscal year: Basic earnings per share $1.50 Net income $20,000,000 Preferred dividends $5,000,000 Weighted average shares outstanding (WASO) 10,000,000 Preferred shares outstanding throughout period 1,000,000 The $100 par value preferred stock pays a 5% dividend. Each preferred share may be converted into five common shares. The preferred stock market price is $102 per share and the common stock trades at $19 per share. Diluted earnings per share (EPS) for Ajax company is closest to: A. $1.00. B. $1.33. C. $1.50.

Ans: B. Diluted EPS is derived from the following calculation: Diluted EPS= To calculate the dilutive effect of the preferred shares, assume that the shares were converted at the beginning of the period. Assuming this conversion, the $5,000,000 preferred dividends would not have been paid and there would have been an additional 5,000,000 common shares (5 new shares for each preferred share outstanding). The formula is: Net income available to common shareholders was $15,000,000 ($20m-$5m in preferred dividends). If the shares were converted, the $5m in preferred dividends is added back. Diluted EPS cannot exceed basic EPS. Basic EPS is calculated as follows: The diluted EPS does not exceed basic EPS. Had diluted EPS exceeded basic EPS, the convertible preferred stock would have been anti-dilutive and diluted EPS would be the same s basic EPS.

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35. Which of the following transactions would typically be included as part of a company’s income from discontinued operations reported on the income statement?

A. A gain from the sale of an investment.

B. A loss incurred from the settlement of a lawsuit.

C. A loss from the operations of a business component classified as “held for sale.”
  Ans: C.

A loss from the operations of “held for sale” business components that have separately identifiable operations, assets and cash flows would typically be reported under discontinued operations.

  

A and B are incorrect. Although each item is considered an unusual or infrequent item, it would be reported as part of income from continuing operations. If significant, the item may be reported as a separate line item as long as it is presented on a pretax basis, appears “above the line”, and is not presented as an extraordinary item.

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36. Bao Company reported net income for the year ended December 31, 2012 of $6,000,000. The company’s tax rate was 40%. At the same date, the company had outstanding $30 million in 6% convertible bonds with a conversion price of $60 per share and 3 million common shares with a par value of $10. The only change in the capital structure during 2012 was the repurchase of 100,000 common shares on April 1. Bao’s diluted earnings per share for 2012 were closest to: A. $2.01. B. $1.98. C. $1.91.

Ans: B. Weighted average shares outstanding = 3,100,000 outstanding before treasury repurchase for ? of the year = 775,000 3,000,000 outstanding before treasury repurchase for ?  of the year = 2,250,000 Weighted average shares = 775,000+2,250,000 = 3,025,000 Basic EPS= income from continuing operations/ WASO                  =$6,000,000/3,025,000 = $1.98 Potential common shares from bond conversion =$30,000,000 /$60 = 500,000 shares Reduction of interest expense net of taxes =$30 million x 6% x (1-0.4) = $1,080,000 Adjusted EPS assuming conversion =($6,000,000+1,080,000)/(3,025,000+500,000) =$2.01 The adjustment for the bond conversion is anti-dilutive (the diluted EPS as calculated is smaller than basic EPS) so basic EPS and diluted EPS are the same at $1.98.

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37. A company’s comparative income statements and balance sheets are presented below.

Income statement For the year ended 31 August (U.S. $ thousands)
	2012	2011
Sales	$100,000	$95,000
COGS	47,000	47,500
Gross profit	53,000	47,500
Operating expenses	34,000	38,000
Interest expense	2,400	2,700
Earnings before taxes	16,600	6,800
Income taxes 33%	5,478	2,244
Net income	$11,122	$4,556

Balance sheet As at 31 August (U.S. $ thousands)
	2012	2011
Assets
Cash & investments	$21,122	$25,000
Accounts receivable	25,000	13,500
Inventories	13,000	8,500
Total current assets	$59,122	$47,000
Total long-term assets	72,000	80,000
Total assets	$131,122	$127,000
Liabilities
Accounts payable	$15,000	$15,000
Other current liabilities	7,000	9,000
Total current liabilities	$22,000	$24,000
Long-term debt	35,000	40,000
Total liabilities	$57,000	$64,000
Shareholders’ equity
Common stock	$58,000	$58,000
Retained earnings	16,122	5,000
	$74,122	$63,000
Total liabilities & equity	$131,122	$127,000

The cash collected from customers in 2012 is closest to:
A.
$88,500.
B.
$96,100.
C.
$111,500.

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38.  Under U.S.GAAP, foreign currency translation adjustments are most likely reported in the company’s:

A. income statement.

B. statement of cash flows.

C. statement of stockholders’ equity.

  
  Ans: C.

The statement of stockholders’ equity includes accumulated other comprehensive income that contains the foreign currency translation adjustment.

Note: other comprehensive income includes transactions that are not included in net income, such as:

·         Foreign currency translation gains and losses.

·         Adjustments for minimum pension liability.

·         Unrealized gains and losses from cash flow hedging derivatives.

·         Unrealized gains and losses from available-for-sale securities.

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39.Is the reporting of an extraordinary item, net of tax, allowed under U.S.GAAP and IFRS?

A. Yes, under both.

B. Yes under IFRS, but not under U.S.GAAP.

C. Yes under U.S.GAAP, but not under IFRS.

  
  Ans: C.

Under U.S.GAAP, an extraordinary item is a material transaction or event that is both unusual and infrequent in occurrence.

IFRS does not allow extraordinary items to be separated from operating results in the income statement.

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40. under U.S.GAAP, disclosures related to the valuation allowance for changes in the carrying amount of a company’s noncurrent investment securities will most likely be included in the company’s:

A. income statement.

B. statement of cash flows.

C. statement of stockholders’ equity.
  Ans: C.

The statement of stockholders’ equity includes accumulated other comprehensive income that contains the unrealized gains and losses on available-for-sale securities.