Question 3 (30 marks)

A. On January 1, 2020, Martino AG had a 10% convertible bond outstanding. The convertible bond was issued on January 1, 2017 at par, with a face value of 100,000, maturing on January 1, 2022. The bond is convertible into 5,000 Martino ordinary shares of 1 per share par value. At the date of issue, the market interest rate for a similar non-convertible bond was 11%. The following bond amortization schedule is provided for this bond.

Effective-Interest Method

Date Cash Paid Interest Expense Premium Amortized Carrying Amount of Bond

1/1/17 0 0 0 96,304

12/31/17 10,000 10,593 593 96,897

12/31/18 10,000 10,659 659 97,556

12/31/19 10,000 10,731 731 98,287

12/31/20 10,000 10,812 812 99,099

12/31/21 10,000 10,901 901 100,000

During the year of 2020, the following transactions occurred.

1. The convertible bond was converted on December 31, 2020. The fair value of the liability component of the bond is determined to be 120,000 on December 31, 2020.

2. The company sold a 200,000, 10% bond at 104 to the public. The company also issued one detachable warrant with each 100 bond. The warrants were for the purchase of 2,000 ordinary shares at 30 per share in two years from the date of issue. The fair value of the bond without the warrants was 192,000. The estimated fair value of the warrants was 26,000 at the date of issue. All the warrants were outstanding and in good standing at the year end.

3. During the current year, the company granted 10,000 share options for 10,000 ordinary shares to its 10 executives. Using a fair value option-pricing model, the company determines that each option is worth 10. The option price is 30. The options were to expire at the year-end and were considered compensation for the current year.

4. All but 1,000 options related to the share-option plan were exercised by the year-end. The expiration resulted because one of the executives failed to fulfill an obligation related to the employment contract.

Required: Prepare journal entries for the current year to record the transactions listed above. Assume that the accrual of interest on the convertible bond related to 2020 has been recorded. (14 marks)

B. Earnings per share (EPS) is the most featured, single financial statistic about modern companies. Daily published quotations of the share prices have recently been expended to include for many securities a times earnings figure that is based on EPS. Securities analysts often focus their discussions on EPS of the companies they study.

Required:

(a) Explain how dividends on outstanding preference shares affect the computation of basic EPS and diluted EPS. (8 marks)

(b) Explain the treasury-share method as it applies to options and warrants in computing diluted EPS data. (4 marks)

(c) Convertible debentures are considered potential ordinary shares. Explain how convertible debentures are handled for the purposes of diluted EPS computation. (4 marks)