QUESTION ONE (25 marks) As auditor for Chrisley and Dale Associates, you have been assigned to check McKesson Corporation's computation of earnings per share for the current year. The financial controller has supplied you with the following computations. $6,800,000 Net Income Ordinary shares issued and outstanding: Beginning of year End of year Average 650,000 4,000,000 2.325,000 Eamings per share calculation: $6.800,000 - $2.92 2.325,000 You have gathered the following information: On January 1, 2020, McKesson Corp. issued 650,000 shares. Additional issues of shares for the year were as follows: April 1 150,000 shares May 1 A 20% share dividend August 1 700,000 shares September 1 340,000 shares November 1 A 2 for 1 share split All 4,000,000 shares were outstanding at December 31, 2020. On January 1, 10% convertible debentures, $60,000,000 face value, were issued at par. Each $1,000 debenture is convertible into 40 ordinary shares. The interest expense for the current year related to the liability component of the convertible debentures is $6,500,000 200,000 preference shares outstanding, $70 par, 8% cumulative, not convertible. Options were granted to purchase 400,000 ordinary shares at $18 each. The company's average market price of ordinary shares was $24. 10 year $3,000,000 face value, 8% bonds issued at par on July 1. Each $500 bond is convertible into 30 ordinary shares. The interest expense on the liability component of convertible bonds for the year was $360,000 McKesson's net income in 2020 was $6,800,000 and its tax rate was 30%. Instructions (a) On the basis of the information above, do you agree with the controller's computation of earnings per share? If you disagree, prepare a revised computation of the earnings per share for 2020. (8 marks) (b) Calculate the diluted earnings per share for 2020. (8 marks) (c) Explain and justify the accounting treatment for share dividends and share splits. (3 marks) (d) The executive officers of Welsh Inc. have a performance based compensation plan. The performance criterion of this plan is linked to growth in earnings per share. When annual EPS growth is 10%, the executives of Welsh will earn 100% of the shares; if growth is 15%, they cam 125%. If EPS growth, however, is lower than 8%, the executives receive no additional compensation. In 2020, Shelly Prince, the financial controller of Welsh, reviews year end estimates of bad debt expense and warranty expense. She calculates EPS growth of 10%. A member of the executive mentioned to her that the estimate of bad debt expense might be decreased, increasing EPS growth to 15%. Shelly is not sure she should include this because she believes that the current bad debt expense is sound. She does recognize though, that a great deal of subjectivity was involved in its computation. Instructions i. ii. What, if any, is the ethical dilemma facing Shelly Prince? (2 marks) Should Shelly's knowledge of the compensation plan influence her estimate? (2 marks) How should Shelly respond to the executive's request? (2 marks) QUESTION ONE (25 marks) As auditor for Chrisley and Dale Associates, you have been assigned to check McKesson Corporation's computation of earnings per share for the current year. The financial controller has supplied you with the following computations. $6,800,000 Net Income Ordinary shares issued and outstanding: Beginning of year End of year Average 650,000 4,000,000 2.325,000 Eamings per share calculation: $6.800,000 - $2.92 2.325,000 You have gathered the following information: On January 1, 2020, McKesson Corp. issued 650,000 shares. Additional issues of shares for the year were as follows: April 1 150,000 shares May 1 A 20% share dividend August 1 700,000 shares September 1 340,000 shares November 1 A 2 for 1 share split All 4,000,000 shares were outstanding at December 31, 2020. On January 1, 10% convertible debentures, $60,000,000 face value, were issued at par. Each $1,000 debenture is convertible into 40 ordinary shares. The interest expense for the current year related to the liability component of the convertible debentures is $6,500,000 200,000 preference shares outstanding, $70 par, 8% cumulative, not convertible. Options were granted to purchase 400,000 ordinary shares at $18 each. The company's average market price of ordinary shares was $24. 10 year $3,000,000 face value, 8% bonds issued at par on July 1. Each $500 bond is convertible into 30 ordinary shares. The interest expense on the liability component of convertible bonds for the year was $360,000 McKesson's net income in 2020 was $6,800,000 and its tax rate was 30%. Instructions (a) On the basis of the information above, do you agree with the controller's computation of earnings per share? If you disagree, prepare a revised computation of the earnings per share for 2020. (8 marks) (b) Calculate the diluted earnings per share for 2020. (8 marks) (c) Explain and justify the accounting treatment for share dividends and share splits. (3 marks) (d) The executive officers of Welsh Inc. have a performance based compensation plan. The performance criterion of this plan is linked to growth in earnings per share. When annual EPS growth is 10%, the executives of Welsh will earn 100% of the shares; if growth is 15%, they cam 125%. If EPS growth, however, is lower than 8%, the executives receive no additional compensation. In 2020, Shelly Prince, the financial controller of Welsh, reviews year end estimates of bad debt expense and warranty expense. She calculates EPS growth of 10%. A member of the executive mentioned to her that the estimate of bad debt expense might be decreased, increasing EPS growth to 15%. Shelly is not sure she should include this because she believes that the current bad debt expense is sound. She does recognize though, that a great deal of subjectivity was involved in its computation. Instructions i. ii. What, if any, is the ethical dilemma facing Shelly Prince? (2 marks) Should Shelly's knowledge of the compensation plan influence her estimate? (2 marks) How should Shelly respond to the executive's request? (2 marks)