QUESTION 1 Illustration 1 ABC Company issues 9% preference shares of FV of $ 10 each on 01.04.2015. Total value of the issue is $ 10,00,000. The shares are issued at a discount of $ 0.50 each, for a period of 5 years and would be redeemed at the end of 5th year. The shares are to be redeemed at $ 11 each. At the end of the year 3, i.e. on 31.03.2018, company finds that it has earned good returns than expected over last three years and can make the redemption of preference shares early. To compensate the shareholders for two years of dividend which they need to forego, company decided to redeem the shares at $ 12 each instead of original agreement of $ 11. Comment on the earnings for the year 2017-18.
Solution
In the given situation, $ 2 per share is the excess payment made by the company amounting to $ 2,00,000 in all. The amount of $ 2,00,000 will be deducted from the earnings of the year 2017-18 while calculating the basic EPS of year 2017-18.
The earnings for the year 2017-18 will be impacted by the early redemption of the preference shares at a higher price than originally agreed upon. The impact will be reflected in the company's income statement and balance sheet.
To calculate the impact on earnings for the year 2017-18, we need to calculate the new redemption price per share and the additional cost of redeeming the shares early. Here are the calculations:
Original redemption price = $11 per share
New redemption price = $12 per share
Discount on issue = $0.50 per share
Number of preference shares issued = Total value of issue / Face value of shares = $1,000,000 / $10 = 100,000 shares
Cost of redeeming shares early = (New redemption price - Original redemption price) x Number of shares = ($12 - $11) x 100,000 = $100,000
The cost of redeeming the preference shares early is $100,000, which will be reflected as an expense in the company's income statement for the year 2017-18. This will reduce the company's net income and earnings per share for the year.
The excess payment of $2 per share, resulting in a total cost of $200,000, will be reflected as an expense in the company's income statement for the year 2017-18. This will reduce the company's net income and earnings per share for the year.
To calculate the impact on basic earnings per share (EPS), we need to divide the company's net income by the weighted average number of outstanding shares. The calculation of weighted average number of shares will depend on whether the preference shares are convertible or not. Assuming that the preference shares are non-convertible, the calculation would be as follows:
After deducting the redemption cost of $200,000 from the net income for the year 2017-18, we can calculate the basic EPS by dividing the adjusted net income by the weighted average number of outstanding shares, which is 100,000 in this case.