clearlycanadian

The primary difference between basic EPS and diluted EPS is that:

A) diluted EPS includes the potential effects of convertible securities while basic EPS does not.

B) proprietors and partners report basic EPS but corporations report diluted EPS.

C) extraordinary items and discontinued operations are omitted from basic EPS but included in diluted EPS.

The primary difference between basic EPS and diluted EPS is that diluted EPS includes the potential effects of convertible securities while basic EPS does not.

clearlycanadian

Advantage Corp.'s capital structure was as follows:

	December 31, 2005	December 31, 2004
Outstanding shares of stock:
Common	110,000	110,000
Convertible Preferred	10,000	10,000
8% Convertible Bonds	$1,000,000	$1,000,000

During 2005, Advantage paid dividends of $3 per share on its preferred stock. The preferred shares are convertible into 20,000 shares of common stock. The 8% bonds are convertible into 30,000 shares of common stock. Net income for 2005 was $850,000. Assume the income tax rate is 30%.
Calculate Advantage's basic and diluted earnings per share (EPS) for 2005.

Basic EPS

Diluted EPS

A) $7.45 $5.66

B) $6.31 $5.66

C) $7.45 $6.26

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Basic EPS = net income − pref div / wt. ave. shares of common
[850,00 − (3 × 10,000)] / 110,000 = $7.45
Diluted EPS = [(net income − preferred dividends) + convertible preferred dividends + (convertible debt interest)(1 − t)] / [(weighted average shares) + (shares from conversion of conv. pfd shares) + (shares from conversion of conv. debt) + (shares issuable from stock options)]
[(850,000 − (3 × 10,000)) + 30,000 + (80,000)(1 − 0.3)] / [(110,000) + (20,000) + (30,000)] = $5.66.

clearlycanadian

Securities that would decrease earnings per share (EPS) if they were exercised and converted to common stock are called:

A) dilutive securities.

B) synthetic securities.

C) antidilutive securities.

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Dilutive securities are securities that decrease EPS if they are exercised or converted to common stock. Stock options, warrants, convertible debt, and convertible preferred stock are examples of dilutive securities.

clearlycanadian

Securities that improve basic per share earnings, or reduce per share losses, if they are exercised or converted to common stock are called:

A) antidilutive securities.

B) dilutive securities.

C) embedded securities.

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Antidilutive securities, upon exercise, increase basic EPS or decrease per share losses. Shares from conversion are not included in the calculation of basic or diluted EPS.

clearlycanadian

Which of the following statements about the earnings per share calculation are most accurate?

A) When calculating diluted EPS you must add the shares created from the conversion of the bonds to the denominator and the interest expense times the tax rate to the numerator.

B) None of these choices are correct.

C) If the diluted EPS is less than the basic EPS, then the diluted EPS is said to be anti-dilutive.

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Anti-dilutive is when dilutive EPS > basic EPS. When calculating diluted EPS, you must add the shares created from the conversion of the bonds to the denominator and the interest (1 – tax rate) to the numerator.

clearlycanadian

Anti-dilutive securities should:

A) not be used in calculating basic or diluted EPS.

B) be used in calculating basic EPS but not diluted EPS.

C) be used in calculating diluted EPS but not basic EPS.

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Antidilutive securities would increase EPS if exercised or converted to common stock.

clearlycanadian

How will dilutive securities affect earnings per share (EPS) when determining diluted earnings per share?

A) Increase EPS.

B) Decrease EPS.

C) Either decrease or increase EPS depending upon if the security is dilutive or antidilutive.

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Dilutive securities such as convertibles and options are found in a complex capital structure and always decrease EPS. Convertibles and options may also be antidilutive, which will increase EPS hence the name antidilutive. The only way to know if a security is dilutive or antidilutive is to compare the basic EPS to diluted EPS. If the diluted EPS is higher than the basic EPS then the security is antidilutive and should not be included when determining diluted EPS.

clearlycanadian

In calculating the numerator for diluted Earnings Per Share, the interest on convertible debt is:

A) subtracted from earnings available to common shareholders after an adjustment for taxes.

B) added to earnings available to common shareholders.

C) added to earnings available to common shareholders after an adjustment for taxes.

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Formula = Diluted EPS = [(Net income − Preferred dividends) + Convertible preferred dividends + (Convertible debt interest)(1 − t)] / [(Weighted average shares) + (Shares from conversion of conv. pfd shares) + (Shares from conversion of conv. debt) + (Shares issuable from stock options)]

clearlycanadian

In calculating the numerator for diluted earnings per share, the dividends on convertible preferred stock are:

A) added to earnings available to common shareholders with an adjustment for taxes.

B) added to earnings available to common shareholders without an adjustment for taxes.

C) subtracted from earnings available to common shareholders without an adjustment for taxes.

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Diluted EPS = [(Net income − Preferred dividends) + Convertible preferred dividends + (Convertible debt interest)(1 − t)] / [(Weighted average shares) + (Shares from conversion of conv. pfd shares) + (Shares from conversion of conv. debt) + (Shares issuable from stock options)]

clearlycanadian

An analyst has gathered the following information about Barnstabur, Inc., for the year:

• Reported net income of $30,000.
• 5,000 shares of common stock and 2,000 shares of 8%, $90 par preferred stock outstanding during the whole year.
• During the year, Barnstabur issued at par, $60,000 of 6.0% convertible bonds, with each of the 60 bonds convertible into 110 shares of the Barnstabur common stock.

If Barnstabur’s effective tax rate is 40%, what will Barnstabur report for diluted earnings per share (EPS)?

A) $1.53.

B) $2.36.

C) $1.66.

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Diluted EPS = adjusted earnings after conversion (EAC) / weighted average plus potential common shares outstanding.
Step 1: Calculate Adjusted EAC

adjusted EAC:		net income - preferred dividends
	+	after-tax interest on convertible debt
	=	adjusted earnings available for common shares

preferred dividends = (0.08)(90)(2,000) = 14,400
convertible debt interest = (60,000)(0.06)(1 – 0.40) = 2,160
adjusted EAC = (30,000 – 14,400 + 2,160) = $17,760

Step 2: Calculate Weighted average plus potential common shares outstanding.

weighted average common shares			=	5,000
shares from conversion of convertible bonds	=	(60 × 110)	=	6,600
weighted ave. plus potential common shares outst.			=	11,600

Step 3: Calculate Diluted EPS

Diluted EPS = 17,760 / 11,600 = $1.53.