[Mike J]

NINJA Question –

At the end of 20X1, the following information applies to Brady Company:

Net income: $46,575
Common stock issued: $215,000 ($10 par value)
5%, $50 cumulative preferred stock issued: $50,000
Dividends declared on common stock: $21,500
Convertible, noncumulative preferred stock issued at $50 par: $50,000

Use this information to compute the basic and diluted earnings per share (EPS) below. Assume that the common shares given are presented as a weighted average.

Compute the basic and diluted EPS for Brady Company

…

The Basic EPS Solution:

For cumulative preferred stock, we must assume that the dividends will be issued even if they have not been declared.
• $50 × .05 = $2.50 per share
• $50,000 ÷ $50 = 1,000 shares
• $2.50 × $1,000 = $2,500 in preferred dividends

The noncumulative convertible preferred stock has no dividends issued and does not enter into the calculation.

Common stock is $215,000 at $10 par value, or 21,500 shares.
Basic EPS = $46,575 – $2,500
21,500 = $2.05 per share

I’m fine with the solution for Basic EPS. Although, computing the dividend was tricky. But, I do see it.

…

Solution for the Diluted EPS:

Diluted EPS = Net income – Dividends on preferred stock
Weighted average common shares + Potential common shares

The dilution results from the assumption that convertible securities were converted, that options or warrants were exercised, or that other shares were issued on the satisfaction of certain conditions.

In this problem, Brady Company has issued convertible preferred stock at $50 par ($50,000 ÷ $50 = 1,000 shares issued). These stockholders have the ability to convert to common stock.

This preferred stock is noncumulative, and no preferred dividends have been declared, so we do not have to take these dividends into account in the calculation.
Diluted EPS = $46,575 – $2,500
21,500 + 1,000 = $1.96 per share

…

My question is the with the solution to Diluted. If you assume the conversion of Preferred Stock into Common, can there be a dividend to subtract in the numerator?

So, shouldn’t the Dilutive Equation be: merely the 46,575 Net Income / 21,500 WACSO + 1,000 converted Pref Stock?
Why are we still subtracting the Preferred Stock Dividend if there is no preferred stock dividend?

Please explain.

[Mike J]

It's fine. I love this forum, but it's sometimes difficult to convey what you need to in a post.

It was a long post because I decided to post the question, solution set, and then ask my question. I wanted to provide the context.

[Anonymous]

Right, but we also have “5%, $50 cumulative preferred stock issued: $50,000.” 5% of 50,000 is $2500 which is what is being subtracted from net income in the solution. So I think since those shares are nonconvertible that's why that dividend is still being subtracted.

[Mike J]

@Allison,

I see that. The first preferred stock has same numbers but didn't say whether it was convertible or non-convertible.

So, are cumulative preferred stock always non-convertible?

I think the question was poorly crafted (probably why it was presumably an AICPA-released question).

[Anonymous]

It's definitely a confusing question, especially since the numbers are the same. Maybe we are supposed to assume that preferred stock is not convertible unless it explicitly says it is.

[Mike J]

@Allison,

Yes. I believe you are right.

I believe I considered them the same preferred stock when I first tried this. Thus, I assumed ALL preferred stock had been convertible/converted. I didn't consider there was a separate class of preferred stock.

[jeff]

I'm posting the EPS chapter of the NINJA Book – I hope it's helpful to everyone:

https://www.dropbox.com/s/66ih4umwrm227u3/NINJA_Book_FAR_EPS.pdf?dl=0

[Mike J]

@Jeff,

Thanks for your responses.

I'm not able to download that (my phone apparently can't read the format you're using).

So, was there a type-o with the question? Or, did I incorrectly assume that both lines in the given information for preferred stock was for the same preferred stock?

Since I am unable to open this file, please explain whether I should have subtracted or ignore the preferred dividend for diluted.

Thanks, everyone

[Anonymous]

Thank you Jeff!!

[Author]

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