[Ralphie Dos Nachos]

I thought bonds aren’t associated with basic EPS? only diluted? so why would they include it in this question when they want BASIC EPS!?!?

12/31/X1 12/31/X2
Outstanding shares of stock: ———- ———-
Common 110,000 145,000
Convertible preferred 10,000 0
8% convertible bonds 1,000,000 500,000
On May 1, 20X2, the preferred shares were converted into 20,000 shares of common stock. The 8% bonds are convertible into 30,000 shares of common stock. On July 1, $500,000 of the bonds were converted. Net income for 20X2 was $850,000. Assume that the income tax rate is 30%. What is the basic earnings per share for 20X2?

A.
$6.80

B.
$6.50

C.
$6.54

D.
$5.86

You answered C. The correct answer is B.

I. Computation of weighted-average shares:

1. Common stock outstanding 01/01/X2 110,000
2. Conversion of preferred stock 05/01/X2 13,333
20,000 x 8/12
(An additional 20,000 shares were
outstanding from May 1 until year-end.)
3. Conversion of convertible bonds 07/01/X2 7,500
15,000 x 6/12
(One-half of the bonds were converted,
so an additional 15,000 shares were
outstanding from July 1 until year-end.) ——-
4. Total weighted-average shares 130,833
=======
II. Basic EPS:

Basic EPS = Net income / Weighted-average number of
outstanding common shares
= $850,000 / 130,833
= $6.50

Note

Preferred dividends are not deducted from Net Income in the basic EPS calculations due to the fact that the preferred stock is convertible. For the purposes of this calculation, the 10,000 shares of preferred stock are converted to 20,000 shares of common, which assumes that there were no preferred dividends. (FASB ASC 260-10-45-10)

[BBHYX]

Think of basic EPS as whats actually happened and diluted as the “worse case scenario” version of EPS.

If the convertible bonds were outstanding but not converted, you would include in diluted only. Because they were actually converted, they're included in basic EPS instead. In this particular question, half of the bonds were converted. That converted half would be in basic EPS, and the other outstanding half would be in your diluted EPS!

Also, note this is why the convertible perf. stock is in the basic EPS calculation when normally, they effect diluted.

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