ExpertHard1 markMultiple Choice
CPA · Question 13 · Area I: Financial Reporting
A public company has 100,000 shares of common stock outstanding. It also has 10,000 shares of 6% cumulative preferred stock, $100 par, convertible into 3 shares of common stock each. Net income for the year is $500,000. No dividends were declared. The tax rate is 30%. What is the Diluted Earnings Per Share (DEPS)?
A public company has 100,000 shares of common stock outstanding. It also has 10,000 shares of 6% cumulative preferred stock, $100 par, convertible into 3 shares of common stock each. Net income for the year is $500,000. No dividends were declared. The tax rate is 30%. What is the Diluted Earnings Per Share (DEPS)?
Answer options:
A.
$3.38
B.
$4.40
C.
$3.85
D.
$5.00
How to approach this question
1. Calculate Basic EPS (NI - Pref Div) / WASO. 2. Calculate Diluted EPS using 'If-Converted' method for preferred stock. Add back dividends to numerator, add converted shares to denominator. 3. Compare. If Diluted < Basic, report Diluted.
Full Answer
C.$3.85✓ Correct
Step 1: Basic EPS. Preferred Dividends = 10,000 × $100 × 6% = $60,000. (Cumulative means deduct even if not declared). Basic EPS = ($500,000 - $60,000) / 100,000 = $4.40.<br/>Step 2: Diluted EPS (If-Converted Method). Assume conversion at beginning of year. <br/>Numerator: $500,000 (Preferred dividends are not subtracted/are added back). <br/>Denominator: 100,000 + (10,000 × 3) = 130,000 shares. <br/>Diluted EPS = $500,000 / 130,000 = $3.85.<br/>Since $3.85 < $4.40, the securities are dilutive.
Common mistakes
Deducting preferred dividends in the Diluted numerator (double counting the cost). Forgetting to deduct cumulative dividends in Basic EPS if not declared.
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