Ch 16.5 (Diluted Earnings Per Share)

Question 1

Dilutive Securities

Answer 1

Securities that can be converted to common stock.

Dilutive securities reduce (dilute) earnings per share.

When a company has a complex capital structure, it generally reports both basic and diluted earnings per share.

Question 2

Diluted EPS

Answer 2

Basic EPS - Impact of Convertibles - Impact of options, warrants, and other dilutive securities.

The company uses the most dilutive conversion rate available.

Question 3

Antidilutive Securities

Answer 3

Securities that upon conversion or exercise increase earnings per share (or reduce the loss per share).

Companies with complex capital structures will not report diluted EPS if the securities in their capital structure are antidilutive.

Question 4

If-converted Method

Answer 4

Method that helps companies measure the dilutive effects of potential conversion on EPS.

This method for a convertible bond assumes (1) the conversion of the convertible securities at the beginning of the period (or at the time of issuance of the security, if issued during the period), and (2) the elimination of related interest, net of tax.

Numerator: The amount of interest expense, net of tax associated with those potential common shares.

Denominator: additional shares assumed issued increase.

Bonds at a premium or discount change the computation.

If company has convertible preferred stocks, then they will treat it as common stock when computing the EPS (it computes no tax effect because preferred dividends generally are not tax-deductible).