A 12 %; \$100,000 convertible bond was issued on Oct 1, 2004. It is dilutive and can be converted into 18,000 shares. The effective income tax rate for the year was 40 percent. What adjustments should be made to calculate diluted earnings per share? A) Interest Added to the Numerator: \$3,000 Shares Added to the Denominator: 4,500 B) Interest Added to the Numerator: \$1,800 Shares Added to the Denominator: 18,000 C) Interest Added to the Numerator: \$3,000 Shares Added to the Denominator: 4,500 D) Interest Added to the Numerator: \$12,000 Shares Added to the Denominator: 18,000

C 12%*100,000/4=3000 18,000*3/12=4500

or A… should either A or C have “\$1,800 increase to numerator”? if so, that would be the one I chose

right, there must be a typo:) either way, add 3000@ numerator, add 4500 at denominator

12% interest on \$100,000 bond = \$12,000 \$12,000 expense for 3 months (i.e. one quarter) = \$12,000/4 = \$3,000 \$3,000 pretax earnings from not paying interest (since bond was converted) should be taxed and then flow to NI \$3,000*(1-0.4)= \$1,800 increase in NI

ups…I DID IT AGAIN. Your right Char-Lee.

Sorry for the Typo. C) Interest Added to the Numerator: \$1,800 Shares Added to the Denominator: 4,500 Is the correct answer. Do you always Avg Weight for the interest payment and shares for a convertible bond?

Yes, you will need to prorate the number of shares and interest payment (implied interest in some cases) by the issue date if issued in the same year. Anytime there are bonds, ALWAYS remember that they are before taxes on the income statement, thus tax deductable and need to be adjusted. You only save the \$ amount that is NOT tax deductable becasue the deductable part you would have saved anyway and is already factored in net income. Side note: Preferred shares are not tax deductable so any preferred dividends are going to be added to net income in the numerator for the full amount.