My question: When calculating Diluted EPS, why in the explanation is “preferred dividends” subtracted and not ADDED in the NUMERATOR? We apply the “IF-CONVERTED METHOD” for diluted EPS. Does Kaplan’s website have an incorrect answer to the question? HELP!

An analyst has gathered the following information about Barnstabur, Inc., for the year:

Reported net income of $30,000.

5,000 shares of common stock and 2,000 shares of 8%, $90 par preferred stock outstanding during the whole year.

Barnstabur, has $60,000 of 6.0% convertible bonds outstanding, with each of the 60 bonds convertible into 110 shares of Barnstabur common stock.

If Barnstabur’s effective tax rate is 40%, what will Barnstabur report for diluted earnings per share (EPS)?

Below is Kaplan online’s explanation:

Diluted EPS = adjusted earnings after conversion (EAC) / weighted average plus potential common shares outstanding.

Step 1: Calculate Adjusted EAC

adjusted EAC: net income - preferred dividends

- after-tax interest on convertible debt

= adjusted earnings available for common shares

preferred dividends = (0.08)(90)(2,000) = 14,400

convertible debt interest = (60,000)(0.06)(1 – 0.40) = 2,160

adjusted EAC = (30,000 – 14,400 + 2,160) = $17,760

Step 2: Calculate Weighted average plus potential common shares outstanding.

weighted average common shares = 5,000

shares from conversion of convertible bonds = (60 × 110) = 6,600

weighted ave. plus potential common shares outst. = 11,600

Step 3: Calculate Diluted EPS

Diluted EPS = 17,760 / 11,600 = $1.53.

(Study Session 7, Module 21.4, LOS 21.h)