Question

Amy Dyken, controller at Swifty Pharmaceutical Industries, a public company, is currently preparing the calculation for basic and diluted earnings per share and the related disclosure for Swifty's financial statements. Below is selected financial information for the fiscal year ended June 30, 2020. Swifty Pharmaceutical Industries Selected Balance Sheet Information June 30, 2020 Long-term debt Notes payable, 10% 9% convertible bonds payable 10% bonds payable Total long-term debt $1,010,000 5,090,000 6,060,000 $12,160,000 Shareholders' equity Preferred stock, 6% cumulative, $50 par value, 93,000 shares authorized, 23,250 shares issued and outstanding Common stock, $1 par, 9,900,000 shares authorized, 990,000 shares issued and outstanding Additional paid-in capital Retained earnings Total shareholders' equity $1,162,500 990,000 3,930,000 6,020,000 $12, 102,500 The following transactions have also occurred at Swifty. 1. Options were granted on July 1, 2019, to purchase 190,000 shares at $16 per share. Although no options were exercised during fiscal year 2020, the average price per common share during fiscal year 2020 was $20 per share. 2. Each bond was issued at face value. The 9% convertible bonds will convert into common stock at 50 shares per $1,000 bond. The bonds are exercisable after 5 years and were issued in fiscal year 2019. 3. The preferred stock was issued in 2019. 4. There are no preferred dividends in arrears; however, preferred dividends were not declared in fiscal year 2020. 5. The 990,000 shares of common stock were outstanding for the entire 2020 fiscal year. 6. Net income for fiscal year 2020 was $1,520,000, and the average income tax rate is 20%.

16.2 #3 PLEASE SHOW ALL WORK

Answer 1

Lets begin with simple things first

So Basic EPS = (Net Income - Preferred Dividend )/Total Shares Outstanding

Now as Preferred shares are cumulative then , even if dividends are not declared they will be deducted into the calculations .
So, Preferred Dividends = 6% of 1,162,500 = $69750
EPS = (1,520,000-69750)/ 990,000

EPS = 1.4648 = $1.46 rounded off

Now lets move to Diluted EPS

Diluted EPS is calculated to get knowledge about the change in EPS when all the dilutive securites are converted into stocks such as preferred shares , bonds and options , how  will EPS change

Now 9% convertible Bonds are dilutive , so interest(after tax) deducted from net income will be added back to it
So interest income will be 9% of $5,090,000=$458,100

But tax had to be deducted @20 % so interest would be $458,100*(1-0.20) = $458,100*0.8 = $366480

Now as each $1000 is equal to 50 common shares and we total have bonds worth $5,090,000 , so  we get around

= 5090,000*50 / 1000 = 254,500 shares

Now check if its dilutive or anti dilutive = 366480 / 254500 =1.44 , its less than 1.46 , this means its dilutive security and would be added in our calculations .

Now talk about other dilutive security i.e options

(So we consider options as exercised while calculating dilutive EPS even when they are not exercised., we use a treasury method to calculate the increase in shares.
Now hypothetically assume we have options to purchase 190,000 shares @16 each so that would be = $3,040,000

Now as shares price is around $20 we use our $3,040,000 to get shares @20 each that would be around 152,000 shares

we had to get 190,000 shares , we had 152,000 shares , so in total increase in shares is 190,000-152,000 = 38000 shares)

Now we could do this shortcut way , (market price- option price) / market price * no. of options = 20-16/20 *190,000 = 38000

Now Diluted EPS = (Net income - preferred dividends + Net interest income) / (Average common shares+ Converted bonds+ converted shares )

Diluted EPS = (1,520,000- 69750 + 366480) / (990,000 + 254500 + 38000) =1816730/ 1282500 = 1.416 =1.42 rounded off