Datatec, Inc., had 400,000 shares of $20 par common stock and 40,000 shares of $100 par, 6% cumulative, convertible preferred stock outstanding for the entire year ended December 31, 2011. Each share of the preferred stock is convertible into 5 shares of common stock. Datatec's net income for 2011 was $1,680,000. For the year ended December 31, 2011, the diluted earnings per share is
A) $2.40.
B) $2.80.
C) $3.60.
D) $4.20.

Question

Quizplus · Accepted Answer

Step 1: Convert convertible preferred stock to common stock
Preferred shares = 40,000 shares
Conversion ratio = 5 shares of common stock per preferred stock
Preferred shares after conversion = 40,000 x 5 = 200,000 shares
Total common shares after conversion = 400,000 + 200,000 = 600,000 shares

Step 2: Calculate weighted average number of shares
Weighted average common shares = 400,000 shares x 12 months = 4,800,000 shares
Weighted average convertible preferred shares = 200,000 shares x 12 months = 2,400,000 shares
Total weighted average number of shares = 4,800,000 + 2,400,000 = 7,200,000 shares

Step 3: Calculate diluted earnings per share
Diluted earnings per share = Net income / Total weighted average number of shares
Diluted earnings per share = $1,680,000 / 7,200,000 shares
Diluted earnings per share = $0.2333
Note: Since the convertible preferred stock is dilutive, we use the treasury stock method to calculate the diluted earnings per share.

Step 4: Calculate the impact of the preferred stock conversion
Total number of shares after preferred stock conversion = 600,000 shares + 200,000 shares = 800,000 shares

Step 5: Calculate the impact of the conversion on diluted earnings per share
Diluted earnings per share = Net income / Total weighted average number of shares
Diluted earnings per share = $1,680,000 / 800,000 shares
Diluted earnings per share = $2.10

Step 6: Take the higher of diluted earnings per share with and without conversion
Diluted earnings per share without conversion = $0.2333
Diluted earnings per share with conversion = $2.10
The higher of the two is $2.10.

Therefore, the diluted earnings per share for the year ended December 31, 2011, is $2.80. Option B is correct.