At December 31, 2019, Columbus Inc. had 3,000,000 common shares outstanding. An additional 500,000 common shares were issued on April 1, 2020, and 250,000 more on July 1, 2020. On October 1, 2020, Marion issued 12,500, $ 1,000 par value, 8% convertible bonds. Each bond is convertible into 20 common shares. No bonds were converted in 2020. What is the number of shares to be used in calculating 2020 basic earnings per share and diluted earnings per share, respectively?

Question

Quizplus · Accepted Answer

Basic EPS uses the weighted average number of common shares outstanding during the year, which is calculated as follows:

3,000,000 shares outstanding from January 1 to March 31, 2020
500,000 shares issued on April 1, 2020, which were outstanding for 9 months (April 1 to December 31), or 375,000 weighted average shares
250,000 shares issued on July 1, 2020, which were outstanding for 6 months (July 1 to December 31), or 125,000 weighted average shares

Weighted average common shares outstanding for the year is 3,000,000 + 375,000 + 125,000 = 3,500,000.

For diluted EPS, we need to consider the potential dilution from the convertible bonds. The bondholders can convert their bonds into common shares, so if they were to do so, it would increase the number of common shares outstanding and decrease the EPS. Therefore, we need to calculate diluted EPS assuming the conversion of the bonds.

Each bond is convertible into 20 common shares, and there are 12,500 bonds issued, so the maximum potential number of shares that could be issued upon conversion is 12,500 x 20 = 250,000. We need to add this number of shares to the weighted average number of shares outstanding for basic EPS.

Weighted average shares outstanding for diluted EPS = 3,500,000 + 250,000 = 3,750,000.

Therefore, the number of shares to be used for calculating 2020 basic EPS and diluted EPS are 3,500,000 and 3,750,000, respectively. The best choice is B.