At December 31, 2019, Felix Ltd. had 500,000 common shares outstanding (no preferred shares issued). On October 1, 2020, an additional 100,000 common shares were issued. In addition, Felix had $ 5,000,000, 6% convertible bonds outstanding at December 31, 2019, which are convertible into 225,000 common shares; however, no bonds were converted during 2020. Net income for calendar 2020 was $ 1,500,000. Assuming the income tax rate was 30%, the diluted earnings per share for 2020 would be

Question

Quizplus · Accepted Answer

To calculate diluted earnings per share, we must consider the potential dilution from convertible securities. In this case, Felix has convertible bonds that have the potential to be converted into common shares.

To calculate the potential number of additional common shares that could be issued if all convertible bonds were converted, we can use the following formula:

Number of additional common shares = (Convertible bond amount / conversion price) - current shares outstanding

Number of additional common shares = ($5,000,000 / $22.22 per share) - 500,000 shares

Number of additional common shares = 225,000 shares

To calculate diluted earnings per share, we must add the potential additional common shares to the current outstanding shares and then divide the net income by the total shares. Therefore, the diluted earnings per share would be:

Diluted earnings per share = (Net income - Preferred dividends) / (Common shares outstanding + Additional common shares)

Diluted earnings per share = ($1,500,000 x (1-0.30))-0 / (500,000 + 225,000 + 100,000)

Diluted earnings per share = $1,050,000 / 825,000

Diluted earnings per share = $1.27

Therefore, the diluted earnings per share for 2020 would be $2.28 (Choice C).