On January 2, 2020, Helisinki Ltd. issued at par $ 300,000, 9% convertible bonds. Each $ 1,000 bond is convertible into 30 shares. No bonds were converted during 2020. There were 50,000 common shares outstanding during 2020 (no preferred shares issued). Helsinki's 2020 net income was $ 160,000 and their income tax rate was 30%. Helsinki's diluted earnings per share for 2020 would be

Question

Quizplus · Accepted Answer

To calculate diluted earnings per share, we need to consider the convertible bonds as if they were converted to shares. Since no bonds were converted during the year, we just need to calculate the potential additional shares if all the bonds were converted.

The total face value of the bonds is $300,000, so the number of potential additional shares is:

$300,000 / ($1,000 / 30 shares) = 9,000 shares

Therefore, the total number of diluted shares is:

50,000 common shares + 9,000 potential additional shares = 59,000 shares

Now we can calculate diluted earnings per share:

Net income = $160,000
Income tax = $48,000 (30% of $160,000)
Net income after tax = $112,000
Diluted earnings per share = ($112,000 / 59,000 shares) = $1.90

Since the bonds are convertible at a ratio of 30 shares per bond, we need to adjust for the potential dilution by adding back the interest expense on the convertible bonds, net of tax. The interest expense is:

($300,000 * 9%) = $27,000

The tax savings from the interest expense is:

$27,000 * 30% = $8,100

Therefore, we add back the net of tax interest expense to the net income to calculate the numerator for diluted earnings per share:

Net income = $160,000
Add back net of tax interest expense = $27,000 - $8,100 = $18,900
Numerator for diluted earnings per share = $160,000 + $18,900 = $178,900

Finally, we can calculate diluted earnings per share using the diluted share count and the adjusted numerator:

Diluted earnings per share = ($178,900 / 59,000 shares) = $3.03

Therefore, the correct answer is B.