Preferred Dividends, Options, and Convertible Debt

Preferred Dividends, Options, and Convertible Debt

  1. Explain how dividends or dividend requirements on any class of preferred stock that may be outstanding affect the computation of EPS.

Earnings per share is a measurement that indicates both the income and investment information and shows the profit made by the organization for each common stock (Kieso, Weygandt & Warfield, 2010). It is calculated by subtracting preferred dividend from the net income and divide the results by weighted average number of shares outstanding. Common stockholders do not receive dividends unless preferred stockholders are paid full dividends; therefore, to compute EPS for common stock, you must subtract preferred dividends from the company’s net income.

2. One of the technical procedures applicable in EPS computations is the “treasury-stock method.” Briefly describe the circumstances under which it might be appropriate to apply the treasury-stock method.

The company will apply the treasury stock method when it has diluted securities. These are securities can be converted to common stock (Kieso, Weygandt & Warfield, 2010). According to GAAP, it is appropriate for the company to use the treasury stock method in the diluted earnings per share calculations because it allows the inclusion of warrants and options. This situation is appropriate because the company will determine the impact of warrants and options on the number of common stocks.

3. Convertible debentures are considered potentially dilutive common shares. Explain how convertible debentures are handled for purposes of EPS computations

Convertible debentures are loans that the stockholder can convert to stock (Kieso, Weygandt & Warfield, 2010). With convertible debentures, the payee can pay a lower interest rate on loan received. When calculating EPS with convertible debentures, the numerator effect is that the interest that is added back into the net income increases the numerator of EPS formula. Similarly, with the denominator, the number of shares obtained from convertible debentures is added into the weighted average shares outstanding thus increasing the denominator of the EPS.



Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2010). Intermediate accounting: IFRS approach. Hoboken, N.J: Wiley.


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