Question

Reid owns all 30,000 shares of common stock of Barry. Reid has 60,000 shares of its own common stock outstanding. During the year Reid earns $200,000 none included from Barry, while Barry reports $150,000. Annual amortization of $10,000 is recognized each year on the consolidated worksheet based on acquisition date fair values. Both companies have convertible bonds outstanding. During the current year bond related interest expense (net of taxes) is $32,000 for Reid and 24,000 for Barry. Reid’s bonds can be converted into 10,000 shares. Reid owns none of Barry’s bonds.

Required:

Prepare a schedule which shows the earnings per share amounts that should Reid should report in its current consolidated income statement.

Answer 1

Answer:

Since Reid owns 100% shares of Barry, we will directly add the entire income statement to Reid's consolidated income statement

Particulars	Reid	Barrys	Consolidated
Revenue (A)	$        2,00,000	$        1,50,000	$       3,50,000
Amortization (B)			$           10,000
EBIT (C = A - B)			$       3,40,000
Interest (net of taxes) (D)	$            32,000	$            24,000	$           56,000
Net income (E = C - D)			$       2,84,000
No of shares (F)	60000	30000	90000
EPS (G = E/F)			$               3.16

Now since Reid's bonds are convertible into 10,000 shares we need to include this in the calculation as Diluted EPS.

But before including we need to check whether the debt is dilutive or anti-dilutive.

We can check this by using the following formula, if the output is greater than the EPS calculated above, we do not calculated diluted EPS and take the basic EPS as the consolidated EPS

(convertible bond interest net of taxes/no. of convertible debt shares) =

= ($32,000/10,000) = $ 3.20 which is greater than 3.16 calculated above.

The bonds are anti-dilutive and hence we do not consider them in EPS calculation.