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FRA – Dilutive securities

  • This topic has 7 replies, 4 voices, and was last updated Apr-17 by Snippy.
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    • Snippy
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      Question from practice exam:

      McLoone Company’s basic earnings per share is $1.20. McLoone has $10 million par value of 5% preference shares outstanding that can be converted into 400,000 common shares. Is McLoone required to report dilutive earnings per share?

      A. Yes, because the preference shares are dilutive to EPS.
      B. No, because the preference shares are not dilutive to EPS.
      C. Yes, because the preference shares are potentially dilutive to EPS.

      Answer being: Diluted EPS must be reported if a firm has any potentially dilutive securities outstanding. In this case, the security is antidilutive ($500,000 / 400,000 = $1.25, which is greater than basic EPS), and the firm will report that diluted EPS is equal to basic EPS.

      Can someone explain this? The answer says that the security is antidilutive. So why does the correct answer become C?

    • lulu123
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      I’m not sure but maybe this is an issue with the way they ask it?
      They say “required to report DILUTIVE” EPS, which is not DILUTED (or is it??)

      My understanding is that they’re asking whether you would disclove this potentially dilutive scenario information (in the notes or something). Because maybe the basic EPS will change or whatnot and they will become dilutive.

      That’s how I understand why C is the answer.

      But I see why you’re concerned… you would have answered B right? (is this from schweser?) :S

    • lulu123
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      plus notice how it says ” the company will report a dilutive EPS equal to basic EPS”
      meaning, that on the financial statements, the two will have the same value but simply by having that “dilutive” line, the reader understands that there are securities outstanding that COULD in the future become dilutive

      I think this is what it is!! woot

    • lulu123
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      have you ever seen statements of companies where the diluted EPS line has the same value as basic EPS??

      this is what it must be!! it’s a signal that there are potentially dilutive things out!

      hope it makes sense now 🙂

    • Snippy
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      Hmm, so even if a security is anti-dilutive but is potentially dilutive to the firm, it has to be reported as diluted EPS?

    • Swift
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      If they’re anti-dilutive they won’t be included in the calculation for diluted EPS so basic EPS and diluted EPS will be the same. I think what the question is getting at is that even if basic and diluted EPS are the same the firm still has to disclose both because it has a potentially dilutive security.

    • Sophie Macon
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      @sidmenon , @lulu123 – the question asks “Is McLoone required to report dilutive earnings per share?”

      The answer is always yes, because they MIGHT be dilutive (although it is not now). So in this case, this year of reporting diluted EPS = basic EPS.

      But the question is about concept/ theory, rather than whether they are dilutive or not today.

    • Snippy
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      Okay, now i get it. Thanks @Sophie and @Swift!

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