A is corrent. The requirement is to identify the amount that should be used as the numerator in the fraction used to compute diluted earnings per share. Because the bonds are convertible, the diluted earnings per share calculation requires interest expense (net of the tax effect) to be added back to net income. Interest expense on the bond is equal to $470,000 [($5,000,000 × 9%) + $20,000]. The tax effect is $117,500 ($470,000 × 25%). Therefore, the numerator is equal to $952,500 ($600,000 + $470,000 – $117,500).
B is incorrect. Because the bonds are convertible, the diluted earnings per share calculation requires interest expense (net of the tax effect) to be added back to net income. Interest expense on the bond is equal to $470,000 [($5,000,000 × 9%) + $20,000]. The tax effect is $117,500 ($470,000 × 25%). Therefore, the numerator is equal to $952,500 ($600,000 + $470,000 – $117,500).
C is incorrect. Because the bonds are convertible, the diluted earnings per share calculation requires interest expense (net of the tax effect) to be added back to net income. Interest expense on the bond is equal to $470,000 [($5,000,000 × 9%) + $20,000]. The tax effect is $117,500 ($470,000 × 25%). Therefore, the numerator is equal to $952,500 ($600,000 + $470,000 – $117,500).
D is incorrect. Because the bonds are convertible, the diluted earnings per share calculation requires interest expense (net of the tax effect) to be added back to net income. Interest expense on the bond is equal to $470,000 [($5,000,000 × 9%) + $20,000]. The tax effect is $117,500 ($470,000 × 25%). Therefore, the numerator is equal to $952,500 ($600,000 + $470,000 – $117,500).
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