Question

1. The Johnson Company is computing diluted earnings per share for the current year. The company has convertible bonds outstanding that have been judged as being anti-dilutive. What is the significance of anti-dilution ?

		The bonds must be included in the computation of diluted earnings per share
		Inclusion of the bonds in the computation must be made using the most conservative method
		Because of the high rate of interest on these bonds, the impact must be separately disclosed within the computation
		Inclusion of the bonds in the computation will cause the reported figure to increase so that the potential conversion of the bonds should be excluded

Answer 1

The answer will be the last option i.e. " inclusion of the bonds in the computation will cause the reported figure to increase so that the potential conversion of the bonds should be excluded".

Explanation: An anti-dilution provision is a clause in an option, security, or merger agreement that gives the investor the right to maintain his or her percentage ownership of a company by buying a proportionate number of shares of any future issue of the security.

Diluted earnings per share shows the worst case scenario with regards to impact on earnings if all convertible items were to become common stock. Convertibles that are anti-dilutive in nature are not included in computing diluted EPS in order to ensure that the worst case scenario is achieved.