THE EFFECTIVE YIELD TEST, THE MARKET PARITY TEST, AND EARNINGS PER SHARE

This study shows that the classification of convertible bonds as common stock equivalents for computing primary earnings per share made by the effective yield test does not closely relate to that made by the market parity test as envisioned by the Accounting Principles Board. Yet, there is a large degree of correspondence between the classifications made by the two tests when the tests are conducted on a year‐by‐year basis. Furthermore, the results of the study suggest that the two tests' predictive power for conversion of convertible bonds can be substantially improved if the tests are periodically performed. These findings may be indicative of the permanent classification problem that could cause the test results to be inaccurate.