ACCTMIS 3201 - Chapter 19: Earnings per share

The Ohio State University

2 Types of capital structure

1. simple capital structure

2. complex capital structure

What does simple capital structure report?

ONLY basic EPS

What does complex capital structure report?

Basic EPS AND Diluted EPS

Basic EPS equation

(Net income - Preferred stock dividends) ÷ weighted avg. common shares outstanding

How do you find the weighted avg. common shares outstanding?

• multiply each stock transaction by the weight of number of months outstanding

• if re-acquiring shares, weight = number of months in the year NOT outstanding

  • if re-acquired in March 1 → 10/12

What are ways that the number of outstanding shares would change?

1. issue more common stock

2. buyback program

3. stock split

4. stock dividends

How do you account for a stock dividend or stock split?

re-state shares PREVIOUS to dividend or split

• multiply weight by amount of dividend or split

• if 50% dividend → 1.5

• if 2 for 1 stock split → 2

Preferred stock dividend equation

= number of shares outstanding * % * par value

Anti-dilutive securities

potential common shares that would increase EPS

• ignored in Diluted EPS calculation

What are the 3 types of potential common shares?

1. stock options

2. convertible bonds

3. convertible preferred stock

What are the assumptions in accounting for stock options?

Assume:

1. options exercised at beginning of year

2. cash proceeds are used to buy back as many shares as possible

How do stock options affect the numerator and denominator of the EPS equation?

Numerator - NO EFFECT

Denominator - ↑ by shares purchased and ↓ by shares re-acquired

When are stock options anti-dilutive?

• if the number of re-acquired shares > the shares purchased

• avg. market share price < option price

What is the assumption in accounting for convertible bonds?

1. bonds converted at the beginning of the year

How do convertible bonds affect the numerator and denominator of the EPS equation?

Numerator - ↑ by after-tax interest

Denominator - ↑ by shares converted

How does convertible preferred stock affect the numerator and denominator of the EPS equation?

Numerator - ↑ by pref. dividends no longer being paid

Denominator - ↑ by additional shares of common stock

How do we account for more than 1 potential common share?

1. for each security, calculate an earnings per incremental share

2. bring securities into diluted EPS calculation

   • start with LOWEST earnings per incremental share

What is the earnings per incremental share for stock options?

ALWAYS 0

When calculating diluted EPS, when is it ok to continue with the next earnings per incremental share?

when the diluted EPS decreases from the basic EPS or previous EPS calculation

What number is reported as the diluted EPS?

the lowest possible number we could come up with

* even if the basic is the lowest * - report both as same number