ACC 313 Chapter 15

Knight, Creighton University

earnings per share (EPS)

income earned for each share of common stock

a company with a simple capital structure has…

• no outstanding convertible bonds

• no outstanding convertible preferred stock

• no outstanding stock warrants, stock rights, or stock options

• no outstanding stock appreciation rights that will be settled in common stock

• no outstanding contingent issuances of common stock

a company with a complex capital structure has…

• convertible bonds

• convertible preferred stock

• stock rights, stock warrants, stock options, or stock appreciation rights

• contingent issuances

EPS must be reported by…

publicly held companies

for a company with a simple capital structure, what do they report in terms of EPS?

just basic EPS

for a company with a complex capital structure, what do they report in terms of EPS?

both basic and dilutive EPS

EPS must be reported for which income statement totals and subtotals?

• net income from continuing operations

• net income

EPS must be reported for which nonrecurring item?

gain/loss from discontinued operations

higher EPS = ….

better

what must be done if a privately held company chooses to report EPS?

they must follow GAAP

EPS formula for net income from continuing operations and net inome

(income amt. - preferred stock dividends) / weighted avg. shares of common stock outstanding

EPS formula for gain/loss from discontinued operations

item amt. / weighted avg. shares of common stock outstanding

which EPS calculation is the check figure for anti-dilution

net income from continuing operations

why is “net income from continuing operations” the check figure for anti-dilution?

FASB Standard states that this is the number for which dilution and all other checks must be made

how are cumulative preferred stock dividends handled in EPS computation?

• preferred dividends are always deducted, whether they have been declared in the current period or not

• dividends in arrears are never deducted since they were already deducted in a prior period

how are noncumulative preferred stock dividends handled in EPS computation?

preferred dividends are only deducted if they are declared in the current period

the number of shares of common stock in the denominator of EPS is…

the weighted average number of shared actually outstanding for the current period

are treasury shares considered to be outstanding?

no

how are contingent issues handled in the computation of weighted avg. number of common shares outstanding? (for basic and diluted EPS)

if all conditions are being met as of the balance sheet date, but the common stock has not been issued, assume that they have been

how are stock splits and stock dividends handled in the computation of weighted avg. number of common shares outstanding?

they must be made retroactive to the earliest possible time that related to any EPS figure that is reported the fin. statements

*true even if the dividend or split occurs after the end of the reporting period but before fin. statements are published

in what instances can stock issued not participate in a stock dividend/split?

stock that is issued after the date of the dividend/split

what are some examples of dilutive securities?

• convertible bonds

• convertible preferred stock

• stock warrants

• stock options

if dividends are declared and a net loss occurs…

dividends are added to the loss

what happens when a stock dividend/split happens?

shares usually double, par value is cut in half

(ex. if it was 4-for-1, shares would quadruple and par value would be cut into fourths)

what happens with reporting dilutive EPS if “net income from continuing operations” is a loss?

any situation with dilutive securities will result in anti-dilution → no diluted EPS is reported

what are the three steps taken when computing diluted EPS?

1. how is the numerator affected?

2. how is the denominator affected?

3. does the conversion/exercise result in anti-dilution?

   • if anti-dilution occurs, the item is omitted from EPS

convertible preferred stock effect on EPS numerator

the conversion of preferred stock results in no preferred stock dividends

convertible preferred stock effect on EPS denominator

conversion of preferred stock results in more shares of common stock being added to the denominator

convertible bonds effect on EPS numerator

conversion of bonds results in the net-of-tax interest expense (± any amortization) being added back to net income

(interest expense on bonds) x (1 x tax rate)

convertible bonds effect on EPS denominator

conversion of bonds results in more shares of common stock being added to the denominator

what is the preliminary test for stock warrants, rights, and options?

exercise of rights does not occur unless…

option price < market price

stock warrants/rights/options effect on EPS numerator

exercise of rights has no effect on numerator

stock warrants/rights/options effect on EPS denominator

computation:

1. issue number of shares relating to exercise of rights

2. all cash that is received upon exercise is used to buy back shares of treasury stock

3. shares issues - treasury stock reacquired = amt. added to denominator

what is the preliminary test for contingent issuances?

is the contingency being met?

→ yes = PASS

contingent issuances effect on EPS numerator

fulfillment of contingent issuance has no effect on numerator

contingent issuances effect on EPS denominator

shares to be issued as part of contingent issuance are assumed to be issued and are added to the denominator

why do you not report diluted EPS for “net income from continuing operations” and “net income” amounts that are losses?

diluted EPS shows “worst case scenario”, and would look better if reported with negative income numbers

dilutive securities

securities that can be converted into common stock; cause EPS to be reduced/diluted upon conversion

antidilutive securities

securities that increase EPS upon conversion/exercise

basic EPS represents…

what’s likely to occur

dilutive EPS represents…

“worst case” scenario

a company should exclude any security that is…

antidilutive

what should be assumed when a dilutive security may be settled in common stock or cash?

if at the decision of the company or holder, it should be assumed that it will be settled in common stock if the effect is more dilutive

when exchange rates on convertible preferred stock or convertible bonds fluctuate over time, use the ________ conversion rate for current and future periods

most dilutive

if the exchange rate for convertible preferred stock or convertible bonds fluctuate due to an entity’s share price, use the _______ for the reporting period

average market price 

in actuality, items must be checked for anti-dilution how?

starting with the most potentially dilutive security first

previously reported diluted EPS figures that are republished are not adjusted for _________ but are adjusted for ________

subsequent conversions, exercises, etc.; subsequent stock splits/dividends

for EPS figures, companies must disclose…

• a description of the pertinent rights and privileges of securities outstanding 

• a reconciliation of numerators and denominators of both basic and diluted EPS

• the effect of preferred dividends in determining income available to common shareholders (preferred dividends # used in computation)

• securities that could potentially dilute EPS but were not included in the current computation because of anti-dilution

• the effect of conversions/exercises subsequent to year-end but before fin. statements have been issued