EARNINGS PER SHARE

Earnings per Share indicates the income earned by each share of common stocks. The idea behind
this is to show how much should a shareholder would receive if the income is distributed. This figure is
relevant to companies, for it tells how much is the stock worth.
Companies report earnings per share only for common stock or ordinary shares. When the income
statement contains intermediate components of income (such as discontinued operations or extraordinary
items), companies should disclose earnings per share for each component.

EARNINGS PER SHARE – SIMPLE CAPITAL STRUCTURE (BASIC EPS)

Simple structure is when there is no potentially dilutive securities in computing the earnings per
share of the common stock. Dilutive means the ability to influence the earnings per share in a downward
direction. Dilutive Securities increases the number of common stocks but decreases the value of earning
per share, here are the following:
1. Stock Options
2. Convertible Preferred Stocks
3. Convertible Bonds

Formula:

Net Income – Preferred Dividends

Basic Earnings per Share =
Weighted-Average Number of Shares Outstanding

Where in:
Preferred Stock Dividends
 Subtract the current-year preferred stock dividend from the net income to arrive at income
available to common stockholders.
 Preferred dividends are subtracted when it is cumulative, whether declared or not, if it is non –
cumulative, it must be declared.
Weighted – Average Number of Shares Outstanding
 Companies must weight the shares by the fraction of the period they are outstanding.
 When stock dividends or share split occur, companies need to restate the shares outstanding
before the share dividend or split. Note that stock dividends are always considered, as it was
happened in the beginning of the year.
Illustration: Archie Inc. has the following changes in its common stock during this period.

Date Share Changes Share Outstanding

January 1 Beginning balance P 100,000
April 1 Issued 50,000 shares for cash 50,000
150,000
June 1 Purchased 21,000 shares (21,000)
129,000
October 1 Issued 40,000 shares for cash 40,000
December 31 Ending balance P 169,000

Compute the weighted-average number of shares outstanding for Archie Inc.

Solution:

A B C
Dates Outstanding Shares Outstanding Fraction of Weighted Shares
Year (A x B)
January 1 – April 1 P 100,000 3/12 P 25,000
April 1 – June 1 P 150,000 2/12 P 25,000
June 1 – October 1 P 129,000 4/12 P 43,000
October 1 – December 31 P 169,000 3/12 P 42,250
Weighted-Average Number of Shares Outstanding P 135,250

EARNINGS PER SHARE – COMPLEX CAPITAL STRUCTURE (DILUTED EPS)

Complex Structure exists when it includes convertible securities, options, warrants, or other
rights, that upon conversion or exercise could dilute earnings per share. Company generally reports both
basic and diluted earnings per share.
Diluted Earnings per Share includes the effect of all potential dilutive common shares that were
outstanding during the period. Companies will not report diluted earnings per share if the securities in
their capital structure are antidilutive.

Diluted Earnings per Share – Convertible Securities

Measure the dilutive effects of potential conversion on earnings per share using the if-converted method.
This method for a convertible bond assumes:
1. The conversion at the beginning of the period (or at the time of issuance of the security, if issued
during the period, and
2. The elimination of related interest, net of tax.
Other factors:

 The conversion rate on a dilutive security may change during the period in which the security is
outstanding. In this situation, the company uses the most dilutive conversion rate available.
  For Convertible Preferred Stock, the company does not subtract preferred dividends from net
income in computing the numerator. Because for purposes of computing earnings per share, it
assumes conversion of the convertible preferred to outstanding common shares.

Formula:

Impact of
Net Income – Preferred options,
Dividends Impact of warrants, and
Diluted Earnings per Share = - - other Dilutive
Weighted-Average Convertibles
Number of Shares Securities
Outstanding

Illustration:
In 2014, Chicha Enterprises issued, at par, 60, P1,000, 8% bonds, each convertible into 100
shares of common stock. Chicha has a net income of P2,580. Throughout 2015, 2,000 shares of common
stock were outstanding: none of the bonds was converted or redeemed. Assume that the tax rate is 40%.
Compute basic earnings per share and diluted earnings per share for 2014.
Solution:

Basic EPS = Net Income – Preferred Dividends

Weighted-Average Number of Shares Outstanding

P2,580
=
2,000

= P1.29

P2,580 + P4,800 x (1 - .40)

Diluted EPS =
2,000 + 6,000

P2,580 + P2,880
=
2,000 + 6,000

P5,460
=
8,000

= P0.68
 In computing the impact of convertible after the basic earnings per share, get the interest expense
(60 bonds x P1,000 par x 8%), because as we converted the bonds into common stock, we also have to
add back to net income the expense we deducted because of the interest expense from the bond. But,
remember that the interest expense is tax deductible of 40%, which means, the 40% is no longer exist and
our net tax saving is P2,880 (P4,800 x .60), that should be added back to our net income.
Problem #1
Earnings per Share
Palm interiors Inc. operates several interior design studios located in different areas in Bataan.
The summary of its Income statement and Balance sheet year 2019 are as follows:

Income Statement:
Net Income P2,250,000
Preferred Stock Dividends 200,000
Balance Sheet: Common Shares Outstanding
01/01/2019 P 150,000
09/01/2019 210,000

Compute the Basic earnings per share.

Problem #2
Earnings per Share
Scarlet Heart reported profit after tax of 3,200,000 for the year ended Dec. 31, 2019 and had
520,000 preferred stock dividends all throughout 2019. The movements in the number of ordinary shares
are as follows:

Date Share Changes Share Outstanding

1/1/2019 Ordinary shares outstanding P140,000
3/1/2019 Shares issued for cash 36,000
9/30/2019 Subscribed shares 28,000
11/1/2019 Reacquisition of treasury shares (18,000)
Outstanding shares at the end of period P186,000

What is the basic earnings per share?

Problem #3
Earnings per Share
Problem #4
Earnings per Share
In 2020, HAKDOG Corporation issued, at par, 100, P1,200, 10% bonds, each convertible into
110 of common shares. It has a net income of P300,000 for the year and weighted-average number of
common shares outstanding during the period of 150,000 share. The tax rate is 40%.
Compute the basic and diluted earnings per share for 2020.
Problem #5
Earnings per Share
JangGa Corporation issued 50,000 shares of 8% convertible, cumulative preference share, P150
par value. Each share is convertible into 10 common shares. The net income on December 31, 2020 is
amounted to P1,600,000, and there were 750,000 common shares issued and outstanding.
Compute the basic and diluted earnings per share.
KEY ANSWERS:
Problem #1

Net Income – Preferred Dividends

Basic EPS =
Weighted-Average Number of Common Shares Outstanding

Weighted – Average CSO: Using Effect Average Method

01/01/2019 150,000 x 8/12 P 100,000
09/01/2019 210,000 x 4/12 70,000
P 170,000

P2,250,000 - P200,000
Basic EPS =
170,000

= P 12.06

The Basic EPS of P12.06 is the amount of income earned by each share of common stock
outstanding.

Problem #2

A B C
Dates Number of shares Months of outstanding Weighted average
(A x B)
1/1/2019 140,000 12/12 P 140,000
3/1/2019 36,000 10/12 30,000
9/30/2019 28,000 3/12 7,000
11/1/2019 (18,000) 2/12 (3,000)
Weighted-Average Number of Shares Outstanding P 174,000

Net Income – Preferred Dividends

Basic EPS =
Weighted-Average Number of Common Shares Outstanding

P3,200,000 - P520,000
=
174,000

= P 15.40
Problem #3

Problem #4

Net Income – Preferred Dividends

Basic EPS =
Weighted-Average Number of Common Shares Outstanding

P300,000
=
150,000

= P 2.00
Since there is no preference shares, all we have to do is to get the net income and divide it by the
weighted-average number of shares outstanding, which are given in the problem.

Net Income – Preferred Dividends Impact of

Diluted EPS = -
Weighted-Average Number of Convertibles
Shares Outstanding

P300,000 P12,000 (1-.40)

= +
150,000 11,000

P307,200
=
161,000

= P 1.91

In getting the diluted earnings per share, we have to get first the basic earnings per share. As we
get the value of the basic earnings per share, we are now going to proceed to the increase effect of the
convertible in the numerator and the denominator. In numerator, we have to get the value of interest
expense (100 bonds x P1,200 par x 10%), since we have converted the bonds into common shares, we
have to eliminate the interest on the bonds and add it back to our net income. And remember that the
interest expense is tax deductible which means the applicable tax rate in the interest expense is no longer
exists, (12,000 x .60), thus only P7,200 will be added back by the net income because it was the net of tax
saving. And by the denominator, we just have to get the product of the number of bonds and its
convertible shares (100 bonds x 110 shares).

Problem #5

Net Income – Preferred Dividends

Weighted-Average Number of Common Shares Outstanding
 Basic EPS =

P1,600,000 - P600,000
=
750,000

= P 1.33

Since we have a preference share, we have to get first the amount of preferred dividends (50,000
shares x P150 par x 8%), then subtract it by net income of P1,600,000 and divided by the weighted
average shares outstanding.

Net Income – Preferred Dividends

Weighted-Average Number of Impact of
Diluted EPS = -
Shares Outstanding Convertibles

P1,600,000 - P600,000 P600,000

= +
750,000 500,000

P1,600,000
=
1,250,000

= P 1.28

In computing our denominator, the weighted average shares will be increased by 500,000 shares
because we have converted each the 50,000 shares into 10 common shares. And in the numerator, we are
going to add back the P600,000 we have deducted in the net income as the dividends, because if we have
converted the preference shares at the beginning of the year, we are no longer have to pay it.