Chapter-05

Earnings per Share (EPS)

(IAS-33)

1. Definition of Earnings per Share

Earnings per Share (EPS) indicate the income earned by which share of common stock. Thus,
earnings per share are reported only for common stock. Earnings per share data are frequently
reported in the financial press and are widely used by stockholders and potential investors in
evaluating the profitability of a company.

2. Earnings per Share – Simple Capital Structure

A corporation capital structure is considered simple if it consist only one common stock or
includes no potential common stock that upon conversion or exercise could dilute earnings
per common stock.

Earnings per Share =

In all computation of earnings per share, the weighted average number of shares outstanding
during the period constitutes the basis for the per share amounts reported. Shares issued or
purchased during the period affect the amount outstanding and must be weighted by the
fraction of the period they are outstanding. The rationale for this approach is to find the
equivalent number of whole shares outstanding for the year.

3. Earnings per Share – Complex Capital Structure

A capital structure is considered complex if it includes securities that could have a dilutive
effect on earnings per common share.

Diluted Earnings Per Share (diluted EPS) is a company's earnings per share (EPS)
calculated using fully diluted shares outstanding (i.e. including the impact of stock option
grants and convertible bonds). Diluted EPS indicates a "worst case" scenario, one that reflects
the issuance of stock for all outstanding options, warrants and convertible securities that
would reduce earnings per share.

Diluted earnings per share (Diluted EPS) takes the basic earnings per share figure one step
further. Basic EPS only takes into account the number of shares outstanding at the time.
Diluted EPS, on the other hand, estimates how many shares could theoretically exist after all
stock options, warrants, preferred stock and / or convertible bonds have been exercised.
The theory goes that because some or all of these investments could be converted or
exercised, the number of shares outstanding could increase at any time. This reduces the
amount of a company's earnings each share is entitled to. In doing so, the price to earnings
ratio becomes higher, and the stock appears more expensive.

In most cases, the diluted earnings-per-share figure is far more accurate estimation of the
total earnings per share and receives special attention when valuing a company.

Diluted shares: To calculate the total number of shares used in the calculation, FASB
prescribes using the treasury method to calculate the dilutive effect of any instruments that
could result in the issuance of shares, including:

 Stock options
 Warrants
 Convertible preferred stock
 Convertible bonds
 Share-based payment arrangements
 Written put options
 Contingently issuable shares

Earnings: The numerator used in calculating diluted EPS is adjusted to take into account the
impact that the conversion of any securities would have on earnings. For example, interest
would be added back to earnings to reflect the conversion of any outstanding convertible
bonds, preferred dividends would be added back to reflect the conversion of convertible
preferred stock, and any impact of these changes on other financial items, such as royalties
and taxes, would also be adjusted.

Calculating Basic and Fully Diluted EPS in a Complex Capital Structure

There are some basic rules for calculating basic and fully diluted ESP in a complex capital
structure. The basic ESP is calculated in the same fashion as it is in a simple capital structure.

Basic and fully diluted EPS are calculated for each component of income: income from
continuing operations, income before extraordinary items or changes in accounting principle,
and net income.

To calculate fully diluted EPS:

Diluted EPS = [(net income - preferred dividend) / weighted average number of shares
outstanding - impact of convertible securities - impact of options, warrants and other dilutive
securities]

Other form: (net income - preferred dividends) + convertible preferred dividend +

(convertible debt interest * (1-t)) Divided by weighted average shares + shares from
conversion of convertible preferred shares + shares from conversion of convertible debt +
shares issuable from stock options.

To understand this complex calculation we will look at each possibility:

If the company has convertible bonds, use the if-converted method:

1. Treat conversion as occurring at the beginning of the year or at issuance date, if it occurred
during the year (additive to denominator).

2. Eliminate related interest expense, net of tax (additive to numerator).

If the company has convertible preferred stock, use the if-converted method:

1. Eliminate preferred dividend from numerator (decrease numerator).

2. Treat conversion as occurring at the beginning of the year or at issuance date, if it occurred
during the year (additive to denominator). Furthermore, use the most advantageous
conversion rate available to the holder of the security.

Options and warrants use the treasury-stock method:

1. Assume that exercise occurred at the beginning of the year or issue date, if it occurs during
the year.

2. Assume that proceeds are used to purchase common stock for treasury stock.
3. If exercise price < market price of stock, dilution occurs.
4. If exercise price > market price, securities are anti-dilative and can be ignored in the
diluted EPS calculation.

Presentation and disclosure

Simple capital structure

a. Basic EPS is presented for income from continuing operations, income before
extraordinary items or change in accounting principle, and net income.
b. Reported for all accounting periods presented
c. Prior-period EPS is restated for any prior-period adjustments.
d. Footnotes are required for stock splits and stock dividends.

Complex capital structure

a. Basic and fully diluted EPS are presented for income from continuing operations,
income before extraordinary items or change in accounting principle, and net income.
b. Reported for all accounting periods presented
c. Prior-period EPS is restated for any prior-period adjustments.
d. Footnotes are required for diluted EPS.
Problem: 01

On January 1, 2013, Maxwel company had 4,80,000 shares of common stock outstanding.
During 2013, it had the following transactions that affected the common stock account.

February 1 Issued 1,20,000 shares

March 1 Issued a 10% stock dividend
May 1 Acquired 1,00,000 shares of Treasury stock
June 1 Issued a 3 for 1 stock split
October 1 Reissued 60,000 shares of Treasury stock

Instructions:

i. Determine the weighted average number of shares outstanding as of December 31,

2013;
ii. Assume that Maxwel Company earned net income of Tk. 34, 56,000 during 2013. In
addition, it had 1, 00,000 shares of 9%, Tk. 100 par nonconvertible, noncumulative
preferred stock outstanding for the entire year. Because of liquidity considerations,
however, the company did not declare and pay a preferred dividend in 2013. Compute
earnings per share for 2013, using the weighted average number of shares determined
in part (i);
iii. Assume the same facts as in part (ii), expect that the preferred stock was cumulative.
Compute earnings per share for 2013.

Solution:

Events Date Shares Restatement Fraction of Weighted

Outstanding Outstanding the Year Shares
Beginning
Jan,1 – Jan31 4,80,000 1.1 X 3.0 1/12 1,32,000
Balance
Issued
Feb, 1 – Feb 28 6,00,000 1.1 X 3.0 1/12 1,65,000
Shares
Stock
Mar 1 – April 30 6,60,000 3.00 2/12 3,30,000
Dividend
Reacquired
May 1 – May 30 5,60,000 3.00 1/12 1,40,000
Shares
Stock
June 1 – Sept 30 16,80,000 4/12 5,60,000
Split
Reissued
Oct, 1 – Dec 31 17,40,000 3/12 4,35,000
Shares
17,62,000
Weighted Average Number of Shares Outstanding

i) We Know,
Earnings per Share =
 = Tk. 1.96

ii) We Know,
Earnings per Share =

= Tk. 1.45

Problem: 02

On June 1, 2012, Andre Company and Agassi Company merged to form Lancaster Inc. A
total of 800,000 shares were issued to complete the merger. The new corporation reports on a
calendar-year basis. On April 1, 2014, the company issued an additional 400,000 shares of
stock for cash. All 1,200,000 shares were outstanding on December 31, 2014. Lancaster Inc.
also issued $600,000 of 20-year, 8% convertible bonds at par on July 1, 2014. Each $1,000
bond converts to 40 shares of common at any interest date. None of the bonds have been
converted to date. Lancaster Inc. is preparing its annual report for the fiscal year ending
December 31, 2014. The annual report will show earnings per share figures based upon a
reported after-tax net income of $1,540,000. (The tax rate is 40 %.)

Instructions

Determine the following for 2014.

(a) The number of shares to be used for calculating:
(1) Basic earnings per share.
(2) Diluted earnings per share.
(b) The earnings figures to be used for calculating:
(1) Basic earnings per share.
(2) Diluted earnings per share.
(a) (1) Number of shares for basic earnings per share.
Dates Shares Fraction Weighted
Outstanding Outstanding of Year Shares
Jan. 1–March 30 800,000 3/12 200,000
April 1–Dec. 31 1,200,000 9/12 900,000
Weighted-average number of shares outstanding 1,100,000
OR
Number of shares for basic earnings per share:
Initial issue of stock 800,000 shares
April 1, 2014 issue (3/4 X 400,000) 300,000 shares
Total 1,100,000 shares
 (2) Number of shares for diluted earnings per share:

Dates Shares Fraction Weighted

Outstanding Outstanding of Year Shares
Jan. 1–April 1 800,000 3/12 200,000
April 1–July 1 1,200,000 3/12 300,000
July 1–Dec. 31 1,224,000* 6/12 612,000
Weighted-average number of shares outstanding 1,112,000

*1,200,000 + [($600,000 ÷ 1,000) X 40]

(b) (1) Earnings for basic earnings per share:

After-tax net income $1,540,000

(2) Earnings for diluted earnings per share:

After-tax net income $1,540,000
Add back interest on convertible
Bonds (net of tax):
Interest ($600,000 X .08 X 1/2) $24,000
Less income taxes (24000 x 40%) 9,600
14,400
Total $1,554,400

[Note to instructor: In this problem, the earnings per share computed for basic earnings per
share is $1.40 ($1,540,000 ÷ 1,100,000) and the diluted earnings per share is $1.40
(technically $1.39784). As a result, only one earnings per share number would be presented.]

Problem: 03

The Simon Corporation issued 10-year, $5,000,000 par, 7% callable convertible subordinated
debentures on January 2, 2014. The bonds have a par value of $1,000, with interest payable
annually. The conversion ratio is 18:1. At the date of issue, the bonds were sold at 98. Bond
discount is amortized on a straight line basis. Simon’s effective tax was 35%. Net income in
2014 was $9,500,000, and the company had 2,000,000 shares outstanding during the entire
year.

Instructions
Prepare a schedule to compute both basic and diluted earnings per share.

Solution:

(a) Net income for year $9,500,000

Add: Adjustment for interest (net of tax) 234,000*
 $9,734,000

*Maturity value $5,000,000

Stated rate X 7%
Cash interest 350,000
Discount amortization [(1.00 – .98) X $5,000,000 X 1/10 years] 10,000
Interest expense 360,000
Tax (3,60,000 X 0.35) 1,26,000
After-tax interest $ 234,000

$5,000,000/$1,000 = 5,000 debentures

Increase in diluted earnings per share denominator:
5,000
X 18
90,000

Earnings per share:

Basic EPS $9,500,000 ÷ 2,000,000 = $4.75
Diluted EPS $9,734,000 ÷ 2,090,000 = $4.66
If the convertible security were preferred stock, basic EPS would be the same assuming there
were no preferred dividends declared or the preferred was noncumulative. For diluted EPS,
the numerator would be the net income amount and the denominator would be 2,090,000.

Problem-04:

For the year ending 30 June 2017, Kirra Ltd. Reported net profit after tax of Tk. 1,30,000. As
at 1 July 2016 Kirra Ltd. Had 20,000 fully paid ordinary shares of Tk. 10 each. The following
issues and purchases were subsequently made during the year:
 10,000 fully paid ordinary shares issued on 1 September 2016 at the prevailing
market price;
 2,500 fully paid ordinary shares purchased back on 1 February 2017 at the prevailing
market price;
 7,000 partly paid ordinary shares issued on 1 April 2017 at an issue price of Tk.
20.00. The shares were partly paid to Tk. 13.00. The partly paid shares carry the right
to participate in dividends in proportion to the amount paid as a fraction of the issue
price.

For the entire financial year Kirra Ltd. Had 5,000 preference shares of Tk. 100 each, which
provide dividends at a rate of 10 percent per year. The dividend rights are cumulative.
Required:
Compute the Basic Earnings per Share amount for 2017.

i) Calculation of Weighted Average Number of Shares Outstanding:

Events Date Outstanding Shares Fraction of Weighted

 Outstanding the Year Shares
Beginning Balance July 1 – August 31 20,000 2/12 3,333
Issued Shares Sep 1 – January 31 30,000 5/12 12,500
Purchased Back Feb 1 – June 30 27,500 5/12 11,458
Partly Paid Ordinary Shares
Issued Partly paid 7,000X
April 1 – June 30 3/12 1,138
Shares (13/20)
Weighted Average Number of Shares Outstanding 28,429

We Know,
Earnings per Share =

= Tk. 2.81

Problem-05:

Net Profit of A Ltd. For the year 2018 Tk. 3 million

Ordinary shares outstanding during 2018 10 million
Average fair value of one ordinary share in 2018 Tk. 8
Share under option during 2018 convertible at Tk. 6 per share 2 million

Required:
Calculate the Basic and Diluted Earnings per share.

Problem-06:

At January 1, 2014, Langley Company’s outstanding shares included the following.

280,000 shares of Tk. 50 par value, 7% cumulative preferred stock
900,000 shares of Tk. 1 par value common stock

Net income for 2014 was Tk. 2,530,000. No cash dividends were declared or paid during
2014. On February 15, 2015, however, all preferred dividends in arrears were paid, together
with a 5% stock dividend on common shares. There were no dividends in arrears prior to
2014.
On April 1, 2014, 450,000 shares of common stock were sold for Tk. 10 per share, and on
October 1, 2014, 110,000 shares of common stock were purchased for Tk. 20 per share and
held as treasury stock.
Instructions:
Compute earnings per share for 2014. Assume that financial statements for 2014 were issued
in March 2015.

Solution:
 Calculation of Weighted Average number of share outstanding

Dates Shares Restatement Fraction of Weighted

Event Outstanding Outstanding Year Shares
Beginning balance Jan. 1–March 30 900,000 1.05 3/12 2,36,250
Issued shares April 1–Sept 30 1,350,000 1.05 6/12 7,08,750
Reacquired shares Oct. 1–Dec. 31 1,240,000 1.05 3/12 3,25,500
Stock Dividend February 15, 2015 1,270,500

Net income Tk 2,530,000

Preferred dividend (280,000 X $50 X 7%) (980,000)
Tk. 1,550,000

Earnings per share for 2014:

Net income applicable to common stock = Tk.1,550,000 = $1.22

Weighted-average number of shares outstanding 1,270,500

Problem-07:

On January 1, 2017, Crocker Company issued 10-year, Tk.2, 000,000 face values, 6% bonds,
at par. Each Tk.1, 000 bonds is convertible into 15 shares of Crocker common stock.
Crocker’s net income in 2017 was Tk.300, 000, and its tax rate was 40%. The company had
100,000 shares of common stock outstanding throughout 2017. None of the bonds were
converted in 2017.
Instructions
a) Compute diluted earnings per share for 2017.
b) Compute diluted earnings per share for 2017, assuming the same facts as above,
except that Tk.1, 000,000 of 6% convertible preferred stock was issued instead of the
bonds. Each Tk.100 preferred share is convertible into 5 shares of Crocker common
stock.