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Earnings per Share

The Introductory Lecture for Acct 414

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The most closely watched statistic on Wall Street
Earnings per share (EPS) is an important indicator of the success or failure of a company.
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Several components of EPS must be disclosed if there are discontinued operations, extraordinary items, or cumulative effects of changes in accounting principles.
Earnings Per Share: Continuing operations $3.15 Discontinued operations .67 Extraordinary loss (.15) Cumulative effect of accounting change .17 Net Earnings Per Share $3.84

Cumulative effect item pretty much gone after SFAS No. 154

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4 .There may be two EPS numbers for each item: Basic Considers only common shares outstanding Diluted Reflects the maximum potential dilution from all possible stock conversions that would have decreased EPS.

Relation between Basic and Diluted EPS 5 .

Diluted earnings per share I like to think of it as the worst case scenario It is the lowest possible number we d report for EPS It is a proforma number. not a fact 6 .

Capital structure determines reporting Many companies will report basic earnings per share only Other companies must report BOTH basic and diluted earnings per share It depends on whether the capital structure is Simple. or  Complex  7 .

8 Common Stock . It has no convertible securities. warrants. or other rights outstanding.A simple capital structure consists of just common stock. stock options. The corporation has only common and nonconvertible preferred stock.

Capital Structures Complex Capital Structure: The corporation has one or more instruments outstanding that could result in issuance of additional Convertible common shares. Preferred Convertible Bonds Stock Options 9 .

Capital Structures Therefore. a company with potential per share dilution is considered to have a complex capital structure. Note that a potentially dilutive security does not necessarily dilute EPS 10 .

11 . Antidilutive Securities: Securities whose assumed conversion or exercise results in an increase in earnings per share.Dilution of Earnings Dilutive Securities: Securities whose assumed exercise or conversion results in a reduction in earnings per share.

Basic Earnings Per Share Net Income .Preferred Dividends Weighted average number of common shares outstanding 12 .

$10 par. issued 200. issued and outstanding 10.000 shares. $100 par value.Earnings Per Share Example A company has the following capital structure at the end of 2006:  6% Cumulative preferred stock.000 shares at cost of $18)   Page 13 109 . outstanding 180.000 shares Common stock.000 shares Treasury stock (20.

2006 declared and distributed a 2 for 1 stock split effected in the form of a stock dividend September 1. 2006 sold 10.000 shares to acquire the assets of another company. Market value of shares was $25 June 30.000 shares of the treasury stock for $28 per share Page 109 14 . the following transactions take place:    April 1. 2006 issued 100.EPS Example During 2006.

000 180.000 Dat 1/1 to 3/31 4/1/2006 4/1 to 6/29 6/30/2006 6/30 to 8/31 9/1/2006 9/1 to 12/31 W ight d average C St 200.000 Tr asur St Months 3/12 S it Factor W ight d 15 .Step 1 find weighted average shares outstanding C Shar s Outstanding 20.000 100.000 100.

Step 1 find weighted average shares outstanding Common Shares Outstanding 20.000 180.000 100.000 Date 1/1 to 3/31 4/1/2006 4/1 to 6/29 6/30/2006 6/30 to 8/31 9/1/2006 9/1 to 12/31 Weighted average Common Stock 200.000 280.000 Treasur Stock Months 3/12 3/12 S it Factor Weighted 16 .000 100.000 20.000 300.

2006 sold 10.000 shares to acquire the assets of another company. the following transactions take place:    April 1. Market value of shares was $25 June 30. 2006 declared and distributed a 2 for 1 stock split effected in the form of a stock dividend September 1.EPS Example During 2006.000 shares of the treasury stock for $28 per share 17 Page 109 . 2006 issued 100.

This must done for all periods presented in the financial statements.Stock Splits & Dividends All stock splits and stock dividends must be incorporated into the computation of weighted average shares outstanding. 18 .

000 Co on hares utstanding 180.000 280.000 20.000 300.000 580.000 onths 3/12 3/12 2/12 lit Factor 2 2 1 Weighted 19 .000 100.000 280.000 280.Step 1 find weighted average shares outstanding Date 1/1 to 3/31 4/1/2006 4/1 to 6/29 6/30/2006 6/30 to 8/31 9/1/2006 9/1 to 12/31 Weighted a erage Co on tock easury tock 20.000 560.000 200.000 100.000 20.

. Think about what would happen if we did NOT make the adjustment .Stock Splits & Dividends This year s EPS figures may have to be changed in the future as a result of stock splits or dividends. . 20 .

Market value of shares was $25 June 30.EPS Example During 2003. 2003 sold 10. 2003 issued 100. the following transactions take place:  April 1.000 shares of the treasury stock for $28 per share Page 109 21 . 2003 declared and distributed a 2 for 1 stock split effected in the form of a stock dividend   September 1.000 shares to acquire the assets of another company.

000 570.000 10.000 300.000 280.000 10.000 ar s utstanding 180.000 100.000 580.000 Split actor 2 2 1 1 ight d Dat 1/1 to /31 4/1/2006 4/1 to 6/29 6/30/2006 6/30 to 8/31 9/1/2006 9/1 to 12/31 Weighted average t 200.000 560.000 280.000 20.000 Mont s 3/12 3/12 2/12 4/12 12/12 22 .000 580.Step 1 find weighted average shares outstanding r asury t 20.000 -10.000 100.000 20.000 280.

Step 1 find weighted average outstanding shares outstanding Multiply sharesyear and by by fraction of split factor Date 1/1 to 3/31 4/1/2006 4/1 to 6/29 6/30/2006 6/30 to 8/31 9/1/2006 9/1 to 12/31 eighted a erage Common to k 200.000 100.000 580.000 300.333 190.000 560.000 280.000 Trea ury to k 20.000 10.000 100.000 280.000 513.000 280.333 Make sure you have accounted for all 12 months and no more than 12 months! Add em up 23 .000 20.000 140.000 580.000 570.000 10.000 Common hare Out tanding 180.000 10.000 93.000 onth 3/12 3/12 2/12 4/12 12/12 plit Fa tor 2 2 1 1 eighted 90.000 20.

000 Preferred dividends = 10.numerator Net income = $3. .000. 24 .000 Note: Always include preferred dividend if it is cumulative preferred stock.Step 2 . only include preferred dividend if declared during year Now let s plug everything into the formula .000 shares * $100 * 6% = $60. . If not cumulative.

! $__________ 25 .000 ± $60.Step 3 compute basic EPS Net income ± Preferred dividends Weighted average shares outstanding $ .000.000 51 .

Taking the same facts.What if . . what if the preferred stock was convertible into 10 shares of common stock at the option of the stockholder?  This would make it a complex capital structure and we d have to report both the basic EPS we computed plus a diluted earnings per share figure. Page 111 26 . .

000 shares of preferred could become 100.000 shares of common stock (outstanding all year) We would NOT pay the preferred dividend because there would be no preferred stock 27 .Convertible preferred The 10.

73 and the $4. Diluted EPS = $__________ Both the $5.89 would be reported on the face of the income statement 28 .000 51 .000 ± $0 + 100.000.Diluted EPS Net income ± Preferred dividends Weighted average shares outstanding $ .

the rate of conversion most advantageous to the security holder is used (maximum dilutive conversion rate) 29 . we use the Treasury Stock Method For computing dilution.Diluted Earnings per Share For convertible bonds and convertible preferred stock we use what is called the If Converted Method For options.

if later. 30 . The weighted average number of shares is increased by the additional common shares assumed issued. Convertible bonds: The interest expense (net of tax) is added back to net income. Convertible preferred: No deduction for preferred dividends.The If-Converted Method The conversion of the securities into common stock is assumed to occur at the beginning of the year or date of issue.

over treasury stock.  Purpose is to acquire treasury stock that can be reissued to option or warrant holders. are added to weighted. 31 .average shares outstanding.  Exercise is assumed to occur on the first day of the year unless issue date is later.Treasury Stock Method Proceeds from conversion are assumed to be used for purchase of treasury stock at AVERAGE market price. If not sufficient. we d have to issue MORE shares Any additional shares issued.

000 Common Shares Outstanding (entire year) Stock Options Outstanding Exercise Price Per Share on Options Average Price of Common Shares 6.Treasury Stock Method-Example: Basic Data Assume the following: Net Income $8.000 $30 $40 32 .000 2.

000 Basic EPS = $1.Treasury Stock Method--Example Net income ± Preferred dividends Weighted average shares outstanding $8.000 Basic EPS = 6.33 33 .

000 from exercise less 1. Additional shares assumed issued: 2.500 purchased with proceeds = 500 net new shares 34 .000*30) = $60.Treasury Stock Method-Example: 3 steps 1.000 cash received 2. Shares assumed repurchased with proceeds ($60.000 / $40) = 1. Options assumed exercised (2.500 3.

500 = 35 .000 Diluted EPS = 6.000/6.23 = $8.000 + 500 Diluted EPS = $1.Treasury Stock Method--Example: Net income ± Preferred dividends = Weighted average shares outstanding $8.

000 * 36 .Short-cut formula: Net new shares = Number of shares to which option holders are entitled * Avg Mkt Price Option Price Avg Mkt Price 2.

Preferred .Formula for diluted EPS dividends if + After-tax Net income preferred bond interest stock is NOT on converconvertible tible bonds Weighted average of common shares assuming maximum dilution (including options) 37 .

take the securities into EPS computation one at a time until the next item on the list is bigger than the most recent EPS figure. Make a list from smallest per share number to largest per share number 3. 38 .Getting the lowest possible number an algorithm 1. For diluted EPS. 2. Compute the per share effect of each potentially dilutive security separately. Compute basic earnings per share 4.