F7 - Earnings Per Share

Front 1

How does a company with a simple capital structure present earnings per share?

Back 1

An entity has a simple capital structure if it has only common stock outstanding. The entity presents basic per share amounts for income from continuing operations and for net income on the face of the income statement.

Front 2

How does a company with a complex capital structure present earnings per share?

Back 2

It presents basic and diluted per share amounts for income from continuing operations and for net income on the face of the income statement with equal prominence.

Front 3

Basic EPS Formula:

Back 3

Basic EPS = Income available to common shareholders/Weighted-average # of common shares outstanding

AKA (NI-PD)/WACSO

Front 4

What is income available to the common shareholders?

Back 4

Income from continuing operations and net income less dividends declared in the period on non-cumulative preferred stock and dividends accumulated in the period on cumulative preferred stock

Front 5

Weighted Average Number of Common Shares Outstanding - Calculation

Back 5

Beg. shares outstanding

+ Shares sold during the period

- Shares reacquired during the period

+ Stock dividends and stock splits

- Reverse stock splits

= Weighted-average # of shares outstanding

Front 6

Stock Dividends and Stock Splits:

Back 6

Stock dividends & stock splits must be treated as though they are occurred at the beginning of the period. The shares outstanding before the stock dividend or stock split must be restated for the portion of the period before the stock dividend/split. If prior periods are presented, the effects of stock dividends & stock splits must be retroactively adjusted for those periods.

Front 7

Potentially dilutive securities:

Back 7

1. Convertible securities (e.g. convertible preferred stock, convertible bonds, etc.)

2. Warrants and other options

3. Contracts that may be settled in cash or stock

4. Contingent shares

Front 8

Diluted EPS - Formula:

Back 8

Diluted EPS = (Income available to the common stock shareholder + Interest on dilutive securities)/Weighted-average # of common shares, assuming all dilutive securities are converted to common stock

Front 9

Dilution from Options, Warrants, and Their Equivalents

Back 9

The dilutive effect of options & warrants is applied using the treasury stock method. The treasury stock method assumes that the proceeds from the exercise of stock options & warrants will be used by the company to repurchase treasury shares at the prevailing market price, resulting in an incremental increase in shares outstanding.

Front 10

Dilutive vs. Antidilutive:

Back 10

Options & similar instruments are only dilutive when the avg. market price of the underlying common stock exceeds the exercise price of the options or warrants. These options or warrants would be "out of the money" & antidilutive. Previously reported EPS should not be adjusted retroactively in the case of options or similar instruments.

Front 11

Treasury Stock Method - Formula to compute additional shares for options & similar instruments

Back 11

Front 12

Dilution from Convertible Securities (bonds or preferred stock)

Back 12

The "if-converted" method should be used to determine the dilutive effects of the convertible securities. The "if-converted" method assumes that the securities were converted to common stock at the beginning of the period (or at the time of issue, if later).

Front 13

Dilution form Convertible Securities - Convertible Bonds

Back 13

IE x (1 - T)

a. Add to the numerator (income available to common shareholders) the interest expense, net of tax, due to the assumed conversion of bonds to common stock.

b. Add to the denominator (i.e., wtd avg. # of shares outstanding) the # of common shares associated w/ the assumed conversion.

Front 14

Dilution from Convertible Securities - Antidilution:

Back 14

Rule of conservatism

Use the results of each assumed conversion only if it results in dilution. Do not include the results of the assumed conversion if it is antidilutive (i.e, increases EPS). In determining whether potential common shares are dilutive or antidilutive, each issue will be considered separately in sequence form most to least dilutive, w/ options & warrants included 1st.

Front 15

Dilution from Convertible Securities - Convertible Preferred Stock

Back 15

a. Adjust the numerator (as preferred stock dividends do not affect net income).

b. Add to the denominator the number of shares associated with the assumed conversion.

c. Antidilution rules apply to convertible preferred stock.

Front 16

Basic vs. Diluted - Pass Key:

Back 16

Front 17

Deck Co. had 120,000 shares of common stock outstanding at January 1, Year 2. On July 1, Year 2, it issued 40,000 additional shares of common stock. Outstanding all year were 10,000 shares of nonconvertible cumulative preferred stock. What is the number of shares that Deck should use to calculate Year 2 earnings per share?

Back 17

1/1/Yr 2: Outstanding all year $120,000

7/1/Yr 2: 40,000 issued x 6/12 = 20,000

Weighted Average = $140,000

Front 18

Which of the following items, if dilutive and if other conditions are met, would enter into the determination of the weighted average shares outstanding to be used in the basic earnings per share (basic EPS) calculation?

I. Stock options.

II. Contingent shares.

Back 18

Choice "a" is correct. Contingent shares (that are dilutive) are included in the calculation of basic earnings per share (EPS) if (and as of the date) all conditions for issuance are met. Stock options do not enter into the calculation of basic EPS.

Front 19

In computing the weighted-average # of shares outstanding during the year, which of the following midyear events must be treated as if it occurred at the beginning of the year?

a. Purchase of treasury stock.

b. Sale of additional common stock.

c. Sale of preferred convertible stock.

d. Declaration & distribution of stock dividend.

Back 19

d. Declaration and distribution of stock dividend.

Front 20

Earnings per share disclosure is required for which of the following:

a. Non-public companies.

b. Investment companies.

c. Wholly-owned subsidiaries of public companies.

d. Companies who have made a filing w/ the SEC in preparation for a sale of public securities.

Back 20

Companies who have made a filing with the SEC in preparation for a sale of public securities. EPS disclosures are required for all companies with publicly traded common stock or potential common stock including: stock options, stock warrants, convertible securities, "Contingent stock" agreement. Also required by companies that have made a filing or are in the process of filing w/ a regulatory agency (e.g., the SEC) in preparation for a public sale of common stock.

Front 21

Which one is not considered contingent shares for purposes of computing EPS?

a. Shares issuable upon the issuance of a patent.

b. Shares issuable upon exercise of a stock option.

c. Shares issuable upon achieving a specific net income target.

d. Shares issuable upon the passage of a specific period of time.

Back 21

Shares issuable upon the exercise of a stock option are not considered contingent shares as the option holder is required to pay the strike price to exercise the options.

Front 22

West had EPS of $15 for the current year before considering the effects of any convertible securities. No conversion or exercise of convertible securities occurred during the year. However, possible conversion of convertible bonds would have reduced EPS by $0.75. The effect of possible exercise of common stock options would have increased EPS by $0.10. What should West report as diluted EPS for the current year?

Back 22

$14.25 diluted earnings per share.

$15.00 - $0.75 = $14.25

The possible exercise of common stock options would increase EPS by $0.10, so they are not used due to the anti-dilution rule.

Front 23

On December 1 of the current year, Clay Co. declared and issued a 6% stock dividend on its 100,000 shares of outstanding common stock. There was no other common stock activity during the year. What number of shares should Clay use in determining basic earnings per share for the current year?

Back 23

106,000. A 6% stock dividend equals 6,000 shares with a total of 106,000 shares outstanding after the distribution of the dividend. Stock dividends and stock splits require restatement of the shares outstanding before the stock dividend or stock split. Thus, the stock dividend would be treated as if it had occurred at the beginning of the fiscal year.

Front 24

When computing the weighted average of common shares outstanding for basic earnings per share, convertible securities are:

a. Recognized whether they are dilutive or anti-dilutive.

b. Recognized only if they are anti-dilutive.

c. Ignored.

d. Recognized only if they are dilutive.

Back 24

Ignored. When computing basic earnings per share, convertible securities are ignored for purposes of computing the weighted average of common shares outstanding.

Front 25

On January 31, Year 2, Pack, Inc. split its common stock 2 for 1, and Young, Inc. issued a 5% stock dividend. Both companies issued their December 31, Year 1, financial statements on March 1, Year 2. Should Pack's Year 1 earnings per share (EPS) take into consideration the stock split, and should Young's Year 1 EPS take into consideration the stock dividend?

Back 25

Stock Split: Yes. Stock dividend: Yes.

Rule: If stock dividend or stock split (or reverse split) changes common stock outstanding, the computation of EPS gives retroactive recognition for all periods presented using the new # of shares because the reader's primary interest is related to current capitalization.

Front 26

In determining earnings per share, interest expense, net of applicable income taxes, on convertible debt that is dilutive should be:

a. Added back to NI for diluted EPS, and ignored for basic EPS.

b. Added back to NI for both basic EPS and diluted earnings per share.

c. Deducted from NI for basic EPS, and ignored for basic diluted earnings per share.

d. Deducted from NI for both basic earnings per share and diluted earnings per share.

Back 26

Added back to net income for diluted earnings per share, and ignored for basic earnings per share.

Front 27

When computing diluted earnings per share, convertible securities are:

a. Recognized only if they are anti-dilutive.

b. Ignored.

c. Recognized whether they are dilutive or anti-dilutive.

d. Recognized only if they are dilutive.

Back 27

Recognized only if they are dilutive.

Front 28

Poe had 300,000 shares of common stock issued & outstanding at Dec 31, Yr 1. No common stock was issued during Year 2. On Jan 1, Yr 2, Poe issued 200,000 shares of nonconvertible preferred stock. During Yr 2, Poe declared & paid $75,000 cash dividends on the common stock & $60,000 on the preferred stock. NI for year ended Dec 31, Yr 2 was $330,000. What should be Poe's Yr 2 EPS?

Back 28

$0.90 earnings per common share.

EPS = (NI - PD)/Wtd shares O/S = $270,000/300,000 = $0.90

Front 29

During the current year, Comma had outstanding: 25,000 shares of common stock, 8,000 shares of $20 par, 10% cumulative preferred stock & 3,000 bonds that are $1,000 par & 9% convertible. The bonds were originally issued at par, & each bond was convertible into 30 shares of common stock. During the year, NI was $200,000, no dividends were declared. What amount was Comma's basic EPS?

Back 29

$7.36.

Basic EPS = Income available to common shareholders/(Weighted - Avg. # of common shares outstanding)

= [$200,000 - (8,000 x $20 x 10%)]/25,000

= $7.36

Front 30

Jen Co. had 200,000 shares of common stock and 20,000 shares of 10%, $100 par value cumulative preferred stock. No dividends on common stock were declared during the year. Net income was $2,000,000. What was Jen's basic earnings per share?

Back 30

When a company has cumulative preferred stock, preferred dividends are deducted from NI to derive income available to common shareholders.

Accumulated preferred dividends = 20,000 shares x $100 par x 10% = $200,000

($2,000,000 - $200,000)/200,000 = $9.00/share

Front 31

Under U.S. GAAP, earnings per share data should be reported on the income statement for:

Extraodinary items? Income before extraordinary items?

Back 31

Extraordinary items: Yes

Income before extraordinary items: Yes

Front 32

A firm has basic EPS of $1.29. If the tax rate is 30%, which security would be dilutive?

a. Cumulative 8%, $50 par preferred stock.

b.10% convertible bonds, issued at par, w/each $1,000 bond convertible into 20 shares of CS.

c.7% convertible bonds, issued at par, w/ each $1,000 bond convertible into 40 shares of CS.

d.6% $100 par cumulative convertible preferred stock, issued at par, w/ each share convertible into 4 shares of common stock.

Back 32

7% convertible bonds, issued at par, w/ each $1,000 bond convertible into 40 shares of CS. A dilutive security will produce an EPS # below basic EPS. Basic EPS is $1.29, & a dilutive security will result in a lower EPS #. If the 7% convertible bonds are converted, the company will save $49 on each bond ($1,000 x .07 x (1 - .30)), but 40 new shares of stock will be issued. This equates to $1.225 per 1 new share, which is a lower ratio than $1.29 per share.

Front 33

Simpson computed its diluted EPS for yr ended Sep 30. The company had 200,000 shares outstanding at beg. of year, issued 60,000 shares at April 1 & reacquired 2,000 shares on July 1. It also had 2,000 options outstanding exercisable at $40/ share. Avg. market price of Simpson's shares was $50. CS equivalents added to the company's weighted shares outstanding used for basic EPS was computed using the treasury stock method. How many add'l shares would Simpson include in its diluted EPS calculation?

Back 33

Front 34

Jones Co. had 50,000 shares of $5 par value common stock outstanding at January 1. On August 1, Jones declared a 5% stock dividend followed by a two-for-one stock split on September 1. What amount should Jones report as common shares outstanding at December 31?

Back 34

50,000 shares outstanding at the beginning of the year × 1.05 (stock dividend) × 2 (stock split) = 105,000

Front 35

Wood's dividends on noncumulative preferred stock have been declared but not paid. Wood has not declared or paid dividends on its cumulative preferred stock in the current or the prior year & has reported a net loss in the current year. For the purpose of computing basic EPS, how should the income available to common stockholders be calculated?

Back 35

Income available to common shareholders is determined by deducting dividends declared in the period on non-cumulative preferred stock (regardless of whether they have been paid) and dividends accumulated in the period on cumulative preferred stock (regardless of whether they have been declared).