EPS Lecture for Acct 414 (for Students)

7/30/2019 EPS Lecture for Acct 414 (for Students)

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Earnings per Share

The Introductory Lecturefor Acct 414


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The most closely watchedstatistic on Wall Street

Earnings pershare (EPS) is

an importantindicator of thesuccess or

failure of acompany.


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Several components of EPS must be

disclosed if there are discontinuedoperations, extraordinary items, orcumulative effects of changes inaccounting principles.

Earnings Per Share:Continuing operations $3.15Discontinued operations .67

Extraordinary loss (.15)Cumulative effect of accounting change .17Net Earnings Per Share $3.84

Cumulative effect item pretty much gone after SFAS No. 154


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Reflects themaximum potential

dilution from allpossible stock

conversions thatwould have

decreased EPS.

Diluted

There may be two EPSnumbers for each item:

Considers onlycommon shares

outstanding

Basic


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Diluted earnings per share

I like to think of it as the

worst case scenario

It is the lowest possible number wed

report for EPSIt is a proforma number, not a fact


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Capital structure determinesreporting

Many companies will report basic earningsper share only

Other companies must report BOTH basic anddiluted earnings per share

It depends on whether the capital structure is

Simple, orComplex


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CommonStock

A simple capital structure consistsof just common stock.

The corporation hasonly common and

nonconvertiblepreferred stock.

It has no convertiblesecurities, stock

options, warrants, orother rightsoutstanding.


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Capital Structures

Complex Capital Structure:The corporation has one or

more instrumentsoutstanding that could result

in issuance of additionalcommon shares.Convertible

Preferred

Stock

Options

ConvertibleBonds


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Capital Structures

Therefore, a company withpotential per share dilution

is considered to have a

complex capital structure.

Note that a potentiallydilutive security doesnot necessarily diluteEPS


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Dilution of Earnings

Dilutive Securities: Securities whoseassumed exercise or conversion results

in a reduction in earnings per share.Antidilutive Securities: Securitieswhose assumed conversion or exercise

results in an increase in earnings pershare.


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Basic Earnings Per Share

Net Income - Preferred DividendsWeighted average number of

common shares outstanding


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Earnings Per Share Example

A company has the following capitalstructure at the end of 2006: 6% Cumulative preferred stock, $100 par

value, issued and outstanding 10,000 shares

Common stock, $10 par, issued 200,000shares, outstanding 180,000 shares

Treasury stock (20,000 shares at cost of$18)

Page


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Step 1 find weighted averageshares outstanding

Date

Common

Stock

Treasury

Stock

Common

SharesOutstanding

Months

Split

Factor Weighted

1/1 to 3/31 200,000 20,000 180,000 3/12

4/1/2006 100,000 100,000

4/1 to 6/29

6/30/2006

6/30 to 8/31

9/1/2006

9/1 to 12/31Weighted average


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Date

Common

Stock

Treasury

Stock

Common

SharesOutstanding

Months

Split

Factor Weighted

1/1 to 3/31 200,000 20,000 180,000 3/12

4/1/2006 100,000 100,000

4/1 to 6/29 300,000 20,000 280,000 3/12

6/30/2006

6/30 to 8/31

9/1/2006



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EPS Example

During 2006, the following transactionstake place:

April 1, 2006 issued 100,000 shares to acquirethe assets of another company. Market value ofshares was $25

June 30, 2006 declared and distributed a 2for 1 stock split effected in the form of astock dividend

September 1, 2006 sold 10,000 shares of thetreasury stock for $28 per share

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Stock Splits & Dividends

All stock splits andstock dividends must beincorporated into the

computation ofweighted averageshares outstanding.

This must done for allperiods presented inthe financialstatements.


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DateCommon

Stock

Treasury

Stock

Common

Shares

Outstanding

MonthsSplit

FactorWeighted

1/1 to 3/31 200,000 20,000 180,000 3/12 2

4/1/2006 100,000 100,000

4/1 to 6/29 300,000 20,000 280,000 3/12 2

6/30/2006 280,000 280,000

6/30 to 8/31 580,000 20,000 560,000 2/12 1

9/1/2006



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Stock Splits & Dividends

This years EPS figuresmay have to be changed

in the future as a result ofstock splits or dividends.

Think about what would

happen if we did NOTmake the adjustment . . .


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EPS Example

During 2003, the following transactionstake place:

April 1, 2003 issued 100,000 shares to acquirethe assets of another company. Market value ofshares was $25

June 30, 2003 declared and distributed a 2 for 1stock split effected in the form of a stock dividend

September 1, 2003 sold 10,000 shares ofthe treasury stock for $28 per share

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DateCommon

Stock

Treasury

Stock

Common

Shares

Outstanding

MonthsSplit

FactorWeighted

1/1 to 3/31 200,000 20,000 180,000 3/12 2

4/1/2006 100,000 100,000

4/1 to 6/29 300,000 20,000 280,000 3/12 2

6/30/2006 280,000 280,000

6/30 to 8/31 580,000 20,000 560,000 2/12 19/1/2006 -10,000 10,000

9/1 to 12/31 580,000 10,000 570,000 4/12 1

Weighted

average 12/12


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DateCommon

Stock

Treasury

Stock

Common

Shares

Outstanding

MonthsSplit

FactorWeighted

1/1 to 3/31 200,000 20,000 180,000 3/12 2 90,000

4/1/2006 100,000 100,000

4/1 to 6/29 300,000 20,000 280,000 3/12 2 140,000

6/30/2006 280,000 280,000

6/30 to 8/31 580,000 20,000 560,000 2/12 1 93,333

9/1/2006 -10,000 10,000

9/1 to 12/31 580,000 10,000 570,000 4/12 1 190,000

Weighted average 12/12 513,333

Multiply shares outstandingby fraction of year and by

split factor

Make sure you have accountedfor all 12 months and no more

than 12 months!

Add

em up


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Step 2 - numerator

Net income = $3,000,000

Preferred dividends =

10,000 shares * $100 * 6% = $60,000

Now lets plug everything into the formula . . .

Note: Always include preferred dividend if it is

cumulative preferred stock. If not cumulative, onlyinclude preferred dividend if declared during year


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Step 3 compute basic EPS

Net income Preferred dividendsWeighted average shares outstanding

$3,000,000 $60,000513,333

$__________


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What if . . .

Taking the same facts, what if thepreferred stock was convertible into 10

shares of common stock at the optionof the stockholder?

This would make it a complex capitalstructure and wed have to report boththe basic EPS we computed plus a dilutedearnings per share figure.

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Convertible preferred

The 10,000 shares of preferred couldbecome 100,000 shares of common

stock (outstanding all year)We would NOT pay the preferreddividend because there would be no

preferred stock


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Diluted EPS

Diluted EPS = $__________Both the $5.73 and the $4.89 would bereported on the face of the income statement

$3,000,000

$0513,333 + 100,000



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The If-Converted Method

The conversion of the securities into commonstock is assumed to occur at the beginning ofthe year or date of issue, if later.

Convertible bonds: The interest expense (netof tax) is added back to net income.Convertible preferred: No deduction forpreferred dividends.

The weighted average number of shares isincreased by the additional common sharesassumed issued.


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Treasury Stock Method

Proceeds from conversion are assumed to beused for purchase of treasury stock at

AVERAGE market price.

Purpose is to acquire treasury stock that can bereissued to option or warrant holders. If notsufficient, wed have to issue MORE shares

Any additional shares issued, over treasurystock, are added to weighted- average

shares outstanding. Exercise is assumed to occur on the first day of

the year unless issue date is later.

T St k M th d


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Treasury Stock Method--Example: Basic Data

Assume the following:

Net Income $8,000

Common Shares Outstanding(entire year) 6,000

Stock Options Outstanding 2,000

Exercise Price Per Share on Options $30Average Price of Common Shares $40


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Treasury Stock Method--Example

Basic EPS = $8,0006,000

$1.33Basic EPS =


T St k M th d


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Treasury Stock Method--Example: 3 steps

1. Options assumed exercised(2,000*30) = $60,000 cash received

2. Shares assumed repurchased withproceeds ($60,000 / $40) = 1,5003. Additional shares assumed issued:

2,000 from exercise less 1,500

purchased with proceeds = 500 netnew shares


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Treasury Stock Method--Example:

Diluted EPS =$8,000

6,000 + 500

=

$1.23Diluted EPS =

= $8,000/6,500 =



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Short-cut formula:

Net new shares

=

Number of sharesto which

option holdersare entitled

*

Avg Mkt Price OptionPrice

Avg Mkt Price

2,000 *


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Formula for diluted EPS

Net income

- Preferreddividends if

preferredstock is NOTconvertible

+ After-tax

bond intereston conver-tible bonds

Weighted average of common shares

assuming maximum dilution(including options)

Getting the lo e t po ible


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Getting the lowest possiblenumber an algorithm

1. Compute the per share effect of eachpotentially dilutive security separately.

2. Make a list from smallest per share numberto largest per share number

3. Compute basic earnings per share4. For diluted EPS, take the securities into EPS

computation one at a time until the nextitem on the list is bigger than the mostrecent EPS figure.

Documents

EPS Lecture for Acct 414 (for Students)