Chapter 18

18th
Edition

Earnings Per
Share

Intermediate
Accounting
James D. Stice

Earl K. Stice
PowerPoint presented by Douglas Cloud
Professor Emeritus of Accounting, Pepperdine
University
2012 Cengage Learning

18-1

Simple and Complex

Capital Structures

Dilutive securities are securities whose

assumed exercise or conversion results in
a reduction in earnings per share, or lead
to a dilution in earnings per share.

Antidilutive securities are securities

whose assumed conversion or exercise
results in an increase in earnings per
share, or lead to antidilution in earnings per
share.
(continued)

18-2

Simple and Complex

Capital Structures

A companys capital structure may be

classified as simplex or complex.

If a company has only common stock, or

common and nonconvertible preferred
stock outstanding and there are no
convertible securities, stock options,
warrants or other rights outstanding, it is
classified as a simple capital structure.
(continued)
18-3

Simple and Complex

Capital Structures

If net income includes extraordinary gains

or losses or other below-the-line items, a
separate EPS figure is required for each
major component of income, as well as for
net income. These historical EPS amounts
are referred to as basic earnings per
share.

(continued)
18-4

Simple and Complex

Capital Structures

Potential EPS dilution exists if the EPS

would decrease or the loss per share
would increase as a result of the
conversion of securities or exercise stock
options, warrants, or other rights based on
the conditions existing at the financial
statement date.

A company with potential earnings per

share dilution is considered to have a
complex capital structure.
18-5

Issuance or Reacquisition of
Common Stock
Net Income Preferred Dividends
Weighted-Average
Common Shares Outstanding

The weighted-average number of

shares can be computed by
determining month-shares of
outstanding stock and dividing by 12.
(continued)

18-6

Issuance or Reacquisition of
Common Stock

Jan. 1 to May 1

10,000 4/12 =

3,333

May 1 to Nov. 1

15,000 6/12 =

7,500

Nov. 1 to Dec. 31

13,000 2/12 =

2,167

Weighted-average number of shares

13,000

18-7

Stock Dividends and

Stock Splits
A company had 2,600 shares of common stock
outstanding on January 1. The following activities
affecting common stock took place during the year.
Dates Economic Event
Changes in Shares Outstanding
Feb. 1 Exercise of stock option
+ 400
May 1 10% stock dividend
(3,000 x 10%)
+ 300
Sept 1 Sale of stock for cash
+ 1,200
Nov. 1 Purchase of treasury stock
400
Dec. 1 3-for-1 stock split
+ 8,200

(continued)
18-8

Stock Dividends and

Stock Splits

All stock splits and stock dividends must be

incorporated into the computation of
weighted average shares outstanding.
When comparative financial statements are
presented, the common shares outstanding
for all periods shown must be adjusted to
reflect any stock dividend or stock split in
the current period.
(continued)
18-9

Stock Dividends and

Stock Splits

Retroactive adjustments must be made

even if a stock dividend or stock split
occurs after the end of the period but
before the financial statements are
prepared.

Disclosure of the situation should be made

in a note to the financial statements.

(continued)
18-10

Preferred Stock Included in

Capital Structure

Basic EPS reflects only income available to

common stockholders; it does not include
preferred stock.
When a capital structure includes preferred
stock, dividends on preferred stock should
be deducted from income before
extraordinary or other special items from
net income in arriving at earnings related to
common shares.
(continued)

18-11

Preferred Stock Included in

Capital Structure

If preferred dividends are cumulative, the full

amount of dividends on preferred stock for
the period, whether declared or not, should
be deducted from income in arriving at the
earnings or loss balance related to the
common stock.

(continued)
18-12

Preferred Stock Included in

Capital Structure
Date

No. of
Shares

2012
1/1 to 6/30

200,000

Stock
Dividend

Portion of
Year

Weighted
Average

6/12

100,000

(continued)
18-13

Preferred Stock Included in

Capital Structure

On June 30, 2013 the firm paid:

An 8% dividend on preferred stock (10,000

shares at $100 par 0.08 = $80,000)
A $0.30 per share dividend on common
stock (300,000 shares $0.30 = $90,000)

These cash dividends would not affect the

weighted-average number of shares of common
stock.

(continued)
18-14

Preferred Stock Included in

Capital Structure
On June 30, 2012, the company issued
100,000 shares of common stock. After the
issuance, the firm has 300,000 shares of
common stock outstanding. However, these
300,000 are only outstanding for six
months, or one-half of the year.

(continues)
18-15

Preferred Stock Included in

Capital Structure
Date

No. of
Shares

2012
1/1 to 6/30
7/1 to 12/31

200,000
300,000

Stock
Dividend

Portion of
Year

Weighted
Average

6/12
6/12

100,000
150,000
250,000

There
There are
are 250,000
250,000 weighted-average
weighted-average
shares
shares outstanding
outstanding at
at the
the end
end of
of 2010.
2010.
On May 1, 2013, the firm issued a 50% stock
dividend on common stock.
(continued)

18-16

Preferred Stock Included in

Capital Structure
Date

No. of
Shares

2012
1/1 to 6/30
7/1 to 12/31

200,000
300,000

2013
1/1 to 5/1

300,000

Stock
Dividend

1.5

Portion of
Year

Weighted
Average

6/12
6/12

100,000
150,000
250,000

4/12

150,000

Now lets roll back the stock

dividend for all the years displayed.
(continued)
18-17

Preferred Stock Included in

Capital Structure
Date

No. of
Shares

Stock
Dividend

Portion of
Year

Weighted
Average

2012
1/1 to 6/30
7/1 to 12/31

200,000
300,000

1.5
1.5

6/12
6/12

150,000
225,000
375,000

2013
1/1 to 5/1

300,000

1.5

4/12

150,000

Now lets roll back the stock

dividend for all the years displayed.
(continued)
18-18

Preferred Stock Included in

Capital Structure
Date

No. of
Shares

Stock
Dividend

Portion of
Year

Weighted
Average

2012
1/1 to 6/30
7/1 to 12/31

200,000
300,000

1.5
1.5

6/12
6/12

150,000
225,000
375,000

2013
1/1 to 5/1
5/1 to 12/31

300,000
450,000

1.5

4/12
8/12

150,000
300,000

The number of shares of common stock outstanding

before the stock dividend (300,000) now becomes
450,000 shares due to the stock dividend.
(continued)

18-19

Preferred Stock Included in

Capital Structure
Date

No. of
Shares

Stock
Dividend

2012
1/1 to 6/30
7/1 to 12/31

200,000
300,000

1.5
1.5

6/12
6/12

150,000
225,000
375,000

2013
1/1 to 5/1
5/1 to 12/31

300,000
450,000

1.5

4/12
8/12

150,000
300,000
450,000

(continued)

Portion of
Year

Weighted
Average

18-20

Preferred Stock Included in

Capital Structure
In 2012, the firm made a net income,
(including a $75,000 extraordinary gain) of
$380,000. The basic earnings per share
before the extraordinary gain is as follows:
$80,000
dividends
Net income
after EI Preferred
$305,000
375,000 shares
of of
Weighted-average
shares
common stock outstanding
Earnings per share from continuing operations = $0.60
(continued)

18-21

Preferred Stock Included in

Capital Structure
Basic earnings per common share,
extraordinary gain for 2012 is as follows:
Extraordinary
$75,000 gain
Weighted-average
375,000 shares
shares
of of
common stock outstanding
Earnings per share from
extraordinary gain = $0.20
(continued)
18-22

Preferred Stock Included in

Capital Structure
Basic earnings per common share, net
income per share (2012):
Preferred
Net income after
Dividend
extraordinary
item
$380,000
$80,000
Weighted-average
375,000 shares
shares
of of
common stock outstanding
Net income per share = $0.80
(continued)
18-23

Preferred Stock Included in

Capital Structure
In 2013, the firm had a net loss of $55,000 and
there were no extraordinary items. The basic
loss per share is as follows:
($55,000)
+ ($80,000)
Net
loss + Preferred
dividends
450,000
Weighted-average
shares of weightedshares of
average
common
common
stock outstanding
outstanding
Preferred
dividends
Preferred
dividends
Basic loss per share = $(0.30)
are
are included
included even
even
though
though they
they were
were not
not
declared.
declared.
18-24

Participating Securities and

the Two-Class Method

Sometimes a company issues more than

one class of stock with ownership privileges.

Different classes do not always have the

same claim upon dividends.

In such a case, earnings attributed to each

share of the different classes of stock are
different and EPS is computed using the
two-class method.
18-25

Dilutive Earnings per Share

Options, Warrants, and Rights

The two major types of potentially dilutive

securities are (1) common stock options,
warrants, and rights, and (2) convertible
bonds and convertible preferred stock.
All computations of diluted EPS are made as
if the exercise or conversion took place at the
beginning of the companys fiscal year or at
the issue date of the stock option or
convertible security, whichever comes later.

18-26

Stock Options,
Warrants, and Rights

Stock options, warrants, and rights provide no

cash yield to the investors, but they have
value because they permit the acquisition of
common stock.
It is assumed that exercise of options,
warrants, or rights takes place as of the
beginning of the year or the date they are
issued, whichever comes later.

(continued)
18-27

Stock Options,
Warrants, and Rights

Options, warrants, and rights are included in

the computation of diluted EPS for a particular
period only if they are dilutive.
The FASB selected the treasury stock
method and recommended it be assumed that
the cash proceeds from the exercise of
options, warrants, or rights to purchase
common stock on the market (treasury stock)
at the average market price.
(continued)
18-28

Stock Options,
Warrants, and Rights
Treasury
Treasury Stock
Stock Method
Method Demonstrated
Demonstrated

At the beginning of the current year,

employees were granted options to acquire
5,000 shares of common stock at $40 per
share.

The average market price of the stock for

the year is $50.
(continued)
18-29

Stock Options,
Warrants, and Rights
The number of shares (using the treasury
stock method) to use for calculating diluted
earnings per share is calculated as follows:
Number of shares sold
Proceeds from sale (5,000 $40) = $200,000
Number of shares that could be purchased with
the proceeds ($200,000/$50)
Number of shares used for diluted EPS

5,000

4,000
1,000

18-30

Illustration of Diluted EPS

with Stock Options

Rasband Corporation had net income of $92,800

for the year.

There are 100,000 shares of common stock

outstanding all year.

There are 20,000 options outstanding to purchase

shares.

The exercise price per share is $6.

The average market price per share during the

year was $10.

(continued)

18-31

Illustration of Diluted EPS

with Stock Options

Basic
Basic Earnings
Earnings per
per Share
Share
$92,800
Basic EPS =
= $0.93
100,000

(continued)
18-32

Illustration of Diluted EPS

with Stock Options
Proceeds from assumed exercise of
options outstanding (20,000 $6)
$120,000
Number of outstanding shares assumed
to be repurchased with proceeds from
options ($120,000/$10)
12,000
Actual number of shares outstanding
100,000
Issued on assumed exercise of
options
20,000
Less assumed options repurchased 12,000
8,000
Total
108,000
(continued)

18-33

Illustration of Diluted EPS

with Stock Options
Diluted Earnings per Share:
$92,800
108,000

= $0.86

COMPARED TO:
Basic Earnings per Share:
$92,800
100,000

The
The diluted
diluted
EPS
EPS isis less
less
than
than the
the basic
basic
EPS,
EPS, so
so itit isis
acceptable.
acceptable.

= $0.93

18-34

Diluted Earnings per Share

Convertible Securities

The method of including convertible

securities as if conversion had taken
place in the EPS computation is referred
to as the if-converted method.

To test for dilution, each potentially

dilutive convertible must be evaluated
individually.

18-35

Multiple Potentially
Dilutive Securities

The FASB requires selection of the

combination of securities producing the

lowest possible EPS figure.
To avoid having to test a large number of
different combinations to find the lowest one,
companies can compute the incremental EPS
for each potentially dilutive security.
Any dilutive stock options and warrants are
considered first before introducing convertible
securities into the computations.
18-36

Financial Statement Presentation

Firms are required to provide the following
disclosure items in the notes to the financial
statements:
1. A reconciliation of both the numerators and
the denominators of the basic and diluted
EPS computations for income from continuing
operations.
2. The effect that preferred dividends have on
the EPS computations.
(continued)
18-37

Financial Statement Presentation

3. Securities that could potentially dilute basic
EPS in the future that were not included in
computing diluted EPS this period because
those securities were antidilutive for the
current period.
4. Disclosure of transactions that occurred after
the period ended but prior to the issuance of
financial statements that would have
materially affected the number of common
shares outstanding or potentially outstanding
such as the issuance of stock options.
18-38

Chapter 18

The
The End
End

$
18-39

18-40