Module 9 Earnings per share Financial Accounting 3 Module 9 Earnings per share

Theoretical foundation EPS is a profitability ratio that public companies must provide to investors. The figure is used to determine the market value of the shares. P/E ratio Price/earnings ratio = market price/EPS once the P/E is established the new EPS can be used to estimate market price of the shares, if other considerations are constant.

Basic EPS Income available to ordinary shareholders divided by the weighted average number of ordinary shares EPS is calculated before and after discontinued operations.

Income available to common shareholders Net income Less Preferred dividends, declared or current cumulative Loss on retirement of preferred shares charged directly to retained earnings

Weighted average number of ordinary shares WAOS The ordinary shares are weighted by the amount of time they are outstanding during the year. Then an average is calculated. Stock dividends, splits and contingently issuable shares are backdated to the beginning of the year.

Diluted EPS Only calculated when complex capital structure exists for the company, that is Convertible bonds Convertible preferred shares Options or warrants outstanding for common shares Contingently issuable shares

Steps for diluted calculations Calculated basic EPS Calculated the individual effect of items that may be dilutive. Determine if each item is potentially dilutive. (options in the money always are dilutive) Rank the items by their effect (options first) Calculate the diluted EPS one item at a time, seeing if the next ranked item is still dilutive. When there are no more dilutive items, you have the diluted EPS.

Options/Warrants Options are dilutive if they are in-the-money. If quarterly share prices are given, this calculation is done quarterly Use the treasury share method Back date to beginning of year or when issued, if issued during the year

Contingently issuable shares The number of contingently issuable shares is added to the denominator if the only element not met is the date of the contingency period has not yet expired.

Preferred shares Calculate the dividends that would have been saved Calculate the increase in ordinary shares Back date to beginning of year or when issued, if issued during the year

Bonds Calculated the interest that would have been saved Don’t forget the tax effect Calculated the increase in the common shares Back date to beginning of year or when issued, if issued during the year

Conversion during the year Back date any conversions that took place during the year to the beginning of the year or date of issue if issued during the year.

Disclosures Page 1134 of textbook