1 Earnings Per Share

2  Detail recent changes in accounting standards relating to earnings per share, and know why the changes were made and how these changes will affect computations relating to earnings per share.  Know the difference between a simple and a complex capital structure, and understand how dilutive securities affect earnings per share computations. Learning Objectives

3  Compute basic earnings per share, taking into account the sale and repurchase of stock during the period as well as the effects of stock splits and stock dividends.  Use the treasury stock method to compute diluted earnings per share when a firm has outstanding stock options, warrants, and rights. Learning Objectives

4  Use the if-converted method to compute diluted earnings per share when a company has convertible preferred stock or convertible bonds outstanding.  Factor into the diluted earnings per share computations the effect of actual conversion of convertible securities or the exercise of options, warrants, or rights during the period, and understand the antidilutive effect of potential common shares when a firm reports a loss from continuing operations. Learning Objectives

5  Determine the order in which multiple potential dilutive securities should be considered in computed diluted earnings per share.  Understand the disclosure requirements associated with basic and diluted earnings per share computations.  Make complex earnings per share computations involving multiple potentially dilutive securities. EXPANDED MATERIAL

6 A firm’s net income does not necessarily correlate with its earnings per share figure.

7 Two EPS Computations Considers only common shares issued and outstanding. Basic

8 Reflects the maximum potential dilution from all possible stock conversions that would have decreased EPS. Diluted Two EPS Computations Considers only common shares issued and outstanding. Basic

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

10 Capital Structures Simple Capital Structure: The corporation has only common and nonconvertible preferred stock and has no convertible securities, stock options, warrants, or other rights outstanding.

11 Capital Structures Complex Capital Structure: The corporation has one or more instruments outstanding that could result in issuance of additional common shares.

12 Capital Structures Therefore, a company with potential per share dilution is considered to have a complex capital structure.

13 Basic Earnings Per Share The Basic Equation: Net Income - Preferred Dividend Weighted-Average Common Shares Outstanding The Complications: –Issuance or reacquisition of common stock. –Stock dividends or stock splits. The Complications: –Issuance or reacquisition of common stock. –Stock dividends or stock splits.

14 Issuance or Reacquisition of Common Stock Assume the following : –Shares Outstanding January 1:1,000 –New Shares Issued May 1:1,000 –Shares Repurchased November 1: 500 Calculate weighted-average shares outstanding on December 31.

15 Jan. 1 to May 11,000 x 4/12 =333 May 1 to Nov. 1 2,000 x 6/12 = 1,000 Nov. 1 to Dec. 31 1,500 x 2/12 = 250 Dec. 31 Weighted-average shares1,583 Issuance or Reacquisition of Common Stock

16 Issuance or Reacquisition of Common Stock That was easy. Now let’s try one with a stock dividend and a stock split.

17 Assume the following: –Shares outstanding January 1: 2,600 –Shares issued for exercise of options on February 1: 400 –Shares issued for 10% stock dividend on May 1: 300 –Shares sold for cash on September 1:1,200 –Shares repurchased on November 1: 400 –Shares issued for 3-for-1 stock split on December 15:8,200 Issuance or Reacquisition of Common Stock

18 Issuance or Reacquisition of Common Stock 1/1-2/12,600 2/1 Option 400 2/1-5/13,000 No. of Stock Stock Portion of Weighted Date Shares Dividend Split Year Average

19 Issuance or Reacquisition of Common Stock 1/1-2/12,600 x /1 Option 400 2/1-5/13,000 x /1 Dividend 300 5/1-9/13,300 No. of Stock Stock Portion of Weighted Date Shares Dividend Split Year Average

20 Issuance or Reacquisition of Common Stock 1/1-2/12,600 x /1 Option 400 2/1-5/13,000 x /1 Dividend 300 5/1-9/13,300 9/1 Sale1,200 9/1-11/14,500 No. of Stock Stock Portion of Weighted Date Shares Dividend Split Year Average

21 Issuance or Reacquisition of Common Stock 1/1-2/12,600 x /1 Option 400 2/1-5/13,000 x /1 Dividend 300 5/1-9/13,300 9/1 Sale1,200 9/1-11/14,500 11/1 Purchase (400) 11/1-12/14,100 No. of Stock Stock Portion of Weighted Date Shares Dividend Split Year Average

22 Issuance or Reacquisition of Common Stock 1/1-2/12,600 x /1 Option 400 2/1-5/13,000 x /1 Dividend 300 5/1-9/13,300 9/1 Sale1,200 9/1-11/14,500 11/1 Purchase (400) 11/1-12/14,100 12/1 Split8,200 12/1-12/3112,300 No. of Stock Stock Portion of Weighted Date Shares Dividend Split Year Average

23 Issuance or Reacquisition of Common Stock 1/1-2/12,600 x 1.10x 3.0 2/1 Option 400 2/1-5/13,000 x 1.10x 3.0 5/1 Dividend 300 5/1-9/13,300 x 3.0 9/1 Sale1,200 9/1-11/14,500 x /1 Purchase (400) 11/1-12/14,100 x /1 Split8,200 12/1-12/3112,300 No. of Stock Stock Portion of Weighted Date Shares Dividend Split Year Average

24 Issuance or Reacquisition of Common Stock 1/1-2/12,600 x 1.10x 3.0x 1/12 =715 2/1 Option 400 2/1-5/13,000 x 1.10x 3.0x 3/12 =2,475 5/1 Dividend 300 5/1-9/13,300 x 3.0x 4/12 =3,300 9/1 Sale1,200 9/1-11/14,500 x 3.0x 2/12 =2,250 11/1 Purchase (400) 11/1-12/14,100 x 3.0x 1/12 =1,025 12/1 Split8,200 12/1-12/3112,300 x 1/12 =1,025 No. of Stock Stock Portion of Weighted Date Shares Dividend Split Year Average The weighted-average shares outstanding is 10,790 (the sum of the weighted-average column).

25 Stock Splits & Dividends All stock splits and stock dividends must be incorporated into the computation of weighted average shares outstanding. This must done for all periods presented in the financial statements. Current EPS figures may have to be changed in the future as a result of stock splits or dividends.

26 Diluted Earnings Per Share Dilution occurs if inclusion of a potentially dilutive security reduces the basic EPS or increases the basic loss per share.

27 Treasury Stock Method Proceeds from conversion are assumed to be used for purchase of treasury stock at current market price. Treasury stock is assumed to be reissued to option or warrant holders. Any additional shares issued, over treasury stock, are added to “weighted- average shares outstanding.” Exercise is assumed to occur on the first day of the year unless issue date is later.

28 Treasury Stock Method-- Example: Basic Data Assume the following: Net Income $8,000 Common Shares Outstanding (entire year) 6,000 10% Bonds Payable $20,000 1-for-1 Options Outstanding 2,000 Exercise Price Per Share on Options$30 Average Price of Common Shares$40 Income Tax Rate 40%

29 Treasury Stock Method--Example: Basic Earnings Per Share Net Income - Preferred Dividend Weighted Average Common Shares Outstanding Basic EPS = $8,000 6,000 $1.33 Basic EPS =

30 Treasury Stock Method-- Example: Option Proceeds Options Assumed Exercised 2,000 Shares Assumed Repurchased With Proceeds * ($60,000 / $40) 1,500 Additional Shares Assumed Issued 500 * Amount of Proceeds (2,000 x $30) $ 60,000

31 Treasury Stock Method-- Example: Number of Shares Actual Shares Outstanding 6,000 Incremental Shares: Issued Assuming Exercise2,000 Repurchased From Proceeds1, Total Shares Assumed Issued 6,500

32 Treasury Stock Method--Example: Diluted Earnings Per Share Adjusted Net Income - Preferred Dividend Total Shares Assumed Issued Diluted EPS Diluted EPS = $8,000 6,500 = $1.23Diluted EPS =

33 Diluted EPS -- “As If ” Continually remind yourself that the events you are considering when computing diluted EPS did not occur. Bonds were not converted, options were not exercised, etc. Diluted EPS is providing information as if these events occurred.

34 “If-Converted” Method-- Example: Basic Data Assume the following: –Net Income$10,000 –10% Convertible Bonds issued 1/1/01 5,000 –15% Convertible Bonds issued 7/1/01 2,000 –Common Shares Outstanding (no changes during year) 10,000

35 “If-Converted” Method-- Example: Basic Data ( continued ) –Tax Rate 40% –Conversion Terms: 10% Bonds: 15 common shares per $100 bond 15% Bonds: 20 common shares per $100 bond

36 “If-Converted” Method--Example: Basic Earnings Per Share Net Income - Preferred Dividend Weighted-Average Common Shares Outstanding Basic EPS = $10,000 10,000 $1.00Basic EPS =

37 “If-Converted” Method--Example: Net Income for Diluted EPS Net Income$10,000 Interest Savings 10% Bond$ % Bond 150 Less: Tax Effect (260) 390 Adjusted Net Income$10,390

38 “If-Converted” Method-- Example: Number of Shares Actual Shares Outstanding 10,000 Incremental Shares: 10% Bond ($5,000/100 x 15) % Bond ($2,000/100 x 20 x 1/2) Total Shares Assumed Issued 10,950

39 “If-Converted” Method--Example: Fully Diluted Earnings Per Share Adjusted Net Income - Preferred Dividend Total Shares Assumed Issued Diluted EPS Diluted EPS = $10,390 10,950 = $0.95Diluted EPS =

40 Convertible Preferred Stock Remember that preferred dividends were initially subtracted from income to arrive at income available to common shareholders. When we assume conversion of the preferred stock, those dividends must be added back. Also remember there is no tax effect associated with dividends.

41 The End