18-1 Intermediate Financial Accounting Earl K. Stice James D. Stice © 2012 Cengage Learning PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University Earnings Per Share Chapter th Edition

18-2 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)

18-3 Simple and Complex Capital Structures A company’s 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)

18-4 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)

18-5 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.

18-6 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) Issuance or Reacquisition of Common Stock

18-7 Issuance or Reacquisition of Common Stock Jan. 1 to May 110,000 × 4/12 =3,333 May 1 to Nov. 1 15,000 × 6/12 = 7,500 Nov. 1 to Dec ,000 × 2/12 = 2,167 Weighted-average number of shares13,000

18-8 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. (continued) Dates Economic Event Changes in Shares Outstanding Feb.1Exercise of stock option+ 400 May 110% stock dividend (3,000 x 10%)+ 300 Sept 1Sale of stock for cash+ 1,200 Nov. 1Purchase of treasury stock– 400 Dec.13-for-1 stock split+ 8,200

18-9 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) Stock Dividends and Stock Splits

18-10 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) Stock Dividends and Stock Splits

18-11 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)

18-12 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) Preferred Stock Included in Capital Structure

/1 to 6/30200,000× 6/12100,000 No. of Stock Portion of Weighted Date Shares Dividend Year Average (continued) Preferred Stock Included in Capital Structure

18-14 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) Preferred Stock Included in Capital Structure

18-15 (continues) 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. Preferred Stock Included in Capital Structure

18-16 There are 250,000 weighted-average shares outstanding at the end of On May 1, 2013, the firm issued a 50% stock dividend on common stock /1 to 6/30200,000× 6/12100,000 7/1 to 12/31300,000× 6/12150, ,000 No. of Stock Portion of Weighted Date Shares Dividend Year Average (continued) Preferred Stock Included in Capital Structure

/1 to 6/30200,000× 6/12100,000 7/1 to 12/31300,000× 6/12150, , /1 to 5/1300,0001.5× 4/12150,000 No. of Stock Portion of Weighted Date Shares Dividend Year Average Now let’s “roll back” the stock dividend for all the years displayed. (continued) Preferred Stock Included in Capital Structure

/1 to 6/30200,0001.5× 6/12150,000 7/1 to 12/31300,0001.5× 6/12225, , /1 to 5/1300,0001.5× 4/12150,000 No. of Stock Portion of Weighted Date Shares Dividend Year Average (continued) Preferred Stock Included in Capital Structure Now let’s “roll back” the stock dividend for all the years displayed.

/1 to 6/30200,0001.5× 6/12150,000 7/1 to 12/31300,0001.5× 6/12225, , /1 to 5/1300,0001.5× 4/12150,000 5/1 to 12/31450,000× 8/12300,000 No. of Stock Portion of Weighted Date Shares Dividend Year Average 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) Preferred Stock Included in Capital Structure

/1 to 6/30200,0001.5× 6/12150,000 7/1 to 12/31300,0001.5× 6/12225, , /1 to 5/1300,0001.5× 4/12150,000 5/1 to 12/31450,000× 8/12300, ,000 No. of Stock Portion of Weighted Date Shares Dividend Year Average (continued) Preferred Stock Included in Capital Structure

18-21 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: Preferred dividends Weighted-average shares of common stock outstanding $80, ,000 shares of Earnings per share from continuing operations = $0.60 Net income after EI – $305,000 (continued) Preferred Stock Included in Capital Structure

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

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

18-24 Weighted-average shares of common stock outstanding 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: Net loss + Preferred dividends ($55,000) + ($80,000) 450,000 shares of weighted- average common outstanding Basic loss per share = $(0.30) Preferred dividends are included even though they were not declared. Preferred Stock Included in Capital Structure

18-25 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.

18-26 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 company’s fiscal year or at the issue date of the stock option or convertible security, whichever comes later.

18-27 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)

18-28 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. Stock Options, Warrants, and Rights (continued)

18-29 Stock Options, Warrants, and Rights Treasury Stock Method 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)

18-30 Number of shares sold 5,000 Proceeds from sale (5,000 × $40) = $200,000 Number of shares that could be purchased with the proceeds ($200,000/$50)4,000 Number of shares used for diluted EPS1,000 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:

18-31 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)

18-32 $92, ,000 Basic EPS == $0.93 Basic Earnings per Share (continued) Illustration of Diluted EPS with Stock Options

18-33 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 outstanding100,000 Issued on assumed exercise of options 20,000 Less assumed options repurchased12,000 8,000 Total108,000 (continued) Illustration of Diluted EPS with Stock Options

18-34 Diluted Earnings per Share: $92, ,000 = $0.86 COMPARED TO: Basic Earnings per Share: $92, ,000 = $0.93 The diluted EPS is less than the basic EPS, so it is acceptable. Illustration of Diluted EPS with Stock Options

18-35 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.

18-36 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.

18-37 Financial Statement Presentation 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. Firms are required to provide the following disclosure items in the notes to the financial statements : (continued)

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. Financial Statement Presentation

18-39 Chapter 18 The End $

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