1. Earnings Per Share and Retained EarningsC 17
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Earnings Per Share and Retained Earnings
Intermediate Accounting 10th edition
Nikolai Bazley Jones
An electronic presentation
by Norman Sunderman
Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

2. Basic Earnings Per Share
Net Income - Preferred Dividends
Weighted Average Number of Common Shares Outstanding

3. Weighted Average Shares
Since a corporation earns its net income over the entire year, the earnings are related to the common shares outstanding during the year.

4. Weighted Average Shares
McTeal Corporation had 12,000 shares of common stock outstanding at the beginning of the year. On March 2, it issued 2,700 shares; on July 3, it issued another 3,300 shares, and on December 1, it reacquired 480 shares as treasury stock.
The nearest whole month is used
Months Shares Shares Fraction of Year Equivalent
Are Outstanding Outstanding Outstanding Whole Units
January-February 12,000 x 2/12 = 2,000
March-June 14,700 x 4/12 = 4,900
July-November 18,000 x 5/12 = 7,500
December 17,520 x 1/12 = 1,460
15,860
Total weighted average common shares

5. Weighted Average Shares
Wallers corporation begins operations in January 2007, and issues 5,000 shares of common stock that are outstanding all during On December 31, 2007, it issues a 2-for-1 stock split.
Months Shares Shares Fraction of Year Equivalent
Are Outstanding Outstanding Outstanding Whole Units
January-December 5,000 x 12/12 = 5,000
The two-for-one split is retroactive to January ,000
Total weighted average common shares ,000
Continued

6. Weighted Average Shares
On May 29, 2008, R Corporation issues 5,000 shares of common stock; on August 3, it issues a 20% stock dividend; and on October 5, it issues 2,000 shares of stock.
2007 Data on 2008 Statement
Months Shares Shares Fraction of Year Equivalent
Are Outstanding Outstanding Outstanding Whole Units
January-December 5,000 x 12/12 = 5,000
5,000 x 200% x 120% = 12,000 equivalent whole units
Continued

7. Weighted Average Shares
2008 Data on 2008 Statement
Months Shares Shares Fraction of Year Equivalent
Are Outstanding Outstanding Outstanding Whole Units
January-May 10,000
June-July 15,000
August-September 18,000
Issued 5,000 shares
Issued 20% stock dividend

8. Weighted Average Shares
2008 Data on 2008 Statement
Months Shares Shares Fraction of Year Equivalent
Are Outstanding Outstanding Outstanding Whole Units
Increases 20%
January-May 10,000
June-July 15,000
August-September 18,000
12,000
Increases 20%
18,000
October-December 20,000

9. Weighted Average Shares
2008 Data on 2008 Statement
Months Shares Shares Fraction of Year Equivalent
Are Outstanding Outstanding Outstanding Whole Units
January-May 12,000 x 5/12 = 5,000
June-July 18,000 x 2/12 = 3,000
August-September 18,000 x 2/12 = 3,000
October-December 20,000 x 3/12 = 5,000
16,000

10. Simple Capital Structure
For purposes of computing earnings per share, there are two types of capital structure -simple and complex.
A simple capital structure is one that consists of
Only common stock, or
Common stock and nonconvertible preferred stock.
Requires only Basic Earnings Per Share

11. Complex Capital Structure
Many corporations have a more complex capital structure that includes outstanding convertible securities or contingent shares that could have a dilutive effect on earnings per share. These securities are referred to as potential common shares.

12. Diluted Earnings Per Share
A corporation with a complex capital structure is required to report two amounts on the face of its income statement.
Yes… basic earnings per share and diluted earnings per share.

13. Diluted Earnings Per Share
The amount for diluted earnings per share shows the earnings per share after including all potential common shares that would reduce earnings per share.

14. Diluted Earnings Per Share
To be included in the diluted earnings per share calculation, any potential common share must have a dilutive effect on earnings per share.

15. Diluted Earnings Per Share
Step 1: Compute the basic earnings per share.
Step 2: Include dilutive stock options and warrants and compute a tentative diluted earnings per share (DEPS).
Step 3: Develop a ranking of the impact of each convertible preferred stock and convertible bond on DEPS.
Step 4: Include each dilutive convertible security in DEPS in a sequential order based on the ranking and compute a new tentative DEPS.
Step 5: Select the lowest computed DEPS as the diluted earnings per share .

16. Stock Options and Warrants
Assumed Shares Issued
Change (Incremental) in Shares + -
Proceeds ($)
Assumed Shares Reacquired (at average market price)

17. Treasury Stock Method
Determine the average market price of common shares during the period.
Compute the shares assumed issued from the assumed exercise of all options and warrants.
Compute the proceeds received from the assumed exercise by multiplying the shares issued by the option price [plus any unrecognized compensation cost (net of tax) per share].
Compute the assumed shares reacquired by dividing the proceeds by the average market price.
Compute the incremental common shares.

18. Average Market Price Per Share
Treasury Stock Method
To illustrate Step 3 further, assume Plummer Corporation has compensatory stock options to purchase 1,000 common shares at $18 per share outstanding the entire year, the average market price for the common stock was $25 per share, and the unrecognized compensation cost (net of tax) was $2 per share. Page 834.
Shares assumed issued from assumed exercise: 1,000
1,000 x ($18 + $2)
$25
Proceeds
Average Market Price Per Share
$20,000
$25 =
= (800)
Assumed increment in common shares for
computing diluted earnings per share 200

19. Convertible Securities
Convertible bonds and convertible preferred stock are considered in DEPS after stock options and warrants. Page 834.

20. Convertible Securities
If convertible bonds were assumed converted, the numerator increases net-of-tax because interest expense would not exist, but income taxes would increase.

21. Convertible Securities
Numerical Value Impact on Diluted Earnings Per Share
Increase in Earnings Per Share Numerator
Increase in Earnings Per Share Denominator
$5,400
3,000 =
$1.80
Security A
9% convertible preferred stock dividends of $5,400 were declared during the year. The preferred shares are convertible into 3,000 shares of common stock.
Continued

22. Convertible Securities
Numerical Value Impact on Diluted Earnings Per Share
$4,800
1,920 =
$2.50
Security B
10% convertible bonds. Interest expense (net of income taxes) of $4,800 was recorded during the year. The bonds are convertible into 1,920 shares of common stock.
Continued

23. Convertible Securities
Numerical Value Impact on Diluted Earnings Per Share
$8,000
5,000 =
$1.60
Security C
8% convertible preferred stock. Dividends of $8,000 were declared during the year. The preferred shares are convertible into 5,000 shares of common stock.
Continued

24. Convertible Securities
Numerical Value Impact on Diluted Earnings Per Share
$6,300
3,150 =
$2.00
Security D
7% convertible bonds. Interest expense (net of income taxes) of $6,300 was recorded during the year. The bonds are convertible into 3,150 shares of common stock.
Continued

25. Convertible Securities
Security Impact Order in Ranking
A $1.80 2
B $2.50 4
C $1.60 1
D $2.00 3
Security C has the lowest impact on DEPS and is the most dilutive. It is the first convertible security (after options and warrants) to be included in DEPS (if dilutive).

26. Testing to Determine Whether a Convertible Security is Dilutive
If the EPS of the first ranked convertible security is less than the tentative EPS, add the potential income to the numerator and the potential shares to the denominator and continue until the impact of the next convertible security is more than the previously computed tentative diluted earnings per share.

27. Diluted Earnings Per Share
Format
Earnings Shares Earnings
Explanation Adjustments Adjustments Per Share =
Basic EPS $x,xxx / xxx = $xxx Basic
Incremental shares (options) xx
Tentative EPS 1 $xxxx / xxx = $xxx Ten.
Savings in interest expense xxx
Incremental shares (bonds) xxx =
Tentative EPS 2 $x,xxx / xxx = $xxx Ten.
Savings in preferred dividends xxx
Incremental shares from Pref. St. xxx = $xxx Ten.
Diluted earnings & shares $x,xxx / xxx = $xxx Diluted

28. Diluted Earnings Per Share
Page 838
Earnings Shares Earnings
Explanation Adjustments (Adjustments) Per Share / =
Basic EPS $2,000 / 900 = $2.22 Basic
Incremental shares (options)
Tentative EPS 1 $2,000 / 985 = $2.03 Ten.
Savings in interest expense
224
Incremental shares (bonds) =
Diluted earnings & shares $2,224 / 1,145 = $1.94 Diluted

29. Additional Disclosures
Identifies the amount of preferred dividends deducted to determine the income available to common stockholders.
Describes the potential common shares that were not included in the diluted earnings per share computation because they were antidilutive.
Describe any material impact on the common shares outstanding of subsequent transactions after the close of the accounting period but before the issuance of the financial report.
When a corporation reports its basic and diluted earnings per share on its income statement, it also is required to make additional disclosures in the notes to its financial statements.

30. Types of Dividends
Cash
Property
Stock
Liquidating
Scrip

31. Dividend Considerations
Declared
Not larger than unrestricted retained earnings
Not paid on treasury stock
Other restrictions
Scrip

32. There are four significant dates for a cash dividend.
The date of declaration
The ex-dividend date
The date of record
The date of payment

33. Fully Participating Dividend
Everett Corporation has issued 10%, participating, cumulative preferred stock with a total par value of $20,000 and common stock with a total par value of $30,000. The preferred stock is two years in arrears. Everett Corporation declares a $9,000 dividend.

34. Fully Participating Preferred Stock
Preferred Common
Current dividend (10% x $20,000) 2,000
Common dividend (10% x $30,000) $3,000
Total to allocate $9,000
Allocated ( 5,000 )
Remainder $ 4,000
$20,000/$50,000 to preferred and $30,000/$50,000 to common 1, ,400
Dividend to each class of stock $3,600 $5,400

35. Partially Participating Preferred Stock (up to 12%)
Again assume a $30,000 dividend.
Preferred Common
Current dividend (10% x $20,000) 2,000
Common dividend (10% x $30,000) $3,000
2% dividend on par
Remainder to common ($9,000 – $6,000) 3,000
Dividend to each class of stock $2,400 $6,600

36. Property Dividend
Occasionally, a corporation will declare a property dividend that is payable in assets other than cash.

37. Property Dividend
The corporation typically uses marketable securities of other companies that it owns for the property dividend.

38. Property Dividend
The corporation records a property dividend at the fair value of the asset transferred, and recognizes a gain or loss.

39. Property Dividend
Asel Corporation declares a property dividend payable in held-to-maturity bonds of Bard Company. The bonds are carried on Asel’s books at a book value of $40,000, but their current fair value is $48,000.
Continued

40. Property Dividend Date of Declaration
Investment in Bard Co. Bonds 8,000
Gain on Disposal of Investments 8,000
Retained Earnings 48,000
Property Dividends Payable 48,000
Date of Payment
Property Dividends Payable 48,000
Investment in Bard Co. Bonds 48,000
Continued

41. Stockholders often view stock dividends favorably even though-
They receive no corporate assets.
Their percentage ownership does not change.
Theoretically the total market value of their investment will remain the same.
Future cash dividends may be limited because retained earnings is decreased by the amount of the stock dividend.
Stockholders often view stock dividends favorably even though-

42. Stock Dividends Stock Dividend
What factors might enhance the perceived attractiveness of stock dividends?
Stock Dividend

43. Additional Paid-In Capital
Stock Dividends
Small
<25%
Large
25% or more
Par Value
Fair Value
Retained Earnings
Capital Stock
Additional Paid-In Capital
Retained Earnings
Capital Stock

44. Stockholders’ Equity Prior to Stock Dividend
Stock Dividends
Stockholders’ Equity Prior to Stock Dividend
Common stock, $10 par (20,000 shares
issued and outstanding) $200,000
Additional paid-in capital 180,000
Retained earnings 320,000
Total stockholders’ equity $700,000

45. Small Stock Dividend
Ringdahl Corporation declares and issues a 10% stock dividend. On the date of declaration, the stock sells for $23 per share.
20,000 shares x 0.10 x $23
Date of Declaration
Retained Earnings 46,000
Common Stock To Be Distributed 20,000
Additional Paid-in Capital From
Stock Dividend 26,000
Par
Continued

46. Small Stock Dividend
Ringdahl Corporation declares and issues a 10% stock dividend. On the date of declaration, the stock sells for $23 per share.
Date of Issuance
Common Stock To Be Distributed 20,000
Common Stock, $10 par 20,000
Par

47. Stockholders’ Equity After Stock Dividend
Small Stock Dividend
Stockholders’ Equity After Stock Dividend
Common stock, $10 par (22,000 shares
issued and outstanding) $220,000
Additional paid-in capital 206,000
Retained earnings 274,000
Total stockholders’ equity $700,000
Note: Total remained the same

48. Large Stock Dividend
Ringdahl Corporation declares and issues a 40% stock dividend. On the date of declaration, the stock sells for $23 per share.
20,000 shares x 0.40 x $10
Date of Declaration
Retained Earnings 80,000
Common Stock To Be Distributed 80,000
Date of Issuance
Common Stock To Be Distributed 80,000
Common Stock, $10 par 80,000
Continued

49. Stockholders’ Equity After Stock Dividend
Large Stock Dividend
Stockholders’ Equity After Stock Dividend
Common stock, $10 par (28,000 shares
issued and outstanding) $280,000
Additional paid-in capital 180,000
Retained earnings 240,000
Total stockholders’ equity $700,000
Note: Same total as small stock dividend

50. Statement of Retained Earnings
Although not a required separate financial statement, some corporations include a statement of retained earnings in their financial statements.

51. Statement of Retained Earnings
Retained earnings, as previously reported, Jan. 1, 2007,
-Plus (minus) Prior period adjustments (net of income tax effect)
Adjusted retained earnings, January 1, 2007
-Plus (minus): Net income (loss)
Minus: -Dividends (specifically identified, including per share amounts)
-Reductions due to retirement or reacquisition of capital stock
-Reductions due to conversion of bonds or preferred stock
Retained earnings, December 31, 2007

52. Accumulated Other Comprehensive Income
Other comprehensive income might include--
Unrealized increases (gains) or decreases (losses) in the market value of investments in available-for-sale securities.
Translation adjustments from converting the financial statements of a company’s foreign operation into U.S. dollars.
Certain gains and losses on “derivative” financial instruments.
Certain pension liability adjustments.

53. Accumulated Other Comprehensive Income
A corporation may report its comprehensive income (net of income taxes)--
On the face of its income statement.
In a separate statement of comprehensive income.
In its statement of changes in stockholders’ equity.

54. C 17
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