2. 17
EARNINGS PER SHARE
After studying this chapter, you should be able to:
Understand why earnings per share (EPS) is an important number.
Understand when and how earnings per share must be presented, including related disclosures.
Calculate earnings per share for companies with a simple capital structure.
Calculate earnings per share for companies with a complex capital structure.
Identify the major differences in accounting between ASPE and IFRS, and what changes are expected in the near future.

3. Earnings Per Share Overview Basic EPS Diluted EPS IFRS/ASPE Comparison
Objective of EPS
Presentation and Disclosure
Basic EPS
Capital structure
Income available to common/ordinary shareholders
Weighted average common/ordinary shares
Comprehensive illustration
Diluted EPS
Complex capital structure
Convertible securities
Options and warrants
Contingently issuable shares
Antidilution revisited
Additional disclosures
Comprehensive earnings per share exercise
IFRS/ASPE Comparison
Analysis
Comparison of IFRS and private enterprise GAAP
Looking ahead

4. Objective of EPS
Earnings per share tells common shareholders how much of the available income is associated with the shares they own (their share of the pie)
Provides insight to common shareholders about:
Future dividend payout
The value of their shareholdings
Impact of other financial instruments on their potential earnings (Diluted EPS)
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5. EPS Calculation = EPS Income available to common shareholders
Weighted average number of common shares
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6. EPS Calculation Basic EPS
Actual earnings and actual number of issued common shares
Diluted EPS
Earnings and number of common shares adjusted for “what-if”
What would the EPS be if any financial instruments that could be converted to common shares were actually converted
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7. Presentation & Disclosure
Under IFRS, EPS must be reported as part of the income statement
Exception: non public (privately held) corporations (not required under ASPE)
Reported for each income component as reported on the income statement
EPS relating to discontinued operations (if applicable) may be presented on face of income statement, or disclosed in notes
Where applicable, both Basic EPS and Diluted EPS reported
Presented for all periods reported
Prior period EPS restated for any stock dividends or stock splits
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8. Presentation & Disclosure
If diluted EPS data are reported for at least one period, they should be reported for all periods that are presented, even if they are the same as basic EPS
When the results of operations of a prior period have been restated as a result of a prior period adjustment, the EPS should also be restated
The effect of the restatement should then be disclosed in the year of the restatement
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9. Presentation & Disclosure - Example
Income Statement Presentation of EPS Components
Earnings per share:
Income from continuing operations $4.00
Loss from discontinued operations, net of tax (.60)
Net Income $3.40
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10. Presentation & Disclosure - Example
EPS Presentation – Complex Capital Structure
Earnings per common share:
Basic earnings per share $3.80
Diluted earnings per share $3.35
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11. Presentation & Disclosure - Example
EPS Presentation, with discontinued operations and complex capital structure
Basic earnings per share:
Income before discontinued operations $3.80
Discontinued operations (.80)
Net Income $3.00
Diluted earnings per share:
Income before discontinued operations $3.35
Discontinued operations (.65)
Net Income $2.70
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12. Earnings Per Share Overview Basic EPS Diluted EPS
Objective of EPS
Presentation and Disclosure
Basic EPS
Capital structure
Income available to common/ordinary shareholders
Weighted average common/ordinary shares
Comprehensive illustration
Diluted EPS
Complex capital structure
Convertible securities
Options and warrants
Contingently issuable shares
Antidilution revisited
Additional disclosures
Comprehensive earnings per share exercise
IFRS and Private Enterprise GAAP Comparison
Analysis
Comparison of IFRS and private enterprise GAAP
Looking ahead

13. Capital Structure
Method of EPS calculation based on the corporation’s capital structure
Simple Capital Structure
When only common shares and preferred share are issued and/or debt with no conversion rights
Basic EPS calculated and presented
Complex Capital Structure
When common shares plus dilutive securities are issued (i.e. a potential common shares)
Basic and Diluted EPS calculated and presented
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14. Capital Structure
Potential/ordinary shares are securities or other financial instruments issued by a corporation that have an option for the holder to convert the security into common shares
This conversion could have a negative or dilutive effect on EPS (i.e. may cause EPS to decrease)
Examples: debt and equity instruments that are convertible into common shares, warrants, and options
Contingently issuable shares
Shares issued for minimal consideration (asset exchange) once a certain condition has been met
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15. EPS Reporting Requirements
Capital Structure
Major Types of Equity Instruments
Impact on EPS Calculations
Simple
Common shares
Preferred shares
Basic EPS only
Complex
Potential Common shares:
Convertible preferred shares
Convertible debt
Options/warrants
Contingently issuable
Other
Basic and Diluted EPS
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16. EPS – Simple Capital Structure
Common shareholders have a residual interest in the company’s income:
Therefore, Income Available to Common Shareholders = Net Income - Preferred Share Dividends
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17. EPS - Simple Capital Structure
If the preferred shares are non-cumulative
deduct only declared dividends
If the preferred shares are cumulative
deduct only declared dividends, or
if no dividends declared, deduct only one year’s dividends
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18. EPS - Simple Capital Structure
If dividends on preferred shares are declared and a net loss occurs, the preferred dividend is added to the loss in calculating the loss per share
In reporting earnings per share information, dividends declared on preferred shares should be subtracted from income from continuing operations and from net income
In other words, dividends on preferred shares should not be deducted in calculating EPS from discontinued operations
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19. EPS - Simple Capital Structure - Example
Given:
Michael Limited’s Net Income: $3,000,000
Shares
100,000 Class A preferred, cumulative shares, dividend amount $4.00 per share
100,000 Class B preferred, non-cumulative shares, dividend amount $3.00 per share
No dividends declared or paid in the current year
Calculate the income available to common shareholders
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20. EPS - Simple Capital Structure - Example
Net Income $3,000,000 Amount attributable to Class A: 100,000 x $ ,000 2,600,000 Amount attributable to Class B: 100,000 x $ Income available to common shareholders $2,600,000
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The Class B shares are non-cumulative, with no dividends
declared for the year no amount is deducted from Net Income

21. EPS – Simple Capital Structure
The weighted average number of shares outstanding is weighted by the period of time they were outstanding
Each transaction (issue of shares, reacquisition of shares, retirement of shares) represents a weighting period
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22. EPS - Simple Capital Structure - Example
Date
Share Changes
Shares Outstanding
January 1
Beginning balance
90,000
April 1
30,000 shares issued
120,000
July 1
39,000 shares purchased
81,000
November 1
60,000 shares issued
141,000
December 31
Year end balance
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23. EPS - Simple Capital Structure - Example
Dates Outstanding
Shares Outstanding
Fraction Weighted Shares
Portion of Year Outstanding
Weighted Shares
Jan. 1st to March 31st
90,000
3/12
22,500
April 1st to June 30th
120,000
30,000
July 1st to October 31st
81,000
4/12
27,000
Nov 1st to Dec 31st
141,000
2/12
23,500
Weighted Average Shares Outstanding
103,000
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24. EPS - Simple Capital Structure
Stock splits and stock dividends require restatement of the weighted average number of shares outstanding from the beginning of the year
Because there has been no change in the company’s assets or in the shareholders’ total investment
By restating the number, valid comparisons of earnings per share can be made between periods before and after the stock split or stock dividend
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25. EPS - Simple Capital Structure
If there is a stock split or stock dividend after the year end but before the publication of the financial statements
The weighted average number of shares outstanding must be restated
This applies to the current year as well as previous years if comparative statements are issued
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26. EPS - Simple Capital Structure - Example
Given – Baiye Limited: January 1: 100,000 shares outstanding March 1: Issued 20,000 shares June 1: 50% Stock dividend (60,000 additional shares issued) November 1: Issued 30,000 shares December 31: Ending Balance = 210,000 shares outstanding
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27. EPS - Simple Capital Structure - Example
Dates O/S
Shares O/S
Restatement
Fraction of Year
Weighted Shares
Jan-Mar
100,000
X 1.50 X
2/12 =
25,000
Mar-Jun
120,000
3/12 =
45,000
Jun-Nov
180,000 X
5/12 =
75,000
Nov-Dec
210,000
35,000
Weighted average shares outstanding
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28. Earnings Per Share Overview Basic EPS Diluted EPS
Objective of EPS
Presentation and Disclosure
Basic EPS
Capital structure
Income available to common/ordinary shareholders
Weighted average common/ordinary shares
Comprehensive illustration
Diluted EPS
Complex capital structure
Convertible securities
Options and warrants
Contingently issuable shares
Antidilution revisited
Additional disclosures
Comprehensive earnings per share exercise
IFRS and Private Enterprise GAAP Comparison
Analysis
Comparison of IFRS and private enterprise GAAP
Looking ahead

29. Complex Capital Structure
When corporation has convertible securities, options, warrants or other rights, and
When converted these could dilute EPS
Dilution is the reduction in EPS if:
Securities, potentially convertible into common stock, are converted (assumed at beginning of the year)
Anti-dilutive securities
Securities, when converted, increase EPS
Anti-dilutive EPS is not reported, only basic EPS
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30. EPS - Complex Capital Structure
Requires dual presentation of EPS
Basic earnings per share
Presented for each separate class of common share
Fully diluted earnings per share
Only securities that reduce earnings per share (dilutive) are considered
Securities that increase earnings per share (anti-dilutive) are ignored
The purpose of presenting both EPS numbers is to inform financial statement users of situations that will likely occur and to provide worst-case situations
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31. EPS - Complex Capital Structure
The dilutive effect of convertible securities is measured by the if-converted method
The dilutive effect of options and warrants is measured by the treasury stock method
For computing dilution, the rate of conversion most advantageous to the security holder is used (maximum dilutive conversion rate)
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32. If-Converted Method
The conversion of the securities into common stock is assumed to occur at the beginning of the year
The net income must be adjusted for:
Interest (net of tax) on the convertible debt
Dividends on the convertible preferred shares
The weighted average number of shares is increased by the additional common shares assumed issued (at the beginning of year)
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33. If Converted Method - Example
Given:
Net income for the year: $210,000
Common shares outstanding during the period: 100,000
Additional securities outstanding:
6% convertible debenture bond sold at 100 for $1,000,000, convertible to 20,000 common shares
10% convertible debenture bond sold at 100 for $1,000,000, convertible to 32,000 common shares and issued April 1st of current year
Calculate diluted EPS assuming a tax rate of 30%
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34. If Converted Method - Example
Net income for the year $410,000
Add back:
Interest on 6% debentures
$60,000 x (1-.30) ,000
Interest on 10% debentures
$50,000 x (1-.30) x 9/ ,250
Adjusted Net Income $478,250
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35. If Converted Method - Example
Weighted Average Number of Shares 100,000
Add: Shares assumed issued:
6% debentures ,000
10% debentures* ,000
Adjusted Weighted Average
Number of Shares 144,000
*32,000 shares x 9/12
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36. If Converted Method - Example
Conversion is always assumed to be at the beginning of the year
If a convertible security is not outstanding for the full 12 months of the year
Conversion is pro-rated for the number of months the convertible security is actually issued
Field Corporation 10% debenture was issued April 1st, therefore the conversion is 32,000 shares times 9 out of 12 months
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37. Example - Field Corporation
EPS Calculation and Disclosure: Net income for the year $410,000 Basic EPS ($410,000  100,000) $4.10 Diluted EPS ($478,250  144,000) $3.32
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38. Options and Warrants
Options and warrants (and their equivalents) are included in EPS computations
An option gives the holder the right to either buy or sell shares
Generally speaking, the holder of options will exercise the right if the options are “in the money”
They are “in the money” if the holder of the options will benefit from exercising them
If company sells (or writes) options, they must be included in the diluted EPS calculations if dilutive
Purchased options will always be antidilutive since they will only be exercised when they are in the money
Therefore, they are not included in EPS
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39. Treasury Stock Method Applies to written call options and equivalents
Two assumptions under this method:
The options are assumed exercised at the beginning of the year
The proceeds from the exercise of options are assumed to be used to buy back common shares
The exercise price per share must be less than the market price per share for dilution to occur
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40. Treasury Stock Method - Example
Given:
Exercise price of an option (for one share of stock): $30
Market price of one share at exercise date: $ 50
Options deemed exercised: 1,500
Calculate the incremental shares outstanding
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41. Treasury Stock Method - Example
Total proceeds from exercise (1,500 x $30) $45,000 Shares issued upon exercise of options 1,500 Treasury shares purchased with proceeds 900* Incremental shares outstanding 600 * ($45,000/$50) Dilution occurs because, on a net basis, more common shares are assumed to be outstanding after the exercise
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42. Reverse Treasury Stock Method
Applies to written put options and forward purchase contracts
Two assumptions under this method:
Enough common shares issued at beginning of the year for the company to purchase shares under the option or forward contract
Proceeds from the share issue will be used to purchase shares under the option or forward contract
The exercise price per share must be greater than the market price per share for dilution to occur
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43. Reverse Treasury Stock Method - Example
Given:
Exercise price of an option (for one share of stock): $30
Market price of one share at exercise date: $20
Options deemed exercised: 1,500
Calculate the incremental shares outstanding
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44. Reverse Treasury Stock Method - Example
Amount needed to buy 1,500 shares (1,500 x $30): $45,000 Shares issued to obtain $45,000 ($45,000  $20): 2,250 Number of shares purchased under the put option: 1,500 Incremental shares outstanding: 750 Dilution occurs because, on a net basis, more common shares are assumed to be outstanding after the exercise
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45. Antidilution Revisited
Securities that cause an increase in EPS if included in EPS calculations are antidilutive
Antidilution can be identified by:
Computing Diluted EPS resulting from the conversion and comparing it to Basic EPS
Computing incremental EPS resulting from the conversion and comparing it to Basic EPS
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46. Antidilution - Example
Given:
Kohl Corporation has $1 million in 6% convertible debt (convertible to 10,000 common shares)
Net income is $210,000
100,000 common shares outstanding
Tax rate: 30%
Basic EPS = $2.10 per share
Determine whether the convertible debt is dilutive
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47. Antidilution - Example
Test for Antidilution (Option #1 – Diluted EPS)
Adjusted Net Income: Net Income $210,000 After-tax interest adjustment ($1.0m x 6%)(1-.30) ,000 Adjusted Net Income $252,000
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Adjusted Number of Shares: Shares outstanding ,000 Shares issued on conversion ,000 Adjusted Number of shares 110,000

48. Antidilution - Example
Basic EPS $2.10 Diluted EPS ($246,000  110,000) $2.24 Antidilutive, therefore not disclosed
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49. Antidilution - Example
Test for Antidilution (Option #2 – Incremental EPS)
Incremental Net Income: After-tax interest adjustment ($1.0m x 6%)(1-.30) ,000 Adjusted Net Income $ 42,000
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Incremental Number of Shares: Shares issued on conversion ,000 Adjusted Number of shares ,000

50. Antidilution - Example
Basic EPS $2.10
Incremental EPS ($42,000  10,000) $4.20
Antidilutive, therefore not disclosed
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51. Additional Disclosures
Disclosed in notes to financial statements:
Amounts used in both numerator and denominator in calculating basic and diluted EPS
Reconciliation of both the numerator and denominator values for basic and diluted earnings per share calculations for income before discontinued operations
Potentially dilutive securities that were not included in the calculation of EPS because they were antidilutive
Description of common share transactions after reporting period that could have impacted EPS numbers
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52. Earnings Per Share Overview Basic EPS Diluted EPS
Objective of EPS
Presentation and Disclosure
Basic EPS
Capital structure
Income available to common/ordinary shareholders
Weighted average common/ordinary shares
Comprehensive illustration
Diluted EPS
Complex capital structure
Convertible securities
Options and warrants
Contingently issuable shares
Antidilution revisited
Additional disclosures
Comprehensive earnings per share exercise
IFRS and Private Enterprise GAAP Comparison
Analysis
Comparison of IFRS and private enterprise GAAP
Looking ahead

53. Analysis
EPS is one of the most highly visible standards of measurement for assessing:
Management stewardship and
Predicting a company's future value
IFRS is therefore very specific regarding its calculation
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54. Comparison of IFRS and ASPE
ASPE does not include standards for calculating EPS
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55. Looking Ahead
EPS standards continue to be revisited as accounting rules for underlying financial instruments evolve
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56. COPYRIGHT
Copyright © 2013 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.