1. Earnings Per Share and Retained Earnings C hapter 17 An electronic presentation by Norman Sunderman Angelo State University 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. Intermediate Accounting 10th edition Nikolai Bazley Jones

2. 2 1. Compute basic earnings per share (EPS). 2. Understand how to compute the weighted average common shares for EPS. 3. Identify the potential common shares included in diluted EPS. 4. Apply the treasury stock method for including stock options and warrants in diluted EPS. Objectives

3. 3 5. Calculate the impact of a convertible security on EPS. 6. Compute diluted EPS. 7. Record the declaration and payment of cash dividends. 8. Account for a property dividend. 9. Explain the difference in accounting for small and large dividends. Objectives

4. 4 10. Understand how to report accumulated other comprehensive income. 11. Prepare a statement of changes in stockholders’ equity. Objectives

5. 5 Net Income - Preferred Dividends Weighted Average Number of Common Shares Outstanding Basic Earnings Per Share

6. 6 Since a corporation earns its net income over the entire year, the earnings are related to the common shares outstanding during the year. Weighted Average Shares

7. 7 Months Shares Shares Fraction of Year Equivalent Are Outstanding Outstanding Outstanding Whole Units January-February12,000x2/12=2,000 March-June14,700x4/12=4,900 July-November18,000x5/12=7,500 December17,520x1/12= 1,460 15,860 Total weighted average common 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 The nearest whole month is used Weighted Average Shares

8. 8 Wallers corporation begins operations in January 2007, and issues 5,000 shares of common stock that are outstanding all during 2007. 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-December5,000x12/12=5,000 Total weighted average common shares 10,000 The two-for-one split is retroactive to January 1 + 5,000 ContinuedContinued Weighted Average Shares

9. 9 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. Months Shares Shares Fraction of Year Equivalent Are Outstanding Outstanding Outstanding Whole Units January-December5,000x12/12=5,000 2007 Data on 2008 Statement 5,000 x 200% x 120% = 12,000 equivalent whole units ContinuedContinued Weighted Average Shares

10. 10 2008 Data on 2008 Statement Months Shares Shares Fraction of Year Equivalent Are Outstanding Outstanding Outstanding Whole Units January-May10,000 June-July15,000 August-September18,000 Issued 5,000 shares Issued 20% stock dividend Weighted Average Shares

11. 11 2008 Data on 2008 Statement Months Shares Shares Fraction of Year Equivalent Are Outstanding Outstanding Outstanding Whole Units January-May10,000 June-July15,000 August-September18,000 Increases 20% 12,000 Increases 20% 18,000 October-December20,000 Weighted Average Shares

12. 12 2008 Data on 2008 Statement Months Shares Shares Fraction of Year Equivalent Are Outstanding Outstanding Outstanding Whole Units January-May12,000x5/12=5,000 June-July18,000x2/12=3,000 August-September18,000x2/12=3,000 October-December20,000x3/12= 5,000 16,000 Weighted Average Shares

13. 13 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 1.Only common stock, or 2.Common stock and nonconvertible preferred stock. 3.Requires only Basic Earnings Per Share Simple Capital Structure

14. 14 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.

15. 15 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. Diluted Earnings Per Share

16. 16 The amount for diluted earnings per share shows the earnings per share after including all potential common shares that would reduce earnings per share. Diluted Earnings Per Share

17. 17 To be included in the diluted earnings per share calculation, any potential common share must have a dilutive effect on earnings per share. Diluted Earnings Per Share

18. 18 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. Diluted Earnings Per Share

19. 19

20. 20 Proceeds ($) Assumed Shares Reacquired (at average market price) Change (Incremental) in Shares + - Stock Options and Warrants Assumed Shares Issued

21. 21 1.Determine the average market price of common shares during the period. 2.Compute the shares assumed issued from the assumed exercise of all options and warrants. 3.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]. 4.Compute the assumed shares reacquired by dividing the proceeds by the average market price. 5.Compute the incremental common shares. Treasury Stock Method

22. 22 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 Proceeds Average Market Price Per Share 1,000 x ($18 + $2) $25 = (800) $20,000 $25 = Assumed increment in common shares for computing diluted earnings per share200 Treasury Stock Method

23. 23 Convertible bonds and convertible preferred stock are considered in DEPS after stock options and warrants. Page 834. Convertible Securities

24. 24 If convertible bonds were assumed converted, the numerator increases net-of-tax because interest expense would not exist, but income taxes would increase. Convertible Securities

25. 25 Numerical Value Impact on Diluted Earnings Per Share Increase in Earnings Per Share Numerator Increase in Earnings Per Share Denominator 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. ContinuedContinued $5,400 3,000 = $1.80 Security A Convertible Securities

26. 26 Numerical Value Impact on Diluted Earnings Per Share 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. $4,800 1,920 = $2.50 Security B ContinuedContinued Convertible Securities

27. 27 Numerical Value Impact on Diluted Earnings Per Share 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. $8,000 5,000 = $1.60 Security C ContinuedContinued Convertible securities

28. 28 Numerical Value Impact on Diluted Earnings Per Share 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. ContinuedContinued $6,300 3,150 = $2.00 Security D Convertible Securities

29. 29 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). Security Impact Order in Ranking A$1.802 B$2.504 C$1.601 D$2.003 Convertible Securities

30. 30 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.

31. 31 EarningsShares Earnings Explanation Adjustments Adjustments Per Share = Format Basic EPS$x,xxx/xxx=$xxx Basic Incremental shares (options) xx Tentative EPS 1$xxxx/xxx=$xxx Ten. Savings in interest expensexxx Incremental shares (bonds)xxx= Tentative EPS 2$x,xxx/xxx=$xxx Ten. Savings in preferred dividendsxxx Incremental shares from Pref. St. xxx=$xxx Ten. Diluted earnings & shares$x,xxx/xxx=$xxx Diluted Diluted Earnings Per Share

32. 32 Example 17-5

33. 33 Earnings Shares Earnings Explanation Adjustments (Adjustments) Per Share / = Page 838 Basic EPS$2,000/900=$2.22 Basic Incremental shares (options) 85 Tentative EPS 1$2,000/985=$2.03 Ten. Savings in interest expense 224 Incremental shares (bonds)160= Diluted earnings & shares$2,224/1,145=$1.94 Diluted Diluted Earnings Per Share

34. 34 1. Identifies the amount of preferred dividends deducted to determine the income available to common stockholders. 2. Describes the potential common shares that were not included in the diluted earnings per share computation because they were antidilutive. 3. 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. Additional Disclosures

35. 35  Cash  Property  Stock  Liquidating  Scrip  Cash  Property  Stock  Liquidating  Scrip Types of Dividends

36. 36  Declared  Not larger than unrestricted retained earnings  Not paid on treasury stock  Other restrictions  Scrip  Declared  Not larger than unrestricted retained earnings  Not paid on treasury stock  Other restrictions  Scrip Dividend Considerations

37. 37  The date of declaration  The ex-dividend date  The date of record  The date of payment There are four significant dates for a cash dividend. Cash Dividend

38. 38 Date Accounting Procedures Date of Declaration Reduce Retained Earnings Increase Liabilities Memorandum Entry Reduce Assets Reduce Liabilities Date of Record Date of Payment Cash Dividend

39. 39 Cash Dividend On November 3, 2007, the board of directors of Bay Corporation declares preferred dividends totaling $10,000 and common dividends totaling $20,000. These dividends are payable on December 15, 2007, to stockholders of record on November 24, 2007. November 3, 2007 Retained Earnings30,000 Dividends Payable: Preferred Stock10,000 Dividends Payable: Common Stock20,000

40. 40 On November 3, 2007, the board of directors of Bay Corporation declares preferred dividends totaling $10,000 and common dividends totaling $20,000. These dividends are payable on December 15, 2007, to stockholders of record on November 24, 2007. November 24, 2007 Memorandum entry: The company will pay dividends on December 15, 2007, to preferred and common stockholders of record as of today, the date of record. Cash Dividend

41. 41 On November 3, 2007, the board of directors of Bay Corporation declares preferred dividends totaling $10,000 and common dividends totaling $20,000. These dividends are payable on December 15, 2007, to stockholders of record on November 24, 2007. December 15, 2007 Dividends Payable: Preferred Stock10,000 Dividends Payable: Common Stock20,000 Cash30,000 Cash Dividend

42. 42 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. Fully Participating Dividend

43. 43 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 1,600 2,400 Dividend to each class of stock$3,600$5,400 Fully Participating Preferred Stock

44. 44 Preferred Common Current dividend (10% x $20,000)2,000 Common dividend (10% x $30,000)$3,000 2% dividend on par 400600 Remainder to common ($9,000 – $6,000) 3,000 Dividend to each class of stock$2,400$6,600 Partially Participating Preferred Stock (up to 12%) Again assume a $30,000 dividend.

45. 45 Occasionally, a corporation will declare a property dividend that is payable in assets other than cash. Property Dividend

46. 46 The corporation typically uses marketable securities of other companies that it owns for the property dividend. Property Dividend

47. 47 The corporation records a property dividend at the fair value of the asset transferred, and recognizes a gain or loss. Property Dividend

48. 48 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. ContinuedContinued Property Dividend

49. 49 Date of Declaration Investment in Bard Co. Bonds8,000 Gain on Disposal of Investments8,000 Retained Earnings48,000 Property Dividends Payable48,000 Property Dividend ContinuedContinued Date of Payment Property Dividends Payable48,000 Investment in Bard Co. Bonds48,000

50. 50  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- Stock Dividends

51. 51 What factors might enhance the perceived attractiveness of stock dividends? Stock Dividends Stock Dividend

52. 52  The stockholders may see the stock dividend as evidence of corporate growth.  The stockholders may see the stock dividend as evidence of sound financial policy.  Other investors may see the stock dividend in a similar light, and increased trading in the stock may cause the market price not to decrease proportionally. Stock Dividends

53. 53  The corporation may state that it will pay the same fixed cash dividend per share.  The stockholders may see the market price decreasing to a lower trading range, making the stock more attractive to additional investors so that the market price may eventually rise. Stock Dividends

54. 54 Retained Earnings Capital Stock Additional Paid-In Capital Small <25% Large 25% or more Par ValueFair Value Retained Earnings Capital Stock Stock Dividends

55. 55 Common stock, $10 par (20,000 shares issued and outstanding)$200,000 Additional paid-in capital180,000 Retained earnings320,000 Total stockholders’ equity$700,000 Stockholders’ Equity Prior to Stock Dividend Stock Dividends

56. 56 Ringdahl Corporation declares and issues a 10% stock dividend. On the date of declaration, the stock sells for $23 per share. Date of Declaration Retained Earnings46,000 Common Stock To Be Distributed20,000 Additional Paid-in Capital From Stock Dividend26,000 20,000 shares x 0.10 x $23 ParPar ContinuedContinued Small Stock Dividend

57. 57 Date of Issuance Common Stock To Be Distributed20,000 Common Stock, $10 par 20,000 ParPar Ringdahl Corporation declares and issues a 10% stock dividend. On the date of declaration, the stock sells for $23 per share. Small Stock Dividend

58. 58 Common stock, $10 par (22,000 shares issued and outstanding) $220,000 Additional paid-in capital206,000 Retained earnings274,000 Total stockholders’ equity$700,000 Stockholders’ Equity After Stock Dividend Note: Total remained the same Small Stock Dividend

59. 59 Ringdahl Corporation declares and issues a 40% stock dividend. On the date of declaration, the stock sells for $23 per share. Date of Declaration Retained Earnings80,000 Common Stock To Be Distributed80,000 20,000 shares x 0.40 x $10 Date of Issuance Common Stock To Be Distributed80,000 Common Stock, $10 par80,000 ContinuedContinued Large Stock Dividend

60. 60 Common stock, $10 par (28,000 shares issued and outstanding) $280,000 Additional paid-in capital180,000 Retained earnings240,000 Total stockholders’ equity$700,000 Stockholders’ Equity After Stock Dividend Note: Same total as small stock dividend Large Stock Dividend

61. 61 Although not a required separate financial statement, some corporations include a statement of retained earnings in their financial statements. Statement of Retained Earnings

62. 62 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 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 Statement of Retained Earnings

63. 63  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. Other comprehensive income might include-- Accumulated Other Comprehensive Income

64. 64  On the face of its income statement.  In a separate statement of comprehensive income.  In its statement of changes in stockholders’ equity. A corporation may report its comprehensive income (net of income taxes)-- Accumulated Other Comprehensive Income

65. 65 APB Opinion No. 12 states: “…disclosures of changes in the separate accounts comprising stockholders’ equity (in addition to retained earnings) and of the changes in the number of shares of equity securities during at least the most recent annual fiscal period…is required to make the financial statements sufficiently informative.” Statement of Changes in Stockholders’ Equity

66. 66 Statement of Changes in Stockholders’ Equity

67. 67 C hapter 17 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.