1. 18-1 Intermediate Accounting,17E Stice | Stice | Skousen © 2010 Cengage Learning PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University Earnings Per Share

2. 18-2 Dividend Payout Ratio Investors are interested in dividends and can use EPS data to compute a dividend payout ratio. Compute by dividing dividends per share by earnings per share. Earnings per share data receive wide recognition in the annual reports issued by companies, in the press, and in financial reporting publications.

3. 18-3 Simple and Complex Capital Structures Dilutive securities are securities whose assumed exercise or conversion results in a reduction in earnings per share. Antidilutive securities are securities whose assumed conversion or exercise results in an increase in earnings per share. (continues)

4. 18-4 Simple and Complex Capital Structures In February 1997 the FASB, working with the IASC, issued Statement No. 128, “Earnings per Share.” The new standard eliminated most of the arbitrary and complex EPS computations that had evolved and replaced them with a historical- based basic EPS. (continues)

5. 18-5 Considers only common shares issued and outstanding. Basic Simple and Complex Capital Structures Reflects the maximum potential dilution from all possible stock conversions that would have decreased EPS. Diluted (continues)

6. 18-6 has only common stock has only common and nonconvertible preferred stock outstanding has no convertible securities, stock options, warrants, or other rights outstanding Simple and Complex Capital Structures A simple capital structure is one where a corporation― (continues)

7. 18-7 The Basic Equation for EPS: Net Income – Preferred Dividends Weighted-Average Common Shares Outstanding Simple and Complex Capital Structures (continues)

8. 18-8 Simple and Complex Capital Structures If the corporation has one or more instruments outstanding that could result in issuance of additional common shares, thus causing a dilution of earnings per share, it has a complex capital structure.

9. 18-9 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. 31 13,000 × 2/12 = 2,167 Weighted-average number of shares13,000

10. 18-10 Stock Dividends and Stock Splits  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 11,200  Shares repurchased on November 1400  Shares issued for 3-for-1 stock split on December 18,200 A company had 2,600 shares of common stock outstanding on January 1. The following activities affecting common stock took place during the year. (continues)

11. 18-11 Stock Dividends and Stock Splits (continues)

12. 18-12 Stock Dividends and Stock Splits All stock splits and stock dividends must be incorporated into the computation of weighted average shares outstanding. This must be 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 stock dividends.

13. 18-13 Preferred Stock Included in Capital Structure Basic EPS reflects only income available to common stockholders; it does not include 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. (continues)

14. 18-14 Preferred Stock Included in Capital Structure 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. (continues)

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

16. 18-16 2010 1/1 to 6/30200,000× 6/12100,000 No. of Stock Portion of Weighted Date Shares Dividend Year Average (continues) Preferred Stock Included in Capital Structure

17. 18-17 On June 30, 2011 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. (continues) Preferred Stock Included in Capital Structure

18. 18-18 (continues) Preferred Stock Included in Capital Structure On June 30, 2010, 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.

19. 18-19 There are 250,000 weighted-average shares outstanding at the end of 2010. On May 1, 2011, the firm issued a 50% stock dividend on common stock. 2010 1/1 to 6/30200,000× 6/12100,000 7/1 to 12/31300,000× 6/12150,000 250,000 No. of Stock Portion of Weighted Date Shares Dividend Year Average (continues) Preferred Stock Included in Capital Structure

20. 18-20 2010 1/1 to 6/30200,000× 6/12100,000 7/1 to 12/31300,000× 6/12150,000 250,000 2011 1/1 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. (continues) Preferred Stock Included in Capital Structure

21. 18-21 2010 1/1 to 6/30200,0001.5× 6/12150,000 7/1 to 12/31300,0001.5× 6/12225,000 375,000 2011 1/1 to 5/1300,0001.5× 4/12150,000 No. of Stock Portion of Weighted Date Shares Dividend Year Average (continues) Preferred Stock Included in Capital Structure Now let’s “roll back” the stock dividend for all the years displayed.

22. 18-22 2010 1/1 to 6/30200,0001.5× 6/12150,000 7/1 to 12/31300,0001.5× 6/12225,000 375,000 2011 1/1 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. (continues) Preferred Stock Included in Capital Structure

23. 18-23 2010 1/1 to 6/30200,0001.5× 6/12150,000 7/1 to 12/31300,0001.5× 6/12225,000 375,000 2011 1/1 to 5/1300,0001.5× 4/12150,000 5/1 to 12/31450,000× 8/12300,000 450,000 No. of Stock Portion of Weighted Date Shares Dividend Year Average (continues) Preferred Stock Included in Capital Structure

24. 18-24 In 2010, 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 $80,000 375,000 shares of Earnings per share from continuing operations = $0.60 Net income after EI – $305,000 (continues) Preferred Stock Included in Capital Structure

25. 18-25 Basic earnings per common share, extraordinary gain for 2010 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 (continues) Preferred Stock Included in Capital Structure

26. 18-26 Basic earnings per common share, net income per share (2010): 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 (continues) Preferred Stock Included in Capital Structure

27. 18-27 Weighted-average shares of common stock outstanding In 2011, 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

28. 18-28 Participating Securities and the Two-Class Method Sometimes a company issues more than one class of stock with ownership privileges. The two 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. (continues)

29. 18-29 Participating Securities and the Two-Class Method Consider the following data for Kay Company. Common shares outstanding: 100,000 for the entire year Participating preferred shares outstanding: 50,000 shares for the entire year Net income: $500,000 Dividends on participating preferred shares: $2.00 per share plus a per-share increase 50% as large as the per-share increase of common dividends above $1.00 per share. (continues)

30. 18-30 (continues) Participating Securities and the Two-Class Method Common dividends paid for the year: $1.80 per share making a total of $180,000 ($1.80 per share × 100,000 shares) Participating preferred dividends paid for the year: $2.40 per share making a total of $120,000 ($2.40 per share × 50,000 shares)

31. 18-31 Participating Securities and the Two-Class Method The undistributed earnings of $200,000 are allocated as follows: (continues)

32. 18-32 Participating Securities and the Two-Class Method The basic earnings per share amounts are computed and reported as follows:

33. 18-33 Diluted Earnings per Share — Options, Warrants, and Rights Dilution occurs if inclusion of a potentially dilutive security reduces the basic EPS or increases the basic loss per share. In general, securities classified as antidilutive are not included in computing diluted EPS. (continues)

34. 18-34 The two major types of potentially dilutive securities are: 1.common stock options, warrants, and rights, and 2.convertible bonds and convertible preferred stock. Diluted Earnings per Share— Options, Warrants, and Rights

35. 18-35 Stock Options, Warrants, and Rights Stock options, warrants, and rights provide no cash yield to investors. 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 for computing EPS when options, warrants, or rights are involved.

36. 18-36 Number of shares of common stock made available to employees 5,000 Average market price of stock per share during the year$50 Exercise price per share on options$40 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 Treasury Stock Method

37. 18-37 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. (continues)

38. 18-38 Illustration of Diluted EPS with Stock Option $92,800 100,000 Basic EPS == $0.93 Basic Earnings per Share (continues)

39. 18-39 Illustration of Diluted EPS with Stock Option 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 (continues)

40. 18-40 Diluted Earnings per Share: $92,800 108,000 = $0.86 COMPARED TO— Basic Earnings per Share: $92,800 100,000 = $0.93 The diluted EPS is less than the basic EPS, so it is acceptable. Illustration of Diluted EPS with Stock Option

41. 18-41 Diluted Earnings per Share― Convertible Securities The method of including convertible securities in the EPS computation is referred to as the if- converted method. To test for dilution, each potentially dilutive convertible must be evaluated individually.

42. 18-42 The following example for Reid Corporation illustrates the computation of diluted EPS when convertible securities exist. (continues) Illustration of Diluted Earnings per Share with Convertible Securities

43. 18-43 Net income + Interest after tax savings Total shares assumed issued Diluted EPS = $83,000 + $28,000 100,000 + 40,000 Diluted EPS = = $0.79 Note Illustration of Diluted Earnings per Share with Convertible Securities

44. 18-44 Computation of Diluted Earnings per Share for Securities issued during the Year If the securities had been issued by Reid Corporation on June 30 of the current year, an adjustment in the calculation would be needed to reflect the issuance date, or one-half of a year. (continues)

45. 18-45 Computation of Diluted Earnings per Share for Securities Issued during the Year In the previous illustration, instead of 8% convertible bonds, assume the company has 8% preferred stock outstanding, par value $500,000, convertible into 40,000 shares of common stock. The preferred stock was outstanding for the entire year. (continues)

46. 18-46 Computation of Diluted Earnings per Share for Securities Issued during the Year Basic earnings per share: Net income, without the deduction for interest on bonds$111,000 Less: Preferred dividends 40,000 Net income identified with common stock$ 71,000 Actual number of shares outstanding÷100,000 Basic EPS ($71,000/100,000)$0.71

47. 18-47 Computation of Diluted Earnings per Share for Securities Issued during the Year Diluted earnings per share: Net income assuming no payment of preferred dividends due to conversion$111,000 Actual number of shares outstanding100,000 Additional shares issued on assumed conversion of preferred stock 40,000 Adjusted number of shares140,000 Diluted EPS ($111,000/140,000)$0.79

48. 18-48 Effect of Actual Exercise or Conversion 400,000 × 9/12 of year300,000 500,000 × 3/12 of year125,000 Weighted-average number of shares for basic EPS425,000 OR (continues)

49. 18-49 Effect of Actual Exercise or Conversion

50. 18-50 Effect of a Loss from Continuing Operations on EPS Assume the following data for Boggs Co. Computation of basic and diluted EPS is shown on Slide 18-51. (continues)

51. 18-51 Effect of a Loss from Continuing Operations on EPS Adjusted number of shares 120,000 Diluted loss per share ($50,000/120,000)$ (0.42) ……………………………………………………. ………………………………………….

52. 18-52 Multiple Potentially Dilutive Securities The FASB requires selection of the combination of securities producing the lowest possible EPS figure. Any dilutive stock options and warrants are considered first before introducing convertible securities into the computations. (continues)

53. 18-53 Multiple Potentially Dilutive Securities A company had no stock options but did have four convertible securities that would have the following effects on diluted EPS if each were considered separately. (continues)

54. 18-54 Multiple Potentially Dilutive Securities Basic EPS was $6.50 ($2,275,000/350,000 outstanding shares). Dilution is determined by adding one security at a time to the basic EPS figure as follows:

55. 18-55 Multiple Potentially Dilutive Securities It would not be necessary to continue the computation beyond Security B because the EPS at that point is lower than the incremental EPS impact of Security C.

56. 18-56 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 : (continues)

57. 18-57 Financial Statement Presentation 3.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.Disclosures 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.