Intermediate accounting 19th by stice stice chapter 18

• 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 outsta

Intermediate

Accounting

James D Stice Earl K Stice

PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine

Earnings Per Share

Chapter 18

19 th

Edition

Simple and Complex Capital Structures

assumed exercise or conversion results in a

reduction in earnings per share, or lead to a

dilution in earnings per share

assumed conversion or exercise results in an increase in earnings per share, or lead to

antidilution in earnings per share

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)

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

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

Net Income – Preferred Dividends

Weighted-Average Common Shares Outstanding

The weighted-average number of

shares can be computed by

Issuance or Reacquisition of

Common Stock

Issuance or Reacquisition of

Common Stock

Jan 1 to May 1 10,000 × 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 shares 13,000

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

Dates Economic Event Changes in Shares Outstanding

Feb 1 Exercise of stock option + 400

May 1 10% stock dividend

Nov 1 Purchase of treasury stock – 400

• 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

• 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.

Stock Dividends and

Stock Splits

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)

• 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

Preferred Stock Included in

Capital Structure

• 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.

Preferred Stock Included in

Capital Structure

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

There are 250,000 weighted-average shares outstanding at the end of 2010.

There are 250,000 weighted-average shares outstanding at the end of 2010

2012

1/1 to 6/30 200,000 × 6/12 100,000 7/1 to 12/31 300,000 × 6/12 150,000

1/1 to 6/30 200,000 × 6/12 100,000 7/1 to 12/31 300,000 × 6/12 150,000

1/1 to 6/30 200,000 1.5 × 6/12 150,000 7/1 to 12/31 300,000 1.5 × 6/12 225,000

1/1 to 6/30 200,000 1.5 × 6/12 150,000 7/1 to 12/31 300,000 1.5 × 6/12 225,000

375,000

2013

1/1 to 5/1 300,000 1.5 × 4/12 150,000 5/1 to 12/31 450,000 × 8/12 300,000

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.

Preferred Stock Included in

Capital Structure

1/1 to 6/30 200,000 1.5 × 6/12 150,000 7/1 to 12/31 300,000 1.5 × 6/12 225,000

375,000

2013

1/1 to 5/1 300,000 1.5 × 4/12 150,000 5/1 to 12/31 450,000 × 8/12 300,000

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

$80,000 375,000 shares of

Earnings per share from continuing operations = $0.60

Net income after EI – $305,000

(continued)

Preferred Stock Included in

Capital Structure

Basic earnings per common share,

extraordinary gain for 2012 is as follows:

Weighted-average shares of common stock outstanding

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

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 average common outstanding Basic loss per share = $(0.30)Preferred dividends

weighted-are included even

Preferred dividends are included even

Preferred Stock Included in

Capital Structure

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

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

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)

• 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

the cash proceeds from the exercise of

options, warrants, or rights to purchase

common stock on the market (treasury stock)

Stock Options, Warrants, and Rights

Stock Options, Warrants, and Rights

Treasury Stock Method Demonstrated

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)

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 EPS 1,000

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:

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)

$92,800 100,000

Basic Earnings per Share

Illustration of Diluted EPS

with Stock Options

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 outstanding 100,000 Issued on assumed exercise of

Less assumed options repurchased 12,000 8,000

(continued)

Illustration of Diluted EPS

with Stock Options

Diluted Earnings per Share:

$92,800 108,000 = $0.86

COMPARED TO:

Basic Earnings per Share:

$92,800

The diluted EPS is less than the basic EPS, so it is acceptable.

The diluted EPS is less than the basic EPS, so it is acceptable.

Illustration of Diluted EPS

with Stock Options

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.

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

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)

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. Disclosure of transactions that occurred after

the period ended but prior to the issuance of financial statements that would have

Financial Statement Presentation