Basic Earnings Per Share
On April 1, 20,000 shares of treasury stock were sold, and on July 1, a 2-for-1 stock split was issued. Net income was $410,000 in 2006 and $350,000 in 2005. What amounts should Strauch report as earnings per share in its 2006 and 2005 comparative income statements? 2006 2005 $1.78 $3.50 $1.78 $1.75 $2.34 $1.75 $2.34 $3.50
$1.78 $1.75 For EPS purposes, stock dividends and splits are retroactively applied to all periods presented, and to all share changes within the year of the split or dividend. This procedure ensures comparability. The 2-for-1 split in 2006 does not substantively change the value of any shares outstanding. Without retroactive application, EPS would be cut roughly in half in 2006 compared to 2005. Yet there was little substantive change in the performance of the firm. For reporting in 2006: Weighted average shares, 2005 = 100,000(2) = 200,000. EPS, 2005 = $350,000/200,000 = $1.75. Weighted average shares, 2006 = [100,000 + 20,000(9/12)]2 = 230,000 EPS, 2006 = $410,000/230,000 = $1.78. Had the 2005 shares not been adjusted for the split, 2005 EPS would be $3.50 = $350,000/100,000, or roughly double the EPS of 2006. Without retroactive application, it would appear that the firm had a drastic reduction in EPS in 2006. The retroactive application of the split ensures that the base on which EPS is computed uses the same measuring unit.
A company had the following outstanding shares as of January 1, year 2: Preferred stock, $60 par, 4%, cumulative 10,000 shares Common stock, $3 par 50,000 shares On April 1, year 2, the company sold 8,000 shares of previously unissued common stock. No dividends were in arrears on January 1, year 2, and no dividends were declared or paid during year 2. Net income for year 2 totaled $236,000. What amount is basic earnings per share for the year ended December 31, year 2? A. $3.66 B. $3.79 C. $4.07 D. $4.21
B. $3.79 Basic EPS = Net Income - Preferred Dividends / Weighted shares outstanding. The numerator is $236,000 - preferred dividends [($60 x 10,000) x .04 = 24,000] = $212,000. The denominator is 50,000 (12/12) + 8,000 (9/12) = 56,000 shares. $212,000 / 56,000 = $3.786 or $3.79.
Balm Co. had 100,000 shares of common stock outstanding as of January 1. The following events occurred during the year: 4/1 Issued 30,000 shares of common stock. 6/1 Issued 36,000 shares of common stock. 7/1 Declared a 5% stock dividend. 9/1 Purchased as treasury stock 35,000 shares of its common stock. Balm used the cost method to account for the treasury stock. What is Balm's weighted average of common stock outstanding at December 31? A. 131,000 B. 139,008 C. 150,675 D. 162,342
B. 139,008 More than one approach is available to compute WA (each yields the same answer) but perhaps the easiest is to weight each item separately going forward to the end of the year. This approach yields 139,008 = [100,000(12/12) + 30,000(9/12) + 36,000(7/12)](1.05) - 35,000(4/12). The beginning shares are outstanding the entire year (12/12). The next two items are weighted for the fraction of the year they are outstanding. Stock dividends and splits are retroactively applied to all items before their issuance - hence the multiplication by 1.05. The treasury shares are removed from the average for 4/12 of the year - these shares already reflect the stock dividend.
The following information pertains to Jet Corp. outstanding stock for 2004: Common stock, $5 par value Shares outstanding, 1/1/04 20,000 2-for-1 stock split, 4/1/04 20,000 Shares issued, 7/1/04 10,000 Preferred stock, $10 par value, 5% cumulative Shares outstanding, 1/1/04 4,000 What are the number of shares Jet should use to calculate 2004 earnings per share? A. 40,000 B. 45,000 C. 50,000 D. 54,000
B. 45,000 The effect of the stock split is applied retroactively to all changes in the number of shares of common stock outstanding before the split. The weighted average shares outstanding for this firm for 2004 is: 45,000 = [20,000(2) + 10,000(1/2)]. The split affects only the shares issued before date of the split. The July 1 issuance is weighted only by 1/2 a year because the shares were outstanding only 1/2 a year. EPS is computed only on common stock outstanding. The preferred shares have no effect on the computation.
Chape Co. had the following information related to common and preferred shares during the year: Common shares outstanding, 1/1 700,000 Common shares repurchased, 3/31 20,000 Conversion of preferred shares, 6/30 40,000 Common shares repurchased, 12/1 36,000 Chape reported net income of $2,000,000 at December 31. What amount of shares should Chape use as the denominator in the computation of basic earnings per share? A. 684,000 B. 700,000 C. 702,000 D. 740,000
C. 702,000 Weighted average shares outstanding are weighted by the number of months the shares were outstanding during the year. The easiest way to do this is to take each change in common stock and multiply by the number of months remaining - add the shares that increased shares outstanding and subtract shares that reduced shares outstanding. Shares Months Wtd avg 700,000 12/12 700,000 - 20,000 9/12 - 15,000 +40,000 6/12 +20,000 -36,000 1/12 - 3,000 702,000
On January 31, 2004, Pack, Inc. split its common stock 2 for 1, and Young, Inc. issued a 5% stock dividend. Both companies issued their December 31, 2003, financial statements on March 1, 2004. Should Pack's 2003 earnings per share (EPS) take into consideration the stock split, and should Young's 2003 EPS take into consideration the stock dividend? Pack's 2003 EPS Young's 2003 EPS Yes No No No Yes Yes No Yes
Yes Yes EPS is used primarily as an input to predictions of future earnings. The stock split and dividend cause the number of shares outstanding to increase, and thus affect the future earnings prospects on a per share basis. These events should be included in the computation of EPS even though they did not occur as of the balance sheet date. Financial statement users view the information as if it were current as of the date of publication.
