Earnings Per Share

Can you solve this? West Co. had earnings per share of $15.00 for Year 3 before considering the effects of any convertible securities. No conversion or exercise of convertible securities occurred during Year 3. However, possible conversion of convertible bonds would have reduced earnings per share by $0.75. The effect of possible exercise of common stock options would have increased earnings per share by $0.10. What amount should West report as diluted earnings per share for Year 3?

$14.25 Securities with a dilutive effect (decrease EPS) are included in the calculation; those with an antidilutive effect (increase EPS) are excluded. This treatment adheres to the conservatism principle (ie, considering the inherent risk on EPS of the potential conversion). West's dilutive convertible bonds are included while the antidilutive stock options are excluded from the calculation. Therefore, diluted EPS would be $14.25 ($15.00 − $.75). Things to remember: Diluted earnings per share (EPS) take into account the effects of all potentially dilutive financial securities that are convertible into common stock. Securities that are dilutive (decrease EPS) are included in the calculation. Antidilutive securities (increase EPS) are excluded

Practice diluted EPS: On June 30, Year 8, Lomond, Inc. issued twenty $10,000, 7% bonds at par. Each bond was convertible into 200 shares of common stock. On January 1, Year 9, 10,000 shares of common stock were outstanding. The bondholders converted all the bonds on July 1, Year 9. The following amounts were reported in Lomond's income statement for the year ended December 31, Year 9: Revenues $977,000 Operating expenses 920,000 Interest on bonds 7,000 Income before income tax 50,000 Income tax at 30% 15,000 Net income$35,000 What is Lomond's Year 9 diluted earnings per share?

Answer $2.85

Practice Wtd Average and treasury stock Coffee Co. had the following information related to common and preferred shares during the year: Common shares outstanding 1/1 700,000 Common shares repurchased 3/3 120,000 Conversion of preferred shares6/30 40,000 Common shares repurchased 12/13 6,000 Coffee reported net income of $2,000,000 at December 31. What amount of shares should Coffee use as the denominator in the computation of basic earnings per share?

Answer: $702,000

Practice basic EPS: Jen Co. had 200,000 shares of common stock and 20,000 shares of 10%, $100 par value cumulative preferred stock. No dividends on common stock were declared during the year. Net income was $2,000,000. What was Jen's basic earnings per share?

Answer: $9 The calculation for basic earnings per share is (Net Income - Preferred Stock Dividends) / Weighted Average Common Stock Outstanding. In this case, net income of $2,000,000 is provided. The preferred stock is cumulative so the dividend is included in the calculation even if it isn't declared or paid during the year. The dividend on the preferred stock is $200,000 ((20,000 shares x $100 par) x 10%). The weighted average common stock outstanding is 200,000, as all shares of common stock were outstanding for all 12 months of the year (200,000 x (12/12)). The calculation appears as follows: ($2,000,000 - $200,000) / 200,000 = $9.00

Good diluted EPS question: The following information is relevant to the computation of Chan Co.'s earnings per share to be disclosed on Chan's income statement for the year ending December 31, Year 2: Net income for Year 2 is $600,000.$5,000,000 face value 10-year convertible bonds outstanding on January 1. The bonds were issued four years ago at a discount, which is being amortized in the amount of $20,000 per year. The stated rate of interest on the bonds is 9%, and the bonds were issued to yield 10%. Each $1,000 bond is convertible into 20 shares of Chan's common stock.Chan's corporate income tax rate is 25%. Chan has no preferred stock outstanding, and no other convertible securities. What amount should be used as the numerator in the fraction used to compute Chan's diluted earnings per share assuming that the bonds are dilutive securities?

Answer: $952,500 CP Notes- You use the stated rate, not the effective rate

The following information pertains to Ceil Co., a company whose common stock trades in a public market: Shares outstanding at 1/1 100,000 Stock dividend at 3/31 24,000 Stock issuance at 6/30 5,000 What is the weighted - average number of shares Ceil should use to calculate its basic earnings per share for the year ended December 31?

Answer: 126,500

Do you understand stock dividends? Based on the stock transactions below, what is the weighted average number of shares outstanding as of December 31, Year 1, that should be used in the calculation of basic earnings per share in financial statements issued on March 1, Year 2? DateTransactions January 1, Year 1 Beginning balance 100,000 April 1, Year 1 Issued 30,000 shares for cash June 1, Year 1 50% stock dividend February 15, Year 22-for-1 stock split March 15, Year 2Issued 40,000 shares for cash

Answer: 367,500 When calculating earnings per share the weighted average number of shares outstanding must reflect stock changes during the reporting period. Additional shares issued must be weighted (prorated) for the portion of the year they are outstanding. Shares issued due to stock splits and stock dividends are treated retroactively (as of the beginning of the earliest period presented). The June stock dividend is treated as if it occurred at the beginning of Year 1 and retroactively increases the shares as of January 1 and April 1 by 50%. Since the financial statements are being issued on March 1, Year 2, the February 15 stock split will be treated as if it had occurred at the beginning of the earliest period presented. The weighted average shares at December 31, Year 1 is 183,750 (Choice B) and 367,500 on March 1, Year 2.

Why does "Shares Outstanding" increase in a complex capital structure as it relates to bond holders?

Because bond holders are converting their debt into equity which has common shares.

Why do we subtract out preferred dividends from net income?

Because we want to know the amount of net income available to common shareholders.

The "if-conversion method" assumes what date for the conversion?

Beginning of the earliest period reported (or at time of issuance, if later) Using the correct conversion date is important since it impacts the EPS formula. For example, the after-tax interest expense not paid on convertible bonds will be for a full year if the bond conversion is treated as from the beginning of the year. If the bonds were issued on July 1, then only half the after-tax expense is avoided and added back to net income Things to remember:Diluted earnings per share uses the if-converted method, which assumes any convertible security (eg, convertible bonds, stock options) that could convert to common stock will convert. The conversion to stock is considered having occurred at the beginning of the earliest period reported. If the convertible securities are issued during the year, the date of issuance is used as the conversion date

How does EPS differ between IFRS and GAAP?

EPS under IFRS is very similar to GAAP as you still report basic and diluted EPS on continuing operations and net income.

What are the 3 EPS requirements for public companies?

Earnings per share (EPS) is the amount of a company's net income that is theoretically earned by each share of outstanding common stock (ie, net income available to common shareholders). Generally, it is considered a good indicator of a company's performance and profitability. All publicly held companies are required to report EPS for the following three income statement items: 1) Income from continuing operations (in the income statement) 2) Income from discontinued operations (in either the income statement or the notes to the financial statements) 3) Net income (in the income statement) Things to remember:Publicly held companies are required to report earnings per share (EPS) for three income statement items: income from continuing operations, income from discontinued operations, and net income. Treasury stock and preferred stock dividends are not reported in the income statement.

How does a stock split effect weighted number of shares?

It is also treated retroactively.

As it relates to diluted EPS, what is the stock options "treasury stock method"?

Say someone has 5,000 options to purchase your company at $12/per share. Mkt price is $15/share for your stock. Well, when they excercise the option at $12/share, you have just bought $60,000 worth of shares for a total amount of 4,000. But we are 1,000 shares short. Add the 1,000 to the denominator. (Mkt price-Option Price)/Mkt price * # of options oustanding. Or see different example in the image.

How are stock dividends treated? What if a stock dividend is issued in February of the year? What is their impact on C/S oustanding?

Stock dividends treated retroactively (as of the beginning of the earliest period presented) since they are issued to existing shareholders. A February stock dividend is treated as if it occurred at the beginning of Year, which retroactively increases the shares as of January 1 by 10%. They are added to the denominator: C/S outstanding. Things to remember:Weighted average shares must be adjusted for stock changes during the year. Shares issued are weighted for the portion of the year outstanding. Stock dividends are treated retroactively, as if occurring at the beginning of the earliest period presented.

Can you solve this? The following information is relevant to the computation of Pharm Co.'s earnings per share to be disclosed on Pharm's income statement for the year ending December 31: Net income for Year 2 is $800,000. $4,000,000 face value 10-year convertible bonds outstanding on January 1. The bonds were issued four years ago at a premium that is being amortized in the amount of $28,000 per year. The stated rate of interest on the bonds is 8%, and the bonds were issued to yield 7%. Each $1,000 bond is convertible into 70 shares of Pharm's common stock. Preferred stock, $10 par, 4% cumulative, 15,000 shares issued and outstanding. No dividend is declared for Year 2. Pharm's corporate income tax rate is 20%. What amount should be used as the numerator in the fraction used to compute Pharm's diluted earnings per share assuming that the bonds are dilutive securities?

Things to remember:The numerator of the earnings per share (EPS) formula is decreased by the annual dividend of cumulative preferred stock. For diluted EPS, the numerator is increased by the after-tax interest expense not paid if the bonds had converted. The amortization of a bond's premium decreases the interest expense.

Can you solve this? Strauch Co. has one class of common stock outstanding and no other securities that are potentially convertible into common stock. During Year 2, 100,000 shares of common stock were outstanding. In Year 3, two distributions of additional common shares occurred: 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 Year 3 and $350,000 in Year 2. What amounts should Strauch report as basic earnings per share in its Year 3 and Year 2 comparative income statements?

Things to remember:Weighted average shares must be adjusted for stock changes during the reporting period. Additional shares issued/reissued must be weighted for the portion of the year they are outstanding. Stock splits are treated retroactively, as if occurred at the beginning of the earliest period presented.

Understanding stock dividends on wtd average: 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?

Things to remember:Weighted-average shares must be adjusted for stock changes during the year. Shares issued and repurchased treasury stock are weighted for the portion of the year outstanding. Stock dividends are treated retroactively, as if occurring at the beginning of the earliest period presented.

As it relates to diluted EPS, what is the "if converted"? Hint: relates to convertible debt and stock

We assume the bonds are converted into equity, why?... because often times it is at the bond holder's discretion. So we would need to disclose this on the financials.

What is the calculation for complex (diluted) capital structure?

We assume the bonds are converted into equity, why?... because often times it is at the bond holder's discretion. So we would need to disclose this on the financials. Why do we add back interest expense? B/c it was taken out of net income, so we have to add it back.