Errors in Reporting Earnings per Share
By: Andrew Fernandez
Mentor: Dr. Sundaresh Ramnath
Background:
Background (Cont.):
• Statement of Financial Accounting Standard No. 128 (Earnings Per
Share) Issued in February 1997 – provides the guidance as to the
required calculation and presentation of earnings per share. This
Statement simplifies the standards for computing earnings per share in
APB Opinion No. 15 (issued in 1969).
• For the latest period for which an income statement is presented, an
entity shall provide a description of any transaction that occurs after the
end of the most recent period but before issuance of the financial
statements that would have changed materially the number of common
shares or potential common shares outstanding at the end of the period
if the transaction had occurred before the end of the period. (1)
• For each period for which an income statement is presented, an entity
should disclose a reconciliation of the numerators and denominators of
the basic and diluted per share computations. (1)
• The Board decided that this Statement should be effective for financial
statements issued for periods ending after December 15, 1997,
including interim periods. (1)
• Diluted earnings per share is a performance metric utilized to gauge a
company’s earnings per share if all convertible securities were
exercised . Therefore, if a company made a profit, the diluted earnings
per share will always be lower than the basic earnings per share.
• The statement requires presentation of earnings per share by all
entities that have issued common stock, or potential common stock
(securities such as options, warrants, convertible securities or contingent
stock agreements) if those securities trade in a public market. (1)
• The following two types of earnings per share are required:
– Basic earnings per share -> the objective is to measure the
performance of an entity over the reporting period. It is computed by
dividing income available to common stockholders by the weightedaverage of common shares outstanding. Income available to
stockholders should be computed by deducting both the dividends
declared in the period on preferred stock (whether paid or not) and the
dividends accumulated for the period on cumulative preferred stock
(whether or not earned) from income from continuing operations and
from net income. (1)
– Diluted earnings per share -> the objective is consistent with that of
basic earnings per share while also giving effect to all dilutive potential
common shares that were outstanding during the period. In other
words, the denominator is increased to include the number of
additional common shares that would have been outstanding if the
dilutive potential common shares would have been issued. (1)
• Presentation: Entities with simple capital structures (those with only
common stock outstanding) shall present basic per share amounts for
income from continuing operations and for net income on the face of the
income statement. All other entities should present basic and diluted per
share amounts. An entity that reports a discontinued operation, an
extraordinary item, or the cumulative effect of an accounting change
shall present basic and diluted per share amounts for those line items
either in the face of the income statement or in the notes of the financial
statements. In addition, earnings per share data shall be presented for
all periods for which an income statement or summary of earnings is
presented. If diluted earnings per share are presented for at least one
period, they shall be reported or all periods presented, even if they are
the same amounts as basic earnings per share. (1)
(1) Statement of Financial Accounting Standard No. 128
• Conversely, if a company has a loss from continuing operations , the
conversion of any potential shares increases the numbers of shares in
the denominator and results in a lower loss in diluted earnings per share
than basic earnings per share. In that situation, the shares are
antidilutive and not included in the earnings per share calculations. As a
result, Statement No. 128 requires that if there is a loss from continuing
operations, diluted earnings per share must equal basic earnings per
share.
• In summary, basic earnings per share is calculated strictly on historical
data and measures the earnings per common share for the applicable
period. On the other hand, diluted earnings per share also takes
prospective events into consideration and presents a more conservative
or “worst case” scenario. As a result, the user of the financial
information is made aware of the range within which earnings per share
may fall.
Process and Purpose of Research:
• Obtained a database of public companies that apparently had
erroneously reported in their figures a higher diluted earnings per share
than basic earnings per share.
• Proceeded to research the companies in the database and obtained
their
official
SEC
filings
through
the
SEC
web
site
http://www.sec.gov/cgi-bin/srch-edgar.
(1) Statement of Financial Accounting Standard No. 128
Process and Purpose of Research
(Cont.):
• Compared and analyzed the figures in the database with the figures
filed with the SEC during the corresponding periods.
• Discovered that numerous figures in the database were erroneous and
did not match the figures in the actual SEC filings.
• Eventually did find several companies in the database that had indeed
improperly reported in their SEC filings, mainly in interim required
filings, diluted earnings per share higher than basic earnings per share.
Conclusion / Recommendations:
• Of the companies that reported the errors in earnings per share, the
majority had losses from operations and all of them failed to report
equal figures for basic and diluted earnings per share, as required.
• The companies (which ranged from the unique Animal Cloning
Sciences Inc. to the ever iconic Coca Cola) were in direct violation of
FASB regulations and SEC filing requirements.
• These errors in reporting earnings per share are strictly unacceptable
(regardless if they were mistakes or were done willfully to mislead) , can
mislead financial statement users, and can potentially translate into
improper decision making.
• Additional controls should be put in place by the regulatory agencies to
ensure that such errors are detected on a timely manner before they
reach the public and have a negative effect on the stakeholders.
• Additional controls (checks and balances) should be placed by the
public companies internally to ensure that all SEC filings are in
compliance with regulations.
• More severe and rigorous penalties should be enforced to public
companies for non compliance of regulatory and filing requirements.