INTERMEDIATE
ACCOUNTING
Seventh Canadian Edition
KIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK
Prepared by:
Gabriela H. Schneider, CMA
Northern Alberta Institute of Technology
CHAPTER
18
Earnings Per Share
Learning Objectives
1. Understand why EPS is an important number.
2. Understand when and how EPS is required to
be presented.
3. Identify potential common shares.
4. Calculate earnings per share in a simple capital
structure.
Learning Objectives
5. Calculate diluted earnings per share using the ifconverted method.
6. Calculate diluted earnings per share using the
treasury stock method.
7. Calculate diluted earnings per share using the
reverse treasury stock method.
8. Identify antidilutive potential common shares.
Earnings Per Share
Overview
Objective
Presentation
and
disclosure
Basic EPS
Simple capital
structure
Income available
to common
shareholders
Weighted
average common
shares
Comprehensive
illustration
Diluted EPS
Perspectives
Complex capital structure Usefulness
Convertible securities
of EPS
If-converted method
Options and warrants
Treasury stock method
Reverse treasury stock
method
Contingently issuable shares
Antidilution revisited
Additional disclosures
Comprehensive illustration
Importance of EPS
• Calculated for common shares
• Tells shareholders how much of the available
income is associated with the shares they own
(their share of the pie)
• Provides insight to shareholders
– Future dividend payout
– Future share value
– Impact of other financial instruments on
their potential earnings (Diluted EPS)
EPS Calculation
• Basic EPS
– Actual earnings and actual number of issued
common shares
• Diluted EPS
– Earnings and number of common shares adjusted
for “what-if”
• What would the EPS be if any financial instruments
that could be converted to common shares were
actually converted
EPS Calculation
Income available to common
shareholders
EPS
=
Weighted average number of
common shares
EPS Disclosure
• CICA Handbook, Section 3500.60 requires EPS to be
reported as part of the income statement
– Exception: non public (privately held) corporation
• Reported for each income component as reported on
the income statement
• Where applicable, both Basic EPS and Diluted EPS
reported
• Presented for all periods reported
– Prior period EPS restated for any stock dividends
or stock splits
EPS Disclosure
Income Statement Presentation of EPS
Components
Earnings per share:
Income from continuing operations
$4.00
Loss from discontinued operations,
net of tax
(.60)
Extraordinary gain, net of tax
1.00
Net Income
$4.40
EPS Disclosure
EPS Presentation – Complex Capital Structure
Earnings per common share:
Basic earnings per share
$3.30
Diluted earnings per share
$2.70
EPS Disclosure
EPS Presentation, with Extraordinary Item
Basic earnings per share:
Income before extraordinary item
$3.80
Extraordinary item
.80
Net Income
$3.00
Diluted earnings per share:
Income before extraordinary item
$3.35
Extraordinary item
65
Net Income
$2.70
Brief Exercise BE 18-9
EPS Presentation for Schrempf Corp.
• Net Income
• Extraordinary Loss
• Common shares
outstanding
$1,480,000
$ 220,000
50,000
Brief Exercise BE 18-9
Basic Earnings Per Share
Total
Income before
extraordinary loss
$1,700,000
Extraordinary loss
220,000
Net Income
$1,480,000
EPS
$34.00
(4.40)
$29.60
Capital Structure
• Method of EPS calculation based on the
corporations capital structure
• Simple Capital Structure
– When only common shares are issued
– Basic EPS calculated
• Complex Capital Structure
– When common shares plus dilutive securities are
issued
• Potential common shares
– Diluted EPS calculated
Potential Common Shares
• Securities, or other financial instruments
issued by a corporation that have an option
for the holder to convert the security into
common shares
• This conversion could have a negative, or
dilutive effect on EPS
– Cause EPS to decrease
• Contingently issuable shares
– Shares issued for minimal consideration
(asset exchange) once a certain condition has
been met
EPS Reporting Requirements
Capital
Structure
Major Types of Equity
Instruments
Impact on EPS
Calculations
Simple
Common shares
Preferred shares
Basic EPS only
Complex
Common shares
Basic and
Diluted EPS
Potential Common shares:
–Convertible preferred shares
–Convertible debt
–Options/warrants
–Contingently issuable
EPS - Simple Capital Structure
Net Income – Preferred Dividends
Weighted Average # of Shares Outstanding
• If the preferred shares are non-cumulative
– include only declared dividends
• If the preferred shares are cumulative
– include only declared dividends, or
– if no dividends declared, include only one year’s
dividends
EPS – The Numerator
Example: Michael Limited
• Net Income
$3,000,000
• Shares
– 100,000 Class A preferred, cumulative shares,
dividend amount $4.00 per share
– 100,000 Class B preferred, non-cumulative
shares, dividend amount $3.00 per share
• No dividends declared or paid in the current
year
EPS – The Numerator
Net Income
$3,000,000
Amount attributable to Class A:
100,000 x $4.00
400,000
2,600,000
Amount attributable to Class B:
100,000 x $0.00
-0Income available to
common shareholders
$2,600,000
The Class B shares are non-cumulative, with no dividends
declared for the year no amount is deducted from Net Income
EPS - Simple Capital Structure
Net Income – Preferred Dividends
Weighted Average # of Shares Outstanding
• Number of shares issued is weighted by the
period of time they were outstanding
• Each transaction (issue of shares,
reacquisition of shares, retirement of shares)
represents a weighting period
EPS – The Denominator
Date
Share Changes
Shares
Outstanding
90,000
January 1
Beginning balance
April 1
30,000 shares issued
July 1
39,000 shares purchased
November 1
60,000 shares issued
141,000
December 31
Year end balance
141,000
120,000
81,000
EPS – The Denominator
Dates Outstanding
Shares
Outstanding
Fraction Weighted Shares
Portion of Year
Outstanding
Weighted
Shares
Jan. 1st to April 1st
90,000
3/12
22,500
April 1st to July 1st
120,000
3/12
30,000
July 1st to Nov 1st
81,000
4/12
27,000
Nov 1st to Dec 31st
141,000
2/12
23,500
Weighted Average Shares Outstanding
103,000
EPS – The Denominator
Net Income – Preferred Dividends
Weighted Average # of Shares Outstanding
• Stock splits and stock dividends require
restatement of the outstanding number of shares
from the beginning of the year
– Because there has been no change in the
company’s assets, or in the shareholders’ total
investment
EPS – The Denominator
• A final note (CICA Handbook, Section 3500)
– If there is a stock split or stock dividend after the
year end but before the publication of the
financial statements
• The weighted average number of shares
outstanding must be restated
• This applies to the current year, as well as
previous years if comparative statements are
issued
EPS – The Denominator
Given – Baiye Limited:
January 1:
100,000 shares outstanding
March 1:
Issued 20,000 shares
June 1:
50% Stock dividend (60,000
additional shares issued)
November 1: Issued 30,000 shares
December 31: Ending Balance = 210,000
shares outstanding
EPS – The Denominator
Dates
O/S
Shares
O/S
Fraction Weighted
Restatement of Year
Shares
Jan-Mar
100,000
X 1.50 X
2/12 =
25,000
Mar-Jun
120,000
X 1.50 X
3/12 =
45,000
Jun-Nov
180,000
X
5/12 =
75,000
Nov-Dec
210,000
X
2/12 =
35,000
Weighted average shares outstanding
180,000
Complex Capital Structure
• Complex capital structure:
– When corporation has convertible securities,
options, warrants or other rights, and
– When converted these could dilute EPS
• Dilution is the reduction in EPS, if:
– Securities, potentially convertible into common
stock, are converted (assumed at beginning of
the year)
• Anti-dilutive securities
– Securities, when converted, increase EPS
– Anti-dilutive EPS are not reported, only basic
EPS - Complex Capital Structure
• Requires dual presentation of EPS
– Basic earnings per share
• Presented for each separate class of common
share
– Fully diluted earnings per share
• Only securities that reduce earnings per share
(dilutive) are considered
• Securities that increase earnings per share (antidilutive) are ignored
Diluted Earnings per Share Methods
• The dilutive effect of convertible securities is
measured by the if-converted method
• The dilutive effect of options and warrants is
measured by the treasury stock method
• For computing dilution, the rate of conversion
most advantageous to the security holder is used
(maximum dilutive conversion rate)
The If-Converted Method
• The conversion of the securities into common
stock is assumed to occur at the beginning of the
year
• The net income must be adjusted for:
– Interest (net of tax) on the convertible debt
– Dividends on the convertible preferred shares
• The weighted average number of shares is
increased by the additional common shares
assumed issued (at the beginning of year)
The If-Converted Method
• Adjust Net Income
– Convertible debt issues
– Income is adjusted for the after-tax interest that would not
have been paid if the debt were converted to common
shares
• Interest adjusted for any premium or discount
amortization
– Convertible preferred shares
• No adjustment to the numerator required if there are
convertible preferred shares
• Adjust (re-calculate) weighted average number of shares
– Adjusted as if all convertible securities were converted to
common shares
Field Corporation
Net Income for the Year
Add back:
Interest on 6% debentures
$60,000 x (1-.40)
Interest on 10% debentures
$100,000 x (1-.40)
Adjusted Net Income
$210,000
36,000
45,000
$291,000
Field Corporation
Unadjusted Weighted Average
Number of Shares
100,000
Add: Shares assumed issued (converted)
6% debentures
20,000
10% debentures *
24,000
Weighted Average Number of Shares 144,000
Field Corporation
• Conversion is always assumed to be at the
beginning of the year
• If a convertible security is not outstanding for
the full 12 months of the year
• Conversion is pro-rated for the number of
months the convertible security is actually
issued
– Field Corporation 10% debenture was issued
April 1st, therefore the conversion is 32,000
shares times 9 out of 12 months
Field Corporation
• EPS Calculation and Disclosure
• Net Income
$210,000
• Basic EPS
$210,000  100,000
$2.10
• Diluted EPS
$291,000  144,000
$2.02
The Treasury Stock Method
• Options and warrants (and their equivalents)
included in EPS computations
• Options and warrants are assumed exercised at
the beginning of the year
• The proceeds from the exercise of options are
assumed to be used to buy back common shares
• The exercise price per share must be less than
the market price per share for dilution to occur
Options and Warrants Treasury Stock Method
Given:
Exercise price of an option (for one share of stock) $ 30
Market price of one share at exercise date: $ 50
Options deemed exercised: 1,500
Compute the number of weighted shares for determining
diluted earnings per share
Total proceeds from exercise:
Shares issued on exercise:
Assumed reacquisition of shares:
Dilution: 1,000 - 250
=
(increase in outstanding shares)
$45,000
1,500
900
750 Shares
Reverse Treasury Stock Method
•
•
Used with put options and forward purchase
contracts
Two assumptions under this method
1. Enough common shares issued at beginning
of the year for the company to purchase
shares under the option or forward contract
2. Proceeds from the share issue will be used
to purchase shares under the option or
forward contract
Reverse Treasury Stock Method
Given:
Exercise price of an option (for one share of stock) $ 30
Market price of one share at exercise date: $ 20
Options deemed exercised: 1,500
Compute the number of weighted shares for determining
diluted earnings per share
Amount needed to buy back the 1,500 shares:
(1,500 * $30)
$45,000
Shares issued to acquire needed cash:
($45,000  $20)
2,250
Number of shares purchased through put:
1,500
Dilution: 2,250 – 1,500
=
750 Shares
(increase in outstanding shares)
Antidilutive Potential Common
Shares
• Securities that cause an increase in EPS if
included in EPS calculations
• Convertible debt antidilutive if conversion
increases EPS to increase by a greater
amount than EPS before conversion
• For example:
Antidilutive EPS
Kohl Corporation
• $1 million in 6% convertible debt –
convertible to 10,000 common shares
• Net Income is $210,000
• 100,000 common shares outstanding
• Basic EPS = $2.10 per share
Antidilutive Shares
Test for Antidilution
Adjusted Net Income:
Net Income
After-tax interest adjustment
($1.0m x 6%)(1-.40)
Adjusted Net Income
Adjusted Number of Shares:
Shares outstanding
Shares issued on conversion
Adjusted Number of shares
$210,000
36,000
$246,000
100,000
10,000
110,000
Antidilutive Shares
Diluted EPS =
$246,000  110,000 = $2.24
Basic EPS
= $2.10
Antidilutive, therefore not disclosed
Earnings per Share:
Complex Structures - Summary
Dual EPS Presentation
Basic EPS
Net Income adjusted for
interest (net of tax) and
preferred dividends
Weighted average number of
common shares assuming
maximum dilution
Diluted EPS
Dilutive Convertibles
Dilutive Options and Warrants
Dilutive Contingent Issues
Additional Disclosure
• Disclosed in notes to financial statements
1. Adjustments to income
2. Reconciliation of both the numerator and
denominator values
3. Potentially dilutive securities
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