Earnings Per Share
I.
II.
General
a. Under both U.S. GAAP and IFRS, all public entities are required to
present earnings per share on the face of the income statement. The
capital structure of the entity determines the manner in which EPS will be
disclosed.
i. Simple Capital Structure
1. Entity has only common stock outstanding
2. Presents on face of income statement basic EPS amount for
a. Income from continuing operations
b. Net Income
ii. Other Entities
1. Present on face of income statement basic and diluted per
share amounts for
a. Income from continuing operations
b. Net Income
2. Present on face of the income statement or in the notes of
the F/S basic and diluted per share amounts
a. Discontinued operations
b. Extraordinary items
Simple Capital Structure (Basic EPS Only)
a. Formula: Basic EPS = Income available to common
shareholders/weighted average number of common shares outstanding
b. Income available to common shareholders
i. Subtract from Income from Continuing Operations and Net Income
1. Dividends declared in the period on preferred stock
(regardless whether they have been paid)
2. Dividend accumulated on cumulative preferred stock
(regardless whether they have been declared).
c. Weighted-Average Number of Common Shares Outstanding: the average
of shares outstanding and assumed to be outstanding for EPS calculations.
Shares sold or reacquired during the period should be weighted for the
portion of the period they were outstanding.
i. Stock dividends and stock splits must be treated as though they
occurred at the beginning of the period.
ii. Rules for Stock issued in a business combination
1. If the purchase method is used, the weighted-average is
measured from the date of combination.
2. If the pooling method is used, the shares issued are
retroactively adjusted for all periods presented.
Example: Weighted-average number of shares outstanding
Date
Transaction
Change in Shares
1/1
Shares o/s
3/31
2-for-1 stock split
1,000,000
4/1
Additional shares sold 3,000,000
12/1
Reacquired shares
(500,000)
Total Shares
1,000,000
2,000,000
5,000,000
4,500,000
3/31 is effective since 1/1
Additional sold shares outstanding 9/12 of year
Reacquired shares 1/12 of year
Computation:
Outstanding shares
Split
Sale
Reacquired shares
1,000,000
1,000,000
2, 250,000 (3,000,000 X 9/12)
(41,667) (500,000 X 1/12)
Weighted-average shares o/s 4,208,333
III.
Complex Capital Structure (Basic and Diluted EPS): the entity has securities
that can potentially be converted to common stock and would therefore dilute
(reduce) EPS (of common stock).
a. Both basic and diluted EPS must be presented.
b. Basic ignores potentially dilutive securities in the weighted-average
number of shares outstanding.
c. The objective of diluted EPS is to measure the performance of an entity
over the reporting period while give effect to all potentially dilutive
common stock shares outstanding during the period. Potentially dilutive
securities include:
i. Convertible securities (convertible preferred stock, convertible
bonds, etc.)
ii. Warrants and other options
iii. Contracts that may be settled in cash or stock
iv. Contingent shares
d. Formula: Diluted EPS = (Income available to common stock shareholder
+ interest on dilutive securities)/Weighted-average number of common
shares, assuming all dilutive securities are converted to common stock.
e. Dilution from Convertible Securities (bonds or preferred stock): Use the
“if converted” method, assuming securities were converted to common
stock at the beginning of the period
i. Convertible Bonds
1. Add to the numerator interest expense (not)
2. Add to the denominator the number of common shares
associated with the conversion.
3. If convertible bonds were issued during the period, assume
the stock was issued at that date for the weighted-average
calculation.
ii. Convertible Preferred Stock
1. No numerator adjustment
2. Add to the denominator the number of shares associated
with the assumed conversion.
iii. Anti-dilution: Use the results of each assumed conversion only if
it results in dilution. Do not include the results of the assumed
conversion if it is anti-dilutive.
Example 1:
A company has outstanding 100,000 shares of common stock and $500,000 in 6%
debentures convertible into 10 shares for each $1,000 bond. Net income for the year is
$100,000. What is diluted EPS assuming a 34% tax rate?
Diluted shares outstanding:
Common stock
Convertible debentures
Total common shares o/s
100,000
5,000 (500 X 10)
105,000
Diluted net income:
Net income
$100,000
Add: Interest on bonds (not) 19,800 (30,000-10,200 tax); 30,000 X .34=10,200
Total Net Income
119,800
Diluted EPS:
$1.14 ($119,800/105,000shares)
Basic EPS:
$1.00 ($100,000/100,000 shares)
The convertible bonds are anti-dilutive and would therefore be excluded.
Example 2:
A company has outstanding 100,000 shares of common stock and 10,000 shares of
convertible preferred stock, convertible into five shares of common stock for each share
of preferred. Net income is $100,000. Dividends paid during the year were $20,000 on
preferred and $30,000 on common. What is diluted EPS assuming a 34% tax rate?
Diluted shares outstanding
Common Stock
Convertible preferred stock
Total
100,000
50,000 (10,000 X 5)
150,000
Diluted Net Income
$100,000
Diluted EPS
$0.67/share ($100,000/150,000)
Note: The preferred stock dividends are not subtracted from net income. We assume that
since the preferred stock was converted into common stock, the preferred stock dividends
were not paid.
Check for anti-dilution:
Basic EPS: ($100,000 - $20,000)/100,000 = $0.80/share. Since diluted EPS is less than
basic EPS, the preferred stock is dilutive and EPS is $0.67/share.
f. Dilution from Options, Warrants and their Equivalents: The dilutive
effect is applied using the treasury stock method.
i. Dilutive vs. Anti-dilutive: Only dilutive when the average market
price of the underlying common stock exceeds the exercise price of
the options or warrants because it is unlikely they would be
exercised if the exercise price were higher than the market price.
ii. Treasury Stock Method
1. Exercise occurs at the beginning of the period
2. Common shares are purchased at the average market price
during the period
3. Formula to compute additional shares: number of shares –
[(number of shares X exercise price)/average market price]
= additional shares outstanding.
4. Example: A company has 1,000 stock OPTIONS
outstanding, which are exercisable at $30 each. If the
average market price is $50/share, determine the number of
shares of common stock equivalents that should be
included for diluted EPS.
1000 – [(1000 X $30)/$50] = 400 shares included in the
denominator.
g. Dilution from contracts settled in cash or stock: It is presumed the
contract will be settled in common stock and the resulting shares included
in diluted EPS if the effect is more dilutive.
h. Cash flow per share should not be reported.
Illustration of EPS Presentation for a Complex Capital Structure:
20XX
Basic Earning per (Common) Share
Income before extraordinary item
$3.20
Extraordinary item
0.22
Net Income
$3.42
Diluted Earning per (Common) Share
Income before extraordinary item
Extraordinary item
Net Income
$3.11
0.21
$3.32