Chapter 19 Share Based Compansation and Earnings Per Share
BASIC EARNING PER SHARE
Earnings per share must be reported on the face of the income statement. It reflects the current
earnings available for each share of common stock. In addition, when the income statement
contains irregular items (items net of tax below the income from operations line) EPS should be
reported for each item.
Earnings per Share-Simple Capital Structure
In a simple capital structure the corporation has no securities that have a conversion option.
Preferred Stock Dividends: If the corporation has both preferred and common stock typically
preferred dividends must be subtracted from net income to derive income available to common
stockholders. If the preferred stock is cumulative, dividends are subtracted whether declared or
not. If the preferred stock in non-cumulative the dividends must be declared. The formula for
calculating basic earnings per share is as follows:
Basic EPS
=
Net Income less Preferred Dividends
Weighted Average Number of Common Shares Outstanding
Issuance of New Shares
Current year preferred dividends are subtracted from net income to derive the net income
available to common stockholders. The weighted average of the number of shares of common
stock outstanding provides the basis for calculating the per share amount. We account for any
shares issued or repurchased during the period. This is accomplished by calculating the fraction
of the period that they are outstanding and adding this to the beginning balance of shares
outstanding.
Example: On January 1, 2003 Spencer Company had 500,000 shares of common stock
outstanding. On May 1, 2003 the company issued an additional 84,000 shares and on September
1 the company repurchased 42,000 shares (treasury stock). On November 1 the company resold
36,000 shares of the treasury stock. The weighted average of common stock outstanding for the
year is calculated as follows:
Weighted-Average Common Shares for Fiscal Year of 2003
Fraction
Weighted
Description
Dates
Shares
of Year
Average
Beginning balance
1/1/03
500,000
4/12
166,667
Issued shares
5/1/03
84,000
Adjusted balance
584,000
4/12
194,667
Repurchased shares
9/1/03
(42,000)
Adjusted balance
542,000
2/12
90,333
Issued shares
11/1/03
36,000
Adjusted balance
578,000
2/12
96,333
Weighted average number of shares outstanding
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548,000
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Chapter 19 Share Based Compansation and Earnings Per Share
Stock Dividends and Stock Splits
The above is fairly straight forward in that there are not complicating issues like stock dividends
and stock splits. If there is a stock dividend or stock split we must restate the number of shares
outstanding prior to the date of dividend or split. Let’s assume that Spencer Company declared a
stock dividend of 40% on October 1, 2003. The calculation of the weighted average of common
shares outstanding for the year would be as follows:
Weighted-Average Common Shares for Fiscal Year of 2003
Restated Fraction Weighted
Description
Dates
Shares Restate Shares
of Year Average
Beginning balance
1/1/03
500,000 1.40
700,000
4/12
233,333
Issued shares
5/1/02
84,000
Adjusted balance
584,000 1.40
817,600
4/12
272,533
Repurchased shares
9/1/02
(42,000)
Adjusted balance
542,000 1.40
758,800
1/12
63,233
40% stock dividend
10/1/02
216,800
Adjusted balance
758,800
758,800
1/12
63,233
Issued shares
11/1/02
36,000
Adjusted balance
794,800
794,800
2/12
132,467
Weighted average number of shares outstanding
764,800
If in the above example Spencer Company had the following items in the calculation of net
income, the related basic EPS would be presented on the income statement as follows.
Income before extraordinary item
Extraoridinary loss, net of tax
Net income
$400,000
(100,000)
$300,000
Earnings per share:
Income before extraordinary item
Extraordinary item, net of tax
Net income
$0.52
(0.13)
$0.39
Each item in the income statement is divided by the weighted average number of shares
outstanding, which are 764,800 in this example.
Answer the following questions regarding earnings per share with a simple capital
structure.
Question 1
With respect to the computation of earnings per share, which of the
following would be most indicative of a simple capital structure?
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Chapter 19 Share Based Compansation and Earnings Per Share
a. Common stock, preferred stock, and convertible securities
outstanding in lots of even thousands
b. Earnings derived from one primary line of business
c. Ownership interest consisting solely of common stock
d. None of these
Answer
c. Ownership interest consisting solely of common stock
Question 2
In computing earnings per share for a simple capital structure,
if the preferred stock is cumulative, the amount that should be
deducted as an adjustment to the numerator (earnings) is the
a. preferred dividends in arrears.
b. preferred dividends in arrears times (one minus the income tax
rate).
c. annual preferred dividend times (one minus the income tax rate).
d. annual preferred dividend.
Answer
d. annual preferred dividend.
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