By: Megan Addison, Nicholas DeMario,
Scott Heydle and Jenn Ritchie
What is Earnings Per Share?
Earnings Per Share (EPS) is the portion of a companies profit allocated to
each outstanding share of common stock.

Serves as an indicator of a companies profitability.
EPS is required by FASB No. 128, which covers the computation,
reporting, and disclosures.

Under this, companies are required to present EPS on the
face of the income statement.

If an entity’s structure is simple– that is it has no
potentially dilutive securities– only the basic EPS needs to
be disclosed. If complex, presentation of both basic and
diluted EPS is mandated
“It is EPS and the related price to earnings ratio– not income, not assets,
not equity, and not any other accounting magnitudes– that are the most
widely reported numbers in investment services…”
-- Dr. John W. Coughlan
President at CPA school of Washington
Looking Back at Accounting 101
When we first encountered calculating EPS in Accounting 101, we simply
divided the net income by the total number of common stock.
Net Income=
250,000
Common Stock=
35,000
EPS here, would be $7.14
This, however, is for limited situations such as:
1. The company has no common stock transactions during the
period, so the same number of shares of stock were outstanding
throughout the entire period.
2. The company has no preferred stock.
3. The company has no other financial securities or contingencies that
could result in the issuance of additional shares of common stock.
This method, however, is not used by
companies in any other situation.
…And as Dr. Kirch would say…
This is
Kindergarten stuff!
Basic Earnings Per Share
Basic EPS, also known as weighted average EPS, is intended to provide a
historical view of a companies performance.
GAAP requires that a weighted average number of common shares
outstanding be used in computing EPS.
To calculate the basic EPS, you must divide net income, less dividends
paid to preferred stock holders, divided by the weighted average of stock
outstanding.
The weighted average number is determined by multiplying the number
of shares issued for any time period by a fraction. Once you have that
number, add it to your already outstanding shares of stock.
Numerator: number of months shares have been outstanding.
Denominator: number of months in the period.
An Example:
10,000 shares were outstanding at 1/1/01
5,000 shares were issued on 7/1/01
Net Income was 55,000
5,000 dividends were paid to preferred stock holders.
Diluted Earnings Per Share
•FAS No. 128: Both Basic and Diluted EPS
•Complex Capital Structures:
•Convertible Securities
•Common Stock Warrants and Options
•Other Contingent Issuance Agreements
•
Diluted EPS Intended to…
•
Antidilution not to be reported
If-Convertible Method
•Convertible Securities (convertible preferred stock and convertible bonds)
•Example…
Treasury Stock Method
•Common Stock Warrants or Options
•Example…
Controversy over Earnings Per Share
•Problem: EPS is helpful in comparing one company to another, assuming they are
in the same industry, but it doesn’t tell you whether it’s a good stock to buy or
what the market thinks of it.
•For that information, it is necessary to look at some ratios.
Options & Warrants
•Problem: The use of the treasury stock method for options and warrants assumes
that proceeds from the exercise of options or warrants would be used to reacquire
a company’s own stock.
•However, the opinion APB No. 15 itself states that the treatment it prescribes
isn’t based on the assumption that the funds provided by exercise would
actually be used in this manner.
Controversy Cont.
•Problem: Using treasury stock method softens the potential dilution of
EPS because only an incremental number of shares rather than all
shares assumed exercised are used. (anti-diluted)
•Further options and warrants are excluded from EPS calculations
when current market prices determine whether options or warrants
are ultimately exercised.
•Different Methods that could be used:
•In accordance with FAS 128, paragraph 101 and 104
1. Imputed Earnings Method
2. Treasury Stock Method with a Discounted Excess Price
3. Maximum Diluted Method
4. Graham-Dodd Method
For each period an income statement is
presented the following must be disclosed
 A reconciliation of the numerators and the
denominators of the basic and diluted pershare computations for income from
continuing operations. The reconciliation
must display income and share mount that
effects esecurities that affect earnings per
share.
Income
(Numerator)
Income before extraordinary item
and accounting change
Less: Preferred stock dividends
Basic EPS
Income available to common
stockholders
Effect of Dilutive Securities
Warrants
Convertible preferred stock
4% convertible debentures
Diluted EPS
Income available to common
stockholders
For the Year Ended 2001
Shares
(Denominator)
Per-Share
Amount
$ 7,500,000
(45,000)
7,455,000
3,991,666
45,000
60,000
30,768
308,333
50,000
$ 7,560,000
4,380,767
$1.87
$1.73


The effect that has been given to preferred
dividends in arriving at income available to
common stock holders in computing basic
EPS
Securities that could potentially dilute basic
EPS in the future that were not included in the
computation of diluted EPS because to do so
would have been anti-dilutive for the period
presented.


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
Examples of those transactions
 Issuance or acquisition of shares
 Issuance of warrants, options or convertible securities
 Resolution of a contingency pursuant to a contingent stock
stock agreement
 Conversion or exercise of potential common shares
outstanding at the end of the period into common shares.
Practice Problem One
Addison Co. issued 6,000 shares of common stock on March 31, 2007.
They began the year with 12,000 shares of common stock
outstanding. If their net income for the year was 85,000 and no
preferred dividends were paid, what was the company’s basic earnings
per share?
Answer: $6.30
Practice Problem Two
Still on Addison Co. assume that at the beginning of the year
there was 3,000 convertible preferred stock outstanding, each
share is convertible to 2 common shares of stock. Calculate the
diluted earnings per share for Addison Co.
Answer: $3.78