Chapter17
Earnings Per Share
and
Retained Earnings
Intermediate Accounting 10th edition
Nikolai Bazley Jones
An electronic presentation
by Norman Sunderman
Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation.
Thomson, the Star logo, and South-Western are trademarks used herein under license.
2
Objectives
Compute basic earnings per share
(EPS).
2. Understand how to compute the
weighted average common shares for
EPS.
3. Identify the potential common shares
included in diluted EPS.
4. Apply the treasury stock method for
including stock options and warrants in
diluted EPS.
1.
3
Objectives
5.
6.
7.
8.
9.
Calculate the impact of a convertible
security on EPS.
Compute diluted EPS.
Record the declaration and payment of
cash dividends.
Account for a property dividend.
Explain the difference in accounting for
small and large dividends.
4
Objectives
10. Understand how to report accumulated
other comprehensive income.
11. Prepare a statement of changes in
stockholders’ equity.
5
Basic Earnings Per Share
Net Income - Preferred Dividends
Weighted Average Number of
Common Shares Outstanding
6
Weighted Average Shares
Since a corporation earns its net
income over the entire year, the
earnings are related to the common
shares outstanding during the year.
7
Weighted Average Shares
McTeal Corporation had 12,000 shares of common stock
outstanding at the beginning of the year. On March 2, it
issued 2,700 shares; on July 3, it issued another 3,300
shares, and on December 1, it reacquired 480 shares as
treasury stock.
The nearest whole month is used
Months Shares
Are Outstanding
Shares
Outstanding
Fraction of Year Equivalent
Outstanding Whole Units
January-February 12,000 x
2/12
=
2,000
March-June
14,700 x
4/12
=
4,900
July-November
18,000 x
5/12
=
7,500
December
17,520 x
1/12
=
1,460
Total weighted average common shares 15,860
8
Weighted Average Shares
Wallers corporation begins operations in January 2007,
and issues 5,000 shares of common stock that are
outstanding all during 2007. On December 31, 2007, it
issues a 2-for-1 stock split.
Months Shares
Are Outstanding
Shares
Outstanding
Fraction of Year Equivalent
Outstanding Whole Units
January-December 5,000 x
12/12
=
The two-for-one split is retroactive to January 1
Total weighted average common shares
Continued
5,000
+ 5,000
10,000
9
Weighted Average Shares
On May 29, 2008, R Corporation issues 5,000 shares of
common stock; on August 3, it issues a 20% stock dividend;
and on October 5, it issues 2,000 shares of stock.
2007 Data on 2008 Statement
Months Shares
Are Outstanding
Shares
Outstanding
January-December 5,000
x
Fraction of Year Equivalent
Outstanding Whole Units
12/12
=
5,000
5,000 x 200% x 120% = 12,000 equivalent whole units
Continued
10
Weighted Average Shares
2008 Data on 2008 Statement
Months Shares
Are Outstanding
Shares
Outstanding
January-May
10,000
June-July
15,000
August-September 18,000
Fraction of Year Equivalent
Outstanding Whole Units
Issued 5,000 shares
Issued 20% stock dividend
11
Weighted Average Shares
2008 Data on 2008 Statement
Months Shares
Are Outstanding
January-May
June-July
August-September
October-December
Shares
Outstanding
12,000
10,000
15,000
18,000
18,000
20,000
Fraction of Year Equivalent
Outstanding Whole Units
Increases 20%
Increases 20%
12
Weighted Average Shares
2008 Data on 2008 Statement
Months Shares
Are Outstanding
Shares
Outstanding
January-May
June-July
August-September
October-December
12,000
18,000
18,000
20,000
x
x
x
x
Fraction of Year Equivalent
Outstanding Whole Units
5/12
2/12
2/12
3/12
=
=
=
=
5,000
3,000
3,000
5,000
16,000
13
Simple Capital Structure
For purposes of computing earnings per
share, there are two types of capital
structure -simple and complex.
A simple capital structure is one that
consists of
1. Only common stock, or
2. Common stock and nonconvertible
preferred stock.
3. Requires only Basic Earnings Per Share
14
Complex Capital Structure
Many corporations have
a more complex capital
structure that includes
outstanding convertible
securities or contingent
shares that could have a
dilutive effect on
earnings per share.
These securities are
referred to as potential
common shares.
15
Diluted Earnings Per Share
A corporation with a complex
capital structure is required to
report two amounts on the face
of its income statement.
Yes… basic earnings per
share and diluted
earnings per share.
16
Diluted Earnings Per Share
The amount for diluted earnings per
share shows the earnings per share
after including all potential common
shares that would reduce earnings
per share.
17
Diluted Earnings Per Share
To be included in the diluted earnings
per share calculation, any potential
common share must have a dilutive
effect on earnings per share.
18
Diluted Earnings Per Share
Step 1: Compute the basic earnings per share.
Step 2: Include dilutive stock options and warrants
and compute a tentative diluted earnings per
share (DEPS).
Step 3: Develop a ranking of the impact of each
convertible preferred stock and convertible
bond on DEPS.
Step 4: Include each dilutive convertible security in
DEPS in a sequential order based on the
ranking and compute a new tentative DEPS.
Step 5: Select the lowest computed DEPS as the
diluted earnings per share .
19
20
Stock Options and Warrants
Assumed Shares
Issued
+
Change
(Incremental) in
Shares
Proceeds ($)
Assumed Shares
Reacquired (at average
market price)
-
21
Treasury Stock Method
1. Determine the average market price of common
shares during the period.
2. Compute the shares assumed issued from the
assumed exercise of all options and warrants.
3. Compute the proceeds received from the assumed
exercise by multiplying the shares issued by the
option price [plus any unrecognized compensation
cost (net of tax) per share].
4. Compute the assumed shares reacquired by dividing
the proceeds by the average market price.
5. Compute the incremental common shares.
22
Treasury Stock Method
To illustrate Step 3 further, assume Plummer
Corporation has compensatory stock options to
purchase 1,000 common shares at $18 per share
outstanding the entire year, the average market price
for the common stock was $25 per share, and the
unrecognized compensation cost (net of tax) was $2 per
share. Page 834.
Shares assumed issued from assumed exercise: 1,000
1,000Proceeds
x ($18 + $2)
$20,000
=
= (800)
Average Market
Price
Per
Share
$25
$25
Assumed increment in common shares for
computing diluted earnings per share
200
23
Convertible Securities
Convertible bonds and
convertible preferred stock
are considered in DEPS after
stock options and warrants.
Page 834.
24
Convertible Securities
If convertible bonds were assumed
converted, the numerator increases
net-of-tax because interest expense
would not exist, but income taxes
would increase.
25
Convertible Securities
Numerical Value Impact on
Diluted Earnings Per Share
$5,400
Increase in Earnings
Per Share Numerator
Security A
= $1.80
3,000
Increase in Earnings
Per Share Denominator
9% convertible preferred stock dividends of
$5,400 were declared during the year. The
preferred shares are convertible into 3,000
shares of common stock.
Continued
26
Convertible Securities
Numerical Value Impact on
Diluted Earnings Per Share
Security B
$4,800
= $2.50
1,920
10% convertible bonds. Interest expense (net
of income taxes) of $4,800 was recorded during
the year. The bonds are convertible into 1,920
shares of common stock.
Continued
27
Convertible securities
Numerical Value Impact on
Diluted Earnings Per Share
Security C
$8,000
= $1.60
5,000
8% convertible preferred stock. Dividends of
$8,000 were declared during the year. The
preferred shares are convertible into 5,000
shares of common stock.
Continued
28
Convertible Securities
Numerical Value Impact on
Diluted Earnings Per Share
Security D
$6,300
= $2.00
3,150
7% convertible bonds. Interest expense (net of
income taxes) of $6,300 was recorded during
the year. The bonds are convertible into 3,150
shares of common stock.
Continued
29
Convertible Securities
Security
Impact Order in Ranking
A
$1.80
2
B
$2.50
4
C
$1.60
1
D
$2.00
3
Security C has the lowest impact on DEPS and
is the most dilutive. It is the first convertible
security (after options and warrants) to be
included in DEPS (if dilutive).
30
Testing to Determine Whether a
Convertible Security is Dilutive
If the EPS of the first ranked convertible
security is less than the tentative EPS,
add the potential income to the
numerator and the potential shares to
the denominator and continue until the
impact of the next convertible security is
more than the previously computed
tentative diluted earnings per share.
31
Diluted Earnings Per Share
Format
Explanation
Earnings
Shares
Earnings
=
Adjustments Adjustments Per Share
Basic EPS
$x,xxx
Incremental shares (options)
Tentative EPS 1
$xxxx
Savings in interest expense
xxx
Incremental shares (bonds)
Tentative EPS 2
$x,xxx
Savings in preferred dividends
xxx
Incremental shares from Pref. St. xxx
Diluted earnings & shares
$x,xxx
/ xxx
xx
/ xxx
= $xxx Basic
xxx
/ xxx
=
= $xxx Ten.
/ xxx
= $xxx Ten.
= $xxx Diluted
= $xxx Ten.
32
Example 17-5
33
Diluted Earnings Per Share
Page 838
Explanation
Earnings
Adjustments /
Shares
Earnings
= Per Share
(Adjustments)
Basic EPS
$2,000 / 900
Incremental shares (options)
85
Tentative EPS 1
$2,000 / 985
Savings in interest expense
224
Incremental shares (bonds)
160
Diluted earnings & shares $2,224 / 1,145
=
$2.22 Basic
=
$2.03 Ten.
=
= $1.94 Diluted
34
Additional Disclosures
Identifies the amount of preferred dividends
deducted to determine the income available to
When
a corporation
reports its basic
common
stockholders.
and
diluted
earnings
per
share
on
its
2. Describes the potential common shares that
income
statement,
it also
required
to per
were
not included
in theisdiluted
earnings
make share
additional
disclosures
inthey
the were
notes
computation
because
to its financial statements.
antidilutive.
3. Describe any material impact on the common
shares outstanding of subsequent transactions
after the close of the accounting period but
before the issuance of the financial report.
1.
35
Types of Dividends
 Cash
 Property
 Stock
 Liquidating
 Scrip
36
Dividend Considerations
 Declared
 Not larger than unrestricted
retained earnings
 Not paid on treasury stock
 Other restrictions
 Scrip
37
Cash Dividend
There are four
significant dates for a
cash dividend.
 The date of
declaration
 The ex-dividend
date
 The date of
record
 The date of
payment
38
Cash Dividend
Date
Accounting Procedures
Reduce Retained Earnings
Date of Declaration
Increase Liabilities
Date of Record
Memorandum Entry
Reduce Assets
Date of Payment
Reduce Liabilities
39
Cash Dividend
On November 3, 2007, the board of directors of Bay
Corporation declares preferred dividends totaling
$10,000 and common dividends totaling $20,000.
These dividends are payable on December 15, 2007,
to stockholders of record on November 24, 2007.
November 3, 2007
Retained Earnings
30,000
Dividends Payable: Preferred Stock
10,000
Dividends Payable: Common Stock
20,000
40
Cash Dividend
On November 3, 2007, the board of directors of Bay
Corporation declares preferred dividends totaling
$10,000 and common dividends totaling $20,000.
These dividends are payable on December 15, 2007,
to stockholders of record on November 24, 2007.
November 24, 2007
Memorandum entry: The company will pay
dividends on December 15, 2007, to preferred and
common stockholders of record as of today, the date
of record.
41
Cash Dividend
On November 3, 2007, the board of directors of Bay
Corporation declares preferred dividends totaling
$10,000 and common dividends totaling $20,000.
These dividends are payable on December 15, 2007,
to stockholders of record on November 24, 2007.
December 15, 2007
Dividends Payable: Preferred Stock 10,000
Dividends Payable: Common Stock 20,000
Cash
30,000
42
Fully Participating Dividend
Everett Corporation has
issued 10%, participating,
cumulative preferred stock
with a total par value of
$20,000 and common stock
with a total par value of
$30,000. The preferred
stock is two years in
arrears. Everett
Corporation declares a
$9,000 dividend.
43
Fully Participating
Preferred Stock
Preferred Common
Current dividend (10% x $20,000) 2,000
Common dividend (10% x $30,000)
Total to allocate
$9,000
Allocated
( 5,000)
Remainder
$ 4,000
$20,000/$50,000 to preferred and
$30,000/$50,000 to common
1,600
Dividend to each class of stock
$3,600
$3,000
2,400
$5,400
44
Partially Participating
Preferred Stock (up to 12%)
Again assume a $30,000 dividend.
Preferred Common
Current dividend (10% x $20,000) 2,000
Common dividend (10% x $30,000)
2% dividend on par
400
Remainder to common
($9,000 – $6,000)
Dividend to each class of stock
$2,400
$3,000
600
3,000
$6,600
45
Property Dividend
Occasionally, a corporation will
declare a property dividend that is
payable in assets other than cash.
46
Property Dividend
The corporation typically uses
marketable securities of other
companies that it owns for the
property dividend.
47
Property Dividend
The corporation records a
property dividend at the fair value
of the asset transferred, and
recognizes a gain or loss.
48
Property Dividend
Asel Corporation declares a property
dividend payable in held-to-maturity bonds
of Bard Company. The bonds are carried on
Asel’s books at a book value of $40,000, but
their current fair value is $48,000.
Continued
49
Property Dividend
Date of Declaration
Investment in Bard Co. Bonds
8,000
Gain on Disposal of Investments
Retained Earnings
Property Dividends Payable
8,000
48,000
48,000
Date of Payment
Property Dividends Payable
Investment in Bard Co. Bonds
Continued
48,000
48,000
50
Stock Dividends
 They receive no corporate
Stockholders
often view
stock
dividends
favorably
even though-
assets.
 Their percentage ownership
does not change.
 Theoretically the total market
value of their investment will
remain the same.
 Future cash dividends may be
limited because retained
earnings is decreased by the
amount of the stock dividend.
51
Stock Dividends
Stock Dividend
What factors might
enhance the perceived
attractiveness of stock
dividends?
52
Stock Dividends



The stockholders may see the stock
dividend as evidence of corporate growth.
The stockholders may see the stock
dividend as evidence of sound financial
policy.
Other investors may see the stock dividend
in a similar light, and increased trading in
the stock may cause the market price not to
decrease proportionally.
53
Stock Dividends


The corporation may state that it will pay
the same fixed cash dividend per share.
The stockholders may see the market price
decreasing to a lower trading range,
making the stock more attractive to
additional investors so that the market
price may eventually rise.
54
Stock Dividends
Retained
Earnings
Small
<25%
Large
25% or more
Fair Value
Par Value
Capital
Stock
Additional
Paid-In
Capital
Retained
Earnings
Capital
Stock
55
Stock Dividends
Stockholders’ Equity Prior to Stock Dividend
Common stock, $10 par (20,000 shares
issued and outstanding)
$200,000
Additional paid-in capital
180,000
Retained earnings
320,000
Total stockholders’ equity
$700,000
56
Small Stock Dividend
Ringdahl Corporation declares and issues a
10% stock dividend. On the date of
declaration, the stock sells for $23 per share.
Date of Declaration
20,000 shares x 0.10 x $23
Retained Earnings
46,000
Common Stock To Be Distributed
Additional Paid-in Capital From
Stock Dividend
Continued
20,000
26,000
Par
57
Small Stock Dividend
Ringdahl Corporation declares and issues a
10% stock dividend. On the date of
declaration, the stock sells for $23 per share.
Date of Issuance
Common Stock To Be Distributed
Common Stock, $10 par
20,000
20,000
Par
58
Small Stock Dividend
Stockholders’ Equity After Stock Dividend
Common stock, $10 par (22,000 shares
issued and outstanding)
$220,000
Additional paid-in capital
206,000
Retained earnings
274,000
Total stockholders’ equity
$700,000
Note: Total
remained the same
59
Large Stock Dividend
Ringdahl Corporation declares and issues
a 40% stock dividend. On the date of
declaration, the stock sells for $23 per
share.
20,000 shares x 0.40 x $10
Date of Declaration
Retained Earnings
80,000
Common Stock To Be Distributed
Date of Issuance
Common Stock To Be Distributed
80,000
Common Stock, $10 par
Continued
80,000
80,000
60
Large Stock Dividend
Stockholders’ Equity After Stock Dividend
Common stock, $10 par (28,000 shares
issued and outstanding)
$280,000
Additional paid-in capital
180,000
Retained earnings
240,000
Total stockholders’ equity
$700,000
Note: Same total as
small stock
dividend
61
Statement of Retained
Earnings
Although not a required separate
financial statement, some
corporations include a statement
of retained earnings in their
financial statements.
62
Statement of Retained Earnings
Retained earnings, as previously reported, Jan. 1, 2007,
-Plus (minus) Prior period adjustments (net of
income tax effect)
Adjusted retained earnings, January 1, 2007
-Plus (minus): Net income (loss)
Minus: -Dividends (specifically identified, including
per share amounts)
-Reductions due to retirement or
reacquisition of capital stock
-Reductions due to conversion of bonds or
preferred stock
Retained earnings, December 31, 2007
63
Accumulated Other
Comprehensive Income
Other comprehensive income might include- Unrealized increases (gains) or decreases
(losses) in the market value of investments in
available-for-sale securities.
 Translation adjustments from converting the
financial statements of a company’s foreign
operation into U.S. dollars.
 Certain gains and losses on “derivative”
financial instruments.
 Certain pension liability adjustments.
64
Accumulated Other
Comprehensive Income
A corporation may report its comprehensive
income (net of income taxes)- On the face of its income statement.
 In a separate statement of comprehensive
income.
 In its statement of changes in stockholders’
equity.
65
Statement of Changes in
Stockholders’ Equity
APB Opinion No. 12 states: “…disclosures of
changes in the separate accounts comprising
stockholders’ equity (in addition to retained
earnings) and of the changes in the number of
shares of equity securities during at least the most
recent annual fiscal period…is required to make
the financial statements sufficiently informative.”
66
Statement of Changes in
Stockholders’ Equity
67
Chapter 17
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