INTERMEDIATE ACCOUNTING
TENTH CANADIAN EDITION
Kieso • Weygandt • Warfield • Young • Wiecek • McConomy
CHAPTER 17
Earnings Per Share
Prepared by:
Lisa Harvey, CPA, CA
Rotman School of Management,
University of Toronto
CHAPTER 17
EARNINGS PER SHARE
After studying this chapter, you should be able to:
• Understand why earnings per share (EPS) is an
important number.
• Understand when and how earnings per share must be
presented, including related disclosures.
• Calculate earnings per share for companies with a simple
capital structure.
• Calculate earnings per share for companies with a
complex capital structure.
• Identify the major differences in accounting between
ASPE and IFRS, and what changes are expected in the
near future.
Copyright © John Wiley & Sons Canada, Ltd.
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Earnings Per Share
Overview
Basic EPS
Diluted EPS
•Objective of
EPS
•Capital structure
•Complex capital
structure
•Presentation
and Disclosure
•Income available to
common/ordinary
shareholders
•Convertible securities
•Options and warrants
•Weighted average
common/ordinary shares
•Contingently issuable
shares
•Comprehensive
illustration
•Antidilution revisited
IFRS/ASPE
Comparison
•Analysis
•Comparison of
IFRS and private
enterprise GAAP
•Looking ahead
•Additional disclosures
•Comprehensive
earnings per share
exercise
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Objective of EPS
• Earnings per share tells common
shareholders how much of the available
income is associated with the shares they
own (their share of the pie)
• Provides insight to common shareholders
about:
– Future dividend payout
– The value of their shareholdings
– Impact of other financial instruments on their
potential earnings (Diluted EPS)
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EPS Calculation
Income available to common
shareholders
EPS
=
Weighted average number of
common shares
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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
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Presentation & Disclosure
• Under IFRS, EPS must be reported as part of the
income statement
– Exception: non public (privately held) corporations (not required
under ASPE)
• Reported for each income component as reported on the
income statement
• EPS relating to discontinued operations (if applicable)
may be presented on face of income statement, or
disclosed in notes
• 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
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Presentation & Disclosure
• If diluted EPS data are reported for at least
one period, they should be reported for all
periods that are presented, even if they
are the same as basic EPS
• When the results of operations of a prior
period have been restated as a result of a
prior period adjustment, the EPS should
also be restated
– The effect of the restatement should then be
disclosed in the year of the restatement
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Presentation & Disclosure Example
Income Statement Presentation of EPS
Components
Earnings per share:
Income from continuing operations
Loss from discontinued operations, net of tax
Net Income
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$4.00
(.60)
$3.40
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Presentation & Disclosure Example
EPS Presentation – Complex Capital
Structure
Earnings per common share:
Basic earnings per share
Diluted earnings per share
$3.80
$3.35
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Presentation & Disclosure Example
EPS Presentation, with discontinued operations
and complex capital structure
Basic earnings per share:
Income before discontinued operations
Discontinued operations
Net Income
$3.80
(.80)
$3.00
Diluted earnings per share:
Income before discontinued operations
Discontinued operations
Net Income
$3.35
(.65)
$2.70
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Earnings Per Share
Overview
Basic EPS
Diluted EPS
•Objective of
EPS
•Capital structure
•Complex capital
structure
•Presentation
and Disclosure
•Income available to
common/ordinary
shareholders
•Convertible securities
•Options and warrants
•Weighted average
common/ordinary shares
•Contingently issuable
shares
•Comprehensive
illustration
•Antidilution revisited
•Additional disclosures
•Comprehensive
earnings per share
exercise
Copyright © John Wiley & Sons Canada, Ltd.
IFRS and
Private
Enterprise
GAAP
Comparison
•Analysis
•Comparison of
IFRS and private
enterprise GAAP
•Looking ahead
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Capital Structure
• Method of EPS calculation based on the
corporation’s capital structure
• Simple Capital Structure
– When only common shares and preferred share are
issued and/or debt with no conversion rights
– Basic EPS calculated and presented
• Complex Capital Structure
– When common shares plus dilutive securities are
issued (i.e. a potential common shares)
– Basic and Diluted EPS calculated and presented
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Capital Structure
• Potential/ordinary shares are 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 (i.e. may cause EPS to decrease)
• Examples: debt and equity instruments that are
convertible into common shares, warrants, and options
• Contingently issuable shares
– Shares issued for minimal consideration (asset exchange) once
a certain condition has been met
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EPS Reporting Requirements
Capital
Structure
Simple
Major Types of Equity
Instruments
Common shares
Preferred shares
Impact on EPS
Calculations
Basic EPS only
Complex
Common shares
Potential Common shares:
– Convertible preferred
shares
– Convertible debt
– Options/warrants
– Contingently issuable
– Other
Basic and
Diluted EPS
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EPS – Simple Capital Structure
• Common shareholders have a residual
interest in the company’s income:
• Therefore, Income Available to Common
Shareholders = Net Income - Preferred Share
Dividends
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EPS - Simple Capital Structure
• If the preferred shares are non-cumulative
– deduct only declared dividends
• If the preferred shares are cumulative
– deduct only declared dividends, or
– if no dividends declared, deduct only one year’s
dividends
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EPS - Simple Capital Structure
• If dividends on preferred shares are declared
and a net loss occurs, the preferred dividend is
added to the loss in calculating the loss per
share
• In reporting earnings per share information,
dividends declared on preferred shares should
be subtracted from income from continuing
operations and from net income
– In other words, dividends on preferred shares should
not be deducted in calculating EPS from discontinued
operations
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EPS - Simple Capital Structure Example
Given:
• Michael Limited’s 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
Calculate the income available to common
shareholders
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EPS - Simple Capital Structure Example
Net Income
Amount attributable to Class A:
100,000 x $4.00
Amount attributable to Class B:
100,000 x $0.00
Income available to
common shareholders
$3,000,000
400,000
2,600,000
-0$2,600,000
The Class B shares are non-cumulative, with no dividends
declared for the year no amount is deducted from Net Income
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EPS – Simple Capital Structure
• The weighted average number of shares
outstanding 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
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EPS - Simple Capital Structure Example
Date
Share Changes
Shares
Outstanding
January 1
Beginning balance
April 1
30,000 shares issued
120,000
July 1
81,000
November 1
39,000 shares
purchased
60,000 shares issued
141,000
December 31
Year end balance
141,000
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90,000
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EPS - Simple Capital Structure Example
Dates Outstanding
Shares
Outstanding
Fraction Weighted Shares
Portion of Year
Outstanding
Weighted
Shares
Jan. 1st to March 31st
90,000
3/12
22,500
April 1st to June 30th
120,000
3/12
30,000
81,000
4/12
27,000
141,000
2/12
23,500
July 1st to October 31st
Nov 1st to Dec 31st
Weighted Average Shares Outstanding
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103,000
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EPS - Simple Capital Structure
• Stock splits and stock dividends require restatement
of the weighted average number of shares
outstanding from the beginning of the year
– Because there has been no change in the company’s
assets or in the shareholders’ total investment
– By restating the number, valid comparisons of
earnings per share can be made between periods
before and after the stock split or stock dividend
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EPS - Simple Capital Structure
• 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
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EPS - Simple Capital Structure Example
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
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EPS - Simple Capital Structure Example
Dates
O/S
Shares
O/S
Restatement
Fraction
of Year
Weighted
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
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180,000
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Earnings Per Share
Overview
Basic EPS
Diluted EPS
•Objective of
EPS
•Capital structure
•Complex capital
structure
•Presentation
and Disclosure
•Income available to
common/ordinary
shareholders
•Convertible securities
•Options and warrants
•Weighted average
common/ordinary shares
•Contingently issuable
shares
•Comprehensive
illustration
•Antidilution revisited
•Additional disclosures
•Comprehensive
earnings per share
exercise
Copyright © John Wiley & Sons Canada, Ltd.
IFRS and
Private
Enterprise
GAAP
Comparison
•Analysis
•Comparison of
IFRS and private
enterprise GAAP
•Looking ahead
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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 is not reported, only basic EPS
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EPS - Complex Capital Structure
• Requires dual presentation of EPS
1. Basic earnings per share
• Presented for each separate class of common share
2. Fully diluted earnings per share
• Only securities that reduce earnings per share (dilutive) are
considered
• Securities that increase earnings per share (anti-dilutive) are
ignored
• The purpose of presenting both EPS numbers is to
inform financial statement users of situations that will
likely occur and to provide worst-case situations
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EPS - Complex Capital Structure
• 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)
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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)
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If Converted Method - Example
Given:
• Net income for the year: $210,000
• Common shares outstanding during the period: 100,000
• Additional securities outstanding:
– 6% convertible debenture bond sold at 100 for $1,000,000,
convertible to 20,000 common shares
– 10% convertible debenture bond sold at 100 for $1,000,000,
convertible to 32,000 common shares and issued April 1st of
current year
Calculate diluted EPS assuming a tax rate of 30%
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If Converted Method - Example
Net income for the year
$410,000
Add back:
Interest on 6% debentures
$60,000 x (1-.30)
42,000
Interest on 10% debentures
$50,000 x (1-.30) x 9/12
26,250
Adjusted Net Income
$478,250
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If Converted Method - Example
Weighted Average Number of Shares
Add: Shares assumed issued:
6% debentures
10% debentures*
Adjusted Weighted Average
Number of Shares
100,000
20,000
24,000
144,000
*32,000 shares x 9/12
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If Converted Method - Example
• 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
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Example - Field Corporation
EPS Calculation and Disclosure:
Net income for the year
$410,000
Basic EPS
($410,000  100,000)
$4.10
Diluted EPS
($478,250  144,000)
$3.32
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Options and Warrants
• Options and warrants (and their equivalents) are
included in EPS computations
– An option gives the holder the right to either buy or sell shares
• Generally speaking, the holder of options will exercise
the right if the options are “in the money”
– They are “in the money” if the holder of the options will benefit
from exercising them
• If company sells (or writes) options, they must be
included in the diluted EPS calculations if dilutive
• Purchased options will always be antidilutive since they
will only be exercised when they are in the money
– Therefore, they are not included in EPS
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Treasury Stock Method
• Applies to written call options and equivalents
• Two assumptions under this method:
1. The options are assumed exercised at the beginning
of the year
2. 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
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Treasury Stock Method - Example
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
Calculate the incremental shares outstanding
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Treasury Stock Method - Example
Total proceeds from exercise (1,500 x $30)
Shares issued upon exercise of options
Treasury shares purchased with proceeds
Incremental shares outstanding
$45,000
1,500
900*
600
* ($45,000/$50)
Dilution occurs because, on a net basis, more common shares
are assumed to be outstanding after the exercise
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Reverse Treasury Stock Method
• Applies to written 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
• The exercise price per share must be greater than
the market price per share for dilution to occur
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Reverse Treasury Stock Method Example
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
Calculate the incremental shares outstanding
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Reverse Treasury Stock Method Example
Amount needed to buy 1,500 shares (1,500 x $30):
$45,000
Shares issued to obtain $45,000 ($45,000  $20):
Number of shares purchased under the put option:
Incremental shares outstanding:
2,250
1,500
750
Dilution occurs because, on a net basis, more common shares
are assumed to be outstanding after the exercise
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Antidilution Revisited
• Securities that cause an increase in EPS if
included in EPS calculations are
antidilutive
• Antidilution can be identified by:
– Computing Diluted EPS resulting from the
conversion and comparing it to Basic EPS
– Computing incremental EPS resulting from the
conversion and comparing it to Basic EPS
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Antidilution - Example
Given:
• Kohl Corporation has $1 million in 6% convertible
debt (convertible to 10,000 common shares)
• Net income is $210,000
• 100,000 common shares outstanding
• Tax rate: 30%
• Basic EPS = $2.10 per share
Determine whether the convertible debt is dilutive
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Antidilution - Example
Test for Antidilution (Option #1 – Diluted EPS)
Adjusted Net Income:
Net Income
After-tax interest adjustment
($1.0m x 6%)(1-.30)
Adjusted Net Income
$210,000
42,000
$252,000
Adjusted Number of Shares:
Shares outstanding
Shares issued on conversion
Adjusted Number of shares
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100,000
10,000
110,000
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Antidilution - Example
Basic EPS
$2.10
Diluted EPS ($246,000  110,000) $2.24
Antidilutive, therefore not disclosed
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Antidilution - Example
Test for Antidilution (Option #2 – Incremental EPS)
Incremental Net Income:
After-tax interest adjustment
($1.0m x 6%)(1-.30)
Adjusted Net Income
42,000
$ 42,000
Incremental Number of Shares:
Shares issued on conversion
Adjusted Number of shares
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10,000
10,000
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Antidilution - Example
Basic EPS
$2.10
Incremental EPS ($42,000  10,000) $4.20
Antidilutive, therefore not disclosed
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Additional Disclosures
• Disclosed in notes to financial statements:
1. Amounts used in both numerator and denominator in
calculating basic and diluted EPS
2. Reconciliation of both the numerator and denominator
values for basic and diluted earnings per share
calculations for income before discontinued
operations
3. Potentially dilutive securities that were not included in
the calculation of EPS because they were antidilutive
4. Description of common share transactions after
reporting period that could have impacted EPS
numbers
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Earnings Per Share
Overview
Basic EPS
Diluted EPS
•Objective of
EPS
•Capital structure
•Complex capital
structure
•Presentation
and Disclosure
•Income available to
common/ordinary
shareholders
•Convertible securities
•Options and warrants
•Weighted average
common/ordinary shares
•Contingently issuable
shares
•Comprehensive
illustration
•Antidilution revisited
•Additional disclosures
•Comprehensive
earnings per share
exercise
Copyright © John Wiley & Sons Canada, Ltd.
IFRS and
Private
Enterprise
GAAP
Comparison
•Analysis
•Comparison of
IFRS and private
enterprise GAAP
•Looking ahead
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Analysis
• EPS is one of the most highly visible
standards of measurement for assessing:
– Management stewardship and
– Predicting a company's future value
• IFRS is therefore very specific regarding
its calculation
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Comparison of IFRS and ASPE
• ASPE does not include standards for
calculating EPS
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Looking Ahead
• EPS standards continue to be revisited as
accounting rules for underlying financial
instruments evolve
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