Earnings Per Share

Earnings Per Share

Importance of earnings per share information • Historical performance of a corporation • Predictive value EPS

Objective of earnings per share information • Present earnings per share possibilities • No potential dilution • Maximum dilution • Antidilutive effect on earnings is not considered EPS

Two measures of earnings per share • Basic earnings per share • no potential dilution • Diluted earnings per share • maximum dilution EPS

Applicability of SFAS #128 • Public companies • required to report • Non-public companies • optional EPS

weighted average number of shares outstanding during the period (S) adjusted net income (ANI) Basic EPS =  Basic earnings per share model EPS

Adjusted net income • Net income from continuing operations • Reduced by preferred stock dividends which have been declared or are cumulative EPS

Weighted average number of common shares • Stock splits/dividends during the period • require restatement of weighted average • Stock splits/dividends subsequent to end of period but prior to issuance of financial statements • require restatement of weighted average • Includes contingently issueable shares if the necessary conditions have been satisfied EPS

Diluted earnings per share model weighted average number of shares outstanding during the period (S) + share adjustment adjusted net income (ANI) + income adjustment Diluted EPS =  EPS

total shares obtainable upon exercise of security Share Adjustment (SA) exercise proceeds = average market price of shares Call options and warrants • “Treasury stock method” • Capture potential dilution – EPS

Call options and warrants computational guidelines • Quarterly averaging technique • if the reporting period is greater that 3 months, a quarterly averaging technique is employed • Which exercise price • use the lowest exercise price EPS

Option computation Example: 12,000 options of which 4,000 were exercised at the beginning of quarter 3. Exercise price equals $20. SA: 3,091  3 quarters = 1,030 shares EPS

Stock-based compensation arrangements • Considered the same as options • Outstanding at the grant date • If dilutive, shares should be included in calculation of DEPS regardless of employees’ rights to the shares • Proceeds consist of: • cash which must be paid at exercise • unrecognized compensation cost • the tax benefit on tax versus book difference EPS

Contingently issued shares Based on: • Passage of time • Passage of time along with other conditions • Maintenance of some level of earnings • Attainment of some level of earnings • Changes in market price of shares • Occurrence of events unrelated to earnings or market price EPS

Contingently issued shares:Conditions satisfied • Treatment in BEPS • include in the calculation of the weighted average number of shares outstanding as of the end of the period in which the condition was satisfied • Treatment in DEPS • include in the calculation of the weighted average number of shares outstanding as of the beginning of the period in which the condition was satisfied EPS

Contingently issued shares:Conditions not yet satisfied • Treatment in BEPS • exclude from the calculation • Treatment in DEPS • if the future conditions would be satisfied based on using the current existing conditions, include as before • otherwise, exclude from the calculation EPS

Convertible securities • Types • convertible bonds • convertible preferred stock • “If Converted” method • what would happen to the income and number of shares used to calculate DEPS if the convertible security had been converted EPS

If converted method:Convertible bonds • Example: • 1,000 8% $100 bonds issued on 4/1/20X4 • issued at 102 • each bond convertible into 4 common shares • bonds mature in 10 years • the effective tax rate is 30% Calculate IA (income adjustment: net of tax effect on income assuming conversion) and SA (share adjustment). EPS

If converted method:Convertible bonds (con’t) Income adjustment: 1,000 bonds  (8%  $100) = 8,000 annual cash interest 2,000 premium  10 years = 200 premium amort 7,800 effective interest exp  9/12 (April 1 - Dec 31)  .7 (after-tax rate) $4,095 income adjustment Share adjustment: 1,000 bonds convert to 4,000 shares  9/12 (April 1 - Dec 31) 3,000 share adjustsment EPS

If converted method:Convertible preferred stock • Dividends are a distribution of income, not a component of income • income adjustment does not require a tax effect • No amortization of premium or discount EPS

Convertible securities:Special issues • Variable conversion rates • always use the conversion rate most favorable to the holder • Earnings per incremental share • evaluate the potential dilutive effect by considering securities in the order of increasing incremental impact (IA  SA) EPS

Presentation of EPS information • In comparative financial statements, if DEPS is shown for one period, it should be shown for all periods • Requirements for interim are the same as annual requirements EPS

Presentation of EPS Information (con’t) • Share amounts for types of income other than from continuing operations (e.g., extraordinary item) • can be shown on the face or in the notes to the financial statements • these calculations use the same number of shares as does the calculation for EPS from continuing operations EPS

Special disclosure requirements • Reconcile the numerator and denominator used to calculate BEPS to those used for DEPS • Preferred dividends effect in arriving at income available to common stockholders for the BEPS calculation • Securities not included in DEPS, because their effect was antidilutive, which could effect BEPS in the future EPS

Disclosure of information about capital structure • All entities are required to disclose a summary of the rights and privileges of various securities outstanding • for example: dividend and liquidation preferences, exercise prices for options and warrants, convertible rates for securities to common stock • Entities must disclose number of shares issued during the past fiscal year or any subsequent interim periods EPS

Earnings Per Share