Earnings Per Share
Self Test
Intermediate Accounting 2
Self Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. Earnings per share represents
a. earnings per common share outstanding for the period
b. earnings per all shares of stock issued during the period
c. cumulative earnings per share
d. earnings per share authorized for the period
Answer
A. Earnings per share is a representation of what each outstanding common share earned for the period.
2. Basic weighted average outstanding shares is computed by considering
a. the quantity of shares outstanding at various times during the year
b. the average shares issued during the year
c. all convertible securities that could potentially be issued
d. total outstanding shares at the end of the period
Answer
A. Weighted average shares considers the number of outstanding common shares outstanding changed at different times during the year.
3. The amount of preferred dividends paid is calculated as
a. total par value of preferred shares x stated %
b. the total preferred shares issued x par value x stated %
c. the stated % x preferred stock dollars reported on the balance sheet
d. all of the above
Answer
D. All of the above are common ways to compute preferred dividends. All result in the same total dollar amount.
4. Weighted average number of shares considers
a. purchases of treasury stock a reduction to weighted average shares
b. reissuance of treasury stock an increase to weighted average shares
c. stock dividends retroactive to the beginning of the year
d. all of the above
Answer
D. All of the items listed are considered in computing weighted average number of outstanding common shares.
5. Fully diluted “EPS” is often
a. a “worse case scenario” given current earnings
b. very aggressive
c. a more accurate picture of the current situation
d. not relevant to a potential investor
Answer
A. Fully diluted EPS is often considered a worst-case scenario. It gives EPS given all shares that could be issued from convertible securities were issued and outstanding. It is a very conservative EPS. It is a potential situation that shows the shareholder the extent of dilution that could occur.
6. Fully diluted EPS is computed using
a. current actual earnings and current actual shares outstanding
b. current actual earnings adjusted for potential conversions and all potential shares outstanding given current convertible securities
c. projected earnings and current actual shares outstanding
d. current actual earnings and all potential shares outstanding given all future convertible securities
Answer
B. Fully diluted EPS uses actual current earnings and weighted average outstanding common shares and adjusts both for potential current convertible security conversions.
7. When a convertible bond is included in Fully Diluted EPS
a. interest expense is subtracted from income and weighted average shares are reduced
b. interest expense is included in income and weighted average shares are reduced
c. interest saved is added to income and weighted average shares are reduced
d. interest saved is added to income and weighted average shares are increased
Answer
D. When you assume the convertible bond is converted to common stock, you add shares and you add interest saved to net income. If you assume you no longer have the bond, you do not have to pay interest.
8. Preferred dividends are not subtracted from net income when computing EPS when
a. the preferred stock is cumulative and dividends are not declared
b. the preferred stock is non cumulative and dividends are not declared
c. the preferred stock is cumulative and dividends are declared
d. the preferred stock is non cumulative and dividends are declared
Answer
B. The only time preferred stock dividends are not subtracted from net income when computing EPS is when the preferred stock is non cumulative and dividends are not declared (both no).
9. The “if converted” method assumes
a. the conversion occurred at the beginning of the year
b. the conversion occurred at the end of the year
c. the conversion only occurs if the convertible is anti-dilutive
d. the convertible was not converted this period
Answer
A. This method assumes all convertible securities that were issued before the beginning of the year are converted at the beginning of the year.
10. The “treasury stock method” related to stock options assumes
a. funds received from exercise are used to repay debt
b. funds received from exercise are used to purchase treasury stock
c. funds received from exercise are used to retire treasury stock”
d. treasury stock is purchased which increases weighted average shares
Answer
B. The treasury stock method assumes that the cash received from the assumed exercise is used to purchase treasury stock at the average price to reduce the number of shares outstanding. The net quantity of shares is added to weighted average shares.
11. A common stock equivalent is a security that
a. has the potential to decrease outstanding common shares
b. has the same fair market value as the common stock
c. carries voting rights equivalent to the common stock
d. has the potential to increase outstanding common shares
Answer
D. A common stock equivalent has the potential to increase outstanding common shares at the option of the investor. Common stock equivalents are options, warrants, convertible preferred stock, and convertible bonds.
12. Anti-dilutive occurs when
a. basic EPS is greater than fully diluted EPS
b. basic EPS is less than fully diluted EPS
c. basic EPS is equal to fully diluted EPS
d. convertible securities are not included in fully diluted EPS
Answer
B. Anti-dilutive occurs when fully diluted EPS is higher than basic EPS. The potential for more shares outstanding should reduce earnings per share. A lower EPS is “diluted”.
13. When earnings per share is anti-dilutive the company must
a. remove the anti-dilutive convertible security from the computation
b. report basic EPS and fully diluted EPS as computed
c. only report basic EPS
d. none of the above
Answer
A. A company may not report a higher fully diluted EPS than basic EPS. The convertible security that caused the fully diluted EPS to be higher must be removed from the computation.
14. When calculating weighted average shares, stock splits
a. are not considered in the weighted average shares calculation
b. are included by adding the additional shares to the total calculation
c. and stock dividends are not considered
d. are considered retroactively to the beginning of the year
Answer
D. Stock splits and stock dividends are considered retroactive to the beginning of the year.
15. Fully diluted earnings per share is computed by
a. ignoring basic earnings per share and doing an entirely different calculation
b. adjusting basic earnings per share by potential conversions to common stock
c. adjusting basic earnings per share for income generated from stock options
d. adjusting basic earnings per share for additional interest expense
Answer
B. Fully diluted EPS is basic EPS adjusted for potential conversions to common stock. Stock options do not impact net income (c.). Interest expense is lower when bonds are assumed converted (d.)