Earnings Per Share
Practice as You Learn
Intermediate Accounting 2
Practice as You Learn
You will be required to do the following:
1) Determine weighted average outstanding shares
2) Compute Basic EPS
3) Compute Diluted EPS
4) Determine the instrument that is making EPS anti-dilutive and remove it from the diluted EPS computation
Remember the following:
Basic Earnings per share =
Net Income (loss) for the period – preferred dividends
Weighted average number of common shares of stock outstanding
Diluted Earnings per share =
Rewrite the Basic computation and adjust the top and bottom lines as follows:
Assume convertible preferred stock is converted:
1) Do not deduct the amount for preferred dividends
2) Add the number of shares issued on conversion using the given conversion ratio
Assume the convertible bonds are converted:
1) Add interest expense net of tax to net income
2) Add the number of shares issued on conversion using the given conversion ratio
Assume the options are exercised if the average FMV is > exercise price
1) Add the net number of shares issued to weighted average shares
# Options exercised (shares issued)
x Exercise price
= Cash received
/ Average FMV of stock
= Shares repurchased (reduce outstanding shares)
Shares issued less shares repurchased = the net change that is added to weighted average # shares.
Practice Problem: Earnings Per Share
On January 1, of the current year, the company had 2,000,000 shares outstanding. The company issued 390,000 shares of stock on April 1st. The company issued 50,000 shares of stock on August 1st. On September 30th, the company paid a 2 for 1 stock split. Net income for the current year is $600,000. The company’s tax rate for the current year is 30%.
In addition, the Company had the following convertible securities outstanding on December 31st of the current year:
Stock options granted 2 years ago: 60,000 shares with an exercise price of $15 per share. The average market price during the current year was $24 per share, and the December 31st, closing price was $20 per share.
Convertible bonds issued 3 years ago: face value $400,000, effective rate of 6%.
The bonds are convertible to 1.9 shares of common stock for each $1 face value
of the bond.
Convertible preferred stock issued in the prior year: 10,000 shares at $75 par, 9% dividend; cumulative. The preferred stock is convertible into 3.1 shares of common stock per share at the discretion of the investor. The dividend was declared during
the current year.
A. Calculate weighted average shares:
B. Calculate Basic EPS for the current year.
C. Calculate Diluted EPS for the current year
D. Determine if there are any anti-dilutive securities
Answer
Earnings Per Share
A.
| 1/1 to 3/31 | 2,000,000 x 3/12 x 2 | = | 1,000,000 |
| 4/1 to 7/31 | 2,390,000 x 4/12 x 2 | = | 1,593,333 |
| 8/1 to 9/29 | 2,440,000 x 2/12 x 2 | = | 813,333 |
| 9/30 to 12/31 | 4,880,000 x 3/12 | = | 1,220,000 |
| Total Weighted Average | 4,626,666 | ||
The 2:1 stock split is retroactive back to the beginning of the year.
Multiply every line before the stock split occurs by 2 also
Determine the length of time out of 12 months the number of shares were outstanding
and multiply by time in months /12
Make sure that all your lines add up to 12/12 and the full year is covered
If changes occur in the middle of the month you should use # days / 365
B. Basic EPS
600,000 – 67,500 = $0.12
4,626,666
Preferred dividends paid =
# preferred shares x par value per share x stated %
10,000 x $75 x 9% = 67,500
Preferred dividends are not an expense.
Use the before tax amount.
Always round EPS to dollars and cents
$0.11509 rounds to $0.12
C. Diluted EPS
Begin with the Basic EPS calculation and adjust for assumed conversions
| PS Bond 600,000 – ////// + 16,800 = $616,800 = $0.11 4,626,666 + 31,000 +760,000 + 22,500 5,440,166 PS Bond Options |
Assume each convertible security is converted on January 1st because they have been outstanding for the entire year:
Preferred Stock:
If converted, there is no stock outstanding to pay a dividend.
Do not deduct the preferred dividend
If converted, there will be more common shares outstanding,
Add 10,000 x 3.1 each = 31,000 common shares
Convertible Bond:
If converted, there will be no interest to pay because there is no bond liability.
Add the interest saved, net of tax, to net income.
| Face Value of Bond | 400,000 |
| x Effective Rate | 6 % |
| = Interest not incurred | 24,000 |
| x 1 less tax rate of 30% | 70% |
| = Added income | 16,800 |
| given interest is not incurred | |
If converted there will be more common shares outstanding,
Add 400,000 x 1.9 per = 760,000 shares
Options
Exercise price is < average FMV, assume exercise
|
# Options exercised (shares issued) 60,000 Net to add to shares 22,500
|
D. Determine if securities are anti-dilutive
Check each convertible security on its own to determine if the added EPS
is higher than the Basic EPS of $0.12
Consider what was changed in the equation:
Preferred Stock
67,500 = $2.18
31,000
Convertible Bond
16,800 = $0.02
760,000
Stock Option
0 = $0
22,500
The preferred stock is anti-dilutive.
Since Diluted EPS in total is not more than the basic EPS, do not remove the preferred stock conversion from the diluted EPS calculation.
The convertible bond conversion offsets it.
If EPS is anti-dilutive in total, remove the preferred stock conversion from the Diluted EPS calculation (both on top and on bottom)
Note:
(Some textbooks say that you do remove this security because it is individually anti-dilutive and no offset is allowed, so check your notes).