Earnings Per Share

1
Earnings Per Share
2
Importance of earnings per share information

• Historical performance of a corporation
• Predictive value

3
Objective of earnings per share information

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

4
Two measures of earnings per share

• Basic earnings per share
• no potential dilution
• Diluted earnings per share
• maximum dilution

5
Applicability of SFAS 128

• Public companies
• required to report
• Non-public companies
• optional

6
Basic earnings per share model

7
Adjusted net income

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

8
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

9
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
?


10
Call options and warrants

• Treasury stock method
• Capture potential dilution

11
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

12
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
13
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

14
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

15
Contingently issued sharesConditions 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

16
Contingently issued sharesConditions 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

17
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

18
If converted methodConvertible 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).
19
If converted methodConvertible bonds (cont)
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
20
If converted methodConvertible 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

21
Convertible securitiesSpecial 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)

22
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

23
Presentation of EPS Information (cont)

• 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

24
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

25
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