Stice | Stice | Skousen Intermediate Accounting,17E Earnings Per Share PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University 18-1 © 2010 Cengage Learning Dividend Payout Ratio • Investors are interested in dividends and can use EPS data to compute a dividend payout ratio • Compute by dividing dividends per share by earnings per share • Earnings per share data receive wide recognition in the annual reports issued by companies, in the press, and in financial reporting publications 18-2 Simple and Complex Capital Structures • Dilutive securities are securities whose assumed exercise or conversion results in a reduction in earnings per share • Antidilutive securities are securities whose assumed conversion or exercise results in an increase in earnings per share (continues) 18-3 Simple and Complex Capital Structures • In February 1997 the FASB, working with the IASC, issued Statement No 128, “Earnings per Share.” • The new standard eliminated most of the arbitrary and complex EPS computations that had evolved and replaced them with a historical-based basic EPS (continues) 18-4 Simple and Complex Capital Structures Basic Considers only common shares issued and outstanding Diluted Reflects the maximum potential dilution from all possible stock conversions that would have decreased EPS (continues) 18-5 Simple and Complex Capital Structures A simple capital structure is one where a corporation― • has only common stock • has only common and nonconvertible preferred stock outstanding • has no convertible securities, stock options, warrants, or other rights outstanding (continues) 18-6 Simple and Complex Capital Structures The Basic Equation for EPS: Net Income – Preferred Dividends Weighted-Average Common Shares Outstanding (continues) 18-7 Simple and Complex Capital Structures If the corporation has one or more instruments outstanding that could result in issuance of additional common shares, thus causing a dilution of earnings per share, it has a complex capital structure 18-8 Issuance or Reacquisition of Common Stock Jan to May 10,000 × 4/12 = 3,333 May to Nov 15,000 × 6/12 = 7,500 Nov to Dec 31 Weighted-average number of shares 13,000 × 2/12 = 2,167 13,000 18-9 Stock Dividends and Stock Splits A company had 2,600 shares of common stock outstanding on January The following activities affecting common stock took place during the year Shares issued for exercise of options on February 400 Shares issued for 10% stock dividend on May 300 Shares sold for cash on September 1,200 Shares repurchased on November 400 (continues) 18-10 Shares issued for 3-for-1 stock split on Illustration of Diluted Earnings per Share with Convertible Securities Note Diluted = EPS Net income + Interest after tax savings Total shares assumed issued Diluted = EPS $83,000 + $28,000 = $0.79 100,000 + 40,000 18-43 Computation of Diluted Earnings per Share for Securities issued during the Year If the securities had been issued by Reid Corporation on June 30 of the current year, an adjustment in the calculation would be needed to reflect the issuance date, or one-half of a year (continues) 18-44 Computation of Diluted Earnings per Share for Securities Issued during the Year In the previous illustration, instead of 8% convertible bonds, assume the company has 8% preferred stock outstanding, par value $500,000, convertible into 40,000 shares of common stock The preferred stock was outstanding for the entire year (continues) 18-45 Computation of Diluted Earnings per Share for Securities Issued during the Year Basic earnings per share: Net income, without the deduction for interest on bonds $111,000 Less: Preferred dividends 40,000 Net income identified with common stock $ 71,000 Actual number of shares outstanding ÷100,000 Basic EPS ($71,000/100,000) $0.71 18-46 Computation of Diluted Earnings per Share for Securities Issued during the Year Diluted earnings per share: Net income assuming no payment of preferred dividends due to conversion $111,000 Actual number of shares outstanding 100,000 Additional shares issued on assumed conversion of preferred stock 40,000 Adjusted number of shares 140,000 Diluted EPS ($111,000/140,000) $0.79 18-47 Effect of Actual Exercise or Conversion 400,000 × 9/12 of year OR 300,000 500,000 × 3/12 of year 125,000 Weighted-average number(continues) of shares for basic EPS 425,000 18-48 Effect of Actual Exercise or Conversion 18-49 Effect of a Loss from Continuing Operations on EPS Assume the following data for Boggs Co Computation of basic and diluted EPS is shown on Slide 18-51 (continues) 18-50 Effect of a Loss from Continuing Operations on EPS Adjusted number of shares 120,000 …………………………………………………… ………………………………………… Diluted loss per share ($50,000/120,000) $ (0.42) 18-51 Multiple Potentially Dilutive Securities • The FASB requires selection of the combination of securities producing the lowest possible EPS figure • Any dilutive stock options and warrants are considered first before introducing convertible securities into the computations (continues) 18-52 Multiple Potentially Dilutive Securities A company had no stock options but did have four convertible securities that would have the following effects on diluted EPS if each were considered separately (continues) 18-53 Multiple Potentially Dilutive Securities Basic EPS was $6.50 ($2,275,000/350,000 outstanding shares) Dilution is determined by adding one security at a time to the basic EPS figure as follows: 18-54 Multiple Potentially Dilutive Securities It would not be necessary to continue the computation beyond Security B because the EPS at that point is lower than the incremental EPS impact of Security C 18-55 Financial Statement Presentation Firms are required to provide the following disclosure items in the notes to the financial statements: A reconciliation of both the numerators and the denominators of the basic and diluted EPS computations for income from continuing operations The effect that preferred dividends have on the EPS computations (continues) 18-56 Financial Statement Presentation Securities that could potentially dilute basic EPS in the future that were not included in computing diluted EPS this period because those securities were antidilutive for the current period Disclosures of transactions that occurred after the period ended but prior to the issuance of financial statements that would have materially affected the number of common shares outstanding or potentially outstanding such as the issuance of stock options 18-57 ... outstanding (continues) 18- 6 Simple and Complex Capital Structures The Basic Equation for EPS: Net Income – Preferred Dividends Weighted-Average Common Shares Outstanding (continues) 18- 7 Simple and... 18- 8 Issuance or Reacquisition of Common Stock Jan to May 10,000 × 4/12 = 3,333 May to Nov 15,000 × 6/12 = 7,500 Nov to Dec 31 Weighted-average number of shares 13,000 × 2/12 = 2,167 13,000 18- 9... Shares repurchased on November 400 (continues) 18- 10 Shares issued for 3-for-1 stock split on Stock Dividends and Stock Splits (continues) 18- 11 Stock Dividends and Stock Splits • All stock