Understand why earnings per share EPS is an important number Understand when and how earnings per share must be presented including related disclosures Calculate earnings per share for companies with a simple capital structure ID: 265276
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17
After studying this chapter, you should be able to:Understand why earnings per share (EPS) is an important number.Understand when and how earnings per share must be presented, including related disclosures.Calculate earnings per share for companies with a simple capital structure.Calculate earnings per share for companies with a complex capital structure.Identify the major differences in accounting between ASPE and IFRS, and what changes are expected in the near future.
EARNINGS PER SHARE
2Slide3
Earnings Per Share
3
Overview
Objective of EPS
Presentation and Disclosure
Diluted EPS
Complex capital structure
Convertible securities
Options and warrants
Contingently issuable shares
Antidilution
revisitedAdditional disclosuresComprehensive earnings per share exercise
Basic EPSCapital structureIncome available to common/ordinary shareholdersWeighted average common/ordinary sharesComprehensive illustration
IFRS/ASPE Comparison
Analysis
Comparison of IFRS and private enterprise GAAP
Looking aheadSlide4
Objective of EPS
Earnings per share tells common shareholders how much of the available income is associated with the shares they own (their share of the pie)Provides insight to common shareholders about:Future dividend payoutThe value of their shareholdingsImpact of other financial instruments on their potential earnings (Diluted EPS)4Slide5
EPS Calculation
5Income available to common shareholders
EPS
=
Weighted average number of common sharesSlide6
EPS Calculation
Basic EPSActual earnings and actual number of issued common sharesDiluted EPSEarnings and number of common shares adjusted for “what-if”What would the EPS be if any financial instruments that could be converted to common shares were actually converted
6Slide7
Presentation & Disclosure
Under IFRS, EPS must be reported as part of the income statementException: non public (privately held) corporations (not required under ASPE)Reported for each income component as reported on the income statementEPS relating to discontinued operations (if applicable) may be presented on face of income statement, or disclosed in notesWhere applicable, both Basic EPS and Diluted EPS reported
Presented for all periods reported
Prior period EPS restated for any stock dividends or stock splits
7Slide8
Presentation & Disclosure
If diluted EPS data are reported for at least one period, they should be reported for all periods that are presented, even if they are the same as basic EPSWhen the results of operations of a prior period have been restated as a result of a prior period adjustment, the EPS should also be restatedThe effect of the restatement should then be disclosed in the year of the restatement8Slide9
Presentation & Disclosure - Example
Income Statement Presentation of EPS ComponentsEarnings per share: Income from continuing operations $4.00 Loss from discontinued operations, net of tax (.60) Net Income $3.40
9Slide10
Presentation & Disclosure - Example
EPS Presentation – Complex Capital StructureEarnings per common share:Basic earnings per share $3.80Diluted earnings per share $3.3510Slide11
Presentation & Disclosure - Example
EPS Presentation, with discontinued operations and complex capital structureBasic earnings per share: Income before discontinued operations $3.80 Discontinued operations (.80) Net Income $3.00
Diluted earnings per share: Income before discontinued operations $3.35
Discontinued operations
(.65)
Net Income
$2.70
11Slide12
Earnings Per Share
12
Overview
Objective of EPS
Presentation and Disclosure
Diluted EPS
Complex capital structure
Convertible securities
Options and warrants
Contingently issuable shares
Antidilution
revisitedAdditional disclosuresComprehensive earnings per share exercise
Basic EPSCapital structureIncome available to common/ordinary shareholdersWeighted average common/ordinary sharesComprehensive illustration
IFRS and Private Enterprise GAAP Comparison
Analysis
Comparison of IFRS and private enterprise GAAP
Looking aheadSlide13
Capital Structure
Method of EPS calculation based on the corporation’s capital structureSimple Capital StructureWhen only common shares and preferred share are issued and/or debt with no conversion rightsBasic EPS calculated and presentedComplex Capital StructureWhen common shares plus dilutive securities are issued (i.e. a potential common shares)
Basic and Diluted EPS calculated and presented
13Slide14
Capital Structure
Potential/ordinary shares are securities or other financial instruments issued by a corporation that have an option for the holder to convert the security into common sharesThis conversion could have a negative or dilutive effect on EPS (i.e. may cause EPS to decrease)Examples: debt and equity instruments that are convertible into common shares, warrants, and options Contingently issuable sharesShares issued for minimal consideration (asset exchange) once a certain condition has been met14Slide15
EPS Reporting Requirements
Capital StructureMajor Types of Equity Instruments
Impact on EPS Calculations
Simple
Common shares
Preferred shares
Basic EPS only
Complex
Common shares
Potential Common shares:
Convertible preferred shares
Convertible debt
Options/warrantsContingently issuableOther
Basic and Diluted EPS
15Slide16
EPS – Simple Capital Structure
Common shareholders have a residual interest in the company’s income:Therefore, Income Available to Common Shareholders = Net Income - Preferred Share DividendsSlide17
EPS - Simple Capital Structure
17If the preferred shares are non-cumulativededuct only declared dividendsIf the preferred shares are cumulative
deduct only
declared dividends
, or
if no dividends declared, deduct only one year’s dividendsSlide18
EPS - Simple Capital Structure
If dividends on preferred shares are declared and a net loss occurs, the preferred dividend is added to the loss in calculating the loss per shareIn reporting earnings per share information, dividends declared on preferred shares should be subtracted from income from continuing operations and from net incomeIn other words, dividends on preferred shares should not be deducted in calculating EPS from discontinued operations18Slide19
EPS - Simple Capital Structure - Example
Given: Michael Limited’s Net Income: $3,000,000Shares100,000 Class A preferred, cumulative shares, dividend amount $4.00 per share100,000 Class B preferred, non-cumulative shares, dividend amount $3.00 per shareNo dividends declared or paid in the current yearCalculate the income available to common shareholders
19Slide20
EPS - Simple Capital Structure - Example
Net Income $3,000,000Amount attributable to Class A: 100,000 x $4.00 400,000 2,600,000Amount attributable to Class B: 100,000 x $0.00 -0-
Income available to
common shareholders
$2,600,000
20
The Class B shares are non-cumulative, with no dividends
declared for the year no amount is deducted from Net IncomeSlide21
EPS – Simple Capital Structure
The weighted average number of shares outstanding is weighted by the period of time they were outstandingEach transaction (issue of shares, reacquisition of shares, retirement of shares) represents a weighting periodSlide22
EPS - Simple Capital Structure - Example
DateShare Changes
Shares Outstanding
January 1
Beginning balance
90,000
April 1
30,000 shares issued
120,000
July 1
39,000 shares purchased
81,000
November 1
60,000 shares issued
141,000
December 31
Year end balance
141,000
22Slide23
EPS - Simple Capital Structure - Example
23Dates Outstanding
Shares Outstanding
Fraction Weighted Shares
Portion of Year Outstanding
Weighted Shares
Jan. 1
st
to March 31
st
90,000
3/12
22,500
April 1
st
to June 30
th
120,000
3/12
30,000
July 1
st
to October 31
st
81,000
4/12
27,000
Nov 1
st
to Dec 31
st
141,000
2/12
23,500
Weighted Average Shares Outstanding
103,000Slide24
EPS - Simple Capital Structure
24Stock splits and stock dividends require restatement of the weighted average number of shares outstanding from the beginning of the yearBecause there has been no change in the company’s assets or in the shareholders’ total investmentBy restating the number, valid comparisons of earnings per share can be made between periods before and after the stock split or stock dividendSlide25
EPS - Simple Capital Structure
If there is a stock split or stock dividend after the year end but before the publication of the financial statementsThe weighted average number of shares outstanding must be restatedThis applies to the current year as well as previous years if comparative statements are issued25Slide26
EPS - Simple Capital Structure - Example
Given – Baiye Limited: January 1: 100,000 shares outstanding March 1: Issued 20,000 shares June 1: 50% Stock dividend (60,000 additional shares issued) November 1: Issued 30,000 shares December 31: Ending Balance = 210,000 shares outstanding
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EPS - Simple Capital Structure - Example
Dates O/SShares O/S
Restatement
Fraction of Year
Weighted Shares
Jan-Mar
100,000
X 1.50 X
2/12 =
25,000
Mar-Jun
120,000
X 1.50 X
3/12 =
45,000
Jun-Nov
180,000
X
5/12 =
75,000
Nov-Dec
210,000
X
2/12 =
35,000
Weighted average shares outstanding
180,000
27Slide28
Earnings Per Share
28
Overview
Objective of EPS
Presentation and Disclosure
Diluted EPS
Complex capital structure
Convertible securities
Options and warrants
Contingently issuable shares
Antidilution revisited
Additional disclosuresComprehensive earnings per share exercise
Basic EPSCapital structureIncome available to common/ordinary shareholdersWeighted average common/ordinary sharesComprehensive illustration
IFRS and Private Enterprise GAAP Comparison
Analysis
Comparison of IFRS and private enterprise GAAP
Looking aheadSlide29
Complex Capital Structure
Complex capital structure:When corporation has convertible securities, options, warrants or other rights, andWhen converted these could dilute EPSDilution is the reduction in EPS if:Securities, potentially convertible into common stock, are converted (assumed at beginning of the year)Anti-dilutive securitiesSecurities, when converted, increase EPSAnti-dilutive EPS is not reported, only basic EPS
29Slide30
EPS - Complex Capital Structure
Requires dual presentation of EPSBasic earnings per sharePresented for each separate class of common shareFully diluted earnings per shareOnly securities that reduce earnings per share (dilutive) are consideredSecurities that increase earnings per share (anti-dilutive) are ignoredThe purpose of presenting both EPS numbers is to inform financial statement users of situations that will likely occur and to provide worst-case situations
30Slide31
EPS - Complex Capital Structure
The dilutive effect of convertible securities is measured by the if-converted methodThe dilutive effect of options and warrants is measured by the treasury stock methodFor computing dilution, the rate of conversion most advantageous to the security holder is used (maximum dilutive conversion rate)31Slide32
If-Converted Method
The conversion of the securities into common stock is assumed to occur at the beginning of the yearThe net income must be adjusted for:Interest (net of tax) on the convertible debtDividends on the convertible preferred sharesThe weighted average number of shares is increased by the additional common shares assumed issued (at the beginning of year)32Slide33
If Converted Method - Example
Given:Net income for the year: $210,000Common shares outstanding during the period: 100,000Additional securities outstanding:6% convertible debenture bond sold at 100 for $1,000,000, convertible to 20,000 common shares10% convertible debenture bond sold at 100 for $1,000,000, convertible to 32,000 common shares and issued April 1
st
of current year
Calculate diluted EPS assuming a tax rate of 30%
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If Converted Method - Example
Net income for the year $410,000Add back: Interest on 6% debentures $60,000 x (1-.30) 42,000 Interest on 10% debentures $50,000
x (1-.30) x 9/12 26,250
Adjusted Net Income
$478,250
34Slide35
If Converted Method - Example
Weighted Average Number of Shares 100,000Add: Shares assumed issued: 6% debentures 20,000 10% debentures* 24,000Adjusted Weighted Average Number of Shares 144,000
*32,000 shares x 9/12
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If Converted Method - Example
Conversion is always assumed to be at the beginning of the yearIf a convertible security is not outstanding for the full 12 months of the yearConversion is pro-rated for the number of months the convertible security is actually issuedField Corporation 10% debenture was issued April 1st, therefore the conversion is 32,000 shares times 9 out of 12 months36Slide37
Example - Field Corporation
EPS Calculation and Disclosure: Net income for the year $410,000 Basic EPS($410,000 100,000) $4.10 Diluted EPS
($478,250 144,000)
$3.32
37Slide38
Options and Warrants
Options and warrants (and their equivalents) are included in EPS computationsAn option gives the holder the right to either buy or sell sharesGenerally speaking, the holder of options will exercise the right if the options are “in the money” They are “in the money” if the holder of the options will benefit from exercising themIf company sells (or writes) options, they must be included in the diluted EPS calculations if dilutive Purchased options will always be antidilutive
since they will only be exercised when they are in the money
Therefore, they are not included in EPS
38Slide39
Treasury Stock Method
Applies to written call options and equivalentsTwo assumptions under this method:The options are assumed exercised at the beginning of the year The proceeds from the exercise of options are assumed to be used to buy back common sharesThe exercise price per share must be less than the market price per share for dilution to occur
39Slide40
Treasury Stock Method - Example
Given: Exercise price of an option (for one share of stock): $30Market price of one share at exercise date: $ 50Options deemed exercised: 1,500Calculate the incremental shares outstanding40Slide41
Treasury Stock Method - Example
Total proceeds from exercise (1,500 x $30) $45,000Shares issued upon exercise of options 1,500Treasury shares purchased with proceeds 900* Incremental shares outstanding 600 * ($45,000/$50)
Dilution occurs because, on a net basis, more common shares are assumed to be outstanding after the exercise
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Reverse Treasury Stock Method
Applies to written put options and forward purchase contractsTwo assumptions under this method:Enough common shares issued at beginning of the year for the company to purchase shares under the option or forward contractProceeds from the share issue will be used to purchase shares under the option or forward contractThe exercise price per share must be greater
than the market price per share for dilution to occur
42Slide43
Reverse Treasury Stock Method - Example
Given: Exercise price of an option (for one share of stock): $30Market price of one share at exercise date: $20Options deemed exercised: 1,500Calculate the incremental shares outstanding43Slide44
Reverse Treasury Stock Method - Example
Amount needed to buy 1,500 shares (1,500 x $30): $45,000Shares issued to obtain $45,000 ($45,000 $20): 2,250Number of shares purchased under the put option: 1,500 Incremental shares outstanding: 750
Dilution occurs because, on a net basis, more common shares are assumed to be outstanding after the exercise
44Slide45
Antidilution Revisited
Securities that cause an increase in EPS if included in EPS calculations are antidilutiveAntidilution can be identified by:Computing Diluted EPS resulting from the conversion and comparing it to Basic EPSComputing incremental EPS resulting from the conversion and comparing it to Basic EPS45Slide46
Antidilution - Example
Given:Kohl Corporation has $1 million in 6% convertible debt (convertible to 10,000 common shares)Net income is $210,000100,000 common shares outstandingTax rate: 30%Basic EPS = $2.10 per shareDetermine whether the convertible debt is dilutive
46Slide47
Antidilution - Example
Test for Antidilution (Option #1 – Diluted EPS)47
Adjusted Net Income:
Net Income $210,000
After-tax interest adjustment
($1.0m x 6%)(1-.30)
42,000
Adjusted Net Income
$252,000
Adjusted Number of Shares:
Shares outstanding 100,000
Shares issued on conversion 10,000Adjusted Number of shares 110,000Slide48
Antidilution - Example
Basic EPS $2.10Diluted EPS ($246,000 110,000) $2.24Antidilutive, therefore not disclosed48Slide49
Antidilution - Example
Test for Antidilution (Option #2 – Incremental EPS)49
Incremental Net Income:
After-tax interest adjustment
($1.0m x 6%)(1-.30)
42,000
Adjusted Net Income
$ 42,000
Incremental Number of Shares:
Shares issued on conversion
10,000
Adjusted Number of shares 10,000Slide50
Antidilution - Example
Basic EPS $2.10Incremental EPS ($42,000 10,000) $4.20Antidilutive, therefore not disclosed50Slide51
Additional Disclosures
Disclosed in notes to financial statements:Amounts used in both numerator and denominator in calculating basic and diluted EPSReconciliation of both the numerator and denominator values for basic and diluted earnings per share calculations for income before discontinued operationsPotentially dilutive securities that were not included in the calculation of EPS because they were antidilutiveDescription of common share transactions after reporting period that could have impacted EPS numbers
51Slide52
Earnings Per Share
52
Overview
Objective of EPS
Presentation and Disclosure
Diluted EPS
Complex capital structure
Convertible securities
Options and warrants
Contingently issuable shares
Antidilution revisited
Additional disclosuresComprehensive earnings per share exercise
Basic EPSCapital structureIncome available to common/ordinary shareholdersWeighted average common/ordinary sharesComprehensive illustration
IFRS and Private Enterprise GAAP Comparison
Analysis
Comparison of IFRS and private enterprise GAAP
Looking aheadSlide53
Analysis
EPS is one of the most highly visible standards of measurement for assessing:Management stewardship andPredicting a company's future valueIFRS is therefore very specific regarding its calculationSlide54
Comparison of IFRS and ASPE
ASPE does not include standards for calculating EPSSlide55
Looking Ahead
EPS standards continue to be revisited as accounting rules for underlying financial instruments evolve55Slide56
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