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ACCT-365 Earnings per Share Review

Earnings per share (EPS) is one of the most widely used financial ratios. It helps common shareholders and potential investors to evaluate the company's profitability and value. Because of the importance of EPS information, most companies are required to report this ratio on the Income statement.
The calculation of EPS depends on the company's type of capital structure. When a corporation's capital structure consists only of common shares and/or debts without conversion rights, then the company has a simple structure and only Basic EPS is calculated. The calculation is based on income available to common shareholders and the weighted average number of common shares outstanding (WASO).
A company has a complex capital structure if the structure includes securities that have a dilutive (negative) effect on EPS. In this situation the company must calculate basic and fully dilutive EPS. The most common types of dilutive securities are:
• Convertible preferred shares
• Convertible bonds
• Options/warrants

EPS CALCULATION

There are some basic rules for calculating basic and fully diluted EPS in a complex capital structure. The basic EPS is calculated in the same fashion as it is in a simple capital structure.
Basic and fully diluted EPS are calculated for each component of income: income from continuing operations, income before extraordinary items or changes in accounting principle, and net income.

BASIC EPS:

1. Bring Net income to Before Extraordinary items and Discontinued operations basis (EIDO)
2. Are there preferred shares? If so, are they cumulative? If they are cumulative, deduct the full amount of dividend from Net income whether they are declared or not. If they are not cumulative, deduct only dividends declared. If there are not preferred shares, go to step #3
3. Calculate weighted average number of common shares outstanding (WASO)
4. Divide the result of #2 by the weighted average shares from #3 above. This will provide BASIC EPS BEFORE EIDO
5. If there are extraordinary items and discontinued operations, divide each one separately by the weighted average shares from #3 above
6. Add #4 and #5 to get BASIC EPS

Presentation:

      Basic EPS before EIDO               xxx

      Extraordinary Item                      xxx - if applicable

      Discontinued Operation             xxx - if applicable

      Basic EPS                                      XXX

FULLY DILUTIVE EPS:

1. Start with item #4 from BASIC EPS calculation above
2. Test the potentially dilutive items
    a. If the company has convertible bonds, use the if-converted method:
        1.Treat conversion as occurring at the beginning of the year or at issuance date, if it occurred during the year (additive to denominator)
        2. Eliminate related interest expense, net of tax (additive to numerator)

IF METHOD TEST
• Calculate
           Interest Expense x (1-Tax rate) / # shares convertible into
• If the result is greater than Basic EPS before EIDO, then the convertible bonds are anti-dilutive and they have to be excluded from the calculation of EPS
• If the result is less than Basic EPS before EIDO, then the convertible bonds are dilutive. Add the numerator to the numerator and the denominator to the denominator in #1 above

    b. If the company has convertible preferred stock, use the if-converted method:
        1. Eliminate preferred dividend from numerator (decrease numerator) 
        2. Treat conversion as occurring at the beginning of the year or at issuance date, if it occurred during the year (additive to denominator)

IF METHOD TEST
• Calculate
           Dividends / # shares convertible into
• If the result is greater than Basic EPS before EIDO, then the preferred shares are anti-dilutive and they have to be excluded from the calculation of EPS
• If the result is less than Basic EPS before EIDO, then the preferred shares are dilutive. Add the numerator to the numerator and the denominator to the denominator in # 1 above

    c. If the company has Rights, Options, and Warrants use the treasury-stock method:
        1. Assume that exercise occurred at the beginning of the year or issue date, if it occurs during the year.

TREASURY - STOCK METHOD
• Determine the total amount to be received from exercise of Rights, Options, and Warrants
• Assume that proceeds are used to purchase common stock for treasury stock. Divide the proceeds by the market price of the share to determine how many shares the proceeds can buy at the market
• Subtract the number of shares at market from the number of shares provided by the Rights, Options, and Warrants
    1. If exercise price < market price of stock and the market provides less shares, dilution occurs
    2. If exercise price > market price and the market provides more shares, the securities are anti-dilutive and can be ignored in the diluted EPS calculation
• If the securities are dilutive, add the difference between the shares provided at the market and the shares provided by the Rights, Options, and Warrants to the denominator in #1 above

3. Calculate FULLY DILUTIVE EPS BEFORE EIDO
4. If there are Extraordinary Items and Discontinued Operations, divide each one separately by the NEW Weighted Average shares from #3
5. Add #3 and #4 to receive the FULLY DILUTIVE EPS

Presentation:

      Fully dilutive EPS before EIDO               xxx

      Extraordinary Item                                  xxx - if applicable

      Discontinued Operation                         xxx - if applicable

      Fully dilutive EPS                                     XXX


  

 



 

 

 

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