Ninja Book FAR EPS - CPA PDF

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V

EARNINGS PER SHARE

A.

Fundamental Earnings-per-Share Concepts

01 Earnings per share (EPS) is a comparison of the earnings applicable to common stock with the of common stock of that enterprise. The concept relates only to common stock and should be thought common share.” 02

Assuming that there is no preferred stock outstanding, the fundamental EPS computation is:

Application: During the current year, Comma Co. had outstanding: 25,000 shares of common stock, $20 par, 10% cumulative preferred stock, and 3,000 bonds that are $1,000 par and 9% convertible. T originally issued at par, and each bond was convertible into 30 shares of common stock. During the y was $200,000, no dividends were declared, and the tax rate was 30%. What amount was Comma's b share for the current year? $3.38 $7.36 $7.55 $8.00 B - Convertible bonds do not affect basic earnings per share. They are used in computing diluted ear When the preferred stock dividend preference is cumulative, the current-year dividend on preferred s deducted each year in computing the numerator for basic earnings per share, regardless of the amou dividends actually declared and/or paid. Comma's basic earnings per share for the current year is: ($200,000 - $16,000) ÷ 25,000 weighted-average shares outstanding $184,000 ÷ 25,000 shares = $7.36 per common share 03

If the enterprise has preferred stock outstanding, the fundamental EPS computation is:

04 All EPS computations involve the division of a dollar amount of earnings (earnings applicable to a number of common shares. The resulting fraction or index represents the pro rata share of earnings allocated to each share of common stock (the denominator).

latter case, the earnings per share calculation takes into consideration the impact that the assumed exercise of the securities that constitute potential common stock would have on both the numerator denominator shares. All earnings-per-share computations are based on a weighted-average numbe outstanding or assumed to be outstanding. 07 Earnings per share (EPS) must be presented on the face of the income statement of publicly follows:

Application: Basic earnings per share for income from continuing operations and for net income a on the face of the income statement. in the notes to the financial statements. for the current period only. if diluted earnings per share are presented. A - Basic EPS is reported on the face of the income statement. 08 Because simple capital structures include no potential common stock, earnings per share is c on the weighted-average number of common shares outstanding during the period. Complex capita other hand, include the potential for dilution, and a dual presentation of EPS is required. Basic EPS weighted-average number of actual common shares outstanding during the period. Diluted EPS is b average number of actual common shares outstanding plus the weighted-average number of comm result from the assumed conversion or exercise of all dilutive potential common stock. 09 In certain circumstances, potential common stock may actually increase rather than decrease the potential common stock is said to be anti-dilutive. Since the objective of the dual presentation of potential dilution of EPS by the assumed conversion or exercise of potential common stock, EPS ca

10 Several definitions are important in an understanding of the dual presentation of EPS for enterp complex capital structure. a.

Dilution (dilutive): A reduction in EPS resulting from the assumption that convertible securities that options or warrants were exercised, or that other shares were issued on the satisfaction of (FASB ASC 260-10-20).

b.

Anti-dilution (anti-dilutive): An increase in earnings-per-share amounts or a decrease in loss-

c.

Potential Common Stock (PCS): A security or other contract that may entitle its holder to obta during the reporting period or after the end of the reporting period.

d.

Weighted-Average Common Shares (WACS): The number of shares determined by relating ( time within a reporting period that common shares have been outstanding to (b) the total time in computing WACS, retroactive application is given to stock splits, stock dividends, and shares of issued in a business combination accounted for as a pooling of interests (i.e., they are treated a outstanding for all of any periods presented).

e.

Basic EPS: The amount of earnings for the period available to each share of common stock ou reporting period.

f.

Diluted EPS: The amount of earnings for the period available to each share of common stock o the reporting period and to each share that would have been outstanding assuming the issuanc shares for all dilutive potential common shares outstanding during the reporting period.

11 The most common types of potential common stock are convertible securities, stock options an other contingent issuances (i.e., arrangements whereby the enterprise is required to issue common st satisfaction of certain conditions). Each potential common stock must be evaluated to determine if it is Application: A firm has basic earnings per share of $1.29. If the tax rate is 30%, which of the followin be dilutive? Cumulative 8%, $50 par preferred stock 10% convertible bonds, issued at par, with each $1,000 bond convertible into 20 shares of common s 7% convertible bonds, issued at par, with each $1,000 bond convertible into 40 shares of common sto 6%, $100 par cumulative convertible preferred stock, issued at par, with each preferred share conver shares of common stock C - Dilutive securities reduce earnings per share. To determine dilution, a conversion basis must be s $1,000 bond yields $49 ($70 - 30% tax) of earnings after tax. The conversion increases the number o The earning per share on the converted bonds is only $1.225 (49/40) thus diluting the basic earnings $1 29

12

EPS Computational Guidelines: The basic EPS and diluted EPS computations can be genera

WACS is the weighted-average number of actual common shares outstanding. WPCS is the weighted common shares that would result from the assumed conversion or exercise of dilutive potential commo outstanding. Application: Deck Co. had 120,000 shares of common stock outstanding at January 1, 20X1. On Ju issued 40,000 additional shares of common stock. Outstanding all year were 10,000 shares of nonco cumulative preferred stock. What is the number of shares that Deck should use to calculate 20X1 ear 140,000 150,000 160,000 170,000 A - 120,000 shares x 6/12 year (120,000 shares + 40,000 shares) x 6/12 year Weighted-average shares outstanding

60,000! 80,000! 140,000

! 13 Preferred Stock Dividends: In computing EPS, dividends on preferred stock are subtracted fro all EPS computations for which the preferred stock is assumed to be outstanding. If the preferred stoc amount to be deducted is the total dividend for the period whether it is declared or not. If the preferred noncumulative, the amount to be deducted is the amount actually declared during the current period. T (deduction) is made to convert net income to the amount of earnings applicable to common stock only 14 In making the EPS computations for any given period, dividends in arrears are ignored. The pre applicable to those prior periods (i.e., the dividends in arrears with respect to the current period) shoul into consideration for the EPS computations for those prior periods. 15 If there are preferred dividends and a net loss occurs, the preferred dividends are added to the purposes of computing the loss per share.

Application: Wood Co.'s dividends on noncumulative preferred stock have been declared but not pa declared or paid dividends on its cumulative preferred stock in the current or the prior year and has re in the current year. For the purpose of computing basic earnings per share, how should the income a common stockholders be calculated? The current-year dividends and the dividends in arrears on the cumulative preferred stock should be loss, but the dividends on the noncumulative preferred stock should not be included in the calculation The dividends on the noncumulative preferred stock should be added to the net loss, but the currentthe dividends in arrears on the cumulative preferred stock should not be included in the calculation. The dividends on the noncumulative preferred stock and the current-year dividends on the cumulative should be added to the net loss. Neither the dividends on the noncumulative preferred stock nor the current-year dividends and the div on cumulative preferred stock should be included in the calculation. C - In determining basic earnings per share, cumulative preferred dividends reduce the amount availa shareholders. Consequently, net income should be reduced or net loss increased for the amount of th dividend. 16 Treasury Stock Method (for Stock Options and Warrants) - Stock options and warrants outstand presently exercisable) should be included in EPS calculations unless they are anti-dilutive. 17 The dilutive effect of stock options and warrants is computed by the treasury stock method. This on the assumption that the options or warrants are exercised at the beginning of the period (or date of and the proceeds from the exercise used to purchase outstanding common stock that would then beco (Hence, the name “treasury-stock” method.) The dilutive effect is the net increase in outstanding share sale of the shares (arising from the exercise of the options or warrants) and the reacquisition of outsta the proceeds from the exercise of the options or warrants. Application: The diluting effect of options and warrants and their equivalents is reflected in diluted E of the treasury stock method, which assumes that: proceeds from exercise are used to retire treasury stock. proceeds from exercise are used to issue treasury stock. proceeds from exercise are used to retire convertible debentures that were issued at par. proceeds from exercise are used to purchase common stock at the average market price. D - Exercise of options and warrants is assumed at the beginning of the period. Proceeds are assum purchase common stock at the average market price during the period. The incremental shares are in denominator of diluted EPS.

assumed exercise of the options or warrants. The net result would be a decrease in the number of sha Since a decrease in the number of shares assumed outstanding (the denominator shares) would caus the options or warrants would be anti-dilutive. In that case, one would not assume the exercise of the o in calculating EPS. 20 In summary, options or warrants are assumed exercised only if the average market price of the exercise price of the options or warrants. Application: Options to purchase common stock are excluded from the computation of diluted EPS i they are issued as part of employee compensation arrangements. their exercise price is greater than the average market price. they are employee compensation and the employee may not be able to sell the stock until some futur their exercise price is less than the average market price. B - Options have a diluting effect when the average market price of the common stock exceeds the ex options. (Note that options would not be exercised by holders if the option price exceeds the market p 260-10-45-28A states that stock-based awards are included in diluted EPS even if the employee may them until some future date. 21 Example: An enterprise has outstanding 10,000 options to acquire common stock at $20 and th price of the stock for the period is $25.

Alternatively, the incremental denominator shares could be computed as follows:

Assuming net income of $100,000 and WACS of 50,000, basic EPS and diluted EPS are computed as

22 “If Converted” Method (for Convertible Securities): The “if converted” method assumes that securities are converted into common stock for purposes of computing EPS. It requires that the numer EPS computation be adjusted for the interest savings (net of the related tax effect) or the dividend sav experienced if a convertible security is assumed to be converted into common stock for purposes of th computation. In other words, if one assumes that a convertible security is converted, it would be incon that interest or dividends would be paid on that security after it is assumed to be converted. Therefore earnings must be adjusted for the effect that the assumed conversion of the security would have on th or dividends. Example: A $200,000, 10% bond issue is convertible into 8,000 shares of common stock. Assuming n $100,000, WACS of 50,000, and a tax rate of 40%, basic EPS and diluted EPS are computed as follow

23 Computation of Weighted Average: Both basic EPS and diluted EPS computations are based average shares concept. Under this concept, the computation of the denominator shares takes into co portion of the period that the common shares were outstanding or assumed to be outstanding for purp computations. To illustrate, assume that an enterprise had common stock outstanding as shown:

In like manner, if a potential common stock is outstanding for only part of a period for which EPS computation of the number of common shares that would result from the assumed conversion or exerc common stock would be based on the portion of the period that the potential common stock was actua

Example: A $100,000, 6% bond issue was sold on April 1, 20X1, convertible into 10,000 shares of com Assuming that net income is $200,000, WACS is 100,000, and the effective tax rate is 40%, earnings p follows:

As the example illustrates, the computation of common shares resulting from the assumed conversion into consideration that the bonds were not outstanding during the entire period. The incremental share that would result from the assumed conversion of the bonds are weighted for the portion of the year (9 outstanding. The numerator adjustment for the interest is similarly weighted for the portion of the year outstanding.

Application: Ian Co. is calculating earnings per share amounts for inclusion in Ian's annual report to has obtained the following information from the controller's office as well as shareholder services: ! Net income from January 1 to December 31 $125,000! ! Number of outstanding shares:! January 1 to March 31 15,000! April 1 to May 31 12,500! June 1 to December 31 17,000 In addition, Ian has issued 10,000 incentive stock options with an exercise price of $30 to its employe market price of $25 per share. What amount is Ian's diluted earnings per share for the year ended De $4.63 $4.85 $7.35 $7.94 D - The exercise of the incentive stock options would be anti-dilutive since the exercise price exceeds of the stock. ! Weighted-average shares:! January 1 to March 31 (3/12 x 15 000)

3 750

24 Comprehensive EPS Illustration: You are responsible for completing the income statement of at year-end 20X2. Your workpapers disclose the following opening balances and transactions in the co stock accounts during the year: a.

Common stock (at October 1, 20X1, stated value $10, authorized 300,000 shares; effective Dec stated value $5, authorized 600,000 shares): Balance, October 1, 20X1 — issued and outstanding 60,000 shares December 1, 20X1 — 60,000 shares issued in a 2-for-1 stock split December 1, 20X1 — 280,000 shares (stated value $5) issued at $39 per share

b.

Treasury stock—Common: March 1, 20X2 — purchased 40,000 shares at $38 per share April 1, 20X2 — sold 40,000 shares at $40 per share

c.

Stock purchase warrants, Series A (initially, each warrant was exchangeable with $60 for one c effective December 1, 20X1, each warrant became exchangeable for two common shares at $3 October 1, 20X1 — 25,000 warrants issued at $6 each

d.

Stock purchase warrants, Series B (each warrant is exchangeable with $50 for one common sh April 1, 20X2 — warrants authorized and issued at $10 each

e.

First mortgage bonds, 5½%, due 20X5 (nonconvertible; priced to yield 5% when issued): Balance October 1, 20X1 — authorized, issued, and outstanding—the face value of $1,400,000

f.

Convertible debentures, 7%, due 20X9 (initially, each $1,000 bond was convertible at any time common shares; effective December 1, 20X1, the conversion rate became 30 shares for each b October 1, 20X1 — authorized and issued at their face value (no premium or discount) of $2,40

g.

The market price for the company’s common stock was as follows: 10/01/X1 04/01/X2 09/30/X2

$66 $40 $43

Average for year ended 09/30/X2—$37.50

i.

Required:

(1) (2) (3) (4)

Compute WACS. Compute basic EPS. Determine the per-share effect of each potential common stock (PCS). Compute diluted EPS.

Requirement 1: Compute WACS.

Requirement 2: Compute basic EPS.

Requirement 3: Determine the per-share effect of each potential common stock (PCS). Series A Warrants: Numerator effect = $0 Denominator effect:

Series B Warrants: Anti-dilutive because the average market price of $37.50 is less than the exercise price of $50. 5.5% first-mortgage bonds: Not a potential common stock (PCS) because the bonds are not convertib 7% convertible debentures:

The per-share effects of the relevant potential common stocks arranged in ascending order: Series A stock purchase warrants 7% convertible debentures

$0.00 1.40

Since the per-share effect of the Series A warrants is the lowest, one would assume exercise of these that the per-share effect of the warrants ($0.00) is also less than the basic EPS of $1.54 (see section 4 case, the Series A warrants are dilutive. Assuming the Series A warrants are exercised, the diluted EP

Since the per-share effect of the 7% convertible debentures ($1.40) is lower than the diluted EPS calc assuming exercise of the warrants only, the assumed conversion of the debentures would reduce dilut the debentures are dilutive and their conversion should be assumed. In that case, the diluted EPS is:

Thus, earnings per share would be presented for the year ended September 30, 20X2, as follows:

Application: Timp, Inc., had the following common stock balances and transactions during 20X1: ! 01/01/X1 02/01/X1

Common stock shares outstanding Issued a 10% common stock dividend

30,000! 3,000!

07/01/X1 12/31/X1

Issued common stock for cash Common stock outstanding

8,000! 41,000!

What was Timp's 20X1 weighted-average shares outstanding? 41,000 36,750 41,800 37,000 Shares Outstanding 33,000 (1) 8,000

Fraction x x

x of Year 12/12 6/12

Weighted Shares! = = =

Outstanding! 33,000! 4,000!

! D - Total weighted-average shares outstanding = 37,000! The common stock dividend shares require “retroactive” treatment. They are assumed to be outstand periods presented.

25 Periods for Which EPS Must Be Presented: Earnings per share must be presented for all per income statement or summary of earnings is presented. If diluted EPS is presented for any period incl financial report, it must be presented for all periods included in that financial report. In other words, if d presented for any period, it must be presented for all periods presented. EPS (if applicable, both basic EPS and diluted EPS) must be presented on the face of the income stat the following income captions if they appear on the income statement: a. b. c.

Income from continuing operations Cumulative effect of a change in accounting principle Net income

26 Required EPS Disclosures: An enterprise should make the following disclosures for each per income statement is presented: a.

A reconciliation of the numerators an...