1. Gabriela H. Schneider, CMA Northern Alberta Institute of Technology
INTERMEDIATE ACCOUNTING Seventh Canadian Edition KIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK
Prepared by:
Gabriela H. Schneider, CMA Northern Alberta Institute of Technology 2

2. C H A P T E R 18
Earnings Per Share

3. Learning Objectives Understand why EPS is an important number.
Understand when and how EPS is required to be presented.
Identify potential common shares.
Calculate earnings per share in a simple capital structure.

4. Learning Objectives
Calculate diluted earnings per share using the if-converted method.
Calculate diluted earnings per share using the treasury stock method.
Calculate diluted earnings per share using the reverse treasury stock method.
Identify antidilutive potential common shares.

5. Earnings Per Share Overview Objective Presentation and disclosure
Basic EPS
Simple capital structure
Income available to common shareholders
Weighted average common shares
Comprehensive illustration
Diluted EPS
Complex capital structure
Convertible securities
If-converted method
Options and warrants
Treasury stock method
Reverse treasury stock method
Contingently issuable shares
Antidilution revisited
Additional disclosures
Comprehensive illustration
Perspectives
Usefulness of EPS

6. Importance of EPS Calculated for common shares
Tells shareholders how much of the available income is associated with the shares they own (their share of the pie)
Provides insight to shareholders
Future dividend payout
Future share value
Impact of other financial instruments on their potential earnings (Diluted EPS)

7. EPS Calculation Basic EPS Diluted EPS
Actual earnings and actual number of issued common shares
Diluted EPS
Earnings 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

8. EPS Calculation = Income available to common shareholders EPS
Weighted average number of common shares

9. EPS Disclosure
CICA Handbook, Section requires EPS to be reported as part of the income statement
Exception: non public (privately held) corporation
Reported for each income component as reported on the income statement
Where applicable, both Basic EPS and Diluted EPS reported
Presented for all periods reported
Prior period EPS restated for any stock dividends or stock splits

10. EPS Disclosure Income Statement Presentation of EPS Components
Earnings per share:
Income from continuing operations $4.00
Loss from discontinued operations,
net of tax (.60)
Extraordinary gain, net of tax
Net Income $4.40

11. EPS Disclosure EPS Presentation – Complex Capital Structure
Earnings per common share:
Basic earnings per share $3.30
Diluted earnings per share $2.70

12. EPS Disclosure EPS Presentation, with Extraordinary Item
Basic earnings per share:
Income before extraordinary item $3.80
Extraordinary item
Net Income $3.00
Diluted earnings per share:
Income before extraordinary item $3.35
Extraordinary item
Net Income $2.70

13. Brief Exercise BE 18-9 EPS Presentation for Schrempf Corp.
Net Income $1,480,000
Extraordinary Loss $ 220,000
Common shares outstanding ,000

14. Brief Exercise BE 18-9 Basic Earnings Per Share Total EPS
Income before
extraordinary loss $1,700, $34.00
Extraordinary loss , (4.40)
Net Income $1,480, $29.60

15. Capital Structure
Method of EPS calculation based on the corporations capital structure
Simple Capital Structure
When only common shares are issued
Basic EPS calculated
Complex Capital Structure
When common shares plus dilutive securities are issued
Potential common shares
Diluted EPS calculated

16. Potential Common Shares
Securities, or other financial instruments issued by a corporation that have an option for the holder to convert the security into common shares
This conversion could have a negative, or dilutive effect on EPS
Cause EPS to decrease
Contingently issuable shares
Shares issued for minimal consideration (asset exchange) once a certain condition has been met

17. EPS Reporting Requirements
Capital Structure
Major Types of Equity Instruments
Impact on EPS Calculations
Simple
Common shares
Preferred shares
Basic EPS only
Complex
Potential Common shares:
Convertible preferred shares
Convertible debt
Options/warrants
Contingently issuable
Basic and Diluted EPS

18. EPS - Simple Capital Structure
Net Income – Preferred Dividends
Weighted Average # of Shares Outstanding
If the preferred shares are non-cumulative
include only declared dividends
If the preferred shares are cumulative
include only declared dividends, or
if no dividends declared, include only one year’s dividends

19. EPS – The Numerator Example: Michael Limited Net Income $3,000,000
Shares
100,000 Class A preferred, cumulative shares, dividend amount $4.00 per share
100,000 Class B preferred, non-cumulative shares, dividend amount $3.00 per share
No dividends declared or paid in the current year

20. EPS – The Numerator Net Income $3,000,000
Amount attributable to Class A:
100,000 x $ ,000
2,600,000
Amount attributable to Class B:
100,000 x $
Income available to
common shareholders $2,600,000
The Class B shares are non-cumulative, with no dividends
declared for the year no amount is deducted from Net Income

21. EPS - Simple Capital Structure
Net Income – Preferred Dividends
Weighted Average # of Shares Outstanding
Number of shares issued is weighted by the period of time they were outstanding
Each transaction (issue of shares, reacquisition of shares, retirement of shares) represents a weighting period

22. EPS – The Denominator Date Share 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

23. EPS – The Denominator Dates Outstanding Shares Outstanding
Fraction Weighted Shares
Portion of Year Outstanding
Weighted Shares
Jan. 1st to April 1st
90,000
3/12
22,500
April 1st to July 1st
120,000
30,000
July 1st to Nov 1st
81,000
4/12
27,000
Nov 1st to Dec 31st
141,000
2/12
23,500
Weighted Average Shares Outstanding
103,000

24. EPS – The Denominator Net Income – Preferred Dividends
Weighted Average # of Shares Outstanding
Stock splits and stock dividends require restatement of the outstanding number of shares from the beginning of the year
Because there has been no change in the company’s assets, or in the shareholders’ total investment

25. EPS – The Denominator A final note (CICA Handbook, Section 3500)
If there is a stock split or stock dividend after the year end but before the publication of the financial statements
The weighted average number of shares outstanding must be restated
This applies to the current year, as well as previous years if comparative statements are issued

26. EPS – The Denominator Given – Baiye Limited:
January 1: 100,000 shares outstanding
March 1: Issued 20,000 shares
June 1: 50% Stock dividend (60, additional shares issued)
November 1: Issued 30,000 shares
December 31: Ending Balance = 210, shares outstanding

27. EPS – The Denominator Dates O/S Shares O/S Restatement
Fraction of Year
Weighted Shares
Jan-Mar
100,000
X 1.50 X
2/12 =
25,000
Mar-Jun
120,000
3/12 =
45,000
Jun-Nov
180,000 X
5/12 =
75,000
Nov-Dec
210,000
35,000
Weighted average shares outstanding

28. Complex Capital Structure
When corporation has convertible securities, options, warrants or other rights, and
When converted these could dilute EPS
Dilution is the reduction in EPS, if:
Securities, potentially convertible into common stock, are converted (assumed at beginning of the year)
Anti-dilutive securities
Securities, when converted, increase EPS
Anti-dilutive EPS are not reported, only basic EPS

29. EPS - Complex Capital Structure
Requires dual presentation of EPS
Basic earnings per share
Presented for each separate class of common share
Fully diluted earnings per share
Only securities that reduce earnings per share (dilutive) are considered
Securities that increase earnings per share (anti-dilutive) are ignored

30. Diluted Earnings per Share - Methods
The dilutive effect of convertible securities is measured by the if-converted method
The dilutive effect of options and warrants is measured by the treasury stock method
For computing dilution, the rate of conversion most advantageous to the security holder is used (maximum dilutive conversion rate)

31. The If-Converted Method
The conversion of the securities into common stock is assumed to occur at the beginning of the year
The net income must be adjusted for:
Interest (net of tax) on the convertible debt
Dividends on the convertible preferred shares
The weighted average number of shares is increased by the additional common shares assumed issued (at the beginning of year)

32. The If-Converted Method
Adjust Net Income
Convertible debt issues
Income is adjusted for the after-tax interest that would not have been paid if the debt were converted to common shares
Interest adjusted for any premium or discount amortization
Convertible preferred shares
No adjustment to the numerator required if there are convertible preferred shares
Adjust (re-calculate) weighted average number of shares
Adjusted as if all convertible securities were converted to common shares

33. Field Corporation Net Income for the Year $210,000 Add back:
Interest on 6% debentures
$60,000 x (1-.40) ,000
Interest on 10% debentures
$100,000 x (1-.40) ,000
Adjusted Net Income $291,000

34. Field Corporation Unadjusted Weighted Average Number of Shares 100,000
Add: Shares assumed issued (converted)
6% debentures ,000
10% debentures * ,000
Weighted Average Number of Shares 144,000

35. Field Corporation
Conversion is always assumed to be at the beginning of the year
If a convertible security is not outstanding for the full 12 months of the year
Conversion is pro-rated for the number of months the convertible security is actually issued
Field Corporation 10% debenture was issued April 1st, therefore the conversion is 32,000 shares times 9 out of 12 months

36. Field Corporation EPS Calculation and Disclosure Net Income $210,000
Basic EPS $210,000  100,000 $2.10
Diluted EPS $291,000  144,000 $2.02

37. The Treasury Stock Method
Options and warrants (and their equivalents) included in EPS computations
Options and warrants 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 shares
The exercise price per share must be less than the market price per share for dilution to occur

38. Options and Warrants - Treasury Stock Method
Given:
Exercise price of an option (for one share of stock) $ 30
Market price of one share at exercise date: $ 50
Options deemed exercised: 1,500
Compute the number of weighted shares for determining
diluted earnings per share
Total proceeds from exercise: $45,000
Shares issued on exercise: ,500
Assumed reacquisition of shares:
Dilution: 1, = Shares (increase in outstanding shares)

39. Reverse Treasury Stock Method
Used with put options and forward purchase contracts
Two assumptions under this method
Enough common shares issued at beginning of the year for the company to purchase shares under the option or forward contract
Proceeds from the share issue will be used to purchase shares under the option or forward contract

40. Reverse Treasury Stock Method
Given:
Exercise price of an option (for one share of stock) $ 30
Market price of one share at exercise date: $ 20
Options deemed exercised: 1,500
Compute the number of weighted shares for determining
diluted earnings per share
Amount needed to buy back the 1,500 shares: (1,500 * $30) $45,000
Shares issued to acquire needed cash: ($45,000  $20) ,250
Number of shares purchased through put: ,500
Dilution: 2,250 – 1,500 = Shares (increase in outstanding shares)

41. Antidilutive Potential Common Shares
Securities that cause an increase in EPS if included in EPS calculations
Convertible debt antidilutive if conversion increases EPS to increase by a greater amount than EPS before conversion
For example:

42. Antidilutive EPS Kohl Corporation
$1 million in 6% convertible debt – convertible to 10,000 common shares
Net Income is $210,000
100,000 common shares outstanding
Basic EPS = $2.10 per share

43. Antidilutive Shares Test for Antidilution
Adjusted Net Income: Net Income $210,000 After-tax interest adjustment ($1.0m x 6%)(1-.40) ,000 Adjusted Net Income $246,000
Adjusted Number of Shares: Shares outstanding ,000 Shares issued on conversion ,000 Adjusted Number of shares 110,000

44. Antidilutive Shares Diluted EPS = $246,000  110,000 = $2.24
Basic EPS = $2.10
Antidilutive, therefore not disclosed

45. Earnings per Share: Complex Structures - Summary
Dual EPS Presentation
Basic EPS
Diluted EPS
Net Income adjusted for
interest (net of tax) and
preferred dividends
Weighted average number of
common shares assuming
maximum dilution
Dilutive Convertibles
Dilutive Options and Warrants
Dilutive Contingent Issues

46. Additional Disclosure
Disclosed in notes to financial statements
Adjustments to income
Reconciliation of both the numerator and denominator values
Potentially dilutive securities

47. COPYRIGHT
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