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

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

3. 1.Understand why EPS is an important number. 2.Understand when and how EPS is required to be presented. 3.Identify potential common shares. 4.Calculate earnings per share in a simple capital structure. Learning Objectives

4. 5.Calculate diluted earnings per share using the if- converted method. 6.Calculate diluted earnings per share using the treasury stock method. 7.Calculate diluted earnings per share using the reverse treasury stock method. 8.Identify antidilutive potential common shares. Learning Objectives

5. OverviewObjective Presentation and disclosure Perspectives Usefulness of EPS Earnings Per Share 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

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

7. EPS Calculation Basic EPSBasic EPS –Actual earnings and actual number of issued common shares Diluted EPSDiluted 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 convertedWhat 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 3500.60 requires EPS to be reported as part of the income statementCICA Handbook, Section 3500.60 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 statementReported for each income component as reported on the income statement Where applicable, both Basic EPS and Diluted EPS reportedWhere applicable, both Basic EPS and Diluted EPS reported Presented for all periods reportedPresented 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 Income from continuing operations$4.00 Loss from discontinued operations, Loss from discontinued operations, net of tax (.60) Extraordinary gain, net of tax 1.00 Extraordinary gain, net of tax 1.00 Net Income$4.40 Net Income$4.40

11. EPS Disclosure EPS Presentation – Complex Capital Structure Earnings per common share: Basic earnings per share$3.30 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 Income before extraordinary item $3.80 Extraordinary item.80 Extraordinary item.80 Net Income$3.00 Net Income$3.00 Diluted earnings per share: Income before extraordinary item $3.35 Income before extraordinary item $3.35 Extraordinary item 65 Extraordinary item 65 Net Income$2.70 Net Income$2.70

13. Brief Exercise BE 18-9 EPS Presentation for Schrempf Corp. Net Income$1,480,000Net Income$1,480,000 Extraordinary Loss $ 220,000Extraordinary Loss $ 220,000 Common shares outstanding 50,000Common shares outstanding 50,000

14. Brief Exercise BE 18-9 Basic Earnings Per Share TotalEPS TotalEPS Income before extraordinary loss$1,700,000 $34.00 extraordinary loss$1,700,000 $34.00 Extraordinary loss 220,000 (4.40) Net Income $1,480,000 $29.60

15. Capital Structure Method of EPS calculation based on the corporations capital structureMethod of EPS calculation based on the corporations capital structure Simple Capital StructureSimple Capital Structure –When only common shares are issued –Basic EPS calculated Complex Capital StructureComplex Capital Structure –When common shares plus dilutive securities are issued Potential common sharesPotential 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 sharesSecurities, 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 EPSThis conversion could have a negative, or dilutive effect on EPS –Cause EPS to decrease Contingently issuable sharesContingently 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 Common shares Potential Common shares: –Convertible preferred shares –Convertible debt –Options/warrants –Contingently issuable Basic and Diluted EPS

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

19. EPS – The Numerator Example:Michael Limited Net Income$3,000,000Net Income$3,000,000 SharesShares –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 yearNo 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 $4.00 400,000 100,000 x $4.00 400,000 2,600,000 2,600,000 Amount attributable to Class B: 100,000 x $0.00 -0- 100,000 x $0.00 -0- Income available to common shareholders $2,600,000 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 Number of shares issued is weighted by the period of time they were outstandingNumber 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 periodEach transaction (issue of shares, reacquisition of shares, retirement of shares) represents a weighting period Net Income – Preferred Dividends Weighted Average # of Shares Outstanding

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 141,000

23. EPS – The Denominator Dates Outstanding Shares Outstanding Fraction Weighted Shares Portion of Year Outstanding Weighted Shares Jan. 1 st to April 1 st 90,0003/1222,500 April 1 st to July 1 st 120,0003/1230,000 July 1 st to Nov 1 st 81,0004/1227,000 Nov 1 st to Dec 31 st 141,0002/1223,500 Weighted Average Shares Outstanding 103,000

24. EPS – The Denominator Stock splits and stock dividends require restatement of the outstanding number of shares from the beginning of the yearStock 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 Net Income – Preferred Dividends Weighted Average # of Shares Outstanding

25. A final note (CICA Handbook, Section 3500)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 restatedThe weighted average number of shares outstanding must be restated This applies to the current year, as well as previous years if comparative statements are issuedThis applies to the current year, as well as previous years if comparative statements are issued EPS – The Denominator

26. 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

27. EPS – The Denominator Dates O/S Shares O/S Restatement Fraction of Year Weighted Shares Jan-Mar100,000 X 1.50 X 2/12 = 25,000 Mar-Jun120,000 X 1.50 X 3/12 = 45,000 Jun-Nov180,000X 5/12 = 75,000 Nov-Dec210,000X 2/12 = 35,000 Weighted average shares outstanding 180,000

28. Complex Capital Structure Complex capital structure: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:Dilution is the reduction in EPS, if: –Securities, potentially convertible into common stock, are converted (assumed at beginning of the year) Anti-dilutive securitiesAnti-dilutive securities –Securities, when converted, increase EPS –Anti-dilutive EPS are not reported, only basic EPS

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

30. Diluted Earnings per Share - Methods The dilutive effect of convertible securities is measured by the if-converted methodThe 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 methodThe 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)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 yearThe conversion of the securities into common stock is assumed to occur at the beginning of the year The net income must be adjusted for: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)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 IncomeAdjust 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 amortizationInterest adjusted for any premium or discount amortization –Convertible preferred shares No adjustment to the numerator required if there are convertible preferred sharesNo adjustment to the numerator required if there are convertible preferred shares Adjust (re-calculate) weighted average number of sharesAdjust (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) 36,000 Interest on 10% debentures $100,000 x (1-.40) 45,000 Adjusted Net Income$291,000

34. Field Corporation Unadjusted Weighted Average Number of Shares100,000 Add: Shares assumed issued (converted) 6% debentures 20,000 10% debentures* 24,000 Weighted Average Number of Shares144,000

35. Field Corporation Conversion is always assumed to be at the beginning of the yearConversion 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 yearIf 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 issuedConversion is pro-rated for the number of months the convertible security is actually issued –Field Corporation 10% debenture was issued April 1 st, therefore the conversion is 32,000 shares times 9 out of 12 months

36. Field Corporation EPS Calculation and DisclosureEPS Calculation and Disclosure Net Income$210,000Net Income$210,000 Basic EPS $210,000  100,000$2.10Basic EPS $210,000  100,000$2.10 Diluted EPS $291,000  144,000$2.02Diluted 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 (and their equivalents) included in EPS computations Options and warrants are assumed exercised at the beginning of the year 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 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 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 Total proceeds from exercise: $45,000 Shares issued on exercise: 1,500 Assumed reacquisition of shares: 900 Dilution: 1,000 - 250 = 750 Shares (increase in outstanding shares) 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

39. Reverse Treasury Stock Method Used with put options and forward purchase contractsUsed with put options and forward purchase contracts Two assumptions under this methodTwo assumptions under this method 1.Enough common shares issued at beginning of the year for the company to purchase shares under the option or forward contract 2.Proceeds from the share issue will be used to purchase shares under the option or forward contract

40. Reverse Treasury Stock Method Amount needed to buy back the 1,500 shares: (1,500 * $30)$45,000 Shares issued to acquire needed cash: ($45,000  $20) 2,250 Number of shares purchased through put: 1,500 Dilution: 2,250 – 1,500 = 750 Shares (increase in outstanding shares) 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

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

42. Antidilutive EPS Kohl Corporation $1 million in 6% convertible debt – convertible to 10,000 common shares$1 million in 6% convertible debt – convertible to 10,000 common shares Net Income is $210,000Net Income is $210,000 100,000 common shares outstanding100,000 common shares outstanding Basic EPS = $2.10 per shareBasic 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) 36,000 Adjusted Net Income$246,000 Adjusted Number of Shares: Shares outstanding 100,000 Shares issued on conversion 10,000 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 Net Income adjusted for interest (net of tax) and preferred dividends Weighted average number of common shares assuming maximum dilution Dual EPS Presentation Basic EPS Diluted EPS Dilutive Convertibles Dilutive Options and Warrants Dilutive Contingent Issues

46. Additional Disclosure Disclosed in notes to financial statementsDisclosed in notes to financial statements 1.Adjustments to income 2.Reconciliation of both the numerator and denominator values 3.Potentially dilutive securities

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