Earnings Per Share
$4.50
$4.00
$3.50
$3.00
$2.50
$2.00
$1.50
$1.00
$0.50
$0.00
Basic
Diluted
1997
1998
1999
2000
2001
Importance of earnings per
share information
 Historical performance of a corporation
 Predictive value
EPS
2
Objective of earnings per share
information
 Present earnings per share possibilities
 No potential dilution
 Maximum dilution
 Antidilutive effect on earnings is not
considered
EPS
3
Two measures of earnings per
share
 Basic earnings per share
– no potential dilution
 Diluted earnings per share
– maximum dilution
EPS
4
Applicability of SFAS #128
 Public companies
– required to report
 Non-public companies
– optional
EPS
5
Basic earnings per share model
Basic
EPS
EPS
=
adjusted
net income
(ANI)

weighted average
number of shares
outstanding
during the period
(S)
6
Adjusted net income
 Net income from continuing operations
 Reduced by preferred stock dividends which
have been declared or are cumulative
EPS
7
Weighted average number of
common shares
 Stock splits/dividends during the period
– require restatement of weighted average
 Stock splits/dividends subsequent to end of
period but prior to issuance of financial
statements
– require restatement of weighted average
 Includes contingently issueable shares if the
necessary conditions have been satisfied
EPS
8
Diluted earnings per share model
Diluted
=
EPS
EPS
adjusted net
income
(ANI)
+ income
adjustment

weighted
average number
of shares
outstanding
during the period
(S)
+ share adjustment
9
Call options and warrants
 “Treasury stock method”
 Capture potential dilution
total shares
Share
obtainable upon
Adjustment =
–
exercise of
(SA)
security
EPS
exercise
proceeds
average market
price of shares
10
Call options and warrants
computational guidelines
 Quarterly averaging technique
– if the reporting period is greater that 3 months,
a quarterly averaging technique is employed
 Which exercise price
– use the lowest exercise price
EPS
11
Option computation
Example: 12,000 options of which 4,000 were exercised at
the beginning of quarter 3. Exercise price equals $20.
Shares
Quarter Obtainable
1
12,000
2
12,000
3
8,000
Treasury
Shares Aquired
$240,000 / $24 = 10,000
240,000 / 22 = 10,909
160,000 / 19 = 8,421
SA
2,000
1,091
0
3,091
SA: 3,091  3 quarters = 1,030 shares
EPS
12
Stock-based compensation
arrangements
 Considered the same as options
 Outstanding at the grant date
 If dilutive, shares should be included in
calculation of DEPS regardless of employees’
rights to the shares
 Proceeds consist of:
cash which must be paid at exercise
unrecognized compensation cost
the tax benefit on tax versus book difference
EPS
13
Contingently issued shares
Based on:
 Passage of time
 Passage of time along with other conditions
 Maintenance of some level of earnings
 Attainment of some level of earnings
 Changes in market price of shares
 Occurrence of events unrelated to earnings or
market price
EPS
14
Contingently issued shares:
Conditions satisfied
 Treatment in BEPS
– include in the calculation of the weighted
average number of shares outstanding as of
the end of the period in which the condition
was satisfied
 Treatment in DEPS
– include in the calculation of the weighted
average number of shares outstanding as of
the beginning of the period in which the
condition was satisfied
EPS
15
Contingently issued shares:
Conditions not yet satisfied
 Treatment in BEPS
– exclude from the calculation
 Treatment in DEPS
– if the future conditions would be satisfied
based on using the current existing
conditions, include as before
– otherwise, exclude from the calculation
EPS
16
Convertible securities
 Types
– convertible bonds
– convertible preferred stock
 “If Converted” method
– what would happen to the income and number
of shares used to calculate DEPS if the
convertible security had been converted
EPS
17
If converted method:
Convertible bonds
Example:
– 1,000 8% $100 bonds issued on 4/1/20X4
– issued at 102
– each bond convertible into 4 common shares
– bonds mature in 10 years
– the effective tax rate is 30%
Calculate IA (income adjustment: net of tax effect on
income assuming conversion) and SA (share adjustment).
EPS
18
If converted method:
Convertible bonds (con’t)
Income adjustment:
1,000 bonds  (8%  $100) = 8,000
2,000 premium  10 years = 200
7,800
 9/12
 .7
$4,095
annual cash interest
premium amort
effective interest exp
(April 1 - Dec 31)
(after-tax rate)
income adjustment
Share adjustment:
1,000 bonds convert to 4,000 shares
 9/12 (April 1 - Dec 31)
3,000 share adjustsment
EPS
19
If converted method:
Convertible preferred stock
 Dividends are a distribution of income, not
a component of income
– income adjustment does not require a tax
effect
 No amortization of premium or discount
EPS
20
Convertible securities:
Special issues
 Variable conversion rates
– always use the conversion rate most favorable to
the holder
 Earnings per incremental share
– evaluate the potential dilutive effect by
considering securities in the order of increasing
incremental impact (IA  SA)
EPS
21
Presentation of EPS information
 In comparative financial statements, if DEPS
is shown for one period, it should be shown
for all periods
 Requirements for interim are the same as
annual requirements
EPS
22
Presentation of EPS Information
(con’t)
 Share amounts for types of income other than
from continuing operations (e.g.,
extraordinary item)
– can be shown on the face or in the notes to the
financial statements
– these calculations use the same number of shares
as does the calculation for EPS from continuing
operations
EPS
23
Special disclosure requirements
 Reconcile the numerator and denominator
used to calculate BEPS to those used for
DEPS
 Preferred dividends effect in arriving at
income available to common stockholders for
the BEPS calculation
 Securities not included in DEPS, because their
effect was antidilutive, which could effect
BEPS in the future
EPS
24
Disclosure of information about
capital structure
 All entities are required to disclose a summary
of the rights and privileges of various
securities outstanding
– for example: dividend and liquidation
preferences, exercise prices for options and
warrants, convertible rates for securities to
common stock
 Entities must disclose number of shares issued
during the past fiscal year or any subsequent
interim periods
EPS
25