Earnings Per Share (EPS)

Question 1

What is Earning Per Share?

Answer 1

the amount of earnings attributable to one share of common stock.

Question 2

What is a simple capital structure?

Answer 2

A company has common stock, nonconvertible preferred stock, and other nonconvertible instruments.

Only report Basic EPS

Question 3

What is a complex capital structure?

Answer 3

A company has oustanding stock options or convertible securities.

Report both Basic EPS and Diluted EPS

Question 4

How are Basic and Diluted EPS reported?

Answer 4

Calculated for Income from continuing operations (i/S)
Calculated from net income if different (I/S)
Calculated from Discontinued operations (I/S or notes)

Question 5

Basic EPS Formula

Answer 5

Basic EPS = Net Income - Cumulative preferred stock dividends /
Weighted average # common shares oustanding

Question 6

What is cumulative preferred stock?

Answer 6

Cumulative preferred stock - the dividends declared or not are subtracted from net income. They must be paid first when dividends are declared.

Question 7

Diluted EPS

Answer 7

Calculated for Complex capital structures and is based on events that have not yet happened. Only calculated if the effect is dilutiive - decreases EPS.

Question 8

Treasury stock method

Answer 8

1. Assume all options are exercised
2. Purchase treasury shares with proceeds at market price
3. Add the incremental shares to denominator in EPS calculation

Question 9

If-Converted Method

Answer 9

Assumes all convertible securities are converted at the beginning of the earliest period reported or issuance date if during the current period reported.

Question 10

If converted (Preferred Shares)

Answer 10

The numerator decreases by dividends not paid.
Denominator increased by the new outstanding common stock.

Question 11

If Converted (Convertible Bonds)

Answer 11

Numerator: + Add interest expense net of tax
Denomiator: +Add the new common shares outstanding

Question 12

During the current year, Chan Co. had net income of $120,000 and an income tax rate of 30%. Chan had convertible 10-year bonds with a face value of $1,000,000 outstanding since January 1. The stated rate of interest on the bonds is 9%. The bonds are convertible into 5,000 shares of Chan’s common stock. Chan had 12,000 shares of common stock outstanding during the entire year. Chan has no preferred stock outstanding and no other convertible securities. Determine Chan’s diluted earnings per share for the year ended December 31.

What is Basic EPS?

What is Diluted EPS?

Answer 12

Basic EPS = $10.00
Diluted EPS = $10.76

Diluted EPS > Basic EPS; only Basic EPS is reported

Question 13

A company had 220,000 shares of common stock outstanding at January 1, Year 2. On July 1, Year 2, it issued 80,000 additional shares of common stock. 20,000 shares of convertible cumulative preferred stock ($55 par, 2%) were outstanding all year. Each share of the convertible preferred stock is convertible into one share of common stock. If the company’s tax rate is 30% and Year 2 net income is $540,000, calculate its diluted earnings per share and basic eps.

Answer 13

Basic EPS =$1.99
Diluted EPS=$1.93

DIlutive EPS < Basic EPS; both are reported.