FAR - Specific Transactions, Events, & Disclosures - Earnings Per Share

Question 1

true/false

EPS measures profitability of a company relative to how much you own of that company?

Answer 1

true

earnings/shares = EPS

Question 2

2 types of EPS

Answer 2

Basic EPS = historical EPS, computed on common shares outstanding ONLY and net income

Diluted EPS = hypothetical EPS, includes assumed conversion of potential common stock (PCS - stock options, convertible securities - items convertible to C/S in future)

DEPS

Question 3

What EPS represents?

Answer 3

Ratio -> income available to common shares / Weighted Avg shares of Common O/S

• computed ONLY for C/S
• Common stock divs have NO effect on EPS
• EPS is not amount of common dividends to be paid

Question 4

Basic EPS

Answer 4

(Net income - Preferred Stock Divs) / WACC

*o/s isn’t year end

Question 5

Diluted EPS

Answer 5

(NI - Preferred stock divs + Adj. to income for assumed PCS) / (WACC + Shares from assumed PCS)

“as if calculation” to see impact on EPS “IF” all PCS were converted

*basic eps is benchmark

Question 6

EPS Reporting Requirements

Answer 6

1) BEPS required to be reported (simple capital structure)
2) DEPS reported ONLY if firm has dilutive PCS (complex capital structure)

Both types are shown on the face of the income statement:

• income from continuing operations
• discontinued operations
• net income

Question 7

amount of preferred dividends is subtracted for noncumulative preferred stock?

Answer 7

Declared amount

Question 8

true/false

dividends subtracted in computing basic EPS are (1) the annual dividend commitment on cumulative preferred whether or not declared or paid, and (2) declared dividends on noncumulative preferred whether paid or not. The firm has negative income. This answer means that the dividends reduce the numerator further - beyond the loss.

Answer 8

true

Question 9

true/false

noncumulative dividends are included because they were declared and one year of cumulative dividends is always included, regardless of whether they were declared. Cumulative dividends must be paid before common receives any dividends

Answer 9

true

Question 10

BEPS Numerator

Answer 10

amount of preferred stock divs to subtract from net income

• subtract 1 full year of cumulative preferred stock divs regardless of amount declared/paid
• subtract declared amount of preferred stock divs if NOT cumulative

Question 11

BEPS Denominator

Answer 11

Computing weighted average shares when stock issued/purchased from treasury during the year; how to handle stock divs/splits

• stock dividends/splits are retroactively applied to BOY
• any stock issuance/treasury stock purchase before a stock div/split is adj.
• div/split also applied to statements of earlier periods shown comparatively

Question 12

Define “contingent shares”.

Answer 12

Shares issuable for little or no cash consideration upon satisfaction of certain conditions.

Question 13

accounting effect of a stock split dividend between balance sheet date and issuance?

Answer 13

Adjustment of all earnings per share (EPS) amounts for stock split or dividend.

Question 14

When are contingent shares considered outstanding?

Answer 14

when their conditions have been met

Question 15

true/false

EPS is used primarily as an input to predictions of future earnings. The stock split and dividend cause the number of shares outstanding to increase, and thus affect the future earnings prospects on a per share basis. These events should be included in the computation of EPS even though they did not occur as of the balance sheet date. Financial statement users view the information as if it were current as of the date of publication.

Answer 15

true

Question 16

Potentially Convertible Securities

Answer 16

Different PCS, user different techniques when computing the numerator/denominator

1) Convertible P/S & bonds, use the “if converted” method -> convertible securities assumed to be converted
2) Stock options/warrants, use “treasury stock method” -> options/warrants assumed to have been exercised
3) more than 1 PCS, use dilution/Antidilution method - use PCS that is most dilutive first

Question 17

Multiple PC

Answer 17

• compute numerator/denominator effect for each PCS
• enter PCS with lowest ratio/compute an initial value for DEPS
• keep going until you have either:

1) entered all PCS
2) find antidilutive PCS -> STOP

Question 18

Antidilution

Answer 18

• never allowed for Income from continuing operations, BUT may occur for other subtotals
• When IFCO = negative, don’t assume exercise/conversion of any PCS & DEPS

Question 19

When are stock options antidilutive?

Answer 19

when option price > market price

Question 20

order of inclusion of preferred common stock into diluted earnings per share?

Answer 20

in order of most dilutive first

Question 21

Which potential common stock (PCS) is the most dilutive when there are multiple PCS?

Answer 21

one with the lowest ratio of numerator effect/denominator effect.

Question 22

Gaap vs IFRS

Dilutive EPS

Answer 22

GAAP:

dilution calculated cumulatively

IFRS:

Dilution calculated each period

Question 23

true/false

If the denominator is decreased by purchasing treasury stock, then the EPS result is increased.

Answer 23

true

smaller denominator = bigger number

bigger numerator = bigger number