EPS Lecture for Acct 414 (for Students)
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Transcript of EPS Lecture for Acct 414 (for Students)
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7/30/2019 EPS Lecture for Acct 414 (for Students)
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Earnings per Share
The Introductory Lecturefor Acct 414
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The most closely watchedstatistic on Wall Street
Earnings pershare (EPS) is
an importantindicator of thesuccess or
failure of acompany.
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Several components of EPS must be
disclosed if there are discontinuedoperations, extraordinary items, orcumulative effects of changes inaccounting principles.
Earnings Per Share:Continuing operations $3.15Discontinued operations .67
Extraordinary loss (.15)Cumulative effect of accounting change .17Net Earnings Per Share $3.84
Cumulative effect item pretty much gone after SFAS No. 154
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Reflects themaximum potential
dilution from allpossible stock
conversions thatwould have
decreased EPS.
Diluted
There may be two EPSnumbers for each item:
Considers onlycommon shares
outstanding
Basic
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Diluted earnings per share
I like to think of it as the
worst case scenario
It is the lowest possible number wed
report for EPSIt is a proforma number, not a fact
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Capital structure determinesreporting
Many companies will report basic earningsper share only
Other companies must report BOTH basic anddiluted earnings per share
It depends on whether the capital structure is
Simple, orComplex
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CommonStock
A simple capital structure consistsof just common stock.
The corporation hasonly common and
nonconvertiblepreferred stock.
It has no convertiblesecurities, stock
options, warrants, orother rightsoutstanding.
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Capital Structures
Complex Capital Structure:The corporation has one or
more instrumentsoutstanding that could result
in issuance of additionalcommon shares.Convertible
Preferred
Stock
Options
ConvertibleBonds
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Capital Structures
Therefore, a company withpotential per share dilution
is considered to have a
complex capital structure.
Note that a potentiallydilutive security doesnot necessarily diluteEPS
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Dilution of Earnings
Dilutive Securities: Securities whoseassumed exercise or conversion results
in a reduction in earnings per share.Antidilutive Securities: Securitieswhose assumed conversion or exercise
results in an increase in earnings pershare.
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Basic Earnings Per Share
Net Income - Preferred DividendsWeighted average number of
common shares outstanding
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Earnings Per Share Example
A company has the following capitalstructure at the end of 2006: 6% Cumulative preferred stock, $100 par
value, issued and outstanding 10,000 shares
Common stock, $10 par, issued 200,000shares, outstanding 180,000 shares
Treasury stock (20,000 shares at cost of$18)
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Step 1 find weighted averageshares outstanding
Date
Common
Stock
Treasury
Stock
Common
SharesOutstanding
Months
Split
Factor Weighted
1/1 to 3/31 200,000 20,000 180,000 3/12
4/1/2006 100,000 100,000
4/1 to 6/29
6/30/2006
6/30 to 8/31
9/1/2006
9/1 to 12/31Weighted average
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Step 1 find weighted averageshares outstanding
Date
Common
Stock
Treasury
Stock
Common
SharesOutstanding
Months
Split
Factor Weighted
1/1 to 3/31 200,000 20,000 180,000 3/12
4/1/2006 100,000 100,000
4/1 to 6/29 300,000 20,000 280,000 3/12
6/30/2006
6/30 to 8/31
9/1/2006
9/1 to 12/31Weighted average
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EPS Example
During 2006, the following transactionstake place:
April 1, 2006 issued 100,000 shares to acquirethe assets of another company. Market value ofshares was $25
June 30, 2006 declared and distributed a 2for 1 stock split effected in the form of astock dividend
September 1, 2006 sold 10,000 shares of thetreasury stock for $28 per share
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Stock Splits & Dividends
All stock splits andstock dividends must beincorporated into the
computation ofweighted averageshares outstanding.
This must done for allperiods presented inthe financialstatements.
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Step 1 find weighted averageshares outstanding
DateCommon
Stock
Treasury
Stock
Common
Shares
Outstanding
MonthsSplit
FactorWeighted
1/1 to 3/31 200,000 20,000 180,000 3/12 2
4/1/2006 100,000 100,000
4/1 to 6/29 300,000 20,000 280,000 3/12 2
6/30/2006 280,000 280,000
6/30 to 8/31 580,000 20,000 560,000 2/12 1
9/1/2006
9/1 to 12/31Weighted average
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Stock Splits & Dividends
This years EPS figuresmay have to be changed
in the future as a result ofstock splits or dividends.
Think about what would
happen if we did NOTmake the adjustment . . .
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EPS Example
During 2003, the following transactionstake place:
April 1, 2003 issued 100,000 shares to acquirethe assets of another company. Market value ofshares was $25
June 30, 2003 declared and distributed a 2 for 1stock split effected in the form of a stock dividend
September 1, 2003 sold 10,000 shares ofthe treasury stock for $28 per share
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Step 1 find weighted averageshares outstanding
DateCommon
Stock
Treasury
Stock
Common
Shares
Outstanding
MonthsSplit
FactorWeighted
1/1 to 3/31 200,000 20,000 180,000 3/12 2
4/1/2006 100,000 100,000
4/1 to 6/29 300,000 20,000 280,000 3/12 2
6/30/2006 280,000 280,000
6/30 to 8/31 580,000 20,000 560,000 2/12 19/1/2006 -10,000 10,000
9/1 to 12/31 580,000 10,000 570,000 4/12 1
Weighted
average 12/12
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Step 1 find weighted averageshares outstanding
DateCommon
Stock
Treasury
Stock
Common
Shares
Outstanding
MonthsSplit
FactorWeighted
1/1 to 3/31 200,000 20,000 180,000 3/12 2 90,000
4/1/2006 100,000 100,000
4/1 to 6/29 300,000 20,000 280,000 3/12 2 140,000
6/30/2006 280,000 280,000
6/30 to 8/31 580,000 20,000 560,000 2/12 1 93,333
9/1/2006 -10,000 10,000
9/1 to 12/31 580,000 10,000 570,000 4/12 1 190,000
Weighted average 12/12 513,333
Multiply shares outstandingby fraction of year and by
split factor
Make sure you have accountedfor all 12 months and no more
than 12 months!
Add
em up
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Step 2 - numerator
Net income = $3,000,000
Preferred dividends =
10,000 shares * $100 * 6% = $60,000
Now lets plug everything into the formula . . .
Note: Always include preferred dividend if it is
cumulative preferred stock. If not cumulative, onlyinclude preferred dividend if declared during year
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Step 3 compute basic EPS
Net income Preferred dividendsWeighted average shares outstanding
$3,000,000 $60,000513,333
$__________
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What if . . .
Taking the same facts, what if thepreferred stock was convertible into 10
shares of common stock at the optionof the stockholder?
This would make it a complex capitalstructure and wed have to report boththe basic EPS we computed plus a dilutedearnings per share figure.
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Convertible preferred
The 10,000 shares of preferred couldbecome 100,000 shares of common
stock (outstanding all year)We would NOT pay the preferreddividend because there would be no
preferred stock
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Diluted EPS
Diluted EPS = $__________Both the $5.73 and the $4.89 would bereported on the face of the income statement
$3,000,000
$0513,333 + 100,000
Net income Preferred dividendsWeighted average shares outstanding
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The If-Converted Method
The conversion of the securities into commonstock is assumed to occur at the beginning ofthe year or date of issue, if later.
Convertible bonds: The interest expense (netof tax) is added back to net income.Convertible preferred: No deduction forpreferred dividends.
The weighted average number of shares isincreased by the additional common sharesassumed issued.
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Treasury Stock Method
Proceeds from conversion are assumed to beused for purchase of treasury stock at
AVERAGE market price.
Purpose is to acquire treasury stock that can bereissued to option or warrant holders. If notsufficient, wed have to issue MORE shares
Any additional shares issued, over treasurystock, are added to weighted- average
shares outstanding. Exercise is assumed to occur on the first day of
the year unless issue date is later.
T St k M th d
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Treasury Stock Method--Example: Basic Data
Assume the following:
Net Income $8,000
Common Shares Outstanding(entire year) 6,000
Stock Options Outstanding 2,000
Exercise Price Per Share on Options $30Average Price of Common Shares $40
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Treasury Stock Method--Example
Basic EPS = $8,0006,000
$1.33Basic EPS =
Net income Preferred dividendsWeighted average shares outstanding
T St k M th d
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Treasury Stock Method--Example: 3 steps
1. Options assumed exercised(2,000*30) = $60,000 cash received
2. Shares assumed repurchased withproceeds ($60,000 / $40) = 1,5003. Additional shares assumed issued:
2,000 from exercise less 1,500
purchased with proceeds = 500 netnew shares
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Treasury Stock Method--Example:
Diluted EPS =$8,000
6,000 + 500
=
$1.23Diluted EPS =
= $8,000/6,500 =
Net income Preferred dividendsWeighted average shares outstanding
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Short-cut formula:
Net new shares
=
Number of sharesto which
option holdersare entitled
*
Avg Mkt Price OptionPrice
Avg Mkt Price
2,000 *
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Formula for diluted EPS
Net income
- Preferreddividends if
preferredstock is NOTconvertible
+ After-tax
bond intereston conver-tible bonds
Weighted average of common shares
assuming maximum dilution(including options)
Getting the lo e t po ible
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Getting the lowest possiblenumber an algorithm
1. Compute the per share effect of eachpotentially dilutive security separately.
2. Make a list from smallest per share numberto largest per share number
3. Compute basic earnings per share4. For diluted EPS, take the securities into EPS
computation one at a time until the nextitem on the list is bigger than the mostrecent EPS figure.