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Dilutive Securities and Earnings Per Share
Learning Objectives
At the end of the presentation, you should learn how to:
1. Compute earnings per share in a simple capital structure.
2. Compute earnings per share in a complex capital structure
3. Disclose EPS information on the statement of income
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Earnings per shareindicates the income earned byeach share of common stock.
Companies report earnings per share only for commonstock.
When income statement contains intermediatecomponents of income, companies should discloseearnings per share for each component.
Computing Earnings Per Share
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Earnings Per Share-Simple Capital Structure
Simple Structure--Only common stock; no
potentially dilutive securities.
Complex Structure--Potentially dilutive securitiesare present.
Dilutivemeans the ability to influence the EPS in
a downward direction.
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Earnings Per Share-Simple Capital Structure
Preferred Stock Dividends
Subtracts the current year preferred stock dividendfrom net income to arrive at income available to
common stockholders.
Preferred dividends are subtracted on cumulativepreferred stock, whether declared or not.
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Earnings Per Share-Simple Capital Structure
Weighted-Average Number of Shares
Companies must weight the shares by the fractionof the period they are outstanding.
Stock dividends or stock splits: companies needto restate the shares outstanding before thestock dividend or split.
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Earnings Per Share
Date Description No. of Shares
1/1 Balance 100,000
4/1 Issued 50,00010/1 Issued 10,000
Compute the weighted average number of shares
of common stock outstanding.
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Earnings Per Share
Compute the weighted average number of shares
of common stock outstanding.
Date Description No. of Shares
Months
Outstanding
Weights
Shares
1/1 Balance 100,000 12/12 100,000
4/1 Issued 50,000 9/12 37,500
10/1 Issued 10,000 3/12 2,500
Weighted average shares outstanding 140,000
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Earnings Per Share
Compute the weighted average number of shares of
common stock outstanding.
Date Description No. of Shares
1/1 Balance 100,000
4/1 Issued 50,000
5/1 Stock dividend(100%) 150,000
10/1 Issued 10,000
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Earnings Per Share
Compute the weighted average number of shares
of common stock outstanding.
1/1 Balance 100,000 12/12 100,000
4/1 Issued shares 50,000 9/12 37,500
5/1 100% stock dividend
Retroactive to 1/1 100,000 12/12 100,000
Retroactive to 4/1 50,000 9/12 37,50010/1 Issued shares 10,000 3/12 2,500
Weighted average shares outstanding 277,500
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Earnings Per Share-Complex Capital Structure
Complex Capital Structure exists when a business
has
convertible securities,
options, warrants, or other rights
that upon conversion or exercise could dilute earnings
per share.
Company reports both basic and diluted earnings per
share.
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Earnings Per Share-Complex Capital Structure
Diluted EPS includes the effect of all potential dilutivecommon shares that were outstanding during the period.
Companies will not report diluted EPS if the securities intheir capital structure are antidilutive.
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Diluted EPS Convertible Securities
Measure the dilutive effects of potentialconversion on EPS using the if-converted method.
This method for a convertible bond assumes:
(1) the conversion at the beginning of the period (or
at the time of issuance of the security, if issuedduring the period), and
(2) the elimination of related interest, net of tax.
Earnings Per Share-Complex Capital Structure
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Earnings Per Share-Complex Capital Structure
Example: (Convertible Bonds):In 2010 BC ltd issued, at par,75, $1,000, 8% bonds, each convertible into 100 shares ofcommon stock. BC had revenues of $17,500 and expensesother than interest and taxes of $8,400 for 2011. (Assume
that the tax rate is 30%.) Throughout 2011, 2,000 shares ofcommon stock were outstanding; none of the bonds wasconverted or redeemed.
Required:
(a) Compute diluted earnings per share for 2011.(b) Assume same facts as those for Part (a), except the 75
bonds were issued on September 1, 2011 (rather than in2010), and none have been converted or redeemed.
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Earnings Per Share-Complex Capital Structure
Solution (a) Compute diluted earnings per share for 2011.
Calculation of Net Income
Revenues $17,500
Expenses 8,400
Bond interest expense (75 x $1,000 x 8%) 6,000
Income before taxes 3,100
Income tax expense (30%) 930
Net income $ 2170
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Earnings Per Share-Complex Capital Structure
(a) Compute diluted earnings per share for 2011.
When calculating Diluted EPS, begin with Basis EPS.
Net income = $2170
Weighted average shares = 2,000= $1.09
Basic EPS
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Earnings Per Share-Complex Capital Structure
(a) Compute diluted earnings per share for 2011.
When calculating Diluted EPS, begin with Basis EPS.
$2170
2,000= $.57
Diluted EPS+ $6,000 (1 - .30)
7,500
Basic EPS= 1.09
$6,370
9,500=
Effect on EPS = .0.56
+
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Earnings Per Share-Complex Capital Structure
Revenues 17,500$
Expenses 8,400
Bond interest expense (75 x $1,000 x 8% x 4/12) 2,000
Income before taxes 7,100
Income taxes (30%) 2,130
Net income 4,970$
Calculation of Net Income
(b) Assume bonds were issued on Sept. 1, 2011 .
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Earnings Per Share-Complex Capital Structure
(b) Assume bonds were issued on Sept. 1, 2011 .
When calculating Diluted EPS, begin with Basis EPS.
$4,970
2,000= $1.42
Diluted EPS$2,000 (1 - .30)
7,500 x 4/12 yr.
$6,370
4,500=
Effect on EPS = .56Basic EPS
= 2.49
+
+
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Earnings Per Share-Complex Capital Structure
Example (Variation-Convertible Preferred Stock):Prior to 2010, BC Ltd issued 40,000 shares of 6%convertible, cumulative preferred stock, $100 par value.Each share is convertible into 5 shares of common stock.
Net income for 2010 was $1,200,000. There were600,000 common shares outstanding during 2010. Therewere no changes during 2010 in the number of common orpreferred shares outstanding.
Required:
(a) Compute diluted earnings per share for 2010.
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Earnings Per Share-Complex Capital Structure
(a) Compute diluted earnings per share for 2010.
When calculating Diluted EPS, begin with Basis EPS.
Net income $1,200,000 Pfd. Div. $240,000*
Weighted average shares = 600,000= $1.60
Basic EPS
* 40,000 shares x $100 par x 6% = $240,000 dividend
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Earnings Per Share-Complex Capital Structure
When calculating Diluted EPS, begin with Basis EPS.
600,000=
$1.50
Diluted EPS$240,000
Basic EPS = 1.60
=
Effect onEPS = 1.20
(a) Compute diluted earnings per share for 2010.
$1,200,000 $240,000
200,000*
$1,200,000
800,000
*(40,000 x 5)
+
+
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Earnings Per Share-Complex Capital Structure
600,000=
$1.67
Diluted EPS$240,000
Basic EPS = 1.60
=
Effect onEPS = 2.00
(a) Compute diluted earnings per share for 2010 assumingeach share of preferred is convertible into 3 shares ofcommon stock.
$1,200,000 $240,000
120,000*
$1,200,000
720,000
*(40,000 x 3)
+
+
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Earnings Per Share-Complex Capital Structure
600,000=
$1.67
Diluted EPS$240,000
Basic EPS = 1.60
=
Effect onEPS = 2.00
$1,200,000 $240,000
120,000*
$1,200,000
720,000
*(40,000 x 3)
Antidilutive
Basic = Diluted EPS
(a) Compute diluted earnings per share for 2010 assumingeach share of preferred is convertible into 3 shares ofcommon stock.
+
+
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Diluted EPS Options and WarrantsMeasure the dilutive effects of potential conversionusing the treasury-stock method.
This method assumes:
(1) company exercises the options or warrants at thebeginning of the year (or date of issue if later),
and(2) that it uses those proceeds to purchase common
stock for the treasury.
Earnings Per Share-Complex Capital Structure
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Earnings Per Share-Complex Capital Structure
Example: (EPS with Options): BC Companys net income for2010 is $40,000. The only potentially dilutive securitiesoutstanding were 1,000 options issued during 2009, eachexercisable for one share at $8. None has been exercised, and
10,000 shares of common were outstanding during 2010. Theaverage market price of the stock during 2010 was $20.
Required
(a) Compute diluted earnings per share.
(b)Assume the 1,000 options were issued on October 1,2010 (rather than in 2009). The average market priceduring the last 3 months of 2010 was $20.
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Proceeds if shares issued (1,000 x $8) $8,000
Purchase price for treasury shares $20
Shares assumed purchased 400
Shares assumed issued 1,000
Incremental share increase 600
Earnings Per Share-Complex Capital Structure
(a) Compute diluted earnings per share for 2010.
Treasury-Stock Method
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Earnings Per Share-Complex Capital Structure
(a) Compute diluted earnings per share for 2010.
When calculating Diluted EPS, begin with Basis EPS.
$40,000
10,000= $3.77
Diluted EPS+
600
Basic EPS= 4.00
$40,000
10,600=
Options
+
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Earnings Per Share-Complex Capital Structure
Proceeds if shares issued (1,000 x $8) 8,000$Purchase price for treasury shares 20$
Shares assumed purchased 400
Shares assumed issued 1,000
Incremental share increase 600Weight for 3 months assumed outstanding 3/12
Weighted incremental share increase 150
Treasury-Stock Method
(b) Compute diluted earnings per share assuming the1,000 options were issued on October 1, 2010.
x
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Earnings Per Share-Complex Capital Structure
(b) Compute diluted earnings per share assuming the1,000 options were issued on October 1, 2010.
$40,000
10,000= $3.94
Diluted EPS
150
Basic EPS= 4.00
$40,000
10,150=
Options
+
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Financial Statement Presentation of EPS Data
Income from continuing operations.
Income before exceptional items.
The cumulative effect of a change inaccounting principle.
Net income.
Earnings per share values are desirable (but notrequired) for exceptional items anddiscontinued operations.
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EPS Presentation and Disclosure
A company should show per share amounts for:
income from continuing operations,
income before exceptional items, and
net income.
Per share amounts for a discontinued operation or an
exceptional item should be presented on the face of the
income statement or in the notes.
Earnings per share values are desirable (but not required) for
exceptional items and discontinued operations.
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Earnings Per Share-Complex Capital Structure
Complex capital structures and dual presentation of EPS requirethe following additional disclosures in note form.
1. Description of pertinent rights and privileges of the varioussecurities outstanding.
2. A reconciliation of the numerators and denominators of the basic
and diluted per share computations, including individual income andshare amount effects of all securities that affect EPS.
3. The effect given preferred dividends in determining incomeavailable to common stockholders in computing basic EPS.
4. Securities that could potentially dilute basic EPS in the future thatwere excluded in the computation because they would beantidilutive.
5. Effect of conversions subsequent to year-end, but before issuingstatements.
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Summary of EPS Computation
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Summary of EPSComputation
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THE END
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