Dr. M.D.

Chase
Advanced Accounting 610 -72B

Long Beach State University

Consolidated Earnings Per Share
Page 1
Review of EPS

I. EARNINGS PER SHARE (Review)

A. Simple Capital Structure:
1. No potentially dilutive securities exist
EPS =

Net Income Available to CS

C/S outstanding*

* This is the weighted average number of shares outstanding if shares were outstanding for only part of a period
B. Complex Capital Structure:
1. Convertible securities, and/or stock options, warrants and rights are outstanding: In a complex capital structure a dual presentation of EPS
is required.
a. PEPS: Primary Earnings per share is defined as:
PEPS =

Net Income Available to CS

C/S outstanding + CSE

CSE =Common Stock Equivolents:-- Securities that derive a substantial portion of their value from the fact that they are convertible into
common stock;
-- SFAS-55 defines CSE as convertible securites whose effective yield at issuance is less than 2/3 the Aa Corporate Bond Yield
--Stock options, rights and warrants are always CSE;
--If CSE exist, CSE are always included in the denominator
b. FDEPS: Fully Diluted Earnings per share is defined as:
FDEPS =

Net Income Available to CS

C/S outstanding + CSE + All CS created under "if converted" method promulgated in APB-15

"If Converted" Method: Convertible securities are assumed to have been converted to CS at the beginning of the current period or at their
date of issuance, if issued during the period. All interest and/or dividends due these securities must be added back
to net income available to CS (increasing the numerator).
FDEPS must result in a lower EPS number than PEPS or it is not reported;
The Treasury Stock Method will be used to determine the dilutive effect of stock options rights and warrants;
1. Determine the proceeds to be received from the excercise of rights/warrants;
2.Determine the number of shares of C/S that can be acquired at average market price (PEPS) or the greater of average market price or
ending market price (FDEPS) using the proceeds as defined in step 1 above;
3.Determine the net increase in number of shares outstanding by deducting the number of shares acquired in step 2 from the number of
shares issued in step 1. This net increase is added to the denominator to the EPS algorithm.
4.If options, rights or warrants are outstanding for only part of a period, the net increase in shares must be weighted for the time period
outstanding (this is the same as the normal weighted average number of shares computation)
5. To be included under the TS method, all warrants/rights/options must be dilutive:

Dr. M.D. Chase

Advanced Accounting 610 -72B

Long Beach State University

Consolidated Earnings Per Share
Page 2

PEPS: average market $ > excercise $

FDEPS: greater of average market $ of ending market $ > excercise $
Short cut approach to TS method:

Net increase in shares = (Market Price per share - Excercise Price per share) x Number shares excercised

Market Price per share

II. CONSOLIDATED EARNINGS PER SHARE

A. Subsidiary Capital Structure:
1. Subsidiary has a "Simple Capital Structure" (no potentially dilutive securities)
a. Calculation of of Consolidated EPS is not affected; all normal procedures for the computation of EPS are followed by each firm; there is no
consolidated affect:
Consolidated EPS =

Consolidated Net Income

Parent C/S outstanding*

*Numerator/Denominator adjustments required due to Parent Dilutive Securities are handled in the normal manner
2. Subsidiary has a "Complex Capital Structure":
a. Issue: do subsidiary warrants, options and convertible securities enable the holders to acquire common stock of subsidiary or common stock
of parent
1. Subsidiary dilutive securities allow holder to acquire Sub C/S:
Step 1: Compute Subsidiary EPS in the normal manner;
Step 2: Compute Consolidated EPS using the Subsidiary EPS computed in step 1 as an adjustment to the numerator;
Subsidiary dilutive securities allow holder to acquire Sub C/S
Cons EPS = PIGNI + P EPS income adj + [("P" equiv Shares of "S" securities) x ("S" EPS)]
P C/S outstanding + Parents share adj.
This model is appropriate for both PEPS AND FDEPS
EXAMPLE:
--"S", an 80% sub of "P" has 5000 shares of stock outstanding
--"S" also has 1000 warrants good for 1000 shares of "S" C/S
(option price=$10/sh; avg mrkt price=$20/sh; Yr end Price=$25/sh)
--"S" has debentures convertible into 2000 shares of "S" C/S
--"P" owns 500 warrants and 90% of the debentures (which are CSE)
--"P" has outstanding debentures (CSE) that pay $5000 interest/yr and are convertible into 3000 shares of "P" C/S
--interest on "S" debentures is $3000 annually
--"S" NI (adjusted for intercompany items) was $22,000
--"S" declared a $2000 dividend on nonconvertible P/S (not held by P)
--"P" internally generated NI=$40,000 and 10,000 shares C/S outstanding
Required:
1. Compute PEPS for subsidiary (USE TREASURY STOCK METHOD)
2. Compute Consolidated PEPS

Dr. M.D. Chase

Advanced Accounting 610 -72B

Long Beach State University

Consolidated Earnings Per Share
Page 3

Solution: (1)
Subsidiary PEPS = $22,000 - $2000(a) + $3000(b) = $3.07
5000 + 2000(c) + 500(d)
(a) dividend on P/S
(b) add back expense on convertible debentures (CSE)
(c) shares issued on conversion of debentures
(d) share adjustment on warrants (1000x$10)/$20=500; 1000-500=500
Solution: (2)
Cons EPS = $40,000 + $5000(a) + $12,280(b) + $5525(c) + $768(d) = $4.89
10,000 + 3000(e)
(a) add back interest on CSE debentures
(b) "P" interest in "S" NI associated with C/S:(.8)(5,000x$3.07)
(c) "P" interest in "S" NI associated with debentures: (1800/2000)(2000x$3.07)=$5526
(d) "P" interest in "S" NI associated with warrants:
(500/1000)(500 incremental shares O/S x $3.07)=$768
(e) adjust number of shares O/S under "if converted" method

2. Subsidiary securities enable the holder to acquire CS of the Parent

a. Securities are not included in the computation of subsidiary EPS but must be included in the Parents share adjustment for
consolidated EPS.
Subsidiary securities enable the holder to acquire CS of the Parent
Cons
EPS

= PIGNI + P NI Adj + [("P" Equiv Shares of"S") x (S EPS)] + Adj to P NI due to S CS which allow holder to acquire P C/S
"P" C/S outstanding + adjustments to "P" stock outstanding

EXAMPLE:
--"P" has NI of $20,000 and 10,000 shares of C/S outstanding
--"P" has outstanding dilutive securities which are CSE,
they pay $1000/yr interest and are convertible into 2000 shares of C/S.
--"S" has NI of $7,000 and 4000 shares of C/S outstanding
--"S" has convertible P/S which are convertible into 2000 shares of "P" C/S.
This stock pays $1,200 dividend and is a CSE for computing "P" EPS.
--"S" also has outstanding 100 warrants to acquire 100 shares of "P" C/S.
(option price=$10; avg mrkt price+$20; ending market price=$25)
--"P" owns 90% of "S" C/S
Cons
PEPS = $20,000 + $1,0009(a) + (.9)(4000 x $7,000 - $1,200)(b) + $1,200(c))
4000
10,000 + 2000 +2000 + 50 (d)
= $1.95
(a) adjust "P" NI for its convertible securities (CSE)
(b) adjust "P" NI for "S" securities effecting consolidated EPS
(c) add back dividends on "S" securities that will not be paid under the "if converted" method but will effect consolidated EPS only.
(d) adjust "P" C/S outstanding for potentially dilutive securities.
NOTE:1. When acquisitions of potentially dilutive subsidiary securities occur during the reporting period normal requirements of
computing the weighted average number of shares apply. Remember to exclude purchased net income where applicable.

Dr. M.D. Chase

Advanced Accounting 610 -72B

Long Beach State University

Consolidated Earnings Per Share
Page 4

a. When the acquisition is a pooling the computation of Consolidated EPS includes "S" income for the entire period;
b. When the acquisition is a purchase the computation of Consolidated EPS includes "S" income since acquisition date;

Consolidated EPS and FDEPS: Illustrative Example

"P" Acquires 80% of "S" on 1/1/x2. As of 12/31/x4 the following facts applied:

Internally Generated Net Income..........................

$
C/S outstanding during year..............................
Warrants to acquire "P" stock outstanding during year....
5% convertible $100 par preferred stock outstanding......
Non convertible $100 par preferred stock outstanding.....

"P"
50,500
$
20,000 shares
2,000 warrants

"S"
56,000
12,000 shares
1,000 warrants
800 shares

1,000 shares

Additional Information:
a. The warrants to Acquire "P" stock were issued in 20x3. Each warrant can be exchanged for one share of "P" common stock (exercise price
$12/share). The three month test was met in 20x3.
b. Each share of convertible preferred stock can be converted into two shares of "S" common. The preferred stock pays an annual dividend
totaling $4,000. When issued in 20x2, the Aa bond yield was 6%. "P" owns 60% of the convertible preferred stock.
c. The nonconvertible preferred stock was isued on 7/1/x4, and payed a six month dividend totalling $500.
d. Relevant market prices per share of "P" common stock during 20x4 were:
Average
Ending
1st Quarter.............
$10
$11
2nd Quarter.............
12
14
3rd Quarter.............
13
15
4th Quarter.............
16
15
Required:1.Compute primary and fully diluted consolidated EPS for the year ended 12/31/x4
Solution: Computation of Consolidated PEPS and FDEPS

Note:1. Under the treasury stock method, warrants must be dilutive (Average Market $ > Exercise $); therefore for the first two quarters
of 20x4 the warrants will not be included
2. Average price is used for PEPS; Ending price is used for FDEPS
3. Subsidiary convertible PS is not CSE (effective yield > 2/3 of Aa corporate bond)

Dr. M.D. Chase

Advanced Accounting 610 -72B

Long Beach State University

Consolidated Earnings Per Share
Page 5

A. Computation of Subsidiary EPS: [(Subsidiary has complex capital structure, PS is convertible but not CSE)]
1. Subsidiary PEPS =

Net Income Available to CS

C/S outstanding + CSE
=

2. Susidiary FDEPS

$56,000 - $4,000 div to PS

12,000 + 0

$4.33

Net Income Available to CS

C/S outstanding + CSE + All CS created under "if converted" method promulgated in APB-15
=

$56,000
12,000 + 0 + (800 x 2)

$4.12

B. Computation of Consolidated EPS:(Complex capital Structure; CSE: warrants outstanding; Convertible securities allow purchase of "P" C/S)
1. Consolidated PEPS:
Cons
P NI
Adj to P NI due to S sec which
PEPS = P NI + Adj + [("P" Equiv Shares of"S") x (S EPS)] + allow holder to acquire P C/S
"P" C/S outstanding + adjustments to "P" stock outstanding
= ($50,500 - $500) + (.80 x 12,000 shares)($4.33) + 0
20,000 + 163* + 82*
= $50,000 + $41,568
20,245

= $4.52

*Short cut approach to TS method:

Net increase in shares = (Market Price per share - Excercise Price per share) x Number shares excercised

Market Price per share

Warrants held by "P":

Quarter 1: Average Market $ < Excercise $; not dilutive
Quarter 2: Average Market $ = Excercise $; not dilutive
Quarter 3: [$13 - $12/$13] (2000) = 154 shares x 1/4 year = 38 weighted average shares
Quarter 4: [$16 - $12/$16] (2000) = 500 shares x 1/4 year = 125 weighted average shares
Total weighted average shares...................... 163 weighted average shares
Warrants held by "S":
Quarter 1: Average Market $ < Excercise $; not dilutive
Quarter 2: Average Market $ = Excercise $; not dilutive
Quarter 3: [$13 - $12/$13] (1000) = 77 shares x 1/4 year = 19 weighted average shares
Quarter 4: [$16 - $12/$16] (1000) = 250 shares x 1/4 year = 63 weighted average shares
Total weighted average shares...................... 82 weighted average shares

Dr. M.D. Chase

Advanced Accounting 610 -72B

Long Beach State University

Consolidated Earnings Per Share
Page 6

2. Consolidated FDEPS: (Note: the same formula is appropriate for both PEPS and FDEPS)
Cons
P NI
Adj to P NI due to S sec which
FDEPS = P NI + Adj + [("P" Equiv Shares of"S") x (S EPS)] + allow holder to acquire P C/S
"P" C/S outstanding + adjustments to "P" stock outstanding

= ($50,500 - $500) + [(.80 x 12,000 C/S)]+[(.60)(1,600 C/S acquired "if converted")] ($4.12) + 0
20,000 + 296* + 148*

= $50,000 + $43,507 = $4.57 NOTE: This number would not be reported as it exceeds PEPS
20,444
NOTE: For FDEPS the market price is defined as the greater of Average or Year-end
Warrants held by "P":
Quarter 1: Ending Market $ < Excercise $; Not Dillutive
Quarter 2: [$14 - $12/$14] (2000) = 286 shares x 1/4 year = 71 weighted average shares
Quarter 3: [$15 - $12/$15] (2000) = 400 shares x 1/4 year = 100 weighted average shares
Quarter 4: [$16 - $12/$16] (2000) = 500 shares x 1/4 year = 125 weighted average shares
Total weighted average shares...................... 296 weighted average shares

Warrants held by "S":

Quarter 1: Ending Market $ < Excercise $; Not Dillutive
Quarter 2: [$14 - $12/$14] (1000) = 143 shares x 1/4 year = 36 weighted average shares
Quarter 3: [$15 - $12/$15] (1000) = 200 shares x 1/4 year = 50 weighted average shares
Quarter 4: [$16 - $12/$16] (1000) = 250 shares x 1/4 year = 62 weighted average shares
Total weighted average shares...................... 148 weighted average shares