Earnings per Share - FAS 128

A. Simple Capital Structure: Common stock, possibly preferred stock

Step 1: Determine income applicable to common stock:

Net income - preferred dividends

Step 2: Determine weighted average number of common stock outstanding:

step 3: Divide income applicable to common stock by weighted average # of shares

equals Earnings per share

Determination of weighted average number of common stock (wac) outstanding:

X company, year 1
Example: 1-Jan 1-Apr 1-Jul 1-Oct 31-Dec

# shares outstanding 50000 75000 75000 90000 100000

# of months outstan-
ding/12 25.00% 25.00% 25.00% 25.00% 0.00%
# shares outstanding 12500 18750 18750 22500 72500

Alternative method:

1-Jan 1-Apr 1-Jul 1-Oct 31-Dec Total

# shares outstanding 50000

additional issued 25000 0 15000 10000 100000
# 0f months outstg/12 1 3/ 4 1/ 4
50000 18750 0 3750 72500

Net income $200,000.00

preferred dividends $ 20,000.00
income available for common stockholders $180,000.00
weighted average number of common stock 72500
Earnings per share $ 2.48

Additional issues:

Stock splits and stock dividends are always assumed to have occurred at the beginning
of the year for computation of weighted average number of shares.

For comparative multi year presentation, they are assumed to have occurred at the
beginning of the earliest year presented.

Example: X company, year 2

no new stock is issued, but on July 1, year 2, the company issues a 10% stock dividend:

# of shares before stock dividend 100000

stock dividend 10000
total number of shares 110000

restatement of year 1:

1-Jan 1-Apr 1-Jul 1-Oct 31-Dec Total

# shares outstanding 55000

additional issued 27500 0 16500 11000 110000
# 0f months outstg/12 1 3/ 4 1/ 4
55000 20625 0 4125 79750

alternatively:
weighted average 3 of shares 72500 1.1 79750

year 2 year 1
Net income $300,000.00 $200,000.00
preferred dividends $ 20,000.00 $ 20,000.00
income available for common stockholders $280,000.00 $180,000.00
weighted average number of common stock
Earnings per share $ 2.55 $ 2.26

# of shares 110,000 79,750

Note: if shares are issued after stock split or stock dividend, they are not adjusted:

Year 3:
# of shares before 2:1 stock split 110,000
total number of shares 220,000

Year 3 year 2 year 1

Net income 500000 $300,000.00 $200,000.00
preferred dividends $ 20,000.00 $ 20,000.00 $ 20,000.00
income available for common stockholders $480,000.00 $280,000.00 $180,000.00
weighted average number of common stock
Earnings per share $ 2.18 $ 1.27 $ 1.13

# of shares 220,000 220,000 159,500

B. Complex Capital Structure

In addition to common and preferred stock the company has any or all of the following:

convertible preferred stock or debt

stock options/warrants
contingent shares

Any of the above must be taken into consideration if and only if they are dilutive

Dilutive securities: If included in the EPS calculation thye will reduce EPS
Step 1: Determine income applicable to common stock:

Step 2: Determine weighted average number of common stock outstanding:

Step 3: Determine if any dilutive securities are outstanding

Test to determine if securities are dilutive:

convertible bonds/preferred stock

a. Determine additional number of shares > increase denominator

b. Determine interest expense (net of tax) or
preferred dividends > increase numerator
c. Compute EPS: if lower than basic EPS > securities are dilutive, must be included

Warrants and options

a. Determine amount of cash resulting from exercise of options/warrants

b. Calculate # of treasury shares that could be purchased with the cash (average market price)
c. Determine net additional number of shares (denominator)
If the number is higher than under basic EPS > securities are dilutive

(simple rule: if exercise price is lower than average market price of stock, securities are dilutive)

Contingent shares: May be contingent on passage of time (merger situation)

attainment of earnings or other goal

If contingency has been met > include shares

Example of complex capital structure:

Common stock 100000 convertible into

pref. stock ($100 par) 10000 8% 40000 shares of common stock
convertible bonds $200,000 10% 4000 shares of common stock
exercise market cash treasury stock net shares
options 20000 45 50 900000 18000 2000

Net income 600000

preferred dividends 80000
income available to common stockholders 520000
EPS (basic) 5.2

Test for dilution

# shares net income
a. convertible preferred stock

common stock 100000 520000

additional shares 40000 80000
140000 600000
EPS $ 4.29 less than basic EPS, > dilutive, include
b. Convertible bonds # shares net income interest tax
common stock 100000 $520,000 20000 35%
additional shares 4000 $ 13,000
104000 $533,000
EPS $ 5.13 less than basic EPS, > dilutive, include

c. Options # shares net income

common stock 100000 $520,000
additional shares 2000 $ -
102000 $520,000
EPS $ 5.10 less than basic EPS, > dilutive, include

All together now:

# shares net income
common stock 100000 $520,000
additional shares, preferred 40000 $ 80,000
additional shares, bonds 4000 $ 13,000
additional shares, options 2000 $ -
146000 $613,000
fully diluted EPS $ 4.20

C. Earnings per share disclosure requirements

If applicable, EPS (basic and fully diluted) must be provided for Net operating income
extraordinary items
discontinued operations
cumulative effect of change in accounting principles
wac

wac
wac
 net
13000

counting principles