Cash Flow Analysis

Learning Objectives
Describe the nature and purpose of the Statement of Cash flows.
Define Cash and Cash Equivalents
Distinguish among operating, investing, and financing activities.
Describe the content and the form of Statement of Cash flows.
Compute and explain the differences between the direct and
indirect method of determining the net cash flows provided by
operating activities
Prepare the statement of cash flows using both the visual inspection
method and worksheet method.

Nature and purposes
The statement of cash flows provide information about cash inflows
and outflows during an accounting period as well as the net
changes in cash from operating, investing, and financing activities
in a manner that reconciles the beginning and ending cash
balances

Users assess and evaluates:
A companys ability to generate positive net cash flows
A companys ability to meet its obligations and pay dividends
A companys need for external financing
The reason for differences between a companys net income and
associated cash receipts and payments and
Both cash and noncash aspects of a companys financing and
investing transactions during the accounting period

Information obtained from
Cash Flow Statement
The changes in net assets of an enterprise and its ability to affect the
amounts and timing of cash flows in order to adopt to changing
circumstances and opportunities
The ability of the enterprise to generate cash and cash equivalents and
enables the users to develop models to assess and compare the present
value of the future cash flows of different enterprise
It enhances the comparability of the reporting of the operating
performance by different enterprise because it eliminates the effects of
using different accounting treatments for the same transactions and
events.

Cash and Cash Equivalents
Cash comprises cash on hand and demand deposits

Cash equivalents is short term and highly liquid investment that are
readily convertible into cash and acquired three months or less
before the date of maturity

Classification of cash flow activities
OPERATING ACTIVITIES
Measuring the cash inflows and outflows caused by core business
operations, the operations component of cash flow reflects how
much cash is generated from a company's products or services.
Generally, changes made in cash, accounts receivable, inventory
and accounts payable are reflected in cash from operations.

Operations
Cash flows from operating activities are related to your principal line
of business and include the following:

Cash inflows
Cash receipts from sales or for the performance of services
Returns on interest earnings assets (interest)
Returns on equity securities (dividends)
Receipts from contracts held for dealing and trading purposes
Tax refunds unless identified with financing and investing activities

Operations
Cash Outflows
Payments to suppliers and contractors
Payment for operating expenses (salaries, rent, insurance, etc.)
Payment for purchases from suppliers other than inventory
(supplies)
Payment for lenders (interest)
Tax payments

Investing
Changes in equipment, assets or investments relate to cash from
investing. Usually cash changes from investing are a "cash out" item,
because cash is used to buy new equipment, buildings or short-term
assets such as marketable securities. However, when a company
divests of an asset, the transaction is considered "cash in" for
calculating cash from investing.

Investing
Cash inflows
Proceeds from the sale of property, plant and equipment
Proceeds from the sale or redemption of investments
Collection of loans (principal) to others (other than advances and loans
made by a financial institution)
Cash outflows
Purchases of property, plant and equipment
Purchases of stock or other securities (other than cash equivalents)
Loans (principal) to others (other than advances and loans made by a
financial institution)

Financing
includes borrowing from creditors and repaying the principal and
obtaining resources from owners and providing them with return on
the investment.

Financing
Financing activities include cash flows relating to the businesss
debt or equity financing:

Cash inflows
Proceeds from loans, notes, and other debt instruments (short and
long-term)
Cash received from the issuance of stock or equity in the business
Cash outflows
Installment payments on loans or other repayment of debts
Dividend payments, purchases of treasury stock, or returns of capital

Non-cash transactions
Provides that investing and financing transactions that do not require
use of cash and cash equivalents shall be excluded from statement of
cash flows.
a. Acquisition of asset either by assuming directly related liability or
by means of finance lease
b. Acquisition of asset by means of issuing share capital or bonds
payable
c. Conversion of debt to equity
d. Conversion of preference share to ordinary share

Interest
Dividend
Selected transactions of the Davis Company are listed below.
1. Common stock is sold for cash above par value.
2. Bonds payable are issued for cash at a discount.
3. Interest on a short-term note receivable is collected.
4. Merchandise is sold to customers for cash.
5. Cash is paid to purchase inventory.
6. Equipment is purchased by signing a 3-year, 10% note
payable.
7. Cash dividends on common stock are declared and paid.
8. One hundred shares of XYZ common stock are purchased for
cash.
9. Land is sold for cash at book value.
10. Bonds payable are converted into common stock.

Instructions
Classify each transaction as either (a) an operating activity, (b)
an investing activity, (c) a financing activity, or (d) a noncash
investing and financing activity.

CONTENT AND FORM OF THE
STATEMENT OF CASH FLOWS
A statement of cash flows for a period shall report
the following:
A. Net cash provided or used by:
Operating Activities
Investing Activities
Financing Activities
B. Net effect of those inflows and outflows on Cash
and Cash Equivalents
NOTE: Noncash investing and financing transactions shall be
disclosed in the Notes to Financial Statements.

REPORTING REQUIREMENTS
Reporting Requirement #1
Report cash flows from operating activities
using either:
Direct Method
Indirect Method
Direct Method
In reporting the cash flows from operating activities
enterprises are encouraged to report major classes of gross
receipts and gross cash payments and the net cash flow
from operating activities.
Under the direct method you would then report the following in the cash
flows from operating activities section of the cash flow statement:
Cash Inflows from Operating Activities
Cash receipts from customers
Interest and dividends collected
Other operating receipts
Cash Outflows for Operating Activities
Cash payments to suppliers
Cash paid for operating expenses
Interest paid
Other operating payments
Taxes paid
Equals net cash provided by (used in) operating activities

Cash receipts from customers:
Net sales per the income statement
Plus decrease in accounts receivable
Minus increase in accounts receivable
Plus increase in deferred revenue
Minus decrease in deferred revenue
Equals cash receipts from customers

Interest and Dividends Collected
Interest revenue and dividend income per income statement
Plus decrease in interest receivable
Minus increase in interest receivable
Plus amortization of premium on investment in bonds
or
Minus amortization of discount on investment in bonds
Equals interest and dividends collected

Other operating receipts
Other revenues per income statement
Plus increase in unearned revenues
Minus decrease in unearned revenues
Minus gains on disposal of assets and liabilities
Minus investment income (equity method)
Equals cash inflows from other operating receipts
Cash payments to suppliers:
Cost of goods sold
Plus increase inventory
Minus decrease inventory
Plus decrease in accounts payable
Minus increase in accounts payable
Equals cash payments for inventory
Cash paid for operating expenses:
Operating expenses per income statement
Minus depreciation expenses, depletion and
amortization
Plus increase in prepaid expenses
Minus decrease in prepaid expenses
Plus decrease in accrued expenses
Minus increase in accrued expenses
Equals cash paid for operating expenses

Interest paid:
Interest expense per the income statement
Plus decrease in interest payable
Minus increase in interest payable
Plus amortization of premium on bonds payable
or
Minus amortization of discount on bonds payable
Equals interest paid
Other operating payments:
Other expenses per income statement
Minus losses on disposal of assets and liabilities
Minus investment loss (equity method)
Equals other operating payments
Tax Expense:
Tax expense per the income statement
Plus decrease in taxes payable
Minus increase in taxes payable
Plus decrease in deferred tax liability
or
Minus increase in deferred tax liability
Equals taxes paid
Indirect Method
In preparing the cash flows from operating
activities section under the indirect method, you
start with net income per the income statement,
reverse out entries to income and expense
accounts that do not involve a cash movement,
and show the change in net working capital.
Net income after taxes
PLUS
A decrease in current assets would be shown as a positive figure, because other current assets were
converted into cash.
An increase in current liabilities (excluding short-term debt which would be reported in the financing
activities section) would be shown as a positive figure since more liabilities mean that less cash was
spent.
Depreciation, depletion and amortization expense
Amortization of discount on bonds payable
Amortization of premium on investment in bonds
Increased in deferred income taxes
Loss (net) on disposal of assets or liabilities
Investment loss under the equity method
Interest expense
Income taxes



MINUS
An increase in current assets (excluding cash and cash equivalents)
would be shown as a negative figure because cash was spent or
converted into other current assets, thereby reducing the cash balance.
A decrease in current liabilities would be shown as a negative figure,
because cash was spent in order to reduce liabilities.
Amortization of premium on bond payable
Amortization of discount on investment in bonds
Decrease in deferred income taxes
Gain (net) on disposal of assets or liabilities
Investment income under the equity method

EQUALS
Net Cash Flow From Operations
LESS
Interest paid
Income Taxes Paid
Net Cash From Operating Activities
Reporting Requirement #2
Report separately major classes of receipts
and payments arising from investing and
financing activities
Reporting Requirement #3
Cash flows arising from the following operating,
investing or financing activities may be reported on a
net basis:
Cash receipts and payments on behalf of customers when the
cash flows reflect the activities of the customer rather than those
of the entity
Cash receipts and payments for items in which the turnover is
quick, the amounts are large and the maturities are short

Reporting Requirement #4
Cash flows arising from each of the following
activities of a financial institution may be reported on
a net basis:
Cash receipts and payments for the acceptance and repayment
of deposits with a fixed maturity date
Placement of deposits with and withdrawal of deposits from other
financial institutions
Cash advances and loans made to customers and the repayment
of those advances and loans

Reporting Requirement #5
Cash flows arising from transactions in a
foreign currency that should be recorded
in an entitys functional currency
Reporting Requirement #6
Cash flows from interest and dividends
received and paid should each be disclosed
separately.
Reporting Requirement #7
Cash flows arising from taxes on income
shall be separately disclosed and shall be
classified as cash flows from operating
activities.
PROCEDURES IN PEPARING
STATEMENT OF CASH FLOWS
2 Common Procedures
VISUAL INSPECTION METHOD

WORKSHEET METHOD

VISUAL INSPECTION METHOD
Used when the Financial Statement are not that
complex and when the relationships between changes
can be easily observed and analyzed.

Steps in Visual Inspection Method
Step 1. Prepare the heading of the SCF
Step 2. Determine the net chance in cash that occurred
during the period
Step 3. Determine the companys NI to be listed as the
first item in CF from operating activities section

Steps in Visual Inspection Method
Step 4. Determine the changes and of each BS account
Step 5. If no cash flow occurred, determine whether the increase or
decrease in each balance is due to non cash IS item.
Step 6. Complete the various sections of SCF.

Steps in Visual Inspection Method
Steps in Visual Inspection Method
WORKSHEET METHOD
Commonly used in practice because analysis of even the most
complex set of Financial Statements may be documented in a
relatively concise working paper.

Steps in Worksheet Method
Step 1.Prepare the column headings in a Worksheet
Step 2. In addition to the 3 normal headings, add Investing and
Financing Activities not affecting Cash
Step 3. Account for all the changes in the noncash accounts that
occurred during that period.

Steps in Worksheet Method
Step 4. Make a final worksheet entry to record the net
change in cash.

Step 5. Prepare SCF and accompanying schedule.

Example of Worksheet Method
Example of Worksheet Method
Example of Worksheet Method
METHOD USED TO ANALYZE
STATEMENT OF CASH FLOW
STEPS USED TO ANALYZE
STATEMENT OF CASH FLOW
Scan the big picture
Check the power of the Cash Flow engine
Determine the Positive and Negative outcome
Integration

Step 1: Scan the big picture
Place your company in context in terms of its age, industry and size.
Flip through the annual report and other accounting records to
determine how management believes the year progressed.
Look at Net Income. Does it show income or losses over the past
few years?

Step 2: Check the power of the
Cash Flow engine
Check if CF from operating activities is greater than zero. Check
whether it is growing or shrinking.
Examine the operating working capital accounts. Inventories,
receivables, and accounts payable usually grow in expanding
companies.

Step 3: Determine the Positive and
Negative outcome
Check CF from Investing activities, whether the company is
generating cash in its investing activities.
Check the entire package to determine the good or bad outcomes
of CF in Financing Activities.

Step 4: Integration
Putting the piece altogether.

Interpretation of Statements of
Cash Flows
What kind of information does the statement of cash flows ,along
with its notes, provide?
(a) the relationships between profit and cash can be seen clearly and
analyzed accordingly
(b) cash equivalents are highlighted, giving a better picture of the
liquidity of the company
(c) financing inflows and outflows must be shown, rather than simply
passed through reserves.

The advantages of cash flow
accounting

Survival in business depends on the ability to generate
cash
Cash flow is more comprehensive than profit which is
dependent on accounting conventions and concept
Creditors are more interested in an entitys ability to
repay them than in its profitability

The advantages of cash flow
accounting :
Cash flow reporting provides a better means of comparing the
results of different companies than traditional profit reporting
Cash flow reporting satisfies the needs of all users better
Cash flow forecasts are easier to prepare, as well as more useful the
profit forecasts

Chapter 7

Gross Profit Variation
Analysis and
Earnings Per Share
Determination
Objective of gross profit variation
analysis
Explain the objective of Gross Profit variation Analysis
State and Explain the factors affecting the change in gross profit
Describe and apply the techniques in G/P Variation Analysis
Analyze the change in Gross Profit of a company
Single product line
Multiple product line
state the procedures in the computation of basic and diluted earnings per
share
Compute the BPS and DPS in accordance with PAS 33 Earnings Per Share
What affects Gross Profit
determination?
Volume
Selling price
Cost
Sales mix
Change in
sales volume
and its affect
on sales, cost of
sales and gross
profit

Volume Factor
Selling Price Factor
Change in unit
selling price and
its effect on
sales and gross
profit

Cost Factor
Change in unit
cost and its
effect on cost of
sales and gross
profit

Techniques in analyzing
Gross Profit Variation
A firm that manufactures or buy
and sell only one product;

A firm that manufactures or buys
and sell two or more products with
unequal gross margin

Sell only One Product
Formula:
Volume/Quantity factor:
Sales this year at last years price xx
Less: Sales Last year xx
Increase (Decrease) in Sales xx
Multiply by: G/P Margin Last Year x%
Increase(Decrease) in G/P xx

Sell only One Product
Formula:
Price factor:
Sales this Year xx
Less: Sales this Year at last years Price xx
Increase(Decrease) in G/P xx

Sell only One Product
Cost factor:
Formula:
Cost of Sales this Year xx
Less: cost of Sales this Year at last years Cost xx
Increase(Decrease) in G/P xx

Sell Multiple Products
Formula:
Price factor:
Sales this Year xx
Less: Sales of different products
this Year at last years Price xx
Increase(Decrease) in G/P xx

Sell Multiple Products
Cost factor:
Formula:
Cost of Sales this Year xx
Less: Cost of Sales of different products
this Year at last years Cost xx
Increase(Decrease) in G/P xx

Sell Multiple Products
Formula:
Volume/Quantity factor:
Sales this year(units) xx
Less: Sales Last year(units) xx
Increase (Decrease) in Total Quantity xx
Multiply by: Average G/P Margin
Last Year x%
Increase(Decrease) in G/P xx

Sell Multiple Products
Sales mix factor
Formula
Average G/P per unit at last Years Price xx
Less: Average G/P per Unit last Year xx
Increase(Decrease) in ave. G/P per unit xx
Multiplies By: Total Quantity Sold This Year xx
Increase(Decrease) in Gross Profit xx
Sample Problem:
2013 2012
Sales 15,000 10,000
Cost of sales 10,000 6,000
Gross profit 5,000 4,000
Additional information:
Units sold 500 400
Selling price 30 25
Cost per unit 20 15
Gross profit rate 50% 40%

2013 2012
Sales 15,000 10,000
Cost of sales 10,000 6,000
Gross profit 5,000 4,000
Questions:
Selling price increase by 25%
Quantity increase by 10%
Cost per unit increased by 10%


Sample Problem:
Earnings Per Share
Determination
Earnings Per Share Determination

Basic Earnings Per Share

Diluted Earnings Per Share
Earnings Per Share
PAS 33 prescribes the principles for the determination and
presentation of EPS for enterprises whose ordinary shares or
potential ordinary share are publicly traded and by
enterprises that are in the process of issuing ordinary share or
potential ordinary shares in public securities market or any
enterprise which discloses earnings per share.

Earnings Per Share (Presentation)
Face of the Income
statement

Continuing Operation
Discontinued Operation
Either on the Face of the income
Statement or notes to FS
EPS (Presentation)

Notes to FS

Consolidated FS
Face of the Separate
Income Statement
Separate FS
Uses of Earnings Per Share
Determinant of Market Price
Measure of Performance
Basic Earnings Per Share
The Basic Equation:
Net Income(Loss) attributable to OS
Weighted-Average
Common Shares Outstanding
The Complications:
Issuance or reacquisition of common stock
Stock dividends or stock splits
Guidelines to be observed in applying
the formula

For the purpose of calculating basic earnings
per share, the net income or loss for the period
attributable to ordinary shareholders should be
the net income or loss for the period after
deducting preferred dividends.
Guidelines to be observed in applying
the formula
The amount of preferred dividends that is
deducted from the net income for the period
Noncumulative preference share
Cumulative preference share
Basic Earnings Per Share(Illustration 1)
Preference share capital, P100 par, 10% cumulative
P1,000,000
Ordinary Share capital, P100 par, 50000 shares
P5,000,000

Income From Continuing Operation P1,500,000
Income From Discontinued Operation P500,000

Compute for BEPS.

Computation of BEPS
Income From Continuing Operation P1,500,000
Preference dividends for current year P 100,000
Income to ordinary share P1,400,000

BEPS
Income From Continuing Operation P28
Income from Discontinued Operation P10
Net income P38
Illustration 2 Compute for BEPS
Preference share capital, P50 par, 40000 shares
outstanding,10% cumulative and fully participating*
P2,000,000
Ordinary Share capital, P100 par, 80000 shares outstanding**
P8,000,000
Net Income for the year P3,000,000

**Dividend declared to ordinary P20/share
*pro rata basis
Computation
Basic dividend Preference Ordinary
Pref(2Mx10%)
Ordinary
Balance
Total dividends
BEPS:

200,000
1,600,000
240,000 960,000
440,000 2,560,000
Pref Share (440,000/40000)
11.00
Ord. Share
(2.56M/80000)
32.00
Guidelines to be observed in applying
the formula
The number of ordinary share should be the
weighted number of ordinary shares outstanding
during the period
Basic Earnings Per Share
Shares Outstanding January 1: 10,000
New Shares Issued May 1: 5,000
Shares Repurchased November 1: 2,000
Weighted-Average Number of Shares
Jan. 1 to May 1 10,000 x 4/12 = 3,333
May 1 to Nov. 1 15,000 x 6/12 = 7,500
Nov. 1 to Dec. 31 13,000 x 2/12 = 2,167
Dec. 31 Weighted-average shares 13,000
Guidelines to be observed in applying
the formula
The weighted average number of ordinary
shares outstanding during the period and for all
periods presented should be adjusted for
events, other that the conversion of potential
ordinary shares, that have changed the number
of ordinary shares outstanding, without a
corresponding change in resources.
Illustration 4 comparative income
statement
Net income 2011 7,200,000
Net income 2012 6,000,000
Ordinary shares Outstanding on Jan.1,2011 200,000

On Oct 1, 2012 entity implemented bonus issue in the ratio
of two ordinary shares for each original ordinary share.
Compute for BEPS.
Computation
Ordinary share Outs.-Jan.1,2011 200,000
Bonus Issue on October1, 2012 400,000
Total ordinary shares Outs. 600,000

BEPS
2011(7,200,000/600,000) 12
2012(6,000,000/600,000) 10
Guidelines to be observed in applying
the formula

Stock dividend and Share Split
Stock Dividends and Stock Splits
Shares outstanding January 1.. 2,600
Shares issued for exercise
of options on February 1. 400
Shares issued for 10% stock
dividend on May 1.. 300
Shares sold for cash on September 1.. 1,200
Shares repurchased on November 1 400
Shares issued for 3-for-1 stock split


on December 15 8,200
Stock Dividends and Stock Splits
1/1 to 2/1 2,600
2/1 Option 400
2/1 to 5/1 3,000
No. of Stock Stock Portion of Weighted
Date Shares Dividend Split Year Average
Stock Dividends and Stock Splits
No. of Stock Stock Portion of Weighted
Date Shares Dividend Split Year Average
1/1 to 2/1 2,600 x 1.10
2/1 Option 400
2/1 to 5/1 3,000 x 1.10
5/1 Dividend 300
5/1 to 9/1 3,300
Stock Dividends and Stock Splits
No. of Stock Stock Portion of Weighted
Date Shares Dividend Split Year Average
1/1 to 2/1 2,600 x 1.10
2/1 Option 400
2/1 to 5/1 3,000 x 1.10
5/1 Dividend 300
5/1 to 9/1 3,300
9/1 Sale 1,200
9/1 to 11/1 4,500
Stock Dividends and Stock Splits
No. of Stock Stock Portion of Weighted
Date Shares Dividend Split Year Average
1/1 to 2/1 2,600 x 1.10
2/1 Option 400
2/1 to 5/1 3,000 x 1.10
5/1 Dividend 300
5/1 to 9/1 3,300
9/1 Sale 1,200
9/1 to 11/1 4,500
11/1 Purchase (400)
11/1 to 12/1 4,100


Stock Dividends and Stock Splits
No. of Stock Stock Portion of Weighted
Date Shares Dividend Split Year Average
1/1 to 2/1 2,600 x 1.10
2/1 Option 400
2/1 to 5/1 3,000 x 1.10
5/1 Dividend 300
5/1 to 9/1 3,300
9/1 Sale 1,200
9/1 to 11/1 4,500
11/1 Purchase (400)
11/1 to 12/1 4,100
12/1 Split 8,200
12/1 to 12/31 12,300
Stock Dividends and Stock Splits
No. of Stock Stock Portion of Weighted
Date Shares Dividend Split Year Average
1/1 to 2/1 2,600 x 1.10 x 3.0 x 1/12 = 715
2/1 Option 400
2/1 to 5/1 3,000 x 1.10 x 3.0 x 3/12 = 2,475
5/1 Dividend 300
5/1 to 9/1 3,300 x 3.0 x 4/12 = 3,300
9/1 Sale 1,200
9/1 to 11/1 4,500 x 3.0 x 2/12 = 2,250
11/1 Purchase (400)
11/1 to 12/1 4,100 x 3.0 x 1/12 = 1,025
12/1 Split 8,200
12/1 to 12/31 12,300 x 1/12 = 1,025
Weighted-average number of shares 10,790
Stock Dividends and
Stock Splits
All stock splits and stock dividends must
be incorporated into the computation of
weighted average shares outstanding.
This must done for all periods
presented in the financial
statements.
Current EPS figures may have to be
changed in the future as a result of
stock splits or dividends.
Guidelines to be observed in applying
the formula
Rights Issue

Fair value per share immediately prior
to the exercise of rights
Theoretical ex-rights fair value per share
Illustration 5 Compute for BEPS
Net Income
2011 P1,375,000
2012 P1,762,000

Ordinary Outs. prior to rights issue 50,000
Rights issue during 2011-one new ordinary share for each 5
outs. Or a total of 10,000
Date of exercise April 1, 2012
MV of share Right-on P110
Exercise or subscription price P50

Theoretical Market value of share Ex-
right
MV of Ordinary shares outstanding(50,000xP110) 5,500,000
Proceeds from Exercise of rights(10,000xP50) 500,000
Total 6,000,000

Theoretical Market value of share Ex-right
(6,000,000/60,000) 100
Computation for Adjustment Factor

Adjustment factor: 1.10
Fair value per share immediately
prior to the exercise of rights
_______________________________________________
Theoretical ex-rights fair value per share
110
100
Computation of BEPS
2011
Ordinary share outs. 50,000
Multiply by adj.factor 1.10
Adjusted ordinary shares 55,000

BEPS
1,375,000/55,000 25
Computation of BEPS 2012
January1 (50,000x1.10x3/12) 13,750
April1 (60,000x9/12) 45,000
Total ave.ordinary shares 58750

BEPS
1,762,500/58,750 P30
Computation for Basic Loss per share
Net loss (5,000,000)
Preference Share capital,100 par, 10% cumulative,
20,000 shares convertible into 40,000 ordinary
shares P2,000,000
Ordinary Share capital, 100 par, 100,000 shares
P10,000,000
Compute for Basic loss per share.
Computation
Net Loss (5,000,000)
Preference dividend(2Mx10%) (200000)
Total Loss to OS (5,200,000)
Ordinary share outstanding 100,000
Basic Loss Per Share P(52)
Diluted Earnings Per Share

Net income attributable to OS as adjusted
Weighted average number of OS and PD
Three Major Types of Potential Ordinary
Shares
Convertible Bond Payable
Convertible Preference Share
Share option and Warrant
Simple and Complex Capital Structures
Dilutive Securities- Securities whose assumed exercise or
conversion results in a reduction in earnings per share.
Antidilutive Securities:- Securities whose assumed
conversion or exercise results in an increase in earnings
per share.

Simple and Complex Capital Structures

Considers only
common shares issued
and
outstanding.


Basic
Simple and Complex Capital Structures

Considers only
common shares issued
and
outstanding.


Basic
Reflects the maximum
potential dilution from all
possible stock conversions
that would have
decreased EPS.
Diluted
Capital Structures
Simple Capital Structure-
The corporation has only
common and nonconvertible
preferred stock and has no
convertible securities, stock
options, warrants, or other
rights outstanding.
Complex Capital Structure- The
corporation has one or more
instruments outstanding that
could result in issuance of
additional common shares.
For example, a firm with
potential for per share dilution.
Diluted Earnings per Share- Options,
Warrants, and Rights
Dilution occurs if inclusion of a potentially dilutive security
reduces the basic EPS or increases the basic loss per share.
Proceeds from conversion are assumed to be used for
purchase of treasury stock at current market price.
Treasury stock is assumed to be reissued to option or warrant
holders.
Any additional shares issued, over treasury stock, are added
to weighted- average shares outstanding.
Exercise is assumed to occur on the first day of the year
unless issue date is later.

Guidelines to be observed in applying
the formula
1. Adjustments may include on an after-tax basis the ff:
a. Dividends on dilutive potential ordinary share.
b. Interest recognized in the period for the dilutive
potential
c. Any other changes in income or expenses that
would result from the conversion of dilutive potential
OS.
Illustration
An entity had the following securities outstanding on January 1,
2011:
10% convertible bonds payable, each P1000 bond convertible
into 10 OS 4,000,000
Ordinary share capital, P100 par, 250,000 shares authorized,
100,000 shares issued 10,000,000
Net Income 5,000,000
Income Tax Rate 30%

Compute for BEPS and DEPS.
Basic earnings per share
Net Income 5,000,000
OS actually outstanding 100,000
BEPS 50

Diluted Earnings Per share
Net Income 5,000,000
Interest expense 400,000
Income tax (120,000) 280,000
Adjusted net income 5,280,000
OS actually outstanding100,000
Assumed Issued OS 40,000 140,000
DEPS 37.71
Guidelines to be observed in applying
the formula
Dilutive potential ordinary shares should deemed
to have been converted into ordinary shares at
the beginning of the period, if later, the date of
issue of the potential ordinary shares.
Guidelines to be observed in applying
the formula
For the purpose of computing diluted earnings
per share, an enterprise should assume the
exercise of dilutive options and other dilutive
potential common shares of the enterprise.
Options and Share warrants
Illustration
Net Income 5,000,000
Ordinary share capital,100 par, 100,000 shares
10,000,000
Employee share option:
Option shares 30,000
Fair value of each share option 20
Option price 130
Average market price 250
Computation
BEPS(5M/100,000shares) 50
DEPS:
Net income 5,000,000
Option shares 30,000
Total option price 150
Proceeds from assumed exercise 4,500,000
Average market price 250
Assumed treasury shares 18,000
Computation
Ordinary Share 100,000
Incremental OS:
Option shares 30,000
Assumed TS (18,000) 12,000
Total ordinary shares 112,000

DEPS(5M/112,000) 44.64
Guidelines to be observed in applying
the formula
To the extent that partly paid shares are not
entitled to participate in dividends during the
financial period they are considered equivalent
of warrant or options.
Potential ordinary shares should be treated as
dilutive when, and only when, their conversion
to ordinary shares would decrease net income
per share from continuing common operations
Multiple Potential Ordinary Share
(illustration)
An entity provide the following data for the current year.
Income from continuing operation 5,000,000
Loss from discontinued operation (1,000,000)
Ordinary share Actually outstanding 500,000
Option shares 50,000
Option Price(including FV of stock option of P10) 60
Average market Price 75
Preference share capital, P100 par 5,000,000
Bond payable 5,000,000
Income Tax rate 30%
The preference share capital is 5% cumulative and convertible into 25,000 ordinary
shares
The bond payable has nominal rate of 10% and convertible into 40,000 OS.
BEPS
Income from continuing operation 5,000,000
Preference dividends (250,000)
Income to OS 4,750,000
OS actually outstanding 500,000
BEPS 9.50

BEPS for discontinued operation (2.00)
DEPS
INCOME ORDINARY SHARE EPS
Basic EPS 4,750,000 500,000 9.50
Options 0 10,000
Diluted EPS 4,750,000 510,000 9.31
Convertible bond 350,000 40,000
Diluted EPS 5,100,000 550,000 9.27
Convertible PS 250,000 25,000
Diluted EPS 5,350,000 575,000 9.30
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