Earnings per Share

Earnings per Share (EPS)
   = Earnings / Number of shares outstanding  
 

Basic Earnings per Share

Basic Earnings per Share = (A) / (B)
   (A) Income available to common stockholders
          = Net income - dividends to preferred stockholders
   (B) Weighted-average number of common shares outstanding

Potential common stock

Financial instruments that can be increase the number of common shares
 
Examples of potential common stock
1. Options to purchase common stock
2. Warrants to purchase common stock
3. Convertible preferred stock
4. Convertible debt securities
 

Diluted Earnings per Share

Diluted Earnings per Share = (C) / (D)
   (C) = (A) + (A1) + (A2)
   (D) = (B) + (B1) + (B2)
 
   (A) Income available to common stockholders
   (B) Weighted-average number of common shares outstanding
   (A1) Dividends to convertible preferred shares
   (A2) Interests to convertible debt securities
   (B1) Incremental common shares from treasury stock method
   (B2) Incremental common shares from if-converted method
 

Treasury stock method

For options and warrants to purchase common stock
 
Treasury stock method
1. Assume that options and warrants were exercised at the beginning of the period or at the time of issuance, if later.
2. Assume that the proceeds from the exercise were used to purchase common stock, at the average market price during the period.
3. If the number of common stock issued is greater than the number of common stock repurchased, the incremental shares are added to the number of common shares outstanding.
 

If-converted method

For convertible securities
 
If-converted method
1. Assume that convertible securities were converted at the beginning of the period or at the time of issuance, if later.

2. Add the followings to the income available for common stockholders
    (1) Dividends to convertible preferred stockholders
    (2) Interests to convertible securities
3. Add the incremental common shares issued due to the assumed conversion of convertible securities
 

Dilution

If the application of treasury stock method or if-converted method decreases the EPS, such a decrease in EPS is called dilution.
 

Antidilution

If the application of treasury stock method or if-converted method increase the EPS, such an increase in EPS is called antidilution.
 

No Antidilution

If the application of treasury stock method or in-converted method has antidilutive effect on EPS, such potential common shares are not assumed to be exercised or converted.
 

Diluted EPS < Basic EPS

Because antidilutive potential common shares are not assumed to be exercised or converted, Diluted EPS cannot be greater than Basic EPS.
  

Two-class method
(EITF 03-6)

For participating securities, Basic EPS and Diluted EPS are presented separately for participating securities and each class of common stock.
 
EITF 03-6
For participating convertible securities, two-class method is required.
For participating convertible securities, if-converted method is not allowed.
   

Participating securities

Holders of participating securities have the right to get dividends from remaining net income after common stockholders and preferred stockholders receive their portion of dividends.
 
Participating preferred stockholders may receive dividends from two layers of net income
   1. Dividends entitled as preferred stockholders.
   2. Dividends from remaining net income after entitled dividends are paid to common and preferred stockholders.
 

Basic EPS
Example 1

Data:
1. Net income for the period = $60,000
2. Number of common shares = 20,000 shares
3. No preferred stock, no potential common shares
 

Basic EPS = $60,000 / 20,000 shares = $3 per share
 

Basic EPS
Example 2

Data:
1. Net income for the period = $75,000
2. Number of common shares
    20,000 shares on January 1, 20X1
    10,000 shares were issued on July 1, 20X1
3. No preferred stock, no potential common shares
 
Weighted-average number of common shares
   = 20,000 x 12/12 + 10,000 x 6/12
   = 20,000 + 5,000 = 25,000
  

Basic EPS = $75,000 / 25,000 shares = $3 per share
 

Basic EPS
Example 3

Data:
1. Net income for the period = $60,000
2. Weighted-average number of common shares = 20,000 shares
3. Number of preferred shares = 8,000 shares
4. Dividends per preferred share = $1.50 per share
 

Net income available to common stockholders
   = $60,000 - dividends to preferred stockholders
   = $60,000 - (8,000 shares x $1.50)
   = $60,000 - $12,000
   = $48,000
  

Basic EPS = $48,000 / 20,000 shares = $2.40 per share
 

Treasury stock method
Example 1

Data:
1. Net income for the period = $60,000
2. Weighted-average number of common shares = 20,000 shares
3. During the previous period, the entity sold options to purchase 4,000 shares of common stock
 

Basic EPS = $60,000 / 20,000 shares = $3 per share
 

Treasury stock method
Options are assumed to have been exercised at the beginning of the period
 

Net income available to common stockholders
   = $60,000 - dividends to preferred stockholders
   = $60,000 - (8,000 shares x $1.50)
   = $60,000 - $12,000
   = $48,000
  
Weighted-average number of common shares after assumed exercise of options = 20,000 + 4,000 = 24,000 shares
 
Diluted EPS = $48,000 / 24,000 shares = $2 per share
 

If-converted method
Example 1

Data:
1. Net income for the period = $80,000
2. Weighted-average number of common shares = 20,000 shares
3. Number of convertible preferred shares = 4,000 shares
4. Each share of preferred stock is convertible to one share of common stock
5. Dividends per preferred share = $2 per share
 

Basic EPS = $80,000 / 20,000 shares = $4 per share
 

If-converted method
Convertible preferred shares are assumed to have been converted at the beginning of the period
 

Net income available to common stockholders
   = $80,000 - dividends to preferred stockholders
   = $80,000 - (4,000 shares x $2)
   = $80,000 - $8,000
   = $72,000
  
Weighted-average number of common shares after assumed conversion of convertible preferred stock
   = 20,000 + 4,000 = 24,000 shares
 
Diluted EPS = $72,000 / 24,000 shares = $3 per share
 

Two-class method
Example 1

Data:
1. Net income for the period = $90,000
2. Weighted-average number of common shares = 20,000 shares
3. Number of participating convertible preferred shares = 10,000 shares
4. Each share of preferred stock is convertible to one share of common stock
5. Dividends per preferred share = $2 per share
6. Dividends to common share = $2 per share
7. Preferred stockholder can participate in additional dividends on a 40:60 per share ratio with Class A common stockholders.
 
Net income = $90,000
Dividends to preferred stockholders = 10,000 shares x $2 = $20,000
Dividends to common stockholders = 20,000 shares x $2 = $40,000
  
Distributed earnings
   = $20,000 + $40,000 = $60,000
  
Undistributed earnings
   = $90,000 - ($20,000 + $40,000)= $30,000
 
Allocation of undistributed earnings:
 
   To preferred stockholders
      $30,000 x (10,000 x 0.4) / (10,000 x 0.4 + 20,000 x 0.6)
      = $30,000 x 4,000 / (4,000 + 12,000)
      = $30,000 x 4,000 / 16,000 = $7,500
 
     $7,500 / 10,000 shares = $0.75 per share

   To common stockholders
      $30,000 x (20,000 x 0.6) / (10,000 x 0.4 + 20,000 x 0.6)
      = $30,000 x 12,000 / (4,000 + 12,000)
      = $30,000 x 12,000 / 16,000 = $22,500
 
     $22,500 / 20,000 shares = $1.125 per share

Basic earnings per share amounts: