Diluted EPS Calculations

QRK Company Earnings Per Share Calculation

• One million common stock shares were outstanding at the beginning of 2005 for QRK Company.
• An additional 200,000 shares were issued on the last day of March.
• 500,000 shares were issued on the last day of June.
• 800,000 shares were issued on the last day of September.
• For calculating 2005 earnings per share, the weighted average number of shares is required.
• The weighted average is calculated by weighting the shares by the portion of the year they were outstanding.
• The weighted number of shares outstanding is the original 1 million + 200,000*(9/12) + 500,000*(6/12) + 800,000*(3/12).
• The weighted average is 1.6 million shares.

JPK, Inc. Earnings Per Share Calculation

• JPK, Inc. paid $80,000 in dividends to preferred shareholders in 2004.
• JPK, Inc. paid $40,000 in dividends to common shareholders in 2004.
• The company had 20,000 common stock shares issued and outstanding on January 1, 2004.
• An additional 7,000 shares were issued on June 1, 2004.
• A 10% stock dividend was paid on August 1, 2004.
• JPK had $150,000 in net income.
• To calculate basic earnings per share (EPS) for 2004, determine the weighted average shares.
• 22,000 shares were outstanding on 1/1/00 adjusted for 10% stock dividend × 12 months = 264,000
• 7,700 shares were issued on 6/1/00 adjusted for 10% stock dividend × 7 months = 53,900
• Total share month = 317,900
• Average shares = 317,900 / 12 = 26,492
• Basic EPS = ($150,000 - $80,000) / 26,492 = $2.64

Basic and Diluted EPS

• A simple capital structure contains no potentially dilutive securities.
• Antidilutive securities increase EPS if exercised or converted to common stock.
• Dilutive securities decrease EPS if they are exercised or converted to common stock

Intangible Assets with Indefinite Lives

• Intangible assets with indefinite lives (e.g., goodwill) are not amortized under IFRS and U.S. GAAP.
• Intangible assets with indefinite lives are tested for impairment at least annually.

Artcraft, Inc. Diluted Earnings Per Share (EPS)

• Net income is $30,000.
• There are 5,000 common stock shares and 500 shares of 8%, $90 par convertible preferred stock outstanding during the whole year.
• Each share of convertible preferred can be converted into 4 shares of common stock.
• At par, $60,000 total face value of 6.0% convertible bonds.
• Each of the 60 bonds are convertible into 110 shares of the Artcraft common stock.
• Artcraft's effective tax rate is 40%.
• Basic EPS = (net income – preferred dividends)/weighted average common shares.
• Diluted EPS = adjusted earnings after conversion (EAC) / weighted average plus potential common shares outstanding.
• convertible preferred dividends = (0.08)(90)(500) = 3,600
• convertible debt interest = (60,000)(0.06)(1 – 0.40) = 2,160
• adjusted EAC = (30,000 – 3,600 + 3,600 + 2,160) = $32,160
• average common shares = 5,000
• shares from conversion of convertible preferred stock = (500 × 4) = 2,000
• shares from conversion of convertible bonds = (60 × 110) = 6,600
• weighted average plus potential common shares outst. = 13,600
• The impact of the convertible preferred stock is $3,600/2,000 = $1.8, which is less than BEPS and so dilutive.
• The impact of the convertible bonds is $2,160/6,600 = $0.33, again less than BEPS and so also dilutive.
• Diluted EPS = 32,160 / 13,600 = $2.36.

Caledonia, Inc. Diluted Earnings Per Share for 20X6

• Caledonia, Inc.'s net income = $460,000
• 2,300,000 shares of common stock were outstanding on January 1.
• The average market price per share was $2 and the year-end stock price was $1.50.
• 1,000 shares of 8%, $1,000 par value preferred shares were outstanding on January 1, then preferred dividends were paid in 20X6.
• 10,000 warrants, each of which allows the holder to purchase 100 shares of common stock at an exercise price of $1.50 per common share, were outstanding the entire year.
• Basic EPS = (net income - preferred stock dividends) / (weighted average common shares outstanding).
• Basic EPS = [$460,000 - ($1,000 × 1,000 × 0.08)] / 2,300,000 = $0.17.
• If the warrants were exercised, cash inflow would be 10,000 × 100 × $1.50 = $1,500,000 using the treasury stock method.
• The number of Caledonia shares that could be purchased with the inflow, using the average share price, is $1,500,000 / $2 = 750,000.
• The net increase in common shares outstanding would have been 1,000,000 – 750,000 = 250,000.
• Diluted EPS = $380,000 / (2,300,000 + 250,000) = $0.15.

Alaska Corporation Earnings Per Share

• At the beginning of 2004, the Alaska Corporation had 2 million common stock shares outstanding, and no preferred stock.
• At the end of August, 2004, Alaska issued 600,000 new common stock shares.
• Alaska reported net income equal to $8.8 million.
• EPS = earnings available to common shareholders divided by the weighted average number of common shares outstanding.
• The weighted average number of shares outstanding equals the original 2 million shares plus 4/12 of the additional 600,000 shares, as the new shares were only outstanding for 4 months of the year.
• Thus, EPS = $8.8 million / [2 million + (4/12)(600,000)] = 8.8/2.2 = $4.00.

Numerator for Diluted Earnings Per Share

• In calculating the numerator for diluted Earnings Per Share, the interest on convertible debt is added to earnings available to common shareholders after an adjustment for taxes.
• Diluted EPS = [(Net income - Preferred dividends) + Convertible preferred dividends + (Convertible debt interest)(1 - t)] / [(Weighted average shares) + (Shares from conversion of conv. pfd shares) + (Shares from conversion of conv. debt) + (Shares issuable from stock options)]

Complex Capital Structure

• A complex capital structure is one that has potentially dilutive elements.
• The warrants for Supple Moves will be dilutive if the average stock prices were over $50.00.

Basic Earnings per Share Calculation

• One million shares were outstanding at the beginning of the year.
• On June 30th, they declared and issued a 10% stock dividend.
• On September 30th, they sold 400,000 shares of common stock at par.
• The basic earnings per share at year-end will be computed on 1,200,000 shares.
• The January 1 balance of common shares outstanding is adjusted retroactively for both stock dividends and stock splits.
• The weighted average shares outstanding for the year = 1,000,000(12) + 100,000(12) + 400,000(3)
• Total = 14,400,000 /12 = 1,200,000

Capital Structure Types

• A complex capital structure contains potentially dilutive securities such as options, warrants, or convertible securities.
• There is no basic capital structure, but there are basic earnings per share which does NOT consider the effects of any dilutive securities in the computation of EPS.

Accounting for Changes in Asset Lives and Salvage Values

• Changes in asset lives and salvage values are changes in accounting estimates and are not considered changes in accounting principle.
• Changes in accounting estimates are applied prospectively.

Feder Corp.'s Diluted Earnings per Share (EPS)

• Feder Corp.'s Net income was $7,650,000. 1,100,000 shares of common stock were outstanding on January 1.
• Dividends were paid during the year and the tax rate was 40%. The average market price share: $62.
• The company had 10,000 shares of 6% $1,000 par value preferred shares convertible into common shares at a rate of 20 common shares.
• 70,000 options, which allow the holder to purchase 10 shares of common stock at an exercise price of $50 per common share, were outstanding the entire year.
• Feder's basic earnings per share was (($7,650,000 – ($1,000 × 10,000 × 0.06)) / 1,100,000 =) $6.41.
• If the convertible preferred stock was converted to common stock at January 1, (10,000 × 20 =) 200,000 additional common shares would have been issued, dividends on the preferred stock would not have been paid, and Diluted EPS would have been ($7,650,000 / (1,100,000 + 200,000) = $5.88.
• If the options were exercised cash inflow would be (70,000 × 10 × $50 =) $35,000,000 using the treasury stock method.
• Diluted EPS was [($7,650,000 - ($1,000 × 10,000 × 0.06)] / (1,100,000 + 135,484) =) $5.71.
• Diluted EPS was (($7,650,000) / (1,100,000 + 200,000 + 135,484) = $5.32.

Advantage Corp.'s Earnings per Share

• Advantage Corp.'s Common outstanding shares of stock: 110,000
• Convertible Preferred:10,000 (December 31, 2005 and December 31, 2004)
• 8% Convertible Bonds:$1,000,000

Explore the steps in calculating diluted EPS, including the impact of stock options, convertible bonds, and warrants. Understand how to adjust values and apply the matching principle under accrual accounting. Learn the formulas for determining common shares created by warrants.