01. Earnings Per Share (EPS): Calculation and Disclosure

By Jay

1. EPS Basic Concept

  • Definition: EPS (Earnings Per Share) is the portion of a company’s net income allocated to each outstanding common share.
  • Importance: A key measure of profitability; fundamental to calculating the P/E ratio.
  • Financial Statement: Must be presented on the income statement.

2. Types of EPS

Basic EPS

  • Formula:
Basic EPS=Net income attributable to common shareholders−Preferred dividendsWeighted-average number of common shares outstanding \text{Basic EPS} = \frac{\text{Net income attributable to common shareholders} - \text{Preferred dividends}}{\text{Weighted-average number of common shares outstanding}}
  • Weighted-average shares: Reflects stock issued, repurchased, split, or distributed over the period.

Diluted EPS

  • Concept: Assumes all convertible instruments are exercised or converted into common stock.

  • Potentially dilutive securities: Include stock options, warrants, convertible debt, and convertible preferred stock.

  • Rule: Diluted EPS must always be less than or equal to Basic EPS.

  • Formula:

Net Income−Preferred DividendsWeighted Avg Shares+Potential Dilutive Shares \frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Weighted Avg Shares} + \text{Potential Dilutive Shares}}

3. Calculation Considerations

Weighted-Average Common Shares

  • Adjust for stock issuance, repurchase, dividends, and splits using appropriate time-weighting.
  • Apply retroactively in case of stock splits or reverse splits.

Preferred Dividends

  • Cumulative preferred: Deduct regardless of declaration.
  • Noncumulative preferred: Deduct only if declared.

Special Items

  • Discontinued operations, extraordinary items, or accounting changes should be included in EPS.
  • Companies may present EPS before and after special items.

4. Complex Capital Structures

Dilution Analysis Methods

  • If-Converted Method: For convertible bonds and preferred stock.
  • Treasury Stock Method: For options and warrants.

Anti-Dilutive Securities

  • Securities that increase EPS when assumed converted are anti-dilutive and excluded from diluted EPS.
  • Test for anti-dilution incrementally to find the most dilutive combination.

5. Financial Statement Disclosures

  • Present both Basic and Diluted EPS on the income statement with equal prominence.
  • Disclose:
    • Adjustments to numerator and denominator.
    • Reconciliation from net income to EPS.
    • Assumptions for potential conversions.
    • Prior-period restatements due to stock splits or accounting changes.

6. Special EPS Situations

Stock Splits & Reverse Splits

  • Apply retroactively to all periods presented.

Retrospective Accounting Changes

  • Restate prior-period EPS to reflect corrections or principle changes.

Compound Financial Instruments

  • Separate into equity and liability components.
  • Only equity component affects EPS.

7. High-Yield USCPA Exam Topics

  • Distinction between Basic and Diluted EPS
  • Handling stock transactions in weighted-average share calculation
  • Application of Treasury Stock Method and If-Converted Method
  • Identification and exclusion of anti-dilutive instruments
  • EPS with discontinued operations or special items
  • EPS under complex capital structures

Sample Questions

Question 1

Which of the following would be excluded when calculating diluted EPS?

A. Convertible preferred stock
B. Stock options with strike price below market
C. Convertible bonds with anti-dilutive effects
D. Stock warrants expected to be exercised

Answer: C
Explanation: Convertible bonds that are anti-dilutive (i.e., increase EPS) are excluded from diluted EPS calculation.

Question 2

In calculating Basic EPS, how should a 2-for-1 stock split occurring at year-end be treated?

A. Ignored for the current year
B. Applied only to post-split period
C. Applied prospectively only
D. Applied retroactively to all periods presented

Answer: D
Explanation: Stock splits are applied retroactively to all periods presented in the financial statements for comparability.