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302Chapter 19 notes

302Chapter 19 notes - 1 LEARNING OBJECTIVES 1 CHAPTER 19...

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1 C HAPTER 19 Earnings Per Share L EARNING O BJECTIVES 1. Detail recent changes in accounting standards relating to earnings per share, and know why the changes were made and how these changes will affect computations relating to earnings per share. In 1997, the FASB issued Statement No. 128, which provides new requirements associated with earnings per share computations and disclosure. < Requires two EPS computations—basic and diluted. < Dilution relates to those convertible securities and stock options that, if exercised, would result in a decrease in EPS. The International Accountings Standards Committee issued a similar EPS standard. 2. Know the difference between a simple and a complex capital structure, and understand how dilutive securities affect earnings per share computations. A simple capital structure exists when a company has only common stock, or common and nonconvertible bonds outstanding, and there are no convertible securities, stock options, warrants, or other rights outstanding. A company with convertible securities or stock options that would, if exercised, result in a dilution in EPS is considered to have a complex capital structure. 3. Compute basic earnings per share, taking into account the sale and repurchase of stock during the period as well as the effects of stock splits and stock dividends. Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding. If a company splits its stock or declares a stock dividend, a retroactive recognition of this change must be made in determining the weighted average number of shares outstanding. When comparative financial statements are presented, the common shares outstanding for all periods shown must be adjusted to reflect any stock dividend or stock split in the current period. 1
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2 4. Use the treasury stock method to compute diluted earnings per share when a firm has outstanding stock options, warrants, and rights. If a firm has stock options, warrants, or rights outstanding, a determination must be made as to their potential effects on earnings per share. If the exercise price is less than the average market price for the period, the option, warrant, or right is considered dilutive and would be included in computing diluted EPS. The treasury stock method involves determining the number of incremental shares that would be issued assuming the options, warrants, or rights were exercised and the proceeds used to buy treasury shares on the market. 5. Use the if-converted method to compute diluted earnings per share when a company has convertible preferred stock or convertible bonds outstanding. A company with convertible securities may be required to adjust both the numerator and the denominator in computing diluted earnings per share if those convertible securities are determined to be potentially dilutive.
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