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

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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.
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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.