Chapter 20 Earnings Per Share

Chapter 20 Earnings Per Share - Chapter 20 Earnings Per...

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Chapter 20 Earnings Per Share Questions for Review of Key Topics Question 20-1 A firm has a simple capital structure if it has no potentially dilutive securities outstanding. These are securities that are not yet common stock, but might become common stock if exercised or converted. Thus, they could potentially dilute (meaning reduce) earnings per share. For a firm with a simple capital structure, EPS is simply earnings available to common shareholders divided by the weighted-average number of common shares outstanding . Question 20-2 There is a fundamental difference between the increase in shares caused by stock dividends and stock splits and an increase from selling new shares. When additional shares are sold , both the assets of the firm and shareholders’ equity are increased by an additional investment by owners. On the other hand, stock dividends or stock splits merely increase the number of shares without affecting the firm’s assets. As a consequence, the same "pie" is divided into more pieces resulting in a larger number of less valuable shares. Shares outstanding prior to a stock dividend or stock split are retroactively restated to reflect the increase in shares, as if the distribution occurred at the beginning of the period. On the other hand, any new shares issued are "time-weighted’ by the fraction of the period they were outstanding and then added to the number of shares outstanding for the entire period. Question 20-3 The weighted-average number of shares for calculating EPS would be 104,500 determined as follows: 100,000 (1.05) – 1,200 (5/12) = 104,500 shares shares stock treasury at Jan. 1 dividend shares adjustment The 1,200 shares retired are weighted by (5/12) to reflect the fact they were not outstanding the last five months of the year. Purchases of shares that occur after a stock dividend or split are not affected by the distribution. Question 20-4
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Preferred dividends are deducted from the numerator in the EPS fraction so that "earnings available to common shareholders" will be divided by the weighted-average number of common shares. An exception would be when the preferred stock is noncumulative and no dividends were declared in the reporting period. Another time the deduction is not made is when the preferred stock is convertible and the calculation of EPS assumes the preferred stock had been converted and therefore no dividends would have been paid. Question 20-5 Basic EPS does not reflect the dilutive effect of potentially dilutive securities. On the other hand, diluted EPS incorporates the dilutive effect of all potentially dilutive securities, if the effect is not antidilutive. Question 20-6 When calculating diluted EPS, we assume that the shares specified by stock options, warrants, and rights are issued at the exercise price and that the proceeds are used to buy back as treasury stock as many of those shares as could be acquired at the average market price during the reporting period. Question 20-7
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This note was uploaded on 08/27/2010 for the course ACC 306 taught by Professor Timathycrawford during the Spring '10 term at Ashford University.

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Chapter 20 Earnings Per Share - Chapter 20 Earnings Per...

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