2 For purposes of computing earnings per share residual securities are those

2 for purposes of computing earnings per share

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2. For purposes of computing earnings per share residual securities are those securities deriving a major portion of their value from their right to be converted into common stock through the exercise of an option or conversion privilege by the owner of the security. Convertible preferred stock, convertible debt, common stock options and common stock warrants are examples of such securities.
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c. Treatments to be given to the listed items in computing earnings per share are: i. Dividends on preferred stock should be deducted from net income and also net income before extraordinary items before computing earnings per share applicable to the common stock and other residual securities. If the preferred stock is cumulative this adjustment is appropriate whether or not the amounts of the dividends are declared or earned. ii. Minor reacquisitions of outstanding common stock which are placed in the treasury may be excluded in the computation of earnings per share. However, in determining earnings per share during the period when a major acquisition of treasury common stock was made, the computation should be based on the weighted average number of shares outstanding during the period. iii. When the number of common shares outstanding increases as a result of a stock split during the year, the computation should be based on shares outstanding at year end and retroactive recognition should be given for an appropriate number of prior years. iv. The existence of a provision for a contingent liability on a possible lawsuit created out of retained earnings will not affect the computation of earnings per share since the appropriation of retained earnings does not affect net income or the number of shares of stock outstanding. v. Outstanding preferred stock with a par value liquidation right issued at a premium, although affecting the determination of book value, will not affect the computation of earnings per share for common stock except with respect to the dividends as discussed in c.i. above. vi. The exercise of a common stock option which results only in a minor increase in the number of shares outstanding during the period may be disregarded in the computation of earnings per share. If, however, the exercise of a common stock option results in a major increase in the number of shares outstanding, the computation of earnings per share should be based on the weighted average number of shares outstanding during the period. The exercise of a stock option by the grantee does not affect earnings, but any compensation to the officers from the granting of the options would reduce net income and earnings per share. vii. The replacement of a machine immediately prior to the close of the current fiscal year will not affect the computation of earnings per share for the year in which the machine is replaced. The number of shares remains unchanged and since the old machine was sold for its book value, earnings are unaffected Case 6-8 Classification of Accounting Changes Morgan Company Morgan Company grows various crops and then processes them for sale to retailers. Morgan has
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