3 The notion of common stock equivalents does not operate effectively in

3 the notion of common stock equivalents does not

This preview shows page 197 - 199 out of 663 pages.

3. The notion of common stock equivalents does not operate effectively in practice. 4. The computation of primary EPS is complex and might not be well understood or consistently applied. 5. Presenting basic EPS would eliminate the criticisms about the arbitrary determination of whether a security is a common stock equivalent. 21 FASB ASC 260 requires the presentation of EPS by all companies that have issued common stock or other securities, which upon exercise or conversion would result in the issuance of common stock when those securities are publicly traded. Companies with simple capital structures are to report only basic EPS figures. FASB ASC 260-10-45 defines simple capital structures as those companies with only common stock outstanding. 22 All other companies are required to present basic and diluted EPS amounts.
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Basic EPS The objective of basic EPS is to measure a company's performance over the reporting period from the perspective of the common stockholder. Basic EPS is computed by dividing income available to common stockholders by the weighted average number of shares outstanding during the period. That is, Diluted EPS The objective of diluted EPS is to measure a company's pro forma performance over the reporting period from the perspective of the common stockholder as if the exercise or conversion of potentially dilutive securities had actually occurred. This presentation is consistent with the conceptual framework objective of providing information on an enterprise's financial performance, which is useful in assessing the prospects of the enterprise. Basic EPS is historical. It reports what enterprise performance was during the period. Diluted EPS reveals what could happen to EPS if and when dilution occurs. Taken together, these two measures provide users with information to project historical information into the future and to adjust those projections for the effects of potential dilution. The dilutive effects of call options and warrants are reflected in EPS by applying the treasury stock method. The dilutive effects of written put options , which require the reporting entity to repurchase shares of its own stock, are computed by applying the reverse treasury stock method. And the dilutive effects of convertible securities are computed by applying the if-converted method. Each of these methods is described below. Securities whose exercise or conversion is antidilutive (exercise or conversion causes EPS to increase) are excluded from the computation of diluted EPS. Diluted EPS should report the maximum potential dilution. When there is more than one potentially dilutive security, the potential dilutive effect of individual securities is determined first by calculating earnings per incremental share. Securities are then sequentially included in the calculation of diluted EPS. Those with the lowest earnings per incremental share (i.e., those with the highest dilutive potential effect) are included first.
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