I'm Larry Walther.
This is principlesofaccounting.com Chapter 15.
In this module, we will look very
carefully at the calculation of earnings per share.
Now, earnings per share is the amount of income of a company divided by the number
of shares or in other words, how much income is generated on a per share basis.
It allows comparisons of companies of different sizes.
For example, two companies that each make $1 million of profit,
if one company at a million shares, their earnings per share would be $1 per share.
If the other company only had 100,000 shares outstanding,
their earnings per share would be $10 per share.
Obviously, the earnings of the latter company on a per share basis is
much stronger, even though the corporate income is the same.
Per share data must be subdivided into continuing operations and
income from other categories.
So earlier in the chapter we looked at income continuing operations,
discontinued operations, extraordinary items, that presentation.
If we have those components, those special categories of income,
then when we show per share data, we're also going to show selected amounts
per share for key categories on the income statement.
Let's start with the basic earnings per share number, its calculations.
It's income available to common shareholders,
which we'll better define in a moment,
divided by the weighted average number of shares outstanding for the period.
We're not going to only take the number of shares at the end of the period, but
we're wanting to look at the average shares outstanding for
the period of time in this calculation.
Income available to common shareholders is generally the net income of the business
minus the portion that's attributable to the preferred dividend requirement of
the company.
There's some nuances with that, but as a general rule, consider that dividends
whether they are paid to common or preferred, dividends do not reduce income.
When we're considering the income per common share of stock,
we need to therefore withhold or back out of the net income calculation,
the amount of preferred dividends so that we know how much income is remaining or
available for the common shareholders.
The weighted average number of shares outstanding accounts for changes and
shares due to issuing additional shares, buying back shares, and so forth.
So let's look at a detailed example,
this same illustration is reproduced in the textbook.
Kooyul Corporation began 20X4 with 1,000,000 shares of stock outstanding.
200,000 additional shares were issued on April 1.
120,000 shares were reacquired on November 1 and the net income for
the year was $2,760,000.
There's some information on dividends.
$500,000 in dividends were paid to the preferred shareholders, and
$270,000 in dividends were paid to the common shareholders.
The basic earnings per share in this case calculates to be $2 per share.
It's not at all apparent how that is derived however,
until we look at the specific calculations.
That's 2,260,000 divided by 1,130,000, yields $2 per share.
We need to dig deeper to see how we get that.
Let's consider the net income minus the preferred dividends.
The company's net income was $2,760,000 total net income, but
remember I said there was $500,000 in dividends for the preferred shares.
We're not going to subtract the common share dividends,
only the preferred shared dividends.
So income available to Kooyal's common shareholders is deemed to be $2,260,000.
Looking at the weighted-average calculation of the shares,
we determined it was $1,130,000 by the following process.
>From January 1 to March 31, the first three months of the year,
we started the year with 1,000,000 shares outstanding, that's three months or
three-twelfths of the year.
So for that phase or that period of time,
we can say three-twelfths of the year times 1,000,000 shares outstanding
contributes 250,000 to the weighted average shares.
For the period April 1 to October 31, another 7 months,
we had 1,200,000 shares outstanding.
That's the 1,000,000 plus the 200,000 additional shares, and so we got 1,200,000
shares outstanding for seven-twelfths of a year, which comes out to be 700,000.
For the last two months of the year, we had 1,080,000 shares outstanding,
we bought back 120,000.
So we'll take the 1,080,000 times 2/12ths to get the 180,000 weighted
average effect, totaling, we've got our 1,130,000 weighted average.
So our income available to common shareholders divided by the weighted
average shares gave us that earnings per share number of $2.
Some companies need to present a dual earnings per share structure.
In addition to the basic earnings per share calculation that we've just looked
at, they would also need to calculate diluted earnings per share.
These are companies that have potentially dilutive securities, outstanding, or
in other words, a complex capital structure.
For example, a company might have stock options and
warrants that entitle the holders to buy additional shares of stock, or
there may be convertible bonds or convertible preferred
shares that can be exchanged for additional shares of common stock.
So diluted earnings per share calculations require a series of assumptions about
dilutive securities being converted into common stock.
We do a number of what if scenarios, we assume that convertible
preferreds are converted, we assume that convertible bonds are converted and so on.
Any time that causes a reduction or dilution in earnings per share,
we'll make that assumption to come up with those revised or
alternative earnings per share number.
So for companies with complex capital structures,
you can expect to see two earnings per share numbers,
the basic number as well as a diluted earnings per share number.