Ch 16 Part 2 EPS Narrated Part II

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This is part 2 of 4 parts of the EPS materials in chapter 16. Be sure to view part 1.

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Prepared by Coby Harmon University of California, Santa Barbara Intermediate Accounting

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LO 7 Compute earnings per share in a complex capital structure. Complex Capital Structure exists when a business has convertible securities, options, warrants, or other rights that upon conversion or exercise could dilute earnings per share. Company reports both basic and diluted earnings per share. EPS - Complex Capital Structure

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LO 7 Compute earnings per share in a complex capital structure. Diluted EPS includes the effect of all potential dilutive common shares that were outstanding during the period. Companies will not report diluted EPS if the securities in their capital structure are antidilutive . Illustration 16-17 EPS - Complex Capital Structure

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Diluted EPS – Convertible Securities Measure the dilutive effects of potential conversion on EPS using the if-converted method . This method for a convertible bond assumes: the conversion at the beginning of the period (or at the time of issuance of the security, if issued during the period), and the elimination of related interest, net of tax . LO 7 Compute earnings per share in a complex capital structure. EPS - Complex Capital Structure

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LO 7 Compute earnings per share in a complex capital structure. E16-22 (Convertible Bonds): In 2012 Buraka Enterprises issued, at par, 75, $1,000, 8% bonds, each convertible into 100 shares of common stock. Buraka had revenues of $17,500 and expenses other than interest and taxes of $8,400 for 2013. (Assume that the tax rate is 40%.) Throughout 2013, 2,000 shares of common stock were outstanding; none of the bonds was converted or redeemed. Instructions (a) Compute diluted earnings per share for 2013. (b) Assume same facts as those for Part (a), except the 75 bonds were issued on September 1, 2013 (rather than in 2012), and none have been converted or redeemed. EPS - Complex Capital Structure

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LO 7 Compute earnings per share in a complex capital structure. E16-22 (a) Compute diluted earnings per share for 2013. Calculation of Net Income Revenues $17,500 Expenses 8,400 Bond interest expense (75 x $1,000 x 8%) 6,000 Income before taxes 3,100 Income tax expense (40%) 1,240 Net income $ 1,860 EPS - Complex Capital Structure

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LO 7 Compute earnings per share in a complex capital structure. E16-22 (a) Compute diluted earnings per share for 2013. When calculating Diluted EPS, begin with Basis EPS. Net income = $1,860 Weighted average shares = 2,000 = $.93 Basic EPS EPS - Complex Capital Structure

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LO 7 Compute earnings per share in a complex capital structure. E16-22 (a) Compute diluted earnings per share for 2013. When calculating Diluted EPS, begin with Basis EPS. $1,860 2,000 = $.57 Diluted EPS + $6,000 (1 - .40) 7,500 Basic EPS = .93 $5,460 9,500 = Effect on EPS = .48 + EPS - Complex Capital Structure

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LO 7 Compute earnings per share in a complex capital structure. Calculation of Net Income E16-22 (b) Assume bonds were issued on Sept. 1, 2013 . EPS - Complex Capital Structure

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LO 7 Compute earnings per share in a complex capital structure. E16-22 (b) Assume bonds were issued on Sept. 1, 2013 . When calculating Diluted EPS, begin with Basis EPS. $4,260 2,000 = $1.21 Diluted EPS $2,000 (1 - .40) 7,500 x 4/12 yr. $5,460 4,500 = Effect on EPS = .48 Basic EPS = 2.13 + + EPS - Complex Capital Structure

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LO 7 Compute earnings per share in a complex capital structure. P16-8 (Variation-Convertible Preferred Stock): Prior to 2012, Barkley Company issued 40,000 shares of 6% convertible, cumulative preferred stock, $100 par value. Each share is convertible into 5 shares of common stock. Net income for 2012 was $1,200,000. There were 600,000 common shares outstanding during 2012. There were no changes during 2012 in the number of common or preferred shares outstanding. Instructions (a) Compute diluted earnings per share for 2012. EPS - Complex Capital Structure

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LO 7 Compute earnings per share in a complex capital structure. P16-8 (a) Compute diluted earnings per share for 2012. When calculating Diluted EPS, begin with Basis EPS. Net income $1,200,000 – Pfd. Div. $240,000 * Weighted average shares = 600,000 = $1.60 Basic EPS * 40,000 shares x $100 par x 6% = $240,000 dividend EPS - Complex Capital Structure

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LO 7 Compute earnings per share in a complex capital structure. When calculating Diluted EPS, begin with Basic EPS. 600,000 = $1.50 Diluted EPS $240,000 Basic EPS = 1.60 = Effect on EPS = 1.20 P16-8 (a) Compute diluted earnings per share for 2012. $1,200,000 – $240,000 200,000 * $1,200,000 800,000 * (40,000 x 5) + + EPS - Complex Capital Structure

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LO 7 Compute earnings per share in a complex capital structure. 600,000 = $1.67 Diluted EPS $240,000 Basic EPS = 1.60 = Effect on EPS = 2.00 P16-8 (a) Compute diluted earnings per share for 2012 assuming each share of preferred is convertible into 3 shares of common stock . $1,200,000 – $240,000 120,000 * $1,200,000 720,000 * (40,000 x 3) + + EPS - Complex Capital Structure

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LO 7 Compute earnings per share in a complex capital structure. 600,000 = $1.67 Diluted EPS $240,000 Basic EPS = 1.60 = Effect on EPS = 2.00 $1,200,000 – $240,000 120,000 * $1,200,000 720,000 * (40,000 x 3) Antidilutive Basic = Diluted EPS P16-8 (a) Compute diluted earnings per share for 2012 assuming each share of preferred is convertible into 3 shares of common stock . + + EPS - Complex Capital Structure

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Diluted EPS – Options and Warrants Measure the dilutive effects of potential conversion using the treasury-stock method . This method assumes: company exercises the options or warrants at the beginning of the year (or date of issue if later), and that it uses those proceeds to purchase common stock for the treasury. LO 7 Compute earnings per share in a complex capital structure. EPS - Complex Capital Structure

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