Welcome back. In this lesson,

we're going to calculate basic earnings per share.

To show how it's done,

we'll look at the simplest case first,

and then we'll look at the impact of

some other transactions that could have occurred during the period.

We'll gradually add complexity.

So, the basic calculation,

let's look at a company.

We'll call it Stone Cold Refrigeration,

has net income of 3 million in the first quarter and has

3,300,000 shares of common stock outstanding.

Well, if they have a simple capital structure with

no preferred stock or no equity interest,

what would their basic earnings per share be?

So, in this situation,

calculating earnings per share is a piece of cake.

You just take the $3 million of net income,

and you divide it by the 3,300,000 shares outstanding,

and you get about 91 cents of earnings per share.

This is basic earnings per share for the quarter.

Now, let's add some complexity.

Let's add some preferred stock dividends.

Remember, those are deducted from that income in calculating earnings per share,

preferred stock again controversially included in equity.

So, the payments to the preferred shareholders do not reduce net income,

but also, are not available to the common shareholders hence, the deduction.

So, let's look at basic EPS now when there's preferred dividends involved.

So, Stone Cold Refrigeration paid $30,000 of preferred dividends during the quarter.

The basic EPS is going to be that 3 million of net income,

take out the 30 million of preferred stock dividends that they paid during the quarter,

assuming there's nothing in arrears at this point,

and divide by 3,300,000 and we get 90 cents per share.

We've diluted the shares a little bit.

This is not fully diluted or diluted earnings per share,

this is still basic earnings per share.

It's just adjusted for the preferred stock dividends.

So again continuing, what if they issue shares during the quarter?

So, if they have 3,300,000 shares outstanding January 1st,

but issue an additional 100,000 shares on March 1st.

Now, we're going to take a weighted average of those shares.

Those 100,000 shares were not outstanding for the entire period.

So, the shares outstanding for thirty-ninetieths are one-third of the period,

because they were issued March 1st.

So, 100,000 times one-third is 33,333.

For purposes of EPS,

shares outstanding will now be 3,300,000 plus 33,333,

it'll be all threes.

Basic EPS now will be the 2,970,000 adjusted for the preferred stock.

Dividends divided by the amount of shares,

adjusted for the shares issued.

Two months into the quarter, and we have now,

$0.89 per share, basic earnings per share.

So, net income from the period is being divided among 3,400,000 shares.

I mean, at the end of the period,

that's the amount that's outstanding.

So, what's the logic then of using this weighted average of

3,333,333 instead of just

dividing it by the number of shares that are outstanding at the end of the quarter?

Well, the logic there is that the resources from

the additional shares were only available for part of the period.

So, we're only going to include those in the earnings per share for part of the period.

This is one of the arbitraries sort of issues that I was talking about before.

So, what if the transaction went the other way?

What if the repurchase of shares,

whether to be retired or retained as treasury shares doesn't matter,

it also affects the calculation?

Now, the weighting for the period for the shares were not outstanding.

So, if they had 3,400,000 shares outstanding now on April 1st,

and repurchased 300,000 shares on June 1st,

that's two months in to the quarter,

how's that going to affect the shares?

Well, I'm going to take the number of days that they were not outstanding.

So, if they were repurchased June 1st,

they were not outstanding from June 1st to June 30th.

So, I will have 30 divided by 90 days not outstanding.

I'm going to take off 100,000 shares.

I will show weighted average shares of 3,300,000.

The original 3,400,000 available on the first day of the quarter,

minus 300,000 shares that were repurchased 60 days in.

So, they were not outstanding for

30 days and the weighted average shares is now 3,300,000.

Note though, that the actual number of shares outstanding at the end of the quarter is

3,100,000 but we're using 3,300,000 for our denominator.

So also, it's important to look at

repurchases of stock and make sure it's not an off-market transaction,

especially if it's a purchase from an insider, or related party.

You've go to make sure there's not something else going on with the purchase.

It could be a stealth bonus,

a settlement of a dispute,

or something else entirely going on.

So, you have to look additionally when

the repurchase especially is targeted toward a particular individual.

Now, what's a stock dividend in a split?

They're different but similar in their impact on the issuance of

repurchase of shares because neither provides resources to the entity.

On the other hand,

neither deprives resources from the entity.

There's no weighting then for stock dividends or splits.

A stock dividend or split will decrease

earnings per share because there'll be more shares outstanding.

This is a process known as dilution.

You could also have a reverse stock split.

However, that will increase earnings per share

for the period and we'll look at all three of these scenarios.

So, what if we have a stock dividend or stock split?

We're not going to take a weighted average.

We're going to take and make

a retroactive adjustment as if the shares had been outstanding for the entire period.

So, I am going to adjust basic EPS retroactively,

not just for the period in which I pay the stock dividend or have the stock split,

I'm going to adjust it for all previous periods issued.

This is for comparability purposes.

Why does this happen?

A stock dividend is when a company declares a dividend that's payable in stock.

There's no cash resources that outflow.

Instead, if a company has 100 shares

outstanding and declares a 10 percent stock dividend,

they will now have 110 shares outstanding without any change in resources available.

So the logic is,

since there was no change in the resources available to the company,

I don't have a weighted average issue.

I'm going to simply make a retroactive adjustment so that

everybody can see exactly how the earnings per share has

changed during the period as if

the stock split or stock dividend had been in effect from the first day.

Now, what if it happens after the end of the reporting period?

I could have a stock split or a stock reversed stock split,

or a stock dividend that happens after the course of the period,

but before the financial statements are issued,

or even in fact available to be issued.

Then, the per share computations for those periods and any prior periods

that I'm going to present in the financial statements

are going to show that new number of shares.

So, it can even require retroactive adjustment if

the stock dividend or a split or reverse

stock split occurs after the end of the reporting period.

And again, we're going to adjust the denominator.

So, let's look back at Stone Cold Refrigeration.

If they have 3,400,000 shares outstanding June 30th and they issue

a 10 percent stock dividend on July 4th

before the quarterly financial statements have been issued,

then you would add 10 percent to the number of shares outstanding for

the period ending June 30th and all prior periods.

And again, this is not a weighted average.

So, the weighted average number of shares at March 31st will be

3,400,000 times 110 percent equals 3,740,000.

Those shares are considered to be outstanding for the entire period in all prior periods

reporting even though the stock dividend took place after the end of the quarter.

So, there's your basic principles.

If the stock is issued or repurchased,

I'm going to do a weighted average and adjust the number of shares.

If the stock was increased or

decreased as a result of the dividend stock split or reverse stock split,

I'm going to adjust retroactively and consider that that had happened as if it

had happened for the entire period and adjust all prior periods as well,

even if the event happens after the end of

the reporting period but before the financial statements have been issued. Thank you.

Earnings Per Share: Basic EPS

Accounting Analysis II: Accounting for Liabilities and Equity

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