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Note that there is no related tax effect on preferred dividends because preferred dividends are not a tax deductible item.

FOURTH: Assume the conversion takes place at the beginning of the period for which EPS is being calculated or at the date of the issuance of the convertible, whichever is later (more recent).

FIFTH: If there is a scale of conversion rates, use the rate that is the most advantageous from the standpoint of the security holder.

C. Treatment of options and warrants:

DILUTED EPS Stock Options and Warrants

Stock options and warrants outstanding are included in diluted EPS unless they are antidilutive. If the exercise price of the option or warrant is LOWER than market price of the stock, common shares are reduced. In this case, the options or warrants are anti-dilutive because their assumed exercise leads to an increase in EPS.

FIRST: Assume the options and warrants are exercised if the effect of that assumption is dilutive. An option or warrant is dilutive if the average market price of the common stock during the period is GREATER than the exercise price of the option or warrant.

SECOND: Use the TREASURY STOCK METHOD. Assume that the proceeds (from the exercise of the options or warrants) are used to purchase treasury stock at the average market price for the period. Thus, shares will be added to the EPS denominator because of the assumed exercise, and then a smaller number of shares will be deducted from the denominator because of the assumed purchase of treasury stock. Weight the resulting net number of common equivalent shares according to the time they are assumed to be outstanding.

THIRD: Assume the exercise occurs at the beginning of the period or at the date of issuance of the options or warrants, whichever is the later.

D. Treatment of contingent issuance agreements:

FIRST: Common stock contingently issuable with the only condition being the mere passage of time should be assumed to be outstanding for computing diluted EPS.

SECOND: common stock contingently issuable upon condition of the attainment or maintenance of a level of earnings should be considered outstanding in computing diluted EPS if that level is currently being attained.

THIRD: Common stock contingently issuable upon condition of the attainment of a market price level should be considered an outstanding share if that level is met at the end of the current year

(End of material from Intermediate Accounting Text).

CONCLUSION

As you can see, when attempting to follow these steps numerous questions arise. The person doing the calculations must know the terminology well, as well as, fully understand the steps and exceptions to some of the steps and rules mentioned. The financial manager must also have accurate amounts of the financial instruments and incomes involved. Any missteps and manipulations, whether deliberate or unintentional, will deliver inaccurate information to the stockholders and other stakeholders. Today erroneous calculations are bringing down many corporations; the inexperienced or greedy managers (especially financial managers) are usually manipulating the data and even omitting important information on the Financial Statements.

Though calculation of EPS may not be considered complicated by many, it is still very intensive and involves more in-depth information and other financial management formulas to determine a more accurate profitability forecast of a firm, or EPS. EPS formula should not be the only criteria used to determine the earnings and value of common stock.

________________________ ____________

My class notes from Advanced Intermediate Accounting (Chapter 17)

Kieso, D. E., Weygandt, J. J., and Warfield, T. D. (2001). INTERMEDIATE ACCOUNTING. New York. John Wiley & Sons, Inc.

Learn more about this author, J. Janie Lipsmeyer.
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