Question

The shareholders’ equity of Proactive Solutions, Inc., included the following at December 31, 2021: 

Common stock, $1 par 

Paid-in capital—excess of par on common stock 

7% cumulative convertible preferred stock, $100 par value 

Paid-in capital—excess of par on preferred stock 

Retained earnings 

Additional Information: 

• Proactive had 7 million shares of preferred stock authorized of which 2 million were outstanding. All 2 million shares outstanding were issued in 2015 for $112 a share. The preferred stock is convertible into common stock on a two-for-one basis until December 31, 2023, after which the preferred stock no longer is convertible. None of the preferred stock has been converted into common stock at December 31, 2021. There were no dividends in arrears. 

• Of the 13 million common shares authorized, there were 8 million shares outstanding at January 1, 2021. Proactive also sold 3 million shares at the beginning of September 2021 at a price of $52 a share. 

• The company has an employee stock option plan in which certain key employees and officers may purchase shares of common stock at the market price at the date of the option grant. All options are exercisable beginning one year after the date of the grant and expire if not exercised within five years of the grant date. On January 1, 2021, options for 2 million shares were outstanding at prices ranging from $45 to $53 a share. Options for 1 million shares were exercised at $49 a share at the end of June 2021. No options expired during 2021. Additional options for 1.5 million shares were granted at $55 a share during the year. The 2.5 million options outstanding at December 31, 2021, were exercisable at $45 to $55 a share. 

The only changes in the shareholders’ equity for 2021 were those described above, 2021 net income, and cash dividends paid. 

 

Required: 

Explain how each of the following amounts should be determined when computing earnings per share for presentation in the income statements. For each, be specific as to the treatment of each item. 

1. Numerator for basic EPS 

2. Denominator for basic EPS 

3. Numerator for diluted EPS 

4. Denominator for diluted EPS

Answer 1

Earnings per Share

EPS described as it is portion of earning earned during the year is allocated to every outstanding share of company. It is measuring tool used by analysts and traders to measure financial strength of company. It is most important variable and consider for calculating value of share.

 

Basic Earnings Per Share

When a firm has no remarkable protections that might weaken income per share, it is said to have a basic capital structure. In this unique situation, to weaken intends to lessen profit per share. For example, in case, there are convertible bonds which are changed over, subsequent expansion in like manner offers could diminish (or weaken) income per share. That is, new offers supplanted by changed over bonds may take an interest in future profit.

 

Diluted Earnings per Share

Conversion allows securities like convertible bonds, convertible preference shares, etc. to get converted in basic stock. Subsequently, income per share gets diluted due to this and thus it is called as potential basic shares. It makes firm’s capital structure complex. Two EPS Calculations are reported by a firm when it has complex capital structure. Dilutive effect of such securities is ignored by Basic EPS; while such effect for all potential common shares would be considered in diluted EPS.

 

 

1.

While ascertaining fundamental income per share, the numerator in the calculation is the earning accessible to basic investors. This will be overall gain diminished by earnings payable to favoured investors. Since the favoured stock is aggregate we take away favoured earnings regardless of whether not announced. Since unpaid earnings aggregate to be paid in a future year when (if) earnings are thusly pronounced, the assumption is that, despite the fact that the year\'s earning inclination isn\'t conveyed for the current year, it in the long run will be paid.

 

2.

While ascertaining essential income per share, the denominator in the calculation is the weighted-normal number of basic offers extraordinary during 2021. Consequently, the 8 million offers exceptional at January l, 2021, in addition to a bit of the offers sold will bring about the weighted-normal number of offers extraordinary for computing essential EPS. The 3 million basic offers gave during 2021 must be remembered for figuring the weighted-normal number of offers remarkable. The 3 million offers will be weighted 33% on the grounds that they were remarkable just for the four months of 2021. The 1 million basic offers gave upon the activity of investment opportunities must be remembered for figuring the weighted-normal number of offers exceptional. The 1 million offers will be weighted one-half since they were exceptional just for the half year of 2021.

 

3.

When ascertaining diluted income per share, the numerator in the calculation is the earning accessible to normal investors. Proactive won\'t decrease total compensation by earnings payable to favoured investors since it will regard the convertible favoured stock as though the favoured offers were changed over and 4 million normal offers were remarkable, except if remembering these offers for the denominator would build income per share (be enemy of dilutive). This implies that for hostile to weakening it would not lessen the numerator for the favoured earnings as it would do if the favoured offers were accepted extraordinary, as in figuring fundamental EPS.

 

4.

When figuring diluted earnings per share, the denominator in the calculation is the weighted-normal number of regular offers extraordinary during the announcing time frame. In any case, since potential regular offers exist in an unpredictable capital structure, as in this circumstance, the count of the denominator turns out to be more included.

 

We start by deciding the weighted-normal of the quantity of basic offers remarkable during 2021, the 8 million offers extraordinary at January l, 2021, in addition to a segment of the offers sold. The 3 million basic offers gave during 2021 must be remembered for processing the weighted-normal number of offers extraordinary. The 3 million offers will be weighted 33% in light of the fact that they were exceptional just for the four months of 2021. The 1 million regular offers gave upon the activity of investment opportunities must be remembered for figuring the weighted-normal number of offers exceptional. The 1 million offers will be weighted one-half since they were extraordinary just for the half year of 2021.

 

For diluted EPS, two changes are expected to the denominator. To begin with, we treat the convertible favoured stock as though the favoured offers were changed over and 4 million extra basic offers were extraordinary, except if remembering these offers for the denominator would expand income per share (be enemy of dilutive). As noted in Requirement 2, this implies likewise that we would not decrease the numerator for the favoured earnings as we would do if the favoured offers were expected as yet extraordinary.

 

Second, we treat the investment opportunities remarkable under the worker investment opportunity plan as having been worked out. The quantity of regular offers spoke to by the alternatives extraordinary ought to be registered by utilization of the depository stock strategy. By this technique, income per share is figured as though the choices were practiced toward the start of the period (or at season of issue, assuming later) and as though the theoretical continues were utilized to buy regular stock at the normal market for the period.

 

The weighted-normal number of offers exceptional for 2021 incorporates the gradual offers (controlled by the depository stock technique) spoke to by the 1 million alternatives extraordinary for the entire year.

 

The alternatives exceptional for just piece of the announcing time frame are remembered for the denominator on a period weighted premise. For the 1.5 million choices allowed during the year, the denominator would incorporate the suitable steady offers (controlled by the depository stock technique) times the proper time-weighting portion for the period from the award date to the furthest limit of the year. (They can\'t be accepted to have been practiced before they were conceded.) Similarly, for the 1 million choices really practiced during the year, the weighted-normal offers ought to incorporate (a) the fitting steady offers (dictated by the depository stock strategy) times the proper time-weighting part for the period preceding genuine exercise and (b) the suitable real offers gave times the suitable time-weighting portion for the period after the activity.