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Earnings per share
FASB- Financial Accounting Standards Board is the body that is vested with the responsibility of providing appropriate guidelines and for making changes in accounting principles and financial reporting issues. EPS is one of the many areas in accounting that FASB has provided some changes in order to meet the requirements of the investors and any other creditors.
FASB current codification standards on US General Accounting Accepted Standards (GAAP/IFR), earning per share is the sum of all earnings that are related/or attributable to each common stock share (FASB), 2012, p. 1). The term is used in reference to both loss and earnings of a share. A common stock refers to a stock which is subordinate to all stock of the company that issues them. It is also referred to as a common share. There are many other terms that are used in the understanding of earnings per shares. These include; antidilution which refers to the increase in EPS amounts or the decrease in loss per share amounts. Basic earnings per share means the total amount of earnings for a certain period available to every outstanding share of common stock or which may not have been paid during the reporting time. Diluted earnings mean the total sum of money/earnings for available period for the outstanding common stock at the time that earnings are being reported. It also relates to each outstanding amount of shares when the issuance of common shares for all potential common shares (dilutive) is outstanding during the reporting period (FASB, 2012, p.2).
Dilution is the reduction/decrease of EPS that results from the assumption that convertible securities was converted or other shares were issued upon meeting certain conditions such as when warrants were exercised.
Business reorganizations and combinations
In the circumstances where common shares are issued in pursuit to acquisition of a new business or a combination, calculation of EPS recognizes the existence of new shares only begin from the date the acquisition commenced (FASB, 2012, p.2). In reorganizations, however, earnings per shares are normally based on analysis that is done on a particular transaction and the provisions of the subtopic.
In the event that there are partially paid shares and partially paid subscriptions for stock that qualify to earn dividends in accordance to the proportion of the amount paid, then the common shares that is equivalent to the partially paid shares is included in the earnings per shares computations as long as they are allowed to participate in dividends. On the other hand, partial paid stock subscriptions which do not share the dividends until they are fully paid are considered as warrants and therefore included in the diluted EPS using treasury stock method (FASB, 2012, p.3). The balance that is not paid is assumed to precede that which was used in purchasing stock using treasury stock method.
Master limited partnerships are also an important part when it comes to how earnings per share are subdivided. A typical master limited partnership contains a general partner interest, publicly traded common units held by limited partners and incentive distribution rights. Publicly traded master limited partnerships often issue multiple classes of securities that may qualify to be adopted in the partnerships distributions according a specific formula provided in the partnership agreement (FASB, 2012, p.2).
The partnerships agreements require that the available partnership is spread over the whole period of reporting as the agreement stipulates. The general partner and the limited partners share the cash accrued using a distribution waterful. Mechanism that allows distributions or prescribes how the partners i.e. the general and the limited partners share the cash after at a certain threshold. Upon meeting the threshold, holders of the separate class of nonvoting unlimited partner’s interest or when incentive distribution rights is encompassed in the general partner interest to the general partner. At the end of the financial period, net loss or profit of the partnership is then allocated to the capital account s of the g limited and general partner on the basis of their respective sharing losses/ incomes as required/specified in the partnership agreement (FASB, 2012, p.2).
In calculating of the earnings per share for capital structures which are not convertible into a class of common stock uses two methods.
The required Earnings per share as presented on income statement
Those businesses with simple/normal capital structures having only common stock outstanding usually present their basic per-share amounts of income from the continuing operations and for the net income that is present on the income statement face (FASB, 2012, p.4). However, all other businesses are required to present both diluted and basic per-share amounts of income from the continuing performance and the amount of net income accrued and presented on the income statement with a consideration of equality.
According to the US general accepted accounting standards, all the terms earning per share and diluted EPS are used in helping to identify the earning per share data that is required to be presented and therefore not used as captions /headings of the income statements (FASB, 2012, p.5). In addition, under the standards, the per-share amounts that are not included in their subtopics as decided by an entity are also computed according with the subtopic and only disclosed in the notes of the financial statements. Clear notes should also be provided to show whether the per-share amounts are net of tax of pretax.
The standards also required that earning per share information/data be presented for all the periods under which the income statement summarizing earnings is provided. For instance, in case diluted earnings per share data are reported for a period, they need to be reported for all the periods that is presented regardless even if they are similar to basic Earning per shares. In the case that both basic and diluted EPS are same, then presentation can be dual and at the same time in one income statement.
Computation of basic earnings per share
These basic earnings per share is calculated by the method of division where income that is available is divided to common stockholders as the numerator by the number of outstanding common shares(weighted-average) which is used as denominator(FASB, 2012, p.6). Income that is give to common stockholders is either loss/income from operations that are continuing or net income or net loss adjusted for preferred stock dividends. While weighted average of outstanding common shares is the sum total of shares that determined by relating the portion of time within a reporting period that common shares have been outstanding to total time in that period. Both shares that are issued and reacquired during the period weighted/calculated for the period in which they are outstanding.
Income that is available for the common stockholders is calculated by subtracting both the declared dividends in the period once preferred stocks whether they are paid or not and the dividends accumulated or the period on a cumulative preferred stock wherever or not they are accrued from continuing operations income earned as per the amount in income statement. In case of a loss or a net loss due to operations being carried out, the loss amount increased due to the addition of preferred dividends. Hence, an adjustment is instituted on net loss and income for the preferred stock dividends is done regardless of the form of payment. Only preferred dividends earned are deducted only to the extent that they are earned (FASB, 2012, p.6).
In case of calculation of EPS in situation where there is on controlling interest in subsidiary in a consolidated group income accrued from net income and continuing operations is excluded from income attributable to the non controlling interest subsidiaries. Calculation of EPS in consolidated financial statements both basic and diluted must be included in the consolidated group. To compute income that is available to common stockholders is computed by deducting preferred stock dividends paid by an issuer is deducted from the net income or is added to the total net loss recorded. Standards also requires that contingently issuable shares be included in the basic EPS only in circumstances that those shares are not going to be issued and basic EPS should not be restated to reflect the changed circumstances.
There are various methods that are used in the computation of the earnings per share to ensure successful implementation. One of the methods used is the weighted average computation. Number of weighted-average- shares is the arithmetic mean average of the total sum of shares that are outstanding and which are thought to be outstanding for the earnings per share computations. However, the preferred and precise average is the sum of the shares that are determined on a daily basis that are then divided by the days in a certain period. However, the US GAAP allows other less precise methods in computation of EPS provided they provide reasonable results. Some methods that normally introduce artificial weighing like the rule of 78 are not allowed in the computation of a number of weighted average shares for earnings per share computations (FASB, 2012, p.10)
The second method is the treasury stock method. This method is also referred to as year-to-date computations (FASB, 2012, p.10). In this method, incremental shares included in quarterly diluted earnings per share are computed using the average- market price in the three months that are included in the reporting. In year-date diluted earnings per shares, the incremental shares used as denominators are determined by computing of year-date weighted average in line to the incremental shares included in the quarterly diluted earnings per shares computations. In case of a year-to-date loss the potential/likely common shares does not form part of the calculation of diluted earnings per share since this would amount to antidilutive. However, in case of a year-to-date income, in the scenario that warrants and money is excluded from the one to more quarterly diluted EPS computation as a result of antidilutive effect, the options such as warrants need to be included in the diluted EPS denominator by use of weighted –average basis when the effect if dilutive. Furthermore, if the effect is undilutive, contingent shares which were excluded in the quarterly computation because of loss incurred from continuing operations need to be included in the year-to-date computation.
Average market can also be used in the calculation of EPS. In most circumstances, the closing market prices are used in the computation of average market prices. However in the circumstances that prices fluctuate or other reasons emerges that may cause effects to the trend then the average of low and high prices for the period is selected or represented would be used as this will produce a more representative price. This method under the US GAAP is used consistently unless it proves to be unrepresentative due to the changes in conditions (FASB, 2012, p.11). A good example is where an entity uses closing market values to compute its average market price for a given period of time or certain number of years under stable market prices, in an event that the market prices fluctuates greatly, then the average of low and high prices will be used in computation to ensure that the price is representative.
Warrants/opinions and equivalents
Options and warrants to buy any convertible securities under the US GAAP/IRP is assumed to be applicable if the average prices of both the common stocks and convertible securities obtained are above the exercise price of options and warrants. The incremental number of convertible securities that are assumed to be issued and converted to common stocks immediately can be calculated by used of treasury stock method (FASB, 2012, p.12). Only those convertible securities that require or permit payment of cash by the holder of the security rate conversion are the only ones that are considered the equivalent of warrants. Therefore, in computing diluted EPS the proceeds that are assumed to be received are the ones which are going to be assumed or used in purchasing of common stock whereas the convertible security are assumed to be converted under if-converted method.
Restatement of earnings per share data
There are some occasions that earnings per share are readjusted based on different factors. There is different mechanism or circumstances that lead to these restatements. These include.
Stock splits/stock dividends
Computations of both diluted basic EPS can be adjusted retroactively based on the circumstances that number of common shares outstanding increases because of stock dividend or decrease to due reverse stock split. These adjustments will cover all the periods presented to be able to reflect the changes in the capital structure that has occurred. However there are circumstances where these stock splits may happen long after the required period is closed and before issuance of financial statement. In such circumstances, the computations of per-share for the period before the financial statement will usually be based on the number of new shares. In circumstances that calculation of EPS reflect adjustments in the sum of shares (total number), the facts are disclosed (FASB, 2012, p.12).
A right issue is yet another factor that affected or triggers adjustments on the computations of the earnings per share. For instance, the exercise prices of a right issue at issuance time is less that the value of the stock (fair)have a bonus element that looks similar to stock dividend. In addition, the circumstance that the right issue contain a bonus and at the same time is issued/offered to all easing stockholders both diluted and basic EPS is adjusted retrospectively because of the bonus element to the all periods that is provided.
In computation of the diluted and basic EPS prior to the right issue is the total number of outstanding common shares immediately prior to the issue of multiplied by the factors; fair value share immediately prior to the exercise of the rights/ theoretical ex-rights fair value per share (FASB, 2012, p.13). Theoretical ex-rights fair value per share is obtained by adding aggregate fair value of the shares immediately prior to the exercise of their rights to the proceeds expected from the exercise of the rights and dividing by the outstanding number of shares after the exercise of the rights.
Prior period adjustments are another kind of adjustment that is normally done on the earnings per share. This is done in the circumstances that the authority literature requires that restatement of the operations result of the prior period is included in the summary earnings or income statement. The impact of the restatement is normally expressed in per-share terms and is usually disclosed in the period in which restatement occurred.
Pre-codification of US GAAP and IFR on earnings per share
According to FAS (2009) the previous codification standards of FASB on earnings per share were not simplified (p. 3). For instance, the standards that were in the APB opinion NO. 15 were complex hampering clear understanding. Presentation of primary EPS was replaced with basic EPS. Furthermore more, the previous codification did not require dual presentation of primary EPS and the earnings per share (diluted) on entities or on income statement with complex capital structures and further reconciliation of the denominator and numerator of calculation of basic earnings per share (common) to those of diluted EPS computation.
In the previous codification of FASB US (GAAP) opinion 15 only permitted one form of presentation (single) of the EP common share for those businesses with simple/common simple capital structures. The presentation was similar to the basic EPS- a common presentation that is not used in USA. However, this opinion -15 required those entities with complex capital structures to present both their primary and fully diluted earnings per share on the income statement. Primary earnings per share computation included the common stock equivalents in its outstanding sum of common shares denominators. The current GAAP/IFR that have earnings per share requires presentation of both basic earnings per share or both basic earnings per share and fully diluted earnings per share only (FAS-128, 2009, P. 4).
According to FASB (1997) rules used in computation of primary earnings per share is criticized on grounds of being extremely complex and having many arbitrary provisions (p.28). Such criticisms focus on determination of convertible securities as common stock equivalents and specifically using Aa corporate bond rate for the common stock equivalency test, classification of a security as an equivalent common stock and the two-thirds yield test for common equivalency (FASB, 1997, p. 28).
Complexities in earnings per share are complicated by the opinion 15. Many auditors misunderstand it and end up using it incorrectly as many user think that the primary EPS is computed without inclusion of common stock equivalents.
Comparison
When compared to the ancient principles, the current principles are easy to use and follow compared to the traditional rules which have many inconsistencies. Political compromises also contributed to the formulation of the past standards. This allowed volatility in the reported earnings hence compelling revision and coming up of new standards. The previous codification when compared to the current codification, little changes have been made regarding to how standards in accounting principles should be done. The section that has undergone a number of changes is the opinion 15 which has always been cited by its users that it causes complexity and confusion. The information and the requirements look almost similar hence triggering need for adjustments in areas that seem to be complex to understand.
Recommendation for the future standards
The objectives of both the diluted and basic EPS should be identified to be able to reach a good conclusion. For instance, EPS should be used in rating how an entity is performing in a given reporting period while that of EPS (diluted) should be consistent with the basic EPS objectives. In addition, the codifications standards the need to be improved and consistent and apply conceptual framework to ensure easy of understanding and applicability of the standards. Clear accounting objectives standards should be stated and sufficient structure and detail should be provided and should be operational and applied in inconsistent manner. Exceptions should also be minimized and use of percentage tests which allow evasion to achieve technical complicate avoided.
To ensure that consistent codes of standards are upheld, the IASC and FASB should come together and analyze the area that have been cited to cause confusion and inconsistent and suggest the best approaches to ensure that reporting and calculation of EPS is done properly in order to appeal to the investors and the local investors.
References
Financial Accounting Standard Board (FASB), (2012). 260 Earnings Per Share. Retrieved from https://asc.fasb.org/combinesubtopic&trid=2144383
Statement of Financial Accounting Standards No.128 (FAS) (1997). Earnings per share, Retrieved from: https://asc.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id &blobwhere=1175823287413&blobheader=application%2Fpdf
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