Hello. Welcome back. In this module,
we're going to talk about Earnings Per Share.
Now, earnings per share is a controversial metric.
Here's a quote from Sir David Tweedie,
he was the Chair of the International Accounting Standards Board.
His opinion of earnings per share was that anybody who still uses it,
needs his head examined.
Well, that's an odd thing to say about what's one of
the most widely used metrics in modern day accounting.
It's also based on a controversial number.
Here's a quote from Don Young who was a member of
the Financial Accounting Standards Board who says,
"If net income stays,
it would be a sign that we failed."
He was talking about a project that was in place in
the mid 2000s to replace earnings per share,
and to replace the income statement with an entirely new model.
It was the financial statement presentation model.
Ultimately, after several years of working on it,
the final standard was not issued,
so I guess they did fail on that.
But it just shows that earnings per share is a sort of
controversial statistic as a metric
to use even though it's the most widely reported metric about financial reporting.
So why is it controversial?
Well, some people view net income itself as
a non-conceptual subtotal on the statement of comprehensive income.
A lot of people have a problem with net income itself,
especially items that are in other comprehensive income in their view,
should just be included within a single total that would be comprehensive income.
And then two, the objective of EPS is to maximize comparability which can often lead to
some arbitrary calculation rules which you'll see when we go through some exercises.
So there's two types of earnings per share that we're going to be talking about.
The first is called Basic Earnings Per Share.
Basic earnings per share is defined as the amount of earnings for the period that's
available to each share of common stock outstanding during the reporting period.
We'll find that there are certain amounts that are not available to
common shareholders and this often is attributable to preferred stock.
Preferred stock dividends are not part of
net income but they they're not available to common shareholders either.
So the objective of basic EPS is to measure
the performance of the entity over the reporting period,
how much is available to the common shareholders for distribution.
So the basic formula is to divide income available to shareholders,
that's going to be the numerator that we'll refer to,
by the weighted average number of common shares outstanding,
that's going to be the denominator during the period.
So notice it says weighted average number of shares outstanding.
You adjust it for any shares issued, any shares retired,
anything that's purchased as is treasury stock.
There's going to be adjustments and this is in basic earnings per share.
In Diluted Earnings Per Share there will be even more adjustments,
we'll talk about those when the time comes too.
And then Income Available,
what is that income available?
Net income is reduced for any preferred stock dividends paid or payable.
What do we mean by payable?
Well, remember that preferred stock dividends are
often cumulative and if they're payable in arrears,
you would delete the entire amount of that from earnings per
share from the numerator when calculating earnings per share.
So let's look at shares outstanding.
It's going to be the number of shares issued and outstanding.
Is going to be a moving target because you can have these new issues,
you can have a repurchase or retirement,
you can have treasury stock.
You can also have stock dividends and splits.
We'll describe what those are and how they impact earnings per share.
It's a weighted average,
you weight it for the time that's been outstanding.
It's an arithmetical mean that you're going to use,
but it's not often exact and precise.
The most precise average would be the sum of the shares determined on a daily basis,
divided by the number of days in the period.
We use the less precise averaging method however,
as long as they produce reasonable results.
So when you have a lot of transactions say in treasury stock,
we'll just look at averages as we go through that.
So we'll do some calculations on that in the next lesson.
John HeppClinical Assistant Professor of Accountancy
