Chapter 15

Question 1

Earnings per share

Answer 1

Income earned for each share of common stock that is used for determining profitability

Question 2

Public companies must report

Answer 2

Earnings per share
Diluted earnings per share

Question 3

Private companies must report

Answer 3

neither EPS but can chose to to for internal use of investor reporting

Question 4

Why must public companies report both EPS

Answer 4

Their common stock or potential common stock is publicly treaded

Question 5

If a company includes discontinued operations they should

Answer 5

Also include the earnings per share for the discontinued operations plus the continued operations

Question 6

Earnings per share has two capital structures

Answer 6

1. Simple capital structure
2. Complex capital structure

Question 7

Simple capital structure is used when

Answer 7

When a corporation only has common stock outstanding

Question 8

Simple capital structure is also used when

Answer 8

Preferred stock is outstanding, however cannot have a conversion feature

Question 9

A simple capital structure reports

Answer 9

Earnings per share

Question 10

What is the conversion feature

Answer 10

Conversing preferred stock to common stock

Question 11

Earnings per share equation

Answer 11

(Net income - Preferred stock) /
Weighted average number of common shares outstanding

Question 12

What does the net income consist of

Answer 12

Continued operations

Question 13

Why is continued operations used for net income

Answer 13

Required by GAAP because it reflects ongoing performance and ensures compatibility

Question 14

Preferred stock dividends

Answer 14

Distributions made to preferred stock holders in the form of dividends

Question 15

Why are preferred stock dividends subtracted from net income when computing EPS

Answer 15

EPS is calculating the earnings per common share and preferred shareholders have a priority right to a fixed dividend before any earnings can go to common share holders

Question 16

What happens if preferred stock dividends is not subtracted from net income when calculating EPS

Answer 16

The earnings actually available to the common share holders would be overstated

Question 17

Two types of preferred stock

Answer 17

Cumulative
Noncumulative

Question 18

The most common preferred stock

Answer 18

Cumulative

Question 19

Which preferred stock is always subtracted from the numerator, even if a dividend is not declared. Why?

Answer 19

Cumulative: Shareholders are entities to receive dividends each year even if the company does not declare them that year. If they are skipped a year the amount will then accumulate and will be paid before common shareholders (obligation)

Question 20

When is noncumulative preferred stock subtracted from the numerator. Why?

Answer 20

Only if the dividend is declared during the year: Past dividends for noncumulative will not be paid in the future, thus do not impact the earnings available to common shareholders

Question 21

Why use the weighted-average common shares outstanding when computing EPS

Answer 21

Shares are issued and purchased over the year, which impacts the amount outstanding. This approach accounts for only the time the shares were outstanding

Question 22

The weighted-average common shares does not include. Why?

Answer 22

Treasury stock (repurchased stock): No longer outstanding

Question 23

What are stock split and stock dividends

Answer 23

When existing shares of a company that are cut into smaller pieces (increasing shares)

Question 24

Stock split and stock dividends do not do what three things

Answer 24

1. Change total stockholders equity
2. Increase/decrease companies assets
3. Change an individual stockholders ownership percentage

Question 25

Why must stock split and stock dividends be treated as if they occurred at the beginning of the period

Answer 25

Since stock split and stock dividends change the number of shares and not the companies total value we pretend those shares existed at the beginning of the period to avoid misleading investors and to keep the EPS consistent and comparable across each period

Question 26

What does retroactive mean

Answer 26

If a split or stock dividend occurs the company must go back and adjust all EPS numbers currently shown on the financial statements to ensure comparison and accuracy throughout the years

Question 27

Why must we still go back and adjust all EPS presented on the financial statement even if the stock split or stock dividend occurred after the year ends

Answer 27

Investors would see a different number of shares than before, causing confusing and the EPS to be misleading

Question 28

Why does some stock not participate in an adjusted stock split

Answer 28

If the split were to occur in July and new stock was issued in October, the October stock then did not exist, thus cannot get adjusted for the split

Question 29

Why does some stock participate in a stock dividend

Answer 29

If new stock was issued in April and a stock dividend occured in July those shares existed before the dividend occurs, thus partaking in the adjustment but only to the month of April

Question 30

A complex capital structure is used when

Answer 30

A corporation has any sort of dilutive security outstanding

Question 31

A complex capital structure must report

Answer 31

Basic EPS Diluted EPS

Question 32

What are the three primary questions when solving for diluted EPS

Answer 32

1. How is the numerator affected in the basic EPS if their is a 'make believe' conversion 2. How is the denominator affected in the basic EPS if their is a 'make believe' conversion 3. Does this 'make believe' conversion result in anti-dilution

Question 33

What is anti-dilution

Answer 33

Increasing the EPS

Question 34

What is convertible preferred stock

Answer 34

Preferred shares are convertible to common shares

Question 35

Convertible preferred stock has what affects on the numerator

Answer 35

Stop subtracting the preferred dividends from net income because the stock was converted into common shares, thus those shares no longer exist. (Increasing numerator)

Question 36

Convertible preferred stock has what affects on the denominator

Answer 36

Since preferred stock was converted into common shares we would have to add the new outstanding shares (Increasing denominator)

Question 37

Convertible preferred stock EPS is considered dilutive if

Answer 37

It is less than the basic EPS

Question 38

What are convertible bonds

Answer 38

Loan bonds that are convertible into common shares

Question 39

Convertible bonds have what affects on the numerator

Answer 39

Typically companies pay an interest on bonds, thus decreasing net income. Since we converted bonds into stock that expense no longer exists, thus we would add back the interest expense to the net income

Question 40

Convertible bond numerator equation

Answer 40

Interest expense x (1- tax rate)

Question 41

Convertible bonds have what affects on the denominator

Answer 41

The bonds converted to common shares would then be added to the denominator to increase common shares outstanding

Question 42

What are stock options

Answer 42

Promises that let people buy back stock as a set price in the future

Question 43

Why is the stock option preliminary test required

Answer 43

It determines if it is dilutive or anti dilutive

Question 44

The stock option has what affect on the numerator

Answer 44

No affect because the company doesn't gain or lose form the exercise

Question 45

The stock option has what affect on the denominator

Answer 45

New shares are created and the company gets cash from selling them. The company then buys back the shares at he average market price. We solve for the difference between the shares issued and the shares bought back, we then add the difference to the outstanding shares

Question 46

What is a contingent issuance

Answer 46

Shares that will only be issued if certain conditions are met

Question 47

What affect does a contingent issuance have on the numerator

Answer 47

No affect

Question 48

What affect does a contingent issuance have on the denominator

Answer 48

Add the extra shares issued, thus decrease the EPS

Question 49

If the company decides if the dilutive security will be settled in cash or common stock they will choose

Answer 49

Which ever is more dilutive, showing the lowest the EPS could possibly be for the shareholders

Question 50

If the investors decides if the dilutive security will be settled in cash or common stock they will choose

Answer 50

Whichever gives them the greater value return