Question

A company reports net income in the current year of $600,000. During the year, the company declares and pays $20,000 in cash dividends on its common stock and $80,000 in dividends on its convertible preferred stock. The company has 20,000 shares of the preferred stock outstanding all year and each isconvertible into three shares of common stock. The company starts the year with 170,000 shares of common stock outstanding. On July 1 of that year, 20,000 additional shares of common stock were issued as a stock dividend so that the company had 190,000 shares for the last six months of the year. What should the company report as its basic earnings per share figure (rounded) ?

Answer 1

Earnings per share means that part of earnings which is left out for the common stockholders after paying off all the expenses. As the common dividend is payable to common stockholders out of the earnings attributable to common stockholders, therefore, it is not deducted while computing earnings per share.

Basic earnings per share

= Income attributable to equity shareholders / Weighted average number of equity shares

= $520,000 / 180,000 shares

= $2.89 per share

Workings

Income attributable to equity shareholders

= Net income – Preferred dividend

= $600,000 - $80,000

= $520,000

Weighted average number of equity shares

Diluted earnings per share

= Net income / Weighted average number of shares

= $600,000 / (180,000 shares + 20,000 preferred shares x 3 shares of common stock)

= $2.50 per share