Earnings per share: time to turn over a new leaf.

Earnings per (EPS) is one of the most widely used statistics in financial statement analysis today. Companies with a simple capital structure present BASIC EPS while those with a complex capital structure present primary and fully diluted EPS. Simple structures consist of common and complex structures

also contain securities that are potentially convertible into common stock (such as convertible bonds, convertible preferred stock and stock options). APB No. 15 was the first statement by the accounting profession to address EPS, and this was eventually modified by several AICPA Interpretations and FASB Amendments.

Over the years a number of weaknesses have been discovered in the EPS presentation. As a result, the FASB issued a prospectus in June 1993 to address these issues. The prospectus summarized the EPS presentation, discussed some of the weaknesses and solicited comments from interested parties regarding whether or not an EPS project should be added to the FASB agenda. Most of the responses were in favor of this proposal. In March 1994, the FASB formally added EPS as a project to its agenda.

The FASB has stated that the objectives of this project are two-fold: first, to simplify and improve the EPS presentation and, second, to issue a standard for the United States that will be compatible with international standards.

This article will discuss inherent in the current presentation of EPS and will propose alternative approaches. It will also present the tentative changes suggested FASB and will then conclude with an example comparing the EPS presentation under the current approach to the new, tentative approach suggested by the FASB.

Weaknesses of the Current Approach

Under the current approach, BASIC EPS, which is presented for simple capital structures, is calculated by dividing the net income by the weighted average common shares actually outstanding during the period. If there are cumulative preferred shares outstanding the preferred dividend is subtracted in the numerator, whether declared or not. If the preferred shares are non-cumulative, the dividend is only subtracted if declared.

For complex capital structures, the presentation consists of primary and fully diluted EPS. For primary EPS, securities that are potentially convertible into common shares (such as convertible preferred stock, convertible bonds and stock options) are considered as if converted provided they are "common stock equivalents" (CSEs). They will thus affect the denominator and, often, the numerator of the EPS fraction. For fully diluted EPS, the CSE test does not have to be met.