SFAS 128, EARNINGS PER SHARE (1997)
SFAS 129, CAPITAL STRUCTURE (1997)
IAS 33, EARNINGS PER SHARE (1997)

These three standards resulted from a joint project conducted by the FASB and IASC. The exposure drafts are discussed in The Analysis and Use of Financial Statements, 2^nd edition (AUFS), on pages 175-6. The resulting standards measure earnings per share identically under U.S. and IASC GAAP; exposure draft differences were eliminated in the final standards.

All public companies with complex capital structures must provide a dual presentation of basic (in lieu of Primary EPS) and diluted EPS on the face of the income statement.

Basic EPS is computed as:

Income available for common shares
Weighted average common shares outstanding

Contingently issuable shares¹ are included in the computation of basic EPS only when issuance is no longer contingent. Contingently redeemable shares are treated  the same way as contingently issuable shares.

Diluted EPS is computed as:

  Adjusted income available for common shares
Weighted average common and potential common shares outstanding

Numerator adjustments include

• Dividends on convertible preferred shares
• After-tax interest on convertible debt
• Effect of the change in income on profit sharing or other expenses²

Computational Guidelines:

1. Each issue of potential common shares must be considered separately rather than in the aggregate. To reflect the maximum dilution, issues of potential common shares are considered in sequence from the most to the least dilutive.

2. Income from continuing operations is the "control number" used to determine whether potential common shares are dilutive. Thus, determination of the dilutive effect is not affected by accounting changes, discontinuing operations, or extraordinary items.
3. Both basic and diluted EPS are computed using the new number of shares outstanding following stock dividends, stock splits, or reverse stock splits occurring after the end of the period but before the issuance of financial statements.
4. The standards mandate the use of the ex-rights method in the computation of basic and diluted EPS for the bonus element in a rights issue.

The ability of the FASB and IASC to harmonize the measurement of EPS is encouraging. However, comparability of the numerator (earnings) remains elusive and continues to impair international comparability of EPS data.

Disclosure requirements include:

• EPS for all components of net income (SFAS 128 only). IAS 33 requires disclosure of EPS only for net income; any other components of EPS reported, however, must accord with the new standard.
• Reconciliation of the numerator and denominator of the basic and diluted EPS computations for income from continuing operations.
• Treatment of preferred dividends in the computation of income available to common stockholders
• Securities that are potentially dilutive in the future but were not included because they were antidilutive in the current period.
• Description of transactions occurring after the end of the period but before the issuance of financial statements that would have changed the number of common shares or potential common shares outstanding if the transaction had occurred before the end of the period.

SFAS 129 disclosure requirements:
This standard applies to both public and nonpublic companies. Firms must disclose the following:

1. Rights and provisions of all outstanding securities, including debt, common and preferred shares, options, and warrants.
2. Number of shares issued during the period due to conversions, exercises, and contingent issuances.
3. Liquidating value of preferred shares when significantly greater than par value or stated amount.
4. Call and redemption provisions for preferred shares.
5. Redemption requirements by year for the next five years.
6. Dividend arrears for cumulative preferred shares.

Some of these disclosures were previously required by other standards.

While IAS 33 does not contain these requirements, many of these disclosures are required by IAS 1 (1997).

The new standards are effective in calendar 1998, including interim periods. Earlier application is not permitted. All prior-period EPS data presented must be restated.

Illustration of New Standards:

Exhibit 4-10 in AUFS page 178 illustrates the computation of earnings per share under APB Opinion 15. The same data are used to illustrate the new computations:

Basic EPS = $500,000 = $5.00
          100,000

Diluted EPS =      ($500,000 + $24,000)      = $ 4.57
          (100,000 + 2,273 + 12,500)

The adjustments are:

Both computations are shown in Exhibit 4-10.

The effect of the new standards on reported EPS follows:

Note that reported EPS is higher under the new standard than under APB 15. In addition, dilution is smaller in both absolute ($4.57 compared to $4.49) and percentage terms (8.6% versus 10%).

Basic EPS is higher because it reflects no dilution, even for securities that were common stock equivalents under APB 15. Diluted EPS is higher under the new standards because the dilutive effect of options is measured using the average price rather than the (higher) closing price.

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¹ Issuable for little or no cash consideration upon satisfaction of certain conditions.

² The reduction in interest expense from the assumed conversion of convertible debt increases income and, therefore, might increase profit sharing, royalties, or other expenses based on income.

³2,273 incremental shares are added to the denominator because SFAS 128 requires the use of the average market price in the application of the treasury stock method for options.

⁴ For options issued under nonqualified plans, the exercise proceeds are increased by the tax benefits realized by the firm when options are exercised. Dilution is therefore reduced as more shares are deemed to be repurchased.

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