THE

CPA
BOARD EXAMS
OUTLINES
by John Mahatma G. Agripa, CPA

FINANCIAL ACCOUNTING AND REPORTING

EARNINGS
PER SHARE:
BASIC & DILUTED
Based on lectures by Tom Siy, CPA and Christian Aris Valix, CPA
(CPAR)
Probability of occurrence in Board Exam: pretty high

DEFINITIONS

Earnings per share (EPS) is a figure representing company earnings

attributable only to shareholders holding ordinary shares, which is
required to be disclosed among public/listed entities since they
are determinant of market price of shares. Losses per share is also
computed if such was the case
This does not apply to preference shareholders since they have a
fixed rate of return, expressed as a percentage of the shares par
value
EPS may be basic or diluted. Diluted EPS assumes that all
potential ordinary shares arising from either convertible bonds,
convertible preference shares, or share options and warrants are
all converted in the period. It also represents the lowest possible
earnings per share (or highest possible loss per share)
The aforementioned securities are considered in the computation
of diluted EPS if their exercise prices are lower than the market
price. Otherwise, they are considered antidilutive, and would cause
EPS to go higher (or LPS to go lower)

BASIC EARNINGS PER SHARE

The formula for basic earnings per share is as follows:

Net income Declared preference dividends
DIVIDE: Weighted average number of ordinary shares
Basic EPS

xx
xx
xx

Net income in the above formula shall be after all deductions,

including interest expense, taxes and income attributed to minority
interest, if such was the case
The preference dividends to be removed shall only pertain to the

current year (arrears not considered). They have to be declared to

be included in the computation. Of course, if the preference shares
are cumulative, the dividends are automatically deducted.
In cases of losses per share, the dividend is still deducted
If the dividends were declared out of redeemable preference
shares, no deduction is necessary, since the dividends are
considered interest expenses, which has been already deducted
from net income. Redeemable preference shares are considered
financial liabilities for the corporation
The weighted average number of outstanding ordinary shares can
be calculated as follows. The fraction represents the portion of the
year the effects of the transactions have become outstanding in
the current year
Beginning number of shares x 12/12
ADD: New shares issued x 10/12 (if issued on March)
ADD: New shares subscribed x 10/12 (if subscribed in March)
DEDUCT: Shares put in treasury x 9/12 (if bought on April)
MULTIPLY: All split-ups (multiply by 2 if 2-for-1)
DIVIDE: All split-downs (divide by 2 if 1-for-2)
MULTIPLY: All share dividends (1 + rate)
Weighted-average ordinary shares outstanding
MULTIPLY: Bonus element from stock rights
Adjusted WAOSO

xx
xx
xx
xx
xx
xx
xx
xx
xx
xx

This figure may be affected by transactions that have a retroactive

effect, namely share splits and share dividends. For example, if a
20% share dividend is declared in May, all outstanding ordinary
shares as of May shall be multiplied by 1.20. All the subsequent
share transactions are no longer adjusted for this particular share
dividend. If another 20% share dividend is declared in November,
the outstanding ordinary shares as of November is further
multiplied with 1.20
The computed weighted average number of ordinary shares
outstanding is further adjusted for any stock rights. These are
instruments that the corporation gives its shareholders that gives
them the right to purchase new shares at a lower price, as to
maintain their proportionate share of the entity. The bonus

element above is computed as follows:

Market price right-on (the actual market price)
DIVIDE: Market price ex-right
Bonus element

xx
xx
xx

If not given as well, the market price ex-right (without the stock
right) is computed as follows:
Market price right-on (the actual market price)
DEDUCT: [ (Market price right on exercise price
Number of rights to be used for one share + 1) ]
Market price ex-right

xx
xx
xx

DILUTED EARNINGS PER SHARE:

SINGLE DILUTER

The formula for diluted earnings per share changes for each type of
diluter. With the presence of convertible preference shares, diluted
EPS is computed as follows:
Net income
DIVIDE: WAOSO + potential ordinary shares
Diluted EPS

xx
xx
xx

Potential ordinary shares refer to all ordinary shares that will be

added if all the convertible preference shares are converted.
Preference dividends are no longer deducted from net income
since theres no more preference shares (they are assumed to be
converted)
For convertible bonds, diluted EPS is computed as follows:
Net income + Interest expense, after tax
DIVIDE: WAOSO + potential ordinary shares
Diluted EPS

xx
xx
xx

Interest expense (after tax) is added back to net income (after tax)
for the same reason preference dividends is no longer deducted
from net income in the previous case. If the bonds were issued in

May, for example, the interest expense to be added back and all
the potential ordinary shares shall be multiplied with 8/12 to
prorate them
As to share options and warrants, the formula is as follows:
Net income
DIVIDE: WAOSO + incremental ordinary shares
Diluted EPS

xx
xx
xx

As a shortcut to the treasury share method, incremental ordinary

shares above can also be computed as follows:
All ordinary shares from the option/warrant
MULTIPLY: [(Market price Option price) Market price]
Incremental ordinary shares

xx
xx
xx

To differentiate, share options are usually given to company

employees as compensation for services, while share warrants are
for bondholders and preference shareholders, all of which
(including stock rights) give their holders the right to acquire new
shares at below market price

DILUTED EARNINGS PER SHARE:

MULTIPLE DILUTERS

When two or all diluters are present, the stepladder approach is

used for computing diluted EPS. The first step is to determine the
diluter with the lower incremental EPS, which is the one to be
computed with diluted EPS first. This can be computed as follows:
Adjustment to net income (net income figure not included)
DIVIDE: Potential ordinary shares (WAOSO not included)
Incremental EPS

xx
xx
xx

Share options and warrants have zero incremental EPS since they
have no adjustment to net income, which means they are the first
in the order always. For convertible bonds, the dividend is after-tax
interest income (prorated), and the divisor is the potential ordinary

shares (prorated). For convertible preference shares, the dividend

is the declared preference dividend, and the divisor is the entire
potential ordinary shares
Remember that if the exercise price of these securities is higher
than market price, they are antidilutive and are thus ignored. An
exception is written put options, which remain dilutive even if the
exercise price is higher than market price

At
December 31, 2015, Jason Company has 900,000 ordinary
shares outstanding. On September 1, 2016, additional 300,000
ordinary shares were issued. In addition, Jason issued Php
10,000,000, 6% convertible bonds on May 1, 2016, which are
convertible into 300,000 ordinary shares. No bonds were
converted during the year. Jason also had 40,000 share options
outstanding during 2015 and 2016 with an option price of Php
22.50, and a market price of Php 30.00. Net income for 2016
amounted to Php 2,250,000. Income tax rate is 30%. Compute for
the diluted EPS
ILLUSTRATION (CPAR FINAL PRE-BOARD ITEM)

Since two potential diluters are present, stepladder method is

used. There is no need to compute for incremental EPS since
the share options will go first than the bonds. However, the
following computations are made still:
Option shares
MULTIPLY: [(30 22.5) 30]
Incremental ordinary shares from options
After-tax interest expense (10,000,000 6% 8/12 70%)
DIVIDE: Potential ordinary shares (300,000 8/12)
Incremental ordinary shares
January 2016 (900,000 12/12)
ADD: September 2016 (300,000 4/12)
Incremental ordinary shares

40,000
0.25
10,000
280,000
200,000
1.4
900,000
100,000
1,000.000

Diluted EPS is then determined with the following tabular

format. Note that the adjustment of one diluter cumulates to

the next one
Net income
Basic
2,250,000
Share options
Diluted EPS after options
2,250,000
Convertible bonds
280,000
Diluted EPS after options, bonds 2,530,000

Shares
1,000,000
10,000
1,010,000
200,000
1,210,000

EPS
2.25
2.23
2.09