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Full disclosure: Earnings per share (EPS) · PwC's accounting podcast

• 0:00
  SPEAKER_01: Thought Leadership from PWC's National Office Studios.
• 0:08
  SPEAKER_02: Welcome to PWC's Accounting Podcast.
• 0:11
  SPEAKER_02: I'm Heather Horn.
• 0:12
  SPEAKER_02: Thanks for tuning in to the next episode in our full disclosure summer series, a show all about presentation and disclosure from the top of the financial statements down to the last footnote.
• 0:23
  SPEAKER_02: While it may sound like accounting 101, I guarantee you'll learn something new in every episode.
• 0:29
  SPEAKER_02: Today's focus, earnings per share.
• 0:32
  SPEAKER_00: The most important thing when you're diving into your EPS computation is to have a holistic view of the capital structure of the company.
• 0:40
  SPEAKER_04: We find you really have to get into the real economics behind it, whatever the transaction is to figure out what the best accounting would be.
• 0:48
  SPEAKER_04: Usually we find that once the facts are known, the accounting presents itself.
• 0:54
  SPEAKER_02: Those are my two guests, Jay Sulliver and John Haran, both from PwC's national office.
• 0:59
  SPEAKER_02: Jay and John understand the complexities when it comes to calculating EPS, and they're going to share with us some key considerations and all the important reminders.
• 1:09
  SPEAKER_02: I have to say, there are a lot of laughs during the recording of this episode, so we may even have a little bit of fun.
• 1:24
  SPEAKER_03: And I know having the two of you on, there'll be lots to talk about.
• 1:28
  SPEAKER_03: And in particular, this topic, there are a lot of nuances and exceptions.
• 1:32
  SPEAKER_03: I think on the surface, people think earnings per share is like division.
• 1:36
  SPEAKER_03: But unfortunately, there's so much more to it.
• 1:38
  SPEAKER_03: So, Jay, maybe just to kick things off, can you remind the listeners of who is supposed to present EPS?
• 1:46
  SPEAKER_04: Sure, Heather.
• 1:47
  SPEAKER_04: And certainly thanks for having both of us here to join you on the series.
• 1:51
  SPEAKER_04: And from a who has to do EPS question, uh, it's only required for companies that have publicly traded equity securities or companies that are making a filing in preparation of selling that public equity.
• 2:11
  SPEAKER_04: And public can either mean traded on a stock exchange or in over-the-counter markets.
• 2:17
  SPEAKER_04: And on that last point about making a filing, we we do believe that also includes confidential filings that a company might make with the SEC, say under the Jobs Act, even though those aren't public filings, they are still ultimately associated with preparing to sell stock in the public market.
• 2:34
  SPEAKER_04: So we would expect that EPS needs to be included there.
• 2:38
  SPEAKER_04: It doesn't apply to a private company that isn't yet planning to sell any stock or make any filings to sell stock.
• 2:46
  SPEAKER_04: And it doesn't apply to a company that only has public debt, because it only applies if you have public equity.
• 2:52
  SPEAKER_04: And now there are also some other exceptions for certain types of entities like investment companies and the like, but figure we won't get into those here on this podcast today.
• 3:01
  SPEAKER_00: Yeah, Jay, and you know, you you mentioned that um it doesn't apply to private companies, but but in fact, you know, private companies can voluntarily present DPS if they like.
• 3:12
  SPEAKER_00: Um however, we we we we hardly ever sue see it, but but if they do, they need to follow this you know the standard as well.
• 3:19
  SPEAKER_03: All right, I think that's a good reminder.
• 3:21
  SPEAKER_03: So then from a level setting, I think that's helpful.
• 3:24
  SPEAKER_03: And we kind of joke about the series that it's accounting 101, but better.
• 3:29
  SPEAKER_03: So hopefully everyone remembers from accounting 101 that you have both basic and diluted EPS.
• 3:35
  SPEAKER_03: But can you just give us a reminder in terms of what you should be showing in your primary financial statements?
• 3:41
  SPEAKER_00: Uh sure, Heather.
• 3:42
  SPEAKER_00: And in terms of what you need to show, um, one needs to show both basic and diluted EPS for all periods for which an income statement is presented for the period.
• 3:52
  SPEAKER_00: And they need to do it for each class of common stock.
• 3:57
  SPEAKER_00: Um, they're not required to do it to report EPS for participating securities.
• 4:02
  SPEAKER_00: We'll discuss those a little later, like preferred stock, for example, although they're not precluded from doing so.
• 4:08
  SPEAKER_00: They're also required to show EPS for continuing operations and for net income on the face of the income statement.
• 4:17
  SPEAKER_00: EPS for discontinued operations, however, is not required to be shown on the face of the income statement.
• 4:23
  SPEAKER_00: It can either be shown there or disclosed in the notes to the financial statements.
• 4:29
  SPEAKER_00: The other thing that sometimes folks forget about is that it's necessary to reconcile net income to income available to common shareholders on the face of the uh income statement if those two amounts are materially different.
• 4:46
  SPEAKER_00: And we typically look at materially different different as being around 10% or so.
• 4:51
  SPEAKER_00: However, regardless of whether income available to common and net income are materially different, it is required to fully reconcile those two numbers in the footnotes.
• 5:02
  SPEAKER_03: Okay.
• 5:02
  SPEAKER_03: So, John, one quick question, because you mentioned for uh disc ops, you can put it on the face or in the footnotes.
• 5:07
  SPEAKER_03: Is there a trend or it's really mixed, depends on the company.
• 5:11
  SPEAKER_00: Yeah, um, I I should have mentioned Heather, you're right.
• 5:14
  SPEAKER_00: It typically we see companies put it on the face of the income statement uh almost entirely.
• 5:19
  SPEAKER_03: Okay, that's helpful.
• 5:20
  SPEAKER_03: I think people always like to know what sort of the trend is, so that's good to know.
• 5:23
  SPEAKER_03: And then I know John, you ran through everything that has to be on the um shown, but Jay, can you fill us in on what you are not allowed to show on a per share basis?
• 5:35
  SPEAKER_04: The guidance is a little concerned at times that people will take things out of context.
• 5:39
  SPEAKER_04: So there is guidance that says that you can't show individual expense line items on a per share basis, like restructuring costs or things like that.
• 5:50
  SPEAKER_04: You can't actually show those on the face of the income statement, although you could include those in the footnotes.
• 5:57
  SPEAKER_04: Uh, but if you do that, you should disclose whether they're either before tax or after tax.
• 6:02
  SPEAKER_04: But the guidance does also say that you can't show cash flow per share amounts anywhere in the statements unless there's some type of contractually defined items like distributable cash flow per share at a master limited partnership or something like that.
• 6:23
  SPEAKER_03: Jay, something like cash flow per share that you can't include in the financials, do you see companies putting it in mDNA or it can't be included in any filing?
• 6:32
  SPEAKER_04: I think other than again these sort of contractually defined types of cash flow items, I think uh while that's more of an SEC rule than a gap rule.
• 6:40
  SPEAKER_04: I think our our sense is that that that should not be presented in the in the mDNA or the footnotes or anywhere else in the filing.
• 6:47
  SPEAKER_03: Okay, thank you.
• 6:48
  SPEAKER_03: So then, Jay, before we get into more detail, this is a presentation and disclosure series.
• 6:54
  SPEAKER_03: So from a disclosure perspective, I know we don't always think about disclosure for EPS, but there definitely are some.
• 7:00
  SPEAKER_03: So can you share what you need to disclose as well?
• 7:03
  SPEAKER_04: Yeah, the guidance does have a few disclosures that are required for each period that an income statement is being shown.
• 7:12
  SPEAKER_04: And one of them is a reconciliation of the numerators and denominators of basic and diluted EPS.
• 7:20
  SPEAKER_04: And we'll we'll get into that more, I know, as we go here today, uh, for income from continuing operations, including the individual income or numerator and share or denominator effects of all securities that are affecting EPS for the period.
• 7:36
  SPEAKER_04: So that's the first disclosure.
• 7:39
  SPEAKER_04: Uh, the second is the effect that has been given to preferred dividends or other items associated with other securities that were used to come up with income available to common stockholders for basic EPS, and that John talked about a little while ago.
• 7:53
  SPEAKER_04: And then third is uh the impact of any securities that could potentially dilute EPS in the future, but that were not included in the computation of diluted EPS in any of the periods shown because they were anti-dilutive, and we'll get into that a little bit more later on, too.
• 8:13
  SPEAKER_04: Uh, and then lastly, while this is more of just a ending balance sheet matter, uh you would have to talk about any transactions that occur after the most recent balance sheet date, but before issuance of the financial statements that would have materially changed the number of shares or potential shares that are outstanding.
• 8:33
  SPEAKER_03: And Jay, that would be things like sales of shares, stock repurchases, those types of items.
• 8:39
  SPEAKER_03: Right.
• 8:39
  SPEAKER_04: Conversions of convertible securities, things like that.
• 8:43
  SPEAKER_03: All right.
• 8:43
  SPEAKER_03: So plenty to think about.
• 8:45
  SPEAKER_03: So then we keep saying we're going to go into more detail.
• 8:47
  SPEAKER_03: So let's jump in.
• 8:48
  SPEAKER_03: And I think an obvious place to start is basic EPS versus diluted EPS.
• 8:54
  SPEAKER_03: And like I said at the beginning, I think superficially people think it's just math, but there's a lot more to it.
• 8:59
  SPEAKER_03: So, John, can you walk us through the two calculations?
• 9:03
  SPEAKER_00: Uh sure, Heather.
• 9:04
  SPEAKER_00: Basic essentially is what it sounds like.
• 9:08
  SPEAKER_00: Um, it's income that is available to common shareholders divided by the weighted average number of shares outstanding for the period.
• 9:17
  SPEAKER_04: That sounds pretty simple, John, or maybe even say basic, but I know we're gonna get into a lot more complexities in coming up with basic EPS as we go along.
• 9:27
  SPEAKER_00: Nothing like a good EPS joke, Jay.
• 9:29
  SPEAKER_00: That's what I always say.
• 9:30
  SPEAKER_03: Um and people think accountants aren't funny.
• 9:35
  SPEAKER_00: Um diluted EPS is similar, but in court it incorporates all the instruments and arrangements that a company has that could potentially result in additional common shares.
• 9:48
  SPEAKER_00: And and and we we refer to these as um uh potential common shares.
• 9:54
  SPEAKER_00: Financial statement users tend to focus on diluted EPS a little bit more than they focus on basic EPS.
• 10:02
  SPEAKER_00: And the reason is because diluted EPS reflects all the potential dilution that might occur in the future.
• 10:08
  SPEAKER_00: So from an investor's perspective, they seem to be more interested in that number.
• 10:12
  SPEAKER_03: All right.
• 10:12
  SPEAKER_03: So, John, that's helpful background.
• 10:15
  SPEAKER_03: Then if we jump into it and say now we're actually going to calculate basic EPS, Jay, can you help us understand the various pieces?
• 10:24
  SPEAKER_04: Sure.
• 10:24
  SPEAKER_04: So the starting point, as we've mentioned a few times, is income from continuing operations or net income.
• 10:31
  SPEAKER_04: But then that amount is reduced or in some cases increased by a few things.
• 10:37
  SPEAKER_04: So the first is the allocation of any income or loss of subsidiaries that has to be attributed to the non-controlling interests or the NCI.
• 10:48
  SPEAKER_04: You have to allocate the amounts to NCI holders first and away from the parent company stockholders, because ultimately we're trying to figure out how much money is rolling up to the parent to be distributed to the shareholders of the parent.
• 11:00
  SPEAKER_04: So that has to be allocated first.
• 11:02
  SPEAKER_04: Then you also have to reduce income by any dividends declared on preferred stock, as well as any undeclared but cumulative dividends on preferred stock.
• 11:16
  SPEAKER_04: So, what do we mean by cumulative dividends?
• 11:19
  SPEAKER_04: Those are dividends that, based on the terms of the security, if they're not declared in the current period, eventually they do have to be declared and paid before you can pay any future dividends on common stock.
• 11:34
  SPEAKER_04: So they basically accumulate and have to get paid off in the future.
• 11:38
  SPEAKER_04: And what's interesting here is for both of these, even when the company is in a loss position, any declared or cumulative dividends would increase the loss in the computation of the numerator.
• 11:51
  SPEAKER_00: Yeah, Jay, that's right.
• 11:52
  SPEAKER_00: And we would also reduce the numerator by any deemed dividends.
• 11:57
  SPEAKER_00: Um deemed dividends are things like uh accretion on redeemable securities to their redemption value.
• 12:04
  SPEAKER_00: For example, redeemable preferred stock that needs to be accreted to its redemption value.
• 12:08
  SPEAKER_00: Deemed dividends would also include things like the excess of consideration paid over the carrying value of preferred stock when it's when it's redeemed, um, or amounts that are paid to an investor in order to induce the investor in that preferred stock to convert the preferred stock would also be considered a deemed dividend.
• 12:34
  SPEAKER_00: Each of these is viewed as an additional return to the preferred shareholders and therefore economically similar to a dividend.
• 12:43
  SPEAKER_00: In the case of redemption of preferred stock, interestingly enough, it's possible that the consideration paid could actually be less than the carrying value of the preferred.
• 12:54
  SPEAKER_00: And in these instances, you'd actually increase the numerator for the amount of that difference.
• 13:02
  SPEAKER_00: Deem dividends would also include things like the amortization of a beneficial conversion feature.
• 13:09
  SPEAKER_00: This is something that's only a concern for companies that haven't implemented the new convertible debt standard yet, ASU 2020, which, you know, in fact does away with beneficial conversion features.
• 13:20
  SPEAKER_00: But it also would include things like the value of the effect of a downround provision in preferred stock that gets triggered.
• 13:28
  SPEAKER_00: And, you know, this, interestingly enough, would only be a consideration for companies after they implement the new ASU 2020, um, because prior to 2020, this that provision in the down round literature didn't apply to preferred stock.
• 13:43
  SPEAKER_03: All right, John, before we go on, I feel like every time I have you on, you mention down rounds.
• 13:49
  SPEAKER_03: And I still think many of our listeners won't know what that is.
• 13:52
  SPEAKER_03: So can you give us the 30 seconds on what you mean when you say that?
• 13:56
  SPEAKER_00: I'll have to remember and not include down rounds in my next podcast.
• 14:00
  SPEAKER_03: Exactly.
• 14:02
  SPEAKER_00: A down round provision is a feature in an instrument such as convertible preferred stock that insists or requires that the strike uh the conversion price on the convertible preferred stock get reduced if in the future the issuer has issued either common shares or another convertible or exercisable instrument with a strike price below that on the instrument that we're talking about.
• 14:28
  SPEAKER_03: All right.
• 14:28
  SPEAKER_03: Thank you.
• 14:29
  SPEAKER_03: Now you can go back to, I know there's a few more items on your list of adjustments.
• 14:33
  SPEAKER_00: That's right.
• 14:35
  SPEAKER_00: Um I think the last thing to mention is that the numerator would also get reduced by any amounts that are being allocated, any amounts of undistributed earnings that are being allocated to participating securities.
• 14:49
  SPEAKER_00: And we don't want to dive too deep into participating securities here because you know that's probably better for a different podcast.
• 14:56
  SPEAKER_00: Essentially, a participating security is a security that participates along with common shares, if and when dividends are paid on those common shares.
• 15:07
  SPEAKER_00: And I think the important thing to remember about participating securities is that it's not important whether or not the company is actually a dividend-paying company or not.
• 15:16
  SPEAKER_00: What's important is the contractual right to receive dividends.
• 15:20
  SPEAKER_00: And I think with that, I'll probably terminate our conversation with respect to participating securities.
• 15:26
  SPEAKER_03: Sounds like enough.
• 15:26
  SPEAKER_04: So after you do all of that, we've walked through on the numerator.
• 15:30
  SPEAKER_04: That's just to get to the numerator.
• 15:33
  SPEAKER_04: Jay, um, this isn't sounding so basic.
• 15:36
  SPEAKER_03: That's what I was saying.
• 15:38
  SPEAKER_04: Now, the denominator sounds a little bit easier to start with.
• 15:42
  SPEAKER_04: It's just the weighted average number of common shares outstanding.
• 15:46
  SPEAKER_04: So you should weight any shares that are issued or shares that are reacquired during the period only for the portion of the period that they're actually outstanding.
• 15:57
  SPEAKER_04: And you only want to include shares that, as I call it, sort of absolutely positively are going to be outstanding and stay outstanding without any contingencies associated with them.
• 16:08
  SPEAKER_03: One of the things that endlessly frustrated me when I was a staff and senior accountant testing basic EPS was that the number of shares on the balance sheet or the statement of stockholders equity and what you include in EPS were not the same number.
• 16:23
  SPEAKER_03: So can you just explain to us why that is?
• 16:27
  SPEAKER_00: That's right, Heather.
• 16:28
  SPEAKER_00: Um there's not always symmetry between the legally issued and outstanding shares and the number of shares we include in the in the EPS computation.
• 16:37
  SPEAKER_00: Um sometimes we add um other things into the computation.
• 16:42
  SPEAKER_00: For example, shares that are issuable for little or no consideration.
• 16:47
  SPEAKER_00: Um we consider those outstanding shares for EPS purposes.
• 16:51
  SPEAKER_00: Um what are those?
• 16:52
  SPEAKER_00: What are shares issuable for little or no consideration?
• 16:55
  SPEAKER_00: Um a couple of things.
• 16:57
  SPEAKER_00: First would be contingently issuable shares, but only once the contingency has been resolved, then you would include them as outstanding shares.
• 17:06
  SPEAKER_00: Another would be penny warrants.
• 17:08
  SPEAKER_00: And what penny warrants are, they're they're warrants that are exercisable for a nominal amount of cash, typically a penny.
• 17:16
  SPEAKER_00: Um, and we we look at those and we say, since the holder can pick up the phone and make a phone call and exercise the security, exercise the penny warrant at any time and receive a share, we look at those and say that their shares issuable for little or no consideration.
• 17:31
  SPEAKER_00: Another would be restricted stock units, once they're vested.
• 17:36
  SPEAKER_00: Um we would look at those as, you know, they represent the right um to get a share in the future, and therefore we would include those in um issued in outstanding shares as uh I mean outstanding shares for EPS computations as well.
• 17:49
  SPEAKER_00: There are also examples of things that we back out of outstanding shares.
• 17:54
  SPEAKER_00: One, for example, would be shares subject to a forward purchase contract for a fixed dollar amount at a fixed point in time.
• 18:03
  SPEAKER_00: And the reason we exclude those is because it's typically viewed like a treasury stock transaction.
• 18:08
  SPEAKER_00: But rather than expending cash for, you know, to repurchase the share, we issued a liability effectively.
• 18:16
  SPEAKER_00: Um, so those would be um left out of the weighted average shares outstanding computation.
• 18:22
  SPEAKER_00: And finally, contingently returnable shares.
• 18:25
  SPEAKER_00: We we typically look at, we'll talk a little bit about this in a little while, but we typically look at contingently issuable shares and contingently returnable shares as the same thing.
• 18:35
  SPEAKER_00: The holder of that share doesn't have all the rights to that share until that contingency is resolved.
• 18:41
  SPEAKER_00: And so therefore we exclude that from the denominator in basic EPS as well.
• 18:46
  SPEAKER_04: In other words, it's not absolutely, positively going to stay outstanding as a share.
• 18:53
  SPEAKER_03: All right.
• 18:54
  SPEAKER_03: So definitely lots of additions, exclusions, changes, and definitely, I'm sure our listeners are thinking does not seem so basic.
• 19:01
  SPEAKER_03: And now we need to move on to diluted.
• 19:04
  SPEAKER_03: So, what are some of those key differences, Jay, if people are doing their diluted calculation?
• 19:10
  SPEAKER_04: Well, it sort of starts out the same way.
• 19:12
  SPEAKER_04: It's the same notion of some amount of income divided by some amount of shares.
• 19:17
  SPEAKER_04: But it is diluted EPS is an attempt to illustrate the impact that any and all of those potential common shares would have on EPS.
• 19:29
  SPEAKER_04: And so, as we said before, those are shares that might be issued in the future based upon outstanding financial instruments and contracts today.
• 19:40
  SPEAKER_04: So basically, this calculation assumes that all these potential common shares were actually outstanding as common shares from the beginning of the period or the time of issuance of that underlying arrangement, if that's later.
• 19:54
  SPEAKER_04: And of course, more shares outstanding means more dilution.
• 19:58
  SPEAKER_04: So that's the underlying concept here.
• 20:01
  SPEAKER_04: Now, a lot of times we also have to incorporate adjustments to the numerator to reflect the fact that if that instrument had actually resulted in the issuance of common stock at the beginning of the period and it didn't exist in its original form, then the effects of that instrument wouldn't have been included in net income during the period either.
• 20:22
  SPEAKER_03: All right.
• 20:23
  SPEAKER_03: So then if that's not complicated enough, I know that there are different methods to calculate the impact of these different instruments on diluted EPS.
• 20:32
  SPEAKER_03: So, John, can you share with us some of those and maybe how they differ?
• 20:37
  SPEAKER_00: Sure, Heather.
• 20:38
  SPEAKER_00: You know, the methods that we use to compute diluted EPS are based on the type of instrument that we're speaking about.
• 20:45
  SPEAKER_00: For example, the the Treasury stock method is used for options, warrants, and forward contracts.
• 20:52
  SPEAKER_00: And essentially that would include all um types of stock-based compensation awards.
• 20:58
  SPEAKER_00: Um and the treasury stock basically is based on the concept that the assumed proceeds from the exercise of the instrument would be used to repurchase shares of the company in the marketplace at the average market price during the period.
• 21:17
  SPEAKER_00: And the number of shares that hypothetically could be repurchased by using those proceeds at the average market price uh the difference between that number and the number of shares that underlie the instrument um would be included as the number of shares to include in your diluted EPS calculation pursuant to the treasury stock method.
• 21:43
  SPEAKER_00: Um so with that in mind, you know, options and warrants are generally dilutive.
• 21:50
  SPEAKER_00: You know, one when um uh when the company has earnings for the period, but two, when the average market Price for the period exceeds the strike price on the instrument.
• 22:05
  SPEAKER_00: I guess another thing to consider is that instruments that are issued or exercised or expired during the period would be included in the diluted EPS computation for for the period of time that they were outstanding during the period.
• 22:20
  SPEAKER_03: Yes.
• 22:21
  SPEAKER_03: Another thing that makes it a little more complicated.
• 22:24
  SPEAKER_03: So then let me ask a question.
• 22:26
  SPEAKER_03: Because you said that typically you use the method depending on the type of instrument.
• 22:31
  SPEAKER_03: And you mentioned a few instruments, but we didn't talk about convertible instruments.
• 22:35
  SPEAKER_03: So, Jay, what method is typically used for those?
• 22:39
  SPEAKER_04: Well, we we use the aptly named if converted method for those types of instruments, uh, for convertible debt, convertible preferred stock, or share settled debt, things like that.
• 22:50
  SPEAKER_04: And what this basically does is that it assumes conversion of the instrument at the beginning of the period or the date of issuance, if that's later.
• 23:00
  SPEAKER_04: And then if it's convertible debt, then any associated interest, net of tax, or if it's convertible preferred stock, then any dividends, either declared or accumulated, would be added back to the numerator, since the diluted EPS computation assumes conversion at the beginning of the period.
• 23:22
  SPEAKER_04: If the instrument actually had been converted at the beginning of the period, then the company wouldn't have had any of that interest or dividends running through their statements.
• 23:29
  SPEAKER_04: So we add that back.
• 23:31
  SPEAKER_04: That add back to the numerator would also include any deemed dividends like accretion or redemption value or allocation of undistributed earnings for participating securities that John talked about earlier that were taken as a deduction from income available to common when you were calculating basic EPS, you would add those back as part of doing this diluted calculation.
• 23:55
  SPEAKER_04: Because again, if if it had been converted into common stock and it wasn't actually a preferred instrument, then those amounts wouldn't have been recognized during the period.
• 24:04
  SPEAKER_04: And then the number of shares is just weighted for the period of time that the instrument was outstanding as potential common shares during the period.
• 24:12
  SPEAKER_04: So you have some impact on the numerator, impact on the denominator, and you have to kind of figure out the net impact of all of that.
• 24:17
  SPEAKER_03: Okay.
• 24:18
  SPEAKER_03: So then, Jay, to that point, and back to the uh comment I made when John made a similar uh remark about the fact that you're only looking at these instruments during the portion of time they're outstanding.
• 24:30
  SPEAKER_03: How do you think about that for convertible debt?
• 24:33
  SPEAKER_04: Well, uh as I alluded to, I if the instrument was issued during the period, then the number of shares that would be assumed to be issued under the F-converted method, the number of common shares, would only be weighted in the diluted EPS denominator for the portion of time that it was outstanding.
• 24:54
  SPEAKER_04: And then the same would be true if it actually was converted during the period, because now in that case, the actual common shares that were issued upon conversion, they'd already be included in the basic EPS denominator for the period of time after the conversion date.
• 25:10
  SPEAKER_04: But then the if converted method should still be applied to the calculation of diluted EPS, and that's waited for the period of time from the beginning of the period until the date of actual conversion to see if there's any extra or incremental shares to include in diluted EPS.
• 25:25
  SPEAKER_03: All right, definitely something to focus on if you have that situation.
• 25:28
  SPEAKER_03: So then let me ask another question, another scenario, which is that I know again, from having dealt with this in the past, that there's cases where shares would only be issued or an instrument would only become exercisable or convertible upon achieving a certain condition.
• 25:45
  SPEAKER_03: And that could be something like achieving a revenue target or an earnings target, stock price, all different types of things, completing a financing.
• 25:53
  SPEAKER_03: So, how would you think about those types of arrangements in this calculation?
• 25:57
  SPEAKER_00: Yeah, Heather, you're right.
• 25:59
  SPEAKER_00: Um, you know, we call these contingently issuable shares in the EPS guidance.
• 26:04
  SPEAKER_00: And we see them in um contingent consideration in business combinations.
• 26:08
  SPEAKER_00: We see them in compensation awards that are issued to employees and uh warrants that are issued to investors, as well as other scenarios as well.
• 26:17
  SPEAKER_00: Um, as I mentioned a little bit earlier, we don't really distinguish between an instrument where a share or an arrangement where a share is contingently issuable and an actually legally issued outstanding share where it's contingently returnable.
• 26:31
  SPEAKER_00: We view them the same from the perspective of the EPS literature.
• 26:35
  SPEAKER_00: And these scenarios can get a little bit complex.
• 26:38
  SPEAKER_00: We don't want to get into too much detail here, but essentially the general idea is to look at the facts and circumstances at the end of each reporting period.
• 26:48
  SPEAKER_00: If the condition or circumstance, whatever it is, is being met at the end of the period based on the numbers or the circumstances that are defined in the arrangement, um, then they would be included in Diluto DPS as of the beginning of that reporting period.
• 27:06
  SPEAKER_00: And it it doesn't really even matter.
• 27:08
  SPEAKER_00: You know, you see scenarios where you know the issuance of the share or the uh exercisability of the instrument is based on, uh is based on earnings in a period two years in the future.
• 27:20
  SPEAKER_00: It doesn't really matter.
• 27:21
  SPEAKER_00: If the earnings at the end of the reporting period are meeting whatever the criteria defined in the arrangement are, we would include them and diluted as of the beginning of the period that we're talking about.
• 27:32
  SPEAKER_00: And if it's not met, it wouldn't be included.
• 27:34
  SPEAKER_03: Okay.
• 27:35
  SPEAKER_03: So then, John, let me flip what you just said a little bit.
• 27:38
  SPEAKER_03: And let's take a scenario where I didn't meet it this period, but I do project or I think it's probable I will meet it, let's say in those two years.
• 27:48
  SPEAKER_03: Then should I still include it?
• 27:50
  SPEAKER_00: Uh-uh.
• 27:50
  SPEAKER_00: You can't project.
• 27:52
  SPEAKER_00: No, no projections, Heather.
• 27:53
  SPEAKER_00: We're not allowed to do that.
• 27:55
  SPEAKER_00: Yeah, the guidance is really trying to be completely objective.
• 27:58
  SPEAKER_00: It's black and white.
• 27:59
  SPEAKER_00: You've either met the criteria at the end of the period, or you haven't met the criteria at the end of the period.
• 28:04
  SPEAKER_00: Um it can get that, you know, that sounds like it's simple.
• 28:09
  SPEAKER_00: That can actually get complicated in and of itself, depending on what the criteria in the particular arrangement are defining.
• 28:18
  SPEAKER_00: But we we we won't get into that, you know, again on this podcast.
• 28:21
  SPEAKER_03: Yes, I can think of many questions, but we'll refer people to the financial statement presentation guide at the end for some more info on that.
• 28:28
  SPEAKER_03: So then let me ask another question.
• 28:30
  SPEAKER_03: I've heard you both talk about only including potential common shares if they're dilutive.
• 28:36
  SPEAKER_03: So I think it might be obvious from the word itself, but what do we mean when we say that?
• 28:41
  SPEAKER_03: And then what are where do we typically see those so people can be on the lookout?
• 28:46
  SPEAKER_04: Sure.
• 28:46
  SPEAKER_04: So you generally would not include any potential common stock instruments for a period where the impact would either increase earnings per share or reduce loss per share.
• 29:03
  SPEAKER_04: Both of those would be considered anti-dilutive.
• 29:06
  SPEAKER_04: Uh and we usually see that happen in one of three ways, although there are some other complexities uh beyond these.
• 29:13
  SPEAKER_04: Uh the first is, I think John mentioned, you mentioned this before, a stock option, a warrant that's out of the money, because that would mean that more shares could be bought back with the proceeds than would be issued upon exercise of the instrument.
• 29:28
  SPEAKER_04: So it'd be kind of like a net negative number.
• 29:30
  SPEAKER_04: That doesn't work.
• 29:31
  SPEAKER_04: Another case would be a convertible instrument where you'd be adding back proportionally more to the numerator in interest or dividends than it would add to the denominator, and therefore effectively raising income per share.
• 29:48
  SPEAKER_04: But that's kind of a numerator and denominator impact that you have to look at.
• 29:52
  SPEAKER_04: And then the third is a situation where the company has a loss from continuing operations.
• 29:58
  SPEAKER_04: In that case, adding in more shares to the denominator would reduce the loss per share.
• 30:05
  SPEAKER_00: Yeah, Jay.
• 30:05
  SPEAKER_00: And you know, interestingly enough, when when we're um computing diluted EPS, we have to um consider each issue of potential common shares from most dilutive to least dilutive when we do the computation.
• 30:22
  SPEAKER_00: The literature refers to this as sequencing uh in the dilutive um EPS computation.
• 30:30
  SPEAKER_00: Um and what this means is that we need to consider those potential common shares that have the lowest add back to the numerator or per incremental share before we include those securities that have a higher add back to the numerator or per incremental share.
• 30:47
  SPEAKER_00: So typically, you know, equity classified options, they're going to be the most dilutive securities because typically they don't have an add back to the numerator when we're including them in the denominator for um diluted EPS purposes.
• 31:02
  SPEAKER_00: And you keep adding in the potential common share issuances as they get um uh uh less and less dilutive uh until you get to the point where the calculation becomes incrementally anti-dilutive.
• 31:21
  SPEAKER_00: Now some companies want to do, Jay, I know what you call the kitchen sink approach, right?
• 31:26
  SPEAKER_00: Which is include all your instruments uh in at the same time.
• 31:30
  SPEAKER_00: And if if you know that calculation, including all the instruments in the in in the computation, is um dilutive vis-a-vis the basic calculation, they sit back and figure, well, that must be my diluted EPS computation.
• 31:43
  SPEAKER_00: But that wouldn't give us the maximum potential dilution.
• 31:47
  SPEAKER_00: So that's why it's required to sequence from the most dilutive security to the least dilutive security as we meander through our um diluted EPS calculation.
• 31:59
  SPEAKER_03: Yes, you guys are reminding me all the things that I wanted to do when I was a staff that we weren't permitted to.
• 32:06
  SPEAKER_03: Uh so then let's let's move on to another topic.
• 32:08
  SPEAKER_03: And John, I know this is one that we've talked about before, so I'm gonna put my question to Jay this time.
• 32:15
  SPEAKER_03: And one of the questions that comes up is the calculation of quarterly diluted EPS versus annual diluted EPS.
• 32:24
  SPEAKER_03: So, Jay, can you just walk us through some of those considerations?
• 32:27
  SPEAKER_04: Sure.
• 32:27
  SPEAKER_04: So let me start with the quarterly calculation.
• 32:30
  SPEAKER_04: So uh the diluted EPS for a quarter is based on the weighted average number of shares of common stock and potential common shares for that quarter.
• 32:42
  SPEAKER_04: And those potential shares would be based on the average stock price during the quarter, if it's under the treasury stock method, or whether a contingency was being met at the end of the particular quarter if it was contingent share guidance, or perhaps whether the company had income or loss for the quarter as well.
• 32:59
  SPEAKER_03: All right.
• 32:59
  SPEAKER_03: And then, Jay, I know another sort of tempting trap here is that companies often would like to just add up their, you know, their quarters to get to the annual number.
• 33:09
  SPEAKER_03: Does that work?
• 33:10
  SPEAKER_04: Well, like with many of these things, there is some mixed guidance here, Heather, uh, about whether you look at things for the whole year as if it was its own independent calculation of full year EPS, or you just add up or average what you've done for each quarter.
• 33:27
  SPEAKER_04: So for some things, you keep what you did each quarter and basically just average the four of those denominators together for the full year number.
• 33:37
  SPEAKER_04: So, for example, in the treasury stock method, the guidance says that the company does not perform a separate year-to-date computation using the average stock price for the year.
• 33:49
  SPEAKER_04: Instead, you just add up the incremental shares or the potential common shares from each quarter's calculation using that quarter's average stock price, and you average all those together.
• 34:03
  SPEAKER_04: And then similarly, when you're using contingent shares under that model, you include those in the full year computation based on whether they were in or out each quarter and just average those.
• 34:15
  SPEAKER_04: But then for other things, you do look at a full-year computation.
• 34:19
  SPEAKER_04: So, for example, the DF-converted method, you include a full year addback of interest or dividends and the weighted average number of shares that would be issued upon conversion, as if they were outstanding for the whole year.
• 34:33
  SPEAKER_04: And even for the treasury stock method, uh, there's an element of looking at full-year results when there's a mix of income and loss in different quarters in deciding what to include for the quarters when you're doing the full year averaging.
• 34:48
  SPEAKER_04: And there's some specific rules and the guidance uh about that that the listeners can look to.
• 34:54
  SPEAKER_04: So as a result of all these rules, it's often the case, what you were saying there, Heather, that the sum of the four quarterly diluted EPS figures is not equal to the full year diluted EPS amount.
• 35:07
  SPEAKER_04: So, how's that for a quirky answer to end with today?
• 35:11
  SPEAKER_03: Yeah, it's definitely a lot to think about.
• 35:14
  SPEAKER_03: So I do have a couple of fun questions.
• 35:16
  SPEAKER_03: So let me start with, especially if people were just listening to that segment, where should they go if they have more questions on this topic?
• 35:23
  SPEAKER_03: I think it gives some great information, but there's definitely a lot of detail.
• 35:27
  SPEAKER_00: Yeah, Heather, I would say the best place to start is chapter seven of our financial statement presentation guide, earnings per share.
• 35:35
  SPEAKER_00: Um, it it marches through the EPS computation very similar to the way we did today, um, from you know, basic the numerator, denominator, diluted.
• 35:45
  SPEAKER_00: It does go into some very complex instruments, but I think that's the best place to start.
• 35:50
  SPEAKER_00: Um, we also have a number of other accounting and reporting guides that touch on various aspects of EPS.
• 35:56
  SPEAKER_00: Um, some of those would be like our carve out guide, the business combination guide.
• 36:01
  SPEAKER_00: Um, and you know, if we would be remiss if we didn't mention SPACs in this podcast.
• 36:07
  SPEAKER_00: You know, we have a recently issued in-depth that goes through some of the EPS considerations for the earnouts and warrants that are common in the SPAC transactions we're seeing these days.
• 36:17
  SPEAKER_03: All right.
• 36:18
  SPEAKER_03: Thanks, Sean.
• 36:18
  SPEAKER_03: So then let me ask you both a different closing question.
• 36:22
  SPEAKER_03: So, John, from your perspective, I know you and I have talked about EPS a lot.
• 36:26
  SPEAKER_03: If you had to summarize EPS, what someone should think about when they're dealing with it, what would you say?
• 36:32
  SPEAKER_00: Oh, that's a tough question.
• 36:35
  SPEAKER_03: You can have a minute if you need a minute.
• 36:37
  SPEAKER_00: Um let's see, what would I say?
• 36:41
  SPEAKER_00: Um I I I guess I would say the the the most important thing when you're diving into your EPS computation is to have a holistic view of the capital structure of the company.
• 36:52
  SPEAKER_00: Understand the types of instruments that the company has issued, whether they're dilutive or potentially dilutive common shares, outstanding common shares.
• 37:02
  SPEAKER_00: And sometimes you have to get behind the things a little bit legally uh to understand, for example, whether they're contingently returnable or not.
• 37:10
  SPEAKER_00: You know, it it sort of piggybacks off your work in the financial instruments area.
• 37:15
  SPEAKER_00: Um, and um, I I think that's the most important thing.
• 37:18
  SPEAKER_03: Yeah, that's fantastic advice and definitely better than just delving into the detail to start with.
• 37:25
  SPEAKER_03: And then, Jay, I have a different closing question for you.
• 37:28
  SPEAKER_03: So, frequent listeners know you've covered a lot of different topics on the podcast.
• 37:33
  SPEAKER_03: And for those who don't know, we're organized into different groups in our national office, including financial instruments, revenue and liabilities, and business combinations.
• 37:45
  SPEAKER_03: And you are changing groups.
• 37:47
  SPEAKER_03: And I heard a rumor you used to be even in financial instruments.
• 37:50
  SPEAKER_03: So you kind of have the trifecta, uh, which is great.
• 37:54
  SPEAKER_03: So just curious if you have a favorite topic or if that's like choosing a favorite child.
• 38:00
  SPEAKER_04: Uh well, that's fair.
• 38:02
  SPEAKER_04: I am shifting right now into our business combinations team, although some of that is returning to a topic that I had covered some years ago.
• 38:10
  SPEAKER_04: But I have straddled uh all three groups across our accounting services practice.
• 38:16
  SPEAKER_04: It is probably hard to pick one, whether that's a favorite child, or to be what I often get asked, my the favorite office or city that I've lived and worked in, is a similarly challenging question, having having been in a number of them.
• 38:28
  SPEAKER_04: So they all have pretty interesting topics, I would say, uh, and and all kind of get back to some of the same, the same core uh matters of you really get to get behind the economics of whatever it is that you're talking about.
• 38:43
  SPEAKER_04: And we talk about that over and over again at these podcasts, right?
• 38:46
  SPEAKER_04: It's easy to kind of get lost in the in the the simple or the mechanical aspects, but sometimes you we find you really have to get into the the real economics behind uh any whatever the transaction is to figure out what the best accounting would be.
• 39:00
  SPEAKER_04: You usually we find that once the facts are known, the the accounting presents itself.
• 39:04
  SPEAKER_03: Well, Chase, so I'm first impressed you managed to avoid my question.
• 39:08
  SPEAKER_03: And then second, you managed to tie back to John's answer.
• 39:10
  SPEAKER_03: So what a fantastic end to the podcast.
• 39:13
  SPEAKER_03: Uh so as always, really appreciate having you both on.
• 39:17
  SPEAKER_03: Thanks so much for all the insights.
• 39:19
  SPEAKER_00: Thank you, Heather.
• 39:20
  SPEAKER_00: Yeah, you're welcome.
• 39:21
  SPEAKER_02: If you have more questions on EPS, then check out our original Back to Basics EPS episode from June 2019 or our podcast on EPS recent developments released earlier this year will include links to both shows in the show notes.
• 39:36
  SPEAKER_02: Don't forget to join me back here every Tuesday and Thursday for new podcast episodes.
• 39:41
  SPEAKER_02: Head over to wherever you listen to your podcast and subscribe to the PWC Accounting Podcast.
• 39:47
  SPEAKER_02: That way, you'll never miss an episode.
• 39:50
  SPEAKER_02: For PWC's National Office Studios, I'm Heather Horn.
• 39:54
  SPEAKER_02: Thanks for tuning in.
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