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Presenting earnings per share (EPS) · PwC's accounting podcast

0:00
SPEAKER_00: Thought Leadership from PWC.
0:06
SPEAKER_01: Welcome to PWC's Accounting Podcast.
0:09
SPEAKER_01: I'm Heather Horn.
0:11
SPEAKER_01: It's the first Tuesday in February, and for us accountants, February in general means reporting and earnings season.
0:18
SPEAKER_01: So to kick off this month of podcasts, we're going to focus on financial statement presentation.
0:25
SPEAKER_01: And this whole year of podcasts, starting with this month, will be based on our most popular guides.
0:31
SPEAKER_01: And no surprise, financial statement presentation is our most popular guide.
0:38
SPEAKER_01: And today's topic is one of our most popular topics, earnings per share, also known as EPS.
0:45
SPEAKER_02: I think there's a couple of reasons why EPS is such a closely watched metric.
0:50
SPEAKER_02: And first is because it's a reliable metric.
0:53
SPEAKER_02: It's based on a gap net income and subject to audit.
0:56
SPEAKER_02: So that's an important factor.
0:58
SPEAKER_02: The second is it's readily available.
1:00
SPEAKER_02: Every public company needs to report EPS.
1:04
SPEAKER_02: And the third thing is I think it lends itself very easily to analysis.
1:16
SPEAKER_01: That was Sean Haran, a managing director in our national office who's joining us for Refresher as we dissect the complexities of EPS computations.
1:27
SPEAKER_01: And as John will explain, it's very important to recognize that this is a computation, not a calculation.
1:34
SPEAKER_01: Intrigued to understand the difference.
1:36
SPEAKER_01: Stay tuned for my conversation with John.
1:39
SPEAKER_01: John, welcome back to the podcast.
1:41
SPEAKER_01: As always, so nice to have you on.
1:43
SPEAKER_01: And a very important topic for this time of year, earnings per share, which I think your joke of, although it may be called basic, it's not so basic.
1:52
SPEAKER_01: Probably it will apply to what we're going to talk about.
1:56
SPEAKER_01: And I'm sorry if I took your your joke away.
1:59
SPEAKER_02: No, I excluded that joke because we've we've overused it.
2:02
SPEAKER_01: Well, this time I was the one who said it.
2:04
SPEAKER_01: So anyway, so nice to have you.
2:06
SPEAKER_01: So I think one thing that can be helpful both for preparers and for auditors is sometimes, you know, we report a lot of information, and particularly this time of year, we don't step back to say, like, why is it important?
2:20
SPEAKER_01: And EPS in particular, I think sometimes just seems like a lot of math.
2:24
SPEAKER_01: So maybe to switch things up a little and start things off, why is this such an important metric to investors?
2:31
SPEAKER_01: I mean, we see stocks move on, you know, a penny a share type of thing.
2:35
SPEAKER_02: Absolutely.
2:36
SPEAKER_02: It's very closely watched by the analysts.
2:38
SPEAKER_02: And you're right, you know, uh a miss by a company of a penny or two can put a lot of downward pressure on their stock.
2:44
SPEAKER_02: I think there's a couple of reasons why EPS is such a closely watched metric.
2:49
SPEAKER_02: And first is because it's a reliable metric, it's based on gap net income and subject to audit.
2:54
SPEAKER_02: So that's an important factor.
2:57
SPEAKER_02: The second is it's readily available.
2:59
SPEAKER_02: Every public company needs to report EPS.
3:02
SPEAKER_02: And the third thing is I think it lends itself very easily to analysis.
3:09
SPEAKER_02: Right?
3:10
SPEAKER_02: So, for example, you know, most companies will look at EPS trends over time.
3:15
SPEAKER_02: Is EPS increasing?
3:17
SPEAKER_02: Is it decreasing?
3:18
SPEAKER_02: Why is it increasing and decreasing?
3:20
SPEAKER_02: The other thing is it also lends itself very easily to comparisons between companies, companies that are pure companies, and other companies in the industry.
3:29
SPEAKER_02: So, for example, most analysts will cite what a company's PE ratio is or price earnings ratio.
3:36
SPEAKER_02: And basically the price-earnings ratio is just the company's share price divided by its earnings per share.
3:42
SPEAKER_02: And so you can compare companies and understand what the multiples of those companies are.
3:46
SPEAKER_02: So I think those are the primary reasons.
3:48
SPEAKER_01: Yeah, it is interesting.
3:50
SPEAKER_01: I I was reflecting while you were speaking that there aren't that many metrics that, particularly if you look across industries, but really that are really putting all companies sort of on the same, I'll say, level playing field.
4:05
SPEAKER_01: And again, maybe it depends how much stock you have out, how much solution things.
4:09
SPEAKER_01: But nonetheless, it is a really helpful starting point if I'm trying to analyze and understand a company and its relative profitability.
4:17
SPEAKER_02: As somebody that spends a lot of time on earnings per share, I couldn't agree more.
4:20
SPEAKER_01: So all right.
4:22
SPEAKER_01: So with that said, and again, it's very timely right now.
4:25
SPEAKER_01: I referenced this at the beginning, but always helpful to re-level set, particularly for people who are only looking at this, you know, once a quarter.
4:33
SPEAKER_01: What are the the two types of EPS that we have?
4:37
SPEAKER_02: Yeah, we like to say there's there's two flavors of EPS, you know, basic EPS and diluted EPS.
4:43
SPEAKER_02: And basic EPS is a ratio that compares the company's earnings for a period to the weighted average number of shares outstanding.
4:53
SPEAKER_02: And it's supposed to measure the performance of the company over that reporting period.
4:57
SPEAKER_02: Diluted EPS is really getting at the same thing.
5:00
SPEAKER_02: The thing about diluted EPS is it it assumes that all of the potential common shares in the capital structure, things like options and warrants and convertible debt, you know, what would happen to that earnings per share if all of those instruments were outstanding shares rather than in their current form as potential common shares?
5:19
SPEAKER_01: All right.
5:20
SPEAKER_01: So it's helpful just sort of level set where we're starting.
5:23
SPEAKER_01: And I know we've done, you and I have done a number of podcasts about EPS, and I'm always happy to chat with you.
5:29
SPEAKER_01: But topic for today, what were some of the areas we thought we'd focus on?
5:34
SPEAKER_02: Well, we've talked a lot, you know, in a couple of different podcasts.
5:38
SPEAKER_02: So I thought today what we would do is focus on some of the more nuanced areas of the EPS computation, right?
5:45
SPEAKER_02: And that's it's a good thing.
5:47
SPEAKER_02: Everybody always calls the EPS computation, a calculation.
5:51
SPEAKER_01: Yes, that's fair.
5:52
SPEAKER_01: That is even I myself would have to say I'm guilty of that.
5:55
SPEAKER_02: As an EPS nerd, I take offense to that.
5:58
SPEAKER_02: And the difference between you say you might say, who cares?
6:01
SPEAKER_02: But the the difference between um a calculation and a computation.
6:05
SPEAKER_02: A calculation is simple, um uh simply um an arithmetic process, adding, subtracting.
6:12
SPEAKER_02: A computation applies specific rules to that arithmetic process.
6:17
SPEAKER_02: And as we're gonna discuss today, certainly the EPS computation applies lots of rules.
6:23
SPEAKER_02: And so I think um we would be remiss not to refer to it as a computation as opposed to a calculation.
6:30
SPEAKER_01: Wow, it's well nice.
6:31
SPEAKER_01: I was not expecting to have, I guess, a um uh a word uh expand my horizons here, but it is very interesting.
6:39
SPEAKER_01: I guess a lot of what we do, well, we do both computations and calculations as accountants.
6:44
SPEAKER_01: So uh it's good to focus today on the computation.
6:48
SPEAKER_01: So starting with basic EPS, it's a little harder for me to see that one as a computation, but perhaps you can explain.
6:57
SPEAKER_02: Yeah, what one of the things that I thought in basic EPS we'd talk about today.
7:00
SPEAKER_02: We've talked about participating in securities in the past and accretion and things like that, um, cumulative dividends on preferred stock.
7:08
SPEAKER_02: I thought we'd talk a little bit about the way that we include attribution of non-controlling interest into the um EPS computation.
7:16
SPEAKER_02: So basic EPS takes net income, computes income available to common shareholders.
7:22
SPEAKER_02: That's the numerator.
7:23
SPEAKER_02: The numerator excludes earnings that are attributable to the company's non-controlling interests.
7:30
SPEAKER_02: And just to level set, you know, I want to assume anything.
7:34
SPEAKER_02: What is a non-controlling interest?
7:36
SPEAKER_02: A non-controlling interest is equity ownership of a subsidiary of a company by shareholders other than the controlling shareholder.
7:45
SPEAKER_02: So usually the controlling shareholder is the parent company, the parent company presents consolidated EPS.
7:51
SPEAKER_02: Sometimes those third parties have um sometimes those subsidiaries have third party shareholders.
7:58
SPEAKER_02: The earnings of that subsidiary need to be attributed to those third-party shareholders, and they get excluded from the computation of income available to uh common shareholders.
8:09
SPEAKER_02: So, how does that happen?
8:11
SPEAKER_02: So imagine a company with uh a subsidiary, all it has is a single class of common equity, and some of that common equity is owned by non-controlling interest holders.
8:22
SPEAKER_02: We need to exclude the earnings of that entity from the basic EPS computation of the consolidated parent.
8:30
SPEAKER_02: So, what we do is we calculate or compute the um uh the earnings per share for the subsidiary.
8:38
SPEAKER_02: And then we pick up the earnings of the subsidiary um by the parent, and we, you know, the way that happens mechanically is the parent would take the number of shares that it owns of the subsidiary, multiply it by the earnings per share of the subsidiary, and that's the number that gets included in the numerator of the parent.
8:58
SPEAKER_01: So, John, maybe one pause here because um I have to admit it's been a long time since I've done EPS.
9:04
SPEAKER_01: And it's interesting because when you think about the income statement, the non the share attributable to the non-controlling interest also gets backed out.
9:11
SPEAKER_01: So I think there may be sort of an inclination to say, oh, well, I'll just start with the number after the net income attributed to the non-controlling interest is backed out.
9:21
SPEAKER_01: And what you're saying is no, that is not the right place to start.
9:26
SPEAKER_01: Well, or does mathematically it works out the same?
9:28
SPEAKER_01: Mathematically it works out the same.
9:30
SPEAKER_01: Okay, I feel better because I was worried there for a moment.
9:32
SPEAKER_01: Okay.
9:32
SPEAKER_02: But the problem is what happens is when you have more complex structures.
9:37
SPEAKER_01: Then it can start or if you have like hypothetical liquidation of book value, I'll just throw that term out, or some other structures like that.
9:44
SPEAKER_01: This approach of just starting with the income statement may not work.
9:47
SPEAKER_02: Well, if there are preferred shareholders of the sub, for example, and the preferred shareholders of the sub are entitled to cumulative dividends, where dividends are declared and paid, that's not going to go through the income statement.
10:01
SPEAKER_02: Right.
10:02
SPEAKER_02: So you would compute the earnings per share at the subsidiary level, and then the uh parent company would pick that up based on the number of shares of the sub they own.
10:11
SPEAKER_01: All right.
10:12
SPEAKER_01: Well, so then basically we're saying don't take a shortcut on this because you could miss something there.
10:17
SPEAKER_01: So uh okay, well, that's definitely helpful.
10:20
SPEAKER_01: And actually, again, I think something we have not talked about before.
10:23
SPEAKER_01: All right, so before we move on then, any other complications that you should be thinking about here?
10:29
SPEAKER_02: Yeah, I mean, this may be too complicated to get into detail on this podcast, but um, when there are redeemable securities at the subsidiary level, you know, whether those um securities that are redeemable are preferred or common can make a difference.
10:43
SPEAKER_02: And um, you know, whether they're getting accreted can make a difference.
10:47
SPEAKER_02: And there's several policy choices that need to be made.
10:50
SPEAKER_02: It's actually one of the more complicated areas, in my view, in the um computation of EPS.
10:56
SPEAKER_02: Um, but I as I said, I you know, I'll cite that.
10:59
SPEAKER_02: There's information out there in our guides on how to do that.
11:05
SPEAKER_02: But for purpose of this podcast, I think it's probably just a little bit a little bit too detailed.
11:10
SPEAKER_01: All right, so helpful at least for for listeners to know they should look out for that.
11:14
SPEAKER_01: And then, John, as I said, it's been a long time since I've done EPS, but I know something that can get very complicated very quickly, even for the basic EPS computation, is the impact of changes in the capital structure and even dividends or stock splits and otherwise.
11:32
SPEAKER_01: So, how do you think about those types of items?
11:35
SPEAKER_02: Uh yeah, if if you have a stock dividend, a stock split or reverse stock split during a reporting period, um, and uh you need to, and that's going to change the number of shares outstanding, you need to retrospectively adjust the number of shares included in the EPS computation for the company for all periods presented.
11:55
SPEAKER_02: And I think it's important to clarify what a you know stock dividend stock split, reverse stock split is.
12:01
SPEAKER_02: It's really just a change in the number of shares that's outstanding.
12:05
SPEAKER_02: It does nothing to the relative ownership or rights of the individual stock.
12:11
SPEAKER_01: Oh, because they will still proportionally have the same amount after this occurs.
12:15
SPEAKER_02: And so that's the reason that you retrospectively adjust the shares in in all periods, because there's been no relative change in rights.
12:22
SPEAKER_01: Um then it makes it, then you really can look at it comparably.
12:26
SPEAKER_01: Yeah.
12:26
SPEAKER_01: Versus if you actually have a stock issuance, then you would have to reflect that in the period that it occurs because it is changing the relative rights of your current stockholders.
12:36
SPEAKER_01: That's right.
12:37
SPEAKER_01: All right.
12:37
SPEAKER_01: That's a very helpful point to keep in mind.
12:40
SPEAKER_02: Interesting thing about stock splits, reverse stock splits is even if they become effective after the um balance sheet date or reporting date, but it's effective before the financial statements are issued, you still need to retrospectively adjust the financial statements.
12:56
SPEAKER_01: Wow.
12:56
SPEAKER_01: So this is a good thing to be communicating with your uh various other treasury and other stakeholders to make sure they do not have that because it's just unnecessary complications.
13:07
SPEAKER_01: So anything else then from sort of more complex capital structures you'd highlight?
13:12
SPEAKER_02: Yeah, I mean, we see reorganizations of companies all the time.
13:16
SPEAKER_02: And you know, often we see it, you know, as leading up to an IPO or immediately before an IPO.
13:22
SPEAKER_02: Lots of companies will adjust their capital structure to make it more attractive, let's say, to public investors.
13:29
SPEAKER_02: And so when we see these types of transactions, it's important to, you know, a lot of times there's judgment involved.
13:35
SPEAKER_02: It's important to understand exactly what's happening.
13:38
SPEAKER_02: Look at the legal steps involved in what's happening with the capital structure.
13:43
SPEAKER_02: But the key determination is hey, this reorganization, was it more akin to a stock split, or was it more akin to a prospective transaction, for example, and an extinguishment of existing equity?
13:56
SPEAKER_02: And so it's very important to understand that.
13:58
SPEAKER_02: Sometimes all we'll see is the exchange of pieces of paper.
14:01
SPEAKER_02: You know, let's say the company was an LLC form, they changed to corporate form, they had just exchanged pieces of paper.
14:07
SPEAKER_02: You know, we'd probably say that's, you know, sounds like a split.
14:11
SPEAKER_02: Yeah.
14:12
SPEAKER_02: Other times, there's, and particularly in complex capital structures, um, there's an exchange of instruments, fair value for fair value.
14:21
SPEAKER_02: So we have a very complex security at the existing company level.
14:26
SPEAKER_02: We want to go public, we're gonna change the corporate form.
14:29
SPEAKER_02: And there's an exchange, they figure out the fair value of the shares they own are and exchange it for, for example, a single class of what's going to be new public shares at fair value.
14:40
SPEAKER_02: Many times we would look at those transactions and say, well, we did change the relative rights and ownership of the of the shareholders of the company.
14:49
SPEAKER_02: And therefore, really what we did is extinguish that um equip pre-previous equity instrument.
14:55
SPEAKER_02: And so that should be treated prospectively in the case of an IPO, usually from the date of the IPO.
15:00
SPEAKER_01: All right.
15:01
SPEAKER_01: So again, probably easier to do closer to the beginning or end of the quarter than right in the middle of a quarter, because that would mean you would need to do have all the information as of that date.
15:12
SPEAKER_01: And that just from a I'm gonna use the word practical point of view, that creates a lot of extra uh complications.
15:20
SPEAKER_01: So all right, that's that's helpful.
15:22
SPEAKER_01: And I guess on the point of complication, you know, often I know we see companies that have multiple classes of common stock, and you were sort of talking about those.
15:31
SPEAKER_01: Um, but then all of the classes will have the same basic undiluted EPS.
15:36
SPEAKER_01: So how does that exactly work and how do you present that?
15:39
SPEAKER_02: Yeah, I mean, ASC260 is clear.
15:42
SPEAKER_02: You need to present EPS on the face of the income statement for all classes of common shares.
15:48
SPEAKER_02: However, when we think of different classes of common shares, typically we think about it as common shares with different dividend rights, different rights to the economics of the of the entity.
15:59
SPEAKER_02: But sometimes what you see is the only difference, economically, they have the same rights.
16:04
SPEAKER_02: The only difference is voting rights.
16:06
SPEAKER_01: Right.
16:06
SPEAKER_02: Let's say you might have supervoting rights in one class and less than supervoting rights.
16:12
SPEAKER_01: That's such a polite way to say it.
16:15
SPEAKER_02: In the other class.
16:16
SPEAKER_02: So um I think what we would say is clearly you need to indicate on the face of the income statement in those situations where the economics are the same, but there are other rights that are different.
16:27
SPEAKER_01: Oh, so you still do need to reflect it though.
16:30
SPEAKER_02: Yeah, you can show it a single, you can show a single number.
16:33
SPEAKER_02: You know, we would say you can show a single number for EPS, but um you should clearly indicate in the caption that it relates to both classes of shares.
16:42
SPEAKER_02: That's kind of what we would say.
16:43
SPEAKER_01: Yeah.
16:43
SPEAKER_01: So like you put the number and say class A and class B common or something like that.
16:47
SPEAKER_01: Okay.
16:47
SPEAKER_02: And nobody would get in trouble if they listed it twice.
16:50
SPEAKER_01: Although that would be very confusing.
16:54
SPEAKER_01: Or maybe people would do a double take.
16:56
SPEAKER_02: So that's that's kind of the way we've answered that question.
16:59
SPEAKER_01: Okay, that's a very helpful note.
17:01
SPEAKER_01: Now, uh we've spent a lot of time actually talking about basic EPS, and I think that was a good transition because that applied to both basic and diluted.
17:08
SPEAKER_01: So anything specific to diluted that again you kind of highlight as sort of traps people can fall into or questions that might come up.
17:16
SPEAKER_02: Yeah, I I would put this in kind of the year-end reminder category.
17:20
SPEAKER_02: Um and I think the first thing that I thought would be a good thing to mention is computing diluted EPS pursuant to the treasury stock method.
17:28
SPEAKER_02: I think most people who are involved in EPS understand that when we have instruments like options and warrants that we're supposed to use or restricted stock, we're supposed to use the treasury stock method to determine the number of incremental shares that we're going to include in the denominator.
17:47
SPEAKER_02: And the treasury stock method is computed by taking proceeds as defined in the standard, which typically would be average unrecognized compensation if they're compensatory instruments during the period, plus the exercise price, you know, the amount of cash the company would receive if the uh holder exercised the option.
18:08
SPEAKER_02: And theoretically assuming that we're going to take those proceeds and repurchase shares during the period at the average market price of the company's stock for the period.
18:19
SPEAKER_02: And then we take that number of shares that we theoretically repurchased and we compare it to the number of shares underlying the instrument, right?
18:28
SPEAKER_02: And assuming that's positive, we include that in diluted EPS.
18:32
SPEAKER_02: But the key is you're supposed to use the average market price for the period.
18:37
SPEAKER_02: Except.
18:38
SPEAKER_01: Of course.
18:38
SPEAKER_01: Of course there's an except.
18:41
SPEAKER_02: Except when those options, warrants, or restricted shares were issued, expired, or exercised during the period.
18:50
SPEAKER_02: So for example, if we issued a tranche of options halfway through a quarter, right?
18:57
SPEAKER_02: When we compute our diluted EPS for those options, we would not use the average market price for the entire period.
19:05
SPEAKER_02: We would use the average market price for the period that those options were outstanding.
19:08
SPEAKER_02: The same for exercised options and expired options.
19:12
SPEAKER_02: Um just a little reminder that you know sometimes the EPS computation can become really, I don't know, repetitive.
19:22
SPEAKER_01: Yeah, you're doing the same thing every day.
19:25
SPEAKER_02: Just to keep in mind that you need to think about that as you're as you're going through the EPS computation.
19:30
SPEAKER_01: Yeah, although the key takeaway I'm learning from this is that you really do need to talk to your treasury people and governance people about when they're they're having these transactions uh to help things.
19:40
SPEAKER_01: So any other year-end reminders, Tanjon, that you would highlight?
19:45
SPEAKER_02: Um Yeah.
19:46
SPEAKER_02: The the last thing I thought um creates some confusion sometimes is the computation of year-to-date EPS when you're um using the treasury stock method.
19:57
SPEAKER_02: Kind of blows people's minds when they when they look at it.
20:00
SPEAKER_02: Yes.
20:00
SPEAKER_02: Right.
20:01
SPEAKER_02: So some would say, don't I just compute the year-to-date EPS independently of the quarters?
20:08
SPEAKER_02: And some would say that makes some sense.
20:14
SPEAKER_02: But that's not allowed by the standard.
20:16
SPEAKER_02: The standard would say that you need to take an average of the number of shares included in each quarter's EPS computation.
20:24
SPEAKER_02: So add up quarter one, quarter two, quarter three, and quarter four.
20:27
SPEAKER_02: Well, that works out great when there's income in every quarter, and every quarter the options are in the money, and we just take those shares, add them up, divide them by four, right?
20:38
SPEAKER_02: But life isn't that easy.
20:40
SPEAKER_02: Of course not.
20:43
SPEAKER_02: So when you have periods where let's just say the year-to-day period is a loss, and the individual quarters included quarters where in the money options were included in the quarter diluted EPS computation uh because there was earnings during those individual quarters.
21:04
SPEAKER_02: We would exclude those shares from the average calculation for the period.
21:08
SPEAKER_02: And the reverse is true as well.
21:10
SPEAKER_02: If the individual quarters had losses, but they were in the money options, and they were excluded from the quarterly calculation because they would have been anti-dilutive in those quarters.
21:20
SPEAKER_02: If there's year-to-date income, we would include those shares in the computation of diluted EPS.
21:27
SPEAKER_01: Right.
21:27
SPEAKER_01: And so what you're saying from a practical point of view is the four quarters may not add up or might not average to the amount.
21:33
SPEAKER_01: All right, so John, this is definitely a great reminder because I do think instinct is to do something different.
21:39
SPEAKER_01: And so it's really important to keep uh to keep that top of mind right now.
21:44
SPEAKER_01: How about then let's move over to disclosure?
21:46
SPEAKER_01: Because I think again, sometimes people think, oh, this is a quick calculation.
21:50
SPEAKER_01: They don't even think of it as a computation, much less the fact that there are also required disclosures.
21:56
SPEAKER_01: So, what types of reminders do you have there?
21:59
SPEAKER_02: Yeah.
21:59
SPEAKER_02: Um Um there are some specific disclosures required by 260, and then there are other disclosures in other areas that are helpful in understanding the impact as uh on EPS as well.
22:09
SPEAKER_02: But I would say one of the bigger disclosure requirements is the reconciliation of the numerator and the denominator.
22:18
SPEAKER_02: So in the footnotes to the financial statements, we need to reconcile net income to income available to common shareholders.
22:25
SPEAKER_02: The numerator.
22:26
SPEAKER_02: And the things that could impact net income in terms of determining income available to common shareholders, things like allocation of earnings to participating securities, which we've talked about prior um webcasts, cumulative dividends on preferred stock, the uh triggering of a down round, and I know you love to have me explain what a down round is in a preferred stock instrument.
22:49
SPEAKER_02: And um certain modifications of equity classified warrants would also um impact the numerator.
22:56
SPEAKER_02: Uh accretion of um of redeemable securities can impact the numerator.
23:02
SPEAKER_02: All of those things need to be included in the reconciliation.
23:05
SPEAKER_02: The denominator reconciliation typically reconciles the weighted average shares outstanding used for the basic EPS computation to the number of shares included in the diluted EPS computation.
23:16
SPEAKER_02: So those incremental shares related to the treasury stock method that we spoke about, incremental shares related to the if converted method for convertible securities, um contingently issuable share type um things might impact the diluted EPS denominator as well.
23:33
SPEAKER_02: So that reconciliation is very important, needs to be shown um in the footnotes.
23:39
SPEAKER_02: There is one little kind of nuanced item, which is um there's an SEC rule that says if there's a material difference between net income and income available to common shareholders, that that reconciliation should be shown on the face of the income statement.
23:53
SPEAKER_02: And although there's no specific number to define what material it is, I think most people look at 10% as a starting.
24:00
SPEAKER_01: As I get least a starting point.
24:02
SPEAKER_02: Right.
24:03
SPEAKER_01: All right, that's helpful.
24:04
SPEAKER_01: Now, before I go on, some of our listeners may like us have been caught by your reference to down rounds and thinking, hmm, I've heard John explain this.
24:12
SPEAKER_01: I don't know how many times.
24:13
SPEAKER_01: I still cannot remember what it is.
24:16
SPEAKER_01: So before you go on, can you just give us that brief explanation?
24:19
SPEAKER_01: And I do promise some before I retire, I will remember this.
24:25
SPEAKER_02: I understand.
24:26
SPEAKER_02: Um so uh a down round is a feature in an instrument that um allows for the downward adjustment of the strike price or the exercise price on a um uh a conversion feature.
24:41
SPEAKER_02: Um if additional equities or potential common equity shares um are issued in the future at a price lower than the strike price on the instrument.
24:52
SPEAKER_02: So it would be a benefit to that instrument holder if share price, you know, share prices fell and the company subsequently subsequently issued equity at a lower price, they would get a downward adjustment.
25:04
SPEAKER_02: And you know, ASU 2020, which I know we've talked about on other um that roped uh down round triggers on preferred stock into the EPS computation.
25:16
SPEAKER_02: Um so you know that that uh you know when 2026 came out, that became something we need to be concerned with in the computation.
25:24
SPEAKER_01: Well, and definitely something, I mean, it is important people who are dealing with this should remember, but my sense is there's probably a lot of other people like me who only hear about it when you talk about it.
25:33
SPEAKER_01: And so at least a helpful reminder.
25:35
SPEAKER_01: So thank you for that.
25:36
SPEAKER_01: Now, anything else from a disclosure perspective?
25:40
SPEAKER_02: Um Yeah, there's a couple other disclosures.
25:43
SPEAKER_02: Um one that generates a little bit of confusion, and we get several calls a quarter, to be honest with you, about this one.
25:49
SPEAKER_02: Um, and it's there's a requirement to disclose securities that would have been, you know, that were anti-dilutive during the period, but may uh become dilutive in the future.
25:59
SPEAKER_02: So for example, if the company had losses during the period and we excluded certain options or warrants from the EPS computation because they would have been anti-dilutive because of the losses.
26:10
SPEAKER_02: We need to disclose that those exist, and we need to give the reader of the financial statements enough information that they can figure out what the future potential dilution would be.
26:21
SPEAKER_02: So the standard doesn't really specifically say, I think the words it uses all terms, uh all terms and conditions of these security should be disclosed.
26:29
SPEAKER_02: Well, you know, what does that mean?
26:31
SPEAKER_01: Exactly.
26:32
SPEAKER_02: So we we'll get that question.
26:33
SPEAKER_02: And we say you need to disclose enough such that the reader can figure out what the future impact is, so so that somebody who's reading the financial statements could actually figure out what that might mean from a dilution perspective.
26:45
SPEAKER_01: All right.
26:46
SPEAKER_01: And that's helpful.
26:47
SPEAKER_01: And then I think the other thing I if go all the way back to my days in practice that was always sort of a tricky situation is subsequent events and how you think about them.
26:57
SPEAKER_01: So what specifically would you remind us?
27:00
SPEAKER_02: Yeah, if you have events that occurred after the balance sheet date um but will um have an impact on the number of shares outstanding, um, there is a requirement to disclose that as well.
27:10
SPEAKER_02: Of course, like everything else, subject to materiality.
27:13
SPEAKER_02: But things that would be included in that is if we had a large issuance of uh common shares, certainly we would we would want to disclose that.
27:21
SPEAKER_02: Um resolution of a contingency on a contingent stock agreement.
27:25
SPEAKER_02: Okay.
27:26
SPEAKER_02: Or the conversion or exercise of a large, you know, conversion on a convertible debt or exercise of a large block of uh instruments that result in the issuance of shares, all of that should be disclosed.
27:38
SPEAKER_02: And then we mentioned this earlier.
27:39
SPEAKER_02: I'm pretty sure I mentioned this when we talked about stock splits.
27:42
SPEAKER_01: It's good to say it again, though.
27:43
SPEAKER_02: Um but yeah, if we had a stock split or s or a reverse stock split during the period where we retroactively adjusted the number of shares, including the EPS computation, we're required to disclose that we did that as well.
27:56
SPEAKER_01: All right.
27:56
SPEAKER_01: Well, John, I know there's a lot of listeners out there that are in the midst of these calculations, so definitely helpful.
28:03
SPEAKER_01: And for those that are not picking up the phone and asking you when they're pulling their hair out, what is the best place to go look for more information?
28:11
SPEAKER_02: Um we have a lot of information in chapter seven of our financial statement presentation guide, which focuses solely on EPS.
28:19
SPEAKER_02: All of the issues we discussed today should be in there and lots of other issues that, you know, some of which we've talked about in the past as well.
28:25
SPEAKER_02: In the addition, I think we do have a couple of uh podcasts.
28:30
SPEAKER_02: The most recent one I remember was Five Things We Need to Know About EPS, um, that Brett and I did.
28:35
SPEAKER_02: And uh that's still out there as well.
28:37
SPEAKER_02: That can be helpful as well.
28:38
SPEAKER_01: All right.
28:38
SPEAKER_01: We'll include some links in the show notes for our listeners.
28:41
SPEAKER_01: And then final question I have for you is I know you get a lot of questions on this, and for our listeners' benefit, you know, John was rattling off all those calculations and the order and everything else without looking at any notes or anything.
28:53
SPEAKER_01: But whereas for most people, I know you know you're studying the book to make sure you're getting it right.
28:57
SPEAKER_02: So I study the book too.
28:59
SPEAKER_01: Okay, you study the book, but then you're able to, you definitely know it.
29:03
SPEAKER_01: So the the question would be you know, if you're giving advice to someone who's relatively newer to the calculation or that every quarter is the thing they dread most about the financial reporting, any tips that you would give or final thoughts for them?
29:17
SPEAKER_02: Um focus on the details.
29:19
SPEAKER_02: It's it it matters.
29:21
SPEAKER_03: It matters.
29:22
SPEAKER_02: It matters in EPS.
29:24
SPEAKER_02: Um, you know, and and there are a lot of, you know, we mentioned we talked about some nuanced things in the computation.
29:31
SPEAKER_02: There's a lot of that.
29:32
SPEAKER_02: Um so you know, my advice is focus on the you gotta get you gotta get nerdy.
29:37
SPEAKER_01: Yeah, you gotta get nerdy.
29:38
SPEAKER_01: And I guess leave enough time.
29:42
SPEAKER_01: You get the right people involved, those, but yeah, you gotta get nerdy because you're the part of the podcast.
29:47
SPEAKER_01: All right, well, John is always such a pleasure to talk to you.
29:50
SPEAKER_01: Thanks for joining me today.
29:52
SPEAKER_02: Thank you.
29:54
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29:56
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30:06
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30:16
SPEAKER_01: From thought leadership at PWC, I'm Heather Horn.
30:20
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30:31
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