BUS103: Introduction to Financial Accounting

A major item of interest to investors and potential investors is how much a company earned during the current year, both in total and for each share of stock outstanding. Firms calculate the earnings per share amount only for the common shares of ownership. They compute earnings per share (EPS) as net income available to common stockholders divided by the average number of common shares outstanding during that period. Income available to common stockholders is net income less any dividends on preferred stock. They deduct the regular preferred dividend on cumulative preferred stock (but not a dividend in arrears) whether or not declared; however, they deduct only declared dividends on noncumulative preferred stock.

To illustrate, Sun Microsystems, Incorporated, had 3,417,000,000 weighted-average common shares outstanding with income available to common shareholders of USD 922,590,000 during a recent year. Sun would compute EPS as follows:

$\begin{aligned} & \mathrm{EPS}=\frac{\text { Income available for common stockholders }}{\text { Weighted - average number of common shares outstanding }} \\ =& \frac{\text { USD } 922,590,000}{3,417,000,000} \\ =& \text { USD } 0.27 \text { per share } \end{aligned}$

Firms calculate EPS for each major category on the face of the income statement. In other words, they make an EPS calculation for income from continuing operations, discontinued operations, extraordinary items, changes in accounting principle, and net income. Note in Exhibit 28 that Anson reports the EPS amounts at the bottom of its income statement.

The price-earnings ratio (current market price per share of common stock divided by EPS) provides an index on whether a stock has future high income potential compared to other stocks. Stocks with future high income potential tend to have a high price-earnings ratio.

In the financial highlights of Kimball International, Incorporated's, recent annual report, the market price at year-end was USD 16.00. Earnings per share were USD . 93 (average of class A & B common stock). Kimball would compute its price-earnings ratio that day as follows:

$\begin{aligned} & \text { Price }-\text { earnings ratio }=\frac{\text { Current market price per share of commonstock }}{\text { EPS }} \\ =& \frac{\text { USD } 16.00}{\text { USD } 0.93} \\ =& \text { USD } 17.20 \end{aligned}$

This chapter completes the study of stockholders' equity. In Chapter 14, you learn about stock investments and international accounting.