EPS: Preferred Dividends, Options, and Convertible Debt

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“Earnings per share” (EPS) is the most featured, single financial statistic about modern corporations. Daily published quotations of stock prices have recently been expanded to include for many securities a “times earnings” figure that is based on EPS. Stock analysts often focus their discussions on the EPS of the corporations they study.


  • Explain how dividends or dividend requirements on any class of preferred stock that may be outstanding affect the computation of EPS.
  • One of the technical procedures applicable in EPS computations is the “treasury-stock method.”
  • Briefly describe the circumstances under which it might be appropriate to apply the treasury-stock method.
  • Convertible debentures are considered potentially dilutive common shares. Explain how convertible debentures are handled for purposes of EPS computations.

Just do response each posted # 1 to 3 down below only.

Posted 1

Hello all,

When a company has both common and preferred stock outstanding, it subtracts the current-year preferred stock divided form net income to arrive at income available to common stockholders. As shown in our textbook, Earnings per Share is calculated by subtracting Preferred Dividends from Net income and dividing it by the Weighted-Average Common Shares Outstanding.

Treasury-stock method is used by companies to include options and warrants and their equivalents in EPS computations. This method assumes the options and warrants are exercised at the beginning of the year, and that the money made from this is used to purchase common stock for the treasury. In order to comply with GAAP, the treasury stock method must be used when computing the companies diluted EPS, when reporting their financial statements.

Convertible debenture is a type of loan that can be issued by a company which can be converted into stock. These are unsecured in the case a company is bankrupt, and are paid after other fixed income holders. The convertible feature is factored into the calculation of the diluted per share metrics, which increases the share count and reduces the metrics like EPS.

Posted 2

Hello Professor and Class,

It is useful for investors to get accurate information on earnings per share (EPS) of an organization since EPS measures its profitability. “Earnings per share indicates the income earned by each share of common stock. Thus, companies report earnings per share only for common stock.” (Kieso, Weygant, & Warfield, 2016, p. 851). In other words, when a company has both common and preferred stocks outstanding, in order to compute the EPS, the company has to subtract the current-preferred dividends from its net income or added to net loss before dividing by the weighted-average common shares outstanding. The reason is that the preferred shareholders must be paid in full before common stockholders can receive any earnings from dividends.

Sometimes, companies offer stock buyers the right to purchase common stocks at a fixed price for a certain period of time like 5 or 10 years or the right to purchase or sell the stocks at an agreed-upon price, called warrants or options. When options and warrants to buy common stock are outstanding and the exercise price (the price can be purchased or sold when trading) is less than the average price that the company could buy back its outstanding share as treasury stock, it uses the treasury-stock method to measure the effect on shares outstanding. In this situation, the options and warrants could be dilutive. Conversely, if the exercise price of options and warrants are higher than the common stock average price, the money the company makes could be used to repurchase more common shares to reduce the outstanding shares. This is called antidilutive. (Kieso, Weygant, & Warfield, 2016, p. 856).

A type of loan issued by a firm that can be converted into stock is called a convertible debenture. Companies do this to raise money at a lower interest rate and net of tax. Therefore, when calculating the EPS, the amount of net of tax interest is added back to net income, then divided by the total weighted average of outstanding shares.

Posted 3

When a company has both common and preferred stock outstanding, it subtracts the current-year preferred stock dividend from net income to arrive at income available to common stockholders. (Kieso, Weygant, & Warfield, 2016) The amount of common shares outstanding is divided into the income available for stockholders, which equals Earnings Per Share or EPS. EPS equals net income minus preferred dividends divided by weighted average common shares outstanding.

Companies use the treasury-stock method to include options and warrants and their equivalents in EPS computations. The treasury-stock method assumes that the options or warrants are exercised at the beginning of the year (or date of issue if later), and that the company uses those proceeds to purchase common stock for the treasury. If the exercise price is lower than the market price of the stock, then the proceeds from exercise are insufficient to buy back all the shares. The company then adds the incremental shares remaining to the weighted-average number of shares outstanding for purposes of computing diluted earnings per share. (Kieso, Weygant, & Warfield, 2016)

A company would use the treasury stock method when it has diluted securities. Dilutive securities are securities that can be converted to common stock. (Kieso, Weygant, & Warfield, 2016) To comply with GAAP when reporting their financial statements, the treasury stock method must be used when computing the companies diluted EPS. EPS is diluted because of outstanding in-the-money options and warrants, which entitle their holders to purchase more common shares at an exercise price below the current market price. (What is the treasury… n.d.)

Using the treasury stock method, there is no effect on net income, as all proceeds from the repurchase are assumed to be depleted in repurchasing treasury stock off the market. However, there is an effect on shares outstanding. Since net income, the numerator, has a change of zero under the treasury stock method and the weighted average shares outstanding, the denominator, increases, there is a guaranteed decrease in the diluted EPS. (What is the treasury… n.d.)

Convertible debentures can be term as debt security or loan that can be converted into equity shares after a stipulated period. The conversion of debentures into equity shares is at the option of the holder. Business firms issue convertible debentures to avail tax benefit. The company can get the advantage of tax deduction on the interest paid to the investors. This reduces the cost of capital of the company. However, at the time of conversion when a company issues additional shares, the value of the equity shareholders decline due to stock dilution. (Borad, 2018)


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