Page 695 - Accounting Principles (A Business Perspective)

17. Analysis and interpretation of financial statements

12 months 2,150.1 million share-months
2,150.1 million share-months/12 months = 179.175 million
Note that all three methods yield the same result. In 2010, the balance in the common stock account did not
change as it had during 2009. Therefore, the weighted-average number of common shares outstanding during 2010
is equal to the number of common shares issued, 183.2 million. The EPS of common stock for the Synotech are:

(USD millions) 2010 2009 Amount of increase
or (decrease)
Net income-preferred dividends USD 736.30 USD 180.50 USD 555.80
(a)
Average number of shares of 183.2 179.13 4.03
common stock (b)
EPS of common stock (a,b) USD 4.02 USD 1.01

Synotech's stockholders would probably view the increase of approximately 298.0 per cent ([USD 4.02 - USD
1.01]/USD 1.01) in EPS from USD 1.01 to USD 4.02 favorably.
EPS and stock dividends or splits Increases in shares outstanding as a result of a stock dividend or stock
split do not require weighting for fractional periods. Such shares do not increase the capital invested in the business

and, therefore, do not affect income. All that is required is to restate all prior calculations of EPS using the
increased number of shares. For example, assume a company reported EPS for 2010 as USD 1.20 (or USD
120,000/100,000 shares) and earned USD 180,000 in 2011. The only change in common stock over the two years
was a two-for-one stock split on 2011 December 1, which doubled the shares outstanding to 200,000. The firm
would restate EPS for 2010 as USD 0.60 (or USD 120,000/200,000 shares) and as USD 0.90 (USD
180,000/200,000 shares) for 2011.
Basic EPS and diluted EPS In the merger wave of the 1960s, corporations often issued securities to finance

their acquisitions of other companies. Many of the securities issued were calls on common or possessed equity
kickers. These terms mean that the securities were convertible to, or exchangeable for, shares of their issuers'
common stock. As a result, many complex problems arose in computing EPS. Until 1997, APB Opinion No. 15
provided guidelines for solving these problems. In 1997, FASB Statement No. 128, "Earnings per Share" replaced
APB Opinion No. 15. A company with a complex capital structure must present at least two EPS calculations, basic
EPS and diluted EPS. Because of the complexities involved in the calculations, we reserve further discussion of
these two EPS calculations for an intermediate accounting text.
Times interest earned ratio Creditors, especially long-term creditors, want to know whether a borrower can
meet its required interest payments when these payments come due. The times interest earned ratio, or

interest coverage ratio, is an indication of such an ability. It is computed as follows:
Income beforeinterest including taxesIBIT
Timeinterest earned ratio=
Interest expense
The ratio is a rough comparison of cash inflows from operations with cash outflows for interest expense. Income

before interest and taxes (IBIT) is the numerator because there would be no income taxes if interest expense is
equal to or greater than IBIT. (To find income before interest and taxes, take net income from continuing
operations and add back the net interest expense and taxes.) Analysts disagree on whether the denominator should
be (1) only interest expense on long-term debt, (2) total interest expense, or (3) net interest expense. We will use
net interest expense in the Synotech illustration.

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