Basic EPS -- cash dividend treatment?

[gimm]

Ran into this basic EPS question tonight during qbank review on accounting:

• 110,000 shares of common outstanding at beginning of the year
• Company repurchases 20,000 of its own common shares on July 1
• Earnings are $300,000 for the year
• 10,000 shares of existing 10 percent cumulative $100 par preferred outstanding that is not in arrears at the beginning or ending of the year
• The company also has $1 million in 10 percent callable bonds outstanding
• The company has declared a $0.50 dividend on the common

What’s the company’s basic EPS?
Answer: interest is already deducted from earnings:
(300,000 - 100,000) / 100,000 = 2.00
My question is this: How are we looking at this dividend? It seems to be ignored here.

 

[dwheats]

Common share dividends are not subtracted when calculating EPS, only pref share dividends are…

 

[S2000magician]

Common dividends are always ignored in EPS calculations. We’re calculating how much we could pay in dividends (from net income), not whether we have actually paid it or not.

 

[dwheats]

^ Also, the $100k that was deducted above is the pref share dividends, not the interest on the callable bonds.
Net income already factors in the interest expense, but it does not factor in the pref dividends that the common shareholders do not have claim to (that is why they must be deducted).
basic EPS=(net income - preferred dividends)/weighted average common shares

 

[MrSmart]

dwheats wrote:
^ Also, the $100k that was deducted above is the pref share dividends, not the interest on the callable bonds.
Net income already factors in the interest expense, but it does not factor in the pref dividends that the common shareholders do not have claim to (that is why they must be deducted).
basic EPS=(net income - preferred dividends)/weighted average common shares

Not always, pref dividends are sometimes included after taxes on the income statement.

 

[S2000magician]

MrSmart wrote:

dwheats wrote:^ Also, the $100k that was deducted above is the pref share dividends, not the interest on the callable bonds.
Net income already factors in the interest expense, but it does not factor in the pref dividends that the common shareholders do not have claim to (that is why they must be deducted).
basic EPS=(net income - preferred dividends)/weighted average common shares

Not always, pref dividends are sometimes included after taxes on the income statement.

That’s bizarre.

 

[dwheats]

MrSmart wrote:

dwheats wrote:
^ Also, the $100k that was deducted above is the pref share dividends, not the interest on the callable bonds.
Net income already factors in the interest expense, but it does not factor in the pref dividends that the common shareholders do not have claim to (that is why they must be deducted).
basic EPS=(net income - preferred dividends)/weighted average common shares

Not always, pref dividends are sometimes included after taxes on the income statement.

That would not be “net income”…
That would be more like “net income applicable to common stock”

 

[MrSmart]

dwheats wrote:

MrSmart wrote:

dwheats wrote:
^ Also, the $100k that was deducted above is the pref share dividends, not the interest on the callable bonds.
Net income already factors in the interest expense, but it does not factor in the pref dividends that the common shareholders do not have claim to (that is why they must be deducted).
basic EPS=(net income - preferred dividends)/weighted average common shares

Not always, pref dividends are sometimes included after taxes on the income statement.

That would not be “net income”…
That would be more like “net income applicable to common stock”

From the 2015 L2 Equity book
Don’t forget that preferred dividends is a perpetual debt.

 

[dwheats]

It says right in the paragraph:
“net income available to common shareholders”

 

[MrSmart]

dwheats wrote:
It says right in the paragraph:
“net income available to common shareholders”

I don’t get the misunderstanding.
Pref dividends are subtracted to get to net income. So yes, it’s the earnings available to common shareholders.
Did I say otherwise?

 

[dwheats]

Pref dividends ARE NOT subtracted to get to net income.
“Net income” is different than “net income available to common shareholders”.

 

[dwheats]

^ A simple generalization would be:
Net income available to common stock = net income - pref dividends

 

[MrSmart]

It doesn’t matter. It’s still the bottom line, whether the NI or NIATCS.
I just wanted to throw it out that preferred dividends are sometimes included in the income statement, as part of the bottom line NI. If so, you do not adjust for them for the calculation of EPS, and add them back for the calculation of FCFF.

But this is probably outside the scope of a L1 candidate. So go with the material of the book.

 

[S2000magician]

MrSmart wrote:

dwheats wrote:

MrSmart wrote:

dwheats wrote:^ Also, the $100k that was deducted above is the pref share dividends, not the interest on the callable bonds.
Net income already factors in the interest expense, but it does not factor in the pref dividends that the common shareholders do not have claim to (that is why they must be deducted).
basic EPS=(net income - preferred dividends)/weighted average common shares

Not always, pref dividends are sometimes included after taxes on the income statement.

That would not be “net income”…
That would be more like “net income applicable to common stock”

From the 2015 L2 Equity book
Don’t forget that preferred dividends is a perpetual debt.

Legally, and according to GAAP, it’s not a debt.

 

[MrSmart]

S2000magician wrote:

MrSmart wrote:

dwheats wrote:

MrSmart wrote:

dwheats wrote:^ Also, the $100k that was deducted above is the pref share dividends, not the interest on the callable bonds.
Net income already factors in the interest expense, but it does not factor in the pref dividends that the common shareholders do not have claim to (that is why they must be deducted).
basic EPS=(net income - preferred dividends)/weighted average common shares

Not always, pref dividends are sometimes included after taxes on the income statement.

That would not be “net income”…
That would be more like “net income applicable to common stock”

From the 2015 L2 Equity book
Don’t forget that preferred dividends is a perpetual debt.

Legally, and according to GAAP, it’s not a debt.

Not legally of course, it’s not even tax deductible. It’s still an obligation simillar to debt, and in perpetuity too.

 

[dwheats]

MrSmart wrote:
Not legally of course, it’s not even tax deductible. It’s still an obligation simillar to debt, and in perpetuity too.

It is not an obligation similar to debt….you dont HAVE to pay dividends to pref shareholders.
You only have to pay them before common shareholders get dividends, but it is not a requirement for either to be paid.

 

[MrSmart]

dwheats wrote:

MrSmart wrote:
Not legally of course, it’s not even tax deductible. It’s still an obligation simillar to debt, and in perpetuity too.

It is not an obligation similar to debt….you dont HAVE to pay dividends to pref shareholders.
You only have to pay them before common shareholders get dividends, but it is not a requirement for either to be paid.

It’s a hybrid security. Some of the preferred stocks are also cumulative. So they are an obligation in the sense that you cannot distribute earnings to shareholders before they get paid first. A mature company with PS in it’s capital structure that doesn’t dividends to CS will eventually see their market price take a hit. So in a sense, it’s not a contractual obligation, but it’s a critical one nonetheless. It’s not something you retain for added growth, since PS does not take advantage of earnings growth, or price appreciation. Hence why it does appear on the income statement for some firms, as it’s a form of obligation after paying interest.

 

[dwheats]

MrSmart wrote:

dwheats wrote:

MrSmart wrote:
Not legally of course, it’s not even tax deductible. It’s still an obligation simillar to debt, and in perpetuity too.

It is not an obligation similar to debt….you dont HAVE to pay dividends to pref shareholders.
You only have to pay them before common shareholders get dividends, but it is not a requirement for either to be paid.

It’s a hybrid security. Some of the preferred stocks are also cumulative. So they are an obligation in the sense that you cannot distribute earnings to shareholders before they get paid first. A mature company with PS in it’s capital structure that doesn’t dividends to CS will eventually see their market price take a hit. So in a sense, it’s not a contractual obligation, but it’s a critical one nonetheless. It’s not something you retain for added growth, since PS does not take advantage of earnings growth, or price appreciation. Hence why it does appear on the income statement for some firms, as it’s a form of obligation after paying interest.

This is completelyside stepping the fact that it is not deducted to arrive at net income.

 

[MrSmart]

dwheats wrote:

MrSmart wrote:

dwheats wrote:

MrSmart wrote:
Not legally of course, it’s not even tax deductible. It’s still an obligation simillar to debt, and in perpetuity too.

It is not an obligation similar to debt….you dont HAVE to pay dividends to pref shareholders.
You only have to pay them before common shareholders get dividends, but it is not a requirement for either to be paid.

It’s a hybrid security. Some of the preferred stocks are also cumulative. So they are an obligation in the sense that you cannot distribute earnings to shareholders before they get paid first. A mature company with PS in it’s capital structure that doesn’t dividends to CS will eventually see their market price take a hit. So in a sense, it’s not a contractual obligation, but it’s a critical one nonetheless. It’s not something you retain for added growth, since PS does not take advantage of earnings growth, or price appreciation. Hence why it does appear on the income statement for some firms, as it’s a form of obligation after paying interest.

This is completelyside stepping the fact that it is not deducted to arrive at net income.

For the small amount of companies that do have PS in their capital structure, some of them do include it as part of the bottom line. Haven’t I showed you the text book already?

 

[dwheats]

This is just not a fact. Find me one real company that deducts preferred dividends from after-tax income to arrive at net income….since your above post would indicate you have come across companies that do this.