[heidster08]

Hi Everyone,

I am having a trouble understanding when calculating weighted average number of common shares outstanding.

I understood the explanation from Becker but when I was doing MCQ homework, I didn’t understand certain explanation from the answer key. I have 3 problems that confuse me so I will lay out all 3 problems and will state my question at the end.

Sorry it’s a bit long but please bear with me! I desperately need help =/

CPA – 01102

Deck Co. had 120,000 shares of common stock outstanding at Jan 1, year 2. On July 1, Year 2, it issued 40,000 additional shares of common stock. Outstanding all year were 10,000 shares of nonconvertible cumulative preferred stock. What is the number of shares that Deck should use to calculate Year 2 EPS?

a. 140,000

b. 150,000

c. 160,000

d. 170,000

Answer: a. 140,000

1/1 yr 2: Outstanding all year: 120,000

7/1 yr 2: 40,000 issued x 6/12 20,000

Weighted Average: 120,000+20,000 = 140,000

CPA – 01107

Elizabeth Corporation acquired Allen Corporation at the end of Year 1. Under terms of the acquisition agreement, Elizabeth agreed to provide former Allen shareholders 1,000 additional shares of Elizabeth stock for each new retail outlet opened during Year 2. Two new outlets were opened during Year 2:

– One on 5/1 Year 2

– One on 9/1, Year 2

What number of shares related to the openings of the new retail outlets should enter into the calculation of Elizabeth’s basic EPS as of 12/31 Year 2?

a. 2,000

b. 1,250

c. 1,000

d. 0

Answer: c. 1,000

Total Shares of 1,000 * 4/12 (May-Aug) = 333 1/3

Total Shares of 2,000 * 4/12 (Sept-Dec) = 666 1/3

Total: 333 1/3 + 666 1/3 = 1,000 Shares

CPA – 05446

The following information pertains to Ceil Co., a company whose common stock trades in a public market:

Stock outstanding at 1/1 = 100,000

Stock dividend at 3/31 = 24,000

Stock issuance at 6/30 = 5,000

What is the weighted-average number of shares Ceil should use to calculate basic EPS for the year ended 12/31?

a. 120,500

b. 123,000

c. 126,500

d. 129,000

Answer: c. 126,500

124,000 shares x 6/12 = $62,000

129,000 shares * 6.12 = $64,500

Weighted Average = 62,000 + 64,500 = 126,500

SO my question is “how do you know when to use the total cumulative number of shares or the change of number of shares to calculate average?”

For the 1st question, it only used “40,000 additional shares issued” to calculate weighted average. It didn’t use (120,000 Outstanding + 40,000 additional shares issued)x6/12.

But for the 2nd question, it used “2,000 shares” for the second retail opened on 9/1 yr 2. Why isn’t it 1,000 shares?

For the 3rd question, it used (100,000 outstanding+24,000 stock dividend)x6/12 and (100,000 outstanding+24,000 stock dividend+5,000 stock issued) *6/12.

Can someone PLEASE clarify this?? I feel like I am missing something to understand this but have no idea what I am missing. I am so confused on what # of shares to use to calculate weighted average.

I am sorry this is long but THANK YOU in advance!!!

[kctiger]

I'm going to do the first problem, so hopefully it makes it clear:

120,000 shares outstanding from January to July (6 Month time period)

120 * 6/12 = 60,000 shares using the weighted average method

160,000 shares outstanding from July to December (6 Month time period)

160 * 6/12 = 80,000 shares using the weighted average method

60 + 80 = 140,000 shares outstanding using the weighted avg. method. This is a fancy word for “pro-rated.” There were not 120,000 shares outstanding all year long. There were 120,000 shares outstanding ONLY for 6 months. When 40,000 shares were issued in July, there were (original 120 + the extra 40 issued) 160,000 shares outstanding for the other 6 months. So, you come up with the average number of shares outstanding using the “weight” of the time period. I'm not very good at explaining this stuff, so I hope I didn't confuse you more.

[acamp]

One of my accounting professor's doctoral thesis was using high level statistics to prove almost zero correlation between stock prices and diluted EPS–basically saying its a worthless calculation, made learning diluted EPS even more painful, lol, enjoy!

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California CPA

[NikkiSkupnjak]

Also make sure you understand that Becker showed 2 ways to calculate Weighted Avg. Common Shares. Pick one method and stick to it, Becker uses the first one presented in the book.

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[FlipACoin]

Hi Heidster…

First off, I think they made a mistake on the third one (others please feel free to chime in if I am the one mistaken). The answer says you had 124,000 outstanding for 6 months but that's not true based upon the info given. The first dividend wasn't issued until 3/31 leaving three months where the balance was just 100K, three months where it was 124K and six months where it was 129K. I think the answer should be (100*.25) + (124*.25) + (129*.5) or 120.5 A.

I'm not sure how Becker does it, but I've always felt it was easier to add the sum of (shares X percentage of time they have been in existance) like they did in problem 1 and just layer fractions of each new issuance on top of the sum. So for problem two I would have just calculated it as follows:

1000 X 8/12 (8 months of the year) + 1000 X 4/12 (4 months of the year) = 666.66 + 333.33 = 1000

For problem 3:

(100,000 * 12/12) + (24,000 * 9/12) + (5,000 * 6/12) = 100,000 + 18,000 + 2,500 = 120,500

As you can see both methods come to the same result, but I think it's quicker than keeping a running balance, especially on test day when you are under pressure. It reduces the chance of a stupid mistake :).

Any better?

[kctiger]

Flip – I believe a stock dividend is treated as retroactive. Thus, whenever it is issued during the year, it is treated as if it was issued at the beginning of the year. I think that is where Becker is getting their answer for the 3rd problem. Although the dividend wasn't issued until 3/31, it is retroactive to the beginning of the year.

[FlipACoin]

kctiger…..Edited…Ok I get it now. You are saying that dividends are treated as full year, but issuances are weighted. That would certainly explain the answer….

[heidster08]

Thank you everyone!! I do now understand what's going on with 3 problems. But I have a final question!

CPA – 05675

Ian Co. is calculating earnings per share amounts for inclusion in the Ian's annual report to shareholders. Ian has obtained the following information from controller's office as well as shareholder services:

Net Income from 1/1 to 12/31 = $125,000

Number of outstanding shares:

1/1 to 3/31 $15,000

4/1 to 5/31 $12,500

6/1 to 12/31 $17,000

In addition, Ian has issued 10,000 incentive stock options with an exercise price of $30 to its employees and a year-end market price of $25 per share. Ian's diluted earnings per share for the year ended 12/31?

a. $4.63

b. $4.85

c. $7.35

d. $7.94

Answer: d. $7.94

$125,000/15,750 = $7.94

15,000 x 3/12 = 3,750

12,500 x 2/12 = 2,083

17,000 x 7/12 = 9,917

Total Weighted Average = 15,750 (3,750 + 2,083 + 9,917)

So here, it did not use the cumulative number of shares but only used the periods that are outstanding rather than from the period till the year end (12/31). Is it because the problem specified the period outstanding like “Jan 1 to March 31”?

Because based on my understanding from the explanation above, I first came up with

15,000 x 12/12 (Jan – Dec) =15,000

12,500 x 9/12 (April – Dec) = 9,375

17,000 x 7/12 (June – Dec) = 9916.66

So total is 34,292

Am I on the right track…?

[FlipACoin]

Hi Heidster…

In this problem they gave you only the total number of shares outstanding (and not the number that are being issued). You have to be sure to use the method consistent with the data you are given. In this example, it's probably a little easier to use the total balance method by proportion of year, but if you wanted to stick with the same calculation methodology so you don't get confused, you just need to take the change in number of shares between the various balances. So for example:

(12/12 x 15,000) + (9/12 x -2500) + (7/12 X 4500) = 15,000 + (1875) + 2625 = 15,750

Where -2500 is the difference between the first balance and the second balance, and 4500 is the difference between the second and the third.

For this problem It definitely takes an extra step to do it this way so I would try to get both methods down if you can, but if you can only get one method just look for quick ways to translate the data into what you need. The math is universal:)

[heidster08]

THANK YOU SO MUCH FLIPACOIN!!!

[FlipACoin]

Glad to help, good luck!

[Author]

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