 Hello and welcome to this session. This is Professor Farhad in which we would look at CPA questions specifically that deals with an important topic, EPS or earnings per share. This topic is covered on the FAR section of the CPA exam as well as intermediate accounting. This topic is important. It means on the exam day, if the AI CPA software determines or notices that you are not well prepared in this major topic, then you may not pass the exam if they don't think you know this topic in depth or enough information that you can answer basic to intermediate questions. So what does that mean? It means on my website farhadlectures.com I do cover this topic in details in my intermediate accounting course. In this session, I will go over some questions just to give you an idea what you need to know before sitting for the exam or at least if you think you know EPS, let's see how can you answer these questions. How well can you answer these questions? If the questions I'm going to go over, I consider them basic to intermediate. I would say more toward basic. Let's see how well you do on these questions. As always, I would like to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1,700 plus accounting, auditing, tax, finance, as well as Excel tutorial. If you like my lectures, please like them, share them, put them in playlists, subscribe to the channel, connect with me on Instagram. As I just stated earlier, on my website farhadlectures.com, you will find intermediate accounting courses, advanced accounting, all sorts of accounting courses, plus 2,000 CPA questions. So if you're interested to add 10 to 15 points to your CPA exam, check out my website. Let's take a look at this question. A company can report basic EPS, but do not have to report diluted EPS. So we have two EPS. We have basic and we have diluted. And you have to know the rules. When do we have to report only basic and when do we have to report diluted? Simply put, if we have a simple capital structure, we only report basic. If we have a complex capital structure, we have to report both basic and diluted. You always have to report basic. So when do you have a complex capital structure? You have complex capital structure when you have any dilutive securities. So we're just dilutive securities. What are dilutive securities? So we're just using words that we're not defining. Dilutive securities, it means securities that could potentially increase your common stock. So what could increase your common stock? What are some potential that could increase your common stocks? If you have options, if you have stock options, that means if they are exercised, they could increase your common stock. If you have any sort of convertible securities, like a preferred stock, that's convertible into common, convertible bond, that's convertible into common, those will give you complex capital structure, which in turn will require you to compute diluted earnings per share. But the question is, would a company can report basic but don't have to report diluted? If they don't have to report diluted, it means they don't have dilutive securities. Let's take a look at one. Common stock outstanding. That's not dilutive. No preferred stock. Even if we have preferred stock, as long as it's not convertible, so so far so good. So common stock and preferred, we can stick with basic so far. And options that are convertible. Hold on a second. Once we have options that are convertible into common stock, we move into a complex capital structure. So here we have to report diluted. Therefore, one cannot be an answer. If one cannot be an answer, we could eliminate A, we could eliminate C. All we have to know now, whatever, two is a correct answer or not a correct answer, okay? Common stock, basic. No preferred stock. That's fine. Basic. Bonds that are convertible into common stock, I'm sorry. If the bonds are convertible, we moved into dilutive, so we have to compute the dilutive. Therefore, two is not a correct answer. Therefore, neither one nor two is the answer. So this company, they'll have to report basic and diluted. They can not only report basic. Why? Because they have dilutive securities. What are the dilutive securities? Well, let me highlight them in yellow. Options, convertible bonds, because they have those dilutive securities. Guess what? They have to report diluted earnings per share. Let's take a look at this question. When calculating the weighted average number of shares outstanding during the period, and usually this is like the most challenging for students as far as a teacher is concerned because when I try to teach this, this is where students kind of struggle into weighted average and compute them that because it gets really involved, frankly, which of the following is treated as if it were outstanding since the beginning of the year. So when you're computing the weighted average number of shares, simply put the weighted average number of shares is the denominator, the weighted average number of shares. This is going to be the denominator and the computation of EPS. Which of the following is treated as if it was outstanding as of the beginning of the year? Stock dividend declared in July and paid in September. Let me tell you something. Once we have stock dividend, stock dividend is outstanding as of the beginning of the year. So when it comes to stock dividend, whether we did it in April, July, July, July, July, even in December, once we know it's a stock dividend, we assume it's outstanding as of the beginning of the year. So one is correct. Now, once we know one is correct, so we know that A is a potential candidate, B cannot be because B is two only. We can take out B, both A and C, both one and two, which is C, that could still be a potential answer because we already have one is an acceptable answer. Now we look at D. D is neither one nor two. We can take D out. All that we have to find out now, if number two, if number two, stock issued above par and August. Now, if the stock are issued in August, they are outstanding as of August. So stock dividend are treated as if they are outstanding as of the beginning of the year, which is one is true, two is not true. So both A and A and two are not, that's out. Stocks are usually issued above the par value, okay? So if they are issued in August, they are outstanding as of August. So here's what you need to know. Stock dividend plus something we called stock split. Both of these things are outstanding, are considered outstanding as of the beginning of the year, if they did occur during the year. So make sure you know this, stock dividend and stock split. Now I said, you know, memorize it. Good. If you get a question like this, but what, what happened if you get a computational problem, go to my website and this is what I have computational problem computing the weighted average number of shares, assuming we have stock dividend or stock split during the year. Let's take a look at this question and we'll work a simple example here later on in a minute, but I would say if you want more, go to my website. For the current year, SNAP Inc. report net income of half a million and pays its preferred stockholder cash dividend of 60. There are 100,000 shares outstanding so that EPS is 440. Hold on a second. They gave us EPS. What is EPS? EPS is net income minus any preferred dividend divided by the number of shares, divided by the number of shares. And they simply gave us everything. This could be the first statement, could be a question. Half a million of net income minus 60,000 divided by 100,000 shares, 440 divided by 100. So the basic earnings per share and you always have to compute the basic here. They gave you the basic. They could have made this question harder because they don't have to give you this 440, but they did. During the year, SNAP also had 10,000 convertible bond outstanding. So now guess what? So yes, we did compute the basic, the basic EPS, but that's not enough because we have now dilutive securities. We have 10,000 convertible bond. Each bond was sold at face. That's fine. $7 in interest. That's fine. In interest, each year and can be converted into two shares of common stock. So the shares can be converted, sorry, not the shares. The stock can be converted, the bond can be converted into two shares of common stock. SNAP had a stock rate of 30%. What amount should SNAP report as diluted earnings per share? Now we have to kind of change our mentality and go from basic to diluted. Now, how do we compute the diluted earnings per share? Well, we're going to have to go with net income minus preferred dividend. So far, so good. And we're going to have to add what we called, not what we called, interest expense net of tax. Why? Because if we, that's to the numerator. So this is what we're going to change in the numerator. In the numerator, we're going to add more profit. We're going to add the interest expense. Why? Because if we convert, if we convert those 10,000 convertible bond, we no longer have to pay interest on them. Well guess what? Then what we did? If we convert, we have to add the interest. Now we have to be very careful. What interest do we add? We add interest net of tax, net of tax. Net of tax means what? Net of tax means we lose the tax deduction. So let's, let's see, let's see what we mean by this. We have 10,000 shares, 10,000 shares, and each shares pays $7 in interest for each times $7. So we have interest expense of $70,000. Now once we lose this deduction, because interest expense is a deduction, once we lose this deduction, we're going to be, we're going to be losing 70,000 times 1 minus the tax rate. We're going to be using that deduction. So we're going to be using 70,000, but we're going to be using times 0.7, which is 0.7 is. So we'll take the interest times 1 minus 30%, which is 70. This is how it came up with 70%. So come up with interest net of tax, we'll take the interest times 1 minus 0.7. So we're looking at only adding to the numerator 49,000. My math should be right, 70,000 times 70% should be 49,000. So we're going to add to the numerator. So we're going to add to the numerator. Let me just start to make the changes up top. So basically, simply put, we're going to add to the numerator 49,000. Now once we convert, we're going to have more shares. We have 10,000 convertible, each converted into 2. So we're going to have 10,000 times 2. 10,000 times 2, we're going to have 20,000 new shares. Therefore we're going to add to the denominator 20,000. Now we could compute the diluted earnings per share. Let's get the calculator and go through the computation. So let's start with 500,000 net income minus preferred dividend plus 49,000. That's 489 divided by 120,000 shares. That's going to give us 4.78. We don't have 4.75, which is we have 4.08. Now 4.7, 4.075 rounded 4.08. Therefore, the diluted earnings per share, it is diluted because it went down. If it didn't go down, it's not dilutive. Therefore, the answer is $4.08 is the diluted earnings per share. So again, it's very important that you are comfortable with this computation on the exam day. I'm not going to keep repeating this, but if you want more explanation and details, go to my website. Let's take a look at this question. Northcorp had 60,000 shares of common stock outstanding as of January 1st, year 13. On July 1st, year 13, it issued 10,000 additional shares of stock. What is the number of shares that North could use to calculate the EPS? So here they're asking you, can you compute the weighted average number of shares outstanding? You remember the computation I told you it's the most challenging for students? Well, one way to do it is I have 60,000 shares outstanding as of the beginning of the year. And really nothing happened to them. So those 60,000 shares were outstanding 12 divided by 12. 12 divided by 12 equal to 60,000. Now here's what happened. On July 1st, I had 10,000 shares issued. So I have 10,000 shares times July, August, September, October, November, and December times 612. You have to be careful. Count the month, count on your fingers. That's 5,000. So one way to do it is to say we have 60,000 outstanding for the whole year. 5,000 outstanding for half of the year, which is the equivalent of 10,000 issued in July. The denominator is 65,000. That's one way to do it. Another way to compute this, well, we can say starting in January, we had 60,000 shares up until July 1st. So up until half of the year, 60,000 divided by 612, that's equivalent to 30,000. Then starting July till the end of the year, we had 70,000 starting in July because we added 10,000 and we had those 612 of the year. That's equal to 35. Now we computed the same number in a different way, 65. Now this is really a simple explanation and a simple example. They could challenge you much more in computing the weighted average number of shares. And I'm going to go back and say, if you want more, go to my website. Visit my website under my intermediate accounting. I do cover EPS. Maybe I have at least two hours of lectures and exercises about just EPS, earnings per share. So if you missed earning per share in college or if you want to learn more about earnings per share and be comfortable, go to my website. Invest in your CPA. It's worth it. It's a lifetime investment. Good luck. Study hard and stay safe during those coronavirus days. Good luck.