Answered Essay: Corporations: Organization, Dividends and Income Reporting

Corporations: Organization, Dividends and Income Reporting

You work as a controller at a medium-sized corporation reporting directly to the CFO. The CFO has expressed concerns that the VP of Operations does not understand the earnings per share calculation. The VP of Operations is questioning if earnings manipulation is occurring because his calculation for earnings per share differs from the CFO’s calculation for earnings per share. The VP of Operations uses the following calculation for EPS: Net Income / Shares Issued. The CFO uses GAAP when calculating earnings per share.

The CFO would like for you to prepare a memo addressed to the VP of Operations to explain what is driving the difference in the two earnings per share calculations. While you are open to discuss whatever you think is important, the CFO would like for you to specifically address the following: shares authorized, shares issued, shares outstanding, weighted average shares outstanding, net income and preferred dividends. She would also like for you to explain possible ways that firms can manipulate earnings per share. This may help the VP of Operations understand that the difference in EPS is due to calculation and not earnings manipulation. The CFO has requested that you do not copy definitions from accounting books. She would prefer that you communicate these topics to the VP of Operations in a way that is easy for a non-accounting person to understand. The CFO has requested that she receive a copy of the memo as well.

Instructions:

The memo should be no more than two pages in length, but at least 500 words. As a manager in an organization, you must learn to communicate with executive management in a clear and concise manner. The memo should be formatted using APA style and include the appropriate headings. Your memo will be checked for plagiarism. Please do not copy and paste from the internet.

Be sure to reference the Read ‘em and WEEP policy in writing your memorandum.

Do NOT use a cover page. The memo should be formatted correctly. If formatted correctly, I will know who you are. Upload this assignment to Blackboard.

In class, you must submit a hard copy of the document you uploaded to Blackboard. If the document is more than one page, please staple the pages together. If you do not submit a copy in class, you will receive a zero on the assignment.

This is a formal memo and should be written using formal English. Please do not write like you talk. Stay away from the following phrases: “with that being said, that being said, in regards to, and being that.”

The due date is September 7th.

Remember, the final copy must also be uploaded to Blackboard by September 7th at 8:00 am.

Expert Answer

 

Date : September 5, 2017
To : Mr. V, Vice President (Operations) ABC Inc.
From : Mr. M, Manager (Finance) ABC Inc

Mr. C, CFO, ABC Inc

Subject : Clarification for questioning the occurrence of manipulation in earnings based on difference in Earning per Share

This memorandum is presented to explain the drivers for difference in calculations of EPS.

Earnings per share is a financial ratio calculated as under:

EPS = (Net Profit for the period attritubale to Common shaeholders)/(Weighted average number of common shares outstanding duirng the period)

Net profit for the period attributable to equity shareholders is the remainder of Profit after tax and after paying the dividend to preferred stock holders. The calculation is as under:

Statement of Profit or Loss:

Particulars Amount $
Revenue xx
Less: Operating Expenses (including depreciation) (xx)
EBIT xx
Less: Interest Expenses (xx)
EBT xx
Less: Tax expenses (xx)
EAT (Earnings/ Net Profit after Taxes) xx
Less: Dividend payable to Preferred Stock Holders (xx)
Earnings attributable to common stock holders xx

Net Income/ Net Profit after taxes after providing all the expenses (including operating, non-operating, cash and non-cash)

However, net income after taxes is fully not available for common stock holders to get distributed among them.

Generally, the capital of an organisation is raised through own funds and borrowed funds. An organisation being corporate or limited liability corporation, can raise its own funds either by issuing common stocks or preferred stock.

The name itself indicates that there is preference given to preferred stock holders.

Preferred stock has a fixed rate of dividend given to them every year. Generally, the rate of dividend, which is prefixed to the category of preferred stock, is calculated on face value or par value but not on issue price. Par value is called as registered value per share with regulator of companies, also known as nominal value. Issue price is the value at which the share is sold.

For example, if an entity issued 12% Preferred stock having par value of $100 each issued at $150. Preferred dividend of 12% on $100 i.e., $12 shall be paid each year from the net income after tax.

Hence, the amount of net income shall be reduced by the preferred dividend to arrive at the net income available for the common stock holders.

The denominator in the ratio weighted average number of common shares outstanding during the period.

The limited liability corporation will get register the amount of capital which it intends to issue and division of capital into common and preferred stocks. Such registered number of shares is called authorised shares. The company can raise capital by issuing the shares within authorised shares. Such number of shares issued to public for raising capital is called issued shares. After issuing the shares purchased by public are called subscribed shares. Such shares which are subscribed by public and paid the money towards the buying of them are called shares outstanding.

So, all the shares outstanding shall be taken into account after adjusting the period for which they are outstanding and amount of value paid per common share. Financial reporting standards specifies the period shall be reckoned in number of days the shares are outstanding.

For example, the weighted average number of shares is calculated as under:

On 01 Jan 2016, the company has 250,000 outstanding common shares of $10 par value each. On 31 March 2016, the company has issued 30,000 common shares of $3 par value each. On 30 September 2016, the company has issued 25,000 common shares of $10 par value each. (assume a year = 360 days)

Calculation of weighted average outstanding common shares:

Category of shares No of Shares Period of Outstanding Factor for Period Par value per share Factor for par value Weighted average number of shares of $ 1 each
Common Stock $ 10 beginning 250,000 360 days (full year) 1 (360/360) 10 10 (10/1) 2,500,000
Common stock $ 3 issued on 31.3.2016 30,000 270 days 0.75 (270/360) 3 3 (3/1) 67,500
Common stock $ 10 issued on 30.9.2016 25,000 90 days 0.25 (90/360) 10 10 (10/1) 62,500
Total 305,000 2,630,000

Taking 305,000 in denominator gives absurd picture of earning per share.

However, also taking 2,630,000 of $1 each depends upon the organisation policy. Usually, the common stocks are valued at $10 each par. Thus 263,000 of $10 each is more appropriate to take in denominator while calculating the Earning per share.

Based on the above, the difference in the calculations of EPS may be one of the listed below possibilities inter alia:

  1. Taking Net profit before tax
  2. Taking net profit after tax but before deducting preferred dividends
  3. Taking all issued shares without adjusting the time factor and par value factor.
  4. Taking outstanding share on simple average or mean of beginning and closing
  5. Taking authorised shares in denominator
  6. Taking outstanding shares adjusting time factor but not adjusting par value factor.
  7. Taking outstanding share adjusting par value factor but considered time factor.

Direct any question to Mr. C at 111-111-1111 or via email to cfo@abcinc.ca or Mr. M at 222-222-2222 or via email to mfin@abcinc.ca

Thank you for your continued support and co-operation with Finance team to improve ABC Inc.

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