Question 25Q - Intermediate Accounting (Kieso)

Question

Neumann Company computed earnings per share as follows.

                         Net income

_____________________________________

Common shares outstanding at year-end

 

Neumann has a simple capital structure. What possible errors might the company have made in the computation? Explain.

Step-by-Step Solution

Answer

According to the given situation, the earnings per share would reflect an inaccurate amount.

Meaning of Earnings Per Share

Earnings per share represent the per share earnings generated by a business entity on its outstanding common stock. It is computed by dividing the profits with outstanding common stock. 

Possible errors made by the company

• In the case of a simple capital structure, the ideal way to compute EPS is to deduct the preferred stock dividend from the net income. Here the company is considering net income without deducting such dividends. 
• Also, the denominator should contain the outstanding number of shares, not the outstanding amount. Hence, the total amount outstanding for common stock should be divided by the number of shareholders to determine the number of common stock outstanding.