Diluted Earnings Per Share Calculation: A Case Study

Understanding Diluted Earnings Per Share: A Case of Sheffield Corp.

This example demonstrates how to calculate diluted earnings per share (EPS), a crucial financial metric for investors.

Scenario: Sheffield Corp. acquired Pharoah Company with an agreement to issue 9,400 additional shares to Pharoah's stockholders in 2020 if Pharoah's net income in 2019 reaches $510,000.

We are given the following information:

• Pharoah Company’s net income in 2018: $530,000* Sheffield Corp.'s net income in 2018: $450,000* Sheffield Corp.'s average number of common shares outstanding in 2018: 96,000 shares

Calculating Diluted EPS:

1. Contingent Share Issuance: Since Pharoah's 2018 net income ($530,000) exceeds the threshold for additional share issuance in 2019 ($510,000), the additional shares will not be issued.

2. Diluted Shares Outstanding: As no new shares are issued, the diluted number of shares outstanding remains the same as the average number of common shares outstanding in 2018 (96,000 shares).

3. Diluted EPS Calculation:

   Diluted earnings per share = Net income / Diluted number of shares outstanding

                                   = $450,000 / 96,000
   
                                   ≈ $4.69 (rounded to the nearest penny)
   

Conclusion: Sheffield Corp. should report a diluted EPS of $4.69 for 2018.

This case illustrates how potential share issuances can impact diluted EPS calculations. Investors should consider such contingencies when evaluating a company's profitability and shareholder value.