Fleming Company has just completed its determination of EPS for the year. As a result of issuing convertible securities during the year, Fleming’ capital structure is now defined as being complex. The basic EPS for this year is $2.90, but the diluted EPS is only $2.50; both figures are down from the prior year’s $3.25 basic EPS figure.

Sonia Leung and Sally Lee, two shareholders, have received their financial statements from Fleming and are discussing the EPS figures over lunch. The following dialogue ensues.

Leung: “I guess Fleming must be having trouble. I see its earnings per share is down significantly.”

Lee: “Maybe so, but this year there are two figures, where before there was only one.”

Leung: “Something to do with the convertible bonds and preference share issued during the year making it a complex capital structure. But both of the earnings per share figures are lower than the single figure the year before.”

Lee: “That’s true. But income for the current year is higher than last year. I’m confused.”

Discussion Questions

1. Enlighten the shareholders. In particular, discuss the EPS presentation that would be required if Fleming has a simple capital structure or a complex capital structure. What factors determine whether a capital structure is simple or complex?

2. Explain the concept of dilution and what diluted EPS is trying to measure?

3. Accountants computing diluted EPS are required to consider the effect on both net income and shares outstanding of events that may or may not happen. Some commentators argue that accountants should not be involved in speculating about the possible exercise of stock options or the conversion of securities in the future. They further argue that basic EPS is based on historical information and should be the only EPS information provided in the financial statements. Do you agree? Why?

Answer rating: 100% (QA)

Answer1 A simple capital structure is a capital structure that does not include converted securities ... View the full answer