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Income Taxes, and Income Taxes, and Unusual Income Tax Unusual Income Tax
ItemsItemsAccounting, 21st Edition
Warren Reeve Fess
PowerPoint Presentation by Douglas CloudProfessor Emeritus of AccountingPepperdine University
© Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved.
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1. Journalize the entries for corporate income taxes, including deferred income taxes.
2. Prepare an income statement reporting the following unusual items: fixed asset impairments, restructuring charges, discontinued operations, extraordinary items, and changes in accounting principles.
3. Prepare an income statement reporting earnings per share data.
ObjectivesObjectivesObjectivesObjectives
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
4. Describe the concept and the reporting of comprehensive income.
ObjectivesObjectivesObjectivesObjectives
5. Describe the accounting for investments in stocks.
6. Describe alternative methods of combining businesses and how consolidated financial statements are prepared.
7. Compute and interpret the price-earnings ratio.
Corporate Income TaxesCorporate Income TaxesCorporate Income TaxesCorporate Income Taxes
A corporation makes four income tax installment payments
throughout the year.
A corporation makes four income tax installment payments
throughout the year.
Assume that a corporation estimates its taxes for the
year to be $84,000.
Assume that a corporation estimates its taxes for the
year to be $84,000.
Corporate Income TaxesCorporate Income TaxesCorporate Income TaxesCorporate Income Taxes
Corporate Income TaxesCorporate Income TaxesCorporate Income TaxesCorporate Income Taxes
Apr. 15 Income Tax Expense 21 000 00
To record quarterly payment of
estimated income tax.
Cash 21 000 00
On April 15, the first of four estimated annual tax payments of $21,000 is made.
On April 15, the first of four estimated annual tax payments of $21,000 is made.
Corporate Income TaxesCorporate Income TaxesCorporate Income TaxesCorporate Income Taxes
Ratio of Reported Income Tax Expense to Earnings Before Taxes for Selected Industries
Automobiles 33%Banking 35Computers 35Food 35Integrated oil 39Pharmaceutical 30Retail 39Telecommunication 17Transportation 38
Allocating Income TaxesAllocating Income TaxesAllocating Income TaxesAllocating Income Taxes
1. Revenues or gains are taxed after they are reported in the income statement.
2. Expenses or losses are deducted in determining taxable income after they are reported in the income statement.
3. Revenues or gains are taxed before they are reported on the income statement.
4. Expenses or losses are deducted in determining taxable income before they are reported in the income statement.
Differences in tax law and GAAP create some temporary differences that reverse in later years.
Temporary differences do not change or reduce the total amount of tax paid, they affect only the timing of when the taxes are paid.
Temporary DifferencesTemporary Differences
Temporary DifferencesTemporary DifferencesTemporary DifferencesTemporary Differences
Year
1 Year
2 Year
3 Year
4
MACRS (tax depreciation)
Straight-line (financial statement depreciation)
Year
5 Years
1-5
Total
Temporary Differences in Reporting RevenuesTemporary Differences in Reporting Revenues
Report NowReport Now Taxable LaterTaxable Later
Report LaterReport Later Taxable NowTaxable Now
EXAMPLE: Income reporting methods.
Point-of-Sale Method
Installment Method
FinancialReporting
TaxReporting
EXAMPLE: Cash collected in advance.
WhenEarned
WhenCollected
RevenueReporting
Temporary DifferencesTemporary DifferencesTemporary DifferencesTemporary Differences
Temporary Differences in Reporting ExpensesTemporary Differences in Reporting Expenses
Deduct NowDeduct Now Deduct LaterDeduct Later
Deduct SlowerDeduct Slower Deduct FasterDeduct Faster
EXAMPLE: Product warranty expense.
WhenEstimated
WhenPaid
FinancialReporting
TaxReporting
EXAMPLE: Methodsof depreciation.
Straight-LineMethod
MACRSMethod
ExpenseDeductions
Temporary DifferencesTemporary DifferencesTemporary DifferencesTemporary Differences
Temporary DifferencesTemporary DifferencesTemporary DifferencesTemporary Differences
At the end of the first year of operations, a corporation reports $300,000 income before income taxes. With a 40% tax rate, the firm faces a tax of $120,000. Using tax planning, the net income is
reduced to $100,000 and the actual income tax due is $40,000. The difference is deferred to future years.
Temporary DifferencesTemporary DifferencesTemporary DifferencesTemporary Differences
The entry to record income taxes on April 15 reflects the deferred amount of $80,000.
The entry to record income taxes on April 15 reflects the deferred amount of $80,000.
Apr. 15 Income Tax Expense 120 000 00
To record income tax for the
year.
Income Tax Payable 40 000 00
Deferred Income Tax Payable80 000 00
Temporary DifferencesTemporary DifferencesTemporary DifferencesTemporary Differences
Apr. 15 Deferred Income Tax Payable 48 000 00
To record current liability for
deferred tax.
Income Tax Payable 48 000 00
If $48,000 of the deferred tax reverses and becomes due in the second year, the entry will reflect this fact.
If $48,000 of the deferred tax reverses and becomes due in the second year, the entry will reflect this fact.
Permanent DifferencesPermanent DifferencesPermanent DifferencesPermanent Differences
Differences between taxable income and income before taxes reported on
the income statement may be the result of differences that never reverse.
Differences between taxable income and income before taxes reported on
the income statement may be the result of differences that never reverse.
Permanent DifferencesPermanent DifferencesPermanent DifferencesPermanent Differences
These differences are referred to as permanent differences. Interest on municipal bonds is an example of
this type of timing difference.
These differences are referred to as permanent differences. Interest on municipal bonds is an example of
this type of timing difference.
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Unusual Items Affecting Income from Continuing
Operations
Unusual Items Affecting Income from Continuing
Operations
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Fixed Asset ImpairmentsFixed Asset Impairments
Decrease in market price of fixed assets Significant changes in the business or
regulations related to fixed assets Adverse conditions affecting the use of fixed
assets Expected cash flow losses using fixed assets
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Fixed Asset ImpairmentsFixed Asset Impairments
On March 1, Jones Company consolidates operations by closing a factory. As a
result of the closing, plant and equipment is impaired by $750,000.
On March 1, Jones Company consolidates operations by closing a factory. As a
result of the closing, plant and equipment is impaired by $750,000.
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Fixed Asset ImpairmentsFixed Asset Impairments
Mar. 1 Loss on Fixed Asset Impairment 750 000 00
To record impairment of fixed
assets due to plant closing.
Fixed Assets—Plant 400 000 00
Fixed Assets—Equipment350 000 00
Jones CorporationPartial Income Statement
For the Year Ended December 31, 2006
Net sales$12,350,000
Cost of merchandise sold 5,800,000
Gross profit$ 6,550,000
Operating expenses $3,490,000Restructuring charge 1,000,000Loss from asset impairment 750,000
5,240,000Income from continuing operations before income tax
$ 1,310,000Income tax expense
620,000Income from continuing operations
$ 690,000
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Restructuring charges are costs associated with involuntarily terminating employees,
terminating contracts, consolidating facilities, or relocating employees.
Restructuring charges are costs associated with involuntarily terminating employees,
terminating contracts, consolidating facilities, or relocating employees.
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Fixed Asset ImpairmentsFixed Asset Impairments
The management of Jones Company communicate a plan to terminate 200
employees from the closed manufacturing plant on March 1. The plan calls for a
termination benefit of $5,000 per employee.
The management of Jones Company communicate a plan to terminate 200
employees from the closed manufacturing plant on March 1. The plan calls for a
termination benefit of $5,000 per employee.
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Restructuring ChargesRestructuring Charges
Mar. 1 Restructuring Charge 1000 000 00
To record restructuring charge
due to plant closing.
Employee Termination
Obligation 1000 000 00
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement
Restructuring ChargesRestructuring Charges
Mar. 1 Restructuring Charge 1000 000 00
Employee Termination
Obligation 1000 000 00
Mar. 25 Employee Termination Obligation 125 000 00
Cash 125 000 00
Unusual Items Not Affecting Income Unusual Items Not Affecting Income From Continuing Operations From Continuing Operations
Unusual Items Not Affecting Income Unusual Items Not Affecting Income From Continuing Operations From Continuing Operations
ClosedClosed
Discontinued OperationsDiscontinued OperationsDiscontinued OperationsDiscontinued Operations
A gain or loss from disposing of a business segment is reported as a gain or loss from discontinued operations.
A gain or loss from disposing of a business segment is reported as a gain or loss from discontinued operations.
Jones CorporationIncome Statement
For the Year Ended December 31, 2006
Net sales $12,350,000
Income from continuing operationsbefore income tax $ 1,310,000
Income tax 620,000
Income from continuing operations $ 690,000
Loss on discontinued operations (Note B) 100,000
Income before extraordinary items and cumulative effect of a change in accounting principle $ 590,000
Extraordinary item:Gain on condemnation of land, net of applicable income tax of $65,000 150,000
Cumulative effect on prior years of changing todifferent depreciation method (Note C) 92,000
Net income $ 832,000
Extraordinary items result from events and transactions that (1) are significantly
different from the typical or the normal operating activities of the business AND
(2) occur infrequently.
Extraordinary items result from events and transactions that (1) are significantly
different from the typical or the normal operating activities of the business AND
(2) occur infrequently.
Extraordinary ItemsExtraordinary ItemsExtraordinary ItemsExtraordinary Items
Jones CorporationIncome Statement
For the Year Ended December 31, 2006
Net sales $12,350,000
Income from continuing operationsbefore income tax $ 1,310,000
Income tax 620,000
Income from continuing operations $ 690,000
Loss on discontinued operations (Note B) 100,000
Income before extraordinary items and cumulative effect of a change in accounting principle $ 590,000
Extraordinary item:Gain on condemnation of land, net of applicable income tax of $65,000 150,000
Cumulative effect on prior years of changing todifferent depreciation method (Note C) 92,000
Net income $ 832,000
Accounting changes occur when a business voluntarily change from one
generally accepted accounting principle to another.
Accounting changes occur when a business voluntarily change from one
generally accepted accounting principle to another.
Accounting ChangesAccounting ChangesAccounting ChangesAccounting Changes
Another type of accounting change occurs when businesses are required to change the way they treat an accounting situation when the FASB issues a new accounting standard.
Another type of accounting change occurs when businesses are required to change the way they treat an accounting situation when the FASB issues a new accounting standard.
Accounting ChangesAccounting ChangesAccounting ChangesAccounting Changes
Jones CorporationIncome Statement
For the Year Ended December 31, 2006
Net sales $12,350,000
Income from continuing operationsbefore income tax $ 1,310,000
Income tax 620,000
Income from continuing operations $ 690,000
Loss on discontinued operations (Note BA) 100,000
Income before extraordinary items and cumulative effect of a change in accounting principle $ 590,000
Extraordinary item:Gain on condemnation of land, net of applicable income tax of $65,000 150,000
Cumulative effect on prior years of changing todifferent depreciation method (Note C) 92,000
Net income $ 832,000
Income from continuing operations Income before extraordinary items and the
cumulative effect of a change in accounting principle
Extraordinary items and the cumulative effect of a change in accounting principle
Net income
Earnings per share (EPS) is the net income per share of common stock outstanding. When unusual items exist, EPS should be reported for:
Earnings per Common ShareEarnings per Common ShareEarnings per Common ShareEarnings per Common Share
Earnings per Common ShareEarnings per Common ShareEarnings per Common ShareEarnings per Common Share
Earnings per common share
=Net Income
Number of common shares outstanding
If there is no preferred stock:
If there is preferred stock:
Earnings per common share
=Net Income – Preferred stock dividends
Number of common shares outstanding
Jones CorporationIncome Statement
For the Year Ended December 31, 2006
Income from continuing operations $690,000
Net income $832,000
Earnings per common share:Earnings per common share:
Income from continuing operations $ 3.45
Loss on discontinued operations (Note B) .50
Income before extraordinary item and cumulative effect of a change in accounting principle $2.95
Extraordinary item .75
Cumulative effect on prior years of changing to a different depreciation method .46Net income $ 4.16
Jones CorporationIncome Statement
For the Year Ended December 31, 2006
Income from continuing operations $690,000
Net income $832,000
Earnings per common share:Earnings per common share:
Income from continuing operations $ 3.45
Loss on discontinued operations (Note B) .50
Income before extraordinary item and cumulative effect of a change in accounting principle $2.95
Extraordinary item .75
Cumulative effect on prior years of changing to a different depreciation method .46Net income $ 4.16
Jones CorporationIncome Statement
For the Year Ended December 31, 2006
Income from continuing operations $690,000
Net income $832,000
Earnings per common share:Earnings per common share:
Income from continuing operations $ 3.45
Loss on discontinued operations (Note B) . 50
Income before extraordinary item and cumulative effect of a change in accounting principle $2.95
Extraordinary item .75
Cumulative effect on prior years of changing to a different depreciation method .46Net income $ 4.16
Jones CorporationIncome Statement
For the Year Ended December 31, 2006
Income from continuing operations $690,000
Net income $832,000
Earnings per common share:Earnings per common share:
Income from continuing operations $ 3.45
Loss on discontinued operations (Note B) .50
Income before extraordinary item and cumulative effect of a change in accounting principle $2.95
Extraordinary item .75
Cumulative effect on prior years of changing to a different depreciation method .46Net income $ 4.16
Jones CorporationIncome Statement
For the Year Ended December 31, 2006
Income from continuing operations $690,000
Net income $832,000
Earnings per common share:Earnings per common share:
Income from continuing operations $ 3.45
Loss on discontinued operations (Note B) .50
Income before extraordinary item and cumulative effect of a change in accounting principle $2.95
Extraordinary item .75
Cumulative effect on prior years of changing to a different depreciation method .46Net income $ 4.16
Comprehensive IncomeComprehensive IncomeComprehensive IncomeComprehensive Income
Companies may report comprehensive income on the income statement, in a separate statement, or in the statement
of stockholders’ equity.
Companies may report comprehensive income on the income statement, in a separate statement, or in the statement
of stockholders’ equity.
Comprehensive IncomeComprehensive IncomeComprehensive IncomeComprehensive Income
Comprehensive income is defined as all changes in stockholders’
equity during a period.
Comprehensive income is defined as all changes in stockholders’
equity during a period.
However, comprehensive income does not include changes caused by
issuing dividends or from stockholders’ investments.
However, comprehensive income does not include changes caused by
issuing dividends or from stockholders’ investments.
Stockholders’ equity: Common stock $ 20,000 $ 20,000Paid-in capital in excess of par 36,000 36,000Retained earnings 165,500 157,000Accumulated other
comprehensive income 1,290 1,200Total stockholders’ equity $222,790 $214,200
Stockholders’ Equity SectionStockholders’ Equity SectionStockholders’ Equity SectionStockholders’ Equity Section
2006 2005
Accounting for Investments in Accounting for Investments in StocksStocks
Trading securities are securities that management intends to actively trade for profit.
Available-for-sale securities are securities that management expects to sell in the future, but which are not actively traded for profit.
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
Temporary investments are recorded in the current
asset account, Marketable Securities, at their cost.
Temporary investments are recorded in the current
asset account, Marketable Securities, at their cost.
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
On June 1, Crabtree Company purchased 2,000 shares of Inis Corporation common stock at
$89.75 per share plus a brokerage fee of $500.
On June 1, Crabtree Company purchased 2,000 shares of Inis Corporation common stock at
$89.75 per share plus a brokerage fee of $500.
June 1 Marketable Securities 180 000 00
Purchased 2,000 shares of Inis
Corporation common stock.
Cash 180 000 00
$89.75 x 2,000 shares + $500$89.75 x 2,000 shares + $500
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
On October 1, Inis declared a $0.90 per share dividend payable on November 30.
On October 1, Inis declared a $0.90 per share dividend payable on November 30.
Nov.30 Cash 1 800 00
Received dividend on Inis
Corporation common stock.
Dividend Revenue 1 800 00
2,000 shares x $0.902,000 shares x $0.90
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
On the balance sheet, temporary investments are reported at their fair market
value. Any difference between the fair market value and the cost is an unrealized
holding gain or loss.
On the balance sheet, temporary investments are reported at their fair market
value. Any difference between the fair market value and the cost is an unrealized
holding gain or loss.
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
At year-end, the total cost of Crabtree Co.’s four temporary investments is
$690,000. The current market for these four items totaled $750,000 at year-end.
Thus, Crabtree Co. had a before tax unrealized gain of $60,000.
At year-end, the total cost of Crabtree Co.’s four temporary investments is
$690,000. The current market for these four items totaled $750,000 at year-end.
Thus, Crabtree Co. had a before tax unrealized gain of $60,000.
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
Crabtree Co.Balance Sheet
December 31, 2006
Crabtree Co.Balance Sheet
December 31, 2006Current assets:
Cash$119,500Temporary investments in
marketable securities at cost $690,000Plus unrealized gain (net of applicable income tax of $18,000) 42,000
732,000
Current assets:Cash$119,500Temporary investments in
marketable securities at cost $690,000Plus unrealized gain (net of applicable income tax of $18,000) 42,000
732,000Stockholders’ Equity
Accumulated other comprehensive income 42,000
Stockholders’ EquityAccumulated other comprehensive income 42,000
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
Crabtree Co.Statement of Comprehensive Income
For the Year Ended December 31, 2006
Crabtree Co.Statement of Comprehensive Income
For the Year Ended December 31, 2006
Net income$720,000
Other comprehensive income:Unrealized gain on temporary investments
in marketable securities (net ofapplicable tax of $18,000)
42,000Comprehensive income
$762,000
Net income$720,000
Other comprehensive income:Unrealized gain on temporary investments
in marketable securities (net ofapplicable tax of $18,000)
42,000Comprehensive income
$762,000
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
Long-term investments are those investments made by a firm that are not intended as a source of cash in the normal operations of the business.
Long-term investments are those investments made by a firm that are not intended as a source of cash in the normal operations of the business.
EquityMethod
CostMethod
Not significantinfluence
Significantinfluence
Ownership %
Controlling Interest
100%100%
CostMethod
Not significantinfluence
0%0%
20%20%
50%50%With less than 20% ownership the buyer
does not usually have significant influence. The buyer uses the cost method
to account for the investment.
With less than 20% ownership the buyer does not usually have significant
influence. The buyer uses the cost method to account for the investment.
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
EquityMethod
CostMethod
No significantinfluence
Significantinfluence
Ownership %
Controlling Interest
0%0%
EquityMethod 50%50%
Ownership over 20% usually indicates significant influence. The buyer uses
the equity method to account for the investment.
Ownership over 20% usually indicates significant influence. The buyer uses
the equity method to account for the investment.
100%100%
20%20%
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
Jan. 2 Investment in Brock Corp. Stock 350 000 00
Purchased 40% of Brock Corp.
common stock.
Cash 350 000 00
On January 2, Hally Inc. pays cash of $350,000 for 40% of Brock Corporation’s common stock.
On January 2, Hally Inc. pays cash of $350,000 for 40% of Brock Corporation’s common stock.
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
Dec. 31 Investment in Brock Corp. Stock 42 000 00
Recorded share (40%) of Brock
Corp. net income of $105,000.
Income of Brock Corp. 42 000 00
For the year ending December 31, Brock Corporation reports net income of $105,000.
For the year ending December 31, Brock Corporation reports net income of $105,000.
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
Dec. 31 Cash 18 000 00
Recorded share (40%) of
dividends of $45,000 paid by
Brock Corp.
Investment in Brock Crop. Stock 18 000 00
On December 31, Brock Corporation declared a $45,000 dividend, payable on December 31.
On December 31, Brock Corporation declared a $45,000 dividend, payable on December 31.
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
Mar. 1 Cash 17 500 00
Sold investment in Drey Inc.
stock.
Investment in Drey Inc. Stock 15 700 00
Gain on Sale of Investments1 800 00
On March 1, an investment in Drey Inc. stock that had a carrying amount of
$15,700 is sold for $17,500.
On March 1, an investment in Drey Inc. stock that had a carrying amount of
$15,700 is sold for $17,500.
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
EquityMethod
CostMethod
No significantinfluence
Significantinfluence
Ownership %
0%0%
20%20%
Controlling Interest
Controlling Interest
Controlling Interest
100%100%
50%50%
Business CombinationsBusiness CombinationsBusiness CombinationsBusiness Combinations
The corporation owning all or a majority of the voting stock is called the parent company. The controlled
corporation is the subsidiary company. Consolidated financial statements are prepared which combines the
operating results of the two entities.
The corporation owning all or a majority of the voting stock is called the parent company. The controlled
corporation is the subsidiary company. Consolidated financial statements are prepared which combines the
operating results of the two entities.
Business CombinationsBusiness CombinationsBusiness CombinationsBusiness CombinationsA merger combines two corporations by one
acquiring the properties of another that is then dissolved.
Many businesses combine in order to produce more efficiently or to diversify product lines.
A consolidation is the creation of a new corporation, to which the combined assets and liabilities of the old corporations are transferred to the new corporation.
Business CombinationsBusiness CombinationsBusiness CombinationsBusiness Combinations
Mergers: Company A acquires company B. The assets and liabilities of B are transferred to A and B is then dissolved.
Mergers
A
B
Consolidations: Company A acquires company B. The assets and liabilities of both A and B are transferred to a new company C and A and B are then dissolved.
Consolidations
CA
B
FINANCIAL ANALYSIS AND
INTERPRETATION
A firm’s growth potential and future earnings prospects are indicated by how
much the market is willing to pay per dollar of a company’s earnings.
A firm’s growth potential and future earnings prospects are indicated by how
much the market is willing to pay per dollar of a company’s earnings.
Accounting: Earnings Per ShareAccounting: Earnings Per Share
Net Income
Common Shares
Earnings per Share of Common
Stock=
Investing: Price - Earnings RatioInvesting: Price - Earnings Ratio
Market Price Per Share
of Common StockEarnings Per Share of
Common Stock
Price-Earnings
Ratio=
The price-earnings ratio represents how much the market is willing to pay per dollar of a company’s earnings. This indicates the market’s assessment of a firm’s growth potential and future earnings prospects.
The price-earnings ratio indicates that a share of common stock was selling for 10 times earnings for 2005 and 12.5 times for 2006.
An example: 2006 2005
Market price per share $20.50 $13.50
Earnings per share $1.64 $1.35
Price-earnings ratioPrice-earnings ratio 12.5 12.5 10.0 10.0
The EndThe End
Chapter 14Chapter 14
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