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The Great Illusion

In: Business and Management

Submitted By dreamdo
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The Great Illusion

According to the Thomas Jeffery Hogan and R. David Mautz, Jr., “Earnings per share (EPS) is considered by some to be the single most important item in the financial statements” (Hogan and Mautz, Jr., 1991, p. 50). Reasons for this are that they are known to be disclosed in statements of public companies as well as a figure auditors refer to. However, earnings per share may not really be the number investors should look at. Concepts Statement #2 requires that in order for information to be useful, it must be relevant and reliable. There seem to be problems with EPS due to the way it is computed and disclosed. Such problems consist of determining what constitutes common stock equivalencies, including stock options and warrants, the effective yield test, and the two types of EPS. There is difficulty in determining what constitutes common stock. According to Thomas Jeffery Hogan and R. David Mautz, Jr., “Common stock equivalents are convertible securities that derive a major portion of their value from the fact that they can be exchanged for common stock” (Hogan and Mautz, Jr., 1991, p. 50). Also once a security I deemed to be a common stock equivalent, it always will be. The reverse of this situation is also true, if a security is not found to be common stock equivalent, it never will be. This is not good because factors in the economy may cause conditions that will reason an effective yield of a specific company to increase or decrease. Stock options and warrants are always considered to be common stock equivalents. The options and warrants are assumed to be exercised and the income received is used to buy treasury stock. This method is known as the treasury stock method. The trouble with this method is that it has a 20% limit on the number of treasury stock that exceeds shares of common stock

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