Hyperinflation & Stagnation

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The term "hyperinflation" refers to a very rapid, very large increase in the price level. Measurement problems will be too minor to notice on this scale. There is no strict formal definition for the term, but cases of hyperinflation tend to be expressed in terms of multiples rather than percentages. "For example, in Germany between January 1922 and November 1923 (less than two years!) the average price level increased by a factor of about 20 billion." Some representative examples of hyperinflation include

"Hyperinflation

1922 Germany 5,000%
1985 Bolivia >10,000%
1989 Argentina 3,100%
1990 Peru 7,500%
1993 Brazil 2,100%
1993 Ukraine 5,000%"
These quotations from other web pages are given mainly as examples of what people have in mind when they talk about hyperinflation, and I cannot say just how accurate the figures are. In any case, figures for the purchasing power lost in hyperinflations can only be rough estimates. Numismatics (coin and currency collecting) gives some examples of just how far hyperinflations can go: an information page for currency collectors tells us that, in the Hungarian hyperinflation after World War II, bills for one hundred million trillion pengos were issued (the pengo was the Hungarian currency unit) and bills for one billion trillion pengos were printed but never issued. (I'm using American terms here -- the British express big numbers differently).
The story behind the German hyperinflation illustrates how all hyperinflations have come about, and is of particular interest in itself. After World War I, Germany had a democratic government, but little stability. A general named Kapp decided to make himself dictator, and marched his troops and militias into Berlin in an attempted coup d'etat known as the "Kapp Putsch." However, the German people resisted this attempt at dictatorship with nonviolent noncooperation. The workers went out in a general strike and the civil servants simply refused to obey the orders of Kapp and his men. Unable to take command of the country, Kapp retreated and ultimately gave up his attempt.

However, the German economy, never very sound, was further disrupted by the conflict surrounding Kapp's putsch and by the strike against it; and production fell and prices rose. The rise in prices destroyed the purchasing power of wages and government revenues, and the government responded to this by printing money to replace the lost revenues. This was the beginning of a vicious circle. Each increase in the quantity of money in circulation brought about a further inflation of prices, reducing the purchasing power of incomes and revenues, and leading to more printing of money. In the extreme, the monetary system simply collapses. In Germany, people would rush out to spend the day's wages as fast as possible, knowing that only a few hours' inflation would deprive today's wages of most of their purchasing power. One source says that people might buy a bottle of wine in the expectation that on the following morning, the empty bottle could be sold for more than it had cost when full. Those with goods to barter resorted to barter to get food; those with nothing to barter suffered.

This is the way that hyperinflations happen: by a self-reinforcing vicious cycle of printing money, leading to inflation, leading to printing money, and so on. This is one reason why inflation is feared. There is always the concern that even a little inflation this year will lead to more next year, and so on. But some countries have experienced very great inflations -- 50 to 100% per year -- without ever falling into the cycle of hyperinflation, and there has never been a hyperinflation that could not have been avoided by a simple government determination to stop the expansion of the money supply.

The key point is this: the monetary system can function reasonably well as long as the value of the monetary unit is reasonably stable and predictable, and the high standards of living of modern societies cannot exist without a functioning monetary system.

Stagnation
A stagnation is a period of many years of slow growth of gross domestic product, in which the growth is, on the average, slower than the potential growth in the economy.
We should stress that this is quite controversial. There are economists who do not believe that stagnation exists as a problem. The difficulty is with the idea that growth is "less than the potential growth in the economy." But what is the potential? Those who see a great potential will see stagnation where those who see less potential will not.
In any case, the idea of stagnation was first discussed in the 1930's. The Great Depression, a period in which the growth of national product was generally negative, was thought of "by some economists" as a symptom of "secular stagnation." The word "secular" in this context meant that the causes of the stagnation were beyond the control of the government. The closing of the frontier, slowing technological progress, and higher savings rates because of higher average incomes were mentioned as possible causes.

Some economists believe that the U. S. A. has suffered from a stagnation in recent decades. One reason for their thinking is expressed in the following table:

Growth of Real GDP by Decades, U.S.A.

decade rate of
growth
1960's 4.46%
1970's 3.24%
1980's 2.84%
1990-1995 1.81%
Remember that in this table we are looking at rates of growth, not the levels of RGDP. Real GDP was greater in the 1990's, but is rising at a slower rate than in the 1960's. Since the middle of the 1990's, we have had a period of fairly steady higher rates of economic growth, around 4%, so it may be that the period of stagnation is over.

It is clear that in 1970-1995, American economic growth slowed down. But is a growth slowdown a problem? It might not be a problem, depending on the reasons for the slowdown.

Causes of Stagnation

There are several reasons why actual or potential Real GDP growth might slow down. The table below shows evidence on some of these possibilities. If both potential and actual growth have slowed to about the same extent, then perhaps we do not have a stagnation problem. (The Table is derived from data from the Bureau of Labor Statistics, Penn World Tables, The Economic Report of the President, and the U. S. Census Bureau).

Population growth might slow
Population growth increases both the demand for goods and services and the supply of labor to produce them, so slower population growth would mean slower potential economic growth. American population growth has slowed to some extent.
Fewer people might choose to work
The proportion of the population who choose to work is called the "rate of labor force participation." A decrease in the rate of labor force participation would slow the potential growth of output, while an increase in the rate of labor force participation would increase it. The American rate of labor force participation has tended to increase in the last few decades, to some extend offsetting the slowing of population growth.
The growth of labor productivity might slow
One of the most important sources of economic growth is the increase in output per worker. Labor productivity is output per unit of labor. If this growth of labor productivity is slower, the growth of total output would also be slower. Productivity growth itself might be stagnant -- that is, less than its own potential -- so it is not clear whether a decrease in productivity growth would be associated with stagnation or not. If productivity growth is itself below potential, we would see that as stagnation, but if potential and actual productivity growth have decreased about the same, then we would not see that as stagnation.
All of these related variables have indeed changed along with economic growth in recent decades.

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WHAT IS LIBOR?

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The London Interbank Offered Rate (or LIBOR, pronounced /ˈlaɪbɔr/) is a daily reference rate based on the interest rates at which banks borrow unsecured funds from other banks in the London wholesale money market (or interbank market).

Introduction

In 1984 it became apparent that an increasing number of banks were trading actively in a variety of relatively new market instruments, notably interest rate swaps, foreign currency options and forward rate agreements. While recognizing that such instruments brought more business and greater depth to the London Interbank market, bankers worried that future growth could be inhibited unless a measure of uniformity was introduced. In October 1984 the British Bankers' Association—working with other parties, such as the Bank of England—established various working parties, which eventually culminated in the production of the BBAIRS terms—the BBA standard for interest rate swaps. Part of this standard included the fixing of BBA interest-settlement rates, the predecessor of BBA LIBOR. From 2 September 1985 the BBAIRS terms became standard market practice.
BBA LIBOR fixings did not commence officially before 1 January 1986, although before that some rates were fixed for a trial period commencing in December 1984.
It should be noted that member banks are international in scope, with more than sixty nations represented among its 223 members and 37 associated professional firms (as of 2008).

Scope

LIBOR rates are widely used as a reference rate for financial instruments such as
forward rate agreements
short-term-interest-rate futures contracts
interest rate swaps
inflation swaps
floating rate notes
syndicated loans
variable rate mortgages.
currencies, especially the US dollar (see also Eurodollar).
They thus provide the basis for some of the world's most liquid and active interest-rate markets.
For the Euro, however, the usual reference rates are the Euribor rates compiled by the European Banking Federation, from a larger bank panel. A Euro LIBOR does exist, but mainly for continuity purposes in swap contracts dating back to pre-EMU times. LIBOR is an estimate and not interred in the legally binding contracts of an LLC. It is however specifically mentioned as a reference rate in the market standard International Swaps and Derivatives Association documentation, which are used by parties wishing to transact in over-the-counter interest rate derivatives.
LIBOR is used by the Swiss National Bank as their reference rate for monetary policy

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Technical features

LIBOR is calculated by and published by the British Bankers' Association (BBA) after 11:00 am (and generally around 11:45 am) each day (London time). It is a trimmed average of inter-bank deposit rates offered by designated contributor banks, for maturities ranging from overnight to one year. LIBOR is calculated for 10 currencies. There are either eight, twelve or sixteen contributor banks on each currency panel and the reported interest is the mean of the middle values (the interquartile mean). The rates are a benchmark rather than a tradable rate, the actual rate at which banks will lend to one another continues to vary throughout the day.
LIBOR is often used as a rate of reference for Pound Sterling and other currencies, including US dollar, Euro, Japanese Yen, Swiss Franc, Canadian dollar, Australian Dollar, Swedish Krona, Danish Krone and New Zealand dollar.
In the 1990s, Yen LIBOR rates were influenced by credit problems affecting some of the contributor banks.
For a precise definition of BBA LIBOR, see: The BBA LIBOR fixing & definition.
Six-month USD LIBOR is used as an index for some US mortgages. In the UK, the three-month GBP LIBOR is used for some mortgages—especially for those with adverse credit history.

Definition of LIBOR

LIBOR is defined as:
"The rate at which an individual Contributor Panel bank could borrow funds, were it to do so by asking for and then accepting inter-bank offers in reasonable market size, just prior to 11.00 London time."
This definition is amplified as follows:-
The rate at which each bank submits must be formed from that bank’s perception of its cost of funds in the interbank market.
Contributions must represent rates formed in London and not elsewhere.
Contributions must be for the currency concerned, not the cost of producing one currency by borrowing in another currency and accessing the required currency via the foreign exchange markets.
The rates must be submitted by members of staff at a bank with primary responsibility for management of a bank’s cash, rather than a bank’s derivative book.
The definition of “funds” is: unsecured interbank cash or cash raised through primary issuance of interbank Certificates of Deposit.

LIBOR-based derivatives


Eurodollar contracts

The Chicago Mercantile Exchange's Eurodollar contracts are based on three-month US dollar LIBOR rates. They are the world's most heavily traded short term interest rate futures contracts and extend up to ten years. Shorter maturities trade on the Singapore Exchange in Asian time.

Interest rate swaps

Interest rate swaps based on short LIBOR rates currently trade on the interbank market for maturities up to 50 years. A "five year LIBOR" rate refers to the 5 year swap rate vs 3 or 6 month LIBOR. "LIBOR + x basis points", when talking about a bond, means that the bond's cash flows have to be discounted on the swaps' zero-coupon yield curve shifted by x basis points in order to equal the bond's actual market price. The day count convention for LIBOR rates in interest rate swaps is Actual/360.

Reliability

On Thursday, 29 May 2008 the Wall Street Journal released a controversial study suggesting that banks may have understated borrowing costs they reported for LIBOR during the 2008 credit crunch.[3] Such underreporting could have created an impression that banks could borrow from other banks more cheaply than they could in reality. It could also have made the banking system or specific contributing bank appear healthier than it was during the 2008 credit crunch.
For example, the study found that rates at which one major bank "said it could borrow dollars for three months were about 0.87 percentage point lower than the rate calculated using default-insurance data."
In response to the study released by the WSJ, the British Bankers' Association announced that LIBOR continues to be reliable even in times of financial crisis. According to the British Bankers' Association, other proxies for financial health, such as the default-credit-insurance market, are not necessarily more sound than LIBOR at times of financial crisis, though they are more widely used in Latin America, especially the Ecuadorian and Bolivian markets.
Additionally, other authorities have contradicted the Wall Street Journal article. In their March 2008 Quarterly Review The Bank for International Settlements have stated that "available data do not support the hypothesis that contributor banks manipulated their quotes to profit from positions based on fixings". Further, In October 2008 the International Monetary Fund published their regular Global Financial Stability Review which also found that "Although the integrity of the U.S. dollar LIBOR-fixing process has been questioned by some market participants and the financial press, it appears that U.S. dollar LIBOR remains an accurate measure of a typical creditworthy bank’s marginal cost of unsecured U.S. dollar term funding"

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Earnings Per Share

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A. Simple Capital Structure--if a corporation's capital structure consists
only of common stock or includes no potentially dilutive convertible
securities, options, warrants, or other rights that upon conversion or
exercise could dilute earnings per common share, a single presentation,
expressed in terms such as basic earnings per common share, is required to
be disclosed on the face of the income statement for income from continuing
operations, income before extraordinary items, and net income and is
computed by dividing the income available to common stockholders by the
weighted average number of common shares outstanding during the period
1. Income Available to Common Stockholders--each element of income for
which earnings per share presentation is required should be reduced by
the current period dividend claim on cumulative preferred stock
whether the dividend has been declared or not and by the current
period dividend claim on noncumulative preferred stock only if the
dividend has been declared
a. Illustrations
1) A corporation reported net income of $300,000 during the
current year; the corporation had a weighted average number of
common shares outstanding of 100,000 during the current year;
the corporation had 1,000 shares of 8% cumulative preferred
stock with a par value of $100 outstanding during the current
year; the preferred stock dividend was declared
Earnings Per Share = (300,000 - 8% x 100 x 1,000) /
100,000 = 2.92

2) A corporation reported net income of $300,000 during the
current year; the corporation had a weighted average number of
common shares outstanding of 100,000 during the current year;
the corporation had 1,000 shares of 8% cumulative preferred
stock with a par value of $100 outstanding during the current
year; the preferred stock dividend was not declared
Earnings Per Share = (300,000 - 8% x 100 x 1,000) /
100,000 = 2.92

3) A corporation reported net income of $300,000 during the
current year; the corporation had a weighted average number of
common shares outstanding of 100,000 during the current year;
the corporation had 1,000 shares of 8% noncumulative preferred
stock with a par value of $100 outstanding during the current
year; the preferred stock dividend was declared
Earnings Per Share = (300,000 - 8% x 100 x 1,000) /
100,000 = 2.92

4) A corporation reported net income of $300,000 during the
current year; the corporation had a weighted average number of
common shares outstanding of 100,000 during the current year;
the corporation had 1,000 shares of 8% noncumulative preferred
stock with a par value of $100 outstanding during the current
year; the preferred stock dividend was not declared
Earnings Per Share = 300,000 / 100,000 = 3.00

2. Weighted Average Number of Common Shares Outstanding--the number of
common shares outstanding at the beginning of the period is increased
or decreased by any common shares issued or retired during the period
weighted by the fraction of the period in which they were outstanding
a. Stock Dividends or Stock Splits--if a stock dividend or stock
split occurs either during the current period or after the end of
the current period but before the financial statements are issued,
the computation of the weighted average number of common shares
outstanding requires that the common shares outstanding before the
occurrence of the stock dividend or stock split be restated to
reflect the effects of the stock dividend or stock split
b. Illustration--a corporation had 100,000 shares of common stock
outstanding on January 1; the corporation issued 2,000 shares of
common stock on April 1; the corporation issued a 5% stock
dividend on the outstanding common shares on June 1; the
corporation repurchased 3,000 shares of common stock on October 1;
the corporation issued 6,000 shares of common stock on December 1
Weighted Average Number of Common Shares Outstanding:
January 1 100,000 x 1.05 x 12 / 12 = 105,000
April 1 2,000 x 1.05 x 9 / 12 = 1,575
October 1 (3,000) x 3 / 12 = (750)
December 1 6,000 x 1 / 12 = ____500
106,325

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B. Complex Capital Structure--if a corporation's capital structure includes
potentially dilutive convertible securities, options, warrants, or other
rights that upon conversion or exercise could dilute earnings per common
share, a dual presentation, expressed in terms such as basic earnings per
share and diluted earnings per share, is required to be disclosed on the
face of the income statement for income from continuing operations, income
before extraordinary items, and net income and is computed by dividing the
income available to common stockholders by the weighted average number of
common shares outstanding during the period
1. Convertible Securities
a. If Converted Method--earnings per share is computed by dividing
the income available to common stockholders by the weighted
average number of common shares outstanding during the period as
if the convertible security were converted
1) Income Available to Common Stockholders--each element of
income for which earnings per share presentation is required
should not be reduced by the current period dividend claim on
convertible preferred stock and should be increased by the
current period interest expense, net of tax, on convertible
bonds
2) Weighted Average Number of Common Shares Outstanding--the
weighted average number of common shares outstanding should be
adjusted as if the convertible security were converted at the
beginning of the period or the date of issuance of the
convertible security if the convertible security were issued
during the period
a) Variable Conversion Rates--the weighted average number of
common shares outstanding is adjusted for the most
advantageous conversion rate available to the holders of
the convertible security
b. Antidilution--a convertible security whose inclusion in earnings
per share computations would increase earnings per share should be
excluded from earnings per share computations
c. Illustrations
1) A corporation reported net income of $800,000 during the
current year; the corporation had a weighted average number of
common shares outstanding of 80,000 during the current year;
the corporation had 5,000 shares of 8% cumulative, convertible
preferred stock with a par value of $100 outstanding during
the current year; the preferred stock was issued at par; each
share of preferred stock is convertible into 2 shares of common
stock
Basic Earnings Per Share = (800,000 - 8% x 100 x 5,000) /
80,000 = 9.50

Per Share Effect = 8% x 100 x 5,000 / (2 x 5,000) = 4.00

Diluted Earnings Per Share = 800,000 / (80,000 + 2 x
5,000) = 8.89

2) A corporation reported net income of $800,000 during the
current year; the corporation had a weighted average number of
common shares outstanding of 200,000 during the current year;
the corporation had 5,000 shares of 8% cumulative, convertible
preferred stock with a par value of $100 outstanding during
the current year; the preferred stock was issued at par; each
share of preferred stock is convertible into 2 shares of common
stock
Simple Earnings Per Share = (800,000 - 8% x 100 x 5,000) /
200,000 = 3.80

Per Share Effect = 8% x 100 x 5,000 / (2 x 5,000) = 4.00


Diluted Earnings Per Share = 800,000 / (200,000 + 2 x
5,000) = 3.81
The preferred stock is antidilutive; therefore, only a
basic earnings per share presentation is required.

3) A corporation reported net income of $800,000 during the
current year; the corporation had a weighted average number of
common shares outstanding of 80,000 during the current year;
the corporation had $750,000 of 10% convertible bonds with a
par value of $1,000 outstanding during the current year; the
bonds were issued at par; each bond is convertible into 20
shares of common stock
Simple Earnings Per Share = 800,000 / 80,000 = 10.00

Per Share Effect = 10% x 1,000 x 750 / 20 x 750 = 5.00

Diluted Earnings Per Share = (800,000 + 10% x 1,000 x 750)
/ (80,000 + 20 x 750) = 9.21

4) A corporation reported net income of $800,000 during the
current year; the corporation had a weighted average number of
common shares outstanding of 200,000 during the current year;
the corporation had $750,000 of 10% convertible bonds with a
par value of $1,000 outstanding during the current year; the
bonds were issued at par; each bond is convertible into 20
shares of common stock
Simple Earnings Per Share = 800,000 / 200,000 = 4.00

Per Share Effect = 10% x 1,000 x 750 / 20 x 750 = 5.00

Diluted Earnings Per Share = (800,000 + 10% x 1,000 x 750)
/ (200,000 + 20 x 750) = 4.07
The bonds are antidilutive; therefore, only a basic
earnings per share presentation is required.

2. Options and Warrants--stock purchase contracts, stock subscriptions
not fully paid, deferred compensation packages providing for the
issuance of common stock, and convertible securities that allow or
require the payment of cash upon conversion are considered the
equivalent of stock options and stock warrants
a. Treasury Stock Method--earnings per share is computed by dividing
the income available to common stockholders by the weighted average
number of common shares outstanding during the period as if the
stock options and stock warrants were exercised and the proceeds
from the exercise of the stock options and stock warrants were used
to purchase common stock for the treasury using the average market
price of the stock if the average market price of the stock is
above the exercise price during the period being reported
1) Income Available to Common Stockholders--each element of income
for which earnings per share presentation is required does not
need to be adjusted
2) Weighted Average Number of Common Shares Outstanding--the
weighted average number of common shares outstanding should be
adjusted as if the stock options and stock warrants were
exercised at the beginning of the period or the date of
issuance of the stock options and stock warrants if the stock
options and stock warrants were issued during the period
a) Variable Exercise Prices—-the weighted average number of
common shares outstanding is adjusted for the most
advantageous exercise price available to the holders of the
stock options
b. Antidilution--stock options and stock warrants whose inclusion in
earnings per share computations would increase earnings per share
should be excluded from earnings per share computations
c. Illustrations
1) A corporation reported net income of $800,000 during the
current year; the corporation had a weighted average number of
common shares outstanding of 100,000 during the current year;
the corporation had 10,000 stock options outstanding during
the current year; the option price is $45 per share; the
average market price of the common stock is $50 per share, and
the closing market price of the common stock is $55 per
share
Basic Earnings Per Share = 800,000 / 100,000 = 8.00

Proceeds From Exercise = 10,000 x 45 = 450,000

Treasury Stock = 450,000 / 50 = 9,000

Per Share Effect = 0 / (10,000 - 9,000) = 0

Diluted Earnings Per Share = 800,000 / (100,000 + 10,000 -
9,000) = 7.92

2) A corporation reported net income of $800,000 during the
current year; the corporation had a weighted average number of
common shares outstanding of 100,000 during the current year;
the corporation had 10,000 stock options outstanding during
the current year; the option price is $45 per share; the
average market price of the common stock is $40 per share, and
the closing market price of the common stock is $55 per
share
Basic Earnings Per Share = 800,000 / 100,000 = 8.00

Proceeds From Exercise = 10,000 x 45 = 450,000

Treasury Stock = 450,000 / 40 = 11,250

Diluted Earnings Per Share = 800,000 / (100,000 + 10,000 –
11,250) = 8.10
The stock options are antidilutive; therefore, only a
basic earnings per share presentation is required.

3. Contingent Issuances--shares of common stock that are issuable upon the
mere passage of time and shares of common stock that are issuable upon
the attainment of a certain earnings level or a certain market value
level or a certain condition other than earnings or market value that
is met at the end of the current period
a. If Issued Method--earnings per share is computed by dividing the
income available to common stockholders by the weighted average
number of common shares outstanding during the current period as
if the contingent shares of common stock were issued
1) Income Available to Common Stockholders--each element of income
for which earnings per share presentation is required does not
need to be adjusted
2) Weighted Average Number of Common Shares--the weighted average
number of common shares outstanding should be adjusted as if
the contingent shares of common stock were issued at the
beginning of the period or the date of the contingent agreement
if the contingent agreement were made during the period
a) Variable Issue Rates--if the common stock is issuable upon
the attainment of a condition other than the mere passage
of time and if the number of shares issuable varies
depending upon the level of the condition, the weighted
average number of common shares outstanding should be
adjusted for the number of shares that would be issued
based upon current conditions
b. Antidilution--a contingent issuance of common stock whose inclusion
in earnings per share computations would increase earnings per
share should be excluded from earnings per share computations
c. Illustrations
1) A corporation reported net income of $600,000 during the
current year; the corporation had a weighted average number of
common shares outstanding of 40,000 during the current year;
the corporation had an agreement outstanding during the
current year that entitles the president of the corporation to
a bonus of 5,000 shares of common stock if the net income of
the corporation reaches $550,000 in any of the succeeding 3
years
Basis Earnings Per Share = 600,000 / 40,000 = 15.00

Per Share Effect = 0 / 5,000 = 0

Diluted Earnings Per Share = 600,000 / (40,000 + 5,000) =
13.33

2) A corporation reported net income of $600,000 during the
current year; the corporation had a weighted average number of
common shares outstanding of 40,000 during the current year;
the corporation had an agreement outstanding during the
current year that entitles the president of the corporation to
a bonus of 5,000 shares of common stock if the net income of
the corporation reaches $650,000 in any of the succeeding 3
years
Basic Earnings Per Share = 600,000 / 40,000 = 15.00
The contingent issuance is ignored since the current
level of earnings is less than $650,000; therefore,
only a basic earnings per share presentation is
required.

C. Multiple Dilutive Securities
1. Ranking--the per share effect of convertible securities, stock options
and stock warrants, and other rights on earnings per share is computed
and is used to rank the convertible securities, stock options and
stock warrants, and other rights from the most dilutive to the least
dilutive
2. Computation--earnings per share is computed by adding the convertible
securities, stock options and stock warrants, and other rights one at
a time to the earnings per share computation in order of their ranking
of their per share effects until a convertible security, a stock
option or a stock warrant, or an other right is antidilutive or until
all convertible securities, stock options or stock warrants, or other
rights are included in the computation
3. Illustrations
a. A corporation reported net income of $425,000 during the current
year; the corporation had a weighted average number of common
shares outstanding of 50,000 during the current year; the
corporation had 4,000 shares of 7.5% cumulative, convertible
preferred stock with a par value of $100 outstanding during the
current year; the preferred stock was issued at par; each share of
preferred stock is convertible into 2 shares of common stock; the
corporation had $300,000 of 8% convertible bonds with a par value
of $1,000 outstanding during the current year; the bonds were
issued at par value; each bond is convertible into 40 shares of
common stock; the corporation had 10,000 stock options outstanding
during the current year; the option price is $20; the average
market price of the common stock is $25 per share, and the closing
market price of the common stock is $30 per share
Basic Earnings Per Share = (425,000 - 7.5% x 100 x 4,000) /
50,000 = 7.90

Proceeds From Exercise = 10,000 x 20 = 200,000

Treasury Stock = 200,000 / 25 = 8,000

Per Share Effects:
Preferred Stock = 7.5% x 100 x 4,000 / (2 x 4,000) = 3.75

Bonds = 8% x 1,000 x 300 / (40 x 300) = 2.00

Options = 0 / (10,000 - 8,000) = 0

Diluted Earnings Per Share:
Options = (425,000 - 7.5% x 100 x 4,000) / (50,000 +
10,000 - 8,000) = 7.60

Bonds = (425,000 - 7.5% x 100 x 4,000 + 8% x 1,000 x 300)
/ (50,000 + 10,000 - 8,000 + 40 x 300) = 6.55

Preferred Stock = (425,000 + 8% x 1,000 x 300) / (50,000 +
10,000 - 8,000 + 40 x 300 + 2 x 4,000) =
6.24

b. A corporation reported net income of $425,000 during the current
year; the corporation had a weighted average number of common
shares outstanding of 100,000 during the current year; the
corporation had 4,000 shares of 7.5% cumulative, convertible
preferred stock with a par value of $100 outstanding during the
current year; the preferred stock was issued at par; each share of
preferred stock is convertible into 2 shares of common stock; the
corporation had $300,000 of 8% convertible bonds with a par value
of $1,000 outstanding during the current year; the bonds were
issued at par value; each bond is convertible into 40 shares of
common stock; the corporation had 10,000 stock options outstanding
during the current year; the option price is $20; the average
market price of the common stock is $25 per share, and the closing
market price of the common stock is $30 per share
Basic Earnings Per Share = (425,000 - 7.5% x 100 x 4,000) /
100,000 = 3.95

Proceeds From Exercise = 10,000 x 20 = 200,000

Treasury Stock = 200,000 / 25 = 8,000


Per Share Effects:
Preferred Stock = 7.5% x 100 x 4,000 / (2 x 4,000) = 3.75

Bonds = 8% x 1,000 x 300 / (40 x 300) = 2.00

Options = 0 / (10,000 - 8,000) = 0

Diluted Earnings Per Share:
Options = (425,000 - 7.5% x 100 x 4,000) / (100,000 +
10,000 - 8,000) = 3.87

Bonds = (425,000 - 7.5% x 100 x 4,000 + 8% x 1,000 x 300)
/ (100,000 + 10,000 - 8,000 + 40 x 300) = 3.68
The preferred stock is antidilutive; therefore, the
preferred stock is excluded from the computation of
diluted earnings per share.

D. Reporting
1. Special Transactions--when the earnings of the period include special
transactions, earnings per share amounts (where applicable) should be
presented for discontinued operations and for extraordinary items
either on the face of the income statement or in the notes to the
financial statements
2. Comparative Financial Statements--earnings per share amounts should be
presented for all periods presented
a. Stock Dividends or Stock Splits--if a stock dividend or stock
split occurs either during the current period or after the end of
the current period but before the financial statements are issued,
the earnings per share amounts presented for all prior periods
should be restated to reflect the effects of the stock dividend or
stock split
b. Prior Period Adjustments--if the results of operations of prior
periods have been restated as a result of a prior period
adjustment or a change in accounting principle, the earnings per
share amounts presented for the prior periods should be restated to
reflect the effect of the prior period adjustment or the change in
accounting principle, and the effects of the restatement should be
disclosed in the year of restatement
c. Diluted Earnings Per Share--if diluted earnings per share is
reported for at least one period, diluted earnings per share should
be reported for all periods presented, even if diluted earnings per
share is the same as basic earnings per share
3. Complex Capital Structure--if a corporation has a complex capital
structure, the notes to the financial statements should disclose the
following:
a. Description of pertinent rights and privileges of the various
securities outstanding
b. A reconciliation of the numerators and denominators of the basic
earnings per share and diluted earnings per share computations
including the individual income and share effects of all securities
that affect earnings per share
c. The effect given preferred dividends in determining income
available to common stockholders in computing basic earnings per
share
d. Securities that could potentially dilute basic earnings per share
in the future that were not included in the computation of diluted
earnings per share because they would be antidilutive
e. Effects of conversion subsequent to year end


ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.

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