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New Rules for Earnings Reports

Securities: Companies must now account for options and other ownership instruments in a standardized manner.


There's something a little different about fourth-quarter corporate profit figures being released this month.

To comply with new accounting industry rules, companies for the first time are reporting two distinct earnings-per-share figures to better show the effect of stock options that are used to compensate top executives.

EPS is an important number because it's used in many valuation calculations such as price-earnings ratios.

In its most basic form, earnings per share is calculated like this: Take net income, subtract from it dividends paid on preferred stock, then divide the remaining figure by the average number of common shares outstanding. In the old system, this was known as simple EPS.

The shortcoming of the boilerplate EPS, though, is it doesn't take into account the potentially dilutive effect of options, warrants and convertible securities. When any of these are turned into common shares, the EPS number shrinks because net income is spread across more shares.

To fill the gap, companies had two other EPS calculations they could use. So-called primary EPS included the effect of certain options, warrants and securities, such as convertible bonds and preferred stock. Fully diluted EPS included the effect of all such securities left out of primary EPS. Companies reported one of the three EPS figures based on how dilutive the options and other securities were.

To simplify matters and bring U.S. rules into sync with international accounting standards, the old figures were dropped in favor of two new EPS measures: basic and diluted. Basic is roughly the same as the old simple EPS. Diluted corresponds to the old fully diluted.

Most analysts and earnings-tracking companies plan to use diluted in their published figures.

Motorola Inc., which reported its fourth-quarter and 1997 profits last week, illustrates how the new system works. For the quarter, Motorola's basic EPS was 54 cents and diluted was 53 cents. Annually, basic EPS was $1.98 while diluted was $1.94.

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