A company reports record net income of $920 million. The stock drops 8% at the open because diluted EPS fell from $4.12 to $3.87, since convertible bonds added 85 million potential shares to the denominator. The market prices diluted earnings, not headline income.
The 1929 crash exposed a market where investors had no reliable way to compare companies. Congress passed the Securities Exchange Act of 1934 to fix that. It created the SEC and forced public companies to file standardized periodic reports so any investor could read the same disclosures the insiders read. The forms below all trace back to that disclosure-parity principle.
Regulation S-X governs the financial statement content and form: which statements appear, how they are presented, what schedules support them, and audit requirements. Regulation S-K governs the non-financial disclosures: MD&A, executive compensation, risk factors, business description, legal proceedings. Every filing draws from both regs.
HIGH-FREQUENCY: The 10-K is the most heavily disclosed filing. Know the Part II items by number.
Common mistakes
- Subtracting noncumulative preferred dividends that were not declared. For noncumulative preferred, subtract only when declared. Candidates who subtract anyway get $1.94 instead of the correct $2.20 when the preferred is noncumulative.
- Failing to retroactively adjust for stock splits. A 3-for-1 split on November 1 applies to the entire year. Opening shares of 100,000 become 300,000 for the full year. The wrong answer weights the split for only 2 months, yielding 133,333.
- Adding option proceeds to the numerator. Under the treasury stock method, the numerator is unchanged. The proceeds are deemed used to repurchase shares. Adding $750,000 in option proceeds to the numerator inflates diluted EPS to $2.74.
Bottom line
- Form 10-K (annual, audited) due 60/75/90 days after fiscal year-end for LAF/AF/SRC; Form 10-Q (quarterly, unaudited) due 40/40/45 days; Form 8-K due 4 business days after a triggering event
- 10-K Part II item 7 = MD&A, item 7A = quantitative and qualitative market risk, item 8 = audited financial statements; 10-Q Part I items 1-3 = interim financials, MD&A, market risk
- Basic EPS = (Net income - Preferred dividends) / Weighted-average common shares; cumulative preferred always subtracted, noncumulative only if declared
- Treasury stock method (options): incremental shares = shares issued - proceeds-funded buyback at average market price; numerator unchanged; in-the-money dilutive, out-of-the-money excluded
Exam shortcut
Memorize the 10-K Part II items by number: item 7 (MD&A), item 7A (market risk), item 8 (audited statements), because the exam loves to swap them. For EPS, rank dilutive securities by incremental EPS and test from smallest to largest; options always go first at $0. If diluted EPS exceeds basic EPS, you included an antidilutive security. Back it out.
The full lesson (about 2,790 words, 19 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- I.D1
Browse all free CPA FAR lessons or jump into free CPA FAR practice questions.