Which of the following is the equation used to determine earnings per share (EPS)?

• A. EPS = \frac{\text{Gross Profit}}{\text{Net Sales}}
• B. EPS = \frac{\text{Net Sales}}{\text{Average Total Assets}}
• C. EPS = \frac{\text{Total Assets}}{\text{Total Liabilities}}
• D. EPS = \frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Weighted Average Number of Common Shares Outstanding}}

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the concept of Earnings Per Share (EPS). EPS is a financial metric used to measure the profitability of a company on a per-share basis. It is particularly useful for comparing the performance of companies within the same industry.
2. Step 2: Identify the components of the EPS formula. The formula for EPS is: EPS = (Net Income - Preferred Dividends) / Weighted Average Number of Common Shares Outstanding. Each component has a specific meaning: Net Income represents the company's total profit, Preferred Dividends are dividends paid to preferred shareholders, and Weighted Average Number of Common Shares Outstanding refers to the average number of common shares available during the reporting period.
3. Step 3: Recognize why preferred dividends are subtracted. Preferred dividends are subtracted because EPS is meant to measure the earnings available to common shareholders, not preferred shareholders.
4. Step 4: Understand the importance of the weighted average number of shares. The weighted average is used instead of a simple average because the number of shares outstanding can change during the reporting period due to stock issuance, buybacks, or other corporate actions.
5. Step 5: Compare the given options to the correct formula. The correct formula for EPS is EPS = (Net Income - Preferred Dividends) / Weighted Average Number of Common Shares Outstanding, which is distinct from the other options provided in the problem.