DipIFR-Session29 d08 Earnings Per Share

SESSION 29 IAS 33 EARNINGS PER SHARE
Accountancy Tuition Centre (International Holdings) Ltd 2008 2901

Overview
Objective
To explain the provisions of IAS 33.

SIGNIFICANCE
OF EPS
Presentation
Disclosure
PRESENTATION
AND
DISCLOSURE
EPS vs earnings
Performance measure
Problems with EPS
INTRODUCTION
EARNINGS PER
SHARE (EPS)
FULLY
DILUTED EPS
WEIGHTED
AVERAGE NUMBER
OF SHARES
Earnings performance
Scope
Definitions
Basic rule
Issues of shares no consideration
Multiple capital changes
Issuable shares
Basic EPS
Which earnings?
Preference shares
Purpose
Method
Options
Contingently
issuable shares

1 Introduction
1.1 Earnings performance
Earnings per share (EPS) shows the trend of earnings performance for a
company over the years.
It is felt to be more useful than an absolute profit figure, which will not
contain information about the increase in investment that has been made in
the period.
It is not useful in comparing companies.
1.2 Scope
IAS 33 applies to the separate financial statements of entities whose debt or
equity instruments are publicly traded (or are in the process of being issued in
a public market).
IAS 33 also applies to the consolidated financial statements of a group whose
parent is required to apply IAS 33 to its separate financial statements.
An entity that discloses EPS should calculate and disclose it in accordance
with IAS 33.
1.3 Definitions
An ordinary share is an equity instrument that is subordinate to all other
classes of equity instruments.
An equity instrument is any contract that evidences a residual interest in the
assets of an entity after deducting all of its liabilities.
A potential ordinary share is a financial instrument or other contract that may
entitle its holder to ordinary shares. For example:
convertible instruments;
share options and warrants;
share purchase plans;
shares which will be issued subject to certain conditions being met.
Options, warrants and their equivalents are financial instruments that give the
holder the right to purchase ordinary shares.
Dilution is the reduction in EPS (or an increase in loss per share) resulting
from the assumption that convertible instruments are converted, that
warrants/options are exercised, or that ordinary shares are issued upon the
satisfaction of specified conditions.
Contingently issuable ordinary shares are ordinary shares issuable for little or
no cash or other consideration upon the satisfaction of specified conditions.
2 Earnings per share (EPS)
2.1 Basic EPS
An entity is required to present the basic earnings per share for:
profit or loss attributable to ordinary shareholders; and
profit or loss relating to continuing operations attributable to those
ordinary shareholders.
The basic EPS calculation is made by dividing the profit (or loss) relating to
the ordinary shareholders by the weighted average number of ordinary shares
outstanding in the period.
2.2 Which earnings?
Basic EPS should be:
the profit or loss attributable to ordinary shareholders; and
the profit or loss relating to continuing operations attributable to the
ordinary shareholders.
Adjusted for:
post-tax effect of preference dividends (and other items relating to
preference shares); and
non-controlling interests.
2.3 Preference dividends
There are two types of preference shares:
Cumulative preference If no dividend is declared in respect of a
period the holders accumulate their rights.
The profit or loss will be adjusted for the post-tax effect of the
preference dividend in relation to the period whether or not the
dividends are declared.

Commentary
They have a right to be paid the dividend in the future.
Non cumulative preference If no dividend is declared then the
holder losses the right to the dividend.
The profit or loss will only be adjusted for preference dividends
declared in relation to the period.
3 Weighted average number of ordinary shares
3.1 Basic rule
The number of ordinary shares will be the weighted average number of
ordinary shares outstanding during the period.
The number in existence at the beginning of the period should be adjusted for
shares that have been issued for consideration during the period.

Commentary
You may see these issues described as issues at full market price.
Consideration may be received in a number of ways:
Issue for cash;
Issue to acquire a controlling interest in another entity;
Redemption of debt.
In each case the earnings will be boosted from the date of issue. In order to
ensure consistency between the top and bottom of the basic EPS calculation
the shares are also included from the date of issue.
Therefore weight the number of shares:

Proforma

Number
Number before
3
12
= X

Number after
9
12
= X

____

X

____

3.2 Issues of shares where no consideration is received
The weighted average number of ordinary shares outstanding during the
period and for all periods presented should be adjusted for events, that have
changed the number of ordinary shares outstanding, without a corresponding
change in resources. For example:
Bonus issues;
Bonus elements in another issue (e.g. a rights issue);
Share splits;
Reverse share splits.
3.2.1 Bonus issues
Treat as if the new shares have been in issue for the whole of the period.
Multiply the number of shares in issue by the bonus fraction.
Illustration 1

Bonus issue of 1 for 10

Bonus fraction:
10
11
10
1 10
=
+

The EPS will fall (all other things being equal) because the earnings are being
spread over a larger number of shares. This would mislead users when they
compare this years figure to those from previous periods.
The comparative figure and any other figures from earlier periods that are
being used in an analysis must be adjusted. This is done by multiplying the
comparative by the inverse of the bonus fraction.
Illustration 2

Last years EPS
11
10

3.2.2 Rights issues
A rights issue has features in common with a bonus issue and with an issue at
full market price. A rights issue gives a shareholder the right to buy shares
from the company at a price set below the market value. Thus:
the company will receive a consideration which is available to
boost earnings (like an issue at full price); and
the shareholder receives part of the share for no consideration (like
a bonus issue).
The method of calculating the number of shares in periods when there has
been a rights issue reflects the above.
A bonus fraction is applied to the number of shares in issue before the date of
the rights issue and the new shares issued are pro-rated as for issues for
consideration.
The bonus fraction is the cum-rights price per share (CRP) divided by the
theoretical ex-rights price per share (TERP). See Worked Example 1.

Worked example 1

X Inc 1 January Shares in issue 1,000,000

31 March Rights issue 1 for 5 at 90c
MV of shares $1 (cum-rights price)

Required:

Calculate the number of shares for use in the EPS calculation.

Worked solution 1

Number
1 January 31 March
1,000,000
3
12

1
9833 .
254,237
1 April 31 December
1,200,000
9
12
900,000

________

1,154,237

________

Rights issue bonus fraction

Shares @ $ $
Cum 5 1 5.0
Rights 1 0.9 0.9

___

____

Ex 6 5.9

___

____

TERP
5 9
6
.
= 0.9833
Bonus fraction
TERP
CRP
=
1
9833 .

Commentary
For presentational purposes, in order to ensure consistency, the comparative figure
for EPS must be restated to account for the bonus element of the issue. This is
achieved by multiplying last years EPS by the inverse of the bonus fraction.
3.3 Multiple capital changes
Method
Write down the number of shares at start of year.
Look forward through the year and write down the total number of shares
after each capital change.
Multiply each number by the fraction of the year that it was in existence.
If the capital change has a bonus element multiply all preceding slices by the
bonus fraction.
Worked example 2

X Inc
1 January 1,000,000 in issue
28 February Issued 200,000 at full market price
31 August Bonus issue 1 for 3
30 November Issued 250,000 at full market price
Required:

Calculate the number of shares which would be used in the basic EPS calculation.

Worked solution 2
1 January 28 February

1,000,000
12
2

3
4
= 222,222

1 March 31 August
1,200,000
12
6

3
4
= 800,000

1 September 30 November
1,600,000
12
3
= 400,000

1 December 31 December
1,850,000
12
1
= 154,167

________

1,576,389

________


Activity 1 Multiple capital changes

1 January 1,000,000 in issue
28 February Full market price 400,000
31 March Bonus issue 1 for 2
31 July Full market price 900,000
30 September Rights issue 1 for 3 Bonus fraction
22
21

Required:

Calculate the number of shares which would be used in the basic EPS
calculation.

Proforma solution
Number

1 March 31 March

1 April 31 July

1 August 30 September

1 October 31 December

________

________

3.4 Issuable shares
3.4.1 Mandatorily convertible instrument
Shares that will be issued on the conversion of mandatorily issuable
instruments will be included in the weighted average number of shares from
the date that the contract is entered into.

Commentary
This is consistent with IAS 39. These are items that will be classified as equity
instruments and therefore it is appropriate to include in the EPS calculation.
3.4.2 Contingently issuable shares
Contingently issuable shares will be included in the weighted average number
of ordinary shares from the date all necessary conditions and events have
occurred to allow the issue of the shares.

Commentary
This is again consistent with IAS 39 as they will be included in liabilities
unless the likelihood of settlement in cash is remote. On conversion they will
be included in equity and also in the EPS calculation.
3.4.3 Contingently refundable shares
Contingently refundable shares will be included in the weighted average
number of ordinary shares only from the time they are no longer subject to
recall.
4 Diluted earnings per share
4.1 Purpose
Potential ordinary shares may exist whose owners may become shareholders
in the future.
If these parties become ordinary shareholders the earnings will be spread over
a larger number of shares i.e. they will become diluted.

Commentary
Diluted EPS is calculated as a warning to existing shareholders that this may
happen.
Potential ordinary shares should be treated as dilutive only if their conversion
to ordinary shares would decrease earnings per share from continuing
operations.
4.2 Method
The net profit attributable to ordinary shareholders and the weighted average
number of shares outstanding should be adjusted for the affects of all dilutive
potential ordinary shares, i.e:
A new EPS is calculated using:
a new number of shares;
a new earnings figure.
4.2.1 New number of ordinary shares
This should be the weighted average number of ordinary shares used in the
basic EPS calculation plus the weighted average number of ordinary shares
which would be issued on the conversion of all the dilutive potential ordinary
shares into ordinary shares.
Dilutive potential ordinary shares should be deemed to have been converted
into ordinary shares at the beginning of the period or, if later, the date of the
issue of the potential ordinary shares.
New number of shares:
Basic number X
No of shares which could exist in the future:
from the later of
first day of accounting period
date of issue X

__

X

__
4.2.2 New earnings figure
The amount of net profit or loss for the period attributable to ordinary shareholder,
used in the basic EPS calculation, should be adjusted by the after-tax effect of the
potential ordinary shares becoming ordinary shares, i.e. add back:
Any dividends on dilutive potential ordinary shares, which have
been deducted in arriving at the net profit or loss for the period,
attributed to ordinary shareholders.
Interest recognised in the period for the dilutive potential ordinary
shares.
Any other changes in income or expense that would result from the
conversion of the dilutive potential ordinary shares.


Worked example 3 Diluted EPS

Convertible bonds

1 January Shares in issue 1,000,000
Profit for the year ended 31 December $200,000

31 March Co issues $200,000 6% convertible bonds

Terms of conversion:

100 shares/$100 if within five years
110 shares/$100 if after five years

Tax rate 33%
Basic EPS
200 000
1 000 000
,
, ,
= 20c

Required:

Calculate diluted EPS.

Worked solution 3
Number of
shares Profit
$
Basic 1,000,000 200,000

Dilution

Shares:
100
200,000
110
9
12
165,000

Interest: $200,000 6%
9
12
0.67 6,030

________

______

1,165,000 206,030

EPS 17.68 cents

When there has been an actual conversion of the dilutive potential ordinary
shares into ordinary shares in the period, a further adjustment has to be made.
The new shares will have been included in the basic EPS from the date of
conversion. These shares must then be included in the diluted EPS
calculation up to the date of conversion.
Worked example 4 Diluted EPS Actual conversion during the year

5% Convertible bonds $100,000
(terms of conversion 120 ordinary shares for $100)

31 March Holders of $25,000 debentures converted to ordinary shares.

Tax rate 30%
Number of
shares
Profit
$

Basic 1,000,000 200,000
New shares on conversion
9
/
12

100
000 , 25 $
120

22,500

Figures for the basic EPS 1,022,500 200,000
Basic EPS is
500 , 022 , 1
000 , 200 $
= 19.6c

Dilution adjustments

Unconverted shares:
100
000 , 75 $
120

90,000

Interest: $75,000 5% 0.7 2,625

Converted shares pre conversion adjustment
3
/
12

100
000 , 25 $
120

7,500

Interest
3
/
12
$25,000 5% 0.7 219

1,120,000

202,844

Diluted EPS is
000 , 120 , 1
844 , 202 $
= 18.1c

4.3 Options
An entity should assume the exercise of dilutive options and other dilutive
potential ordinary shares of the entity.
The assumed proceeds from these issues should be considered to be
received from the issue of shares at fair value.
The difference between the number of shares issued and the number
of shares that would have been issued at fair value should be treated
as an issue of ordinary shares for no consideration.
Options will be dilutive only when they result in the entity issuing shares at
below fair value.
Each issue of shares under an option is deemed to consist of two elements.
A contract to issue a number of shares at a fair value. (This is taken
to be the average fair value during the period.)

Commentary
These are non dilutive.
A contract to issue the remaining ordinary shares granted under the
option for no consideration.(a bonus issue).

Commentary
These are dilutive.
Worked example 5 Options

Average fair value $8

The company has in issue options to purchase 200,000 ordinary shares
Exercise price $6

Required:

Calculate the diluted EPS for the period.


Worked solution 5
Diluted EPS
Number of
shares Profit EPS
$

Basic 1,000,000 100,000 10c

Dilution (W) 50,000

1,050,000 100,000 9.5c

WORKING
Proceeds of issue 200,000 $6 1,200,000

Number that would have been issued at FV $8 = 150,000

Number actually issued 200,000

Number for free 50,000

4.4 Contingently issuable shares
Contingently issuable ordinary shares are included in the calculation of
diluted earnings per share if all the conditions have been satisfied or all the
events have occurred. They would be included from the start of the period
(or from the date the contract was entered into - if later).
If the conditions have not been met, the amount of contingently issuable shares
included in the diluted EPS calculation will be the number of shares that would
be issuable if the end of the period was the end of the contingency period.
5 Significance of EPS
5.1 EPS vs earnings
Prior to 1960, the decision to report EPS, the manner in which it was
calculated, and where it was reported was left solely to the discretion of
company management.
As expected, management chose to report performance in whole dollar
earnings only, which tended to favour large corporations over small
companies. EPS became a reporting necessity to create a level playing
field in performance measurement comparability.
EPS allows comparison between different-sized companies whereas, if only
actual earnings were being compared, the relative size of the company could
not be taken into account.
5.2 Performance measure
The EPS figure is used by market analysts in the calculation of a companies
Price/Earnings (P/E) ratio. Great emphasis is placed on this measure which
can have a significant effect on the way a companys share price moves.
The P/E ratio is also used by investors in assisting in their decisions to
buy/hold or sell shares in a company.
5.3 Problems with EPS
EPS is affected by a companys choice of accounting policy, so can be
manipulated. It also means that comparisons with other companies is not
possible if different policies are being used.
EPS is a historic figure and should not be used as a prediction of future
earnings. A high EPS figure could be achieved through a lack of investment
in new assets, but this will have a detrimental effect on future profits as lack
of investment will lead to companies falling behind their competitors.
EPS is a measure of profitability, but profitability is only one measure of
performance. Many companies now place much higher significance on other
performance measures such as:
customer satisfaction;
cash flow;
manufacturing effectiveness, and
innovation.
6 Presentation and disclosure
6.1 Presentation
Basic and diluted earnings per share (or loss per share if negative) should be
presented in the statement of comprehensive income for:
the profit or loss from continuing operations attributable to ordinary
equity holders of the parent; and
the profit or loss for each class of ordinary shares that has a
different right to share in the net profit for the period.
Basic and diluted earnings per share should be presented with equal
prominence for all periods presented.
If an entity presents the components of profit or loss in a separate income
statement (per IAS 1), that statement should present:
basic and diluted earnings per share; and
basic and diluted earnings per share for discontinued operations.
Illustration 3

Consolidated income statement for year ended 31 December 2006 (extract)
(in CHF)
Earnings per share from continuing operations
Basic earnings per share 7 23.71 20.82
Fully diluted earnings per share 7 23.56 20.63

Nestl Consolidated accounts 2006

6.2 Disclosure
6.2.1 General
The amounts used as the numerators in calculating basic and diluted earnings
per share, and a reconciliation of those amounts to the net profit or loss for
the period.
The weighted average number of ordinary shares used as the denominator in
calculating basic and diluted earnings per share, and a reconciliation of these
denominators to each other.
Instruments that could potentially dilute basic EPS in the future but they were not
included in the diluted EPS because they are anti-dilutive for the period
A description of ordinary or potential share transactions that occurred after
the reporting period that would have significantly changed the number of
ordinary shares or potential ordinary shares had the transactions occurred
before the end of the period.
Illustration 4

7. Earnings per share from continuing operations
2006 2005
(a)

Basic earnings per share (in CHF)
(b)
23.71 20.82
Net profit from continuing operations (in millions of CHF) 9 123 8 095
Weighted average number of shares outstanding 384 801 089 388 812 584

Fully diluted earnings per share (in CHF) 23.56 20.63
Theoretical net profit from continuing operations
(b)
assuming the exercise of all outstanding options
and sale of all treasury shares (in millions of CHF) 9 262

8 248
Number of shares
(c)
393 072 500 399 860 700

(a) 2005 comparatives have been restated following the first application of the option of IAS 19 Employee B
Determining whether an Arrangement contains a Lease, as well as the decision to transfer the fresh che
Nutrition (refer to Note 29).
(b) Profit for the period attributable to the shareholders of the parent adjusted for the net profit/(loss) on disc
(c) Net of the Nestl S.A. shares held in connection with the Share Buy-Back Programme (refer to Note 25)

Nestl Consolidated accounts 2006

6.2.2 Additional EPS
If an additional EPS figure using a reported component of net profit other
than net profit or loss for the period attributable to ordinary shareholders, is
disclosed, such amounts should be calculated using the weighted average
number of ordinary shares determined in accordance with IAS 33.

Commentary
A non-standard profit figure can be used to calculate an EPS in addition to
that required by IAS 33 but the standard number of shares must be used in the
calculation.
If a profit figure is used which is not a reported as a line item in the statement
of comprehensive income, a reconciliation should be provided between the
figure and a line item, which is reported in the statement of comprehensive
income.
6.2.3 Retrospective adjustments
If an EPS figure includes the effects of:
a capitalisation or bonus issue; or
share split; or
decreases as a result of a reverse share split.
The calculation of basic and diluted earnings per share for all periods
presented should be adjusted retrospectively.
For changes after the reporting period but before issue of the financial
statements, the per share calculations for those and any prior period financial
statements presented should be based on the new number of shares.

Commentary
When per share calculations reflect such changes in the number of shares,
that fact should be disclosed.
Basic and diluted EPS of all periods presented should be adjusted for the
effects of errors, and adjustments resulting from changes in accounting
policies.

Focus
You should now be able to:

recognise the importance of comparability in relation to the calculation of
earnings per share (EPS) and its importance as a stock market indicator;
explain why the trend of EPS may be a more accurate indicator of
performance than a companys profit trend;
define earnings;
calculate the EPS in accordance with IAS 33:
basic EPS;
where there has been a bonus issue of shares/stock split during the year; and
where there has been a rights issues of shares during the year;
explain the relevance to existing shareholders of the diluted EPS, and
describe the circumstances that will give rise to a future dilution of the EPS;
compute the diluted EPS where:
convertible debt or preference shares are in issue; and
share options and warrants exist;
identify anti-dilutive circumstances.
Activity solution
Solution 1 Multiple capital change

1,000,000
2
12

3
2

22
21
= 261,905

1 March 31 March
1,400,000
1
12

3
2

22
21
= 183,333

1 April 31 July
2,100,000
4
12

22
21
= 733,333

1 August 30 September
3,000,000
2
12

22
21
= 523,810

1 January 31 December
4,000,000
3
12
=1,000,000

________

2,702,381

________

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SESSION 29 IAS 33 EARNINGS PER SHARE

Accountancy Tuition Centre (International Holdings) Ltd 2008 2901

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