DipIFR-Session29 d08 Earnings Per Share

7/27/2019 DipIFR-Session29 d08 Earnings Per Share

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SESSION 29 IAS 33 EARNINGS PER SHARE

Accountancy Tuition Centre (International Holdings) Ltd 2008 2901

Overview

Objective

To explain the provisions of IAS 33.

SIGNIFICANCEOF EPS

Presentation Disclosure

PRESENTATIONAND

DISCLOSURE

EPS vs earnings Performance measure Problems with EPS

INTRODUCTION

EARNINGS PERSHARE (EPS)

FULLYDILUTED EPS

WEIGHTEDAVERAGE 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


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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 notcontain information about the increase in investment that has been made inthe period.

It isnotuseful 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 ina public market).

IAS 33 also applies to the consolidated financial statements of a group whoseparent is required to apply IAS 33 to its separate financial statements.

An entity that discloses EPS should calculate and disclose it in accordancewith IAS 33.

1.3 Definitions

An ordinary share is an equity instrument that is subordinate to all other

classes of equity instruments.

An equity instrumentis any contract that evidences a residual interest in theassets of an entity after deducting all of its liabilities.

Apotential ordinary share is a financial instrument or other contract that mayentitle 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 theholder the right to purchase ordinary shares.

Dilution is the reduction in EPS (or an increase in loss per share) resultingfrom the assumption that convertible instruments are converted, thatwarrants/options are exercised, or that ordinary shares are issued upon thesatisfaction of specified conditions.

Contingently issuable ordinary shares are ordinary shares issuable for little orno cash or other consideration upon the satisfaction of specified conditions.


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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 thoseordinary shareholders.

The basic EPS calculation is made by dividing the profit (or loss) relating tothe ordinary shareholders by the weighted average number of ordinary sharesoutstanding 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 theordinary shareholders.

Adjusted for:

post-tax effect of preference dividends (and other items relating topreference 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 aperiod the holders accumulate their rights.

The profit or loss will be adjusted for the post-tax effect of thepreference 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 theholder losses the right to the dividend.

The profit or loss will only be adjusted for preference dividendsdeclared in relation to the period.


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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 forshares 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 toensure consistency between the top and bottom of the basic EPS calculationthe 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 theperiod and for all periods presented should be adjusted for events, that havechanged the number of ordinary shares outstanding, without a correspondingchange in resources. For example:

Bonus issues; Bonus elements in another issue (e.g. a rights issue); Share splits; Reverse share splits.


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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

110=

+

The EPS will fall (all other things being equal) because the earnings are beingspread 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 arebeing used in an analysis must be adjusted. This is done by multiplying thecomparative by the inverse of the bonus fraction.

Illustration 2

Last years EPS11

10

3.2.2 Rights issues

A rights issue has features in common with a bonus issue and with an issue atfull market price. A rights issue gives a shareholder the right to buy sharesfrom the company at a price set below the market value. Thus:

the company will receive a consideration which is available toboost earnings (like an issue at full price); and

the shareholder receives part of the share for no consideration (likea bonus issue).

The method of calculating the number of shares in periods when there hasbeen a rights issue reflects the above.

A bonus fraction is applied to the number of shares in issue before the date ofthe rights issue and the new shares issued are pro-rated as for issues forconsideration.

The bonus fraction is the cum-rights price per share (CRP) divided by thetheoretical ex-rights price per share (TERP). See Worked Example 1.


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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 March1,000,000

3

12

1

9833.254,237

1 April 31 December1,200,000

9

12900,000

________

1,154,237________

Rights issue bonus fraction

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

___

____

Ex 6 5.9___

____

TERP5 9

6

.= 0.9833

Bonus fractionTERP

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.


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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 sharesafter 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 thebonus fraction.

Worked example 2

X Inc

1 January 1,000,000 in issue28 February Issued 200,000 at full market price31 August Bonus issue 1 for 330 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 February1,000,000

12

2

3

4= 222,222

1 March 31 August1,200,000

12

6

3

4= 800,000

1 September 30 November1,600,000

12

3= 400,000

1 December 31 December1,850,000

12

1= 154,167

________

1,576,389________


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Activity 1 Multiple capital changes

1 January 1,000,000 in issue28 February Full market price 400,00031 March Bonus issue 1 for 231 July Full market price 900,000

30 September Rights issue 1 for 3 Bonus fraction22

21

Required:

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

calculation.

Proforma solutionNumber

1 January 28 February

1 March 31 March

1 April 31 July

1 August 30 September1 October 31 December

________

________


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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 fromthe 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 haveoccurred 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 averagenumber of ordinary shares only from the time they are no longer subject torecall.

4 Diluted earnings per share

4.1 Purpose

Potential ordinary shares may exist whose owners may become shareholdersin the future.

If these parties become ordinary shareholders the earnings will be spread overa 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 conversionto ordinary shares would decrease earnings per sharefrom continuingoperations.


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4.2 Method

The net profit attributable to ordinary shareholders and the weighted averagenumber 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 thebasic EPS calculation plus the weighted average number of ordinary shareswhich would be issued on the conversion of all the dilutive potential ordinaryshares into ordinary shares.

Dilutive potential ordinary shares should be deemed to have been convertedinto ordinary shares at the beginning of the period or, if later, the date of theissue of the potential ordinary shares.

New number of shares:

Basic number XNo 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 havebeen 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 ordinaryshares.

Any other changes in income or expense that would result from theconversion of the dilutive potential ordinary shares.


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Worked example 3 Diluted EPS

Convertible bonds

1 January Shares in issue 1,000,000Profit 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 years110 shares/$100 if after five years

Tax rate 33%

Basic EPS200 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

12165,000

Interest: $200,000 6% 9

12 0.67 6,030

________

______

1,165,000 206,030

EPS 17.68 cents


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When there has been an actual conversion of the dilutive potential ordinaryshares 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 ofconversion. These shares must then be included in the diluted EPScalculation up to the date of conversion.

Worked example 4 Diluted EPS Actual conversion during the year

1 January Shares in issue 1,000,0005% Convertible bonds $100,000(terms of conversion 120 ordinary shares for $100)Profit for the year ended 31 December $200,000

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 is500,022,1

000,200$= 19.6c

Dilution adjustmentsUnconverted 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

Interest3

/12 $25,000 5% 0.7 2191,120,000

202,844

Diluted EPS is000,120,1

844,202$= 18.1c


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4.3 Options

An entity should assume the exercise of dilutive options and other dilutivepotential ordinary shares of the entity.

The assumed proceeds from these issues should be considered to bereceived from the issue of shares at fair value.

The difference between the number of shares issued and the numberof shares that would have been issued at fair value should be treatedas an issue of ordinary shares for no consideration.

Options will be dilutive only when they result in the entity issuing shares atbelow 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 takento be the average fair value during the period.)

Commentary

These are non dilutive.

A contract to issue the remaining ordinary shares granted under theoption for no consideration.(a bonus issue).

Commentary

These are dilutive.

Worked example 5 Options

1 January Shares in issue 1,000,000Profit for the year ended 31 December $100,000Average fair value $8

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

Required:

Calculate the diluted EPS for the period.


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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

WORKINGProceeds 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 ofdiluted earnings per share if all the conditions have been satisfied or all theevents 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 sharesincluded in the diluted EPS calculation will be the number of shares that wouldbe 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 ofcompany management.

As expected, management chose to report performance in whole dollarearnings only, which tended to favour large corporations over smallcompanies. EPS became a reporting necessity to create a level playingfield in performance measurement comparability.

EPS allows comparison between different-sized companies whereas, if onlyactual earnings were being compared, the relative size of the company couldnot be taken into account.


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5.2 Performance measure

The EPS figure is used by market analysts in the calculation of a companiesPrice/Earnings (P/E) ratio. Great emphasis is placed on this measure whichcan 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 tobuy/hold or sell shares in a company.

5.3 Problems with EPS

EPS is affected by a companys choice of accounting policy, so can bemanipulated. It also means that comparisons with other companies is notpossible if different policies are being used.

EPS is a historic figure and should not be used as a prediction of futureearnings. 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 lackof investment will lead to companies falling behind their competitors.

EPS is a measure of profitability, but profitability is only one measure ofperformance. Many companies now place much higher significance on otherperformance 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 bepresented in the statement of comprehensive income for:

the profit or loss from continuing operations attributable to ordinaryequity 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 withequalprominence for all periodspresented.

If an entity presents the components of profit or loss in a separate incomestatement (per IAS 1), that statement should present:

basic and diluted earnings per share; and basic and diluted earnings per share for discontinued operations.


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Illustration 3

Consolidated income statement for year ended 31 December 2006 (extract) (in CHF)Earnings per share from continuing operationsBasic earnings per share 7 23.71 20.82Fully 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 earningsper share, and a reconciliation of those amounts to the net profit or loss forthe period.

The weighted average number of ordinary shares used as the denominator incalculating basic and diluted earnings per share, and a reconciliation of thesedenominators 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 afterthe reporting period that would have significantly changed the number ofordinary shares or potential ordinary shares had the transactions occurredbefore the end of the period.


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Illustration 4

7. Earnings per share from continuing operations2006 2005 (a)

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

Fully diluted earnings per share (in CHF) 23.56 20.63Theoretical 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 BDetermining whether an Arrangement contains a Lease, as well as the decision to transfer the fresh cheNutrition (refer to Note 29).

(b) Profit for the period attributable to the shareholders of the parent adjusted for the net profit/(loss) on dis(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 otherthan net profit or loss for the period attributable to ordinary shareholders, isdisclosed, such amounts should be calculated using the weighted averagenumber 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 thefigure and a line item, which is reported in the statement of comprehensiveincome.


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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 periodspresented should be adjusted retrospectively.

For changes after the reporting period but before issue of the financialstatements, the per share calculations for those and any prior period financialstatements 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 theeffects of errors, and adjustments resulting from changes in accountingpolicies.

Focus

You should now be able to:

recognise the importance of comparability in relation to the calculation ofearnings per share (EPS) and its importance as a stock market indicator;

explain why the trend of EPS may be a more accurate indicator ofperformance 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, anddescribe 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.


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Activity solution

Solution 1 Multiple capital change

1 January 28 February1,000,000

2

12

3

2

22

21= 261,905

1 March 31 March1,400,000

1

12

3

2

22

21= 183,333

1 April 31 July2,100,000

4

12

22

21

= 733,333

1 August 30 September3,000,000

2

12

22

21= 523,810

1 January 31 December4,000,000

3

12 =1,000,000

________

2,702,381________


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DipIFR-Session29 d08 Earnings Per Share