EARNINGS PER SHARE

1 Business Context

A key performance measure of an entity is its earnings per share (EPS) figure. It is an important element of the price earnings ratio which is often used for business valuation purposes. However, EPS is only as good as the basis on which it has been calculated. If there were no guidelines setting out how such a measure should be calculated, then entities would have the ability to derive a measure that presented a favorable position even where this was not the reality. Put simply, EPS is calculated as reported profits divided by the number of shares in issue. Although entities adopt different accounting policies which may affect their reported profits, they are required to calculate the number of shares in issue in a consistent manner. Setting such guidelines minimizes an entity’s ability to report an EPS figure that has been adjusted to fit particular circumstances. Consistency of calculation improves an entity’s financial reporting and aids the ability of users to make useful comparisons between different entities.

2 Chapter Objectives

On completion of this chapter you should be able to:

 understand the purpose of earnings per share and the objective of IAS 33 Earnings per share;

 demonstrate knowledge of the calculation of basic EPS;

 be able to adjust EPS for changes in the number of shares resulting from, for example, a bonus issue;

 understand what diluted and adjusted EPS figures are; and

 demonstrate the disclosure requirements within IAS 33.

3 Objectives, Scope and Definitions of IAS 33

The objective of IAS 33 is to set out principles for the calculation and presentation of EPS, to improve performance comparisons between different entities in the same reporting period and between different reporting periods for the same entity. Since EPS is a measure of performance based on the reported profits of the entity, it is important to appreciate that

entities may have adopted different accounting policies in calculating their profits. IAS 33 applies to entities whose ordinary shares are publicly traded or are in the process of being issued in public markets. Where an entity presents both group financial statements and individual entity financial statements, EPS disclosures are only required in the consolidated financial statements. However, an entity is permitted to disclose EPS information in the entity’s individual financial statements. [IAS 33.2, 33.4]

4 Basic Earnings Per Share

An entity is required to calculate and present a basic EPS amount based on the profit or loss for the period attributable to the ordinary equity holders of the parent entity. If an entity has reported such a profit or loss from ‘continuing operations’ separately, then it is also required to report a basic EPS figure based on that profit or loss.

If an entity reports the profit or loss from discontinued operations, basic EPS should also be calculated based on that profit or loss. Basic EPS is calculated by dividing the relevant profit or loss (the numerator) by the weighted average number of ordinary shares outstanding (the denominator) during the period. Net profit (loss) for the period attributable to ordinary shareholders/ Weighted average number of ordinary shares outstanding during the period Shares should generally be included in the weighted average number of shares from the date the consideration for their issue (this is generally the date of their issue) is receivable.

4.1 Calculating earnings

To arrive at the profit or loss attributable to the ordinary shareholders, it is necessary to deduct any dividends or other financing costs in relation to preference shares. Such adjustments will include the financing cost associated with any redemption premium payable on preference shares. The dividends on redeemable preference shares are usually included as part of profit or loss for the period as finance costs in accordance with IAS 32 Financial instruments: presentation. Where a dividend has not been declared in respect of non-cumulative preference shares, no deduction should be made. However, where an entity has cumulative preference shares, one year of dividend should be deducted, regardless of when the dividend is actually declared and paid. [IAS 33.12]

Illustration 1

An entity’s profit after tax is CU10,000. The entity has two classes of preference share capital in issue:

 CU10,000 8% redeemable preference shares which are classified as debt within the financial statements. The related dividend has been included in profit or loss for the period as a finance cost.

 CU5,000 10% irredeemable preference shares which are classified within equity. The related dividend is included in the statement of changes in equity. The redeemable preference share dividend has already been deducted in arriving at the profit after tax. The irredeemable preference dividend of CU500 needs to be deducted to arrive at the profit attributable to ordinary shareholders of CU9,500.

4.2 Calculating the weighted average number of ordinary shares

The weighted average number of ordinary shares is used in the calculation of the basic EPS figure. This takes into account changes in the number of shares during the period. The starting point is the number of shares that were outstanding at the beginning of the period. This is then adjusted for shares issued or cancelled during the period. Where the number of shares has changed during the period, a time weighting factor should be applied, being the number of days that the shares were outstanding as a proportion of the total number of days in the period.

Illustration 2

An entity has 10m ordinary shares in issue at 1 January 2007. Its year end is 31

December. During 2007 the following events occur:

1 April 2007 2m shares are issued to acquire a subsidiary;

1 October 2007 4m shares are issued to raise cash to repay borrowings. The weighted average number of ordinary shares is calculated as follows.

Number of shares outstanding at the beginning of the period

10m x 12/12 = 10.0m

2m additional shares issued 1 April as consideration for the acquisition, in existence for

the remaining 9 months of the year

2m x 9/12 = 1.5m

4m additional shares issued 1 October for cash, in existence for the remaining 3

months of the year

4m x 3/12 = 1.0m

Weighted average number of shares outstanding = 10.0 + 1.5 + 1.0 = 12.5m

The share issues in Illustration 2 both result in an increase in the entity’s resources, in the form of cash and profit-earning net assets respectively. As these additional resources were only available for part of the accounting period, the number of shares has been time weighted proportionately. But where there has been a change in the number of shares without a corresponding change in the resources of the entity, as with a bonus issue, for example, the weighted average number of shares should be adjusted by assuming that this new number of shares had always been outstanding. This adjustment therefore assumes that the new issue of shares had occurred at the beginning of the earliest period reported. The EPS calculation for

comparative periods reported should also be adjusted in respect of such issues. [IAS 33.26] Examples of where the number of shares change but there is no corresponding change in resources include:

 a bonus issue (or stock dividend). This is where shares are issued to current shareholders for no consideration, i.e. shares given for free. In a stock dividend,

shares are issued to the shareholders rather than the entity paying out a cash dividend. In such circumstances the number of shares increases but there is no change to the entity’s resources (assets); and

 a share split. This is where the entity splits each share that is currently in issue. For example, an entity currently has 1,000 CU10 shares in issue. The entity is reorganizing its funding and therefore wishes to split the shares into CU5 units. Following the share split there will be 2,000 CU5 shares in issue. The resources of the entity have not changed.

This backdating of the new shares to the beginning of the earliest period reported is also to be applied to bonus and other similar issues made after the end of the reporting period but before the financial statements are authorized for issue.

Illustration 3

At 1 January 2007 an entity had in issue 20m ordinary shares. During 2007 the following events took place:

 31 May 2007: issue of 6m shares for cash.

 30 September 2007: 1 for 2 bonus issue. Net profit for the year ended 31 December 2007 was CU8m.

EPS for 2007

Weighted average shares: Weighted average number of shares at the beginning of the year

20m x 12/12 = 20.0m

6m shares issued for cash on 31 May, in existence for 7 months

6m x 7/12 = 3.5m

1 for 2 bonus issue on 20 September – as no additional resources were received, adjust number of shares for the complete period

 For shares outstanding at the beginning of the year: 20m x ½ x 12/12 = 10.0m

 For shares issued on 31 May: 6m x ½ x 7/12 = 1.75m

Weighted average number of shares for the period is:

20.0m + 3.5m + 10.0m + 1.75m = 35.25m

Earnings per share for 2007:

CU8m / 35.25m = CU0.227

Chapter 24 – Earnings Per Share

Page 345

5 Diluted Earnings Per Share

In certain circumstances IAS 33 also requires an entity to disclose a diluted EPS figure. A diluted EPS figure takes account of any convertible instruments such as convertible preference shares already in issue, presenting a performance measure setting out the effect that these will have on the basic EPS calculation if conversion occurs. A dilution is basically a reduction in the EPS figure (or increase in a loss per share) that will result on the conversion of convertible instruments in issue as a result of more shares being in issue.

5.1 Calculation of earnings

The starting point in calculating the profit or loss used in the diluted EPS figure is the profit or loss for basic EPS. However, following the conversion of the convertible instruments, the entity will no longer have to pay out the financing costs on the convertible instruments. Holders will instead be entitled to participate in the net profit attributable to the ordinary equity holders, through their holdings of the additional shares. Therefore, the net profit should be increased by the financing costs no longer payable on these convertible instruments.

5.2 Calculation of the weighted average number of shares

The weighted average number of shares is that used for basic EPS plus the number of shares that would be issued if the convertible instruments were converted. It is assumed that the conversion took place at the beginning of the earliest period reported, i.e. they had always been in existence. The conversion of all instruments with the potential to be ordinary shares should be assumed. This embraces not only convertible debt or preference shares but also, for example, shares options. All such instruments are included in the calculation if their presumed conversion would lead to a dilution in basic EPS (a decrease in EPS or increase in a loss per share). To establish whether such instruments are dilutive, their conversion should be determined using the profit or loss from continuing operations. Where dilutive share options are held, the proceeds received from their exercise is presumed to have been from the issue of shares at the average market price. If the number of shares from this calculation is less than the actual number of shares required to be issued

on exercise, then the additional shares are assumed to have been issued for no consideration (i.e. a bonus issue).

6 Presentation and Disclosure

An entity is required to present both the basic and diluted EPS figures for profit or loss from continuing operations in its statement of comprehensive income. The basic and diluted EPS figures should be presented with equal prominence for all periods reported i.e. comparative figures are also required. The EPS figures are required even where the entity has made a loss during the period, in which case the reported figures will represent a loss per share. In addition, if the entity has discontinued operations during the period, then a basic and diluted EPS figure should be reported based on the discontinued results of the entity. This figure may be presented either in its statement of comprehensive income or as part of the notes. If a separate income statement and statement of comprehensive income is prepared by the entity in accordance with IAS 1 Presentation of financial statements, then the EPS calculations based on continuing and discontinued operations should be reported in the separate income statement.

An entity should disclose the following with respect to the basic and diluted EPS figures:

 the amounts used as the numerator in both calculations and a reconciliation of those amounts to the reported profit or loss attributable to the parent entity for the period;

 the weighted average number of ordinary shares used as the denominator for both calculations; and

 a reconciliation of the weighted average number of shares used in the basic EPS calculation to that used for diluted EPS. Individual adjustments should be separately identified in the reconciliation. If share transactions have taken place after the end of the reporting period and the number of shares would have changed significantly from those used in the calculations had the issue taken place before this date, then this fact should be disclosed. An entity is permitted to report an EPS figure that has been adjusted for specific events in addition to the basic and diluted EPS figures. Examples of such additional EPS figures

might be to remove one-off profits or losses that have arisen during the period from, say, the sale of a large piece of machinery. In these circumstances the entity may wish to report a more ‘steady’ EPS figure. If such additional EPS figures are reported, then they should be calculated based on the same weighted average number of shares as for the basic and diluted EPS figures. If the profit or loss figure used in the calculation is not a reported component of the statement of comprehensive income, then a reconciliation to such an item should be presented. Additional EPS figures should be presented in the notes to the

financial statements.