Chapter 18

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Earnings per share

Contents
1. IAS 33 Earnings per share 2. Basic EPS 3. Effect on EPS of changes in capital structure 4. Diluted EPS 5. Presentation, disclosure and other matters

IAS 33 Earnings per share

Earnings per share EPS is used to assess the ongoing financial performance of a company from year to year, and to compute the major stock market indicator of performance, the Price Earnings ratio PE ratio)

Key Definition
Ordinary shares. An equity instrument that is subordinate to all other classes of equity instruments. Potential ordinary share. A financial instrument or other contract that may entitle its holder to ordinary shares. Options, warrants and their equivalents. Financial instruments that give the holder the right to purchase ordinary shares. Financial instrument. Any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. Equity instrument. Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities

Basic EPS
Calculation of basic EPS:
Basic EPS Weighted Net average profit /(loss) number of attributable to ordinary shareholders ordinary shares outs tan ding during the period

Preference dividends deducted from net profit consist of:

Preference dividends on non-cumulative preference shares deciared in respect of the period

The full amount of the required preference dividends for cumulative preference shares for the period, whether or not they have been declared

Weighted average number of shares

Example:
Justina Co, a listed company, has the following share transactions during 207 Shares Date Details issued
1 January 207 31 May 207 31 December 207 Balance at beginning of year Issue of new shares for cash Balance at year end 170,000 80,000 250,000

Required Calculate the weighted average number of shares outstanding for 207.

Weighted average number of shares

Solution
The weighted average number of shares can be calculated in two ways. (a) (170,0005/12)+(250,0007/12) =216,666 shares (b) (170,00012/12)+(80,0007/12) =216,666 shares

Consideration
Consideration
In exchange for cash

Start date for inclusion

When cash is receivable

As a result of the conversion of a Date interest ceases accruing debt instrument to ordinary shares
In place of interest or principal on other financial instruments In exchange for the settlement of a liability of the entity As consideration for the acquisition of an asset other than cash For the rendering of services to the entity Date interest ceases accruing The settlement date The date on which the acquisition if recognized As services are rendered

Basic EPS Question

Flame Co is a company with a called up and paid up capital of 100,000 ordinary share of $1 each and 20,000 10% redeemable preference shares of $1 each. The company manufactures gas appliances. During its financial year to 31 December the company had to pay $50,000 compensation and costs arising from an uninsured claim for personal injuries suffered by a customer while on the company premises. The gross profit was $200,000. Flame Co paid the required preference share dividend and declared an ordinary dividend of 42c per share. Assuming an income tax rate of 30% on the given figures show the trading results an EPS of the company.

Basic EPS Answer

FLAME CO
TRADING RESULTS FOR YEAR TO 31 DECEMBER Gross profit Expense (50,000+2,000 preference dividend) Profit before tax Tax at 30% Profits for the period $ 200,000 (52,000) 148,000 (44,400) 103,600

EARNINGS PER SHARE

103,600/100,000=103.6c

Earnings per share with a new issue Example

On 30 September 202, Boffin Co made an issue at full market price of 1,000,000 ordinary shares. The companys accounting year runs from 1 January to December. Relevant information for 201 and 202 is as follows.
Share in issue as at 31 December Profit after tax and preference dividend 202 9,000,000 $3,300,000 201 8,000,000 $3,280,000

Required
Calculate the EPS for 202 and the corresponding figure for 201.

Earnings per share with a new issue Solution

202
Weighted average number of shares
8 million9/12 8 million3/12 6,000,000 2,250,000 8,250,000 8,000,000 $3,300,000$ 3,280,000 40 cents 41 cents

201

Earnings EPS

Earnings per share with a new issue

The events which change the number of share outstanding

Capitalization of bonus issue

Rights-issue

Reverse share split

Share split

Earnings per share with a bonus issue

Example
Greymatter Co had 400,000 shares in issue, until on 30 September 202 it made a bonus issue of 100,000 shares. Calculate the EPS for 202 and the corresponding figure for EPS are to remain comparable.

Earnings per share with a bonus issue

Solution
Earnings Shares at 1 January Bonus issue EPS

202 $80,000 400,000 100,000

500,000 share

201 $75,000 400,000 100,000

500,000 share

16c

15c

The number of shares for 201 must also be adjusted if the figures for EPS are to remain comparable.

Theoretical ex-rights price

Example
Suppose that Egghead Co has 10,000,000 shares in issue. It now proposes to make a 1 for 4 rights issue at a price of $3 per share. The market value of existing shares on the final day before the issue is made is $3.50 (this is the with rights value). What is the theoretical ex-rights price per share?

Theoretical ex-rights price

Solution
$
Before issue 4 shares, value $3.50 each Rights issue 1 share, value $3 Theoretical value of 5 shares 14.00 3.00 17.00

Theoretical ex-rights price=$17.00/5=$3.40 per share Not that this calculation can alternatively be performed using the total value and number of outstanding shares.

Procedures
(a) The EPS for the corresponding previous period should be multiplied by the following fraction.

Fair

Theoretical ex rights fair value per share value per share immediately before the exercise

of

rights

(b) To obtain the EPS for the current year you should: (i) Multiply the number of shares before the rights issue by the fraction of the year before the date of issue and by the following fraction. Fair value per share immediately before the exercise of rights Theoretical ex rights fair value per share

(ii) Multiply the number of shares after the rights issue by the fraction of the year after the date of issue and add to the figure arrived at in (i).

Earning per share with a rights issue

Example
Brains Co had 100,000 shares in issue, but then makes a 1 for 5 rights issue on 1 October 202 at a price of $1. The market value on the last day of quotation with rights was $1.60. Calculate the EPS for 202 and the corresponding figure for 201 given total earnings of $50,000 in 202 and $40,000 in 201.

Theoretical ex-rights price

Solution
Calculation of theoretical ex-rights price:
Before issue 5 shares, value$1.60 Rights issue 1 share, value $1.00 Theoretical value of 6 shares $ 8.00 1.00 9.00

Theoretical ex-rights price=$9/6=$1.50 EPS for 201

EPS as calculated before taking into account the tights issue=40c EPS=1.5/1.640c=37.5c

Theoretical ex-rights price

Solution
EPS for 202
Number of shares before the tights issue was 100,000.20,000 shares were issued. stage 1: 100,0009/121.6/1.5 80,000 stage 2: 120,0003/12 30,000 EPS=$50,000/110,000=45.5c

The figure for total earnings is the actual earnings for the years.

Diluted EPS
Diluted EPS is a theoretical measure of the effect of dilution on basic EPS and is not used as much as basic EPS by analysts because of its hypothetical nature.

Earnings
The earnings calculated for basic EPS should be adjusted by the post-tax (including deferred tax) effect of: (a) Any dividends on dilutive potential ordinary shares that were deducted to arrive at earnings for basic EPS. (b) Interest recognized in the period for the dilutive potential ordinary shares. (c) Any other changes in income or expenses (fees or discount) that would result from the conversion of the dilutive potential ordinary shares.

Per share
It should be assumed that dilutive ordinary shares were converted into ordinary shares at the beginning of the period or, if later, at the actual date of issue. There are two other point.

The computation assumes the most advantageous conversion rate or exercise rate from the standpoint of the holder of the potential ordinary shares.

Contingerntly issuable (potential) ordinary shares are treated as for basis EPS; if the conditions have not been met, the number of contingently issuable shares included in the computation is based on the number of shares that would be issuable if the end of the reporting period was the end of the contingency period.

Diluted EPS
Example
In 207 Farrah Co had a basic EPS of 105c based on earnings of $105,000 and 100,000 ordinary $1 shares. It also had in issue $40,000 15% convertible loan stock which is convertible in two years time at the rate of 4 ordinary shares for every %5 of stock. The rate of tax is 30%. In 207 gross profit of $200,000 and expenses of $50,000 were recorded, including interest payable of $6,000.

Required
Calculate the diluted EPS.

Diluted EPS
Solution
Diluted EPS is calculated as follows: Step 1 Number of shares: the additional equity on conversion of the loan stock will be 40,0004/5=32,000 shares Step 2 Earnings: Farrah Co will save interest payments of $6,000 but this increase in profits will be taxed. Hence the earnings figure may be recalculated:
Gross profit Expenses (50,000-6,000) Profit before tax Tax expense (30%) Earnings
$ 200,000 (44,000) 156,000 (46,800) 109,200

Diluted EPS

Step 3
Step 4

Calculation:
Dilution:

Diluted EPS=$109,200/132,000=82.7c the dilution in earnings would be 105c-82.7c=22.3c per share

Presentation, disclosure and other matters

Presentation

Disclosure must still be made where the EPS figures (basic and/or diluted) are negative (ie a loss per share).

Disclosure

An entity should disclose the following. (a) The amounts used as the numerators in calculating basic and diluted EPS, and a reconciliation of those amounts to the net profit or loss for the period. (b) The weighted average number of ordinary shares used as the denominator in calculating basic and diluted EPS, and a reconciliation of these denominators to each other.

Presentation, disclosure and other matters

Alternative EPS figures

An entity may present alternative EPS figures if it wishes. IAS 33 lays out certain rules where this takes place. (a) The weighted average number of shares as calculated under IAS 33 must be used. (b) A reconciliation must be given between the component of profit used in the alternative EPS (if it is not a line item in the statement of comprehensive income) and the line item for profit reported in the statement of comprehensive income. (c) Basic and diluted EPS must be shown with equal prominence.

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