Calculating Basic Earnings per Share
Justin Chircop
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Objectives
• To introduce the concept of earnings per share and to understand why
so much emphasis is placed on this number
• To distinguish between the ‘basic earnings per share’ and ‘diluted
earnings per share’ metrics
• To review some of the key issues and techniques associated with
computing basic earnings per share
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Session overview
• What is earnings per share and why is it such an important figure?
• Relevant accounting standards for basic (and diluted) earnings per share
• Computational practicalities involving the numerator (earnings)
– The definition of earnings
• Computational practicalities involving the denominator (number of
shares)
– Weighted average number of shares
– Adjustments for share issues involving no corresponding inflow of capital
– Hybrid share issues such as discounted rights issue
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Earnings per share
• Given the equity approach to financial reporting, a natural demand exists
for an equity-based measure of periodic performance
– Earnings per share (EPS) is designed to meet this demand
• The concept of EPS is that earnings are apportioned to owners’ equity
Profit after tax, minority interest, preference dividends
Number of ordinary shares
– Provides indication of amount of earnings available to ordinary shareholders
– Enables earnings associated with an equity stake in one company to be
compared with those from an equity stake in another company
• EPS is one of the most widely quoted statistics in financial analysis
– Important input to earnings-based valuation models
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Earnings per share (continued)
• How important is EPS for valuation?
“At 8.15am each weekday morning the security salesmen and analysts
at my firm meet to consider the ideas that will be put to our 300 or so
institutional customers during the day. Analysts give their
recommendations for specific shares: buy, hold or sell. It is these
recommendations, together with similar conclusions reached at 20 or
so other security houses, that collectively drive the share prices in the
market. The single most important figure affecting the analysts’ and
hence the markets’ view is forecasted EPS.”
(Ian Hay Davidson, Financial Analyst at CLSA)
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Number
of
Estimate
s
Announce
date of the
Actual,
from the
Detail
Actuals File
IBES
Ticker
Symbol
Official
Ticker
Symbol
Measur
e
Periodicity
@TSC
TSCO
EPS
ANN
34
32.52
32.73
1.74
36.86
29.6
20110228
35.72
20110419
@TSC
TSCO
EPS
ANN
30
34
34
1.67
37
31
20120229
37.41
20120418
@TSC
TSCO
EPS
ANN
26
31.47
31.63
1.83
35
28.6
20130228
35.97
20130417
Median
Estimate
Mean
Estimate
Standard High
Deviation Estimate
Low
Estimat
e
Actual
Value,
from
Forecast
the
Period End Detail
Date (SAS Actual
Format)
s File
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Earnings per share – frequently used in performance contracts
• How important is EPS for performance measurement?
EXECUTIVE COMPENSATION ARRANGEMENTS AT TESCO PLC
ALL EXECUTIVE DIRECTORS: PERFORMANCE-RELATED INCENTIVE PAY (TESCO 2012 AR)
PERIOD
Shortterm
(70% of
bonus)
Longterm
MEASURES INCENTIVISES
MAX
INCLUDING
POTENTIAL %
OF BASE
SALARY
Earnings per
Year on year
200-250%
share
earnings growth
(underlying
profit)
EPS growth
Longer-term
225-275%
earnings growth
PERFORMANCE
PERIOD
DELIVERED
VIA
One Year
Annual cash and
annual deferred
share bonuses
(3-year deferral)
Executive shares or
discretionary share
options*
Three years
Note: Vesting of the options is dependent on the achievement of earnings per share performance
conditions, with the first 100% subject to the achievement of EPS growth of at least RPI plus 9% over three
years and the balance vesting for achieving EPS growth of at least RPI plus 15%.
(2012 AR, p. 67)
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Calculating earnings per share – IAS 33 (Revised)
• IAS 33 was first introduced for accounting periods beginning on or after
1 Jan 1998, and revised for periods beginning on or after 1 Jan 2005.
Only minor differences to SFAS 128 in USA (now ASC 260).
• IAS 33 (Revised) requires calculation of both basic and diluted EPS
– Basic EPS aims to provide a measure of the interests of each ordinary share of
a parent entity in the performance of the entity over the reporting period
– The aim of diluted EPS is consistent with basic EPS while also taking into
account all dilutive potential ordinary shares outstanding during the period
• The underlying logic of IAS 33 is that EPS (including diluted EPS) should be
a historical (i.e., backward-looking) performance measure
– Diluted EPS relates to currently ‘overhanging’ securities and not potential
future securities
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS – IAS 33 -top
• Basic EPS calculated as follows:
NB: IAS 33 also requires firms to report EPS
from continuing operations where profit (loss)
on continuing operations is presented as a
separate line item in the P&L statement
Profit (loss) attributable to ordinary shareholders
Number of ordinary shares outstanding and ranking for dividend in the period
© Department of Accounting & Finance,
Lancaster University
Compass Plc 2010 Income Statement: Two EPS figures reported under IAS 33
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS – IAS 33 -top
• Basic EPS calculated as follows:
NB: IAS 33 also requires firms to report EPS
from continuing operations where profit (loss)
on continuing operations is presented as a
separate line item in the P&L statement
Profit (loss) attributable to ordinary shareholders
Number of ordinary shares outstanding and ranking for dividend in the period
• Issues concerning the numerator (earnings)
– Includes all income after deducting
– expense items
– non-controlling interests
– Tax and any preference share dividends
– Ordinary dividends are NOT deducted from the profit figure
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS – bottom (continued)
• Issues concerning the denominator (number of shares)
– Focus is on outstanding ordinary shares (as formally defined in IAS 33)
– All outstanding ordinary shares included in basic EPS with the exception of:
• Partly paid ordinary shares included as a fraction of a share based on their
dividend participation relative to fully paid shares
• Repurchased treasury shares not considered as outstanding for EPS purposes
• Shares that are contingently returnable (e.g., put warrants) → excluded from the
basic eps calculation until they cease to be subject to recall
• Ordinary shares issued subject to conditions (e.g., convertible preference shares)
only included from the date when all conditions satisfied
– Non-equity shares (such as non-voting preference shares) are explicitly
excluded from denominator
– If more than one class of ordinary shares, EPS calculated for each class
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS: A simple example
Capital structure: 45,000,000 ordinary shares of €1 each
10,000,000 5% preference shares of €1 each
Profit on ordinary activities before tax
Tax on profit on ordinary activities
Profit on ordinary activities after tax
Minority interests
Profit for financial year attributable to
members of the holding company
Preference dividends
Ordinary dividends
Retained profit for year
Basic EPS = €5,031,000 / 45,000,000
€’000
6,519
916
5,603
72
5,531
(500)
(2,301)
2,730
= €0.11
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS: Time weighting using weighted average
• Further issues concerning the denominator: Changes during period
– Under IAS 33 all outstanding ordinary shares are brought into the basic EPS
calculation, time-weighted for changes occurring during the period
– Rationale for time-weighting based on an assumed positive correlation
between capital (or more precisely, income-generating assets) and earnings
• More capital implies higher expected earnings and vice versa
• Calculation of basic EPS as a performance measure therefore requires number of
shares to be adjusted to reflect changes in capital available to generate earnings
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Weighted average calculation: Timeline representation
Details:
Financial Year Begins:
Financial Year Ends:
Issued Shares at beg of year:
No. of Shares in Treasury:
Outstanding shares at beg of year:
Share Issues:
Share Repurchases:
1 January 2012
31 December 2012
2,000 shares
300 shares
1,700
800 new shares issued on 31
May 2012
250 shares repurchased on 1
December 2012
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Weighted average calculation: Timeline representation
1 Jan 2012
Start of
financial year
31 Dec 2012
End of
financial year
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Weighted average calculation: Timeline representation
1 Jan 2012
Start of
financial year
31 May 2012
31 Dec 2012
End of
financial year
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Weighted average calculation: Timeline representation
No. shares: 1,700
No. months: 5
(1,700  5/12)
1 Jan 2012
Start of
financial year
31 May 2012
31 Dec 2012
End of
financial year
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Weighted average calculation: Timeline representation
(1,700  5/12)
1 Jan 2012
31 May 2012
31 Dec 2012
800 new
shares issued
Start of
financial year
End of
financial year
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Weighted average calculation: Timeline representation
(1,700  5/12)
1 Jan 2012
31 May 2012
1 Dec 2012 31 Dec 2012
800 new
shares issued
Start of
financial year
End of
financial year
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Weighted average calculation: Timeline representation
No. shares: 2,500
No. months: 6
(1,700  5/12)
1 Jan 2012
+
(2,500  6/12)
31 May 2012
1 Dec 2012 31 Dec 2012
800 new
shares issued
Start of
financial year
End of
financial year
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Weighted average calculation: Timeline representation
(1,700  5/12)
1 Jan 2012
+
(2,500  6/12)
31 May 2012
800 new
shares issued
Start of
financial year
1 Dec 2012 31 Dec 2012
250 existing
shares
repurchased
End of
financial year
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Weighted average calculation: Timeline representation
No. shares: 2,250
No. months: 1
(1,700  5/12)
1 Jan 2012
+
(2,500  6/12)
31 May 2012
800 new
shares issued
Start of
financial year
+ (2,250  1/12)
1 Dec 2012 31 Dec 2012
250 existing
shares
repurchased
End of
financial year
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Total weighted average calculation: Timeline representation
No. shares: 1,700
No. shares: 2,500
No. shares: 2,250
No. months: 5
No. months: 6
No. months: 1
(1,700  5/12)
1 Jan 2012
+
(2,500  6/12)
31 May 2012
800 new
shares issued
Start of
financial year
+ (2,250  1/12)
1 Dec 2012 31 Dec 2012
250 existing
shares
repurchased
End of
financial year
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Incremental weighted average : Timeline representation
(1,700  12/12)
+
(800  7/12)
- (250  1/12)
1 Jan 2012
31 May 2012
800 new
shares issued
Start of
financial year
1 Dec 2012 31 Dec 2012
250 existing
shares
repurchased
End of
financial year
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS: Time weighting using weighted average
• Further issues concerning the denominator: Changes during period
– Under IAS 33 all outstanding ordinary shares are brought into the basic EPS
calculation, time-weighted for changes occurring during the period
– Rationale for time-weighting based on an assumed positive correlation
between capital (or more precisely, income-generating assets) and earnings
• More capital implies higher expected earnings and vice versa
• Calculation of basic EPS as a performance measure  requires no. of shares to be
adjusted to reflect changes in capital available to generate earnings
– Calculation of weighted average:
1
31
1
31
Jan 2012
May 2012
Dec 2012
Dec 2012
Weighted average total
Bal. @ beginning of year
Issue of new shares
Repurchase of treasury shares
Bal. @ year end
Issued
2,000
800
2,800
Treasury Outstanding
(300)
1,700
2,500
(250)
2,250
(550)
2,250
= (1,700  5/12) + (2,500  6/12) + (2,250  1/12) = 2,146 shares
Weighted average incremental = (1,700 x 12/12)+(800 x 7/12) – (250x1/12) = 2,146 shares
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS – More complex changes during the year
• The weighted average technique is used in the following circumstances
involving a change in the number of ordinary shares during the period:
– Shares issued for cash (either at full market price or at a discount)
– Rights issue (either at full market price or at discount)
– Shares repurchased for cash
– Share options exercised during the year
– Convertible securities converted during the year
– Issue of shares to acquire another business
• Such shares included in basic EPS calculation under assumption that shares were
issued on the acquisition date (even if the actual date of issue is later)
• Use acquisition date because this is the date from which the results of the newly
acquired business are recognised in the income statement
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS – Bonus issue as if at start of year
• While many changes in outstanding share capital involve corresponding
inflow (outflow) of resources, some do not:
1. Capitalisation, bonus or scrip issue
– Increases the number of shares without inflow of resources, as ordinary
shares issued to existing shareholders for no consideration
– Consequently, no additional earnings will be expected to accrue as a result of
the issue
→ Treat additional shares as having been in issue for the whole period
• Also include additional shares in EPS calculation of all prior period comparative
data so as to ensure comparability over time
Example:
3 million ordinary shares @ 1 Jan 2012: 1 for 3 bonus issue of shares @ 1 Dec 2012
No. shares used in basic EPS calculation:
3,000,000 +
[1/3  3,000,000] = 4,000,000
Assume extra shares issued at
beginning of year (i.e.,  12/12)
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS – Rights issue as if part bonus and part full price
2. A bonus element in any other issue (e.g., as part of a rights issue at discount)
– A rights issue is a popular mechanism through which entities are able to
access the capital markets for further funds
– existing shareholders given the opportunity to acquire further shares on
a pro-rata basis to their existing shareholdings
– ‘rights’ will usually be offered at a discount
– the transaction is equivalent to a bonus issue combined with an issue of
shares at full market price
→ Denominator adjustment consists of two components
• Bonus element as if bonus shares have been in issue for the whole period
(exactly the same as bonus issue example)
• Full market price element included under weighted average method from date
of rights issue
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS: Rights issue at discount – bonus fraction
• A rights issue at discount is equivalent to:
– A bonus issue of shares reflecting the discounted element of the issue (i.e.,
shares or part thereof issued for ‘free’), plus
– An issue of shares at full market price
• Need to compute the bonus element of the issue
– Bonus element is known as the ‘bonus fraction’, and is computed using:
Actual cum-rights price on last day of quotation cum-rights
Theoretical ex-rights price
Actual price at which the shares are
quoted inclusive of opportunity to take
up future shares under the rights issue
Theoretical price at which
the shares would be quoted
(all else equal) after the new
shares have been issued
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS: Rights issue at discount example
Example
Capital structure @ 1 January 2012: 48 million ordinary shares of €0.50 each
Profit on ordinary activities after taxation @ 31 December 2012: €2.4m
Actual prior to rights issue share price (‘cum-rights’) on last day of quotation cum-rights
was €1
(‘cum’ = ‘with’, ‘ex’ = ‘without’)
Rights issue occurs on 31 August 2012 on a 1 for 4 basis @ €0.80
• The EPS calculation is a 4 stage process:
– Stage 1: Calculate theoretical ex-rights price
Initial holding of
Rights taken up
New holding
48m shares
48x1/4 shares
60m shares
Theoretical ex-rights price
= €57.60m / 60m = €0.96
Market value
Cost 80p
Theoretical value
€m → Denominator in ‘bonus fraction’
48.00
9.60
57.60
Assumptions:
1. All rights are taken up
2. The value of the company
rises exactly by the rights
cash received
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS: Rights issue at discount (continued)
ALTERNATIVE CALCULATION OF EX-RIGHTS PRICE
• The EPS calculation is a 4 stage process:
– Stage 1: Calculate theoretical ex-rights price (alternative method)
60,000,000  €x = (48,000,000  €1) + (12,000,000  €0.80)
60,000,000  €x = €48,000,000 + €9,600,000
x = €0.96
No. shares after rights issue:
48m + (48m  1/4)
No. shares before
rights issue
No. shares in rights
issue: 48m  1/4
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS: Rights issue at discount – bonus fraction applied
– Stage 2: Compute the bonus element implicit in the issue
Actual cum-rights price
Theoretical ex-rights price
= 100 = 25
96
24
Bonus fraction (i.e., 1.04167)
→ Actual issue can therefore be split into components:
• Bonus issue of 0.04167 for 1 (0.04167 x 48 = 2m), reducing the
theoretical share price to €0.96
• Issue of the 10m residual number of shares (=12m – 2m) at the new
(theoretical) market price of €0.96
Note: No bonus element exists if bonus fraction < 1. Rights issue treated as
an issue for cash at the full market price
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS: Rights issue – computing weighted average
– Stage 3: Compute weighted average share capital for the period
No. of shares in issue @ 1 Jan:
As if bonus element:
= 48m  0.04167
Adjusted no. of shares in issue @ as if 1 Jan:
As if full price new share element at 31 August
= 48m
= 2m
= 50m
=
12m – 2m
No. of shares in issue after rights issue: 48m + (48m  1/4)
= 10m
= 60m
Weighted average number of shares in issue during year:
50  8/12
60  4/12
=
33,333,334
=
20,000,000
53,333,334
– Stage 4: Final EPS calculation
Basic EPS = £2.4 million / 53.3 million  £0.045
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Total weighted average : Timeline representation
(60m  4/12)
(50m  8/12)
1 Jan 2012
31 Aug 2012
31 Dec 2012
Rights issue
50m x 8/12 + 60 x 4/12 = 53.333m
Start of
financial year
End of
financial year
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Incremental weighted average : Timeline representation
(48m  12/12)
(2m  12/12)
+
+
1 Jan 2012
Bonus element =
48m x 1.00 = 50m x 0.96
(10m  4/12)
31 Aug 2012
Full price element = 12m
x 0.80 = 10m x 0.96
31 Dec 2012
Rights issue
48m x 12/12 + 2m x 12/12 + 10m x 4/12 = 53.333m
Start of
financial year
End of
financial year
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Basic EPS: Rights issue at discount – intuitive demonstration
Example
Capital structure @ 1 January 2012: 48 million ordinary shares of €0.50 each
Profit on ordinary activities after taxation @ 31 December 2012: €2.4m
Rights issue occurs on 31 August 2012 on a 1 for 4 basis @ €0.80
Actual cum-rights price on last day of quotation cum-rights was €1
• Ex-rights as a total calculation
Share holding
Pre-rights issue
Rights taken up
Post-rights issue
Number
Market price
48m
£1.00
12m (= 48m x 1 / 4) £0.80
60m
£0.96 (=£57.60 / 60m)
Market
capitalisation
£48.00m
£ 9.60m
£57.60m
Bonus fraction = 1.00/0.96 = 1.04167 for 1 bonus issue
Therefore the rights issue of 12m shares is partitioned into:
a) 0.4176 x 48m = 2m ‘free’ / bonus shares, and
b) The remaining 10m x £0.96 full price shares (=12m – 2m)
© Department of Accounting & Finance,
Lancaster University
COMPUTING EARNINGS PER SHARE: BASIC EPS
Summary and review
• Earnings per share is one of the most widely quoted and used financial
statement statistics
– Provides a basis for performance measurement (widely used in executive
compensation contracts
– Provides a basis for valuation (via the PE ratio)
• Changes in the number of shares outstanding during the accounting
period represent the major computational complication
– Computing the weighted average number of shares
– Adjusting for share issues that do not involve a corresponding inflow of
capital (e.g., bonus issues, share splits, etc.)
– Accounting for the impact of a discounted rights issue (which involves both
bonus issue and issue at full market price elements)
© Department of Accounting & Finance,
Lancaster University