CHAPTER 23
EARNINGS PER SHARE
Connolly – International Financial Accounting and Reporting – 4th Edition
23.1 INTRODUCTION
•
Used by existing and potential investors:



Compare results over time
Compare performance with similar companies and/or
the market
Key component of P/E ratio
Connolly – International Financial Accounting and Reporting – 4th Edition
23.2 EARNINGS - QUALITY
•
•
Quantity vs. Quality
Defining quality
 Repeatable earnings
 Controllable earnings
 Bankable earnings
Connolly – International Financial Accounting and Reporting – 4th Edition
23.3 PRO-FORMA EARNINGS
•
•
•
•
Earnings calculated on the basis of hypothetical amounts
being excluded from the financial statements (e.g. certain
non-recurring items such as goodwill impairment or
restructuring costs)
To help assess core underlying operations and future
prospects
Part of a package of information
But unregulated and subjective, and why should ‘one-off’
costs be excluded as they are real and might be a sign of
poor management
Connolly – International Financial Accounting and Reporting – 4th Edition
23.4 EARNINGS MANAGEMENT
•
•
•
•
Material and intentional misrepresentation of results
Adjustments outside the bounds of acceptable accounting
practice
Income smoothing
Variety of methods employed



Unsuitable revenue recognition
Inappropriate accruals and estimates
Excessive provisions
Connolly – International Financial Accounting and Reporting – 4th Edition
23.5 IAS 33 EARNINGS PER SHARE
•
•
•
Objective
 To prescribe principles for the determination and
presentation of earnings per share
 Focus on determining the denominator of calculation
Scope
 Enterprises whose shares are publicly traded
 Enterprises in process of issuing such shares
 Enterprises electing to disclose EPS
When a entity presents both consolidated and separate
financial statements, the disclosures required by IAS 33
need be presented only on the basis of consolidated
information
Connolly – International Financial Accounting and Reporting – 4th Edition
BASIC EPS
Connolly – International Financial Accounting and Reporting – 4th Edition
23.6 BASIC EPS
Profit / loss attributable to ordinary shareholders*
Weighted average number of ordinary shares in issue during
period
*Profit after interest, tax, NCI and preference dividends
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.1: Basic EPS – no changes in period (1)
A company has profits (or earnings) for the year of €100,000
and has 200,000 ordinary shares.
EPS
=
€100,000 x 100
=
50 cent per share
200,000
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.2: Basic EPS – no changes in period (2)
A company has the following issued share capital throughout
the year:
• 200,000 ordinary shares of €1; and
• 50,000 10% preference shares of €1.
Extracts from the company’s financial statements for the year
ended 31 December 2012 showed:
€
Net profit
60,000
Taxation
(20,000)
Net profit after taxation
40,000
Dividends not deducted in arriving at the profit figure:
Preference dividend
5,000
Ordinary dividend
9,000
Requirement
Calculate the basic EPS for 2012
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.2: Basic EPS – no changes in period (2)
Solution
EPS = €35,000 / 200,000 = 17.5 cent per share
See Chapter 23, Example 23.3
Connolly – International Financial Accounting and Reporting – 4th Edition
LOSSES
If the earnings figure is a negative figure then the earnings per
share should be calculated in the normal way but shown as a
loss per share
Connolly – International Financial Accounting and Reporting – 4th Edition
Changes in ordinary share capital and its effect on basic EPS
If new shares are issued, the denominator in basic EPS
calculation has to be changed. For example:
1. Issue at full market price
2. Bonus issue, share split and share consolidation
3. Rights issues
4. Shares issued as part of the purchase consideration for a
business combination
Connolly – International Financial Accounting and Reporting – 4th Edition
1. Issue at full market price
•
•
Where new ordinary shares have been issued either for
cash at full market price or as consideration for the
acquisition of an asset, the earnings should be apportioned
over the average number of shares ranking for dividend
during the period weighted on a time basis
There is no retrospective effect
See Chapter 23, Example 23.4
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.5: Issue at full market price (2)
RP plc prepares its financial statements to 31 December each
year and has a capital structure consisting of:
•
•
100,000 10% preference shares of €1 each; and
100,000 €1 ordinary shares.
In 2011 and 2012, RP plc had profits after tax of €50,000 and
€60,000 respectively. On 30 September 2012, RP plc made an
issue at full market price of 50,000 €1 ordinary shares.
Preference dividends are not charged in arriving at profit after
tax.
Requirement
Calculate the basic EPS for 2012 and the corresponding figure
for 2011.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.5: Issue at full market price (2)
Solution
Profit after tax
Preference dividend
Shares at 1 January
Issue of shares at full market
price (50,000 x 3/12)
Shares for EPS calculation
EPS
2012 (€)
2011 (€)
60,000
50,000
(10,000)
(10,000)
50,000
40,000
100,000
100,000
12,500
Nil
112,500
100,000
44c
(€50,000 / 112,500)
40c
(€40,000 / 100,000)
Connolly – International Financial Accounting and Reporting – 4th Edition
2. Bonus issue, share split and share consolidation
Bonus issue = capitalisation of reserves and will have no
effect on the earning capacity of the company.
•
•
•
Ordinary shares are issued to existing shareholders for no
additional consideration
The number of shares outstanding is increased without an
increase in resources
The number of shares outstanding is adjusted as if the
share issue occurred at the beginning of the earliest period
presented
the corresponding figures for all earlier periods should
be adjusted accordingly
See Chapter 23, Example 23.6
Connolly – International Financial Accounting and Reporting – 4th Edition
Change in ordinary share capital after the reporting date
•
•
As noted previously, retrospective adjustment of
comparative EPS is required in the case of a full or partial
bonus issue of ordinary shares
This also applies if a change in ordinary share capital due
to a bonus issue occurs after the reporting period but
before the financial statements are authorised for issue
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.7: Bonus issue (2)
At 31 December 2011, Ben plc had 4 million ordinary 25 cent
shares in issue and 500,000 10% preference shares of €1
each. On 1 October 2012, the company made a one for four
bonus issue out of reserves. The profit after tax for the year
ended 31 December 2012 was €550,000 and for the year
ended 31 December 2011 was €450,000. Preference dividends
are not charged in arriving at the profit after tax.
Requirement
Calculate the basic EPS for 2011 and 2012.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.7: Bonus issue (2)
Solution
EPS 2012
€
Profit after tax
550,000
Preference dividend
(50,000)
Earnings
500,000
Number of Shares
4m x 5 / 4
EPS (€500,000 / 5,000,000)
5,000,000
10c
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.7: Bonus issue (2)
Solution
€
EPS 2011
Profit after tax
450,000
Preference dividend
(50,000)
Earnings
400,000
As originally reported 10c (€400,000 / 4,000,000)
Restated in 2012 financial statements
8c
(10c x (4m / 5m))
Connolly – International Financial Accounting and Reporting – 4th Edition
2. Bonus issue, share split and share consolidation
Share splits and share consolidations
Similar considerations apply where equity shares are split into
shares of smaller nominal value [e.g. a share of €1 nominal
value is divided into 4 shares of 25c each] or consolidated into
shares of a higher nominal value [e.g. 4 shares of 25c each are
consolidated into one share of €1].
i.e. number of shares outstanding before the event is adjusted
for the proportionate change.
The comparative figure must be adjusted.
See Chapter 23, Example 23.8
Connolly – International Financial Accounting and Reporting – 4th Edition
3. RIGHTS ISSUE
•
•
•
Issue of shares for cash to existing shareholders at a price
(usually) below the current market price
Equivalent to a cash issue at full market price combined with
a subsequent bonus issue
When a company makes a RI at less than full market price,
this results in there being a new market price (after RI),
which will be less than that which existed when the rights
issue took place. The new market price is known as the
theoretical ex rights price (TERP).
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.9: Rights issue (1)
ABC has the following capital structure: €200,000 10% €1
preference shares and €200,000 €1 ordinary shares. On 1
October 2012, ABC plc made a one for five rights issue at a
price of €1.20. The market value on the last day of quotation
cum rights was €1.50.
Calculation of TERP:
€
Wealth of shareholder with 5 ordinary shares prior to RI:
5 x €1.50
7.50
Cost of taking up the right to buy one ordinary share:
1 x €1.20
1.20
8.70
No of shares in issue:
/6
Therefore TERP:
€1.45
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.10: Rights issue (2)
2010
2011
Net profit as at 31 December
€24,000 €30,400
Shares before rights issue
100,000
2012
€36,000
The rights issue is to be one share for every five currently held
(giving 20,000 new shares). Exercise price is €1.00. The last date to
exercise rights is 1 April 2011. The fair value of an ordinary share
before the issue is €2.20.
Requirement
Calculate the basic EPS for 2010, 2011 and 2012.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.10: Rights issue (2)
Solution
2010
€24,000 / 100,000 share = 24 cent
2011
Step 1: Calculate the TERP
5 shares x €2.20
11.00
1 share x €1.00
1.00
6 shares
12.00
TERP €12.00 / 6 shares = €2.00
Step 2: Adjust 2010 EPS in 2011 FS
24c x 2.00 / 2.20 = 21.82 c
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.10: Rights issue (2)
Step 3: Calculate the basic EPS
100,000 x 3/12 x €2.20 / €2.00
27,500
120,000 x 9/12
90,000
117,500
EPS = €30,400 / 117,500 = 25.87c
2012
EPS = €36,000 / 120,000 = 30c
Connolly – International Financial Accounting and Reporting – 4th Edition
4. Shares issued as part of the purchase consideration for a
business combination
Shares issued as part of the purchase consideration for a
business combination are included in the weighted average
number of shares as and from the date of acquisition.
Why?
The results of the new subsidiary are included in the
consolidated financial statements from that date only.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.11: Shares issued as part of the purchase
consideration for a business combination
Pete plc has 1 million shares in issue on 1 January 2012. On 1
July 2012, Pete plc acquired 80% of the ordinary shares of Sue
plc. As part of the consideration, Pete plc issued 400,000
ordinary shares at market value 2.50.
The number of shares for the EPS calculation for year ended
31 December 2012 is:
(1m x 6/12) + (1.4m x 6/12) = 1.2m
Connolly – International Financial Accounting and Reporting – 4th Edition
Disclosure requirements for basic EPS
•
On face of SPLOCI – basic EPS for profit/loss from
continuing operations attributable to the ordinary equity
holders, including comparative figures. Disclosure still
required if basic EPS negative.
•
In the notes – amount used as the numerator in calculating
basic EPS and a reconciliation of that amount to the net
profit/loss for the period.
•
In the notes – weighted average number of ordinary shares
used in the calculation.
Connolly – International Financial Accounting and Reporting – 4th Edition
DILUTED EPS
Connolly – International Financial Accounting and Reporting – 4th Edition
23.7 DILUTED EPS
A company may have securities which do not have a claim to
equity earnings NOW, but may do in the FUTURE. These
include:
1. options or warrants;
2. rights granted under employee or other share purchase
plan;
3. contingently issuable shares;
4. convertible loan stock or preference shares; and
5. separate classes of equity share not yet entitled to a share
of equity earnings, but becoming so in the future.
i.e. they could increase the number of equity shares ranking
for dividend and so dilute or ‘water down’ EPS
Connolly – International Financial Accounting and Reporting – 4th Edition
Diluted EPS
Net profit attributable to ordinary shareholders
(adjusted for effects of all dilutive ordinary shares)
Divided by
Weighted average number of ordinary shares outstanding
during period
(adjusted for effects of all dilutive ordinary shares)
Connolly – International Financial Accounting and Reporting – 4th Edition
Diluted EPS
•
•
•
•
•
•
At the end of a reporting period, an entity may have securities that
do not have a claim to equity earnings at the reporting date but
may at some future date
These securities are potential ordinary shares (POS)
Diluted EPS is a calculation of how basic EPS may be diluted in
the future as a result of the existence of POS
Dilutive POS 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 POS
In considering whether POS are dilutive or anti-dilutive, each
issue of POS is considered separately rather than in aggregate
In order to maximise the dilution of basic EPS, each issue of POS
is considered in sequence from the most dilutive to the least
dilutive
Connolly – International Financial Accounting and Reporting – 4th Edition
Diluted EPS
POS should be treated as dilutive when conversion
would decrease the net profit per share from continuing
ordinary operations
Connolly – International Financial Accounting and Reporting – 4th Edition
1. Share options or warrants
•
•
•
A share option allows purchase of a share at a favourable
amount (less than its fair value)
Proceeds are assumed to be a combination of shares
issued at fair (market) value and shares issued for nil
consideration
Calculation of diluted EPS includes those shares deemed
as issued for no consideration as those issued at market
value are deemed to be non dilutive
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.12: Share options
Net profit for 2012
Weighted average number of ordinary shares
for 2012
Average fair value of one ordinary share
Weighted average number of shares under
option during 2012
Exercise price for shares under option in 2012
Requirement
Calculate the basic and diluted EPS for 2012
Connolly – International Financial Accounting and Reporting – 4th Edition
€1,000,000
10 million
€2.40
3 million
€2.00
Example 23.12: Share options
Solution
Basic for 2012
Earnings
Shares
EPS
€1,000,000
10,000,000
10c
Nil
500,000
€1,000,000
10,500,000
Options
Number of options
Options
Issued at fair value 3.0m X 2.00 / 2.40
Shares at nil consideration
Connolly – International Financial Accounting and Reporting – 4th Edition
3.0m
(2.5m)
0.5m
9.5c
2. Employee share options
•
•
•
Increasingly popular as an incentive scheme
Many include performance criteria which mean that they are
contingent on certain conditions being met
As with the share option approach, only include those shares
deemed as issued for no consideration
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.13: Non-performance-related employee share
option scheme
A company runs a share option scheme based on the employee’s
period of service. At 31 December 2012 the provisions of the
scheme were:
Date of grant
Market price at grant date
Exercise price of option
Date of vesting
Number of shares under option
Net profit for 2012
Weighted average number of ordinary shares
Average fair value of an ordinary share
Requirement
Calculate the basic and diluted EPS for 2012
Connolly – International Financial Accounting and Reporting – 4th Edition
1 January 2012
€2.24
€1.80
31 December 2014
3 million
€1,000,000
10 million
€2.70
Example 23.13: Non-performance-related employee share
option scheme
Solution
Shares Net profit
Basic EPS
10m
Number of shares on option
3m
EPS
€1,000,000
10c
9.1c
No of shares that would have been
issued at FV: (3m x €1.80)/€2.70
(2.0m)
Issued for no consideration
1.0m
Diluted EPS
11.0m €1,000,000
Connolly – International Financial Accounting and Reporting – 4th Edition
3. Contingently issuable shares
•
•
•
•
Issued after certain criteria have been met
For purposes of diluted EPS, these shares are included in
full
Many employee share option schemes operate in this
manner
Include in EPS calculation from the date when all necessary
conditions are satisfied (i.e. when the contingent events
have occurred)
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.14: Contingently issuable shares
A company has 500,000 ordinary shares in issue at 1 January 2010. A recent
business acquisition has given rise to the following contingently issuable shares:
• 10,000 ordinary shares for every new branch opened in the three years 2010 –
2012; and
• 1,000 ordinary shares for every €2,000 of net profit in excess of €900,000 over
the three years ended 31 December 2012.
Shares related to the opening of a new branch are issue when the branch is opened,
while shares related to the net profit contingency are issued on 1 January following
the period in which the condition is met.
A new branch was opened on 1 July 2010, another on 31 March 2011 and another
on 1 October 2012.
Reported net profits over the three years were €350,000, €400,000 and €600,000
respectively.
Requirement
Calculate the basic and diluted EPS for 2010, 2011 and 2012.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.14: Contingently issuable shares
2010
2011
2012
€
€
€
Earnings
350,000
400,000
600,000
Ordinary shares
500,000
510,000
520,000
Branch contingency
5,000 (i)
7,500 (i)
2,500 (i)
Earnings contingency
- (ii)
- (ii)
- (ii)
Total shares
505,000
517,500
522,500
Basic EPS
69.3p
77.3p
114.8p
Earnings
350,000
400,000
600,000
Ordinary shares
505,000
517,500
522,500
Branch contingency
5,000 (iii)
2,500 (iii)
7,500 (iii)
Earnings contingency
-
-
225,000 (iv)
Total shares
510,000
520,000
755,000
Diluted EPS
68.6p
76.9p
79.5p
.
Additional shares:
Connolly – International Financial Accounting and Reporting – 4th Edition
4. Convertibles
•
•
•
•
•
Convertible loans or convertible preference shares
Conversion of these instruments would affect both earnings
and number of shares in an EPS calculation
Interest is paid out on the bond, but when conversion takes
place this interest is no longer payable
Preference dividends saved when preference shares are
converted
Whereas loan interest is allowable for tax purposes,
dividends are not
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.15: Convertible debt
Net profit
€500
Ordinary shares in issue
1,000
Convertible 15 % bonds
200
Each block of 5 bonds is convertible to 8 ordinary shares.
The tax rate (including any deferred tax) is 40%.
Solution
Basic EPS
= €500 / 1,000
= 50c
Diluted EPS
Earnings per basic EPS
Add interest saved net of tax 200 x 15% x 60%
€
500
18
518
1,000
320
1,320
Shares per basic EPS
Add maximum shares on conversion 200 x 8/5
DEPS
= 518 / 1,320
= 39.2c
Connolly – International Financial Accounting and Reporting – 4th Edition
5. Ranking dilutive securities
•
•
•
•
•
When there is more than one type of POS, it is necessary to
determine whether each type is dilutive or anti-dilutive
When calculating diluted EPS, each type of POS is
considered separately and in sequence from the most
dilutive to the least dilutive
Most dilutive POS are those with the lowest earnings per
incremental share
POS do not necessarily have a dilutive effect on basic
EPS
POS are anti-dilutive when their conversion to ordinary
shares would increase EPS from continuing operations
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.16: Ranking dilutive securities (1)
Net profit attributable to ordinary shareholders
€20m
Net profit from discontinued operations
€5.0m
Ordinary shares outstanding
50m
Average fair value per ordinary share
€5.00
Potential ordinary shares:
• Convertible preference shares – 500,000 entitled to a
cumulative dividend of €5. Each is convertible to 3 shares.
• 3% convertible bond – nominal amount €50m. Each €1,000
bond is convertible to 50 shares. There is no amortisation of
premium or discounting affecting the interest expense
• Options – 10m with exercise price of €4.
Tax rate is 30%.
Requirement
Calculate the basic and diluted EPS.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.16: Ranking dilutive securities (1)
Solution
The effect on earnings on conversions of POS:
Convertible
Impact on
Earnings
€
Impact on Shares
Effect on
earnings per
incremental
shares
Preference
shares
2,500,000
(500k x 5)
1,500,000
(500k x 3)
1.67
1,050,000
(50m x 3% x 70%)
2,500,000
(50m / 1,000 x 50)
0.42
Nil
2,000,000
(10m – (10m x 4/5))
Nil
Bonds
Options
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.16: Ranking dilutive securities (1)
Basic EPS
Options
3% conv. bonds
Conv. pref. shares
Earnings (€)
Shares
EPS
15,000,000
50,000,000
30.0c
Nil
2,000,000
15,000,000
52,000,000
1,050,000
2,500,000
16,050,000
54,500,000
2,500,000
1,500,000
18,550,000
56,000,000
See Chapter 23, Example 23.17
Connolly – International Financial Accounting and Reporting – 4th Edition
28.8c
Dilutive
29.4c
Anti Dilutive
33.1c
Anti Dilutive
Presentation and disclosure
•
•
•
•
EPS is presented for every period for which a SPLOCI is
presented
Present basic and diluted EPS with equal prominence on
the face of the SPLOCI
Present EPS for discontinued operations if discontinued
operations reported
Present basic and diluted EPS even if amounts are
negative (i.e. a loss per share)
Connolly – International Financial Accounting and Reporting – 4th Edition
Presentation and disclosure
•
•
•
•
Amounts used in the numerators of the calculations and a
reconciliation to profit or loss presented in the SPLOCI
Weighted average number of ordinary shares for basic and
diluted EPS, with a reconciliation of these denominators to
each other
POS excluded because they are anti-dilutive
Alternative per share calculations
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.18: Basic and diluted EPS
The following information is available for Diamond Limited for 2012:
Earnings
Net profit attributable to continuing operations
Less preference dividends
Profit from continuing operations attributable
to ordinary shareholders
Loss from discontinued operations
Net profit attributable to ordinary shareholders
Ordinary shares outstanding
Average market price of one ordinary share during 2012
Potential ordinary shares:
Options
Convertible preference shares
5% convertible bond
€
16,400,000
(6,400,000)
10,000,000
(4,000,000)
6,000,000
2,000,000
€75
100,000 options with exercise price of €60
800,000 8% €100 convertible preference shares, with
each preference share held convertible into two
ordinary shares
100m 5% €1 convertible bonds, with each 1,000 block
convertible into 20 ordinary shares
40%
Tax rate
Requirement
Calculate the basic and diluted EPS for 2012.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.18: Basic and diluted EPS
Increase in earnings attributable to ordinary shareholders on conversion of POS
Increase
in
earnings
Options
Increase in earnings
Incremental shares
(100,000 x (€75 - €60) / €75)
Convertible preference shares
Increase in earnings
(€8 x 800,000)
Incremental shares
(2 x 800,000)
5% convertible bonds
Increase in earnings
(100m x 5% x 0.6)
Incremental shares
Increase
in number
of ordinary
shares
Earnings
per
incremental
share
20,000
Nil
1,600,000
4
2,000,000
1.50
Nil
6,400,000
3,000,000
Ranking – (1) options, (2) convertible bonds, (3) convertible preference shares
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 23.18: Basic and diluted EPS
Computation of diluted earnings per share
Earnings (€)
As reported
Options
10,000,000
5% convertible bonds
Convertible preference shares
10,000,000
3,000,000
13,000,000
6,400,000
19,400,000
Ordinary
shares
2,000,000
20,000
2,020,000
2,000,000
4,020,000
1,600,000
5,620,000
EPS
5.00
4.95 dilutive
3.23 dilutive
3.45 antidilutive
The convertible preference shares are ignored in calculating the DEPS as they are
antidilutive.
Computation of basic and diluted EPS:
Profit from continuing operations
Loss from discontinued operations
Net profit
* (€4,000,000 ÷ 2m)
** (€4,000,000 ÷ 4.02m)
Basic
5.00
(2.00)*
3.00
= (2.00)
= (0.99)
Connolly – International Financial Accounting and Reporting – 4th Edition
Diluted
3.23
(0.99)**
2.24