Earnings per share JOIN KHALID AZIZ COACHING CLASSES ICMAP STAGE 1,2,3,4,5 ICAP MODULE A,B,C,D PIPFA BBA & MBA B.COM & M.COM ACCOUNTING OF O/A LEVEL MA-ECONOMICS KARACHI, PAKISTAN

YOU HAVE EXPERIENCED ALL THE INSTITUTES AND COACHING CENTRES BUT AT THE END YOUR RESULT IS STILL LAPSE/ FAIL OR REFERRAL. THE REASONS ARE Ø NON COMMANDABILITY ON BASIC CONCEPTS OF STUDENTS. Ø INSTITUTES DO NOT TAKE PAINS TO TEACH BASIC CONCEPTS. Ø STRENGTH OF EVERY CLASS IS ABOVE 30 STUDENTS. Ø LACK OF INDIVIDUAL ATTENTION. Ø SHY STUDENTS ALWAYS BECOME THE VICTIM OF THIS SYSTEM. IN A NUT SHELL YOU HAVE TO ULTIMATELY CHANGE YOUR FIELD BECAUSE OF YOUR INCAPABILITY TO REACH BEYOND INTERMEDIATE STAGE OR MODULE A OR B OF ICMAP/ICAP. W HAT ARE YOU W AITING FOR JOIN KHALID AZIZ AND IMPROVIZE YOUR BASIC CONCEPTS BECAUSE ITS IMPOSSIBLE TO CLEAR THE PAPERS OF CA/ICMAP WITHOUT HAVING A SOUND GRIP OVER BASIC CONCEPTS. KHALID AZIZ R-1173, AL-NOOR SOCIETY BLOCK 19, F.B.AREA, KARACHI.

Earnings per Share EPS is used particularly by investors and analysts to assess the performance of a company over a period of time, and to compare the performance of a company with that of other companies It is a more reliable measure than profit alone It is used to calculate the P/E ratio (Price/Earnings) Need for a standardised approach  SSAP 3 and FRS 15

FRS 14 Defines Basic Earnings per Share as  The net profit or loss attributable to ordinary shares after deducting dividends and other appropriations in respect of non-equity shares, divided by the weighted average number of ordinary shares outstanding in a period. Earnings Earnings  Basic EPS = No of Issued Ordinary Shares

EPS Numerator The earnings available to the ordinary shares are: Net profit after tax,interest, minority interest, dividends on other classes of shares and exceptional & extraordinary items.

Example for numerator Illustration 1 £000 Profit before tax & extraord. items8000 Less tax2500 Profit after tax5500 less extraord. items (net of tax) Dividends Preference1000 “Ordinary Retained profit for year2700

Solution to Illustration 1 The earnings figure for EPS purpose: Profit after tax & extraord items5000 less preference dividend1000 Earnings as per EPS4000 Note: prior to FRS 3, the EPS was calculated on profits before Extraordinary items thus open to manipulation

The Denominator The denominator is the weighted average number of ordinary shares in issue during the period (not the average value) It is a time weighted average because new funds were available to generate profits for only part of the year

Issue of shares at market value during the period Illustration 2 Garnet plc has 4m shares of 25 pence on 1st January 20x2. On 1 st October 20x2, 200,000 new ordinary shares were issued at market value On 1 st October 20x2, 200,000 new ordinary shares were issued at market value New resources introduced as a result New resources introduced as a result

Solution to Illustration 2 The denominator would be the time- weighted average of the number of shares during the year 4,000,000 x 12/12 = 4,000, ,000 x 3/12 =50,000 Total shares= 4,050,000

Bonus Issue Bonus issues are created by “capitalising” reserves. In other words, share capital is increased and at the same time there is a corresponding reduction in the value of reserves No new resources are introduced Earnings are divided by all ordinary shares in issue at year end Previous period’s EPS has to be restated for comparison

Illustration 3 Topaz plc has 3m ordinary shares in issue at 1 st January 20x4. On 1 st July 20x4 there is a 1 for 3 bonus issue. (No new resources as the result of the issue). The denominator for this period would be Shares in issue3,000,000 Bonus issue 3,000,000/31,000,000 Total shares4,000,000

Rights issue A rights issue involves an offer to existing shareholders to subscribe for new shares pro-rata to their existing holding Issue price lower than market price Treated as a mixture of : an issue at full market price a bonus issue

Bonus Issue To reflect the bonus element, it is necessary to calculate an adjustment factor based on the “theoretical ex-rights price” Steps required to calculate BEPS if a rights issue made during the year 1. Calculate average price of shares after the rights issue and compare to the share price before the issue to identify bonus element 2. Calculate the weighted average number of shares for the current year 3. Calculate the BEPS for current year 4. Previous year BEPS is adjusted for bonus element

Illustration 4 Zircon plc has 4m ordinary shares of 25 pence at the beginning of the period 1st July 20x8. A rights issue of 1 for 2 shares held is made on 30th September 20x8. A rights issue of 1 for 2 shares held is made on 30th September 20x8. The issue price is £3.40 and the market price prior to issue is £4. Profit for the year was £7,500,000 EPS for period ended 30th June 20x8 were £1.05

Illustration 4 Calculate the average price of shares after the issue (theoretical ex-rights value) 2 shares at fair value share at discounted price shs at fair value after rights issue Theoretical ex-rights price (11.40/3)3.80 Bonus element ( ).20

Illustration 4 cont’d Calculate weighted average number of shares Shares to date of rights issue held for full year4,000,000 shares from rights issue2,000,000 bonus shares ((4,000,000 x 4/3.8) - 4,000,000) 210,526 Weighted average number of shares6,210,256

Illustration 4 cont’d Calculate BEPS for current year 7,500,000/6,210,256 = £1.21 Adjust the previous year’s BEPS for the bonus element of the rights issue BEPS for previous year X adjustment factor £1.05 X 3.8/4 =£

Diluted EPS What is meant by dilution? A number of classes of persons may be entitled to become ordinary shareholders at a future date If entitlement exercised then ordinary shares will increase and EPS could be reduced or “diluted” FRS 14 requires diluted EPS be disclosed Basis of calculation is to assume that the right had been exercised in full at the beginning of the period under review and previous year’s figure is adjusted correspondingly

Illustration 5 Ruby plc has 1m ordinary shares of £1 each and £200,000 10% debenture stock convertible in 2010 on the basis of 3 ordinary shares for every £2 of stock. The profit after tax for the accounting period ended 31st December 2001 is £105,000 The profit after tax for the accounting period ended 31st December 2001 is £105,000 The corporation tax rate is 30%

Illustration 5

Dilution and Options/Warrants Where options or warrants exist entitling the holder to acquire ordinary shares at lower than fair value (i.e. average market price over the period) the potential issue of new shares should be split notionally into shares at fair value and shares at no value. Since shares at fair value is not dilutive, the denominator is increased by shares at no value only.

Illustration 6 Share Options On 1 st January 20x1, Amethyst plc have issued share capital of 8m ordinary shares of 25 pence. Post tax profits for the period attributable to ordinary shares are £1m There are options in existence, issuable in 20x2 at an exercise price of £3 per share, The average market price per share over the year 20x1 is £5 Calculate the BEPS and the diluted EPS.

Illustration 6

Limitations of EPS Measure of growth but must take care when making comparisons inter-company Share value Accounting policies Based on historical earnings Open to manipulation May lead to strategies for short term improvement Should consider more than one ratio