1. ACCOUNTING STANDARD – 20 EARNINGS PER SHARE By : CA Chandrashekhar Shetty S B.Com, PGDCA, PGDFM, DISA, ACS, ACWA, FCA

2. DISCUSSION ON : DISCUSSION ON : - Why EPS ? - Why EPS ? - For Whom EPS ? - For Whom EPS ? - What is EPS ? - What is EPS ? - How EPS ? - How EPS ? - When EPS ? - When EPS ?

3. EPS – An Overview Popular measure of the performance of a company and a factor in the valuation of its shares. It is the reward of an investor for making his investment and it is the best measure of performance of a firm. Ordinary investors make their investment decision based on EPS.

4. Objective of financial management to maximize the EPS----- -- from the view point of both the investor and investee ---maximization of value measure in terms of market price of equity share

5. Effects Of EPS EPS affects the following: – –Value of a Share (Price Earning Ratio) Market Price = EPS * P/E ratio – –Valuation of the Business as a whole – –Expectations of the Investors – –Dividend Payout Ratio etc……

6. Legal Framework Accounting Standard - 20 issued by ICAI – –Commenced on 1-4-2001 – –Mandatory for Companies Accounting Standard Interpretation – 12 International Accounting Standard – 33

7. Legal Framework To provide for uniform computational methodology AS – 20 was issued. To provide for uniform computational methodology AS – 20 was issued. Its mandatory for- Its mandatory for- –Enterprises whose equity shares or potential equity shares are listed in India. –Enterprises whose shares are not so listed and are willing to disclose the EPS –Requirement of Part IV to Schedule VI of the Companies Act, 1956 –Applicable for Level I Enterprises. –Level II and Level III Enterprises – No Diluted EPS and Disclosure as per 48(ii)

8. ACCOUNTING STANDARDS INTERPRETATION - 12 APPLICABILITY OF AS 20 Every company, which is required to give information under Part IV of Schedule VI to the Companies Act, 1956, should calculate and disclose EPS in accordance with AS 20, whether or not its equity shares or potential equity shares are listed. Every company, which is required to give information under Part IV of Schedule VI to the Companies Act, 1956, should calculate and disclose EPS in accordance with AS 20, whether or not its equity shares or potential equity shares are listed.

9. ACCOUNTING STANDARDS INTERPRETATION - 12 APPLICABILITY OF AS 20 Basis For Conclusions Basis For Conclusions AS 20 does not mandate an enterprise, which has neither equity shares nor potential equity shares which are so listed, to calculate and disclose EPS, but, if that enterprise discloses EPS for complying with the requirement of any statute, it should calculate and disclose EPS in accordance with AS 20 AS 20 does not mandate an enterprise, which has neither equity shares nor potential equity shares which are so listed, to calculate and disclose EPS, but, if that enterprise discloses EPS for complying with the requirement of any statute, it should calculate and disclose EPS in accordance with AS 20

10. Areas of Concern : 1 Whether applicable for Banking and insurance companies? 2. Disclosure in Part IV – only Basic or Both Basic and Diluted?

11. Practical Issues FY 05-06 Banking Sector Vijaya Bank ING VYSYA Syndicate Bank Bank EPS on the face of P&L No (But in Notes On A/C) Yes Yes Balance Sheet Abstract (Part IV) No Yes No

12. Practical Issues FY 05-06 Others ITL ITLWIPRO Separate Disclosure of Extra-ordinary item YesNo Part IV Diluted EPS YesNo Part IV – Segregation of Extraordinary items No NoNo

13. Objectives of AS 20 Prescribes principles for the determination and presentation of EPS. Prescribes principles for the determination and presentation of EPS. The focus of this statement is on the denominator of the EPS calculation. The focus of this statement is on the denominator of the EPS calculation.

14. Presentation-Para 8 and 9 An enterprise should present earnings per share for all periods presented. An enterprise should present earnings per share for all periods presented. Presentation on the Face of P & L A/c. Presentation on the Face of P & L A/c. Separately for each class of equity share that has a different right to share in profit Separately for each class of equity share that has a different right to share in profit Types of EPS-   Basic EPS   Diluted EPS A ) Whether disclosure is must when Profit is Negative? A ) Whether disclosure is must when Profit is Negative? B ) If yes, whether both Basic and Diluted EPS have to be presented? B ) If yes, whether both Basic and Diluted EPS have to be presented?

15. Measurement I. BASIC EARNINGS PER SHARE A. Earnings – Basic = PAT – Pref. Div. incl. CDT Points to Be Noted - Numerator 1. Tax and impact of AS -22 2. AS – 5 – Include Extraordinary items 3. Preference Dividend –Non Cumulative – Deduct if provided -- Cumulative - Full Dividend ( only of current year) -- Cumulative - Full Dividend ( only of current year) 4. > one class of equity shares – apportion the profits as per dividend rights

16. B. Per Share - Basic - = Earnings / Weighted avg. No. Of Eq. shares Points to Ponder - Denominator 1. Consider the weighted average no. of equity shares o/s. during the period – time weighting factor - Refer Table I 1. Consider the weighted average no. of equity shares o/s. during the period – time weighting factor - Refer Table I 2. AS- 14 : Transferee company a. Purchase method – from the date of acquisition a. Purchase method – from the date of acquisition b. Merger method – From the beginning of the reporting period b. Merger method – From the beginning of the reporting period 3. Partly paid shares - proportion to div rights – Refer Table II 4. Rights issue – consider the bonus element – Refer – Table III 5. Bonus issue or share split - Increase in shares without increase in resources - Computation is from the beginning of the earliest period reported – Refer Table IV

17. NO of Shares Issued No. of Shares Bought Back No. of Shares Outstanding 1 st January, 2001 Balance at beginning of year 1800 -1800 31 st May, 2001 Issue of shares for cash 600 -2400 1st Nov, 2001 Buy Back of Shares -3002100 31 st Dec, 2001 Balance at end of year 24003002100 Table I - Weighted Average Number Of Shares (Accounting year 01-01-2001 to 31-12-2001) (Accounting year 01-01-2001 to 31-12-2001)

18. Computation of Weighted Average No : Computation of Weighted Average No : (1800*5/12) + (2400*5/12) +(2100*2/12) = 2100 shares (1800*5/12) + (2400*5/12) +(2100*2/12) = 2100 shares The weighted average number of shares can alternatively be computed as follows : The weighted average number of shares can alternatively be computed as follows : (1800*12/12) + (600*7/12) – (300*2/12) = 2100 shares (1800*12/12) + (600*7/12) – (300*2/12) = 2100 shares

19. Table II – Partly paid shares (Accounting year 01-01-2001 to 31-12-2001) No. of shares issued Nominal value of shares Amount paid 1 st Jan, 2001 Balance at beginning of year 1800 Rs 10 31 st October, 2001 Issue of shares 600 Rs 10 Rs 5 Assuming that partly paid shares are entitled to participate in the dividend to the extent of amount paid, number of partly paid equity shares would be taken as 300 for the purpose of calculation of EPS. shares would be taken as 300 for the purpose of calculation of EPS. Computation of Weighted Average would be as follows : (1800*12/12) + (300*2/12) = 1850 shares

20. Table III – Right Issue (Accounting year 01-01-2000 to 31-12-2000) Net Profit Year 20*0 : Rs 11,00,000 Year 20*1 : Rs 15,00,000 No. of shares outstanding prior to rights issue 5,00,000 shares Rights issue One new share for each five outstanding (i.e. 1,00,000 new shares) Rights issue price : Rs 15.00 Fair value of one equity share immediately prior to exercise of rights on 1 st March 2001 Rs 21.00

21. Computation of theoretical ex-rights fair value per share Fair value of all outstanding shares immediately prior to exercise of rights + total amount received from exercise Number of shares outstanding prior to exercise + number of shares issued in the exercise (Rs 21 * 5,00,000 shares) + (Rs 15 * 1,00,000 shares) / 5,00,000 + 1,00,000 shares (Rs 21 * 5,00,000 shares) + (Rs 15 * 1,00,000 shares) / 5,00,000 + 1,00,000 shares Theoretical ex-rights fair value per share = Rs 20.00 Computation of Adjustment factor Rs 21.00 (Fair value per share prior to exercise of rights) / Rs 20.00(Theoretical ex-rights value per share) = 1.05

22. Computation of EPS Computation of EPS Year 2000 Year 2001 EPS for the year 2000 as originally reported : Rs 11,00,000/5,00,000 shares Rs 2.20 EPS for the year 2000 restated for rights issue : Rs 11,00,000 / (5,00,000 shares * 1.05) Rs 2.10 EPS for the year 2001 including effects of rights issue Rs 15,00,000 / (5,00,000 * 1.05 * 2/12) + (6,00,000 * 10/12) Rs 2.55

23. Table IV – Bonus Issue (Accounting year 01-01-2000 to 31-12-2000) Net profit for the year 2000 Rs 18,00,000 Net profit for the year 2001 Rs 60,00,000 No. of equity shares outstanding until 30 th September 2001 20,00,000 Bonus issue 1 st Oct 2001 2 equity shares for each equity share outstanding at 30 th Sept, 20*1 20,00,000*2=40,00,000 Earnings per share for the year 2001 60,00,000/(20,00,000 + 40,00,000) = Rs 1.00 Adjusted EPS for the year 2000 18,00,000/(20,00,000+40,00,000) = Rs 0.3 Since the Bonus issue is an issue without consideration, the issue is Since the Bonus issue is an issue without consideration, the issue is treated as if it had occurred prior to the beginning of the year 2000, the treated as if it had occurred prior to the beginning of the year 2000, the earliest period reported. earliest period reported.

24. Table V - Determining the Order in Which to Include Dilutive Securities in the Computing of Weighted Average Number Of Shares Earnings, i.e., Net profit attributable to equity shareholders Rs 1,00,00,000 No. of equity shares outstanding 20,00,000 Average fair value of one equity share during the year Rs 75.00 Potential Equity Shares Options 1,00,000 with exercise price of Rs 60 Convertible Preference shares Attributable tax, e.g., corporate dividend tax 8,00,000 shares entitled to a cumulative dividend of Rs 8 per sahre. Each preference share is convertible into 2 equity shares. 10% 12% Convertible Debentures of Rs 100 each Nominal amount Rs 10,00,00,000. Each debenture is convertible into 4 equity shares. Tax rate 30%

25. Increase in Earnings Attributable to Equity Shareholders on Conversion of Potential Equity Shares Increase in Earnings Increase in no. of Equity Shares Earnings per Incremental share Options Increase in earnings Nil No. of incremental shares issued for no consideration{1. 00,000*(75- 60)/75} 20,000Nil

26. Convertible Preference shares Increase in net profit attributable to equity shareholders as adjusted by attributable tax [Rs 8*8,00,000)+10 %(8*8,00,000)] Rs 70,40,000 No. of incremental shares{2*8,00,0 00)] 16,00,000 Rs 4.40

27. 12% Convertible Debentures Increase in net profit {Rs 10,00,00,000*0. 12*( 1 – 0.30)} Rs 84,00,000 No. of incremental shares{10,00,00 0*4} 40,00,000 Rs 2.10 It may be noted from the above that options are most dilutive as their earnings per Incremental shares is nil. Hence, for the purpose of computation of diluted EPS, options will be considered first. 12% convertible debentures being second most dilutive will be considered next and thereafter convertible preference shares will be considered (see para 42)

28. Computation of Diluted EPS Net Profit Attributable (Rs) No. of Equity shares Net profit attributable per share (Rs) As reported 1,00,00020,00,0005.00 Options20,000 1,00,00,00020,20,0004.95Dilutive 12% Convertible Debentures 84,00,00040,00,000 1,84,00,00060,20,0003.06Dilutive Convertible Pref shares 70,40,00016,00,000 2,54,40,00076,20,0003.34Ati-Dilutive Since diluted EPS is increased when taking the convertible pref shares in A/C (from Rs 3.06 to Rs 3.34), the convertible pref shares are anti-dilutive and are ignored in the calculation of diluted EPS. Therefore, diluted EPS is Rs 3.06. calculation of diluted EPS. Therefore, diluted EPS is Rs 3.06.

29. II. DILUTED EARNINGS PER SHARE  A. Earnings – Diluted Points to Ponder 1. Nr and Dr. – adjusted for effects of dilutive potential equity shares. - Potential equity share is a financial instrument or other contract that entitles, or may entitle, its holder to equity shares - Potential equity share is a financial instrument or other contract that entitles, or may entitle, its holder to equity shares -Potential equity shares should be treated as dilutive when, and only when, their conversion to equity shares would decrease net profit per share from continuing ordinary operations (PARA 39) -Potential equity shares should be treated as dilutive when, and only when, their conversion to equity shares would decrease net profit per share from continuing ordinary operations (PARA 39) --Ignore Anti-dilutive potential equity shares` --Ignore Anti-dilutive potential equity shares`

30. Net Profit for the period attributable to equity shares - increased by dividends and tax - increased by dividends and tax - increased by interest subject to tax - increased by interest subject to tax - any other item affecting profits - any other item affecting profits

31. B. Per Share – Diluted B. Per Share – Diluted Dilutive potential equity shares should be deemed to have been converted into equity shares at the beginning of the period or, if issued later, the date of the issue of the potential equity shares. Dilutive potential equity shares should be deemed to have been converted into equity shares at the beginning of the period or, if issued later, the date of the issue of the potential equity shares. -Share application money or advance share application money is to be treated in same manner as dilutive potential equity shares. -Share application money or advance share application money is to be treated in same manner as dilutive potential equity shares.

32. Steps : Para 35 to 37 Steps : Para 35 to 37 1. Assume the exercise of dilutuve securities e.g. ESOP 1. Assume the exercise of dilutuve securities e.g. ESOP 2. Determine the fair value of share( e.g. avg. of last 6 months’ weekly closing prices) 2. Determine the fair value of share( e.g. avg. of last 6 months’ weekly closing prices) 3. Determine the exercise price 3. Determine the exercise price 4. Shares issued for no consideration = Step 2 - Step 3 4. Shares issued for no consideration = Step 2 - Step 3 5. Dilutive shares only to the extent of Step No. 4 ( Refer Table V) 5. Dilutive shares only to the extent of Step No. 4 ( Refer Table V) 6. Sequence – Most dilutive to least dilutive 6. Sequence – Most dilutive to least dilutive Most Dilutive = Earnings per Incremental Share is least Most Dilutive = Earnings per Incremental Share is least

33. Free shares considered A. Right and Buy back--- Both for Basic and Diluted A. Right and Buy back--- Both for Basic and Diluted B. Options -- Only for Diluted ( Potential shares) B. Options -- Only for Diluted ( Potential shares)

34. Factors Affecting EPS Bonus issues, stock-splits and reverse stock- splits (consolidation of shares) change the number of outstanding shares without changing the resources available to the firm. Therefore, companies adjust the number of equity shares outstanding for those periods for bonus issues, stock-splits and reverse stock-splits while calculating the EPS. Bonus issues, stock-splits and reverse stock- splits (consolidation of shares) change the number of outstanding shares without changing the resources available to the firm. Therefore, companies adjust the number of equity shares outstanding for those periods for bonus issues, stock-splits and reverse stock-splits while calculating the EPS.

35. RESTATEMENT If the shares outstanding increases as a result of a bonus issue or decreases as a result of basic and diluted earnings per share should be adjusted for all the periods presented. If the shares outstanding increases as a result of a bonus issue or decreases as a result of basic and diluted earnings per share should be adjusted for all the periods presented. An enterprise does not restate diluted earnings per share of any prior period presented for changes in the assumptions used or for the conversion of potential equity shares into equity shares outstanding. An enterprise does not restate diluted earnings per share of any prior period presented for changes in the assumptions used or for the conversion of potential equity shares into equity shares outstanding. Normally, EPS is not adjusted for transaction occurring after the balance sheet date – no effect on capital used. Normally, EPS is not adjusted for transaction occurring after the balance sheet date – no effect on capital used.

36. Example A firm XYZ whose net profit attributable to equity share holders for 2005 was Rs 10,00,000 and the number of outstanding shares 50,000. The EPS for 2005 will be 20. A firm XYZ whose net profit attributable to equity share holders for 2005 was Rs 10,00,000 and the number of outstanding shares 50,000. The EPS for 2005 will be 20. In the year 2006 if the profit is 15,00,000 and company issues 1:1 bonus. In the year 2006 if the profit is 15,00,000 and company issues 1:1 bonus. In the financial statement of 2006 the EPS for 2005 would be readjusted to Rs 10 (Rs10,00,000/1,00,000) to ensure comparability, even though it was reported at Rs 20 in financial statements for the year 2005. In the financial statement of 2006 the EPS for 2005 would be readjusted to Rs 10 (Rs10,00,000/1,00,000) to ensure comparability, even though it was reported at Rs 20 in financial statements for the year 2005.

37. DISCLOSURE - Para 48 to 51 48 (i)Where the statement of profit or loss includes extraordinary items, the enterprise should disclose basic and diluted EPS computed on the basis of earnings excluding extraordinary items 48 (i)Where the statement of profit or loss includes extraordinary items, the enterprise should disclose basic and diluted EPS computed on the basis of earnings excluding extraordinary items --- Prior period items ? --- Prior period items ?

38. DISCLOSURE  48( ii) (a)the amounts used as numerators, and a reconciliation of those amounts to net profits or loss; (b) the weighted average number of equity shares used as the denominator; (b) the weighted average number of equity shares used as the denominator; © the nominal value of shares along with EPS figures. © the nominal value of shares along with EPS figures.

39. AS – 20 and other AS - Interconnection As - 1 As - 1 AS – 2 AS – 2 AS – 4 AS – 4 AS – 5 AS – 5 AS – 6 AS – 6 AS – 7 AS – 7

40. AS – 9 AS – 9 AS – 10 AS – 10 AS -11 AS -11 AS – 12 AS – 12 AS – 13 AS – 13 AS – 14 AS – 14 AS – 15 AS – 15

41. AS – 19 AS – 19 AS – 21 AS – 21 AS – 22 AS – 22 AS – 24 AS – 24 AS – 25 AS – 25 AS – 28 AS – 28 AS – 29 AS – 29

42. Other Matters : IAS – 33 January 1996 Exposure Draft -- Earnings Per Share 18 December Revised version of IAS 33 issued by the IASB 2003 2003 1 January 2005 Effective date of IAS 33 (Revised 2003) February 1997 IAS 33 Share Earnings Per 1 January 1999Effective Date of IAS 33 (1997)

43. Objective of IAS 33 to improve performance comparisons between different enterprises in the same period and between different accounting periods for the same enterprise. to improve performance comparisons between different enterprises in the same period and between different accounting periods for the same enterprise.

44. Scope IAS 33 applies to entities whose securities are publicly traded or that are in the process of issuing securities to the public. [IAS 33.2] Other entities that choose to present EPS information must also comply with IAS 33. [IAS 33.3] IAS 33 applies to entities whose securities are publicly traded or that are in the process of issuing securities to the public. [IAS 33.2] Other entities that choose to present EPS information must also comply with IAS 33. [IAS 33.3]

45. Shortcomings of EPS Does not consider the opportunity cost of capital and can be manipulated by short-term actions. Does not consider the opportunity cost of capital and can be manipulated by short-term actions.

46. Let us take an example. Assume that a company has 20,000 outstanding shares and earnings available to shareholders is Rs 200,000. The EPS is (Rs 2,00,000/ 20,000), or Rs 10. Assume that the company borrows Rs 10,00,000 at an interest rate of 8 per cent to buy back 10,000 shares. Assuming an income tax rate of 40 per cent, the earnings available to shareholders after the shares are bought back will be [Rs 2,00,000 - (1.00 - 0.40) x Rs. 80,000] or 1.52,000. Accordingly, EPS will be reported at [Rs 1,52,000/10,000] or Rs 15.20. Let us take an example. Assume that a company has 20,000 outstanding shares and earnings available to shareholders is Rs 200,000. The EPS is (Rs 2,00,000/ 20,000), or Rs 10. Assume that the company borrows Rs 10,00,000 at an interest rate of 8 per cent to buy back 10,000 shares. Assuming an income tax rate of 40 per cent, the earnings available to shareholders after the shares are bought back will be [Rs 2,00,000 - (1.00 - 0.40) x Rs. 80,000] or 1.52,000. Accordingly, EPS will be reported at [Rs 1,52,000/10,000] or Rs 15.20.

47. Shortcomings of EPS Indeed, financial economics tells us that (in the first approximation) these two effects cancel out exactly and the return on invested capital (ROIC) and the cost of capital do not change with a change in the capital structure. Accordingly, economic profit (often called EVA) too does not change with the change in the capital structure. Yet, the example above shows that the EPS can increase in such circumstances. Indeed, financial economics tells us that (in the first approximation) these two effects cancel out exactly and the return on invested capital (ROIC) and the cost of capital do not change with a change in the capital structure. Accordingly, economic profit (often called EVA) too does not change with the change in the capital structure. Yet, the example above shows that the EPS can increase in such circumstances. Therefore, it is not correct to conclude that the increase in EPS always reflects better performance by the company. Therefore, it is not correct to conclude that the increase in EPS always reflects better performance by the company. For example, if a company finances a new project totally by debt, EPS will increase if the project returns are higher than the after-tax cost of debt, even if the project earns a return lower than the cost of capital (WACC) of the company. Although the EPS increases, such a project destroys value. For example, if a company finances a new project totally by debt, EPS will increase if the project returns are higher than the after-tax cost of debt, even if the project earns a return lower than the cost of capital (WACC) of the company. Although the EPS increases, such a project destroys value.

48. Shortcomings of EPS Another important shortcoming of EPS is that it does not relate EPS with the invested capital. For example, two companies may have same EPS, even if one company has lower invested capital as compared to the other. Another important shortcoming of EPS is that it does not relate EPS with the invested capital. For example, two companies may have same EPS, even if one company has lower invested capital as compared to the other. Ignores the Scale and size of operations Ignores the Scale and size of operations

49. Problems with EPS Reporting Standards Complex Computation mechanism of Diluted EPS Basic EPS is subject to replacement on the income statement by two hypothetical EPS numbers. The test used to identify common stock equivalent securities is among the most controversial of those rules

50. Inability to pinpoint the meaning of common stock equivalency Changing relationships between the terms of particular securities and prevailing market conditions are not considered in the computational rules for EPS.

51. Do these complicated EPS disclosures assist investors and creditors in decision making? The answer is unclear. Millar, et. al., report in the September-October, 1987 Financial Analysts journal that basic EPS and cash flow per share numbers are more closely related to stock returns than either primary or fully diluted EPS. Additional research is needed to ascertain the relative usefulness of basic, primary and fully diluted EPS. In the mean time, accountants and auditors are saddled with complicated rules of questionable usefulness.

52. WRAP UP Adhere to AS – 20 Adhere to AS – 20 Be practical and objective oriented Be practical and objective oriented Make no little plans ; they have no magic to stir men’s blood – Daniel Hudson Burnham Make no little plans ; they have no magic to stir men’s blood – Daniel Hudson Burnham

53. THANK YOU THANK YOU ONE AND ALL ONE AND ALL