1. CHAPTER 23
EARNINGS PER SHARE

2. 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

3. 23.2 EARNINGS - QUALITY
Quantity vs. Quality
Defining quality
Repeatable earnings
Controllable earnings
Bankable earnings

4. 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

5. 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

6. 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

7. BASIC EPS

8. 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

9. 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

10. 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 ,000
Taxation (20,000)
Net profit after taxation 40,000
Dividends not deducted in arriving at the profit figure:
Preference dividend ,000
Ordinary dividend ,000
Requirement
Calculate the basic EPS for 2012

11. 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

12. 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

13. 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:
Issue at full market price
Bonus issue, share split and share consolidation
Rights issues
Shares issued as part of the purchase consideration for a business combination

14. 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

15. 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.

16. Example 23.5: Issue at full market price (2)
Solution
2012 (€)
2011 (€)
Profit after tax
60,000
50,000
Preference dividend
(10,000)
40,000
Shares at 1 January
100,000
Issue of shares at full market price (50,000 x 3/12)
12,500
Nil
Shares for EPS calculation
112,500
EPS
44c
(€50,000 / 112,500)
40c
(€40,000 / 100,000)

17. 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

18. 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

19. 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.

20. 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 5,000,000 EPS (€500,000 / 5,000,000) 10c

21. 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))

22. 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

23. 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).

24. 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 €
Cost of taking up the right to buy one ordinary share:
1 x €
8.70
No of shares in issue: / 6
Therefore TERP: €1.45

25. Example 23.10: Rights issue (2)
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 The fair value of an ordinary share before the issue is €2.20. Requirement Calculate the basic EPS for 2010, 2011 and 2012.
2010
2011
2012
Net profit as at 31 December
€24,000
€30,400
€36,000
Shares before rights issue
100,000

26. Example 23.10: Rights issue (2)
Solution 2010 €24,000 / 100,000 share = 24 cent 2011 Step 1: Calculate the TERP 5 shares x € share x € shares TERP €12.00 / 6 shares = €2.00 Step 2: Adjust 2010 EPS in 2011 FS 24c x 2.00 / 2.20 = c

27. Example 23.10: Rights issue (2)
Step 3: Calculate the basic EPS 100,000 x 3/12 x €2.20 / € , ,000 x 9/12 90, ,500 EPS = €30,400 / 117,500 = 25.87c 2012 EPS = €36,000 / 120,000 = 30c

28. 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.

29. 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 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

30. 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.

31. DILUTED EPS

32. 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:
options or warrants;
rights granted under employee or other share purchase plan;
contingently issuable shares;
convertible loan stock or preference shares; and
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

33. Net profit attributable to ordinary shareholders
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

34. 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

35. Diluted EPS
POS should be treated as dilutive when conversion would decrease the net profit per share from continuing ordinary operations

36. 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

37. Example 23.12: Share options
Requirement Calculate the basic and diluted EPS for 2012
Net profit for 2012
€1,000,000
Weighted average number of ordinary shares for 2012
10 million
Average fair value of one ordinary share
€2.40
Weighted average number of shares under option during 2012
3 million
Exercise price for shares under option in 2012
€2.00

38. Example 23.12: Share options
Solution Number of options Options 3.0m Issued at fair value 3.0m X 2.00 / 2.40 (2.5m) Shares at nil consideration 0.5m
Earnings
Shares
EPS
Basic for 2012
€1,000,000
10,000,000
10c
Options
Nil
500,000
10,500,000
9.5c

39. 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

40. 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 January 2012
Market price at grant date €2.24
Exercise price of option €1.80
Date of vesting December 2014
Number of shares under option 3 million
Net profit for €1,000,000
Weighted average number of ordinary shares 10 million
Average fair value of an ordinary share €2.70
Requirement
Calculate the basic and diluted EPS for 2012

41. Example 23.13: Non-performance-related employee share option scheme
Solution
Shares Net profit EPS
Basic EPS 10m €1,000,000 10c
Number of shares on option 3m
No of shares that would have been
issued at FV: (3m x €1.80)/€2.70 (2.0m)
Issued for no consideration m
Diluted EPS m €1,000, c

42. 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)

43. Example 23.14: Contingently issuable shares
A company has 500,000 ordinary shares in issue at 1 January 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.

44. Example 23.14: Contingently issuable shares
€ € €
Earnings 350, , ,000
Ordinary shares 500, , ,000
Branch contingency 5,000 (i) 7,500 (i) 2,500 (i)
Earnings contingency - (ii) (ii) (ii) .
Total shares 505, , ,500
Basic EPS p 77.3p p
Ordinary shares 505, , ,500
Additional shares:
Branch contingency 5,000 (iii) 2,500 (iii) 7,500 (iii)
Earnings contingency ,000 (iv)
Total shares 510, , ,000
Diluted EPS 68.6p 76.9p 79.5p

45. 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

46. 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, = 50c
Diluted EPS €
Earnings per basic EPS
Add interest saved net of tax 200 x 15% x 60% 18
518
Shares per basic EPS 1,000
Add maximum shares on conversion 200 x 8/5 320
1,320
DEPS = 518 / 1, = 39.2c

47. 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

48. Example 23.16: Ranking dilutive securities (1)
Net profit attributable to ordinary shareholders €20m
Net profit from discontinued operations €5.0m
Ordinary shares outstanding m
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.

49. 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
Bonds
1,050,000
(50m x 3% x 70%)
(50m / 1,000 x 50)
0.42
Options
Nil
2,000,000
(10m – (10m x 4/5))

50. Example 23.16: Ranking dilutive securities (1)
Earnings (€)
Shares
EPS
Basic EPS
15,000,000
50,000,000
30.0c
Options
Nil
2,000,000
52,000,000
28.8c
Dilutive
3% conv. bonds
1,050,000
2,500,000
16,050,000
54,500,000
29.4c
Anti Dilutive
Conv. pref. shares
1,500,000
18,550,000
56,000,000
33.1c
See Chapter 23, Example 23.17

51. 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)

52. 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

53. Example 23.18: Basic and diluted EPS
The following information is available for Diamond Limited for 2012:
Earnings € Net profit attributable to continuing operations ,400,000 Less preference dividends (6,400,000) Profit from continuing operations attributable to ordinary shareholders ,000,000 Loss from discontinued operations (4,000,000) Net profit attributable to ordinary shareholders ,000,000   Ordinary shares outstanding ,000,000 Average market price of one ordinary share during €75    Potential ordinary shares: Options ,000 options with exercise price of €60 Convertible preference shares 800,000 8% €100 convertible preference shares, with each preference share held convertible into two ordinary shares
5% convertible bond m 5% €1 convertible bonds, with each 1,000 block convertible into 20 ordinary shares Tax rate % Requirement
Calculate the basic and diluted EPS for 2012.

54. Example 23.18: Basic and diluted EPS
Increase in earnings attributable to ordinary shareholders on conversion of POS Increase Increase Earnings in in number per earnings of ordinary incremental shares share Options Increase in earnings Nil Incremental shares (100,000 x (€75 - €60) / €75) , Nil Convertible preference shares Increase in earnings (€8 x 800,000) ,400,000 Incremental shares (2 x 800,000) ,600, % convertible bonds Increase in earnings (100m x 5% x 0.6) ,000,000 Incremental shares ,000,   Ranking – (1) options, (2) convertible bonds, (3) convertible preference shares  

55. Example 23.18: Basic and diluted EPS
Computation of diluted earnings per share   Ordinary Earnings (€) shares EPS As reported ,000, ,000, Options , ,000, ,020, dilutive 5% convertible bonds ,000, ,000, ,000, ,020, dilutive Convertible preference shares 6,400, ,600, ,400, ,620, antidilutive   The convertible preference shares are ignored in calculating the DEPS as they are antidilutive.   Computation of basic and diluted EPS: Basic Diluted Profit from continuing operations Loss from discontinued operations (2.00)* (0.99)** Net profit   * (€4,000,000 ÷ 2m) = (2.00) ** (€4,000,000 ÷ 4.02m) = (0.99)