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17 Accounting Standard-20
17 Accounting Standard-20
DISCUSSION ON :
- When EPS ?
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.
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
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
Legal Framework
Legal Framework
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)
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.
Yes
No
WIPRO No
Yes
No
No
No
Objectives of AS 20
Prescribes principles for the determination and presentation of EPS. The focus of this statement is on the denominator of the EPS calculation.
Presentation-Para 8 and 9
presented.
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
Types of EPS Basic EPS Diluted EPS A ) Whether disclosure is must when Profit is Negative? B ) If yes, whether both Basic and Diluted EPS have to be presented?
Measurement
I. BASIC EARNINGS PER SHARE
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 2. AS- 14 : Transferee company a. Purchase method from the date of acquisition 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
600
2400
2400
300 300
2100 2100
Amount paid
1800
Rs 10
Rs 10
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. Computation of Weighted Average would be as follows : (1800*12/12) + (300*2/12) = 1850 shares
Rights issue
One new share for each five outstanding (i.e. 1,00,000 new shares) Rights issue price : Rs 15.00
Rs 21.00
Fair value of one equity share immediately prior to exercise of rights on 1st March 2001
Computation of EPS
Year 2000 Year 2001
EPS for the year 2000 Rs 2.20 as originally reported : Rs 11,00,000/5,00,000 shares EPS for the year 2000 restated for rights issue : Rs 11,00,000 / (5,00,000 shares * 1.05) 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 2.10
Rs 2.55
2 equity shares for each equity share outstanding at 30th Sept, 20*1 20,00,000*2=40,00,000 60,00,000/(20,00,000 + 40,00,000) = Rs 1.00 18,00,000/(20,00,000+40,00,000) = Rs 0.3
Earnings per share for the year 2001 Adjusted EPS for the year 2000
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 earliest period reported.
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 No. of equity shares outstanding Average fair value of one equity share during the year Rs 1,00,00,000 20,00,000 Rs 75.00
16,00,000
Rs 4.40
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)
As reported Options
1,00,000
84,00,000
60,20,000 16,00,000
3.06
Dilutive
2,54,40,000
76,20,000
3.34
Ati-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.
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 -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`
that entitles, or may entitle, its holder to equity shares
Net Profit for the period attributable to equity shares - increased by dividends and tax - increased by interest subject to tax - any other item affecting profits
Steps : Para 35 to 37
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) 3. Determine the exercise price 4. Shares issued for no consideration = Step 2 - Step 3 5. Dilutive shares only to the extent of Step No. 4 ( Refer Table V) 6. Sequence Most dilutive to least dilutive
Bonus issues, stock-splits and reverse stocksplits (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.
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. 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.
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. 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.
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
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; the nominal value of shares along with EPS figures.
As - 1 AS 2 AS 4 AS 5 AS 6 AS 7
AS AS AS AS AS AS AS
9 10 -11 12 13 14 15
AS AS AS AS AS AS AS
19 21 22 24 25 28 29
Earnings Per
Effective Date of IAS 33 (1997) Revised version of IAS 33 issued by the IASB
2003
1 January 2005 Effective date of IAS 33 (Revised 2003)
Objective of IAS 33
to improve performance comparisons between different enterprises in the same period and between different accounting periods for the same enterprise.
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]
Shortcomings of EPS
Does not consider the opportunity cost of capital and can be manipulated by short-term actions.
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.
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. 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.
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. Ignores the Scale and size of operations
Complex Computation mechanism of Diluted EPS Basic EPS is subject to replacement on the income statement by two
The test used to identify common stock equivalent securities is among the most controversial of those rules
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.
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.
WRAP UP
Adhere to AS 20
Be practical and objective oriented
Make no little plans ; they have no magic to stir mens blood Daniel Hudson Burnham
THANK