Retained earnings

Retained earnings represent the cumulative profits (net of losses, distribution to owners, and other
adjustments) which are retained in the business and not yet distributed to the shareholders.
Total retained earnings may consist of:
a) Unrestricted -the portion of retained earnings that is available for future distribution to the
shareholders.
b) Appropriated (Restricted) - the portion of retained earnings that is not available for
distribution unless the restriction is subsequently reversed.
Appropriations are disclosed in the notes. In the absence of such disclosure, the retained earnings
are deemed unrestricted.
Appropriation may be a result of:
1. Legal requirement- such as retained earnings appropriated for the cost of treasury shares
reacquired and those transferred to statutory reserves.
2. Contractual requirements- such as retained earnings appropriated in compliance with loan
agreements or bond indentures for the protection of creditors.
3. Voluntary- such as retained earnings appropriated for probable contingencies, business
expansion, and the like.

The appropriation of retained earnings is recorded as follows:

Date Retained earnings- unrestricted xx
Retained earnings- appropriated xx

When the restriction on the retained earnings no longer exists, the entry above is simply
reversed as follows:
Date Retained earnings-appropriated xx
Retained earnings- unrestricted xx

Appropriations of retained earnings do not mean that a corresponding cash fund has been set aside.
Appropriations only indicate amounts that are not available for distribution to the owners.

Negative balances in equity

When the retained earnings account has a negative balance (i.e., debit balance), it is
described in the financial statements as “deficit.”
When total shareholders’ equity has a negative balance (such as when liabilities exceed
assets), it is described in the financial statements as’capital deficiency."
Dividends
Distributions to shareholders are called dividends. Dividends may be in the form of:
1. Cash dividends- distributions in the form of cash.
Liability dividends- are dividends issued by a corporation that has a temporary cash
shortage. Liability dividends may be either:

I. Scrip dividends- short-term and may or may not bear interest

II. Bond dividends- long-term and bear interest

2. Property dividends- distributions in the form of noncash assets.

3. Share dividends- distributions in the form of the entity’s own shares.
Dates relevant to the accounting for dividends
a) Date of declaration- the date when the board of directors formally announces the
distribution of dividends.

b) Date of record -the date on which the stock and transfer book of the corporation is closed
for registration. Only those who are listed as of this date shall be entitled to receive
dividends. Thus, it is only on this date that the entity determines the exact amount of
dividends to be distributed on date of distribution. No entry is made on this date, except
when there are adjustments to the initially recognized amount of dividends on date of
declaration.

c.) Date of distribution -the date when the dividends declared are distributed to the
shareholders who are entitled to the dividends.

Share-based compensation plan

Share-based compensation plan is an arrangement whereby, in exchange for services, an employee

is compensated in the form of (or based on) the entity’s equity instrument. Examples of shared
based compensation:
a. Employee share options (equity-settled) ‘
b. Employee share appreciation rights (cash settled)
c. Compensation plans with a choice of settlement between (a) and (b) above.

Share-based compensations are given to key employees as bonuses or additional compensation.

The benefits of a share-based Compensation to the employer may include a possible reduction in
employee turnover because employees will have to remain in the entity’s employ during the service
period in order to exercise the equity instrument granted.

Employee share option plans

Share option is a”contract that gives the holder the right, but not the obligation, to subscribe to the
entity’s shares at a fixed or determinable price for a specified period of time.” (PFRS 2.Appx.A)
Some share options given to employees do not require any subscription price, meaning the shares
will be issued solely in exchange for employee services.

Measurement of compensation
Employee share option plans are equity-settled share-based payment transactions with employees.
Accordingly, the services received are measured using the following order or priority:
1. Fair value of equity instruments granted at grant date
2. Intrinsic value
Equity-settled share-based payment transactions
Goods or services received from equity-settled share based payment transactions with non-
employees are measured at the fair value of the goods or services received, or if this is not
determinable, at the fair value of the equity instruments granted.
For the transaction of employees and other providing similar services, the fair value of the
services received is often not possible to estimate reliably.
Equity-settled share based payment transaction with:
Non-employees
Order of priority in measurement:
1. Fair value of goods and services
received
2. Fair value of equity instruments
granted
Employees and Others providing similar
services
Order of priority in measurement:
1. Fair value of equity instrument
2. Intrinsic value

Intrinsic value – is the difference between the fair value of the shares which the
counterparty has the right to subscribe or receive and the subscription price that the
counterparty is required to pay.
Cash-settled share-based payment transactions
A cash-settled share based payment transaction is one whereby an entity acquires goods or
services and incurs an obligation to pay cash at an amount that is based on the fair value of equity
instruments.
The goods or services received, and the related liability, are measured at the fair value of
the liability.
The most common form of a cash settled share-based payment transaction is share
appreciation rights (SARs) granted to an employee.

Earnings per Share

Earnings per share (EPS) are a computation made for ordinary shares. It is a form of
profitability ratio which provides a measure of how much profit (loss) each ordinary share has
earned (incurred) during the period.
Normally, no EPS is computed for preference shares because they have a fixed return, as
represented by their dividend rates. In some cases, however, EPS may be computed for preference
shares when they are also entitled to a variable return in addition to their fixed return (e.g.,
participating preference shares). Such preference shares are “considered special ordinary shares
for purposes of EPS computation.

Ordinary share is “an equity instrument that is subordinate to all other classes of equity
instruments.”
Ordinary shares participate in profit for the period after all other classes of shares
(e.g., preference shares) have participated. They have more voting rights than the
preference shares.
Preference share-is one that has preference over other classes of shares, such as preference
over dividends or preference over net assets in cases of liquidation, but typically does not
have voting rights.

Uses of earnings per share

1. EPS may be used to assess the value of an entity's shares. It shows how much profit one
share of the entity is producing. Obviously the higher this ratio is, the better, because the
value of the share will increase.

2. EPS promotes comparability when measuring performance of different entities with

different resource bases, different capital structures, and different nature of operations.
 3. EPS provides a basis for dividend policy. The higher profit a share is producing, the more
likely that higher dividends will be declared on the share.

Types of Earnings per Share

PAS 33 requires the following two presentations of EPS:
3. Basic earnings per share
4. Diluted earnings per share

If the entity does not have dilutive potential ordinary shares, it presents basic earnings per share only.

Basic Earnings per Share

Basic EPS is computed as follows:

Profit (Loss) less Preferred dividends

Basic EPS = Weighted average number of outstanding ordinary share

Diluted Earnings per Share

An entity with dilutive potential ordinary shares (i.e., complex capital structure) presents diluted
EPS in addition to basic EPS. An entity with no dilutive potential ordinary shares (i.e., simple capital
structure) presents basic EPS only.

A potential ordinary share is "a financial instrument or other contract that may entitle its
holder to ordinary shares." (PAS 33.5)

Examples of potential ordinary share:

a) Convertible preference shares -are preference shares that are convertible into the issuer’s
ordinary shares.
b) b. Convertible bonds
c) Options, warrants and their equivalents are “financial instruments that give the holder the
right to purchase ordinary shares.” (PAS 33.5)

Potential ordinary shares are considered when computing for diluted EPS only when they are
dilutive. Potential ordinary shares are dilutive if, when exercised, they decrease basic earnings
per share or increase basic loss per share.

Antidilutive potential ordinary shares are ignored‘ Potential ordinary shares are
antidilutive if, when exercised, they increase basic earnings per share or decrease basic loss per
share.‘
 Convertible bonds and convertible preference shares are dilutive if their conversion
decreases basic EPS or increases in basic loss per share.

Options, warrants and their equivalents 'are dilutive if their exercise price. is less than the
market value of the ordinary shares, making the exercise favorable on the part of the
holder.

The computation of diluted earnings per share is based on the assumption that the dilutive
potential ordinary shares were converted or exercised. It is:
1. ”As if’ the convertible preference shares or convertible bonds have been converted; or ,
2. ”As if” the options or Warrants have been exercised.

The conversion or exercise is assumed to have taken place on the date the potential ordinary
shares first became outstanding, regardless of the .date .of actual conversion or exercise.

For example, convertible bonds outstanding as of January 1 are assumed to have been
converted on January 1. Options issued on April 1 are assumed to have been exercised on April

Diluted EPS is computed as follows:

Profit(Loss) Plus After tax interest expense on convertible bonds

Diluted = Weighted average number of outstanding ordinary shares plus Incremental shares
Arising from the assumed conversion or exercise of dilutive potential ordinary shares.

Convertible preference shares

When computing for diluted EPS, convertible preference shares are assumed to have
already been converted into additional ordinary shares. Thus, there is no adjustment to profit or
loss for any dividends on the convertible preference shares.
The incremental shares arising from the assumed conversion of the convertible preference
shares are added in the denominator.