Financial Accounting & Reporting III

Earnings per Share

Basic EPS
Diluted EPS

BASIC EARNINGS PER SHARE

Earnings per share (EPS) – the amount attributable to every ordinary share outstanding during the
period.
- EPS information pertains only to ordinary shares.
- It is not necessary for preference share because there is a definite rate of return for such share.

 The computation EPS is covered by IAS 33 which requires two presentations of EPS:
(1) Basic EPS
(2) Diluted EPS
 The presentation of EPS is required for entities whose ordinary shares or potential ordinary
shares are publicly traded and by entities that are in the process of issuing ordinary shares or
potential ordinary shares in the public securities market.
 Public entities are required to present EPS.
 Nonpublic entities are not required but are encouraged to present EPS.

PRESENTATION:
 An entity shall present on the face of the statement of comprehensive income the basic and
diluted EPS for income or loss from continuing operations.
 An entity that reports a discontinued operation shall disclose the basic and diluted EPS for the
discontinued operation either on the face of statement of comprehensive income or in the notes to
financial statements.
 An entity shall present basic and diluted EPS even if the amounts are negative.
 When an entity presents both consolidated and separate financial statements, the disclosures
required by the standard need to be presented only on the basis of the consolidated information.
 An entity that chooses to disclose EPS on its separate financial statements shall present such EPS
only on the face of its separate statement of comprehensive income.

USES OF EPS:
 It is a determinant of the market price of ordinary share, thus indicating the attractiveness of the
ordinary share as an investment.
 It is a measure of performance of management in conducting operations.
 It is the basis of dividend policy of an entity.

Potential ordinary share – a financial instrument or other contract that may entitle its holder to ordinary
shares.

Warrants or options – financial instruments that give the holder the right to purchase ordinary shares.

dividends∗¿
Basic EPS=Net income−Preferred of ordinary shares
Weighted Average ¿

* If the preference share is cumulative, the preferred dividends for current year only is deducted,
whether declared or not. If the preference share is non-cumulative, the preferred dividend for the current
year is deducted only if there is a declaration.

DETERMINATION OF WEIGHTED AVERAGE NUMBER OF ORDINARY SHARES:

 Shares are usually included in the weighted average number of shares from the date consideration
is received or receivable, which is the date of issuance.
 In the case of a stock dividend or share split, ordinary shares are issued to existing shareholders
for no additional consideration. the increase or decrease in the number of shares shall be
recognized retroactively, the stock dividends or split shall be treated as a change from the date
the original shares were issued.
 Subscribed ordinary shares or partly paid shares are included in EPS because under the
Corporation code, subscribed shares are entitled to participate fully in dividends.

STOCK RIGHTS

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  When rights are issued to shareholders most often the exercise price < fair value of shares.
 PHILIPPINE TERM: Stock rights; LEGAL TERM: Right of Pre-emption.
 The adjustment factor = ratio of the market value of the share right-on to the theoretical market
value of the share ex-right.

Adjustment factor=FVperShimmediately prior ¿ the exercise of rights ¿

Theoretical market value of the share ex−¿

Market value of the share right-on – the market value of the share immediately prior to the exercise of
rights.

Theoretical market value of the share ex−¿

¿ Total market value of outstandings shares+ proceeds ¿ the exercise of rights ¿
Number of shares outstanding after th

-or-

valueof one ¿=Market value of share ¿−on−exercise price ¿ purchase one share+1 ¿
Number of rights ¿

ADJUSTMENTS FOR DIFFERENCES ON THE SETTLEMENT OF PREFERENCE SHARES

 Retirement price > original issue price
Net income−Preferred dividends−(retirement price−CV of PS)
EPS=
WANOSO

 Retirement price < original issue price

Net income−Preferred dividends+(CV of PS−retirement price)
EPS=
WANOSO

DILUTED EARNINGS PER SHARE

 When the capital structure of an entity is simple, that it consists only of ordinary shares and
nonconvertible securities, the computation of EPS is easy.
 But where the capital structure of an entity is complex, that it consists of ordinary shares and
potential shares, the computation of the EPS becomes complicated.
 Potential ordinary share is a financial instrument that represents future issuance of ordinary
shares.

Three major types of potential ordinary shares:

(1) Convertible bonds
(2) Convertible preferred stocks
(3) Share options and warrants
Dilution – arises when the inclusion of the potential ordinary shares decreases the basic EPS (increases
basic loss per share).
- Dilutive securities
Antidilution – arises when the inclusion of the potential ordinary shares increases the basic EPS
(decreases basic loss per share) .
- Anti-dilutive securities and ignored in computing dilutive EPS.

 The computation of diluted EPS is based on the “as if” scenario:

o As if the convertible bonds were converted into ordinary shares.
o As if the convertible preferred stocks were converted into ordinary shares.
o As if the share options and warrants were exercised.

Convertible bonds
 The computation of diluted EPS assumes that the bonds were converted into ordinary share.
 Adjustment shall be made both to net income and to the number of shares outstanding. Net
income is adjusted by adding back the interest on bonds, net of tax.

Convertible preference shares

 The computation of diluted EPS assumes that the preference shares is converted into ordinary
share.

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  The net income is not reduced by the amount of preferred dividend. (if not paid)

Options and warrants

Share options – granted to employees enabling them to acquire OS of the entity at a specified price
during a definite period of time.

Share warrants – granted to shareholders enabling them to acquire OS of the entity at a specified price
during a definite period of time.

 Options and warrants are dilutive if the exercise or option price < market price of the OS.

Treasury share method

 The options and warrants are assumed to be exercised at the beginning of the current year or at
the date they are issued during the current year.

Multiple potential ordinary shares

 In considering, whether potential ordinary shares are dilutive or antidilutive, each issue of
potential ordinary shares shall be considered separately rather than aggregate.
 In order to maximize the dilution of the basic EPS, each issue is considered in sequence from the
most dilutive to the least dilutive. The potential ordinary share with the lowest incremental EPS is
ranked first.

Test for dilution:

1. Options and warrants – these are dilutive if option price < market price.
o These are the most dilutive because they have no impact on net income. They are ranked
first in computing diluted EPS.

2. Convertible preference shares – the contribution of the PS to net income is the amount of
preference dividend that is avoided because of conversion.
3. Convertible bonds - the contribution of the bonds to net income is the amount of interest
expense that is avoided because of the conversion.