8/6/2023

Chapter 12
Earnings per Share

Copyright © 2019 by McGraw-Hill Education (Asia). All rights reserved. 1

Learning Objectives

1. Understand the significance of earnings per share;

2. Understand the difference between basic and diluted earnings

per share;

3. Understand how new issues affect earnings per share through

the weighted average number of shares;

4. Understand the concept of dilution;

5. Understand the concept of control number in diluted earnings

per share; and

6. Use the methods for calculating diluted earnings per share: the
if-converted method and the treasury method.
2

Content

1. Introduction

2. Computation of a Weighted Average Number of Shares

3. Diluted Earnings per Share

1
 8/6/2023

Significance of EPS

2 main functions:
1. Measure firm’s profitability
2. Denominator in price-earnings ratio (PE ratio)
– PE ratio is widely used as a basis for comparing share-valuation
with peers
– Historic PE
• Current market price/EPS in the most recent FYE
– Prospective PE
• Current market price/projected EPS for the upcoming
FYE

Basic vs. Diluted EPS

Capital Structure

Simple Capital Structure Complex Capital Structure

Does not include potential Includes potential ordinary
ordinary shares shares, e.g. convertible
bonds/preference shares,
warrants, options, or other
contractual rights which, when
exercised, could in the aggregate
decrease earnings per ordinary
share

Report basic EPS only Report basic and diluted EPS only

Basic EPS

Net profit attributable to ordinary shareholders of a parent entity*

Basic EPS =
Weighted average no. of ordinary shares during a reporting period

*after deduction of non-controlling interests’ share of net profit or loss

Numerator:
• After deducting amounts due to preference shareholders in respect of:
– Preference dividends
– Gain/loss arising on the repurchase or early conversion of preference shares
– Amortization of discount or premium on increasing rate preference shares

Types of Preference Shares:

Cumulative preference shares: Requires the issuer to pay dividends, even if in arrears.

Increasing rate preference shares: Shares that are issued at a discount and that
provide a low initial dividend to compensate the issuer for selling at a discount.

2
 8/6/2023

Adjusting for Preference Dividends

Scenario Treatment
Non-cumulative preference shares Deducted when declared
Cumulative preference shares Deducted when due
Increasing rate preference shares Amortization of discount/premium treated
as part of preference dividend
Preference shares repurchased in Excess deducted from net profit
a tender offer (FV > carrying value) attributable to ordinary equity holders of
parent entity
Early conversion of preference This is a loss to the issuer and a return to
shares (Consideration > FV of the preference shareholders. Deduct loss
ordinary shares issuable) from net profit attributable to ordinary
equity holders of parent entity

Illustration 1: Preference Shares and Basic

EPS
GTO’s capital structure comprises the following:
− 5,000,000 ordinary shares
− 2,000,000 non-cumulative 6% preference shares
− 1,000,000 cumulative 4.5% preference shares
• Net profit for 20x3 and 20x4 were $300,000 and $5,000,000 respectively
• No dividend was declared or paid in 20x3
• In 20x4, dividends were declared and paid on the non-cumulative
preference shares and cumulative preference shares (for both 20x3 and
20x4)
• During 20x4, 500,000 cumulative preference shares were repurchased in a
tender offer at a premium of 50 cents over their carrying value
• Assume that the preference dividends and gains or losses on repurchase of
preference shares have no tax effects

Content

1. Introduction

2. Computation of a Weighted Average Number of Shares

3. Diluted Earnings per Share

3
 8/6/2023

Changes in Shares Issued during the Year

• Generally, changes in the shares issued during the year are due to
one of more of the following reasons:
– Issue of new shares during the year for cash or other assets
– Issue of new shares in the form of a bonus issue or share split
– Issue of new shares at a discounted price as a result of the exercise of
a rights issue
– Consolidation of existing shares through a reverse split
– Issue of new shares from the conversion of potential ordinary shares
such as convertible bonds or convertible preference shares
– Issue of new shares from the exercise of potential ordinary shares such
as stock options issued to employees or creditors
– Contingently issuable shares become actual issues when conditions
have been met
– Purchase of treasury shares and issue of previously purchased treasury
shares
10

Basic EPS
• When there are changes in the share capital during the year,
adjustment have to be made to the denominator (number of shares)
− Weighted number of shares outstanding during the period has to be
calculated
− The term “weighted average” refers to time-weighting, when there are
changes in the number of ordinary shares during the financial year.

• General rule:
− Shares are time-weighted from the date consideration is receivable
(usually the date of share issue)
− Time-weighting is only performed when there is an inflow of resources

11

Basic EPS

Examples:

Date to use for time-weighting

Shares issued for
acquisition/Business Date of acquisition
combination
Conversion of mandatorily
Date of contract
convertible instrument
Contingently issuable shares Date when all necessary
are issued conditions are satisfied

12

4
 8/6/2023

Calculating Basic EPS for Various Scenarios

Scenario 1: Issue of new shares for cash or other assets

• Issue of new shares for cash or other assets increases the

resources available to the firm
• Additional resources have a positive impact on net earnings from
the date they flow into the firm
− Hence, number of shares has to be time-weighted

13

Illustration 2: Issue of New Shares at Fair

Value
Scenario
• Company A had issued share capital of 5,000,000 ordinary shares at the
beginning of the year.
• On 30 June, it issued 3,000,000 shares at fair market value for cash.
• Net profit attributable to ordinary shares was $300,000 for the first 6
months and $800,000 for the full year.

14

Calculating Basic EPS for Various Scenarios

Scenario 2: Issue of bonus shares (stock dividends)

Reserves
Reserves
(Retained
earnings
+ Capital Bonus issue
reserves) Total Total
Equity Equity
Share
capital
Share
capital

shareholders
15

5
 8/6/2023

Calculating Basic EPS for Various Scenarios

• Bonus shares are issued out of reserves, such as capital reserves or

retained earnings
• Total shareholders’ equity remains unchanged but composition of
shareholders’ equity has changed
– Share capital increase
– Capital reserves or retained earnings decrease
– Total number of shares increase

• No inflow of resources → Earnings are not affected by issue of shares

→ Not time-weighted
• Treatment:
– Any bonus issues taking place in a period are assumed to be issued at the
beginning of the period (no time-weighting)
– Retroactively restate previous year’s EPS comparatives based on new
number of shares

16

Illustration 3: Issue of Bonus Shares (or

Stock Dividend)
Scenario
• Company A had a paid up share capital of $10,000,000 comprising
10,000,000 ordinary shares at the beginning of 20x3
• Net profit attributable to ordinary shareholders for YE 31 Dec 20x3 and
20x4 were $2,000,000 and $2,600,000 respectively
• On 30 Jun 20x4, the company declared a 1-for-2 bonus issue, the bonus
shares being issued from capital reserves
• Total number of shares increased from 10,000,000 to 15,000,000

17

Calculating Basic EPS for Various Scenarios

Scenario 3: Share splits

• An existing share is split into 2 or more shares

• No inflow of resources → not time-weighted
• Retroactive restatement of comparative EPS

Scenario 4: Consolidation of existing shares through reverse splits

• 2 or more shares are consolidated into one share

• No inflow of resources → not time-weighted
• Retroactive restatement of comparative EPS

18

6
 8/6/2023

Calculating Basic EPS for Various Scenarios

Scenario 5: Rights issue at a discount to market price

• Entitlement of existing shareholders to a rights issue is such that after

subscribing to the new shares, their proportionate interest in the firm after
the rights issue remains the same as before

• Number of shares issued comprises of:

1. Number of shares that would have been issued at the full market price
to achieve the same total proceeds
2. Number of shares that is deemed to be issued for no consideration or
the “bonus element”

19

Illustration 4: Rights Issue

Scenario
• On 30 Sep 20x4, Atlantis Co. made a one-for-two rights issue at a
subscription price of $1.50 per share to existing shareholders
• The market price immediately before the exercise of rights issue was
$3.00
• Atlantis Co’s paid-up capital consisted of 10,000,000 shares as at 1 Jan
20x4
• The company reported net profit attributable to ordinary shareholders of
$2,500,000 for the year ended 31 Dec 20x4

20

Illustration 4: Rights Issue

Additional points:
• Total proceeds from the rights issue = $7,500,000 (5,000,000 x $1.50)
– Inflow of new resources → time-weighting involved
• If the issue was made at full market price, only 2,500,000 new shares
needed to be issued ($7,500,000/$3)
• No. of shares in bonus element = 2,500,000

Total new shares issued 5,000,000

Comprising:
Shares deemed issue at full market price 2,500,000
Shares deemed issued as bonus shares 2,500,000
5,000,000

• There is an inflow of new resources as cash is raised. Thus, earnings from

30 September onwards are positively affected by rights issue
– Time-weighted by 3/12 for the full issue
21

7
 8/6/2023

Illustration 4: Rights Issue

• Bonus factor should be applied retrospectively to outstanding shares

before the rights issue

• Bonus issue factor = Full market price/ Theoretical ex-rights price

• Theoretical ex-rights price

= Value of existing shares + Proceeds from the rights issue
Total no. of shares after the rights issue

= ($3 x 10,000,000) + ($1.5 x 5,000,000)

10,000,000 + 5,000,000

= $2.5

• Hence, bonus issue factor = $3/$2.5 = 1.2

22

Illustration 4: Rights Issue

From 1 January 20x4 to 30 September 10,000,000 x 1.2 x

9,000,000
20x4 9/12

From 1 October 20x4 to 31 December

15,000,000 x 3/12 3,750,000
20x4
Weighted average number of shares 12,750,00
Net profit attributable to ordinary
$2,500,000
shareholders
Basic EPS (20x4) 19.6 cents

23

Calculating Basic EPS for Various Scenarios

Scenario 6: New issue of shares from the conversion of debt

• Capital structure of the issuer changes when the holders of

convertible debt exercises their conversion rights

• On conversion,
− Equity increases, debt decreases
− No inflow of cash and hence, increases the net assets of issuer
− Interest expense on debt is saved and thus, earnings increase
▪ Earnings have to be time-weighted

24

8
 8/6/2023

Illustration 5: Additional Shares Issued on

the Conversion of Debt
Scenario
• Capital Ltd had the following capital structure at Jan 20x5:
− 10,000,000 ordinary shares
− $10,000,000 8% convertible bond
• Conversion ratio of bond: every $1,000 nominal value of bond was
convertible into 500 ordinary shares
• On 1 Jul 20x5, 40% of the bond holders exercised their conversion rights
• Net profit for YE 31 Dec 20x5 was $3,300,000 which included interest
expense save because of the partial conversion of the bonds

25

Calculating Basic EPS for Various Scenarios

Scenario 7: Contingently issuable shares

• IAS 33:5: These are ordinary shares issuable for little/no cash or other
consideration upon the satisfaction of specified conditions in a contingent
share agreement

• When contingent events have occurred, the outstanding shares are time-
weighted from the date when all necessary conditions are satisfied, even
if the shares have yet to be issued.

26

Illustration 6: Contingently Issuable Shares

Scenario
• On 1 Jan 20x5, Alpha Company acquired Beta Corporation, a franchisor
for a reputable brand of footwear
• Consideration was paid entirely in cash
• Terms of acquisition included a contingent share agreement that required
Alpha Company to issue 10,000 additional new shares to shareholders of
Beta Corporation for each franchise contract secured in 20x5
• One contract was secured on 1 June 20x5 and another on 1 Dec 20x5
• Alpha’s share capital is comprised solely of 100,000 ordinary shares
• There had been no issue of new ordinary shares during the year
• Profit for the year ended 31 Dec 20x5 is $388,000
• Alpha’s Company interim financial statements were prepared half-yearly

27

9
 8/6/2023

Calculating Basic EPS for Various Scenarios

Scenario 8: Share repurchase and Treasury shares

• IAS 32:33: The entity that reacquires its own equity instruments
should deduct these instruments (“treasury shares”) from equity. No
gain or loss is recognized in P/L

• After repurchase, these shares should not be included in the

weighted average number of ordinary shares. If bought back during
the year, they should be time-weighted

• For shares repurchased and held since the beginning of the previous
financial year, they should not be included in the weighted average
number of ordinary shares for both prior and current period

28

Illustration 7: Impact of Treasury Shares

Scenario
• Co X has issued share capital of 4,000,000 ordinary shares as at 31 Dec 20x5.
• Profit for the year attributable to ordinary shareholders amounted to $1.2 million.
• In 20x3, a total of 500k were repurchased from the market under the company’s
share repurchase mandate and held in treasury.
• On 31 Aug 20x5, X bought back another 800k shares from the market. Similarly,
these shares are not cancelled and are held in treasury.
• Movement in the share capital account:
No. of Shares
1 Jan 20x5 Balance as at beginning 4,000,000
Less: Treasury shares (bought in 20x3) (500,000)
3,500,000
31 Aug 20x5 Shares repurchased during the year (800,000)
31 Dec 20x5 Balance as at end 2,700,000

Calculate weighted average number of ordinary shares and basic EPS

29

Content

1. Introduction

2. Computation of a Weighted Average Number of Shares

3. Diluted Earnings per Share

30

10
 8/6/2023

Diluted EPS

• An entity can issue both ordinary shares and potential ordinary

shares. The following situations give rise to potential ordinary
shares, requiring computation of diluted earnings per share if
the shares are dilutive
– The entity has outstanding potential ordinary shares in the form of
options and warrants or convertible instruments
– The entity has contingently issuable shares, and the conditions have
not been met
– The entity has entered into contracts that may be settled in ordinary
shares or cash, either at the entity’s discretion or the holder’s
discretion

31

Diluted EPS

• It is EPS under the assumption of full conversion or exercise of

potential ordinary shares or issuance on satisfaction of specified
conditions
− Potential ordinary shares are financial instruments or contracts
that give rise to ordinary shares at the exercise or conversion by
the holder or on satisfaction of specified conditions

• It is the “worst-case scenario” EPS

• What is the purpose of presenting diluted EPS?
– Enhance comparability for firms with complex capital structures
➢ Focuses on profitability rather than timing of actual
conversions
– Provides indication of dilutive impact of existing potential ordinary
shares

32

Anti-dilution

• If a conversion/exercise of potential ordinary shares cause EPS to

increase, anti-dilution occurs

• IAS 33:41 – Potential ordinary shares that are anti-dilutive are

excluded from the calculation of diluted EPS
− Diluted earnings (loss) per share should never be higher (lower)
than basic EPS

• Use of profit or loss from continuing operations attributable to the

parent entity as the “control number” to determine whether
potential ordinary shares are dilutive or anti-dilutive

33

11
 8/6/2023

Anti-dilution

Is diluted EPS from continuing operations >

basic EPS from continuing operations?

yes no

Anti-dilution occurs. No anti-dilution. Include

Diluted EPS for the potential ordinary
(overall) profit/loss shares in the
attributable to ordinary computation of diluted
shareholders is equal EPS for (overall)
to basic EPS. profit/loss attributable
to ordinary
shareholders.

34

Illustration 8: Profit from continuing

operations and overall loss
Scenario
• Regis Corporation had 10,000,000 ordinary shares and stock options
outstanding throughout the year that potentially give rise to 1,000,000
ordinary shares
• Regis Corporation had no other potential shares such as convertible
preference shares or convertible debt
• For the year ended 31 Dec 20x4, Regis Corporation reported the
following:

Profit from continuing operations $3,800,000

Loss from discontinued operations (4,200,000)
Loss attributable to ordinary shareholders $(400,000)

35

Adjustments to the Computation of Diluted

EPS
Adjustments to the numerator of diluted EPS:
Scenario Impact on numerator

Dividends on convertible preference shares Not deducted from net profit

After-tax interest and amortization expenses on

Added back to net profit after tax
convertible bond

Other expense (income) relating to potential

Added back (deducted from) NPAT
ordinary shares

Adjustments to the denominator of diluted EPS:

• Potential ordinary shares are included in the denominator at the beginning
of reporting period or date of issue of potential ordinary shares, whichever
is the later

36

12
 8/6/2023

Calculating Diluted EPS for Various

Scenarios

Scenario 1: Options/Warrants
• Options and warrants are instruments that give their holder the right but
not the obligation to subscribe for shares in the issuing firm at a specified
price for a specified period
• Assumption: all options and warrants are exercised either at the
beginning of the period or at the date of issue if issued during the period
• Call options and warrants are only dilutive if they are “in-the-money”
− Average market price of ordinary shares during the period exceeds the
exercise price
• Use the treasury method to calculate dilutive EPS (the same method as
applied to calculate EPS for a rights issue)

37

Treasury Method

• The treasury method assumes that the issuing entity would buy back
shares from the open market with the proceeds it collects from the option
holders
– If the option is “in-the-money”, the number of repurchased shares would be
insufficient to issue to option holders
– Additional shares will be issued to option holders for free

Total number of shares issuable to option holders = N

Number of shares repurchased in the open market N x EXP
=
at market price (MP) MP
Bonus issue element in a stock option that is “in- N – (N x EXP)
=
the-money” MP

– Assume that stock options are exercisable into ordinary shares at any time
throughout the period → Market price is the average for the period in
which stock options are outstanding and not the price at the end of period
38

Illustration 9: Complex capital structure with

options
Scenario
• The following information pertains to Supreme Corporation for year ended
31 Dec 20x6:

Net profit for the year $2,000,000

Preference shares None
Ordinary shares outstanding 2,000,000
Shares to be issued under options 400,000
Date options issued 1 January 20x6
Exercise price of options during 20x6 $6
Average market price of one ordinary share during 20x6 $8
Proceeds from the assumed exercise of 400,000 options $2,400,000

There are no other potential ordinary shares

39

13
 8/6/2023

Calculating Diluted EPS for Various

Scenarios

Scenario 2: Convertible Instruments

• Use the “if-converted” method to compute diluted EPS

• All convertible instruments are assumed to be converted either at
the beginning of the period or at the date of issue if issued during
the period
• Preference dividends or interest (net of tax) relating to the
convertible instruments are added back to the net profit
attributable to ordinary shareholders
• If the amount of preference dividends declared (or accumulated)
for the period or the interest (net of tax) per ordinary share on
conversion is more than the basic EPS, the convertible
preference shares is anti-dilutive

40

Calculating Diluted EPS for Various

Scenarios

Alternative approach to test whether convertible preference shares

are anti-dilutive:
• If earnings per preference share without conversion > earnings per
preference share with conversion
→ The convertible preference shares/ convertible debt is anti-
dilutive
→ Excluded from calculation of diluted EPS

41

Illustration 10: Potential Ordinary Shares

that are Convertible Securities
Scenario
• Company A recorded net profit of $2,320,000 for YE 30 Jun 20x5
• Company had 50,000,000 ordinary shares outstanding at the beginning of
the year
• No new shares were issued during the year
• Company A had outstanding 5,000,000 6.4% cumulative preference
shares that are convertible into ordinary shares at the ratio of one
preference share for one ordinary share

42

14
 8/6/2023

Calculating Diluted EPS for Various

Scenarios
Scenario 3: Contingently Issuable Shares

• If the contingent events are met, these shares are included in the
calculation of diluted EPS, from beginning of period or date of
agreement, if later

• If the contingent events are not met, we take the number of shares
issuable if the end of the period is the end of the contingency period
(IAS 33:52)

43

Illustration 11: Contingently Issuable Shares

when Conditions have been Met
Scenario
• On 1 Jan 20x5, Alpha Company acquired Beta Corporation, a franchisor
for a reputable brand of footwear
• Consideration was paid entirely in cash
• Terms of acquisition included a contingent share agreement that
required Alpha Company to issue 10,000 additional new shares to
shareholders of Beta Corporation for each franchise contract secured in
20x5
• One contract was secured on 1 June 20x5 and another on 1 Dec 20x5
• Alpha’s share capital is comprised solely of 100,000 ordinary shares
• There had been no issue of new ordinary shares during the year
• Profit for the year ended 31 Dec 20x5 is $388,000
• Assume that there are no other potential ordinary shares other than the
contingently issuable shares
44

Illustration 12: Contingently Issuable Shares

when Conditions have not been Met
Scenario
• Delta Corporation entered into a contingent share issue agreement on 1
Jan 20x5 as part of the compensation plan for its CEO
• Terms of agreement, which ended on 31 Dec 20x6, required Delta to
issue a bonus of 1 ordinary share for every $2 of year-to-date
consolidated, after-tax net profit in excess of $1,000,000 during the
agreement period
• Delta had 5,000,000 ordinary shares outstanding in 20x5 and had no
outstanding options, warrants or convertible securities
• Delta prepares financial statements on a quarterly basis
Quarter ended Year-to-date consolidated after-
tax net profit
31 March 20x5 $800,000
30 June 20x5 1,200,000
30 September 20x5 1,000,000
31 December 20x5 1,500,000
45

15
 8/6/2023

Illustration 12: Contingently Issuable Shares

when Conditions have not been Met
• The number of shares to be included in diluted EPS for each quarter and for the
full year is as follows:
First Second Third Fourth
Full year
quarter quarter quarter quarter
20x5
20x5 20x5 20x5 20x5
Basic EPS:
Numerator $800,000 $400,000 $(200,000) $500,000 $1,500,000
Denominator:
Ordinary shares outstanding 5,000,000 5,000,000 5,000,000 5,000,000 5,000,000
Basic EPS (cents) 16 8 (4) 10 30
Diluted EPS:
Numerator $800,000 $400,000 $(200,000) $500,000 $1,500,000
Denominator:
Ordinary shares outstanding 5,000,000 5,000,000 5,000,000 5,000,000 5,000,000
Contingency shares 0 100,000 0 250,000 250,000
Total shares 5,000,000 5,100,000 5,000,000 5,250,000 5,250,000
Diluted EPS (cents) 16 7.8 (4) 9.5 28.6
46

Contracts that May be Settled in Ordinary

Shares or Cash
• Potential ordinary shares are present when a firm enters into a
contract that gives the issuer or the holder the option for
settlement of the contract in ordinary shares or cash

• If the option lies with the entity, presumption is that the contract
will be settled in ordinary shares
− Resulting potential ordinary shares are to be included in diluted
EPS if the shares are dilutive

• If the option for settlement lies with the holder of the instrument,
the more dilutive of the two options of cash settlement and share
settlement is assumed in calculating EPS

47

Contracts that May be Settled in Ordinary

Shares or Cash
Example: written put option
• If the option is “in-the-money” during the period (i.e. exercise price
above average market price)
− Dilutive effect on EPS calculated using treasury method for a
share-buy-back arrangement (IAS 33 Para 63)
− Assumes that at the beginning of the period, sufficient ordinary
shares are issued at the average market price during the
period to raise funds to finance the share buy-back
− Incremental ordinary shares is the difference between the
shares issued and the shares bought back

48

16
 8/6/2023

Contracts that May be Settled in Ordinary

Shares or Cash
Total number of shares to be bough back under a written option = N

Exercise price = EXP

Market price = MP

Number of shares to be issued to finance the share buy back = (N x EXP)/MP

Incremental ordinary Number of shares to issue in Number of

shares from a written = the open market to finance – shares to be
put option share buy-back bought back
(N x EXP) – N
=
MP

49

Anti-dilution Sequencing

• Purpose of reporting diluted EPS is to report maximum dilution

• A potential ordinary share may be dilutive on its own, but may be
anti-dilutive when included with other potential ordinary shares
• There are so many permutations and combinations, so we need
to find an order of inclusion
– Start with the most dilutive, process stops when the inclusion of
a potential ordinary share increases the diluted EPS

50

Anti-dilution Sequencing

Approach to calculate diluted EPS:

1. Compute basic EPS

2. Compute earnings per incremental share (EPIS) for each class of

potential ordinary shares

Increase in earnings from assumed conversion or exercise

EPIS =
Incremental number of shares from assumed conversion or exercise

• The class of shares with the lowest impact on the numerator (earnings)
and the highest impact on the denominator (the no. of shares) has the
lowest EPIS and is the most dilutive.

51

17
 8/6/2023

Anti-dilution Sequencing

3. Rank them from the most dilutive to the least dilutive and include the
most dilutive first in diluted EPS calculation.

4. The process stops when all the potential ordinary shares have been
included or when the inclusion of the next ranked potential ordinary share
results in a higher diluted EPS than the previous provisional diluted EPS.

* The reported diluted EPS is the lowest possible figure and must never be
higher than the basic EPS.

52

Comprehensive Illustration

Financial statement and share information of Company A for 20x6 are

as follows:

Net profit after tax 12,000,000

Less preference dividends -24,000
Net profit attributable to ordinary shareholders 11,976,000
No. of issued ordinary shares at 31 December 4,250,000

53

Comprehensive Illustration
Information on movements in ordinary shares:
1 Jan 20x4 New issue for cash (incorporation) 1,000,000
1 April 20x5 New issue for cash 200,000
1 July 20x5 Bonus issue: 1 for 1 1,200,000
1 Oct 20x5 From conversion of preference shares 500,000
1 July 20x6 Rights issue: 1 for 2 1,450,000
1 new share for every 2 existing shares
Exercise price: $2
Market price: $3
All rights were taken up -100,000
1 Oct 20x6 Shares re-purchased at fair value

54

18
 8/6/2023

Comprehensive Illustration
Information on Potential Ordinary Shares (dilutive instruments)

1. On 1 July 20x4, the company issued 1,000,000 6% non-cumulative

preference shares that are convertible to 500,000 ordinary shares. The
original conversion ratio is 2 preference shares to 1 ordinary share. After the
bonus issue, each reference share was convertible to 1 ordinary share.
(Ignore the effects of the rights issue on the conversion ratio)

On 1 Oct 20x5, 500,000 preference shares were converted to ordinary shares.

Preference dividends were declared on outstanding balance of preference
shares as at 30 June of each year.

55

Comprehensive Illustration
2. On 1 July 20x5, the company issued 500,000 units of stock options. Each
stock option unit entitles the holder to purchase 1 unit of ordinary share.
Exercise price: $2.50
Average market price (20x6) $3.00

None were exercised during the period because of a vesting period

requirement.

3. On 1 Oct 20x5, the company issued $10,000,000 convertible bonds which are
convertible to 10,000,000 ordinary shares.
Market interest rate: 5% per annum
Tax rate: 20%. None were converted during 20x5 or 20x6

Required: Prepare diluted EPS for 20x6

56

Comprehensive Illustration
Step 1: Determine the Earnings per Incremental Share (EPIS) for each
type of potential ordinary shares.

a) Convertible preference shares

Incremental shares arising from the assumed conversion of the preference
shares as at 1 Jan 20x6

Assumed converted from 1 Jan 20x6 to 31 Dec 20x6: 500,000 (500,000 x 12/12)
(No partial conversions during the year; hence, assume the balance at year-end
is converted at beginning of year)

Impact on profit attributable to ordinary shareholders from assumed conversion:

Avoidance of dividends declared on preference shares during 20x6 = 24,000
Earnings per Incremental Share = 0.048 (24,000/500,000)

57

19
 8/6/2023

Comprehensive Illustration

b) Stock Options
Incremental shares arising from the assumed exercise of options as at 1 Jan
20x6

No. of ordinary shares issued if outstanding options are exercised: 500,000

Equivalent number of shares at fair market value: 416,667 (500,000 x 2.5)/3.0
Incremental number of shares issued for no consideration: 83,333
• Apply a whole year’s weighting since the stock options were in existence at beginning of
20x6.

Impact on profit attributable to ordinary shareholders from assumed exercise:

Earning per Incremental Share = 0

58

Comprehensive Illustration
c) Convertible Bonds
Incremental shares arising from the assumed conversion of convertible
bonds as at 1 Jan 20x6

No. of ordinary shares issued if the convertible bonds were converted

= 10,000,000 (10,000,000 x 12/12)

Impact on profit attributable to ordinary shareholders from assumed conversion

as at 1 Jan 20x6:
Savings of interest expense (after-tax) on convertible bonds
=10,000,000 x 5% x 12/12 x 0.8 = 400,000
Earnings per Incremental Share = 0.04

59

Comprehensive Illustration

Step 2:
Ranking by EPIS EPIS

1) Stock Options 0 (most dilutive)

2) Convertible Bonds 0.04

3) Convertible Preference Shares 0.048 (least dilutive)

60

20
 8/6/2023

Comprehensive Illustration
Changes in number of ordinary shares in 20x5
Increase in ordinary
Date Item
shares

1 Jan 20x5 Balance at start 1,000,000

1 Apr 20x5 New issue for cash 200,000

1 July 20x5 Bonus issue 1,200,000

Conversion of
1 Oct 20x5 500,000
preference shares

31 Dec 20x5 Balance at year-end 2,900,000

61

Comprehensive Illustration
Calculating weighted average number of shares in 20x6
Date 1 Jan 20x6 1 July 20x6 1 Oct 20x6
Item Shares re-
Balance at start Rights issue
purchased
Increase in ordinary shares
2,900,000 1,450,000 (100,000)

Add bonus issue 362,500 (362,500)

Cumulative balance
3,262,500 4,350,000 4,250,000

Period outstanding
1 Jan – 1 Jul 1 Jul – 1 Oct 1 Oct – 31 Dec

Time weight 1/2 1/4 1/4

Weighted average number of shares
1,631,250 1,087,500 1,062,500

62

Comprehensive Illustration
• Number of ordinary shares as at 31.12.20x6
= 2,900,000 + 1,450,000 – 100,000
= 4,250,000

• Weighted average number of shares in 20x6

= 1,631,250 + 1,087,500 + 1,062,500
= 3,781,250

63

21
 8/6/2023

Comprehensive Illustration
Step 3: Introduce the most dilutive security first into aggregate DEPS
calculation
Profit WA no. of DEPS
shares
Basic EPS 11,976,000 3,781,250 3.167207
Include effects of assumed exercise of 0 83,333
options
Aggregate DEPS 11,976,000 3,864,583 3.098911 Dilutive
Include effects of assumed conversion of 400,000 10,000,000
convertible bonds
Aggregate DEPS 12,376,000 13,864,583 0.892634 Dilutive
Include effects of assumed conversion of 24,000 500,000
convertible preference shares
Aggregate DEPS 12,400,000 14,364,583 0.863234 Dilutive
Reported DEPS (20x6) 0.863234

64

Presentation and Disclosures

• Basic and diluted EPS to be presented in income statement, in

respect of:
− Profit attributable to ordinary shareholders of parent company
from continuing operations
− Profit attributable to ordinary shareholders of parent company for
the period

• Where there are discontinued operations, basic & diluted EPS

for discontinued operations must be disclosed in the income
statement or in the notes

65

Presentation and Disclosures

Other information that should be in the notes (IAS 33:70):
1. Earnings used in numerator of EPS, as well as a reconciliation of
earnings to the income statement. (Include individual earnings effect
of each class of instruments on EPS)
2. Denominator in calculating basic and diluted EPS and a reconciliation
of both denominators. (Include individual denominator effect of each
class of instruments on EPS)
3. Potential ordinary shares that were not included in the calculation of
diluted EPS, because they were anti-dilutive
4. Subsequent events – description of transactions which would have
significantly changed the no. of ordinary shares/potential ordinary
shares outstanding at the end of period

66

22