ro fee CHAPTER 21 pILUTED EARNINGS PER SHARE Multiple potential ordinary shares TECHNICAL KNOWLEDGE To determine diluted earnings per share where there is combination of multiple potential ordinary shares. To apply the test for dilution of potential ordinary shares. | To know the accounting treatment of contingent ordinary shares in EPS computation. | ' 6471 ordinary shares Multiple potential ential ordinary share, there one dilutive P° If there is only’ i roblem. is no accounting P! A problem arises where the entity has two or more dilutiy, potential ordinary shares. In considering whether potential ordinary shares are dilutivé or antidilutive, each issue oF series of potentia) ordinary shares shall be considered separately oy individually, rather than in the aggregate. In order to maximize the dilution of the basic earnings per share, each issué is considered in sequence from the most dilutive.to the least dilutive. tial ordinary shares shall be ranked In other words, the potent f incremental EPS. based on their contribution in terms 0} The potential ordinary share with the lowest incremental EPS is ranked first. 648yr. gest for dilution options and warrants e options od Warrants are dilutive if the option price oF exere! wer than the average market price. ae options and Warrants are the most dilutive because option ‘ants have no impact on net income. hus, the options and warrants a i uting giluted earnings per share. re ranked first in comp’ Convertible preference share he contribution of the preference share to net income is the amount of preference dividend that is avoided because of the conversion. The incremental EPS for convertible preference share is equal to the amount of annual preference dividend divided by the number of ordinary shares into which the preference share is convertible. If this incremental EPS is lower than the basic EPS, the convertible preference share is probably dilutive. If this incremental EPS is higher than the basic EPS, the preference share is antidilutive. Convertible bond’ payable The contribution of the bond payable to net income is the amount of interest expense that is avoided because of the conversion. The incremental EPS for the convertible bond ‘payable is equal to the interest expense, net of tax divided by the number of ordinary. shares into which the bond payable is convertible. If this incremental EPS is lower than the basic EPS, the convertible bond payable is probably dilutive. If this incremental EPS is higher than the basic EPS, the Convertible bond payable is antidilutive. 649Llustration i rovided the following data for the current yea, An entity P! rc ; ; Hades i erations poset att csi Ordinary shares actually outstanding ae Option shares 7 ha Parke price ‘5 lgene chare capital, P100 par ome Bond payable , i 0 Income tax rate The preference share capital is 5% cumulative and convertible into 25,000 ordinary shares. The bond payable lias nominal rate of 10% and is convertible into 40,000 ordinary shares. Procedures The first step is to compute the basic earnings per share. Income from continuing operations 5,000,000 Preference dividends (5% x 5,000,000) (250,000) Income to ordinary share 4,750,000 Divide by ordinary shares actually outstanding ' 500,000 Basic EPS . 9.50 In calculating whether potential ordinary shares are dilutive, the income figure used as the “control number" is the income from continuing operations. The second step is to determine ial e ' whether the potenti® ordinary shares are dilutive or antidilutive. 7 650F a gest for dilution The options are dilutive by ' than the average markets the option price is lower Price, The number of incr; ‘ . as follows: - mental ordinary shares is determined Option shares 50,000 Assumed treasury shares (50,000 x 60 = 3,000,000 / 75) (40,000) Incremental ordinary shares 10,000 10,000 b. Convertible preference share Annual preference dividend (5% x nnual Pr 5,000,000) 250,000 Divide by incremental ordinary shares from conversion __ 25,000 Incremental EPS 10.00 The convertible preference share is antidilutive because the incremental EPS is higher than the basic EPS of P9.50. c. Convertible bond payable Interest expense, net. of tax (5,000,000 x 10% x 70%) 350,000 Divide by incremental ordinary shares from conversion _ 40,000 Incremental EPS 8.75 The convertible bond payable is potentially dilutive because the incremental EPS is lower than the basic EPS. The three potential ordinary shares shall be ranked in the computation of the diluted EPS starting with the lowest incremental EPS. 651Ranking of potential ordinary shares irst - tions are always F Fumio im act on net income incremental EPS. Second — The convertible bond pa: EPS of P8.75 Third — The convertible pre incremental EPS of P10.00. Observe the following compu sequence from the most dilutive anked first because o, ti and therefore have can able with an incrementa) ference share with an tation of diluted EPs in to the least dilutive, (a) (b) (a/b) Income Ordinary shares EPS Basic EPS 4,750,000 500,000 - 9.50 Options 0 , —10,000 — Diluted EPS 4,750,000 510,000 9.31 Convertible bond “350,000 40,000 (es) Diluted EPS 5,100,000 550,000 9.27 Convertible PS — 250,000 —25,000 — Diluted EPS 5,350,000 575,000 8.30 Notice that the diluted EPS is increased from P9.27 to P9.30 when taking into account the convertible preference share, Accordingly, the convertible preference share is ignored in the calculation of the diluted EPS, Presentation of earnings per share Basic earnings per share Income from continuing operations (4,750,000/500,000) —9.50 Loss from discontinued operations (1,000,000 /500,000) (2.00) Net income 50 ‘ Diluted earnings per share Income from continuing operations 9.27 Loss from discontinued operations (6,100,000 560,000) (2,000,000 560,000) (1.82) Netincome : 652written put options 1 options on ordinary polder the right to, sel] for a given period, shares are contracts that give the ordinary shares at a specified price Contracts that require the entity to repurchase its own shares, such as written put options and forward purchase contracts are reflected in the ca i ‘ per share if the effect is dilutive, Jf these contracts are in the Money, meaning the exercise or settlement price is high , Price is ‘er than the average market price, the potential dilutive effect on earnings per share shall be calculated as follows: a, Itis assumed that at the beginning of the period sufficient ordinary shares will be issued at the average market price. b. Itis assumed that the proceeds from the issue are used to satisfy the contract or buy back the ordinary shares covered by the written put options. c. The difference between the number of ordinary shares assumed issued and the number of ordinary shares repurchased under the written put options represents the incremental ordinary shares. d. The incremental ordinary shares shall be included in the calculation of diluted earnings per share.: 653Illustration tanding 12,000 written put options on the An entity has outst ; t y . ith an exercise price of P350. ordinary shares wi must repurchase its own 12,009 share or a total put obligato, arket price is P280. This means that the entity ordinary shares at P350 per of P4,200,000. The average ™ ordinary shares would be issueg The question is how many Se the put obligation of P4,200,009, by the entity in order to raise In this case, it is assumed that the entity shall issue ordinary shares at the average price of P280 per share. Accordingly, the total ordinary shares assumed issued would be equal to P4,200,000 divided P280 or 15,000 shares. The number of incremental ordinary shares to be included in computing diluted earnings per share is determined as follows: Ordinary shares assumed issued 15,000 Ordinary shares repurchased under the written putoptions 12,000 Incremental ordinary shares 654poe Contingent ordinary shares i t ordini Contingent ary shares are oydi i for jittle oF no cash o} re ordinary shares issuable t other’ considorati isfaction of i iti A ‘eration upon satisfaction 0} specified conditions in a contingent share agrooment A contingent share a ordinary shares that specified conditions, 8reement is an agreement to issue 1s dependent on the satisfaction of Contingent ordinary shares are treated as outstanding and included in the computation of both basic and diluted earnings per share if the conditions are satisfied. The difference lies in the number of contingent shares that would be included in the computation of earnings per share. Contingent ordinary shares are included in the calculation of basic earnings per share from the date the condition is satisfied. = Contingent ordinary shares are included in the computation of diluted earnings per share from the beginning of the period or from the date of the contingent agreement, if later. 655ca Illustration i 12,000, _ Net income for the year on Ordinary shares outstanding on January 1, 2020 soo. An agreement on January l 2020 related to a busines, combination provides for the issue of additional orqj 4 eh nar shares based on the following conditions: 'y a. 15,000 additional ordinary shares for each new retajj bite opened during 2020. *— Retail sites were opened on May 1, 2020 and Octobe; 1 2020. b. 10,000 additional ordinary shares for every P1,000,009 net income in excess of P10,000,000 for 2021. Basic earnings per share Ordinary shares - January 1, 2020 500,000 Retail site condition satisfied: May 1,2020 (15,000 x 8/12) 10,000 October 1,2020 (15,000 x 3/12) 3,750 Total ordinary shares 513,750 Basic earnings per share (12,000,000 / 513,750) 23.36 Note that the second condition about earnings contingency , has no effect on basic earnings per share because it is not certain that the condition is satisfied until the end of the contingency period on December 31, 2021. 656piluted earnings per share dinaxy shares outstanding — Rriailsite condition: "6 Zanwary 1, 2020 500,000 May + 1,2020 ae October 1, 2020 OD Barnings condition (10,000 x. 2) a 000 qotal ordinary shares 560,000 Diluted earings per share (12,000,000 / 550,000) 21,82 As stated earlier, contingent ordinary shares are included in the computation of diluted earnings per share from the beginning of the period or from the date of agreement, if later. Thus, the full ordinary shares from the retail site condition and earnings condition are recognized. Note that the earnings condition must be satisfied on December 31, 2021 but already considered in computing diluted earnings per share. PAS 33, paragraph 53, provides that if a specified amount of earnings is a condition for a contingent issue and that amount is already attained at the end of the current period, the contingent ordinary shares are included in the computation of the diluted earnings per share. It is as if the amount of earnings at the end of the current period is the amount of‘earnings at the end of the contingency period, Restatement is not permitted if the conditions are not met when the contingency expires on December 31, 2021. 657Convertible bonds settled in shares or cash When an entity has issued bonds payable that may be Settleg in ordinary shares or cash at the issuer's option, the eny: ity shall presume that the bo ree i 7 i hares shall be includeg ; The resulting potential ordinary s! b luded in the calculation of diluted earnings per share if the effeg, is dilutive. Convertible bonds are compound instrument and accounteg for as partly liability and partly equity. rads will be settled in ordinary sha The interest expense, net of tax, on the liability component is added back to the net income. Illustration At the beginning of the current year, an entity issued 3-year convertible bonds with face value of P5,000,000. The issue price is equal to the face value and the interest is payable annually at the rate of 6%. Each P1,000 bond is convertible into 200 ordinary shares. The entity has the option to settle the principal amount of bonds payable in ordinary shares or cash. When the bonds are issued, the prevailing market interest rate for similar bonds without the conversion feature is 9%, The following data are available for the current year: Net income 10,000,000 Bonds payable 5,000,000 Ordinary shares outstanding * 2,500,000 Potential ordinary shares, each P1,000 bond is convertible into 200 shares (5,000 x 200) 1,000,000 Income tax rate 30% The convertible bonds shall be accounted for as partly liability and partly equity. ‘Thus, the proceeds of P5,000,000 should be allocated first the liability component and ithe remainder to the equity component. . 658piability component jabilit aaa chew 18 equal to the sum of the following: t Present value of the face amount of 5,000,000 discounted ® ¢ 9% for 3 period ae oda is OFT a The precent value of 1 at 9% for 8 b. Freed port aentetest on bonds payable discounted é . The pr u annuity of 1 at 9% for 3 marisa is gale of an ordinary Market value of the bonds payable resent value oo amount (5,000,000 x.77) 3,850,000 {6,000,000 x 6% = 300,000 x 2.58) 759,000 total liability component 7,609,000 ‘total proceeds from bond issuance 5,000,000 Liability component (4,609,000) Bquity component 391,000 Basic earnings per share Net income — 10,000,000 Divide by ordinary shares outstanding 2,500,000 Basic EPS Diluted earnings per share Itis presumed that the entity shall settle the bonds payable by the issue of ordinary shares. Ordinary shares outstanding 2,500,000 Potential ordinary shares 1,000,000 | Ttalordinary shares 3,500,000 Net income 10,000,000 terest on the bonds payable at the market rate (9% x 4,609,000x 70%) 290,367 Adjusted net income 10,290,367 | Diluted earnings per share (10,290,367 3,500,000), 659 .QUESTIONS 1, Explain the test for dilution of share options. 2. Explain the test for dilution of convertible Preferengs shares. 3. Explain the test for dilution of convertible bonds Payable, 4.Define written put options. 5.Explain the treatment of written put options ;, calculating diluted earnings per share. 6. What are contingent ordinary shares? 7%. Explain the treatment of contingent ordinary shares in calculating basic earnings per share. 8. Explain the treatment of contingent ordinary shares in calculating diluted.earnings per share. 9. Explain the treatment of convertible bonds payable that may be settled in ordinary shares or cash. 10. Explain the computation of the liability component from the issue of convertible bonds payable. 660pnoBLEMS problem 21-1 (ACP) atrina Company reported the atof reporting period: following information at the en -10% ads payable ~ 10% 1,600,000 Botrence share capital, 190% cumulative, P100 par, 30,000 shares : "3,000,000 ordinary share capital, 100,000 shares, P50 par 5,000,000 e bonds are convertible into ordinary shares in the ratio of 20 ordinary shares for every P1,000 bond. ghe peer share is convertible into ordinary share in the ratio of two ordinary shares for one preference share. The net income for the year was P3,695,000 and the income tax rate is 30%, 7 Required: 1, Basic earnings per share 2, Diluted earnings per share Problem 21-2 (IAA) Atyear-end, Gaze Company had 100,000 ordinary shares and | 20,000-convertible preference shares outstanding in addition to 10% convertible bonds payable in the face amount of P2,000,000. : During the current year, the entity paid dividends of P5 per share on the preference share. , The preference share is convertible into 40,000 ordinary shares. The 9% bonds are convertible into 30,000 ordinary shares, / | The net income for the current year was P2,410,000 and the imeome tax rate is 30%. | Required: k 7 Basic earnings per share * Yuluted earnings per share 661os Problem 21-3 (AICPA Adapted) Amaze Company reported the following information “ year-end: 2020 2019 i i 360,000 309 Ordinary shares outstanding f 000 Noneonvertible preference outstanding shares ee 10,009 10% convertible bonds payable -face value 1,000,000 1,000,099 The entity provided the following additional information, * On September 1, 2020, the entity sold 60,000 additiona) ordinary shares. * Net income for the year ended December 31, 2020 was P6,700,000.* * During 2020, the entity paid dividends of P30 per share on the nonconvertible preference share. The 10% convertible bonds are convertible into 40° ordinary shares for each P1,000 bond. Unexercised share options to purchase 30,000 ordinary shares at P20 per share were outstanding at the beginning and end of 2020. The fair value of each stock option is P5. The average market price of ordinary share was P30 during 2020. The market price was P40 on December 31, 2020. ay Warrants to purchase 20,000 ordinary shares at P45 per share were attached ‘to the preference share at the time of issuance. The warrants, which expire on December 31, 2022, were outstanding on December 31, 2020. * The income tax rate is 30%. Required: 1. Basic earnings per share 2. Diluted earnings per share 662r problem 21-4 (AICPA Adapted) passanin Company reported the following capital structure at Ye : : sath outstanding shares: 2019 20: Ordinary 600 Sones ona tooo0 100,000 sopconversble bonds payable 3,000,000 3,000,000 ane eee shane, “NY Paid the annual dividend of P5 on ve ; he preference shares are convertible into 200,000 ordinary shares and the 10% bonds are convertible into 100,000 ordinary shares. ne net income for the cur 00. The hee tax rate is 30% Curent Year was P5,000,0 " Required: , 1, Basic earnings per share 9, Diluted earnings per share Problem 21-5 (AICPA Adapted) Camiguin Company reported the following information at year-end: Ordinary share capital 110,000 shares Convertible noncumulative preference share capital 20,000 shares 10% convertible bonds payable 2,000,000 Share options to purchase 60,000 shares at P15 were outstanding. Market price of share was P25 at yer-end and averaged P20 during the year. The entity paid the annual dividend of P5 on the preference share. The preference shares are convertible into 40,000 ordinary shares. The 10% bonds are convertible into 30,000 ordinary shares. The net income for the current year was P650,000. The | Meome tax rate is 30%. | Required: 1. Basic earni hal a ‘ings per share L Diluted earnings per share ¥ 663Problem 21-6 (IFRS) | Turkey Company provided the following information fo, the year ended December 31, 2020: i 5,900.09 Net income for the year ,000 Ordinary shares outstanding on January 1, 2020 1,000,009 On January 1, 2020, an agreement related to a recent business combination provides for the issue of additiong) ordinary shares based on the following conditions: a. 50,000 additional ordinary shares for each new branch opened during 2020. b. 1,000 additional ordinary shares for each P1,000 of net ~ income in excess of P5,000,000 for the year ended December 31, 2021. “The entity opened two new branches, one on April 1, 2020 and the other on July 1, 2020. Required: 1. Basic earnings per share 2. Diluted earnings per share 664problem 21-7 (AA) | anzel Company had 299 000 ordi mE ‘ r i shares, 20,0! onvertible preference shares, and P6,000,000 of 10% convertible-bonds outstanding during the current year. The preference shares are convertible into 40,000 ordinary shares. Bach P1,000 bond is convertible into ordinary shares. During the current Year, the entity paid dividends of P20 per share on the ordinary shares and P40 per share on the preference shares, The net income for the current year was P8,000,000 and the income tax rate is 30%, 1, What amount should be reported as basic earnings per share? a. 40.00 b. 35.00 ce. 16.00 d, 36.00 2. What is the total number of potential ordinary shares? 40,000 65,000 45,000 |. 60,000 peop 3. What amount should be reported as diluted earnings per share? a. 36.00 b. 33.56 , f © 31.61 4. 30.19 665Problem 21-8 (IAA) During the current year, Quarry Company was authorized to issue 2,000,000 shares with P10 par value. The entity entered into the following transactions relating to shareholders' equity: Jan. 2 Issued 1,500,000 ordinary shares for cash. Jan. 3 Entered an agreement with the company president to issue up to 200,000 additional ordinary shares based on the earnings of the entity in the current year. If net income exceeds P10,000,000, the president will receive 100,000 shares and 200,000 shares if net income exceeds P12,000,000. Dec. 81 Net,income for the'current year was P11,000,000. 1. What amount should be reported as basic earnings per share for the current year? a. (7.33 b. 6.00 c. 5.50 d. 5.00 2. What amount should be reported as diluted earnings per share for the current year? al 6.47 : b. 6.88 ce 611 d. 5.24 666rr problem 21-9 (IAA) Qn January 1, 2020, Helen Company had 100,000 ordinary shares outstanding and 50,000 7% P100 par cumulative preference shares outstanding. On March 1, 2020, the entity purchased 24,000 treasury ordinary shares at P45 per share and sold 8,000 treasury shares on October 1, 2020 at P50 per share. Also outstanding on January 1, 2020 were share options to buy 50,000 ordinary shares at P40, The cae price of ordinary share averaged P50 during 2020. No share options were exercised during 2020. On January 1, 2020, the entity issued P5,000,000 6% bonds at face amount. The bonds are convertible into 25,000 ordinary shares. None of the bonds had been converted during the year. The net income was P5,400,000 for the current year and the income tax rate is 30%. 5 1. What amount should be reported as basic EPS? 65.85 50.50 61.59 54.00 peop 2. What amount should be reported as diluted EPS? a. 45.78 b. 33.50 | ©. 44,96 d. 43.16 667. Problem 21-10 (IAA) Venus Company provided the Sea transactio,, involving the ordinary share capital: 2020 J 1 Hada balance of 200,000 shares of P10 par value, ‘April. 1 Converted P2,500,000 of convertible bonds with 59 hares issued for each P1,000 bond. July 1 Declared a 10% share dividend. October 1 Employeesexercised options to purchase 7,000 shares for P20 a share. 2021 April 1 Declared a2 for 1 share eplit. October 1 Sold 170,000 shares for P30 a share. 1. What is the weighted average number of shares for 2020 to be used for basic EPS computation for comparative financial statements on December 81, 2021? 649,750 729,000 664,000 364,500 peep 2. What is the weighted average number of shares for 2021 to be used for basic EPS computation for comparative financial statements on December 31, 2021? 771,500 899,000 834,000 706,500 peop 668poblem 31-11 (AA) January 1, 2020, Shay om outstanding," “O™PAny had 100,000 ordinary os she ghe following transactions occurred during 2020: Ri . ue : eae 3,000 shares accounted for a8 1 Sold all treas; septs ury shares, Dee. 1 Sold 66,000 new shares for cash. Dee. $1 Reported a net income of P2,600,000. The following transactions occurred during 2021: Jan. 15 Declared and issued a 25% share dividend. Dec. 31 Reported a net income of P4,000,000. 1, What amount should be reported as basic earnings per share for 2020 for presentation in comparative financial statements on December 81, 2021? a, 15.66 b. 20.00 ec, 20.80 d. 19.90 2 What amount should be reported as basic earnings per share for 2021 for presentation in comparative financial statements on December 81, 2021? a. 24.10 b. 19.28 ©. 30.77 d. 32.00 1 6691-12 (AICPA Adapted) ic earnings per share of P150 §, West come hed Pnversion or exercise of converte securities occurred during the year. version of convertible bonds w, per share by P8. Problem 2 However, possible con oul have reduced earnings The effect of the possib have increased earnings What amount should be reported as diluted earnings per share) le exercise of share options w, per share by P1.00. ould a.- 142 b. 148 c. 150 d. 151 Problem 21-13 (AICPA Adapted) Newton Company had basic earnings per share of P120 for the current year. No conversion or exercise of dilutive securities took place in the current year. However, possible conversion of convertible preference shares would have reduced earnings per share to P119. The effect of possible exercise of share warrants would have reduced earnings. per share by an additional P2. _1. What is the maximum amount that may be reported as a single presentation of earnings per share? a. 120 b. 119 ce. 117 d. 121 2. What amount should be reported as diluted earnings P¢” share? : a. 120 b. 121 e. 119 d. 117 670