Earnings Per Share: Connolly - International Financial Accounting and Reporting - 4 Edition

EARNINGS PER SHARE
Connolly – International Financial Accounting and Reporting – 4th Edition

23.1 INTRODUCTION
• Used by existing and potential investors:
 Compare results over time
 Compare performance with similar companies and/or

the market
 Key component of P/E ratio

23.2 EARNINGS - QUALITY
• Quantity vs. Quality

• Defining quality
 Repeatable earnings
 Controllable earnings
 Bankable earnings

23.3 PRO-FORMA EARNINGS
• Earnings calculated on the basis of hypothetical amounts

being excluded from the financial statements (e.g. certain
non-recurring items such as goodwill impairment or
restructuring costs)
• To help assess core underlying operations and future

prospects
• Part of a package of information
• But unregulated and subjective, and why should ‘one-off’

costs be excluded as they are real and might be a sign of
poor management

23.4 EARNINGS MANAGEMENT
• Material and intentional misrepresentation of results
• Adjustments outside the bounds of acceptable accounting

practice
• Income smoothing
• Variety of methods employed
 Unsuitable revenue recognition
 Inappropriate accruals and estimates
 Excessive provisions

23.5 IAS 33 EARNINGS PER SHARE
• Objective
 To prescribe principles for the determination and
presentation of earnings per share
 Focus on determining the denominator of calculation
• Scope
 Enterprises whose shares are publicly traded
 Enterprises in process of issuing such shares
 Enterprises electing to disclose EPS
• When a entity presents both consolidated and separate

financial statements, the disclosures required by IAS 33 need
be presented only on the basis of consolidated information

BASIC EPS

23.6 BASIC EPS
Profit / loss attributable to ordinary shareholders*

Weighted average number of ordinary shares in issue during
period
*Profit after interest, tax, NCI and preference dividends

Example 23.1: Basic EPS – no changes in period (1)
A company has profits (or earnings) for the year of €100,000

and has 200,000 ordinary shares.
EPS = €100,000 x 100 = 50 cent per share

200,000

A company has the following issued share capital throughout

the year:
•200,000 ordinary shares of €1; and
•50,000 10% preference shares of €1.
Extracts from the company’s financial statements for the year
ended 31 December 2012 showed: €
Net profit 60,000
Taxation (20,000)
Net profit after taxation 40,000
Dividends not deducted in arriving at the profit figure:
Preference dividend 5,000
Ordinary dividend 9,000
Requirement
Calculate the basic EPS for 2012

Solution
EPS = €35,000 / 200,000 = 17.5 cent per share
See Chapter 23, Example 23.3

LOSSES
If the earnings figure is a negative figure then the earnings

per share should be calculated in the normal way but
shown as a loss per share

Changes in ordinary share capital and its effect on basic EPS
If new shares are issued, the denominator in basic EPS calculation has
to be changed. For example:
1.Issue at full market price
2.Bonus issue, share split and share consolidation
3.Rights issues
4.Shares issued as part of the purchase consideration for a business

combination

1. Issue at full market price
• Where new ordinary shares have been issued either for cash
at full market price or as consideration for the acquisition of
an asset, the earnings should be apportioned over the
average number of shares ranking for dividend during the
period weighted on a time basis
• There is no retrospective effect

Example 23.5: Issue at full market price (2)
RP plc prepares its financial statements to 31 December each

year and has a capital structure consisting of:
•100,000 10% preference shares of €1 each; and
•100,000 €1 ordinary shares.
In 2011 and 2012, RP plc had profits after tax of €50,000 and
€60,000 respectively. On 30 September 2012, RP plc made an
issue at full market price of 50,000 €1 ordinary shares.
Preference dividends are not charged in arriving at profit after
tax.
Requirement
Calculate the basic EPS for 2012 and the corresponding figure
for 2011.

Example 23.5: Issue at full market price (2)
Solution
2012 (€) 2011 (€)
Profit after tax 60,000 50,000
Preference dividend (10,000) (10,000)
50,000 40,000
Shares at 1 January 100,000 100,000

Issue of shares at full market
price (50,000 x 3/12) 12,500 Nil
Shares for EPS calculation 112,500 100,000
EPS 44c 40c

(€50,000 / 112,500) (€40,000 / 100,000)

2. Bonus issue, share split and share consolidation
Bonus issue = capitalisation of reserves and will have no
effect on the earning capacity of the company.
•Ordinary shares are issued to existing shareholders for no

additional consideration
•The number of shares outstanding is increased without an
increase in resources
•The number of shares outstanding is adjusted as if the share
issue occurred at the beginning of the earliest period presented
the corresponding figures for all earlier periods should be

adjusted accordingly

Change in ordinary share capital after the reporting date
• As noted previously, retrospective adjustment of

comparative EPS is required in the case of a full or partial
bonus issue of ordinary shares
• This also applies if a change in ordinary share capital due

to a bonus issue occurs after the reporting period but
before the financial statements are authorised for issue

Example 23.7: Bonus issue (2)
At 31 December 2011, Ben plc had 4 million ordinary 25 cent

shares in issue and 500,000 10% preference shares of €1
each. On 1 October 2012, the company made a one for four
bonus issue out of reserves. The profit after tax for the year
ended 31 December 2012 was €550,000 and for the year
ended 31 December 2011 was €450,000. Preference dividends
are not charged in arriving at the profit after tax.
Requirement
Calculate the basic EPS for 2011 and 2012.

Solution
EPS 2012 €
Profit after tax 550,000
Preference dividend (50,000)
Earnings 500,000
Number of Shares
4m x 5 / 4 5,000,000
EPS (€500,000 / 5,000,000) 10c

Solution
EPS 2011 €
Profit after tax 450,000
Preference dividend (50,000)
Earnings 400,000
As originally reported 10c (€400,000 / 4,000,000)

Restated in 2012 financial statements 8c
(10c x (4m / 5m))

2. Bonus issue, share split and share consolidation
Share splits and share consolidations

Similar considerations apply where equity shares are split into
shares of smaller nominal value [e.g. a share of €1 nominal
value is divided into 4 shares of 25c each] or consolidated into
shares of a higher nominal value [e.g. 4 shares of 25c each are
consolidated into one share of €1].
i.e. number of shares outstanding before the event is adjusted
for the proportionate change.
The comparative figure must be adjusted.

3. RIGHTS ISSUE
• Issue of shares for cash to existing shareholders at a price

(usually) below the current market price
• Equivalent to a cash issue at full market price combined with

a subsequent bonus issue
• When a company makes a RI at less than full market price,

this results in there being a new market price (after RI),
which will be less than that which existed when the rights
issue took place. The new market price is known as the
theoretical ex rights price (TERP).

Example 23.9: Rights issue (1)
ABC has the following capital structure: €200,000 10% €1
preference shares and €200,000 €1 ordinary shares. On 1
October 2012, ABC plc made a one for five rights issue at a
price of €1.20. The market value on the last day of quotation
cum rights was €1.50.
Calculation of TERP: €
Wealth of shareholder with 5 ordinary shares prior to RI:
5 x €1.50 7.50
Cost of taking up the right to buy one ordinary share:
1 x €1.20 1.20
8.70
No of shares in issue: /6
Therefore TERP: €1.45

2010 2011 2012

Net profit as at 31 December €24,000 €30,400 €36,000
Shares before rights issue 100,000
The rights issue is to be one share for every five currently held (giving 20,000
new shares). Exercise price is €1.00. The last date to exercise rights is 1 April
2011. The fair value of an ordinary share before the issue is €2.20.
Requirement
Calculate the basic EPS for 2010, 2011 and 2012.

Solution
2010
€24,000 / 100,000 share = 24 cent
2011
Step 1: Calculate the TERP
5 shares x €2.20 11.00
1 share x €1.00 1.00
6 shares 12.00
TERP €12.00 / 6 shares = €2.00
Step 2: Adjust 2010 EPS in 2011 FS

24c x 2.00 / 2.20 = 21.82 c

Step 3: Calculate the basic EPS

100,000 x 3/12 x €2.20 / €2.00 27,500
120,000 x 9/12 90,000
117,500
EPS = €30,400 / 117,500 = 25.87c
2012
EPS = €36,000 / 120,000 = 30c

4. Shares issued as part of the purchase consideration for a
business combination
Shares issued as part of the purchase consideration for a business

combination are included in the weighted average number of shares
as and from the date of acquisition.
Why?
The results of the new subsidiary are included in the consolidated

financial statements from that date only.


Example 23.11: Shares issued as part of the purchase
consideration for a business combination
Pete plc has 1 million shares in issue on 1 January 2012. On 1

July 2012, Pete plc acquired 80% of the ordinary shares of Sue
plc. As part of the consideration, Pete plc issued 400,000 ordinary
shares at market value 2.50.

The number of shares for the EPS calculation for year ended 31
December 2012 is:
(1m x 6/12) + (1.4m x 6/12) = 1.2m


Disclosure requirements for basic EPS
• On face of SPLOCI – basic EPS for profit/loss from continuing

operations attributable to the ordinary equity holders, including
comparative figures. Disclosure still required if basic EPS
negative.
• In the notes – amount used as the numerator in calculating

basic EPS and a reconciliation of that amount to the net
profit/loss for the period.

• In the notes – weighted average number of ordinary shares

used in the calculation.

DILUTED EPS

23.7 DILUTED EPS
A company may have securities which do not have a claim to
equity earnings NOW, but may do in the FUTURE. These
include:
1.options or warrants;
2.rights granted under employee or other share purchase plan;
3.contingently issuable shares;
4.convertible loan stock or preference shares; and
5.separate classes of equity share not yet entitled to a share of
equity earnings, but becoming so in the future.
i.e. they could increase the number of equity shares ranking for
dividend and so dilute or ‘water down’ EPS

Diluted EPS
Net profit attributable to ordinary shareholders

(adjusted for effects of all dilutive ordinary shares)
Divided by
Weighted average number of ordinary shares outstanding

during period
(adjusted for effects of all dilutive ordinary shares)

Diluted EPS
• At the end of a reporting period, an entity may have securities that

do not have a claim to equity earnings at the reporting date but
may at some future date
• These securities are potential ordinary shares (POS)
• Diluted EPS is a calculation of how basic EPS may be diluted in
the future as a result of the existence of POS
• Dilutive POS should be deemed to have been converted into
ordinary shares at the beginning of the period or, if later, the date
of the issue of the POS
• In considering whether POS are dilutive or anti-dilutive, each issue
of POS is considered separately rather than in aggregate
• In order to maximise the dilution of basic EPS, each issue of POS
is considered in sequence from the most dilutive to the least
dilutive

Diluted EPS
POS should be treated as dilutive when conversion

would decrease the net profit per share from continuing
ordinary operations

1. Share options or warrants
• A share option allows purchase of a share at a favourable

amount (less than its fair value)
• Proceeds are assumed to be a combination of shares

issued at fair (market) value and shares issued for nil
consideration
• Calculation of diluted EPS includes those shares deemed

as issued for no consideration as those issued at market
value are deemed to be non dilutive

Example 23.12: Share options
Net profit for 2012 €1,000,000

Weighted average number of ordinary shares 10 million
for 2012
Average fair value of one ordinary share €2.40
Weighted average number of shares under 3 million
option during 2012
Exercise price for shares under option in 2012 €2.00
Requirement
Calculate the basic and diluted EPS for 2012

Example 23.12: Share options
Solution
Earnings Shares EPS
Basic for 2012 €1,000,000 10,000,000 10c
Options Nil 500,000
€1,000,000 10,500,000 9.5c
Number of options
Options 3.0m
Issued at fair value 3.0m X 2.00 / 2.40 (2.5m)
Shares at nil consideration 0.5m

2. Employee share options
• Increasingly popular as an incentive scheme
• Many include performance criteria which mean that they are

contingent on certain conditions being met
• As with the share option approach, only include those shares

deemed as issued for no consideration

Example 23.13: Non-performance-related employee share
option scheme
A company runs a share option scheme based on the employee’s
period of service. At 31 December 2012 the provisions of the scheme
were:
Date of grant 1 January 2012

Market price at grant date €2.24
Exercise price of option €1.80
Date of vesting 31 December 2014
Number of shares under option 3 million
Net profit for 2012 €1,000,000
Weighted average number of ordinary shares 10 million
Average fair value of an ordinary share €2.70
Requirement
Calculate the basic and diluted EPS for 2012


Example 23.13: Non-performance-related employee share
option scheme
Solution
Shares Net profit EPS
Basic EPS 10m €1,000,000 10c
Number of shares on option 3m
No of shares that would have been
issued at FV: (3m x €1.80)/€2.70 (2.0m)
Issued for no consideration 1.0m
Diluted EPS 11.0m €1,000,000 9.1c

3. Contingently issuable shares
• Issued after certain criteria have been met
• For purposes of diluted EPS, these shares are included in full
• Many employee share option schemes operate in this manner
• Include in EPS calculation from the date when all necessary

conditions are satisfied (i.e. when the contingent events have
occurred)

Example 23.14: Contingently issuable shares
A company has 500,000 ordinary shares in issue at 1 January 2010. A recent
business acquisition has given rise to the following contingently issuable shares:
•10,000 ordinary shares for every new branch opened in the three years 2010 –
2012; and
•1,000 ordinary shares for every €2,000 of net profit in excess of €900,000 over the
three years ended 31 December 2012.
Shares related to the opening of a new branch are issue when the branch is opened,
while shares related to the net profit contingency are issued on 1 January following
the period in which the condition is met.

A new branch was opened on 1 July 2010, another on 31 March 2011 and another
on 1 October 2012.

Reported net profits over the three years were €350,000, €400,000 and €600,000
respectively.
Requirement
Calculate the basic and diluted EPS for 2010, 2011 and 2012.

Example 23.14: Contingently issuable shares
2010 2011 2012
€ € €
Earnings 350,000 400,000 600,000
Ordinary shares 500,000 510,000 520,000
Branch contingency 5,000 (i) 7,500 (i) 2,500 (i)
Earnings contingency - (ii) - (ii) - (ii) .
Total shares 505,000 517,500 522,500
Basic EPS 69.3p 77.3p 114.8p

Earnings 350,000 400,000 600,000
Ordinary shares 505,000 517,500 522,500
Additional shares:
Branch contingency 5,000 (iii) 2,500 (iii) 7,500 (iii)
Earnings contingency - - 225,000 (iv)
Total shares 510,000 520,000 755,000
Diluted EPS 68.6p 76.9p 79.5p

4. Convertibles
• Convertible loans or convertible preference shares
• Conversion of these instruments would affect both earnings

and number of shares in an EPS calculation
• Interest is paid out on the bond, but when conversion takes

place this interest is no longer payable
• Preference dividends saved when preference shares are

converted
• Whereas loan interest is allowable for tax purposes,

dividends are not

Example 23.15: Convertible debt
Net profit €500
Ordinary shares in issue 1,000
Convertible 15 % bonds 200
Each block of 5 bonds is convertible to 8 ordinary shares.
The tax rate (including any deferred tax) is 40%.

Solution
Basic EPS = €500 / 1,000 = 50c

Diluted EPS €
Earnings per basic EPS 500
Add interest saved net of tax 200 x 15% x 60% 18
518
Shares per basic EPS 1,000
Add maximum shares on conversion 200 x 8/5 320
1,320

DEPS = 518 / 1,320 = 39.2c

5. Ranking dilutive securities
• When there is more than one type of POS, it is necessary to

determine whether each type is dilutive or anti-dilutive
• When calculating diluted EPS, each type of POS is

considered separately and in sequence from the most
dilutive to the least dilutive
• Most dilutive POS are those with the lowest earnings per
incremental share
• POS do not necessarily have a dilutive effect on basic

EPS
• POS are anti-dilutive when their conversion to ordinary

shares would increase EPS from continuing operations

Example 23.16: Ranking dilutive securities (1)
Net profit attributable to ordinary shareholders €20m
Net profit from discontinued operations €5.0m
Ordinary shares outstanding 50m
Average fair value per ordinary share €5.00
Potential ordinary shares:
•Convertible preference shares – 500,000 entitled to a
cumulative dividend of €5. Each is convertible to 3 shares.
•3% convertible bond – nominal amount €50m. Each €1,000
bond is convertible to 50 shares. There is no amortisation of
premium or discounting affecting the interest expense
•Options – 10m with exercise price of €4.
Tax rate is 30%.
Requirement
Calculate the basic and diluted EPS.

Solution
The effect on earnings on conversions of POS:
Convertible Impact on Impact on Shares Effect on

Earnings earnings per
€ incremental
shares
Preference 2,500,000 1,500,000 1.67
shares (500k x 5) (500k x 3)
Bonds 1,050,000 2,500,000 0.42
(50m x 3% x 70%) (50m / 1,000 x 50)
Options Nil 2,000,000 Nil
(10m – (10m x 4/5))

Earnings (€) Shares EPS
Basic EPS 15,000,000 50,000,000 30.0c
Options Nil 2,000,000
15,000,000 52,000,000 28.8c
Dilutive
3% conv. bonds 1,050,000 2,500,000
16,050,000 54,500,000 29.4c
Anti Dilutive
Conv. pref. shares 2,500,000 1,500,000
18,550,000 56,000,000 33.1c
Anti Dilutive

Presentation and disclosure
• EPS is presented for every period for which a SPLOCI is

presented
• Present basic and diluted EPS with equal prominence on

the face of the SPLOCI
• Present EPS for discontinued operations if discontinued

operations reported
• Present basic and diluted EPS even if amounts are

negative (i.e. a loss per share)

Presentation and disclosure
• Amounts used in the numerators of the calculations and a

reconciliation to profit or loss presented in the SPLOCI
• Weighted average number of ordinary shares for basic and

diluted EPS, with a reconciliation of these denominators to
each other
• POS excluded because they are anti-dilutive
• Alternative per share calculations

Example 23.18: Basic and diluted EPS
The following information is available for Diamond Limited for 2012:
Earnings €
Net profit attributable to continuing operations 16,400,000
Less preference dividends (6,400,000)
Profit from continuing operations attributable
to ordinary shareholders 10,000,000
Loss from discontinued operations (4,000,000)
Net profit attributable to ordinary shareholders 6,000,000

Ordinary shares outstanding 2,000,000
Average market price of one ordinary share during 2012 €75

Potential ordinary shares:
Options 100,000 options with exercise price of €60
Convertible preference shares 800,000 8% €100 convertible preference shares, with each
preference share held convertible into two ordinary shares
5% convertible bond 100m 5% €1 convertible bonds, with each 1,000 block
convertible into 20 ordinary shares
Tax rate 40%
Requirement
Calculate the basic and diluted EPS for 2012.

Increase in earnings attributable to ordinary shareholders on conversion of POS
Increase Increase Earnings

in in number per
earnings of ordinary incremental
shares share
Options
Increase in earnings Nil
Incremental shares
(100,000 x (€75 - €60) / €75) 20,000 Nil
Convertible preference shares
Increase in earnings
(€8 x 800,000) 6,400,000
Incremental shares
(2 x 800,000) 1,600,000 4
5% convertible bonds
Increase in earnings
(100m x 5% x 0.6) 3,000,000
Incremental shares 2,000,000 1.50

Ranking – (1) options, (2) convertible bonds, (3) convertible preference shares


Computation of diluted earnings per share

Ordinary
Earnings (€)shares EPS
As reported 10,000,000 2,000,000 5.00

Options 20,000
10,000,000 2,020,000 4.95 dilutive
5% convertible bonds 3,000,000 2,000,000
13,000,000 4,020,000 3.23 dilutive
Convertible preference shares 6,400,000 1,600,000
19,400,000 5,620,000 3.45 antidilutive

The convertible preference shares are ignored in calculating the DEPS as they are antidilutive.

Computation of basic and diluted EPS:
Basic Diluted
Profit from continuing operations 5.00 3.23
Loss from discontinued operations (2.00)* (0.99)**
Net profit 3.00 2.24

* (€4,000,000 ÷ 2m) = (2.00)
** (€4,000,000 ÷ 4.02m) = (0.99)

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EARNINGS PER SHARE

Connolly – International Financial Accounting and Reporting – 4th Edition

• Used by existing and potential investors:

 Compare results over time

 Compare performance with similar companies and/or

 Key component of P/E ratio

Connolly – International Financial Accounting and Reporting – 4th Edition

• Quantity vs. Quality

Connolly – International Financial Accounting and Reporting – 4th Edition

• Earnings calculated on the basis of hypothetical amounts

• To help assess core underlying operations and future

• Part of a package of information

• But unregulated and subjective, and why should ‘one-off’

Connolly – International Financial Accounting and Reporting – 4th Edition

• Material and intentional misrepresentation of results

• Adjustments outside the bounds of acceptable accounting

Connolly – International Financial Accounting and Reporting – 4th Edition

• When a entity presents both consolidated and separate

Connolly – International Financial Accounting and Reporting – 4th Edition

Connolly – International Financial Accounting and Reporting – 4th Edition

Profit / loss attributable to ordinary shareholders*

*Profit after interest, tax, NCI and preference dividends

Connolly – International Financial Accounting and Reporting – 4th Edition

A company has profits (or earnings) for the year of €100,000

EPS = €100,000 x 100 = 50 cent per share

Connolly – International Financial Accounting and Reporting – 4th Edition

A company has the following issued share capital throughout

Connolly – International Financial Accounting and Reporting – 4th Edition

EPS = €35,000 / 200,000 = 17.5 cent per share

See Chapter 23, Example 23.3

Connolly – International Financial Accounting and Reporting – 4th Edition

If the earnings figure is a negative figure then the earnings

Connolly – International Financial Accounting and Reporting – 4th Edition

1.Issue at full market price

2.Bonus issue, share split and share consolidation

4.Shares issued as part of the purchase consideration for a business

Connolly – International Financial Accounting and Reporting – 4th Edition

• There is no retrospective effect

See Chapter 23, Example 23.4

Connolly – International Financial Accounting and Reporting – 4th Edition

RP plc prepares its financial statements to 31 December each

Connolly – International Financial Accounting and Reporting – 4th Edition

Shares at 1 January 100,000 100,000

EPS 44c 40c

Connolly – International Financial Accounting and Reporting – 4th Edition

•Ordinary shares are issued to existing shareholders for no

the corresponding figures for all earlier periods should be

See Chapter 23, Example 23.6

Connolly – International Financial Accounting and Reporting – 4th Edition

• As noted previously, retrospective adjustment of

• This also applies if a change in ordinary share capital due

Connolly – International Financial Accounting and Reporting – 4th Edition

At 31 December 2011, Ben plc had 4 million ordinary 25 cent

Connolly – International Financial Accounting and Reporting – 4th Edition

Connolly – International Financial Accounting and Reporting – 4th Edition

As originally reported 10c (€400,000 / 4,000,000)

Connolly – International Financial Accounting and Reporting – 4th Edition

Share splits and share consolidations

See Chapter 23, Example 23.8

Connolly – International Financial Accounting and Reporting – 4th Edition

• Issue of shares for cash to existing shareholders at a price

• Equivalent to a cash issue at full market price combined with

• When a company makes a RI at less than full market price,