Topic 9 Reporting financial performance IAS 33 Earnings Per Share The basic EPS calculation is simply Earning/Shares P/E ratio = Market value of share/EPS 5-1

Topic 9 Earnings per share Bonus issue In a bonus issue of shares- or a share split-ordinary share are issued to existing shareholders for no additional consideration. In these circumstances the number of ordinary shares outstanding before the issue is adjusted for the proportionate change in the number of shares outstanding as if the event has occurred at the beginning of the earliest period reported. The practical effect of this measure is to base all EPS computations on the new number of shares in issue. 5-2

Topic 9 Earnings per share Rights issues A rights issue often gives rise to a bonus element since the exercise price is often less than the fair value of the shares. The number of ordinary shares to be used in calculating basic EPS for all relevant periods is the number of ordinary shares outstanding before the issue, multiplied by the factor: Fair value of share immediately before the exercise of rights Theoretical ex-rights fair value of share 5-3

Topic 9 Earnings per share Rights issues Example: Draft income statement for the year ended 31 Dec. 2004 $000 $000 Profit before tax 5,060 Taxation (2,300) Profit after tax 2,760 Dividends information Paid-preference interim dividend 276 Paid-ordinary interim dividend 828 Proposed-preference final dividend 276 5-4

Topic 9 Earnings per share Rights issues Example: On 1 Jan 2004, the issued share capital of Gerard was 9,200,000 6% preference shares of $1 each and 8,280,000 ordinary shares of $1 each. Suppose now that Gerard’s only share issue in 2004 was a rights issue of $1 ordinary shares on 1 Oct. 2004 in the proportion of one for every five shares held at a price of $1.20. The middle market price for the shares on the last day of quotation cure rights was $1.80 per share. Calculate the EPS. 5-5

Topic 9 Earnings per share Rights issues Example: Solutions: TERP=(1.2+1.8*5)/6=1.7(Theoretical ex-right price) Bonus element = 8280*1.8/1.7-8280= 487 Full price element = 8280/5-487 =1169 WANS = 8280+487+1169*3/12=9059 (weighted average no. of shares) (existing shares bonus element + time-apportion of bonus shares) Profit after preference dividend 2208 EPS = 2208/9059 = 24.4C When there is bonus elements, it is better to calculate the comparative figure for previous years Adjust comparative figure by multiplying 1.7/1.8 or: (8280+1169)/ (8280 + 487 + 1169) 5-6

Topic 9 Earnings per share Diluted EPS Equity share capital may change in future owing to circumstances which exist now. Diluted EPS attempts to alert shareholders to the potential impact on EPS. Potential changes may arise for may of the following reasons. The issue of debt instruments (e.g. loan stock) that are convertible into ordinary shares. Share options and share warrants Rights granted under employee or other share purchase plans. 5-7

Topic 9 Earnings per share Diluted EPS Where potential ordinary shares are actually issued the basic EPS will be affected due to two factors: The number of shares in issue will increase The profits available to the shareholders may increase Therefore the standard requires- as a historical performance measure- the disclosure of the diluted EPS on the assumption that the potential ordinary shares were issued on the first day of the accounting period or, if later, on the day the relevant potential ordinary shares came into existence. 5-8

Topic 9 Earnings per share Diluted EPS The number of ordinary shares that would be issued on the conversion of potential ordinary shares should assume the most advantageous conversion rate or exercise price for the stand point of the holder of potential ordinary shares. The conversion rate might vary in the case of convertible debt instruments where the conversion price varies according to the date of actual conversion. 5-9

Topic 9 Earnings per share Shares options and warrants Where a company has potential ordinary shares in issue then the diluted EPS needs to consider the effect on earnings anf on the number of shares issued if the potential ordinary shares are converted into ordinary shares. In the case of share options and warrants it is not immediately obvious what the effect on future earnings is likely to be. Therefore the standard requires that the assumed proceeds from the issue of shares under the option or warrant should be considered as comprising: The issue of a number of ordinary shares at FV- having no dilutive effect The issue of a number of ordinary shares for no consideration with a consequential dilutive impact on the number of shares in issue. Summary format: Earnings + notional extra earnings Numbers of shares + notional extra shares 5-10

Topic 9 Earnings per share Limitations EPS as a performance indicator Although EPS is believed to have a real influence on the market price of shares, it has several important limitations as a performance measure. It does not take account of inflation. Apparent growth in, earning may not be real. It is based on historic information and therefore it does not necessarily have predictive value. An entity’s earnings are affected by the choice of its accounting policies. Therefore it may not always be appropriate to compare the EPS of different companies. 5-11