1. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-1 Chapter 26 Earnings per share

2. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-2 Objectives of this lecture Be able to define and calculate basic earnings per share Know how to adjust the calculation of basic earnings per share to take account of the existence of a bonus or rights entitlement Understand what potential ordinary shares are, and be able to determine whether they are dilutive Understand how to calculate diluted earnings per share

3. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-3 Introduction to accounting for earnings per share Relevant accounting standard is AASB 133 Earnings per Share The objective of the Earnings per Share project is to simplify and converge the calculation of earnings per share according to IAS 33 Earnings per Share and SFAS No. 128 Earnings per Share The IASB issued an exposure draft of proposed amendments to IAS 33 in August 2008

4. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-4 Introduction to accounting for earnings per share (cont.) In 2012 the earnings per share project is currently paused and will resume, the date is yet to be confirmed Hence, while we can anticipate some changes will be made to the accounting standard covered in this lecture, the nature and timing of the changes are uncertain

5. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-5 Introduction to accounting for earnings per share (cont.) Requires disclosure of basic earnings per share and diluted earnings per share on the face of the statement of comprehensive income (per AASB 133, par. 66) An entity must disclose earnings per share on the face of the statement of comprehensive income and must be presented even if the amounts are negative (loss per share) under AASB 133, par. 69 Comparatives must also be shown Standard need only apply to the consolidated financial statements

6. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-6 Computation of basic earnings per share Earnings determined after deducting: –any preference share dividends appropriated for the financial year to the extent that they have not been treated as expenses of the entity Preference share dividends are deducted to provide earnings on the basis that EPS is calculated from the perspective of the ordinary shareholders—EPS relates to earnings per ordinary share Preference dividends In periods where preference dividend not paid, need to consider whether or not preference shares are cumulative

7. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-7 Computation of basic earnings per share (cont.) Earnings must be calculated to exclude the following: Any portion attributable to non-controlling interests Any costs of servicing equity, paid or provided for, other than dividends on ordinary shares and partly paid shares Calculating weighted-average number of ordinary shares Definition of ordinary shares (AASB 133, par. 5) Determining number of shares

8. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-8 Computation of weighted-average number of ordinary shares For example, if a company has 1 000 000 ordinary shares issued at the beginning of the year (say, 1 July 2014) and it issues 200 000 fully paid shares on 1 March 2015, as well as buying back 100 000 shares on 1 April 2015, the weighted-average number of shares would be calculated as: Number of Proportion shares Weighted Period of year outstanding average Fully paid ordinary shares 1/7/14–28/2/15 243 ÷ 365 1 000 000 665 753 1/3/15–31/3/15 31 ÷ 365 1 200 000 101 918 1/4/15–30/6/15 91 ÷ 365 1 100 000 274 247 365 days Total weighted-average number of ordinary shares 1 041 918

9. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-9 Computation of basic earnings per share (cont.) Considering partly paid shares in weighted average Weighted average number of ordinary shares (denominator when calculating EPS) also needs to take into account partly paid shares Partly paid shares will be included only to the extent that they carry rights to participate in dividends relative to an ordinary share (AASB 133, par. 15) Where the partly paid ordinary shares carry no rights to participate in earnings, they would not be included in the weighted-average number of ordinary shares

10. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-10 Computation of basic earnings per share (cont.) Mandatory convertible securities Entities might also have on issue mandatory convertible securities (securities that must ultimately be converted to ordinary shares) Ordinary shares that will be issued upon the conversion of a mandatory convertible instrument are included in the calculation of basic earnings per share from the date the contract is entered into (AASB 133, par. 23) Refer to Worked Example 26.1 on p. 844—Calculation of basic EPS

11. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-11 Adjustment for the effect of discontinuing operations A discontinuing operation is defined in AASB 5 as: –a component of an entity that either has been disposed of or is classified as held for sale and: (a)represents a separate major line of business or geographical area of operations (b)is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations, or (c)is a subsidiary acquired exclusively with a view to resale

12. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-12 Adjustment for the effect of discontinuing operations (cont.) In the presence of discontinuing operations, two EPS figures must be calculated and disclosed Calculated as basic earnings based upon profit from continuing operations divided by the weighted average number of ordinary shares Refer to Worked Example 26.2 (p. 845)—Calculation of basic EPS in the presence of discontinued operations

13. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-13 Computation of basic earnings per share (cont.) Adjustment for bonus issues Bonus issues have an impact on the weighted-average number of ordinary shares The bonus issue does not change total shareholders’ funds—it involves a transfer from retained earnings to share capital (assuming funded from retained earnings) The number of shares outstanding before the bonus issue should be increased as if the bonus has been in place for the entire reporting period Weighted-average number of ordinary shares prior to rights or other issue is divided by an adjustment factor Refer to AASB 133 (pars 27 and 28)

14. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-14 Computation of basic earnings per share (cont.) Adjustment for bonus issues (cont.) If one-for-one bonus issue, number of shares would double Given no effect on earnings, doubling shares would halve EPS Prior period comparatives for EPS are also adjusted for the bonus issue so that comparisons can be made as if the bonus shares had been issued in the previous period If shares issued at the prevailing market price, there is no bonus element, and no adjustment is necessary

15. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-15 Computation of basic earnings per share (cont.) Calculation of adjustment factor Adjustment factor = P x ÷ P o, where: –P x = theoretical ex-rights price = [(P o x N o ) + P r ] ÷ (N o + 1) –P o = last sales price or, if higher, last bid price cum rights –N o = no. of shares required for one right –P r = subscription price of right + present value of dividends forgone in respect of ordinary shares required for one right not presently participating in dividends Refer to Exhibit 26.1 on p. 848—Adjustment factor for EPS in respect of the bonus element in an issue of ordinary shares Refer to Worked Example 26.3 on p. 849—Calculation of EPS in the presence of a bonus issue

16. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-16 Computation of basic earnings per share (cont.) Rights issue Existing shareholders may be provided with rights to acquire additional shares at a price below the current market price of the firm’s shares If exercise price is less than the market price of the shares, the rights issue includes a bonus element Where there is a bonus element the weighted-average number of shares needs to be adjusted using the previous formula Refer to Worked Example 26.4 on p. 851—Calculation of EPS in the presence of a rights issue with a bonus element

17. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-17 Diluted earnings per share AASB 133 requires that diluted EPS be disclosed together with basic EPS on the face of the statement of comprehensive income Diluted EPS must be calculated where an entity has on issue ‘potential ordinary shares’ that are, in fact, dilutive Refer to AASB 133, par. 31

18. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-18 Diluted earnings per share (cont.) Potential ordinary shares (AASB 133, par. 5) A financial instrument or other contract that may entitle its holder to ordinary shares Potential ordinary shares are considered dilutive when and only when the conversion to, calling of, or subscription for ordinary shares would decrease (or increase) net profit (or loss) from continuing ordinary operations per share

19. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-19 Diluted earnings per share (cont.) Potential ordinary shares (cont.) If securities currently on issue might be converted to ordinary shares, this will increase the number of ordinary shares on issue, leading to a decrease in EPS Users of financial statements need to know about this potential reduction (dilution) in EPS Diluted earnings per share will show how EPS would fall if the potential ordinary shares were actually converted to ordinary shares—aim is to inform investors about how EPS could be affected in the future

20. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-20 Diluted earnings per share (cont.) To determine diluted EPS Weighted-average number of shares calculated as per basic EPS –Adjusted by a factor based on weighted-average number of potential ordinary shares that the company had on issue throughout all or part of the financial year General rule applies that if a potential ordinary share issue would increase EPS, it is not considered to be dilutive –Excluded from calculation of diluted EPS

21. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-21 Diluted earnings per share (cont.) To determine diluted EPS (cont.) Each type of potential ordinary share needs to be considered separately If the conversion is at the option of the entity, and the conversion is probable, the potential ordinary shares must be included in the diluted EPS calculation—even if their inclusion does not dilute EPS If conversion of potential ordinary shares to ordinary shares is mandatory, they would have already been included in basic EPS calculation

22. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-22 Diluted earnings per share (cont.) Calculating earnings for diluted EPS Start with earnings used to calculate basic EPS and make adjustments for the after-tax effect of (AASB 133, par 33): (a)any dividends or other items related to dilutive potential ordinary shares deducted in arriving at profit or loss attributable to ordinary equity holders of the parent entity as calculated in accordance with paragraph 12 (b)any interest recognised in the period related to dilutive potential ordinary shares (c)any other changes in income or expense that would result from the conversion of the dilutive potential ordinary shares Refer also to AASB 133, pars 32 and 35

23. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-23 Diluted earnings per share (cont.) Calculating the weighted-average number of shares for diluted EPS –Start with number used to calculate basic EPS and add the following:  weighted-average number of shares deemed to be issued for no consideration  weighted-average number of shares that are contingently issued Dilutive potential ordinary shares are weighted by the number of days they were outstanding

24. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-24 Diluted earnings per share (cont.) Shares issued for no consideration If the price paid for the shares is less than the market price: Refer to AASB 133, pars 46 and 47 In the case of options, for example, there is a need to calculate the number of shares issued for no consideration—this number is added to the number of ordinary shares (to the denominator) in the computation of EPS

25. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-25 Diluted earnings per share (cont.) Contingently issuable shares Ordinary shares issued for little or no cash or other consideration upon the satisfaction of specified conditions in a contingent share agreement (AASB 133, par. 5) Refer to AASB 133, par. 52

26. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-26 Diluted earnings per share (cont.) Refer to Worked Example 26.5 on pp. 854–57— Calculation of basic and diluted EPS –Need to initially calculate basic EPS –Each potential ordinary share to be considered separately, i.e. convertible debentures, share options, convertible cumulative preference shares –Potential ordinary shares need to be ranked from greatest to least dilution

27. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-27 Diluted earnings per share (cont.) –A trigger test needs to be applied to determine whether potential ordinary shares are, in fact, dilutive—if a particular security does not dilute EPS, it is not to be included when calculating diluted EPS (unless conversion is mandatory or probable and at the option of the entity) –Potential ordinary shares found to be dilutive based on trigger test are used in calculation of diluted EPS

28. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-28 Summary Australian-listed entities and those in the process of listing are required, pursuant to AASB 133, to disclose information about EPS in their annual reports EPS is calculated from the perspective of the ordinary shareholder Determined by dividing the earnings of the company by the weighted-average number of ordinary shares outstanding during the year In determining earnings, preference share dividends are excluded Need to consider the implications of a bonus issue or a rights issue and the use of an adjustment factor in the calculation of weighted-average number of shares

29. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-29 Summary (cont.) Diluted EPS is also disclosed together with basic EPS on the face of the statement of comprehensive income In calculating diluted EPS, the adjusted earnings (calculated on the notional basis that the various securities have actually been converted to ordinary shares) are to be divided by the weighted-average number of ordinary and potential ordinary dilutive shares Each type of potential ordinary share must be considered separately when calculating diluted EPS If a particular type of potential ordinary share (e.g. convertible notes, convertible preference shares, or share options) is not considered to be dilutive, it should be excluded from the calculation of diluted EPS