Overview
IAS 33 Earnings per share – The rules for calculating EPS are set out in IAS 33 Earnings per share. It is simply the profit for the year (adjusted for a few things) divided by the weighted average number of ordinary shares in that year. These IAS 33 summary notes are prepared by mindmaplab team and covering the key definitions, full standard with examples. This is the IAS 33 full text; we have also prepared IAS 33 pdf version download.
IAS Standards
IAS 2 Inventories
IAS 7 Statements of cash flows
IAS 7 Statement of cash flows – Revisited
IAS 8 Accounting policies, changes in accounting estimates, and errors
IAS 10 Events after the reporting period
IAS 16 Property, plant and equipment
IAS 20 Accounting for government grants and disclosure of government assistance
IAS 21 The effects of changes in foreign exchange rates
IAS 24 Related party disclosures
IAS 27 Consolidated and separate financial statements
IAS 28 Investments in associates and joint ventures
IAS 32 Financial instruments: presentation
IAS 33 Earnings per share – Revisited
IAS 37 Provisions, contingent liabilities and contingent assets
IFRS Standards
IFRS 5 Non-current assets held for sale and discontinued operations
IFRS 7 Financial instruments: disclosures
IFRS 10 Consolidated financial statements
IFRS 12 Disclosure of interests in other entities
IFRS 13 Fair value measurement
IFRS 15 Revenues from contracts with customers
IAS 17 VS IFRS 16 Lease – Differences
IAS 33 Objectives and scope
The rules for calculating EPS are set out in IAS 33 Earnings per share.
It is simply the profit for the year (adjusted for a few things) divided by the weighted average number of ordinary shares in that year.
IAS 33 specifies the profit figure that should be used and explains how to calculate the appropriate number of shares when there have been changes in share capital during the period under review.
IAS 33 also describes the concept of dilution which is caused by the existence of potential ordinary shares.
The higher a company’s EPS, the more profitable it is considered.
A fall in EPS will affect the share price.
The objective of IAS 33 is to set out principles for:
- the calculation of EPS; and
- the presentation of EPS in the financial statements.
Most publicly-traded entities prepare consolidated financial statements as well as individual financial statements. When this is the case, IAS 33 requires disclosure only of EPS based on the figures in the consolidated financial statements.
IAS 33 requires entities to calculate:
- the basic earnings per share on its continuing operations
- the diluted earnings per share on its continuing operations.
Additional requirements apply to earnings relating to discontinued operations.
IAS 33 Definitions
Ordinary share – An ordinary share is an equity instrument that is subordinate to all other classes of equity instruments.
Potential ordinary share – A potential ordinary share is a financial instrument or other contract that may entitle its holder to ordinary shares at some time in the future.
- For examples:
- convertible debentures, convertible preference shares
- share options and warrants
- shares that will be issued if certain contractual conditions are met, such as contractual conditions relating to the purchase of a business.
Diluted EPS is a metric used in fundamental analysis to gauge its quality of earnings per share assuming all convertible securities are exercised.
Convertible securities include all outstanding convertible preferred shares, convertible debt, options (mainly employee-based options) and warrants.
BASIC EPS
Basic earnings per share is calculated by dividing the profit or loss attributable to ordinary shareholders during a period on continuing operations by the weighted average number of ordinary shares in issue during the period.
Formula: Basic EPS
Total earnings
weighted average number of shares in issue during the period
Total earnings
The total earnings figure is the profit or loss from continuing operations after deducting tax and preference dividends (and in the case of consolidated financial statements, after excluding the earnings attributable to non-controlling interests). Total earnings include any income from associates (i.e. any share of profits or losses of associates).
Earnings from discontinued operations are dealt with separately. An EPS from any discontinued operations must also be disclosed.
The total earnings figure must be adjusted for the interests of preference shareholders before in can be used in EPS calculations.
Total earnings adjustments
Preference shares
Preference shares must be classified as equity or liability in accordance with the rules in IAS 32: Financial Instruments: Presentation.
If a class of preference shares is classified as equity, any dividend relating to that share is recognised in equity. Any such dividend must be deducted from the profit or loss from continuing operations.
If a class of preference shares is classified as liability (redeemable preference shares), any dividend relating to that share is recognised as a finance cost in the statement of profit or loss. It is already deducted from the profit or loss from continuing operations and no further adjustment need be made.
Cumulative preference shares
Some preference shares are cumulative preference shares. This means that if a company fails to declare a preference dividend in a period the holders are entitled to receive the missed dividend sometime in the future.
If there are cumulative preference shares in issue the dividend must be deducted from profit or loss from continuing operations regardless of whether the dividend has been declared or not.
if preference shares are non-cumulative then the dividend is deducted only in case of declaration by the company.
Increasing rate preference shares
These are preference shares that provide for a low initial dividend to compensate an entity for selling the preference shares at a discount, or an above-market dividend in later periods to compensate investors for purchasing preference shares at a premium.
The discount or premium arising on the issue of increasing rate preference shares is amortised using the effective interest method and treated as a preference dividend for the purposes of calculating earnings per share.
All these elements should be deducted in arriving at the earnings attributed to ordinary equity holders.
Early conversion of preference shares
An entity may achieve early conversion of convertible preference shares by improving the original conversion terms or paying additional consideration. Where this is the case, the excess amount transferred as a result of the improvement of conversion terms is treated as a return to the preference shareholders and must be deducted in arriving at earnings attributable to ordinary equity holders.
Deduction = Fair value of ordinary shares issued (consideration paid) – Fair value of ordinary shares issuable under original terms
Repurchase of preference shares
Where the fair value of consideration paid to preference shareholders exceeds the carrying value of the preference shares repurchased, the excess is a return to the preference shareholders and must be deducted in calculating profits attributable to ordinary equity holders.
Where the carrying value of preference shares repurchased exceeds the fair value of consideration paid, the excess is added in calculating profit attributable to ordinary equity holders.
In respect of preference shares that are classified as liabilities, the above adjustments, where these are relevant, would have already been made in arriving at the profit or loss for the period.
Participating securities and two-class ordinary shares
The equity of some entities includes:
- instruments that participate in dividends with ordinary shares.
- a class of ordinary shares with a different dividend rate from that of another class of ordinary shares.
To calculate basic earnings per share:
Step 1 – Adjust profit or loss attributable to ordinary equity holders of the parent entity.
Step 2 – Allocate the profit or loss to ordinary shares and participating equity instruments to the extent that each instrument shares in earnings as if all of the profit or loss for the period had been distributed. The total profit or loss allocated to each class of equity instrument is determined by adding together the amount allocated for dividends and the amount allocated for a participation feature.
Step 3 – Divide the total amount of profit or loss allocated to each class of equity instrument by the number of outstanding instruments to which the earnings are allocated to determine the earnings per share for the instrument.
Weighted average number of outstanding shares
The number of shares outstanding in a company will often change due to a company issuing new shares, repurchasing, and retiring existing shares and other financial instruments, such as employee options being converted into shares.
The weighted average number of shares is determined by taking the number of outstanding shares and multiplying it by the percentage of the reporting period (in terms of months) for which that number applies for each period.
There are different ways in which the number of shares may change:
- Issues for full consideration (issue or redemption) of shares at a full market price).
- Issues for no consideration (issue or redemption) of shares with no change in net assets), for example:
- Bonus issues
- Share splits (where one share is split into several others)
- Reverse share splits (share consolidation)
- Bonus elements in other issues (see later discussion on rights issues)
- Rights issues (issue of shares for consideration but at less than the full market price of the share).
IAS 33 gives guidance on how to incorporate changes in share capital during a period into the calculation of the weighted average of shares that must be used in the EPS calculation.
Issue of shares at full market price
The consideration received is available to boost earnings. Therefore, the shares are included from the date of issue.
There is no adjustment to comparatives resulting from an issue at full price.
Partly paid shares
The number of ordinary shares is calculated based on the number of fully paid shares. In order to do this partly paid shares are included as an equivalent number of fully paid shares to the extent they are entitled to participate in dividends.
Bonus issues of shares
A bonus issue of shares (also called a scrip issue or a capitalisation issue) is an issue of new shares to existing shareholders, in proportion to their existing shareholding, for no consideration.
No cash is raised from a bonus issue, therefore is no earnings boost from the issue. Bonus issued shares are treated as if they have always been in issue.
The new number of shares (i.e. the number of shares after the bonus issue) can be found by multiplying the number of shares before the bonus issue by the bonus issue fraction.
Formula: Bonus issue fraction
Number of shares in holding after the bonus issue
Number of shares in holding before the bonus issue
* Remember that if a capital change is due to a bonus issue each preceding must be multiplied by the bonus fraction.
Comparatives
In order to ensure that the EPS in the year of the bonus issue is comparable with the previous year’s EPS, IAS 33 requires that the weighted average number of shares should be calculated as if the bonus shares had always been in issue.
This means that:
- the current period’s shares are adjusted as if the bonus shares were issued on the first day of the year; and
- the comparative EPS for the previous year is restated on the same basis.
The restatement of the comparatives is easily achieved by multiplying it by the inverse of the bonus fraction.
Rights issues of shares
A rights issue of shares is an issue of new shares for cash, where the new shares are offered initially to current shareholders in proportion to their existing shareholdings.
The issue price of the new shares in a rights issue is always below the current market price for the shares already in issue. This means that they include a bonus element which must be taken into account in the calculation of the weighted average number of shares.
Any comparatives must be restated by multiplying them by the inverse of the rights issue bonus fraction.
Formula: Rights issue bonus issue fraction
Actual cum rights price
Theoretical ex rights price
The actual cum-rights price is the market price of the shares before the rights issue.
The theoretical ex-rights price is the price that the shares ought to be, in theory, after the rights issue. It is a weighted average price of the shares before the rights issue and the new shares in the rights issue.
DILUTED EPS
‘Dilution’ means ‘watering down’ or ‘reduction in strength’.
An entity might have potential ordinary shares in issue. There is a possibility that these will become actual ordinary shares at some time in the future.
If potential shares become actual ordinary shares, the earnings figure will be shared with a larger number of ordinary shares. This would dilute the EPS.
Diluted EPS is calculated by adjusting the earnings and number of shares figures used in the basic EPS calculation.
Earnings is adjusted to remove the effect of dividends or interest that have been recognised during the year for the potential ordinary shares, and for any other income or expense that would alter as a result of the conversion of the potential ordinary shares into actual ordinary shares.
The dividend or interest reduces total earnings. However, if they had already been converted into ordinary shares (and the calculation of diluted EPS is based on this assumption) the dividends or interest would not have been payable. Total earnings would therefore have been higher. To calculate the diluted EPS, total earnings are adjusted to allow for this.
Weighted average number of shares – Diluted EPS
The weighted average number of shares must be adjusted. The method of making this adjustment is different for:
- convertible bonds or convertible preference shares; and
- share options or warrants.
Convertible preference shares and convertible bonds
Total earnings
Total earnings are adjusted because the entity would not have to pay the dividend or interest on the convertible securities.
- For convertible preference shares, add back the preference dividend paid in the year. Total earnings will be increased by the preference dividend saved.
- For convertible bonds, add back the interest charge on the bonds in the year less the tax relief relating to that interest. Total earnings will increase by the interest saved less tax.
Number of shares
The weighted average number of shares is increased, by adding the maximum number of new shares that would be created if all the potential ordinary shares were converted into actual ordinary shares.
New issue of convertibles in the year
If new convertibles are issued during the course of the year, the additional number of shares and the earnings adjustment are included only from the time that the convertibles were issued.
Options and warrants
A different situation applies with share options and share warrants.
Options (warrants) are contracts issued by a company which allow the holder of the option to buy shares of the company at some time in the future at a pre-agreed price.
If the option holder exercises this right the number of shares would increase and the company would receive the cash paid for the shares and this would be available to invest in the business and in turn this would be expected to boost its earnings. However, it is impossible to predict how total earnings will be affected when the cash is eventually received.
The amount that would be received on exercise of the options is treated as cash received from selling shares at full price with the remaining shares having been given away. The shares sold at full price are not considered to be dilutive as any cash would be invested to earn the same return as earned in the period. It is only the free shares that are dilutive.
The following steps must be taken:
Step 1 – Calculate the cash that would be received if the options are exercised.
Step 2 – Calculate the number of shares that could be sold at (average) full market price to raise the same amount of cash. (Divide the figure from step 1 by the average share price in the period).
Step 3 – Identify the number of shares that will be issued if all the options are exercised.
Step 4 – Subtract the number of shares in step 2 from the number at step 3. These shares are treated as having been given away for free and is added to the existing number of shares in issue, to obtain the total shares for calculating the diluted EPS.
Options are only included in the diluted EPS calculation if the average share price in the year is greater than the exercise price of the option. If this were not the case the option would not be exercised.
- When the exercise price of the option is less than the share price they are said to be in the money.
- When the exercise price of the option is more than the share price they are said to be out of the money.
* In the money options are always dilutive. Out of the money options are always not dilutive.
Employee share options
Employee share options that have vested are treated in exactly the same way as any other option.
Unvested options
The company will recognise an expense in the future for those options which are unvested at the reporting date. This expense represents the service of the employee that will be consumed and used by the company in the future.
IAS 33 requires that the future “service” received per share be added to the exercise price for the purpose of calculating the number of dilutive shares.
The following steps must be taken:
Step 1 – Calculate the cash that would be received if the options are exercised and the future expense that is expected to be charged to profit or loss.
Step 2 – Calculate the number of shares that could be sold at full market price to raise an amount of cash equal to the future benefit identified at step 1. (Divide the figure from step 1 by the average share price in the period).
Step 3 – Identify the number of shares that will be issued if all the options are exercised.
Step 4 – Subtract the number of shares in step 2 from the number at step 3. These shares are treated as having been given away for free and is added to the existing number of shares in issue, to obtain the total shares for calculating the diluted EPS.
Potential ordinary shares that are not dilutive
Only dilutive potential ordinary shares are included in the dilutive EPS calculation.
When there are several types of potential ordinary share in issue, they should be ranked in order of dilution, with the most dilutive potential ordinary shares ranked first. In order to carry out the ranking the earnings per incremental share is found for each potential ordinary share.
In the money options always rank first as they increase the number of shares in the calculation without affecting the earnings.
A diluted EPS should then be calculated in stages, taking in one potential ordinary share at a time, to establish whether any of them are not dilutive.
Contingently issuable shares
A company might enter into a contract where it will issue shares on the occurrence of some future event. They are taken into account in the diluted EPS only if the conditions leading to their issue have been satisfied. For this purpose, the reporting date is treated as the end of the contingency period.
Actual conversion during the year
If a conversion right is exercised during the year, interest paid to the holders of the convertible bond ceases on the date upon which they exercise their right to the shares and the new shares are included as part of the weighted average number of shares used in the basic EPS calculation.
When this happens, the new shares issued and the resulting interest saving must be included in the diluted EPS calculation as an adjustment for the period before the right was exercised.
The Price/Earnings (P/E) Ratio
The price/earnings ratio (P/E ratio) is a key stock market ratio. It is a measure of the company’s current share price (market price) in relation to the EPS.
Formula: Price earnings ratio
Market value of share
Earnings per share
The P/E ratio can be used by investors to assess whether the shares of a company appear expensive or cheap. A high P/E ratio usually indicates that the stock market expects strong performance from the company in the future.
IAS 33 Presentation and Disclosure requirements
An entity should present in the statement of profit or loss:
- the basic EPS and
- the diluted EPS for the profit or loss from continuing operations.
For consolidated accounts, this is the EPS and diluted EPS attributable to the owners of the parent company.
If there is a discontinued operation, the basic EPS and diluted EPS from discontinued operation should be shown either on the face of the statement of profit or loss or in a note to the financial statements.
The basic and the diluted EPS should be presented, even if it is a negative figure (even if it is a loss per share).