Earnings per Share (PAS 33)

Earnings per share is a ratio, so PAS 33 is a standard about two numbers. Get the numerator right by asking what belongs to the ordinary shareholders, and the denominator right by asking how long each share was outstanding. Everything else is bookkeeping.

Only entities whose ordinary shares are publicly traded, or that are in the process of issuing them, are required to present earnings per share. An entity that presents it voluntarily must comply with PAS 33 in full.

Core concept

Basic earnings per share

Basic EPS = profit attributable to ordinary equity holders of the parent / weighted average number of ordinary shares outstanding

The numerator. Start with profit for the period attributable to the parent, then deduct preference dividends:

• Cumulative preference shares: deduct the dividend for the current period only, whether or not it was declared. Do not deduct dividends in arrears from prior periods, since those were already deducted in the periods to which they relate.
• Non-cumulative preference shares: deduct only the dividend actually declared for the period.

The denominator. Shares are weighted by the fraction of the period they were outstanding. But there is one class of change that is not time-weighted:

• Bonus issues, share dividends, and share splits involve no consideration and therefore no change in resources. They are treated as if they had occurred at the beginning of the earliest period presented, and all prior-period earnings per share figures are restated.
• A share issue for cash, an exercise of options, or a reverse split for consideration is weighted from its date.
• A rights issue offered below fair value contains a bonus element, and its adjustment factor is applied retroactively as well.

Diluted earnings per share

Dilution asks a hypothetical: if every potential ordinary share had been converted or exercised at the beginning of the period, or at its issue date if later, what would earnings per share have been?

Convertible instruments: the if-converted method.

• Numerator: add back the after-tax interest on convertible bonds, since converted bonds pay no interest. For convertible preference shares, add back the preference dividend that was deducted, since converted preference shares receive none.
• Denominator: add the shares that would be issued on conversion.

Options and warrants: the treasury share method. These affect the denominator only, because they generate no earnings and cost no interest.

Incremental shares = shares issuable on exercise - (proceeds from exercise / average market price of one ordinary share)

The logic is that the entity is assumed to use the exercise proceeds to buy back shares at the average market price. Only the shortfall, the "free" shares, dilutes. Options are dilutive only when the exercise price is below the average market price.

Antidilution, and the order of inclusion

A potential ordinary share is included in diluted earnings per share only if it is dilutive, that is, only if it reduces earnings per share from continuing operations. An antidilutive instrument is ignored entirely.

Where several potential ordinary shares exist, they must be considered in sequence from the most dilutive to the least, because including a less dilutive instrument first can wrongly make a more dilutive one appear antidilutive. Rank them by incremental earnings per share:

Incremental EPS of an instrument = increase in the numerator / increase in the denominator

Options and warrants always rank first, since their incremental earnings per share is zero: they add shares and no earnings.

Whether a security is dilutive is determined by reference to profit or loss from continuing operations, not to total profit.

How this appears in the exam

• A profit figure, a preference share class described as cumulative with no dividend declared, and a request for basic earnings per share. The dividend is deducted anyway.
• Shares issued for cash mid-year and a share dividend late in the year. The cash issue is time-weighted; the share dividend is applied retroactively to all shares, including those issued for cash earlier in the year.
• Convertible bonds with an incremental earnings per share above the basic figure. They are antidilutive and excluded.
• Options with an exercise price above the average market price. They are antidilutive and excluded, and the treasury share method would in any case produce negative incremental shares.

Common traps

• Deducting dividends in arrears on cumulative preference shares. Only the current year's dividend is deducted.
• Time-weighting a share dividend or split. They are retroactive to the start of the earliest period presented, and comparatives are restated.
• Forgetting the tax effect on convertible bond interest. The add-back is the interest net of tax.
• Adding back a dividend on convertible bonds. Bonds pay interest, not dividends, and the add-back is after tax. Convertible preference shares are the ones whose dividend is added back, and there is no tax effect, because dividends are not deductible.
• Including every potential ordinary share. Test each for dilution, in order of incremental earnings per share, and drop the antidilutive ones.

Worked examples

Example 1: basic earnings per share

Laguna Textiles reports profit for the year of P5,600,000. Its capital structure:

• 10% cumulative preference shares, total par P6,000,000. No dividend was declared this year.
• Ordinary shares: 1,200,000 outstanding on 1 January; 200,000 additional shares issued for cash on 1 October.

Numerator. The preference shares are cumulative, so the dividend is deducted whether or not declared:

Preference dividend = 10% x P6,000,000 = P600,000

Profit attributable to ordinary shareholders = P5,600,000 - P600,000 = P5,000,000

Denominator.

Shares	Period outstanding	Weighted
1,200,000	12/12	1,200,000
200,000	3/12	50,000
	Weighted average	1,250,000

Basic EPS = P5,000,000 / 1,250,000 = P4.00

Example 2: diluted earnings per share, in the correct order

Continue with Laguna Textiles. Two potential ordinary shares exist, both outstanding for the whole year. The income tax rate is 25%, and the average market price of one ordinary share was P25.

• 8% convertible bonds, face value P5,000,000, convertible into 250,000 ordinary shares.
• 100,000 share options, exercise price P10.

Step 1: incremental earnings per share of each instrument.

Convertible bonds. Interest = 8% x P5,000,000 = P400,000. After tax = P400,000 x (1 - 0.25) = P300,000.

Incremental EPS = P300,000 / 250,000 shares = P1.20

Options. Proceeds on exercise = 100,000 x P10 = P1,000,000. Shares assumed repurchased = P1,000,000 / P25 = 40,000.

Incremental shares = 100,000 - 40,000 = 60,000

Incremental EPS = P0 / 60,000 = P0.00

Step 2: rank from most to least dilutive. Options (P0.00) first, then bonds (P1.20). Both are below basic EPS of P4.00, so both look dilutive, but each must be tested in sequence.

Step 3: include the options.

P5,000,000 / (1,250,000 + 60,000) = P5,000,000 / 1,310,000 = P3.82

P3.82 is below P4.00, so the options are dilutive. Keep them.

Step 4: include the bonds.

(P5,000,000 + P300,000) / (1,310,000 + 250,000) = P5,300,000 / 1,560,000 = P3.40

P3.40 is below P3.82, so the bonds are dilutive. Keep them.

Diluted EPS = P3.40

Notice why order matters. Had the bonds been tested first against basic EPS and the options ignored, the answer would have been P5,300,000 / 1,500,000 = P3.53, and the sequence would never have revealed that the options push it lower still.

Example 3: an antidilutive instrument

Suppose instead that Laguna's convertible bonds carried a 16% coupon on the same P5,000,000 face and converted into only 50,000 ordinary shares.

Interest = 16% x P5,000,000 = P800,000. After tax = P600,000.

Incremental EPS = P600,000 / 50,000 = P12.00

P12.00 exceeds basic EPS of P4.00. Converting these bonds would raise earnings per share, so they are antidilutive and are excluded from the diluted computation entirely. Diluted EPS would rest on the options alone, at P3.82.

Example 4: a share dividend is retroactive

Assume the same facts as Example 1, and add that on 1 December Laguna declared a 20% share dividend.

A share dividend brings in no resources, so it is treated as though it occurred on 1 January. Every share already counted, including the 200,000 issued on 1 October, is multiplied by 1.20:

Weighted average = 1,250,000 x 1.20 = 1,500,000

Basic EPS = P5,000,000 / 1,500,000 = P3.33

The prior year's reported earnings per share is also restated by the same factor, so the two years remain comparable.

Quick review

• Basic EPS = (profit attributable to the parent - preference dividends) / weighted average ordinary shares.
• Cumulative preference dividends are deducted whether or not declared, for the current period only. Non-cumulative dividends are deducted only if declared.
• Issues for consideration are time-weighted. Bonus issues, share dividends, and splits are retroactive to the beginning of the earliest period presented, and comparatives are restated.
• Convertible bonds: add back after-tax interest to the numerator; add conversion shares to the denominator. Convertible preference shares: add back the dividend, with no tax effect.
• Options and warrants: treasury share method, denominator only. Incremental shares = issuable shares less proceeds divided by the average market price. Dilutive only when the exercise price is below that average.
• Include potential ordinary shares in order of incremental EPS, from most to least dilutive. Options rank first, at zero. Discard antidilutive instruments, judged against profit from continuing operations.