Chapter 45 – Diluted Earnings per Share

15 vocabulary flashcards covering key terms and concepts for calculating, analyzing, and reporting diluted earnings per share under IAS 33.

Diluted Earnings per Share (Diluted EPS)

A hypothetical EPS measure that assumes all dilutive potential common shares have been converted, calculated as (net earnings available to common shareholders + income effect of dilutive PCS) ÷ (WACSO + share effect of dilutive PCS).

Potential Common Shares (PCS)

Financial instruments or contracts—such as convertible bonds, convertible preferred shares, options, or warrants—that may entitle the holder to obtain common shares and therefore can dilute EPS.

Incremental EPS

The income impact of a class of PCS divided by its share impact; used to determine whether the PCS is dilutive (incremental EPS < basic EPS) or anti-dilutive (incremental EPS ≥ basic EPS).

Weighted Average Common Shares Outstanding (WACSO)

The time-weighted average number of common shares outstanding during a reporting period, used in both basic and diluted EPS calculations.

If-converted Method

Technique for convertible bonds and convertible preferred shares that adds back the after-tax interest (or preferred dividends) saved and includes the additional shares that would be issued if the instruments were converted at the start of the period.

Treasury Stock Method

Approach for options and warrants that assumes exercise of in-the-money options, receipt of cash by the company, and repurchase of shares at the average market price; income effect is zero, share impact equals options × (market price – exercise price) ÷ market price.

In-the-money Option

An option whose exercise price is lower than the current (or average) market price of the underlying common share; always considered dilutive in EPS calculations.

Out-of-the-money Option

An option whose exercise price exceeds the current (or average) market price; it is anti-dilutive and excluded from the diluted EPS computation.

Convertible Bonds

Debt instruments that can be exchanged for a predetermined number of common shares; income impact in diluted EPS equals after-tax interest avoided, share impact equals shares issuable upon conversion.

Convertible Preferred Shares

Preferred shares that can be exchanged for common shares; income impact equals dividends (adjusted for cumulativeness), with no tax effect, and share impact equals additional shares on conversion.

Contingently Issuable Shares

Shares promised upon satisfaction of future conditions (e.g., performance targets); included in basic EPS once conditions are met and in diluted EPS from the beginning of the period based on shares that would be issued at period-end if conditions were satisfied.

Anti-dilutive Securities

PCS whose conversion or exercise would increase EPS or decrease loss per share; such instruments are excluded from the diluted EPS calculation under IAS 33.

Provisional EPS

The step-by-step recalculated EPS obtained during Step 4 as each dilutive PCS is sequentially included from most to least dilutive until final diluted EPS is determined.

IAS 33 – Earnings per Share

The International Accounting Standard that prescribes the guidance for calculating, presenting, and disclosing basic and diluted EPS for publicly accountable enterprises.

Presentation and Disclosure Requirements (EPS)

IAS 33 mandate to present basic and diluted EPS from continuing operations on the face of the statement of comprehensive income and disclose reconciliations, WACSO details, anti-dilutive instruments, and significant post-year-end share transactions in the notes.

Which of the following describes how incremental EPS is determined in calculating diluted EPS?

Income impact of PCS/ share impact of PCS

Which of the following is the effect on diluted EPS when there is a loss per share rather than earnings per share (that is, EPS is negative)?

Diluted EPS will be equal to basic EPS

An entity has ordered incremental EPS for each PCS instrument. Which of the following is the next step in calculating diluted EPS?

Recompute a provisional EPS by comparing and applying the most dilutive PCS to the least dilutive unitl diluted EPS is determined

Which of the following describes how incremental EPS are ordered when calculating diluted EPS?

From the most dilutive to the least dilutive

The following information relates to Malfoy Corp.’s current year ended March 31:

• Net income attributable to common shareholders: $1,920,000

• WACSO: 1,347,917

• Bonds: $4,000,000, 2%, 10-year bonds, issued at par and convertible into 25 shares for each $1,000 bond

• Stock options: 75,000 outstanding options to purchase shares at $3.50 each

• The average market price for the year was $10.

Which of the following statements regarding Malfoy’s ordering incremental EPS when calculating diluted EPS is true? Malfoy is a Canadian public company reporting under IFRS and has a 35% tax rate.

The options are ordered first and the bonds second

Which of the following statements best describes PCS?

Financial instruments or other contracts found in complex capital structures that may entitle their holder to obtain common shares at any point in the future

Steven is the controller for Strange Ltd., a public company, and is preparing the EPS calculation for the current year ended December 31. Select financial information for Strange for its current fiscal year is provided below:

• Profit for the year is $3,900,000.

• Net income attributable to the common shareholders is $3,600,000.

• WACSO for basic EPS is 2,200,000.

• During the year, 500,000 employee stock options outstanding with an exercise price of $15 were issued. The average share price during the year was $25.

• $4,000,000 of 5%, 10-year convertible bonds are outstanding. The bonds were issued at par. Before maturity, at the option of the holder, each $1,000 bond is convertible into 45 common shares.

• Strange’s corporate tax rate is 25%.

What is the diluted EPS for Strange for its current fiscal year?

The stock options are in the money; therefore, they are always the most dilutive instrument because there is no income effect. The number of shares to be issued using the treasury stock method is: 500,000 shares × ($25 market price – $15 exercise price) / $25 market price = 200,000.

For the convertible bonds: income effect = ($4,000,000 × 5%) × (1 – 25%) = $150,000; share effect = $4,000,000 / $1,000 × 45 = 180,000; incremental EPS = $150,000 / 180,000 = $0.83.

Diluted EPS is calculated as:

	Income	Shares	Basic EPS	Provisional EPS	Diluted EPS
Basic EPS	$3,600,000	2,200,000	$1.64
Stock options	—	200,000
Provisional EPS	$3,600,000	2,400,000		$1.50
Convertible bonds	150,000	180,000
Provisional EPS	$3,750,000	2,580,000		1.45	$1.45

Which of the following statements best describes the share effect of convertible preferred shares when calculating incremental EPS?

The number of common shares that would be issued if the preferred shares were converted, multiplied by the portion of the year the preferred shares were outstanding

Which of the following describes diluted EPS?

A hypothetical measure of company earnings attributable to each common shareholder assuming all dilutive securities have been converted to common shares

Which of the following is the equation for determining the income effect when calculating incremental EPS for convertible bonds for diluted EPS?

Bond carrying value x effective interest rate x (1-tax rate)