Earnings Per Share (EPS)

Earnings Per Share (EPS)

Lecture Contents

• Meaning of Earnings per share
• Objectives of EPS calculation
• Significance of Earnings per share
• Limitations of Earnings per share
• Calculation of Basic Earnings per share – Simple structure
• Calculation of Diluted Earnings per share – Complex structure
• Disclosure of EPS in financial statements

Meaning of Earnings Per Share (EPS)

• Earnings per share (EPS) is the amount of profit earned during an accounting period for each ordinary share in issue during that period.
• EPS explains the company's performance by showing how much money it earns for each share of its stock.
• IAS 33 provides a set of rules for the calculation and presentation of a company's earnings per share (EPS) figure.
• The aim of the standard is to improve the reliability of performance comparisons between different companies in the same reporting period and between different reporting periods of the same company.

Objectives of EPS Calculation

• To provide a measure of the interest of each ordinary share of an entity in the performance of that entity over a given reporting period (Basic EPS).
• To provide a measure of the interest of each ordinary share in the performance of an entity, taking into account all of the potential dilutive ordinary shares outstanding during the period (Diluted EPS).

Significance of Earnings Per Share (EPS)

• EPS can be used to compare the financial standing of a company over the years and over different accounting periods.
• EPS helps to determine the Price/Earnings ratio which is used as an indicator for further investment prospective.
• EPS helps in comparing the performance of promising companies to help pick the most suitable investment option. Seasoned investors usually do not prefer companies with irregular EPS.
• A higher EPS means more profitability, which suggests that the company may increase dividend payout over time.
• EPS not only helps measure a company's current financial standing but also helps track its past performances.

Limitations of Earnings Per Share (EPS)

• Cash flow analysis is an important tool for gauging a company's ability to repay its debt.
  • However, cash flow is not factored in EPS calculation, which means a high EPS may still prove ineffective for gauging a company's solvency.
• Most business owners tend to manipulate the EPS to project their venture as profitable frequently.
  • However, most of such attempts are made for the short-term, which often hampers a business venture's image and profitability in the long run.

Basic Earnings Per Share – Simple Structure

• The calculation of basic EPS takes into account only those ordinary shares which are already outstanding.
• Basic Earnings Per Share (EPS) is calculated as:

Procedure for Calculating Profit or Loss Attributable to Ordinary Equity Shareholders:

• Profit for the period after deducting tax XXX
• Less: Preference dividends paid during the period (XXX)
• Less: Net income attributable to Non Controlling Interest (if available) (XXX)
• Profit or loss attributable to ordinary equity shareholders XXX

Procedure for Calculating Weighted Average Number of Ordinary Shares:

• Number of ordinary shares outstanding at the beginning of the period XXX
• Add: No. of ordinary shares issued during the period x Appropriate time weighting factor XXX
• Less: No. of ordinary shares bought back during the period x Appropriate time weighting factor (XXX)
• Weighted Average Number of ordinary Shares (WANS) XXX

Basic Earnings Per Share – Simple Structure - Note

• When additional ordinary shares are issued during an accounting period, the use of WANS ensures that basic EPS is fairly adjusted to reflect the amount of additional capital raised and the length of time it has been used for the purpose of generating earnings.
• The above calculation assumes that shares are issued or bought back at full market price.
• Further adjustments are required for bonus issue or rights issue.

Example 1 for Calculation of Basic Earnings Per Share – Simple Structure

• A company's summarized statement of comprehensive income for the year ended 31st December 2018 is as follows:
  • Profit before tax: OMR 660,000
  • Taxation: (110,000)
  • Profit for the period after tax: 550,000
• The following information is also available:
  • The company's issued share capital consists of 600,000, 10% preference shares of OMR 1 each and one million OMR 1 each ordinary shares. There were no changes to the issued share capital during the year.
  • The preference dividend of OMR 60,000 was paid in full during the year.
• Calculate basic EPS for the year to 31st December 2018.

Solution:

• Basic Earnings Per Share (EPS) = Profit or loss attributable to ordinary equity shareholders is calculated as follows:
  • Profit for the period after deducting tax: OMR 550,000
  • Preference dividends paid during the period: (60,000)
  • Profit or loss attributable to equity shareholders: 490,000
• Therefore, basic EPS = $490,000 / 1,000,000 = 0.490$ OMR per share

Practice Question 1: Calculation of Basic Earnings Per Share – Simple Structure

• A company's summarized statement of comprehensive income for the year to 31st December 2018 is as follows:
  • Profit before tax: OMR 1,320,000
  • Tax paid: (220,000)
  • Profit for the period after tax: 1,100,000
• The following information is also available:
  • The company's issued share capital consists of 1,000,000, 10% preference shares of OMR 1 each and two million ordinary shares of OMR 1 each. There were no changes to the issued share capital during the year 2018.
  • The company has paid preference dividend for 2018 in full.
• Calculate basic EPS for the year to 31st December 2018.

Solution:

(Solution not provided in the transcript)

Example 2 for Calculation of Basic Earnings Per Share – Simple Structure

• On 1 January 2017, a company's issued share capital consisted of 60,000 ordinary shares OMR 1 each. On 1 March 2017, the company issued 30,000 ordinary shares. On 1 October 2017, the company bought back 10,000 ordinary shares. Both the share issue and the buy-back were made at full market price.
• Calculate the weighted average number of ordinary shares outstanding in the year 31st December 2017.

Solution:

• The weighted average number of ordinary shares for the year 2017 is calculated as follows:
  • The number of ordinary shares outstanding at the beginning of the period: 60,000
  • The number of ordinary shares issued during the period x Appropriate time weighting factor: $30,000 \times (10/12) = 25,000$
  • The number of ordinary shares bought back during the period x Appropriate time weighting factor: $10,000 \times (3/12) = (2,500)$
  • Weighted Average Number of ordinary Shares for 2017 (WANS): 82,500

Practice Question 2:

• On 1 January 2019, a company's issued share capital consisted of 100,000 ordinary shares OMR 1 each. On 1 April 2019, the company issued 70,000 ordinary shares. On 1 September 2019, the company bought back 50,000 ordinary shares. Both the share issue and the buy-back were made at full market price.
• Calculate the weighted average number of ordinary shares outstanding in the year 31st December 2019.

Solution:

(Solution not provided in the transcript)

Example 3 for Calculation of Basic Earnings Per Share – Simple Structure

• A company's profit after tax for the year to 31st December 2018 was OMR 3.8 million. The comparative figure for the year to 31st December 2017 was OMR 3.6 million.
• The company's issued share capital on 1st January 2017 consisted of 4 million ordinary shares of RO 0.500 each. No shares were issued during the year 2017 but a further 1 million ordinary shares were issued (at full market price) on 1 July 2018.
• Required:
  • Calculate basic EPS for the year 2017.
  • Calculate basic EPS for the year 2018.

Solution:

• Basic EPS for 2017 = $3,600,000/4,000,000 = 0.9$
• The weighted average number of ordinary shares for the year 2018 is calculated as follows:
  • Number of ordinary shares outstanding at the beginning of the period: 4,000,000
  • Number of ordinary shares issued during the period X Appropriate time weighting factor: $1,000,000 \times (6/12) = 500,000$
  • Weighted Average Number of Shares for 2018: 4,500,000
• Basic EPS for 2018 = $3,800,000/4,500,000 = 0.844$

Example 4 for Calculation of Basic Earnings Per Share – Simple Structure

• The profit after tax of Company B for the year ended 31st December 2018 is OMR 217,500. The comparative figure for the year 31st December 2017 was OMR 188,000.
• On 1st January 2017, the company's issued share capital consisted of 100,000 ordinary shares of OMR 1 each. On 1st April 2018, a further 15,000 ordinary shares were issued at full market price.
• Required:
  • Calculate basic EPS for the year 2017.
  • Calculate basic EPS for the year 2018.

Solution:

• Basic EPS for 2017 = $188,000/100,000 = 1.88$
• The weighted average number of ordinary shares for the year 2018 is calculated as follows:
  • Number of ordinary shares outstanding at the beginning of the period: 100,000
  • Number of ordinary shares issued during the period x Appropriate time weighting factor: $15,000 \times (9/12) = 11,250$
  • Weighted Average Number of ordinary Shares for 2018: 111,250
• Basic EPS for 2018 = $217,500/111,250 = 1.955$

Practice Question 3:

• The profit after tax of B Company for the year to 31st December 2020 was OMR 412,000. The comparative figure for the year 31st December 2021 was OMR 488,000.
• On 1st January 2020, the company issued 75,000 ordinary shares of OMR 1 each. On 1st July 2020, a further 20,000 ordinary shares were issued at full market price. Further it issued 10,000 ordinary shares on 1.9.2021.
• Required:
  • Calculate basic EPS for the year 2020.
  • Calculate basic EPS for the year 2021.

Solution:

(Solution not provided in the transcript)

Calculation of Basic Earnings Per Share – Simple Structure (with Bonus Issue)

• A bonus issue is free additional issue of shares to existing shareholders in proportion to their existing shareholdings.
• From the point of view of calculating EPS, the bonus issue increases the number of shares outstanding but without increasing the company's capacity to earn profits.
• If a bonus issue made during a period is treated like issue of shares at full price, the effect would be to reduce the EPS figure and distort the comparison with EPS to previous periods.
• To resolve this issue, IAS-33 states that a bonus issue should be treated as if it had occurred "at the beginning of the earliest period presented". It means that bonus issues are usually treated as if they had occurred at the beginning of the previous period.
• In the above circumstance, we must recalculate and restate EPS for the previous period as well as calculate EPS for the current period.

Example 5 for Calculation of Basic Earnings Per Share – Simple Structure – with Bonus Issue

• A company's profit after tax for the year ended 31st December 2018 was OMR 2.2 million. The comparative figure for the year to 31st December 2017 was OMR 2 million.
• The company's issued share capital at 1st January 2017 consisted of 800,000 ordinary shares. No shares were issued during the year 2017 but a 1 for 4 bonus issue was made on 1st March 2018.
• Required:
  • Calculate basic EPS for the year 2018.
  • Calculate restated basic EPS for the year 2017 and explain why this restatement is necessary.

Solution:

• Basic EPS for the year 2018
  • WANS = $800,000 + (800,000 \times 1/4 = 200,000) = 1,000,000$ shares
  • Basic Earnings Per Share (EPS) = $2,200,000 / 1,000,000 = 2.200$ OMR per share
• Restated basic EPS for the year 2017 and explain why this restatement is necessary
  • Basic EPS (Before bonus issue) = $2,000,000 / 800,000 = 2.500$ OMR per share
  • Restated basic EPS (after bonus issue) = $2,000,000 / 1,000,000 = 2$ OMR per share
• Explanatory Notes:
  • IAS-33 states that a bonus issue should be treated as if it had occurred "at the beginning of the earliest period presented”
  • Basic EPS for the year 2017 would have been stated originally as 2.50 RO share (earnings of RO 2 million divided by 800,000 ordinary shares). If this were not restated as above, it would appear that the company's financial performance had declined during the year 2018, which is not the case.

Practice Question 4:

• A company has the following after-tax profits for its two most recent accounting periods:
  • Year ended 31st December 2016: OMR 330,000
  • Year ended 31st December 2017: OMR 341,000
• On 1st January 2016, the company's issued share capital consisted of 600,000 ordinary shares. On 1 August 2017, the company made a 1 for 6 bonus issue.
• Required:
  • Calculate basic EPS for the year 2017.
  • Calculate restated basic EPS for the year 2016 and explain why this restatement is necessary.

Solution:

(Solution not provided in the transcript)

Calculation of Basic Earnings Per Share – Simple Structure (with Rights Issue)

• A rights issue is issue of additional shares to existing shareholders in proportion to their existing shareholdings.
  • If a rights issue is made at full market price, then calculation of EPS is the same as issue of shares at full market price.
  • If a rights issue is made at lower than market price, then “bonus element” should be determined.

Steps for Calculation of Basic Earnings Per Share – Simple Structure (with Rights issue)

• Step 1: Calculate Theoretical Ex-Rights price (TERP)
• Step 2: Calculate bonus element = Market Price before the rights issue / TERP
• Step 3: Calculate WANS
  • Time apportioned shares before right issue x Bonus element = XXX ①
  • (+) Time apportioned shares after right issue (do not include bonus element) = XXX
• Step 4: Calculate restated basic EPS = Profit attributable to ordinary equity shareholders / ①
• Current year basic EPS = Profit attributable to ordinary equity shareholders / WANS

Calculation of TERP

• A theoretical ex-rights price (TERP) is the market price that a stock will theoretically have following a new rights issue.

• TERP = (M.V. of shares before R.I. + Amount raised through R.I.) ÷ Total no. of shares after R.I.

  which can also be written as:

Example 6 for Calculation of TERP

• A company issues 120,000 shares of the face value of OMR 0.550 each. These shares had a market value of OMR 0.725. Further to this there was a rights issue of 2 shares for every 6 shares at an offer price of OMR 0.650.
• What is the TERP?

Solution:

• Market value of shares before the rights issue (120,000 X 0.725) = OMR 87,000
• The rights issue (120,000 X 2/6) 40,000 shares and raised (40,000 x 0.650) = OMR 26,000
• Total number of issued shares = 160,000
• Therefore, TERP (113,000 / 160,000) = OMR 0.70625 per share

Example 7 for Calculation of Basic Earnings Per Share – Simple Structure (with Rights Issue)

• A company's profit after tax for the year 31st December 2018 was OMR 500,000. The comparative figure for the year 31st December 2017 was OMR 300,000.
• The company's issued share capital at 1st January 2016 consisted of 100,000 ordinary shares. No shares were issued during the year 2017 but a 1 for 2 rights issue was made on 1st July 2018 at OMR 0.600 per share and this was fully subscribed.
• The market value of the company's shares just before the rights issue was OMR 1.200 per share.
• Required:
  • Calculate basic EPS for the year 2018
  • Calculate the restated basic EPS for the year 2017.

Solution:

• Step 1: Theoretical Ex-Rights price (TERP)
  • Market value of shares before the rights issue (100,000 X 1.2) = 120,000
  • The rights issue (100,000 X ½) 50,000 shares and raised (50,000 x 0.600) = 30,000
  • Market Value of Shares 150,000
  • Total number of issued shares =150,000
  • Therefore, TERP (150,000 / 150,000) = OMR 1 per share.
• Step 2: Bonus element= Market Price before exercise the rights/TERP = 1.200/1 = 1.2
• Step 3: WANS
  • Time apportioned shares before right issues x Bonus element (100,000 X 1.200) = 120,000 ①
  • (+) Time apportioned shares after right issue (do not include bonus element) (50,000X6/12) = 25,000
  • WANS=145,000
• Step 4: Calculation restated basic EPS = 300,000 / 120,000 ① = OMR 2.500 per share
• Current year basic EPS = 500,000 / 145,000 = OMR 3.448 per share

Practice Exercise 5 for Calculation of TERP

• A company with an issued share capital of 100,000 ordinary shares makes a new share issue. The market price of the company's ordinary shares just before this issue was OMR 6 per share.
• Calculate the theoretical market value per share just after the issue has been made, assuming that the issue comprises:
  • either (a) a 1 for 2 bonus issue
  • or (b) a 1 for 5 rights issue at OMR 4.20 per share.

Solution:

(Solution not provided in the transcript)

Practice Question 6 for Calculation of Basic Earnings Per Share – Simple Structure (with Rights Issue)

• A company's profit after tax for the year 31st December 2018 was OMR 800,000. The comparative figure for the year 31st December 2017 was OMR 500,000.
• The company's issued share capital at 1st January 2016 consisted of 200,000 ordinary shares. No shares were issued during the year 2017 but a 1 for 2 rights issue was made on 1st July 2018 at RO 0.600 per share and this was fully subscribed.
• The market value of the company's shares just before the rights issue was RO 1.500 per share.
• Required:
  • Calculate basic EPS for the year 2018
  • Calculate the restated basic EPS for the year 2017.

Solution:

(Solution not provided in the transcript)

Practice Question 7 for Calculation of Basic Earnings Per Share – Simple Structure (with Rights Issue)

• A company's profit after tax for the year 31st December 2018 was OMR 400,000. The comparative figure for the year 31st December 2017 was OMR 250,000.
• The company's issued share capital at 1st January 2016 consisted of 150,000 ordinary shares. No shares were issued during the year 2017 but a 1 for 2 rights issue was made on 1st July 2018 at OMR 0.800 per share and this was fully subscribed.
• The market value of the company's shares just before the rights issue was RO 1.200 per share.
• Required:
  • Calculate basic EPS for the year 2018
  • Calculate the restated basic EPS for the year 2017.

Solution:

(Solution not provided in the transcript)

Share Splits and Stock Dividends

• If shares are issued as a stock dividend or a stock split, they are not weight-averaged.
• Instead, the stock dividend or stock split is treated as though it had been in effect for the whole period.
• It is also included for all prior years disclosed as comparative data (i.e., dividend and split shares are treated as though they have always been outstanding).

IAS 33 – Disclosure of EPS in Financial Statements

IAS 33 requires an entity to disclose:

• The amounts used as the numerators in calculating basic and diluted earnings per share, and a reconciliation of those amounts to profit or loss.
• The weighted average number of ordinary shares (WANS) used as the denominator in calculating basic and diluted earnings per share, and a reconciliation of these denominators to each other.
• A description of any other instruments (including contingently issuable shares) that could potentially dilute basic earnings per share in the future, but that were not included in the calculation of diluted earnings per share.
• A description of ordinary share transactions that occur after the reporting period and that could have changed the EPS calculations significantly if those transactions had occurred before the end of the reporting period.
• An enterprise should present basic and diluted earnings per share on the face of the statement of profit and loss for each class of equity shares that has a different right to share in the net profit for the period.
• An enterprise should present basic and diluted earnings per share with equal prominence for all periods presented.
• This standard requires an enterprise to present basic and diluted earnings per share, even if the amounts disclosed are negative (a loss per share).
• Where the statement of profit and loss includes extraordinary items (within the meaning of AS 5, net profit or loss for the period, prior period items and changes in accounting policies), the enterprise should disclose basic and diluted earnings per share computed on the basis of earnings excluding extraordinary items (net of tax expense).