ACCA paper f 7 financial reporting F7FR session27 d08

SESSION 27 – IAS 33 EARNINGS PER SHARE OVERVIEW Objective To explain the provisions of IAS 33 INTRODUCTION EARNINGS PER SHARE (EPS) Basic EPS Which earnings? Earnings performance Scope Definitions WEIGHTED AVERAGE NUMBER OF SHARES DILUTED EARNINGS PER SHARE Basic rule Issues of shares – no consideration Multiple capital changes Issuable shares SIGNIFICANCE OF EPS PRESENTATION AND DISCLOSURE Purpose Method Options EPS vs earnings Performance measure Problems with EPS Presentation Disclosure 2701 SESSION 27 – IAS 33 EARNINGS PER SHARE INTRODUCTION 1.1 Earnings performance Earnings (EPS) shows the trend of earnings performance for a company over the years It is felt to be more useful than an absolute profit figure, which will not contain information about the increase in investment that has been made in the period It is not useful in comparing companies 1.2 Scope IAS 33 applies to the separate financial statements of entities whose debt or equity instruments are publicly traded (or are in the process of being issued in a public market) IAS 33 also applies to the consolidated financial statements of a group whose parent is required to apply IAS 33 to its separate financial statements An entity that disclosed EPS should calculate and present it in accordance with IAS 33 1.3 Definitions An ordinary share is an equity instrument that is subordinate to all other classes of equity instruments An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities A potential ordinary share is a financial instrument or other contract that may entitle its holder to ordinary shares For example: convertible instruments; share options and warrants; share purchase plans; shares which will be issued subject to certain conditions being met Options, warrants and their equivalents are financial instruments that give the holder the right to purchase ordinary shares Dilution is the reduction in EPS (or an increase in loss per share) resulting from the assumption that convertible instruments are converted, that warrants/options are exercised Or that ordinary shares are issued upon the satisfaction of specified conditions Contingently issuable ordinary shares are ordinary shares issuable for little or no cash or other consideration upon the satisfaction of specified conditions 2702 SESSION 27 – IAS 33 EARNINGS PER SHARE EARNINGS PER SHARE (EPS) 2.1 Basic EPS An entity is required to present the basic earnings per share for Profit or loss attributable to ordinary shareholders AND Profit or loss relating to continuing operations attributable to those ordinary shareholders The basic EPS calculation is made by dividing the profit (or loss) relating to the ordinary shareholders by the weighted average number of ordinary shares outstanding in the period 2.2 Which earnings? Basic EPS should be The profit or loss attributable to ordinary shareholders and The profit or loss relating to continuing operations attributable to the ordinary shareholders Adjusted for Post-tax effect of preference dividends (and other items relating to preference shares) and Non-controlling interest WEIGHTED AVERAGE NUMBER OF ORDINARY SHARES 3.1 Basic rule The number of ordinary shares will be the weighted average number of ordinary shares outstanding during the period The number in existence at the beginning of the period should be adjusted for shares that have been issued for consideration during the period Commentary You may see these issues described as issues at full market price Consideration may be received in a number of ways: Issue for cash; Issue to acquire a controlling interest in another entity; Redemption of debt 2703 SESSION 27 – IAS 33 EARNINGS PER SHARE In each case the earnings will be boosted from the date of issue In order to ensure consistency between the top and bottom of the basic EPS calculation the shares are also included from the date of issue Therefore weight the number of shares: Proforma Number No before × No after × 12 12 = = X X _ X _ 3.2 Issues of shares where no consideration is received The weighted average number of ordinary shares outstanding during the period and for all periods presented should be adjusted for events, that have changed the number of ordinary shares outstanding, without a corresponding change in resources For example: Bonus issues; Bonus elements in another issue (e.g a rights issue); Share splits; Reverse share splits 3.2.1 Bonus issues Treat as if the new shares have been in issue for the whole of the period Multiply the number of shares in issue by the bonus fraction Illustration Bonus issue of for 10 Bonus fraction: 10 + 11 = 10 10 The EPS will fall (all other things being equal) because the earnings are being spread over a larger number of shares This would mislead users when they compare this year’s figure to those from previous periods 2704 SESSION 27 – IAS 33 EARNINGS PER SHARE The comparative figure and any other figures from earlier periods that are being used in an analysis must be adjusted This is done by multiplying the comparative by the inverse of the bonus fraction Illustration Last year’s EPS 3.2.2 × 10 11 Rights issues A rights issue has features in common with a bonus issue and with an issue at full market price A rights issue gives a shareholder the right to buy shares from the company at a price set below the market value Thus: the company will receive a consideration which is available to boost earnings (like an issue at full price); and the shareholder receives part of the share for no consideration (like a bonus issue) The method of calculating the number of shares in periods when there has been a rights issue reflects the above A bonus fraction is applied to the number of shares in issue before the date of the rights issue and the new shares issued are pro-rated as for issues for consideration The bonus fraction is the cum-rights price per share (CRP) divided by the theoretical exrights price per share (TERP) See Illustration Illustration X Inc January Shares in issue 1,000,000 31 March − Rights issue for at 90c − MV of shares $1 (cum-rights price) Required: Calculate the number of shares for use in the EPS calculation 2705 SESSION 27 – IAS 33 EARNINGS PER SHARE Solution Number January − 31 March 1,000,000 × 12 × 254,237 9833 April − 31 December 1,200,000 × 900,000 _ 12 1,154,237 _ Rights issue bonus fraction Cum Rights Shares _ Ex _ 5.9 TERP Bonus fraction CRP TERP @$ 0.9 $ 5.0 0.9 5.9 = = 0.9833 9833 For presentational purposes, in order to ensure consistency, the comparative figure for EPS must be restated to account for the bonus element of the issue This is achieved by multiplying last years EPS by the inverse of the bonus fraction 3.3 Multiple capital changes Method Write down the number of shares at start of year Look forward through year and write down the total number of shares after each capital change Multiply each number by the fraction of the year that it was in existence If the capital change has a bonus element multiply all preceding slices by the bonus fraction 2706 SESSION 27 – IAS 33 EARNINGS PER SHARE Illustration X Inc January 28 February 31 August 30 November 1,000,000 in issue Issued 200,000 at full market price Bonus issue for Issued 250,000 at full market price Required: Calculate the number of shares which would be used in the basic EPS calculation Solution January − 28 February 1,000,000 × March − 31 August 1,200,000 × September − 30 November 1,500,000 × December − 31 December 1,750,000 × 12 12 12 12 × × 5 = 208,333 = 750,000 = 375,000 = 145,833 1,479,166 2707 SESSION 27 – IAS 33 EARNINGS PER SHARE Example — Multiple capital changes January 28 February 31 March 31 July 30 September 1,000,000 in issue Full market price 400,000 Bonus issue for Full market price 900,000 22   Rights issue for Bonus fraction  21   Required: Calculate the number of shares which would be used in the basic EPS calculation Proforma solution January – 28 February Number March − 31 March April − 31 July August − 30 September October − 31 December 2708 SESSION 27 – IAS 33 EARNINGS PER SHARE 3.4 Issuable shares 3.4.1 Mandatorily convertible instrument Shares that will be issued on the conversion of mandatorily issuable instruments will be included in the weighted average number of shares from the date that the contract is entered into Commentary This is consistent with IAS 39 These are items that will be classified as equity instruments and therefore it is appropriate to include in the EPS calculation 3.4.2 Contingently issuable shares Contingently issuable shares will be included in the weighted average number of ordinary shares from the date all necessary conditions and events have occurred to allow the issue of the shares Commentary This is again consistent with IAS 39 as they will be included in liabilities unless the likelihood of settlement in cash is remote On conversion they will be included in equity and also in the EPS calculation DILUTED EARNINGS PER SHARE 4.1 Purpose Potential ordinary shares may exist whose owners may become shareholders in the future If these parties become ordinary shareholders the earnings will be spread over a larger number of shares i.e they will become diluted Commentary Diluted EPS is calculated as a warning to existing shareholders that this may happen Potential ordinary shares should be treated as dilutive only if their conversion to ordinary shares would decrease earnings per share from continuing operations 4.2 Method The profit attributable to ordinary shareholders and the weighted average number of shares outstanding should be adjusted for the affects of all dilutive potential ordinary shares, i.e.: A new EPS is calculated using: a new number of shares; a new earnings figure 2709 SESSION 27 – IAS 33 EARNINGS PER SHARE 4.2.1 New number of ordinary shares This should be the weighted average number of ordinary shares used in the basic EPS calculation plus the weighted average number of ordinary shares which would be issued on the conversion of all the dilutive potential ordinary shares into ordinary shares Dilutive potential ordinary shares should be deemed to have been converted into ordinary shares at the beginning of the period or, if later, the date of the issue of the potential ordinary shares New number of shares Basic number No of shares which could exist in the future: from the later of − first day of accounting period − date of issue X X X 4.2.2 New earnings figure The amount of profit or loss for the period attributable to ordinary shareholder, used in the basic EPS calculation, should be adjusted by the after-tax effect of the potential ordinary shares becoming ordinary shares, i.e add back: Any dividends on dilutive potential ordinary shares, which have been deducted in arriving at the profit or loss for the period, attributed to ordinary shareholders Interest recognised in the period for the dilutive potential ordinary shares Any other changes in income or expense that would result from the conversion of the dilutive potential ordinary shares 2710 SESSION 27 – IAS 33 EARNINGS PER SHARE Illustration — Diluted EPS Convertible bonds January Shares in issue Profit for the year ended 31 December 31 March Co issues $200,000 6% convertible bonds 1,000,000 $200,000 Terms of conversion 100 shares/$100 if within five years 110 shares/$100 if after five years Tax rate 33% 200 ,000 Basic EPS ,000 ,000 = 20c Required: Calculate diluted EPS Solution Number of shares Basic 1,000,000 Profit $ 200,000 Dilution 200,000 Shares: 100 × 110 × 165,000 12 Interest $200,000 × 6% × EPS 12 × 0.67 6,030 1,165,000 206,030 17.68 cents 2711 SESSION 27 – IAS 33 EARNINGS PER SHARE When there has been an actual conversion of the dilutive potential ordinary shares into ordinary shares in the period, a further adjustment has to be made The new shares will have been included in the basic EPS from the date of conversion These shares must then be included in the diluted EPS calculation up to the date of conversion 4.3 Options An entity should assume the exercise of dilutive options and other dilutive potential ordinary shares of the entity The assumed proceeds from these issues should be considered to be received from the issue of shares at fair value The difference between the number of shares issued and the number of shares that would have been issued at fair value should be treated as an issue of ordinary shares for no consideration Options will be dilutive only when they result in the entity issuing shares at below fair value Each issue of shares under an option is deemed to consist of two elements A contract to issue a number of shares at a fair value (This is taken to be the average fair value during the period.) Commentary These are non dilutive A contract to issue the remaining ordinary shares granted under the option for no consideration.(a bonus issue) Commentary These are dilutive Illustration — Options January Shares in issue Profit for the year ended 31 December Average fair value The company has in issue options to purchase Exercise price Required: Calculate the diluted EPS for the period 2712 1,000,000 $100,000 $8 200,000 ordinary shares $6 SESSION 27 – IAS 33 EARNINGS PER SHARE Solution Diluted EPS: Number of shares Basic 1,000,000 Dilution (W) EPS 100,000 10c 50,000 _ 1,050,000 _ WORKING Proceeds of issue Profit $ 100,000 200,000 × $6 Number that would have been issued at FV 9.5c 1,200,000 ÷ $8 = 150,000 Number actually issued 200,000 _ Number for “free” 50,000 _ SIGNIFICANCE OF EPS 5.1 EPS vs earnings Prior to 1960, the decision to report EPS, the manner in which it was calculated, and where it was reported was left solely to the discretion of company management As expected, management chose to report performance in whole dollar earnings only, which tended to favour large corporations over small companies EPS became a reporting necessity to create a “level playing field” in performance measurement comparability EPS allows comparison between different-sized companies whereas, if only actual earnings were being compared, the relative size of the company could not be taken into account 5.2 Performance measure The EPS figure is used by market analysts in the calculation of a companies Price/Earnings (P/E) ratio Great emphasis is placed on this measure which can have a significant effect on the way a company’s share price moves The P/E ratio is also used by investors in assisting in their decisions to buy/hold or sell shares in a company 2713 SESSION 27 – IAS 33 EARNINGS PER SHARE 5.3 Problems with EPS EPS is affected by a company’s choice of accounting policy, so can be manipulated It also means that comparisons with other companies is not possible if different policies are being used EPS is a historic figure and should not be used as a prediction of future earnings A high EPS figure could be achieved through a lack of investment in new assets, but this will have a detrimental effect on future profits as lack of investment will lead to companies falling behind their competitors EPS is a measure of profitability, but profitability is only one measure of performance Many companies now place much higher significance on other performance measures such as: customer satisfaction; cash flow; manufacturing effectiveness, and innovation PRESENTATION AND DISCLOSURE 6.1 Presentation Basic and diluted earnings per share (or loss per share if negative) should be presented on the face of the statement of comprehensive income for The profit or loss from continuing operations and The profit or loss for the period Each class of ordinary shares that has a different right to share in the net profit for the period Basic and diluted earnings per share should be presented with equal prominence for all periods presented 2714 SESSION 27 – IAS 33 EARNINGS PER SHARE Illustration (in CHF) Basic earnings per share 20.82 Fully diluted earnings per share 20.63 Nestlé Consolidated accounts 2006 6.2 Disclosure 6.2.1 General The amounts used as the numerators in calculating basic and diluted earnings per share, and a reconciliation of those amounts to the profit or loss for the period The weighted average number of ordinary shares used as the denominator in calculating basic and diluted earnings per share, and a reconciliation of these denominators to each other Instruments that could potentially dilute basic EPS in the future but they were not included in the diluted EPS because they are anti-dilutive for the period A description of ordinary or potential share transactions that occurred after the end of the reporting period that would have significantly changed the number of ordinary shares or potential ordinary shares had the transactions occurred before the end of the period 2715 SESSION 27 – IAS 33 EARNINGS PER SHARE Illustration 2005 (a) (in CHF) (b) Net profit from continuing operations (in millions of CHF) Weighted average number of shares outstanding (in CHF) 20.82 095 388 812 584 20.63 Theoretical net profit from continuing operations (b) assuming the exercise of all outstanding options and sale of all treasury shares (in millions of CHF) Number of shares (a) (b) (c) (c) 248 399 860 700 2005 comparatives have been restated following the first application of the option of IAS 19 Employee B Determining whether an Arrangement contains a Lease, as well as the decision to transfer the fresh che Nutrition (refer to Note 29) Profit for the period attributable to the shareholders of the parent adjusted for the net profit/(loss) on disc Net of the Nestlé S.A shares held in connection with the Share Buy-Back Programme (refer to Note 25) Nestlé Consolidated accounts 2006 6.2.2 Additional EPS If an additional EPS figure using a reported component of profit other than profit or loss for the period attributable to ordinary shareholders, is disclosed, such amounts should be calculated using the weighted average number of ordinary shares determined in accordance with IAS 33 A non-standard profit figure can be used to calculate an EPS in addition to that required by IAS 33 but the standard number of shares must be used in the calculation If a profit figure is used which is not a reported as a line item in the statement of comprehensive income, a reconciliation should be provided between the figure and a line item, which is reported in the statement of comprehensive income This additional EPS figure may not be shown on the face of the statement of comprehensive income, it can only be disclosed in the notes to the financial statements 6.2.3 Retrospective adjustments If an EPS figure includes the effects of: a capitalisation or bonus issue; or share split; or decreases as a result of a reverse share split 2716 SESSION 27 – IAS 33 EARNINGS PER SHARE The calculation of basic and diluted earnings per share for all periods presented should be adjusted retrospectively For changes after the end of the reporting period but before issue of the financial statements, the per share calculations for those and any prior period financial statements presented should be based on the new number of shares Basic and diluted EPS of all periods presented should be adjusted for the effects of errors, and adjustments resulting from changes in accounting policies FOCUS You should now be able to: calculate the EPS in accordance with relevant accounting standards, dealing with bonus issues, full market value issues and rights issues; explain the relevance of the diluted EPS and calculate the diluted EPS involving convertible debt and share options or warrants; explain why the trend of EPS may be a more accurate indicator of performance than a company’s profit trend and the importance of EPS as a stock market indicator; discuss the limitations of using EPS as a performance measure 2717 SESSION 27 – IAS 33 EARNINGS PER SHARE EXAMPLE SOLUTION Solution — Multiple capital change January − 28 February 1,000,000 × March − 31 March 1,400,000 × April − 31 July 2,100,000 × August − 30 September 3,000,000 × October − 31 December 4,000,000 × 12 12 12 12 12 × × × × × 3 × × 22 21 22 21 22 21 22 21 = 261,905 = 183,333 = 733,333 = 523,810 =1,000,000 2,702,381 2718 ... detrimental effect on future profits as lack of investment will lead to companies falling behind their competitors EPS is a measure of profitability, but profitability is only one measure of performance... beginning of the period or, if later, the date of the issue of the potential ordinary shares New number of shares Basic number No of shares which could exist in the future: from the later of − first... share if negative) should be presented on the face of the statement of comprehensive income for The profit or loss from continuing operations and The profit or loss for the period Each class of ordinary