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Earnings per Share (IAS 33)

There are few events that cause a change in number of ordinary shares in issue other than because of the issue of share against inflow of resources. These include:

• Capitalization of reserves or issue of bonus shares.
• Bonus element in rights issue of share capital to the existing share holders.

In these events it is necessary to make adjustments in the denominator of the EPS formula so that the current and comparative EPS figures are meaningful.

Bonus Issue of Share Capital:

Bonus issue of share capital causes an increase in the number of ordinary shares without corresponding increase in the financial resources of the entity. Bonus shares are issued against capitalization of the reserves kept in the owners’ equity. Because of the bonus issue the total amount of net assets of owners’ equity remains the same as it was prior to the issue.

As the increase in ordinary share capital does not bring financial resources in the business, and this change in share capital causes a decrease in the EPS comparing with the previous year’s EPS, therefore this problem is solved by adjusting the number of ordinary shares outstanding before the event for the proportionate change in the number of shares outstanding as if the event had occurred at the beginning of the earliest period reported.

Solved problem # 1:

Great Master Co had 400,000 shares in issue, until on September 30, 2009 it made a bonus issue of 100,000 shares. Calculate the EPS for the year 2009 and the corresponding figure for the year 2008 if total earnings were Rs. 80,000 in the year 2009 and Rs. 75,000 in the year 2008. The company’s accounting year runs from January 1 to December 31.

Solution: 2009 2008

Earnings (in Rupees) 80,000 75,000

Number of share on January 1 400,000 400,000 Bonus Issue during the year 2009 100,000 100,000 Total number 500,000 500,000

EPS 16 paisa 15 paisa

The number of shares in the year 2008 must also be adjusted if the figures for EPS are to remain comparable. Because if the number of shares in the year are not adjusted with the number of bonus share issued in the year 2009 then the results will be very much distorted.

Like the EPS in the year 2008 will then be Rs. 75,000 = 18.75 paisa 400,000

This working shows that the company’s earnings were more than the current year’s earnings, which is not true in fact. The company earned Rs. 80,000 profit with the same amount of financial resources in terms of the share capital which it had in the year 2007, when the profits were Rs. 75,000, therefore how come it can be said that the year 2007 was better than the year 2008. To fix this problem there are two alternatives, either to calculate EPS in both years with a denominator of 400,000 number of shares it will give comparable results, or to calculate EPS in both years with a denominator of 500,000 number of shares. Later approach is recommendable because doing this will not require further adjustments in the subsequent years when the actual number of ordinary share are 500,000.

Rights Issue of Share Capital:

A rights issue of share capital is an issue of new shares to existing shareholders at a price below the current market value. The offer of new shares is made on the basis of a number of new shares for every number of shares currently held, e.g. a 1 for 3 rights issue is an offer of 1 new share at the offer price for every 3 shares currently held. This means that there is a bonus element included in the rights issue. To arrive at figures for EPS when a rights issue is made, we need to calculate first of all the theoretical ex-rights price. This is a weighted average value per share; concept of theoretical ex-right price will become clear after doing the following problem.

Solved problem # 2:

On January 1, 2008, Egg Co has 10,000 shares in issue. On June 30, 2008 it proposes to make a 1 for 4 rights issue at a price of Rs. 3 per share. The market value of existing shares on June 30, 2008, before the issue is made is Rs. 5 (this is cum right value also known as with right value). Calculate the theoretical ex-rights price per share.

Solution:

This calculation can alternatively be performed as under Number of shares held @ Market price 10,000 x Rs. 5 50,000 Number of shares offered @ Offer price 2,500 x Rs. 3 7,500 Theoretical price of 12,500 shares 57,500

Theoretical ex-right price per share 57,500 = Rs. 4.60/sh 12,500

Procedure to calculate EPS:

1. Calculate theoretical ex-rights price
2. Determine the bonus element in rights issue
3. Add the bonus element in the outstanding number of ordinary shares of current year and also add the same figure in the outstanding number of ordinary shares of the previous year
4. Calculate the weighted average number of shares representing the resources element in the rights issue and add this figure in the current year’s outstanding number of ordinary shares
5. Calculate EPS

Solved problem # 3:

Continuing the above example in solved problem # 2, earnings of the Egg Co for the years 2007 and 2008 were Rs. 20,000 and Rs. 22,000 respectively. Calculate EPS for the year 2008 and its corresponding figure for 2007.

Solution:

Rights issue 2,500 shares Offer price Rs. 3 per share Market price Rs. 5 per share Theoretical ex-right price Rs. 4.60 per share Total amount of investment 2,500 @ Rs. 3 = Rs. 7,500 Consideration element Rs. 7,500/Rs. 4.60 = 1,630 shares Bonus element 2,500 – 1,630 = 870 shares

Schedule of weighted average number of shares outstanding during the year

2008 2007

Opening balance 10,000 10,000

Rights issue Bonus element 870 870 Consideration/resource element 1,630 x 6/12 815

A company produced the following net profit figures for the years ending December 31;

Rs. 2006 110,000 2007 150,000 2008 180,000

On January 1, 2007 the number of shares outstanding was 500,000. During 2007 the company announced a rights issue with the following details.

Rights: 1 new share for each 5 outstanding Exercise price Rs. 5 per share Last date to exercise rights March 1, 2007 (10 months outstanding) Market price on March 1, 2007 Rs. 11

Required:

Calculate EPS for the years 2006, 2007 and 2008.

Solution:

Theoretical ex-right price Shares Value Rs. Number of shares held @ market price 500,000 @ Rs. 11 5,500,000 Number of shares offered @ offer price 100,000 @ Rs. 5 500,000 Theoretical value of 600,000 6,000,000

Theoretical ex-right price Rs. 6,000,000 = Rs. 10 per share

600,000 Bonus element Total investment Rs. 500,000 Number of shares out of the market at offer price Rs. 500,000/Rs, 10 Consideration element 50,000 shares Bonus element (Total rights issue – consideration element) 50,000 shares

Schedule of weighted average number of shares outstanding during the year

Outstanding number on opening date 500,000 500,000 600,000 Bonus element 50,000 50,000 Consideration/resources element (50,000 x 10/12) 41,667