EXPLANATORY NOTE
The need for the disclosure of Earnings Per Share (EPS) is based on the increasing use of the Price/Earnings (P/E) ratio as a standard stock market indicator. The formula for the calculation of the P/E ratio is:
Market Price of Share
EPS
Therefore, the P/E ratio can be seen as a “purchase of a number of year’s earnings” but perhaps more significantly, for many investors it also represents the future prospects of the share. A higher P/E ratio is believed to indicate a faster growth in the company’s EPS in the future. Conversely, the lower the P/E ratio, the lower the expected future growth.
The continued use of P/E ratios requires that the EPS, on which that ratio is based, should be calculated and disclosed on a comparable basis as between one company and another and as between one financial period and another, so far as this is possible.
In addition to this, the trend shown by a comparison of a company’s profits over time is a rather crude measure of performance and can be misleading without careful interpretation of all the events that the company has experienced. Particularly, this would be the case where a company is enlarged by amalgamation or issues of shares for cash. Profits can be expected to increase as the resources of the company increase. Earnings Per Share will show whether profits are increasing less, equally or more than the company’s resources. As new shares are issued, a company may well show rising profits without reflecting a corresponding growth in EPS.
IAS 33 Earnings Per Share outlines the principles for the determination and presentation of EPS, in order to improve comparisons between different companies in the same reporting period and between different reporting periods for the same company.
SCOPE
IAS 33 applies to entities whose ordinary shares (or potential ordinary shares) are publicly traded and to entities that are in the process of issuing shares (or potential ordinary shares) in public securities markets.
DEFINITIONS
Ordinary Share An equity instrument that is subordinate to all other classes of equity instruments. It is an instrument that falls under the definition of “equity shares” in IAS 32, i.e. a contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. Ordinary shares participate in the net profit for the period only after other types of shares, such as preference shares. An entity may have more than one class of ordinary shares.
Earnings The earnings should be the after-tax net profit / loss after deducting preference dividends and other appropriations for non-equity shares. All items of income and expense that are recognised in a period, including exceptional items and non-controlling interests, are included in the determination of net profit or loss for the period.
Therefore, the calculation of the earnings figure effectively becomes:
Profit Less Tax
Less Non-Controlling Interest (in the case of group accounts)
Less Preference dividends (or other non-equity appropriations)
EPS is normally expressed in Rwandan francs (RWF).
The amount of preference dividends that is deducted from the net profit for the period is:
- The amount of any preference dividends on non-cumulative preference shares declared in respect of the period;
OR
- The full amount of the required preference dividends for cumulative preference shares for the period, whether or not the dividends have been declared, as the undeclared amount is still deductible as an appropriation. The amount of preference dividends for the period does not include the amount of any preference dividends for Cumulative Preference Shares paid or declared during the current period in respect of previous periods.
Where an entity has more than one class of ordinary shares, the earnings for the period are apportioned over different classes of shares in accordance with their dividend rights or other rights.
NUMBER OF SHARES
For the purpose of calculating basic earnings per share, the number of shares should be the weighted average number of ordinary shares outstanding during the period.
The weighted average number of ordinary shares outstanding during the period reflects the fact that the amount of shareholders capital may be varied during the period as a result of a larger or lesser number of shares being outstanding at any time. It is the number of ordinary shares outstanding at the beginning of the period, adjusted by the number of ordinary shares bought back or issued during the period multiplied by a time weighting factor.
The time weighting factor is the number of days that the specific shares are outstanding as a proportion of the total number of days in the period (a reasonable approximation of the weighted average is adequate in many circumstances).
MEASUREMENT OF BASIC EARNINGS PER SHARE
EPS = Profit – Tax – Non-Controlling Interest – Preference Dividends
Weighted average number of Ordinary Shares in issue during the period
CHANGES IN CAPITAL STRUCTURE
When a firm’s capital structure changes, the denominator of the EPS fraction changes also. There are a number of possible causes for such a change. The most common are:
- Issue of shares at their full market price
- A Capitalisation or Bonus issue
- A Rights Issue
- Share Exchange
- Issue Of Shares At Full Market Price
Rule = New shares should be included in the EPS calculation, weighted on a time basis
Do not adjust previous year’s EPS
The rationale of this approach is that cash or other assets are introduced into the business during the year as a result of the share issue. These assets should generate additional earnings for that portion of the year for which they are issued. Therefore, in order to compare like with like, the denominator should include the additional shares only for that portion of the year in which shares are issued.
PRESENTATION AND DISCLOSURE
The entity must present, on the face of the Statement of Comprehensive Income, the EPS in respect of the profit or loss from continuing operations, attributable to the ordinary equity holders.
If the entity reports a discontinued operation, it must disclose the EPS for the discontinued operation either on the face of the Statement of Comprehensive Income or in the notes to the financial statements.
The entity must disclose the following:
- The amount used as the numerator in calculating EPS, together with a reconciliation of those amounts to the net profit or loss for the period
- The weighted average number of ordinary shares used as the denominator in calculating the EPS, together with a reconciliation of these denominators to each other.
If the entity makes a net loss for the period, the EPS is still calculated using the net loss (as adjusted) as the numerator. Thus, the EPS will be a negative figure. Disclosure is still mandatory when the EPS is negative.
RETROSPECTIVE ADJUSTMENTS
If the number of ordinary shares increases as a result of:
- A capitalisation / bonus / scrip issue; or
- A share split
The calculation of EPS for all periods must be adjusted retrospectively.
If these changes occur after the Statement of Financial Position date but before the financial statements are authorised for issue, the EPS calculations for those and any prior period financial statements presented must be based on the new number of shares. The fact that the EPS calculation reflects such changes in the number of shares must be disclosed.
In addition, the EPS of all periods presented in the financial statements must be adjusted for the effects of errors and adjustments arising from changes in accounting policies accounted for retrospectively.
[Note that other major share transactions after the Statement of Financial Position date are Non-Adjusting Events according to IAS 10 and so are not applied retrospectively. However, they must be disclosed in the notes to the financial statements].
