ACCOUNTING FOR LIABILITIES – EARINGS PER SHARE (IAS 33)

EARNINGS PER SHARE (EPS):

EPS is widely used as a measure of a company’s performance and is of particular importance in
comparing the results over a period several years. A company must be able to sustain its earning
in order to pay dividends and reinvest in the business so as to achieve future growth. Investors
also look for growth in EPS from one year to the next.
EPS is defined as the profit in shillings attributable to each ordinary share. EPS is:
(a) Based on consolidated profit of the period after tax and:
(i) After deducting minority interests
(ii) After deducting preference dividends
(iii) But before taking into account extra-ordinary items – These are unusual, non-
repeating items that affect profits in one year. Including these items within EPS
would spoil the value of the EPS as a measure of comparison with previous
periods and other companies. Hence extra-ordinary items are excluded.
(b) Divided by the number of ordinary shares in issue and ranking for dividend. Thus: Earnings:
Profit on ordinary activities after tax xxx
LESS: Minority Interest xxx
LESS: Preference Dividends xxx
TOTAL Earnings or Loss xxx
Therefore:
Earnings
EPS =
Number of Ordinary Shares∈issue that are ranking for dividend
EXAMPLE:
The Following information were extracted from Pala Company for the 2021 financial period:

DETAILS SH
Profit before extraordinary items and Taxation 505,000,000
Interest Charges 85,000,000
Tax on ordinary operations 137,000,000
Extraordinary losses (Net of Tax) 46,000,000

Nominal Values of Issued Shares (Sh. 100 per Share) 100,000,000

1
SOLUTION:
Interest Charges have already been deducted in arriving at profits before tax figure, and so
should be ignored.

DETAILS SH
Profit before extraordinary items and Taxation 505,000,000
Tax on ordinary operations 137,000,000
EARNINGS 368,000,000

Number of Shares (100,000,000/100) 1,000,000

368,000,000
EPS = = Sh. 368
1,000,000

Problems with Calculating and interpreting an EPS:

EPS on its own does not tell us anything. It must be seen in the context of several other matters:

 EPS is used for the comparison of results of companies over time. Is this EPS growing?
What is the rate of growth? Is the rate of growth increasing or slowing down? etc.
 Is there likely to be a significant dilution of EPS in the future, perhaps due to the exercise
of share options or warrants or the conversion of convertible loan stock into equity?
 EPS should not be used blindly to compare the earnings of one company with another. For
example, if A Limited Company has an EPS of h. 12 for its Sh. 1000 million Sh. 10 share
and B Limited Company has EPS of Sh. 24 for its Sh. 5000 million Sh. 25 shares, so what?
So it may not be used alone, normally it is used with the other ratio called Price Earnings
Yield (PE).
 If EPS is to be a reliable basis for comparing results it must be calculated consistently. The
EPS of one company must be directly comparable with the EPS of another, and the EPS of
a company in one year must be directly comparable with its published EPS figure for
previous years. This point might seem obvious, but there are certain problems, mainly
those caused by changes in the share capital of a company during the cause of a year.
IMPACT ON EPS OF CHANGES IN ISSUED SHARE CAPITAL
When a company increases or reduces its issued share capital, there will be an impact on the
other shareholders. This impact will vary according to whether:
(a) Share capital being increased or reduced;
(b) The size of the increase or reduction;

2
 (c) The nature of the change i.e. has shares been issued to raise cash or to take over a
subsidiary in a share exchange deal, or as a script issue?
When a company alters its share capital structure – by issuing more shares, a direct comparison
of its EPS for the year when share capital changes with the EPS in previous years becomes
trickier.
For example:
Suppose C limited company had 10,000,000 shares in issue in the year to 31 December 20X6
and made earnings of Sh. 400,000,000. Again suppose that C Limited Company then made an
issue of 2,000,000 shares on 1st October 20X7, and made earnings of Sh. 450,000,000, in the
year to 31st December, 20X7.
On the basis of these figures, the EPS might seem to be
Sh . 400,000,000
For 20X6: EPS = = Sh. 40
10,000,000
450,000,000
For 20X7: EPS = = Sh. 37.5
12,000,000

The comparison would not be a fair one, however, because the 2,000,000 new share in 20X7 and
the funds and the assets they provided for the company, were only in use for 3 months of 20X7,
from 1st October, 20X7. In other words, the new shares were only “earnings” for a quarter of a
year in 20X7, and the EPS for 20X7 should reflect this. The number of shares in issue 20X7,
should be a weighted figure, and calculated as follows:
3
¿ x 12,000,000 ¿ = 7,500,000 + 3,000,000
12
= 10,500,000.
Thus the EPS figure for 20X6 and 20X7 would now be:
Sh . 400,000,000
For 20X6: EPS = = Sh. 40
10,000,000
450,000,000
For 20X7: EPS = = Sh. 42.86
10,500,000
Note that the EPS has gone up in 20X7 compared with 20X6, whereas the original figure (with
no weighting for the number of shares in issue) suggested that the EPS had follen.

RIGHTS ISSUE AND EPS:

If a company makes rights issue, we should expect:

3
 (a) Earnings per share to fall;
(b) The market price per share to fall because the new shares will have been issued at a lower
price.
To achieve comparability between the current year EPS and the previous year’s EPS, we must
therefore make some adjustments to both:
(1) Previous year’s EPS and
(2) The current year’s EPS.

(a) The EPS for the Previous year must be multiplied by the fraction:
Theoretical ex−rights price
Market price onlast day of quotation cumrights

(b) To obtain an EPS for current year, we must adjust the number of shares in issue to arrive at an
appropriate weighted total. This is done by:
(i) Multiplying the number of shares before the rights issue by
 A fraction of a year after the date of issue, and
 By the fraction:
Market price onlast day of quotation cumrights
Theoretical ex−rights price
(ii) Multiply the number of shares after the rights issue by the fraction of the year after
the date of issue
(iii) Add the figure in (i) to the figure in (ii) to arrive at total number of shares, called
weighted total of shares.
(iv) Divide total earnings by this weighted total of shares in (iii).
EXAMPLE:
Pata Mali PLC. Makes a 1 for 5 rights issue on 1 October 20X2, at a price of Sh. 100. The
Market value on the last day of quotation cum rights was Sh. 160.
There were 1,000,000 shares in issue before the rights issue. Total earnings in 20X1 were Sh.
40,000,000. Total earnings for the year ended December 20X2 were Sh. 50,000,000.
Required:
Calculate the EPS for 20X2 and the corresponding figure for 20X1, a they would appear in the
company’s 20X2 accounts, and compare the EPS figures for the two years.
SOLUTION:
Calculation of Theoretical ex-rights Price:

4
Consider a share holder of 5 shares in the following situations:

Consider the holder of 5 shares:

Before the Rights Issue
Shares from Rights Issue
TOTALS
Shares held Value
Sh.
5 800
1 100
6 900

Sh . 900
Theoretical ex-rights Price = = Sh. 150
6
(a) EPS for 20X2:
The number of shares before the rights issue was 1,000,000. Therefore, the number of rights
1,000,000
issued is given by: = 200,000 Shares. The Issue was 1 st October 20X2, and s
5
the issue took place 9/12 of the way through 20X2.
9 160
Stage 1: 1,000,000 x x = 800,000 shares
12 150
3
Stage 2: 1,200,000 x = 300,000 shares
12

TOTAL 1,100,000 shares

Sh . 50,000,000
EPS = = Sh. 45.45
1,100,000
(b) Corresponding (or Re-stated) EPS for 20X1:
40,000,000 150
x = Sh. 37.50
1,000,000 160
(c) Comparing the EPS Figures:
7.95
The EPS increased by Sh. 7.95 (Sh. 45.5 – Sh. 37.5) or about 21% i.e. { x 100 } in 20X2
37.5
compared with 20X1.
FULLY DILUTED EARNINGS PER SHARE
Fully Diluted EPS is the net income available to ordinary shareholders (common shareholders)
as calculated by the weighted average number of common shares outstanding, plus all dilutive
securities, whether or not they are considered common stock equivalents. Fully diluted EPS is
calculated by dividing net income available to common shareholders by the weighted average

5
number of common shares outstanding plus all dilutive securities, whether or not they are
considered common stock equivalents. The purpose of presenting fully diluted EPS is to show
the worst possible case, which assumes that all the dilutive securities were converted. Thus,
present and potential investors can see what their earnings per share would be, assuming
maximum dilution.

According to IAS 33, potential ordinary shares should be treated as dilutive when, and only
when, their conversion to ordinary shares would decrease net profit per share from continuing
operations.

The fully diluted EPS is potentially important when analyzing a company’s account. It deals with
how much the EPS might be reduced or watered down (hence diluted) in the figure by:
(a) Extra shares being issued in the future; or
(b) By shares becoming entitled to dividends in the future but which currently do not rank for
dividend.

In terms of extra shares being issued, fully diluted EPS is only concerned with obligations that
the company has already entered into, and so, shares that as at Statement of Financial Position
might foreseeably be issued in the future because:

(a) Some people have a right to buy new shares, because they hold share options which they
can exercise at some time in the future;
(b) The company has issued some convertible debentures or loan stock, and so these
debentures or loan stock holders will have the right in the future, if they wish to convert
their stock into ordinary shares;

The company has issued share warrants, and the warrant holders will have the right to use their
warrants to buy shares at a predetermined price at some time in the future. Warrants are a
contract that gives the right, but not the duty (obligation), to buy or sell a security—most
usually, equity—before expiry at a certain amount. The price at which the underlying security
may be bought or sold is called the exercise price or the strike price.
If people exercise their options, convert their convertible loan stock, or use their warrants there
will be more shares in issue, and so there might be a dilution in the company’s EPS. The fully
diluted EPS is intended to make an assessment of how much watering down of the EPS there
might be, on the assumption that the maximum foreseeable number of new shares wwere to
come into existence.

The calculation of the fully diluted EPS involves an adjustment to:

(a) The number of ordinary shares ranking for dividends; but also to
(b) The earnings:

6
 (i) If holders of convertible loan stock exercise their right to convert the stock into
ordinary shares, the company would make a saving of interest payments, and so total
earnings would arise by the amount of interest saved (less tax on the extra profits)

If holders of share options or share warrants exercise their right to subscribe for new shares, they
will have to make some payment for the shares, albeit at a price below the current market price
of the company’s existing shares. The funds they pay into the company would inevitable be put
to use to earn more profits and so the IAS 33 states that suitable estimate of the extra profits
should be made as appropriate.

PRESENTATION:
1) An entity shall present in the statement of comprehensive income basic and diluted earnings
per share for profit or loss from continuing operations attributable to the ordinary equity
holders of the parent entity and for profit or loss attributable to the ordinary equity holders of
the parent entity for the period for each class of ordinary shares that has a different right to
share in profit for the period. An entity shall present basic and diluted earnings per share with
equal prominence for all periods presented.
2) Earnings per share is presented for every period for which a statement of comprehensive
income is presented. If diluted earnings per share is reported for at least one period, it shall be
reported for all periods presented, even if it equals basic earnings per share. If basic and
diluted earnings per share are equal, dual presentation can be accomplished in one line in the
statement of comprehensive income.
3) If an entity presents items of profit or loss in a separate statement as described in paragraph
10A of IAS 1 (as amended in 2011), it presents basic and diluted earnings per share, as
required in paragraphs 66 and 67, in that separate statement.
4) An entity that reports a discontinued operation shall disclose the basic and diluted amounts
per share for the discontinued operation either in the statement of comprehensive income or in
the notes.
5) If an entity presents items of profit or loss in a separate statement as described in paragraph
10A of IAS 1 (as amended in 2011), it presents basic and diluted earnings per share for the
discontinued operation, as required in paragraph 68, in that separate statement or in the notes.
6) An entity shall present basic and diluted earnings per share, even if the amounts are negative
(ie a loss per share).

DISCLOSURE:
An entity shall disclose the following:
a. the amounts used as the numerators in calculating basic and diluted earnings per share, and a
reconciliation of those amounts to profit or loss attributable to the parent entity for the
period. The reconciliation shall include the individual effect of each class of instruments that
affects earnings per share.

7
 b. 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. The
reconciliation shall include the individual effect of each class of instruments that affects
earnings per share.
c. instruments (including contingently issuable shares) that could potentially dilute basic
earnings per share in the future, but were not included in the calculation of diluted earnings
per share because they are antidilutive for the period(s) presented.
d. a description of ordinary share transactions or potential ordinary share transactions, that
occur after the reporting period and that would have changed significantly the number of
ordinary shares or potential ordinary shares outstanding at the end of the period if those
transactions had occurred before the end of the reporting period.
e. an issue of options, warrants, or convertible instruments;
f. the achievement of conditions that would result in the issue of contingently issuable shares.

NOTE: Earnings per share amounts are not adjusted for such transactions occurring after the
reporting period because such transactions do not affect the amount of capital used to produce
profit or loss for the period.

EXAMPLE: CONVERTIBLE LOAN STOCK

Piny Pek PLC. Has 1 million ordinary shares in issue. In 20X4 total earnings before interest and
tax were Sh. 50,000,000. The company also has 180,000,000 of 10% convertible loan stock
issue. The conversion rights are:

PRICE PER
DATE SHARE
SH.
30:06:20X4 150
30:06:20X5 180
30:06:20X6 190
30:06:20X7 200

Required
To calculate the fully diluted earnings per share for the year to 31 st December 20X4 on the
assumption that no conversion was made during 20X4. Take Tax rate to be 35%.

SOLUTION:

SH. SH.
Earnings 50,000,000

8
 ADD BACK: Interest Saving that
would arise if the loan stock had
been converted (10% x 180m) 18,000,000
LESS: Tax on the extra profit 6,300,000
11,700,000
61,700,000

The EPS calculation is being made at the end of 20X4. By that time the greatest number of
shares that would be issued on conversion would be at Sh. 180 per share. The price of Sh. 150
would yield more shares but was only available on 30:06:20X4, and that date has now gone by.

Sh . 180,000,000
Number of Shares issued would be: 1,000,000
Sh . 180

Shares already in issue 1,000,000

Number of shares assumed to be in issue on 1:01:20X4 2,000,000

Sh . 61,700,000
Fully diluted earnings per share = = Sh. 30.85
2,000,000

EXAMPLE: SHARE OPTION

Omulembe PLC. Has issued share option to selected employees. The dates of issue, the number
of options issued, and the exercise price are as follows:

DATE ISSUED NUMBER EXERCISE PRICE

SH.
July 20X0 200,000 120
November 20X1 300,000 130

1
The price of 2 % consolidated stock on 1st January 20X2 was Sh. 2,000 per cent. The company
2
has 1,000,000 shares in issue and earnings for 20X2 were Sh. 60,000,000. Corporation tax is at
the rate of 35%.

9
 1
The yield on 2 % consolidated bought at Sh. 2,000 per cent (i.e. Sh. 2,000 is equivalent to
2
100%):

1 100 1
2 %x = 12 %
2 20 2

Subscription monies receivable = Sh. 120 x 200,000 + Sh. 130 x 300,000 = Sh. 63,000,000

1
Thus yield on Sh. 63,000,000@ 2 % = Sh. 7,875,000.
2

SH. SH.
Earnings 60,000,000
1
Yield on Sh. 63m. at 12 % as
2
above 7,875,000
LESS: Tax on the extra profit 2,756,300
5,118,700
65,118,700

Shares at 1st January 1,000,000

65,118,700
Shares from options ( ) 500,913
130

1,500,913

65,118,700
Fully diluted earnings per share = Sh. 43.39.
1,500,913

PRACTICE QUESTIONS
1. Jumbo PLC had issued and fully paid share capital of a company on January 2021
comprised of:
Sh.
400,000 7% preference share of Sh. 100 per share 40,000,000
3,000,000 Ordinary shares of Sh. 100 per share 300,000,000
340,000,000

10
On 1 September, 2021 a further 600,000 of the ordinary shares were issued and fully paid in
cash. Profit for the Financial year to 31 December, 2021 was Sh. 19,760,000.

Required
Calculate EPS for the financial year ended 31 December 2021

2. Mambo Plc’s issued and fully paid shares capital on 1 January, 2020 comprised:

4,800,000 ordinary shares of Sh. 25 per share Sh. 120,000,000

On 1 July 2020 Mambo PLC, declared a 1 for 4 bonus (capitalization) issue of fully paid shares out of
reserves. Profit for the financial year to 31 December 2020 was Sh. 23,400,000. EPS for the previous year
was Sh. 55.
Required:
(i) EPS for the year to 31 December 2020.
(ii) Adjusted EPS for the year 2019
(iii) The note to be included in the accounts

3. Bottom Up PLC had issued and fully paid on 1 January 2020 share capital made up of:

SH.
100,000 7% preference shares of Sh. 100 per share 10,000,000
4,000,000 ordinary shares of Sh. 100 per share 400,000,000
410,000,000

On 1 October 2020 the company declared a 1 for 4 rights issue of ordinary share at Sh. 140 per
share. The market price of the ordinary shares on the last day of quotation on cum right basis,
was Sh. 240 per share. The profit for the financial year to 31 December 2020 was 11,554,000.
The EPS for the previous year was Sh. 280.

Required:
(i) Calculate the theoretical ex-rights price for the company.
(ii) The EPS for the financial year to 31 December 2020
(iii) Comparative EPS for 2019
(iv) Note to be included in the accounts

4. The issued and fully paid share capital of a company on 31 December 2020 comprised:
400,000 7% preference shares of Sh. 100 per share Sh. 40,000,000
4,000,000 ordinary shares of Sh. 100 per share Sh. 400,000,000
Sh. 440,000,000

11
 Profit for the financial year to 31 December 2020 was Sh. 37,200,000. On 1 October 2012 the
company had issued Sh. 120,000,000 6% convertible loan stock 2021/2025, convertible per Sh.
10,000 of loan stock into ordinary shares of Sh. 100 per share as follows:

30 September, 2021 120

2022 115
2023 110
2024 108
2025 105
Required:
(i) Calculate the Basic EPS for the financial year to 31 December 2020.
(ii) Calculate fully diluted EPS when the convertible stock will take place in 2021.
(iii) Calculate convertible loan stock equivalent shares by 30 September 2022.

5. The issued and fully paid share capital of a company on 1 January 2020 comprised:
SH.
400,000 7% preference shares of Sh. 100 per share 40,000,000
4,480,000 ordinary shares of Sh. 100 per share 448,000,000
TOTAL 488,000,000

Profit for the financial year ended 31 December 2020 was Sh. 38,008,000. On 1 October 2011,
the company had issued Sh. 120,000,000 6% convertible loan stock 2020/2023 convertible into
ordinary shares at variable rates. On 30 September 1999, Sh. 40000000 of loan stock had been
converted into ordinary shares at 120 per Sh. 100 stock. The remainder of the stock was
converted on 30 September 2020 at 115 per Sh. 100 stock into 920,000 ordinary shares which
ranked for dividends in 2020.

Required:
Basic EPS
Fully diluted EPS

12