Introduction

Earnings per share (EPS) is a ratio that is widely used by financial analysts, investors and other users to gauge an entity’s profitability and to value its shares. Its purpose is to indicate how effective an entity has been in using the resources provided by the ordinary shareholders, and to assess the entity’s current net earnings.

EPS also forms the basis for calculating the ‘price-earnings ratio’, which is widely used by investors and analysts to value shares.

Throughout this chapter, reference is made to ‘equity holders of the parent’. In IAS 1, ‘equity holders of the parent’ was amended to ‘owners of the parent’. IAS 33 has not been updated to reflect this change, so we have used ‘equity holders of the parent’ in line with IAS 33.

EPS is a ratio of the numerator (that is, earnings measured in terms of profits available to ordinary equity holders of the parent entity) to the denominator (that is, the weighted average number of ordinary shares). In addition to basic EPS, diluted EPS is disclosed with the objective to illustrate effect of all dilutive potential ordinary shares.

Dilution is a reduction in EPS resulting from the assumption that convertible instruments are converted, that options or warrants are exercised, or that additional ordinary shares are issued upon the satisfaction of specified conditions.

Objectives

IAS 33 prescribes the principles for the determination and presentation of EPS.

Scope

IAS 33 applies to the following entities:

• Those whose ordinary shares or potential ordinary shares (such as convertible debt or warrants) are traded in a public market (that is, a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets).
• Those that file, or are in the process of filing, financial statements with a securities commission or other regulatory body for the purpose of issuing ordinary shares in a public market (that is, not private placements).

EPS is required only on the basis of consolidated information even if the parent’s separate and consolidated financial statements are presented together.

An entity may choose to present EPS based on its separate (rather than consolidated) entity financial statements, as well as that based on the consolidated financial statements. The separate entity EPS figures should not be shown in the consolidated financial statements.

They should be shown only on the face of the separate entity statement of profit or loss and other comprehensive income (or income statement, if presented as a separate statement).

Entities whose securities are not publicly traded are not required to disclose EPS. However, where such entities choose to disclose EPS, they need to calculate and disclose EPS in accordance with IAS 33.

Puttable instruments presented as equity Some entities with a mutual form of ownership have no instruments in issue that can be presented as equity under IFRS Standards. This continues to be case despite the amendments to IAS 32 in February 2008, which resulted in more puttable financial instruments and obligations arising on liquidation being classified as equity. IAS 32 recognises that puttable instruments and obligations arising on liquidation that are presented as equity following the 2008 amendments still meet the definition of a financial liability but are presented as equity as an exception. Because IAS 33 was not amended when the amendments to IAS 32 were issued, there had been confusion as to whether IAS 33 would apply to an entity which previously had no equity but which, as a result of the amendments, reclassified puttable instruments or obligations arising at liquidation as equity. In August 2008, the Board published an exposure draft (ED) Simplifying Earnings per Share, which proposed to amend IAS 33 to make clear that entities that previously had no equity, but would present instruments as equity following the IAS 32 amendments, should apply IAS 33 when the amended IAS 32 is applied. However, this exposure draft was never finalised as a Standard and, therefore, those entities with puttable instruments presented as equity that have no other equity do not appear to be required to present EPS information.

Entities voluntarily presenting EPS information

IAS 33 requires that any entity that presents EPS information does so in accordance with that Standard. Therefore, an entity whose ordinary shares or potential ordinary shares are not publicly traded that voluntarily presents EPS information is bound by the requirements of IAS 33.

Consolidated and separate financial statements

When an entity presents both consolidated financial statements and separate financial statements in accordance with IFRS 10 and IAS 27, respectively:

• the disclosures required by IAS 33 need only be given in respect of the consolidated information;
• if the entity chooses to disclose EPS information based on its separate financial statements, it is required to prepare that information in accordance with IAS 33 and to present it only in its statement of comprehensive income; and
• EPS information based on the separate financial statements should not be presented in the consolidated financial statements (either in the statement of comprehensive income or in the notes).

If an entity presents profit or loss in a separate statement, it should present EPS information only in that separate statement.

Shares listed but not intended to be traded – example The shares of Company A are listed on the Luxembourg exchange. Company A has completed a listing for marketing purposes only because its investors (which are pension funds) are restricted by their governing laws to investing in listed entities. It is not expected that these shares will be traded. Although these shares are not expected to be traded, the entity is within the scope of IAS 33 and EPS should be presented in accordance with that Standard. The notion of ‘publicly traded’ requires only an ability to trade the shares publicly, not the actual trading of shares.

Definitions

Ordinary share

IAS 33 defines an ordinary share as an equity instrument that is subordinate to all other classes of equity instruments. An equity instrument is defined in IAS 32 as any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. IAS 33 explains that ordinary shares participate in profit for the period only after other types of shares (such as preference shares) have participated.

Ordinary shares of the same class have the same rights to receive dividends, but it is possible for an entity to have more than one class of ordinary shares.

Entities will sometimes issue preference shares with many of the characteristics of ordinary shares. The terms of such preference shares will need to be evaluated carefully. If they share the characteristics of ordinary shares and have no preference attributed to them, such instruments should be considered as ordinary shares regardless of the legal name assigned to them.

Potential ordinary share

Definition of potential ordinary share – general

A potential ordinary share is defined as a financial instrument or other contract that may entitle its holder to ordinary shares. Examples of potential ordinary shares include:

• financial liabilities or equity instruments, including preference shares, that are convertible into ordinary shares;
• options and warrants (i.e. financial instruments issued by the entity that give the holder the right to purchase ordinary shares); and
• shares that would be issued upon the satisfaction of conditions resulting from contractual arrangements, such as the purchase of a business or other assets.

Nature of potential ordinary shares in EPS computations The concept of a potential ordinary share has evolved to meet the reporting needs of investors in entities that have issued certain types of convertible and other complex securities. The holders of these instruments can expect to participate in the appreciation in value of the ordinary shares resulting principally from the earnings and earnings potential of the issuing entity. The attractiveness of these instruments to investors is often based on the potential right to participate in increases in the earnings potential of the entity, rather than on fixed returns or other senior security characteristics. The value of instruments that are considered potential ordinary shares is derived largely from the value of the ordinary shares to which they relate. Changes in the value of such instruments tend to reflect changes in the value of the ordinary shares.

Derivatives over own equity If an entity enters into a derivative over its own ordinary shares that may entitle the holder to ordinary shares, that derivative is a potential ordinary share if the settlement terms of the derivative may result in the delivery of ordinary shares of the entity. The only exception applies to forward purchase contracts and written put options over own ordinary shares when the issuer regards the shares to be delivered under the forward contract or written put option as effectively purchased upon entering into the contract. In this case only, the ordinary shares subject to the contract are deemed as acquired, resulting in a reduction in the number of shares outstanding for both basic and diluted EPS. If, however, the settlement terms of the derivative permit only net settlement in cash or other financial assets, and/or settlement by the exchange of gross amounts of cash or other financial assets, the instrument does not ‘entitle its holder to ordinary shares’ and is not a potential ordinary share. If there is a settlement choice, either by the issuer or the holder, as to whether ordinary shares will be delivered under the contract, the arrangement is still a potential ordinary share because there is the potential for delivery of ordinary shares under the contract. However, the detailed computation of diluted EPS differs according to whether the settlement alternatives are at the option of the holder or the issuer.