2, 2019

Chapter 24
Earnings per share

Review questions

24.2 Potential ordinary shares are dilutive if the EPS is recalculated on the basis that the
securities were converted to ordinary shares and the recalculated diluted EPS figure is
less than the basic EPS (which is based on the ordinary shares on issue). Potential
ordinary shares would emanate from such instruments as share options, convertible
notes and convertible preference shares.

24.3 As paragraph 27 of AASB 133 explains:

Ordinary shares may be issued, or the number of ordinary shares outstanding
may be reduced, without a corresponding change in resources. Examples
include:
(a) a capitalisation or bonus issue (sometimes referred to as a stock dividend);
(b) a bonus element in any other issue, for example a bonus element in a rights
issue to existing shareholders;
(c) a share split; and
(d) a reverse share split (consolidation of shares).
Paragraph 28 further explains:

In a capitalisation or bonus issue or a share split, ordinary shares are issued to existing
shareholders for no additional consideration. Therefore, the number of ordinary
shares outstanding is increased without an increase in resources. The number of
ordinary shares outstanding before the event is adjusted for the proportionate change
in the number of ordinary shares outstanding as if the event had occurred at the
beginning of the earliest period presented. For example, on a two-for-one bonus
issue, the number of ordinary shares outstanding before the issue is multiplied by
three to obtain the new total number of ordinary shares, or by two to obtain the
number of additional ordinary shares.

24.6 It should be noted that given that the preference dividends are cumulative, it does not
matter whether or not they have been paid. If they were non-cumulative, the right to
the preference dividend would be lost if they had not been declared, and, hence, for
non-cumulative preference shares, the dividend will be deducted from earnings only if
the dividend has been appropriated. Hence, earnings would be calculated as:

After-tax net profit $1 200 000

less Preference share dividends (50 000)
Earnings for basic EPS $1 150 000

Determination of the weighted-average number of ordinary shares

1
 Weighted-
Portion of average no. of
Period year No. outstanding shares
Fully paid ordinary shares
1/7/19–31/10/19 123/365 400 000 134 795
1/11/19–28/2/20 120/365 480 000 157 808
1/3/20–30/6/20 122/365 430 000 143 726
Partly paid ordinary shares
1/6/19–30/6/20 30/365 100 000 ($1.00/$2.00) 4110
Total weighted-average number of ordinary shares 440 439

Basic earnings per share, therefore, is $1 150 000 ÷ 440 439 = $2.6110

24.7 Earnings calculation

Net profit after tax $1 000 000
less Preference share dividends (6000)
Net profit after-tax less preference dividends $994 000

Theoretical ex bonus price = ($3.00)(5) + 0 = 2.50

5+1
Adjustment factor = 2.50 ÷ 3.00 = 0.8333
Calculation of the weighted-average number of ordinary shares and ordinary share
equivalents
Weighted-
Portion No. Adjustment average no. of
Period of year outstanding factor shares
Fully paid ordinary shares
1/7/18–30/9/18 92/365 600 000 0.8333 181 487
1/10/18–30/4/19 212/365 750 000 0.8333 522 761
1/5/19–30/6/19 61/365 900 000 150 411
854 659
Basic earnings per share for 2019 would be: $994 000 ÷ 854 659 = $1.1630
The comparative figures for 2018 would be adjusted for the bonus issue. The adjusted
figure would be: $2.30 × 0.8333 = $1.9166. Note that when determining the
weighted-average number of shares for the current financial year, the number of
shares outstanding prior to the bonus issue is divided by the adjustment factor.
Failure to adjust the previous period’s earnings would provide misleading figures as it
would appear that the company was not performing as well, when in fact the
reduction in EPS may be due to the bonus issue.
24.8

2
 Weighted- Basic
average Earnings
EPS
Fully paid ordinary shares ordinary $
shares $
365/365 × 100 000 000 100 000 000
30*/365 × 0.50/2.00 × 15 000 000 308 219
100 308 219 $410 000 000 $4.09
*1 July 2018–31 May 2019 is 335 days
1 June 2019–30 June 2019 is 30 days
Note: It is assumed that holders of the partly paid shares are entitled to dividends in
proportion to the paid-up amount of the shares.

24.12
365 days/365 days × 9 750 000* = 9 750 000
51 days/365 days × $2.00**/$2.30 × 3 250 000 = 394 878
10 144 878
EPS = $3 750 000***/10 144 878
= $0.3696
* weighted-average outstanding ordinary shares
** the number of ordinary share equivalents is to be based on a weighted average
determined by reference to the number of days during the financial year that the
relevant partly paid ordinary shares carried those rights to participate in dividends as a
proportion of the number of days in the financial year
*** profit after tax

24.13 The profit after tax earnings for each 6-month period is calculated using the first two
columns given in the question, as follows:
12 Months to 6 Months to 6 Months to
30 June 2019 31 December 2018 30 June 2019
Profit 17 500 000 7 035 800 10 464 200
Income tax expense 5 500 000 1 756 000 3 744 000
Profit after tax 12 000 000 5 279 800 6 720 200

Basic EPS
365 days/365 days × 5 000 000 = 5 000 000

EPS = $12 000 000/5 000 000 = $2.40

Diluted EPS
Options
As the options had not been on issue for the entire year, we must weight them for the
time they were outstanding. The standard requires that we consider the number of
shares that would effectively be issued for no consideration if these options are
exercised. To determine this we make the following calculation:
Options issued on 15 September 2018

3
 Number of shares issuable 10 000 000
Number of shares that would be issued at market price for
the actual proceeds of $25 000 000 = $25 000 000 ÷ $2.20 11 363 636
Number of shares deemed issued for no consideration (1 363 636)

As the above calculation is negative, meaning no shares would be issued for no

consideration given the current market price, and as the exercise of the options is not
mandatory, then the above option issue is not dilutive and can be ignored for the
purposes of calculating diluted EPS.
Options issued on 15 March 2019
Number of shares issuable 1 000 000
Number of shares that would be issued at market price for 909 091
the actual proceeds of $2 000 000 = $2 000 000 ÷ $2.20
Number of shares deemed issued for no consideration 90 909

As these options were not in place at the beginning of the year, they will be weighted
for the number of days they have been on issue: 90 909 × 107/365 = 26 650
Calculation of diluted EPS
$12 000 000/(5 000 000 + = $12 000 000/ = $2.3873
26 650) 5 026 650

Challenging questions
24.14 Calculation of basic earnings per share
Weighted-
average number
of ordinary Earnings
shares $ Basic EPS
Fully paid ordinaries
365/365 × = 90 000 000
90 000 000
Partly paid ordinaries
365/365 × 1.00/2.00 × = 5 000 000
10 000 000 **
Dividend reinvestment
91/365 × 1 000 000 * = 249 315
Partly paid call
122/365 × = 835 616
0.50/2.00 × 10 000
000 **
96 084 931 $23 000 000 $0.2394

4
 The effective date to commence weighting is after 31 March 2020, i.e. 1 April
2020. At this point the dividend became payable.
** Partly paid shares should be included in Basic EPS by calculating the fully paid
equivalent number of shares. When a call is made in the period, the time
weighting should commence from the date the call is due and payable. In this
case the closing date is 28 February 2020.
Calculation of diluted EPS
We need to consider those securities that are potential ordinary shares. The options
and partly paid shares are potentially dilutive. Each security must be considered
separately. For both options and partly paid shares, there will be an inflow of funds
into the organisation when the option is exercised, or the call is paid. For the options,
the accounting standard assumes that there will only be an inflow of funds if the
exercise price is less than the market price. The weighted-average number of shares
used to calculate diluted EPS is adjusted for options and partly paid ordinary shares
by adjusting for the number of ordinary shares that are assumed to be issued for no
consideration. (This can be contrasted to convertible instruments, such as convertible
notes or convertible preference shares, where the adjustment takes into account the
maximum number of ordinary shares to be issued as well as an adjustment to
earnings.)
Calculate earnings per incremental share
Partly paid shares
There is no adjustment to earnings for the capital inflow associated with the partly
paid shares. Their conversion is deemed to be mandatory, hence they would be ranked
last if we apply the ‘trigger test’. To determine the number of shares deemed issued
for no consideration, we must acknowledge that at least $0.50 was outstanding on the
partly paid shares for the entire year, with $1.00 being outstanding until 28 February.
To account for period to call date of 28 February:
Number of shares issuable 10 m × ($1.00  $2.00)
= 5m
Number of shares that would be issued at market
price for the actual proceeds of $10m ($10 m  $2.50)
=4m
Number deemed issued for no consideration 1 m × (243  365) =
665 753
To account for period from call date of 28 February:
Number of shares issuable 10 m × ($0.50  $2.00) =
2.5 m
Number of shares that would be issued at market
price for the actual proceeds of $10m ($5m  $2.50) = 2 m
Number deemed issued for no consideration 0.5m × (122  365) =
167 123
832 876

5
Share options issued on 1 January 2018
As they were on issue at the beginning of the year, they are potentially dilutive for the
entire year. We need to consider the number of shares that would effectively be issued
for no consideration if these options were exercised. (If shares were effectively issued
for no consideration then that would encourage the options holders to exercise the
option; there would be no incentive to exercise the option if they were not effectively
getting something for ‘free’.)
Number of shares issuable 10 000 000
Number of shares that would be issued at market price
for the actual proceeds of $26m = $26 m  $2.5 10 400 000
Number deemed issued for no consideration (400 000)

We can see that no shares would effectively be issued for ‘no consideration’ as the
above number is negative. As the price to be paid for the shares (the exercise price) is
greater than the market price of the shares, they would not be deemed to be ‘shares
issued for no consideration’, and hence can be ignored for the purposes of calculating
diluted EPS. They are ignored because as the market price is less than the exercise
price, it is not likely that the options would be exercised under the current market
conditions.
Share options issued on 30 June 2018
As they were on issue at the beginning of the year, they are potentially dilutive for the entire
year.
Number of share issuable @ $2.10 10 000 000
Number of shares that would be issued at market price
for the actual proceeds of $21 m = $21 m  $2.5 8 400 000
Number of shares deemed issued for no consideration 1 600 000

As the number of shares would increase, but notional earnings is not adjusted, the
above issue is deemed to be dilutive.
In determining diluted EPS, we will ignore any potential ordinary shares that are not
dilutive. In this case, the share option issue made on 1 January 2018 is ignored. As the
option issue on 30 June 2018 increases potential ordinary shares without increasing
earnings, and as the partly paid shares also increase the number of shares without
increasing earnings, then the ‘trigger test’ would be deemed to be met.
Profit Ordinary shares
As reported for basic EPS $23 000 000 96 084 931

Options Nil 1 600 000

Partly-paid shares Nil 832 876
$23 000 000 98 517 807
Diluted EPS = $23 000 000 ÷ 98 517 807 = $0.2335

6
 Again, as the option issue made on 1 January 2018 is not dilutive, it is not included in
the calculation of diluted EPS. However, had its conversion been mandatory, it would
be included even though the effect is anti-dilutive.
24.15 Calculation of basic earnings per share
Fully paid
ordinary shares
1 July 2017 75 000 000 × 304/365  0.8514* 73 368 280
1 May 2018 100 000 000 × 61/365 16 712 329
90 080 609
Basic earnings per share = $70 000 000/
90 080 609
= $0.777

* Theoretical ex-rights price = [(2.50 – 0.035) × 3) + 1]/ 3 + 1 = 2.09875

Adjustment factor = 2.09875/2.465

= 0.8514

Calculation of diluted EPS

We need to consider those securities that are potential ordinary shares. The
convertible notes and options are potentially dilutive. Each security must be
considered separately.
Share options
As the options have been on issue for the entire year, we treat them as potentially
dilutive as of the beginning of the year. The standard requires that we consider the
number of shares that would effectively be issued for no consideration if these options
are exercised. To determine this we make the following calculation:
Number of shares issuable (exercise price $2): 10 000 000
Number of shares that would be issued at market price for
the actual proceeds of $20 000 000 = $20 000 000 ÷ $2.50 8 000 000
Number of shares deemed issued for no consideration 2 000 000
Given that the standard requires that there is no adjustment to earnings in relation to
the options, the earnings per incremental share is $nil. 2 000 000 shares will be added
to the denominator to calculate diluted EPS.
Convertible notes
If the notes were converted to ordinary shares, the pre-tax earnings would be
increased by $500 000 (the interest expense that would no longer be payable, which is
equal to 2 000 000 × $2.50 × 10%). This would lead to an after-tax increase in
earnings of $300 000, which is $500 000 × (1 – 0.40).
As an additional 2 000 000 shares would be created, the increase in earnings
attributable to ordinary shareholders on conversion of the convertible debentures
would, on an incremental share basis, be: $300 000 ÷ 2 000 000 = $0.15

7
We must now rank the above potential ordinary shares in order from greatest to
least dilution.
AASB 133 requires that when we consider whether potential ordinary shares are
dilutive, each issue or series of potential ordinary shares must be considered
separately, rather than in aggregate. Each issue or series of potential ordinary shares
must be considered in sequence from the most dilutive (smallest earnings per
incremental share) to the least dilutive (largest earning per incremental share). In this
question, the order from most dilutive to least dilutive is:

Earnings per
Increase in shares incremental share
Options 2 000 000 $nil
Convertible notes 2 000 000 $0.15

We must now determine the ‘trigger test’

AASB 133 includes a ‘trigger test’ to determine whether potential ordinary shares are
dilutive. If the shares cause EPS to decrease from the initial amount determined for
the trigger test, then they are considered dilutive. The standard uses net profit or loss
from continuing ordinary operations as the initial amount for the trigger test to
determine whether potential ordinary shares are dilutive (however, it requires that the
earnings figure used in the actual calculation of diluted EPS includes discontinuing
operations, adjustments for changes in accounting policies and corrections of
fundamental errors). Paragraph 42 of AASB 133 states:
An entity uses profit or loss from continuing operations attributable to the
parent entity as the control number to establish whether potential ordinary
shares are dilutive or antidilutive. Profit or loss from continuing operations
attributable to the parent entity is adjusted in accordance with paragraph 12
and excludes items relating to discontinued operations.
The net profit or loss from continuing operations excludes amounts relating to
discontinuing operations; adjustments for changes in accounting policies that affect
the current reporting period but relate to prior reporting periods; and corrections of
fundamental errors. We will assume that in this question it is also equal to $70
million.
Apply trigger test
We have already determined the order in which to include potential ordinary shares in
the calculation of diluted EPS.
Profit and
adjustments Ordinary shares EPS Dilutive?
Net profit from continuing
ordinary operations $70 000 000 90 080 609 $0.7771
Options Nil 2 000 000
$70 000 000 92 080 609 $0.7602 Yes
Convertible notes $300 000 2 000 000
$70 300 000 94 080 609 $0.7472 Yes

8
 In the above calculation, profit or loss from continuing operations is the starting point
in the trigger test. After this point, each potential ordinary share is considered in order
of smallest earnings per incremental share to largest earnings per incremental share. If
a particular security does not dilute EPS then it is not to be included when calculating
diluted EPS, unless the conversion is mandatory, or conversion is probable and at the
option of the entity.
Calculation of diluted EPS
Profit Ordinary shares
As reported for basic EPS $70 000 000 90 080 609
Options Nil 2 000 000
Convertible debentures $300 000 2 000 000
$70 300 000 94 080 609
Diluted EPS = $70 300 000 ÷ 94 080 609 = $0.7472.
24.16 Calculation of basic earnings
Profit attributable to members of the parent entity $16 488 000
less Preference share dividends (30/9/2018) $360 000
less Cumulative preference dividends not paid,
nor provided for (31/3/2019) [$6 000 000 x 0.06] $360 000
Basic earnings, based upon total profit $15 768 000
add Loss from discontinuing operations after related income tax $492 000
Basic earnings, based upon profit from continuing operations $16 260 000
The preference shares issued on 1 March 2019 were not entitled to dividends at 30
June 2019 and no partial dividend entitlement has been accrued.
Calculation of basic weighted-average number of shares
Number of Weighted-average
Share issue Weighting shares number of shares
Original 1 July 2018 1 = 365/365 4 600 000 4 600 000
Public issue 1 December 2018 212/365 8 000 000 4 646 575
Partly paid shares 91/365 = 480 000 x 0.3 35 901
Rank for dividends 1 April 2019 = 144 000
Share buy back 1 May 2019 61/365 (260 000) (43 452)
Total 9 239 024

Calculation of basic EPS, based upon profit from continuing operations

Basic EPS = Basic earnings, based upon profit from continuing operations = 16 260 000 = $1.7599 per
share
Basic weighted-average number of shares 9239 024

Calculation of basic EPS, based upon total profit

Basic EPS = Basic earnings, based upon total profit = 15 768 000 = $1.7067 per share

9
Basic weighted-average number of shares 9 239 024

10