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Advanced Financial Accounting

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Advance Financial Accounting (FIN-611)
VU
LESSON # 34
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
75,000
Earnings (in Rupees)
80,000
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
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Advance Financial Accounting (FIN-611)
VU
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.
Rs. 75,000 = 18.75 paisa
Like the EPS in the year 2008 will then be
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:
Number of shares held @ Market price
4 x Rs. 5
20
Number of shares offered @ Offer price
1 x Rs. 3
3
Theoretical price of 5 shares
23
Theoretical ex-right price per share
23 = Rs. 4.60/sh
5
184
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Advance Financial Accounting (FIN-611)
VU
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
57,500 = Rs. 4.60/sh
Theoretical ex-right price per share
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
185
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Advance Financial Accounting (FIN-611)
VU
Weight average
11685
10,870
20,000
Earnings per share
22,000
11,685
10,870
EPS
Rs. 1.88
Rs. 1.84
Solved problem # 4:
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:
Shares
Value Rs.
Theoretical ex-right price
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
186
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Advance Financial Accounting (FIN-611)
VU
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
Weighted average
550,000
591,667
600,000
EPS
110,000
150,000
180,000
550,000
591,667
600,000
Rs. 0.20
Rs. 0.2535
Rs. 0.30
187
Table of Contents:
  1. ACCOUNTING FOR INCOMPLETE RECORDS
  2. PRACTICING ACCOUNTING FOR INCOMPLETE RECORDS
  3. CONVERSION OF SINGLE ENTRY IN DOUBLE ENTRY ACCOUNTING SYSTEM
  4. SINGLE ENTRY CALCULATION OF MISSING INFORMATION
  5. SINGLE ENTRY CALCULATION OF MARKUP AND MARGIN
  6. ACCOUNTING SYSTEM IN NON-PROFIT ORGANIZATIONS
  7. NON-PROFIT ORGANIZATIONS
  8. PREPARATION OF FINANCIAL STATEMENTS OF NON-PROFIT ORGANIZATIONS FROM INCOMPLETE RECORDS
  9. DEPARTMENTAL ACCOUNTS 1
  10. DEPARTMENTAL ACCOUNTS 2
  11. BRANCH ACCOUNTING SYSTEMS
  12. BRANCH ACCOUNTING
  13. BRANCH ACCOUNTING - STOCK AND DEBTOR SYSTEM
  14. STOCK AND DEBTORS SYSTEM
  15. INDEPENDENT BRANCH
  16. BRANCH ACCOUNTING 1
  17. BRANCH ACCOUNTING 2
  18. ESSENTIALS OF PARTNERSHIP
  19. Partnership Accounts Changes in partnership firm
  20. COMPANY ACCOUNTS 1
  21. COMPANY ACCOUNTS 2
  22. Problems Solving
  23. COMPANY ACCOUNTS
  24. RETURNS ON FINANCIAL SOURCES
  25. IASBíS FRAMEWORK
  26. ELEMENTS OF FINANCIAL STATEMENTS
  27. EVENTS AFTER THE BALANCE SHEET DATE
  28. PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS
  29. ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS 1
  30. ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS 2
  31. BORROWING COST
  32. EXCESS OF THE CARRYING AMOUNT OF THE QUALIFYING ASSET OVER RECOVERABLE AMOUNT
  33. EARNINGS PER SHARE
  34. Earnings per Share
  35. DILUTED EARNINGS PER SHARE
  36. GROUP ACCOUNTS
  37. Pre-acquisition Reserves
  38. GROUP ACCOUNTS: Minority Interest
  39. GROUP ACCOUNTS: Inter Company Trading (P to S)
  40. GROUP ACCOUNTS: Fair Value Adjustments
  41. GROUP ACCOUNTS: Pre-acquistion Profits, Dividends
  42. GROUP ACCOUNTS: Profit & Loss
  43. GROUP ACCOUNTS: Minority Interest, Inter Co.
  44. GROUP ACCOUNTS: Inter Co. Trading (when there is unrealized profit)
  45. Comprehensive Workings in Group Accounts Consolidated Balance Sheet