Earnings per Share

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Advance Financial Accounting (FIN-611)

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

Bonus Issue during the year 2009

100,000

Total number

500,000

EPS

16 paisa

15 paisa

183

Advance Financial Accounting (FIN-611)

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

Number of shares offered @ Offer price

1 x Rs. 3

Theoretical price of 5 shares

Theoretical ex-right price per share

23 = Rs. 4.60/sh

184

Advance Financial Accounting (FIN-611)

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

Rights issue

Bonus element

870

Consideration/resource element

1,630 x 6/12

815

185

Advance Financial Accounting (FIN-611)

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:

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

Advance Financial Accounting (FIN-611)

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

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

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