Diluted EPS
Diluted EPS Earnings
Adjust Basic EPS Earnings to arrive at starting Diluted EPS Earnings
When calculating Diluted EPS on partly paid ordinary shares, no adjustment is required to the Diluted EPS numerator since the payment, by ordinary shareholders for the remaining balance on their partly paid ordinary shares, will have no appreciable effect on income or expense. You will need, however, to make an adjustment to the denominator.
To make the adjustment to the denominator, you will need to apply the treasury share method by: (1) taking the remaining balance due from partly paid ordinary shares and using it to purchase ordinary shares at the average market price; (2) calculating the adjustment to the denominator [ = (numbers of shares subscribed - number of ordinary shares purchased at the average market price) x time weighting].
Fill in the `Bonus Element*` with the difference between number of shares subscribed and the number of ordinary shares purchased at the average market price. If the partly paid shares were issued during the year, before you fill in the `Bonus Element*`, you will need to time apportion the issued shares by the number of months (or days if absolutely necessary) they were in issue.
Generally, your partly paid ordinary shares will be dilutive when the unpaid balance per share is lower than the average market price of an ordinary share during the period.
Illustration 1: Calculation of Bonus Element
Fraction of partly paid ordinary shares not entitled to dividends
a
Subscription price
b
Assumed proceeds (c = a x b)
c
Average market price of ordinary shares
d
Number of ordinary shares deemed to have been issued (e = c / d)
e
Bonus element (f = a - e)
f
Example 1: Fill in the Bonus Element
Fact pattern:
Net profit for the year
CU5,200,000
Opening number of ordinary shares
1,000,000
On 1 May, your company issues 300,000 shares with a subscription price of CU10. 80% payable on issue and with the balance required to be paid when called for. You receive 300,000 x 80% x CU10 = CU2,400,000. Keeping in accordance with your company's constitution, shareholders of partly paid ordinary shares are entitled to participate in dividends at the percentage the shares are paid up in comparison with fully paid ordinary shares. The average market price of your ordinary shares between 1 May and 31 December is CU17.
As in this example, partly paid ordinary shares should be considered POSs because they are treated as the equivalent of warrants or options (i.e. they are not entitled to dividends relative to fully paid ordinary shares).
Fraction of partly paid ordinary shares not entitled to dividends [(1 - 80%) x 300,000)]
60,000
Subscription price
CU10.00
Assumed proceeds (60,000 x CU10)
CU600,000
Average market price of ordinary shares
CU17
Number of ordinary shares deemed to have been issued ( CU600,000 / CU17)
35,294
Bonus element [(60,000 - 35,294) x 8/12]
16,471
Fill in 16,471 in the `Bonus Element` input box. The bonus element will be weighted for the period the ordinary shares are not fully paid — in this case 8 months. You can apportion by the number of days remaining if you prefer, but the months remaining is a reasonable estimate since you are calculating it by hand.
Potential Ordinary Shares
Different classes of POSs outstanding during the reporting period including:
- Options, warrants and their equivalents
- Convertible preference shares and convertible bonds
- Contingently issuable ordinary shares
- Contingently issuable potential ordinary shares
When calculating Diluted EPS on partly paid ordinary shares, no adjustment is required to the Diluted EPS numerator since the payment, by ordinary shareholders for the remaining balance on their partly paid ordinary shares, will have no appreciable effect on income or expense. You will need, however, to make an adjustment to the denominator.
To make the adjustment to the denominator, you will need to apply the treasury share method by: (1) taking the remaining balance due from partly paid ordinary shares and using it to purchase ordinary shares at the average market price; (2) calculating the adjustment to the denominator [ = (numbers of shares subscribed - number of ordinary shares purchased at the average market price) x time weighting].
Fill in the `Bonus Element*` with the difference between number of shares subscribed and the number of ordinary shares purchased at the average market price. If the partly paid shares were issued during the year, before you fill in the `Bonus Element*`, you will need to time apportion the issued shares by the number of months (or days if absolutely necessary) they were in issue.
Generally, your partly paid ordinary shares will be dilutive when the unpaid balance per share is lower than the average market price of an ordinary share during the period.
Illustration 1: Calculation of Bonus Element
Fraction of partly paid ordinary shares not entitled to dividends
a
Subscription price
b
Assumed proceeds (c = a x b)
c
Average market price of ordinary shares
d
Number of ordinary shares deemed to have been issued (e = c / d)
e
Bonus element (f = a - e)
f
Example 1: Fill in the Bonus Element
Fact pattern:
Net profit for the year
CU5,200,000
Opening number of ordinary shares
1,000,000
On 1 May, your company issues 300,000 shares with a subscription price of CU10. 80% payable on issue and with the balance required to be paid when called for. You receive 300,000 x 80% x CU10 = CU2,400,000. Keeping in accordance with your company's constitution, shareholders of partly paid ordinary shares are entitled to participate in dividends at the percentage the shares are paid up in comparison with fully paid ordinary shares. The average market price of your ordinary shares between 1 May and 31 December is CU17.
As in this example, partly paid ordinary shares should be considered POSs because they are treated as the equivalent of warrants or options (i.e. they are not entitled to dividends relative to fully paid ordinary shares).
Fraction of partly paid ordinary shares not entitled to dividends [(1 - 80%) x 300,000)]
60,000
Subscription price
CU10.00
Assumed proceeds (60,000 x CU10)
CU600,000
Average market price of ordinary shares
CU17
Number of ordinary shares deemed to have been issued ( CU600,000 / CU17)
35,294
Bonus element [(60,000 - 35,294) x 8/12]
16,471
Fill in 16,471 in the `Bonus Element` input box. The bonus element will be weighted for the period the ordinary shares are not fully paid — in this case 8 months. You can apportion by the number of days remaining if you prefer, but the months remaining is a reasonable estimate since you are calculating it by hand.
Convertible preference shares are equity instruments that allow an investor to receive your company's ordinary shares in whole or in part upon conversion. Convertible preference shares, other than those that are mandatorily convertible, are POSs because they may entitle their holders to you company's ordinary shares.
Example: Convertible Preference Shares
Let's say that your net profit after tax for the year is CU5,000,000 and the number of ordinary shares outstanding at the beginning of the year is 1,000,000. In a prior year, your company had issued 100,000 CU1 17% convertible preference shares. In this tax jurisdiction, preference shares are classified as equity and their dividends are not subject to tax.
Go to the `Basic EPS` tab. Fill in the `Profit / (Loss)*` input box with the value 5,000,000. Fill in the `Ordinary Shares Outstanding on First Day of Reporting Period*` input box with the value 1,000,000. You will need to fill appropriate values for the `First Day of Reporting Period*` and `Last Day of the Reporting Period*` input boxes.
Return to the `Convertible Preference Shares` section of the `Diluted EPS` tab. The full conversion of the issued preference shares will increase the number of outstanding shares by 100,000. Fill in the `Weighted-average Number of Shares*` input box with the value 100,000. Since the preference shares are classified as equity and their dividends are not tax deductible, enter the value 17,000 (100,000 x CU1 x 17%) into the `Earnings` input box.
Illustration: Finding the Weighed-average Number of Ordinary Shares
Your company has a class of non-cumulative preference shares that are convertible to ordinary shares all with the same conversion terms. The following transaction occurred during the year:
- On 1 January, 2,000 preference shares are outstanding (2,000 x 3/12 = 500).
- On 1 April, 500 preference shares are converted into ordinary shares (2,000 - 500 = 1,500 x 3/12 = 375).
- On 1 July, another 1,000 preference shares are issued (1,500 + 1,000 = 2,500 x 6/12 = 1,250).
Weighted average for the year = 500 + 375 + 1,250 = 2,125. Enter 2,125 into the `Weighted-average Number of Ordinary Shares*` input box.
Convertible bonds are debt instruments that allow an investor to receive your company's ordinary shares in whole or in part upon conversion. Convertible bonds, other than those that are mandatorily convertible, are POSs because they may entitle their holders to your company's ordinary shares.
Example: Convertible Debt
Let's say that your net profit after tax for the year is CU5,000,000 and the number of ordinary shares outstanding at the beginning of the year is 1,000,000. On 1 January, your company issues 500,000 convertible bonds for CU1 each. Every 10 of these bonds are convertible into one ordinary share at the holder's discretion. The interest expense for the year related to the liability component of the convertible bonds is CU100,000. In your tax jurisdiction, interest expense is tax-deductible with an applicable income tax rate of 40%.
Go to the `Basic EPS` tab. Fill in the `Profit / (Loss)*` input box with the value 5,000,000. Fill in the `Ordinary Shares Outstanding on First Day of Reporting Period*` input box with the value 1,000,000. You will need to fill appropriate values for the `First Day of the Reporting Period*` and `Last Day of the Reporting Period*` input boxes.
Return to the `Convertible Bonds` section of the `Diluted EPS` tab. The full conversion of the issued bonds will increase the number of outstanding shares by 50,000 (500,000 / 10). Fill in the `Weighted-average Number of Ordinary Shares*` input box with the value 50,000. The full conversion of the issued bonds would increase profit or loss for the year by the after-tax amount of the interest expense CU60,000 [(interest expenses on the convertible bonds) x (1 - income tax rate) = (100,000) x (1 - 40%) = 60,000]. Fill in the `Earnings` input box with the value 60,000. Including the impact of the convertible bonds in Diluted EPS will bring the Diluted EPS to CU4.60.
Example: Numerator Adjustment for Employee Profit-sharing Plan Expense
Assume that your company has issued a convertible bond. During the year, the interest expense recognized on the bond is CU100,000. Your company also has a non-discretionary employee profit-sharing plan that pays 10% of its net profit annually to all eligible employees. All expenses are tax-deductible. The applicable income tax rate is 40%.
When you calculate EPIS for the convertible bond, you should assume that the bond is converted into ordinary shares from the beginning of the year. With the assumed conversion, the interest on the bond would not have been recognized in the year, and would have led automatically to an increase in the employee profit-sharing plan expense. Let's calculate the decrease in interest expense = CU100,000 - CU40,000 (CU100,000 x 40%) = CU60,000. Next, let's look at the increase in employee profit-sharing expense = - CU10,000 (- CU100,000 x 10%) + CU4,000 (CU10,000 x 40%) = - CU6,000. In total, you should enter CU54,000 (CU60,000 - CU6,000) in the `Earnings` input box.
Example: Numerator Adjustment on Capitalized Borrowing Costs
Assume that your company has issued a convertible bond that is convertible into its ordinary shares. During the year, the interest on the bond CU120,000, of which CU90,000 is recognized in the income statement and CU30,000 is capitalized into the cost of property, plant and equipment in accordance with IAS 23. There are no other borrowing costs that would be capitalized if the instrument had been converted.
Of the interest of CU30,000 that is capitalized during the year, CU6,000 is recognized as part of the year's depreciation expenses.
All expenses are tax-deductible. The applicable income tax rate is 40%.
When you calculate the EPIS for the convertible bond, you should assume that the bond is converted into ordinary shares from the beginning of the year. With the assumed conversion, the interest on the bond would not have been recognized during the year leading to: (1) a reduction in the interest expense; (2) a reduction in the interest capitalized; and (3) a reduction in depreciation expense recognized in respect of such capitalized interest.
Let's calculate the decrease in interest expense = CU90,000 - CU36,000 (CU90,000 x 40%) = CU54,000. Next, let's look at the decrease in depreciation expense = CU6,000 - CU2,400 (CU6,000 x 40%) = CU3,600.
So, in total, you should enter CU57,600 (CU54,000 + CU3,600) in the `Earnings` input box.
Information about Forward purchase contracts and Written Put Options Generally, ordinary shares issued to acquire a business impact only Basic EPS. Contingent consideration settleable in ordinary shares, however, will have an impact on Diluted EPS.
Illustration 1: Contingently Consideration Settleable in Ordinary Shares
On 1 January 2015, your company acquires company Y as a IFRS 3 business combination. You acquire control on 1 March 2015 with the payment of cash consideration. There is a contingent consideration of 200,000 ordinary shares if Y's profit for the 12 month period ending 29 February 2016 is greater than CU1,000,000 or 300,000 ordinary shares if Y's profit for the same period is greater than CU1,500,000. The contingent consideration is recognized as a financial liability.
Your profit for the year ended 31 December 2015 was CU900,000. The expense for the change in fair value of the contingent consideration recognized in profit is CU100,000. The expense for the change in the fair value is tax-deductible and the applicable tax rate is 40%.
Example: Numerator Adjustment When There is No Consequential Effect on the Income Statement
Consider a scenerio where your company issues share options to your employees. Your company writes a call option to an investment bank to purchase its own shares at market price.
In this example, your company will conclude that the call option is not a derivative since the value of the option does not depend on an underlying variable — it always has a fair value of zero. Therefore, as far as the call option between your company and your investment bank is concerned, the assumed conversion of the employee options will not have any consequential effect to the profit or loss. No numerator adjustment is needed to the EPIS.
Example: Numerator Adjustment When There is No Consequential Effect on the Income Statement
Continuing the above scenario, to reduce its exposure to an increase in the market price of its shares when the options become exercisable, your company enters into a share swap with your bank. Your company (1) takes a notional loan from the bank, with the principal amount equal to the purchase price of a notional number of shares at a notional share price; (2) pays interest on the notional loan and the bank pays dividends on the notional number of shares when your company declares dividends; and (3) may change the number of notional shares implicit in the notional loan by notifying the bank in advance, and has the intention of reducing the notional shares in line with the reduction in share options outstanding. The difference between the notional price and the market price of shares is refunded by the bank if the the number of shares decreases. The difference between the notional price and the market price of shares needs to be topped by your company if the number of shares increases.
Your company may intend to adjust the notional amount under the swap arrangement to hedge the share-based payment liability, the adjustment is not automatic and your company has the discretion to adjust its exposure.
Since there is not really connection between the swap arrangement with your bank and the exercise of options to consider changes in the swap arrangement with your bank to be a consequential change to be a consequential change to profit or loss. In this scenerio, no numerator is necessary to EPIS.
Illustration 1: Contingently Consideration Settleable in Ordinary Shares
On 1 January 2015, your company acquires company Y as a IFRS 3 business combination. You acquire control on 1 March 2015 with the payment of cash consideration. There is a contingent consideration of 200,000 ordinary shares if Y's profit for the 12 month period ending 29 February 2016 is greater than CU1,000,000 or 300,000 ordinary shares if Y's profit for the same period is greater than CU1,500,000. The contingent consideration is recognized as a financial liability.
Your profit for the year ended 31 December 2015 was CU900,000. The expense for the change in fair value of the contingent consideration recognized in profit is CU100,000. The expense for the change in the fair value is tax-deductible and the applicable tax rate is 40%.
Generally, ordinary shares issued to acquire a business impact only Basic EPS. Contingent consideration settleable in ordinary shares will, however, have an impact on Diluted EPS since they are POSs.
Example 1: Contingent Consideration Settleable in Ordinary Shares
Fact pattern:
On 1 January 2015, your company agrees to acquire company X as an IFRS 3 business combination. You acquire control on 1 March 2015 with the payment of cash consideration. There is contingent consideration of 200,000 ordinary shares if X's profit for the 12 month period ending 29 February 2016 is greater than CU750,000 or 300,000 ordinary shares if X's profit for the same period is greater than CU1,250,000. The contingent consideration is recognized as a financial liability.
The expense for the change in fair value of the contingent consideration recognized in profit or loss is CU100,000. The expense for the change in the fair value is tax-deductible and the applicable tax rate is 40%.
Net profit for the year end 31 December 2015
CU900,000
Opening number of ordinary shares
200,000
The cumulative earnings target will need to be tested on 29 February 2016. At 31 December 2015, X's cumulative earnings is CU900,000 which exceeds CU750,000 but is less than CU1,250,000. 200,000 ordinary shares will be included in the Diluted EPS denominator.
Increase in profit or loss from post-tax change in the fair value of the liability [CU100,000 x (1 - 40%)]
CU60,000
The weighted average number of shares to include on 1 March 2015 [200,000 x (10 / 12)]
166,667
Fill in 60,000 in the `Earnings` input box. Fill in 166,667 in the `Ordinary Shares Issuable*` input box. Fill in 1/3/2015 in the `Earliest Date of Inclusion*` input box.
Partly paid ordinary shares will have a potential impact on diluted EPS.
Non-cumulative preference dividends lapse if they are not declared or paid when scheduled. Once a dividend payment is missed, it will not be paid in future and it will not be reported as dividends in arrears.
Returns on non-cumulative preference shares are not deducted when arriving at `Net Profit / (Loss)*.` So the numerator for Basic EPS needs to be deducted for these returns so that the numerator only reflects the profit or loss attributable to ordinary shareholders.
Non-cumulative Preference Share Dividend Scenarios:
Scenario 1: Declared and authorized before the end of the period (before the reporting date)
Action Needed: Adjust Basic EPS Numerator for the dividend declared
Scenario 2: Declared and authorized after the end of the period (after the reporting date) but before its financial statements for the period are authorized for issue
Action Needed: No action needed - the preference dividends were not declared before the reporting date and should be ignored when calculating the Basic EPS Numerator
Scenario 3: Declared and authorized after the financial statements are authorized for issue
Action Needed: No action needed - the preference dividends were not declared before the reporting date and should be ignored when calculating the Basic EPS Numerator
Example: Non-cumulative Preference Dividend Declared
If your called-up capital includes 400,000 non-cumulative 7% equity-classified preference shares of CU1 each which have been declared and authorized for the period before the end of the period (the reporting date). Then your total non-cumulative preference dividends declared will be 400,000 x 0.07 x CU1 = CU28,000.
Fill in the `Dividends for Non-cumulative Preference Shares*` input box with the value 28,000.
Diluted EPS Workings
| Earnings | Weighted Average Number of Shares | Per Share | Dilutive? | |||
|---|---|---|---|---|---|---|
| Adjusted Starting Diluted EPS Earnings | Basic EPS from Continuing Operations | |||||
| -- | ||||||
Basic EPS Numerator +
Diluted EPS = Diluted POS Adjustments
Basic EPS Denominator +
Diluted POS Adjustments
Diluted EPS =
Diluted EPS =
Database Offline
Your work is not being saved.