Earnings per share (IAS 33) - Basic EPS calculation

Learning Outcomes

After reading this article, you will be able to calculate basic earnings per share (EPS) in accordance with IAS 33, including adjustments for new share issues, bonus issues, and rights issues. You will learn to identify the correct profit figure for the numerator, determine the correct weighted average number of shares for the denominator, and state how and when to restate prior year comparatives. This is essential for ACCA FR calculations and interpretations.

ACCA Financial Reporting (FR) Syllabus

For ACCA Financial Reporting (FR), you are required to understand, calculate, and explain the relevance of basic earnings per share. In particular, revision should focus on:

• Calculating EPS in accordance with IAS 33 (including adjustments for bonus issues, full market value issues, and rights issues)
• Identifying the correct earnings figure to use for EPS
• Determining the weighted average number of ordinary shares outstanding during the period
• Restating comparative EPS after bonus and rights issues
• Understanding the importance and limitations of EPS as a performance measure

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which profit figure should be used as the numerator in the basic EPS calculation for a group?
2. True or false? When a company makes a bonus issue during the year, prior year EPS must be restated.
3. Briefly explain how a rights issue affects the EPS calculation—what adjustment must be made?
4. An entity with 2 million shares in issue issues a further 1 million shares at full market value on 1 October. Calculate the weighted average number of shares for the year ended 31 December.

Introduction

Earnings per share (EPS) is a key performance indicator for companies with publicly traded shares. IAS 33 stipulates a standard calculation to ensure comparability across periods and companies. Straightforward EPS calculation is expected in the ACCA FR exam—errors usually result from missing adjustments for new share issues or from misunderstanding how to weight or restate share numbers.

EPS answers two questions:

• How much profit is attributable to each ordinary share?
• How have changes in share capital during the period affected comparability with previous years?

A clear understanding of the correct formula, the right figures to use, and the required adjustments is essential to score marks.

Key Term: earnings per share (EPS)
The amount of profit attributable to each ordinary share, calculated as profit attributable to ordinary shareholders divided by the weighted average number of ordinary shares outstanding during the reporting period.

Key Term: weighted average number of shares
The number of ordinary shares in issue, adjusted for the proportion of the period they were in issue, and further adjusted for bonus or rights issues in accordance with IAS 33.

BASIC EPS: CALCULATION PRINCIPLES

IAS 33 presents a clear formula:

• Numerator: “Profit attributable to ordinary shareholders” means group profit after tax, less any amounts due to irredeemable preference shareholders or non-controlling interests.
• Denominator: The number of shares is weighted to reflect changes during the year, and adjusted for bonus or rights issuances.

Key Term: bonus issue
An issue of new shares to existing shareholders without payment, usually in a fixed ratio (e.g. one for five). Also called a scrip or capitalisation issue.

Key Term: rights issue
An offer to existing shareholders to buy additional shares, usually below market price, resulting in an element of “free” shares and requiring adjustment for comparability.

Step 1: Identify the Correct Earnings Figure

Use the group profit after tax attributable to ordinary shareholders. Deduct any irredeemable preference dividends or non-controlling interest shares of profit.

Step 2: Calculate the Weighted Average Number of Shares

• Shares in issue at period start are included for the full year.
• Shares issued or repurchased during the year are time-weighted—from the date of issue.
• Bonus issues: Treated as if issued at the very start of the earliest period presented—weight all shares accordingly and restate prior periods.
• Rights issues: Adjust for the bonus element in the rights issue (see below), from the period start.

Worked Example 1.1

Company Alpha had 400,000 shares in issue on 1 January 20X7. On 1 July 20X7, it issued 200,000 shares at full market value. Net profit after tax for the year was $330,000.

What is basic EPS for the year ended 31 December 20X7?

Answer:
Weighted average shares:

• 400,000 for 6/12 = 200,000
• 600,000 for 6/12 = 300,000 Total = 200,000 + 300,000 = 500,000 shares

Basic EPS = $330,000 / 500,000 = $0.66 per share

Adjustments for Bonus Issues

• Bonus shares are deemed issued at the start of the period and for all preceding periods.
• All EPS comparatives must be restated.
• No cash is received; the bonus fraction increases the shares outstanding without increasing net assets.

Worked Example 1.2

Beta Co had 1,000,000 shares at 1 January 20X8. A 1 for 4 bonus issue was made on 1 October 20X8. Net profit for the year was $525,000.

Calculate basic EPS for the year and show how prior year comparative would be restated.

Answer:
Shares before bonus: 1,000,000 Bonus shares: 1,000,000 x 1/4 = 250,000 → total 1,250,000 shares

For EPS: Both current and previous year’s number of shares must be restated at 1,250,000; the full bonus effect is backdated.

Basic EPS = $525,000 / 1,250,000 = $0.42 per share (current and restated for prior year)

Adjustments for Rights Issues

• A rights issue combines extra capital with an element of “free” shares (usually at a discount to market value).
• EPS is adjusted by applying a “bonus fraction”—the ratio of the pre-rights market price to the theoretical ex-rights price (TERP).

Steps

1. Calculate TERP (weighted avg price following the rights issue)
2. Calculate the bonus fraction = market price before the issue / TERP
3. Apply the bonus fraction to shares issued before the rights issue, for both current and prior periods

Worked Example 1.3

Gamma issued 2,000,000 existing shares at $5 each. On 1 October, a 1 for 4 rights issue at $3. Market price before issue was $5.

How should shares in the EPS denominator be adjusted?

Answer:

• For every 4 old shares, 1 new is issued: 2,000,000 x 1/4 = 500,000 new shares
• TERP = ((4 x $5) + (1 x $3)) / 5 = ($20 + $3)/5 = $4.60
• Bonus fraction: $5/$4.60 = 1.087
• Weighted shares issued before rights are multiplied by 1.087
• Apply to previous year also

Exam Warning

For bonus issues and rights issues, you must restate the prior year’s EPS for comparability. Marks are often lost through failure to apply or mention this adjustment.

Summary

Basic EPS is a key ratio and must be accurately calculated in accordance with IAS 33. Use profit attributable to ordinary shareholders, divided by the weighted average number of shares, correctly adjusted for all new issues, with bonus and rights issues carefully restated for all periods. Know the exact treatment for each type of share change.

Key Point Checklist

This article has covered the following key knowledge points:

• Identify the correct profit figure to use for basic EPS (group profit after tax attributable to ordinary shareholders)
• Calculate the weighted average number of shares, time-weighting any new issues or buybacks
• Include bonus shares from the start of the earliest period presented and restate prior year figures
• Calculate and apply the bonus fraction for rights issues, including adjustments to comparative EPS
• Recognize the necessity to restate comparative EPS for bonus and rights issues
• Avoid common calculation pitfalls with share adjustments in EPS questions

Key Terms and Concepts

• earnings per share (EPS)
• weighted average number of shares
• bonus issue
• rights issue