EARNING PER SHARE - IAS 33

Earning Per Share(EPS) is widely used by investors and other stakeholders to assess the performance of a company. It is also used to calculate the Price/Earning ratio, which is of particular importance to investors. In order to ensure consistency in the calculation of EPS, IAS 33 was published. EPS is the only financial ratio which is regulated by a standard.

What is Earnings

Earnings are profit after tax and preference dividend. In other words, it is the profit attributable to the owners of the company after deducting all expenses.

Basic Earning Per Share

The formula for calculating basic earning per share is given as:

How to calculate weighted average number of shares

If a company has 10,000 shares at the beginning of the year(January 1, 2019) and issues 50,000 shares in July 1, 2019, the weighted average shares for the year ending December 31 2019 is calculated as follows:

Step 1, Determine the number of months the initial number of shares were in issue until the new issue. From the illustration, the 10,000 shares were in issue from January, February, March, April, May, and June, which is 6 months. Divide the result by 12 months and multiply by the shares.

Example 1

On January 1, a company had  5,000,000 ordinary shares in issue. On 1 April, 1,000,000 shares were issued. On 1 July an extra 1,000,000 shares came into existence. On 1 November 500,000 more shares were issued. All issues were at full market price.

Required:

Calculate the weighted average number of shares.

Solution

Types of Share Issues

There are three types of share issues. These are

1. Share issue at full market price

2. Bonus issue

3. Right issue

1. Share issue at full market price: This is where a company issue shares at the prevailing market price of the shares.

2. Bonus issue: Refers to the issue of new shares to existing shareholders, in proportion to their existing shareholding, for no consideration. It means the shareholders do not pay for the new shares.

3. Right issue: This is where a company issues new shares for cash for existing shareholders. However, the shares are priced below the market price. This means that there is a bonus element in right issue.

Calculation of Bonus Issue

The number of bonus shares is calculated by calculating the bonus fraction. The bonus fraction is then multiplied by the number of existing shares in issue.

Example:

ATL Limited had 2,000,000 shares in issue in January 1, 2019. On July 1, 2019, it made a 1 for 4 bonus issue.

Required:

Calculate the bonus fraction

Restatement of Comparative Figures

Whenever bonus shares are issued, the previous year’s EPS should be adjusted as if the bonus shares were in issue that year. The calculation is quite straightforward.

The calculation is as follows:

Multiply the previous year EPS by the inverse of the bonus fraction. Assuming that the previous year EPS was GH¢5 per share. The restated EPS will be:

Calculation of Right Issue

Remember, we said the right issue has a bonus element. This means the bonus fraction should be calculated. In order to calculate the bonus fraction, we need to find the following:

1. Market share price: This is the prevailing market price. Usually given in the question

2. Theoretical ex right price: This is the assumed(theoretical) price of shares after the right issue.

Example

A company had 3,600,000 shares in issue on 1 Jan Year 2. It made a 1 for 4 right issue on 1 June Year 2, at a price of GH¢40 per share. The share price just before the right issue was GH¢50. Total earnings in the financial year to 31 December Year 2 was GH¢25,125,000. The reported EPS in Year 1 was GH¢6.4.

Required:

Calculate EPS for Year 2 and a comparative EPS for Year 1.

Diluted EPS: Options

Options are contracts issued by an entity which allow the holder of the option to buy shares of the company at some point in the future at a pre-determined price.

Example:

A company has 5,000,000 ordinary shares in issue. Earnings for the year ended 2019 was GH¢25,000,000. There are outstanding share options on 400,000 shares , which can be exercised at a future date, at an exercise price of GH¢25 per share. The average market price of shares in 2019 was GH¢40.

Required:

(a) Calculate the Basic EPS

(b) Calculate the Diluted EPS

CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

 The conceptual framework for financial reporting is prepared by IFRS foundation. Financial reports are based on conventions, models, assumptions, judgment instead of the actual figures/exact depictions. The framework serves as a common guide in making such depictions. In other words, it provides the basis upon which assumptions, judgments are made by Accountants.

The conceptual framework covers the following:

1. The objective of financial reporting;

2. The qualitative characteristics of useful financial information;

3. The definition, recognition and measurement of elements of financial statement.

Purpose of the Conceptual Framework

The purpose of the Conceptual Framework is to:

(a) Assist the International Accounting Standard Board to develop standards that are based on consistent concepts;

(b) Assist national standard-setting bodies in developing national standards;

(c) Assist auditors in forming an opinion on whether financial statements comply with IFRs;

(d) Assist all parties to understand and interpret Standards.

Qualitative Characteristics of Useful Financial Information

Financial reports are used by external parties such as investors, bankers, creditors etc., in making decision on providing economic resources to the entity. Therefore, the report should be dependable and not misleading as in the case of ENRON where management prepared financial report that misled investors and eventually led to the Company’s collapse.

According to the conceptual framework, financial information is useful if it is relevant and faithfully represent what it purport to represent.

Relevance

Relevant financial information is capable of making a difference in the decisions made by users. For a financial information to make a difference, it should have predictive value, confirmatory value or both. Predictive value means users can use the information to estimate or determine the future performance or outcome of an entity. Financial information has confirmatory value if its confirms prediction that was made in the past.

Faithful Representation

This is where financial information represent faithfully/truthfully(without deception, omissions) the substance of the phenemonon/transaction that its purport to represent. Faithful financial information means the information is:

(a) Complete: it includes all relevant information with nothing withheld or hidden.

(b) Neutral: the information is not biased.

(c) Free from error: there are no errors or omissions in the report.

Enhancing Qualitative characteristics of Financial Information

These are:

(a) Comparability

(b) Verifiability

(c) Timeliness

(d) Understandability

Comparability

Comparability requires comparison between two or more items. It allows users to understand the similarities or differences between items in financial statements. For information to be comparable, like things must look alike and different things must look different.

Verifiability

Verifiability means that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a true representation.

Timeliness

Timeliness means having the information available to users in time to be capable of influencing their decision. Generally, the older the information is, the less useful it is.

Understandability

This means classifying, characterising and presenting information clearly and concisely.

MEASUREMENT OF ELEMENTS OF FINANCIAL STATEMENTS

The Conceptual Framework allows the following measurement techniques:

1. Historical Cost: Assets are measured at the amount of cash paid, or at the fair value of the consideration given to acquire them. Liabilities are measured at the amount of proceeds received in exchange of the obligation;

2. Current Cost:  Assets are measured at the amount that would be paid to purchase the same or similar asset currently. Liabilities are measured at the amount that would be required to settle the obligation currently.

3. Realizable value. Assets are measured at the amount that could be obtained by selling them. Liabilities are measured at the amount that would be required to settle them currently.

Present Value: Assets are measured at the value of the future net cash inflows that the item is expected to generate, discounted to a present value. Liabilities are measured at the discounted present value of the expected cash outflows that will be made to settle the liability.

INTANGIBLE ASSETS - IAS 38

Apart from tangible assets(assets that have a physical substance) that a company owns,  the company may own other assets without a physical substance. Examples of such assets are trademarks, logos, brand name, goodwill. Even though these assets do not have a physical substance, they are very essential to the company. A brand name may be considered as a powerful asset of a company. Brands such as Apple, Nike, Rolex are worth in millions of dollars. For example, in 2019, Apple brand was worth $205.5 billion. Assets without a physical substance are known as intangible assets.

IAS 38 defines intangible assets as " an identifiable, non-monetary assets without physical substance.

According to IAS 38, intangible assets should be recognized as an assets if they satisfy the following criteria:

1. Future economic benefit: The asset should be able to bring in future economic benefit such as revenue from sales of goods and services. For example, intellectual property, copyright are able to bring in economic benefit to the company.

2. Control: The entity must have the power to obtain the future economic benefits  flowing from the intangible assets. If the entity cannot control the future economic benefit flowing to the entity, the expenditure incurred should be expensed. For example, expenditure on staff training improves such skills, which improves productivity and therefore likely to generate higher future economic benefit. However, entities don't have control over staff because a staff member may choose to resign at anytime and the entity cannot do anything about it

3. Non-monetary: Monetary assets are defined as "money held and assets to be received in fixed or determinable amounts of money". Items such as cash, bank deposit, trade receivables are not intangible assets but rather financial assets.

4. Identifiable: Identifiable means the intangible assets should be separable. Separable is the quality of the assets being separated from the entity and sold, transferred, licensed, rented, or exchanged.

Cost of Intangible Assets

1. the purchase price, including any import duties and non-refundable purchase taxes, after deducting trade discounts and rebates; and

2. any directly attributable expenditure  on preparing the asset for it intended use. e.g professional fees for legal services, cost of testing.

If the asset is to be paid at a future date, the amount to be paid in the future is discounted to the present value. The difference between the amount to be paid and the present value amount is treated as interest.

Internally Generated Intangible Assets

IAS 38 states  that internally generated intangible assets shall not be recognised as an assets. It should be expensed. IAS 38 does not recognize the following as internally-generated items as intangible assets

1. goodwill

2. brands

3. customer list

However, if these were purchased from an external source, it would be recognized as an intangible assets.

Research and Development Cost

Research cost should be expensed. However, development cost should be capitalized if the following criteria can be met:

1. it is technically feasible to complete the development project

2. the company intends to complete the development of the asset for use or sale

3. future economic benefit can be generated

4. resources are available to complete the project

5. the development expenditure can be measured reliably

Example 1

During the year to 31 March 2018, a company incurred the following expenditure with regard to the development of a new production process:

                                                                                $000

1 April to 31 October 2017                                     230

1 November to 31 March 2018                               410

The criteria for the recognition of an internally generated asset were satisfied as from 1 November 2017. Explain the accounting treatment of the development costs.

Solution

The $230,000 must be written off as an expense. The $410,000 must be capitalized and recognized as an intangible asset in the statement of financial position.

NON CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS - IFRS 5

INTRODUCTION

Non-current assets are usually held for use in the production of income in a business. The accounting treatment for these assets is to spread the cost of the non-current assets over their useful lives through annual depreciation. However, at a point, management may make a decision to sell the assets instead of using them in the business. In this case, the assets will no longer to be depreciated because they are no longer in use in the business. They are rather classified us held for sale. As an example, a company may purchase a vehicle with a useful life of five (5) years. However, in the third year, management may decide to dispose/sell the vehicle. At this point, the vehicle will no longer be depreciated but it will be classified as held for sale.

IFRS 5 states that an asset should be classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than continuing use. The asset in question should be available for immediate sale in its present condition and the sale must be highly probable. The sale is highly probable if:

a.      Management is committed to a plan to sell the asset and an active program has been initiated to locate a buyer

b.      The asset is being actively marketed at a sale price that is reasonable in relation to its current fair value

c.       A completed sale is expected within one year of classification

d.      It is unlikely there will be any significant changes to the plan or the plan will be withdrawn.

If these criteria are not satisfied at the end of the reporting period, the asset should not be classified as held for sale.

 The classification also applies to disposal groups, which are a group of assets and possibly some liabilities which an entity intends to dispose of in a single transaction.

EXAMPLE 1

1.      Company A is committed to a plan to sell its headquarters building and has initiated an active programme to find a buyer and complete the plan. The building is being marketed at a reasonable price and a completed sale is expected within 12 months. It is unlikely that this plan will change significantly. The Company will not actually vacate the building until a buyer is found but then the time taken to vacate the building will not exceed what is regarded as usual and customary for such buildings.

Ans: Strictly speaking, the building is not immediately available since it will take time for the company to move out once a buyer is found. However, the time taken will be “usual and customary”. Furthermore, all of the other criteria for classification as held for sale are satisfied. Therefore the building should be classified as held for sale.

2.      Company B is also committed to a plan to sell its headquarters building and is in precisely the same situation as Company A except that it will not vacate the building and transfer it to a buyer until a new headquarters building has been constructed.

Ans: The building is not available for immediate sale since the sale cannot be completed until a new HQ building has been constructed. This building should not be classified as held for sale.

Measurement of non-current assets held for sale

IFRS requires that a non-current asset or disposal group which is held for sale should be measured at the lower of its carrying amount when it was initially classified as held for sale and its “fair value less cost to sell”

When an asset or disposal group is initially classified as held for sale, an impairment loss should be recognized if the fair value less costs to sell of the asset or group at that time is lower than its carrying value. A further impairment loss should be recognized if there is a decrease in the fair value less cost to sell and a gain should be recognized if there is an increase in fair value less costs to sell.

EXAMPLE 2

 On 1 July 2017, Do It All Limited which prepares financial statements to 31 December classifies a non-current asset as held for sale. The asset’s carrying amount on that day is GH¢ 10,000 and its fair value less costs to sell is GH¢ 9500. The asset is sold in May 2018 for GH¢9400(net of costs). Calculate any impairment losses (or gains) that should be recognized if the asset’s fair value less costs to sell at 31 December 2017 is:

i.                    GH¢ 9,200

ii.                  GH¢9,700

iii.                GH¢10,100

In each case, also calculate the gain or loss that should be recognized on the disposal of the asset.

Answer.

On 1 July 2017, the asset should be recognized in the balance sheet at the lower of its carrying amount and fair value less cost to sell. This means it will be valued at GH¢ 9,500. And impairment loss of GH¢500 will be recognized.

On 31 December 2017,

i.                    If the fair value less cost to sell is GH¢ 9,200, the asset will be remeasured at GH¢9,200 and impairment loss of GH¢300 will be recognized

ii.                  If the fair value less cost to sell is GH¢ 9,700, the asset will be remeasured at GH¢ 9,700 and a gain of GH¢200 will be recognized

iii.                If the fair value less cost to sell is GH¢ 10,100, the asset will be remeasured to GH¢ 10,000 and a gain of GH¢500 is recognized.(the gain cannot be GH¢600 since this would exceed the previously recognized impairment losses in relation to the asset

The gain or loss on the sale in May 2018 is as follows:

i.                    GH¢9400 - GH¢9200 = GH¢200 gain

ii.                  GH¢9400 - GH¢9,700 = GH¢300 loss

iii.                GH¢ 9400 - GH¢10,000 = GH¢ 600 loss

Measurement of Assets no longer classified as held for sale

If an asset is classified as held for sale and management realizes the conditions that allows it to be classified as held for sale cannot be met, the asset should cease to be classified as held for sale. The asset is then measured at the lower of:

·         Its carrying amount before being classified as held for sale, less any depreciation that would have been charged in the meantime if it had not been held for sale, and

·         Its recoverable amount at the date of the decision not to sell.

CALCULATIONS ON GOVERNMENT GRANT - IAS 20

Example 1:

Do IT BETTER Limited opens a factory in Koforidua and receives $15,000.00 government grant for capital equipment whose cost is $100,000.00. All plant and machinery in DO IT BETTER is depreciated using 20% straight line.

Required

Prepare an extract of statement of profit or loss and statement of financial position for the grant in the first year under both approaches prescribed by IAS 20.

GOVERNMENT GRANT - IAS 20

Government grants are assistance by government in the form of transfers of resources to an entity in return for past or future compliance with certain conditions relating to the operating activities of the entity.

Types of Grants

There are two (2) types of grants. These are:

1.       Capital Grant

2.       Revenue Grant

Capital Grant: Grant government gives to an entity to purchase, construct or acquire long term assets. Example: Government grant given to an entity to set up a factory, build a branch office in a particular location.

Revenue Grant: Grant government gives to an entity to take care of expenses such as salaries, utility cost, training cost etc.

Government grants, including non-monetary grants at fair value shall not be recognized until there is a reasonable assurance that:

1.       The entity will comply with the conditions attaching to them; and

2.       The grants will be received.

   

Treatment of Government Grant

Capital Grant

There are two methods of treating capital grants. These are:

1.       Deferred Income Approach: This is where the grant is recognised as deferred income and amortised(sent to the income statement) periodically in proportion to the useful life of the related asset

2.       Deduct grant from the cost of Asset: Deduct the grant from the cost of the asset and recognize the result in the income statement.