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.