The question asked of the Committee was whether, in determining profit attributable to
ordinary shareholders in the basic EPS calculation, an entity should reflect the tax benefit
that would arise from the hypothetical distribution of profit to participating equity holders.
The Committee concluded that, when calculating basic EPS in the fact pattern
described in the submission, an entity should adjust profit or loss attributable to ordinary
shareholders for the portion of any tax benefit attributable to those ordinary
shareholders. This is because the tax benefit is a direct consequence of the hypothetical
distribution of profit to the participating equity holders required by IAS 33 (see 5.4
above). This accounting treatment should be applied regardless of whether an entity
would have recognised the tax benefit in equity or in profit or loss.
Because, in its view, the principles and requirements in IAS 33 provide an adequate basis
to calculate basic EPS in this scenario the Committee decided not to add this matter to its
standard-setting agenda. In publishing this decision, the Committee indicated its decision
to publish an illustrative example as educational material to accompany the agenda
decision, although no indication of when it would do so was given.
5.5 Other
bases
It is not uncommon for entities to supplement the EPS figures required by IAS 33 by
voluntarily presenting additional amounts per share. For additional earnings per share
amounts, the standard requires:
(a) that the denominator used should be that required by IAS 33;
(b) that basic and diluted amounts be disclosed with equal prominence and presented
in the notes;
(c) an indication of the basis on which the numerator is determined, including whether
amounts per share are before or after tax; and
(d) if the numerator is not reported as a line item in the statement of comprehensive
income or separate statement of profit or loss, a reconciliation to be provided
between it and a line item that is reported in the statement of comprehensive
income. [IAS 33.73, 73A].
In September 2007 the IASB indicated that it intended, as part of the annual
improvements project, to modify IAS 33 to prohibit the presentation of alternative EPS
figures on the face of the statement of comprehensive income. [IAS 1.BC103]. However,
that project was ultimately finalised without addressing this issue. As a result, alternative
EPS figures may be (and, in practice, are) presented on the face of the statement of
comprehensive income (or separate income statement) as well as in the notes, provided
that basic and diluted amounts are similarly disclosed with equal prominence.
The prevalence, within the European Union, of reporting alternative EPS measures on
the face of the income statement was a matter considered by the European Securities
and Markets Authority (ESMA). In April 2018 it published a report entitled Enforcement
and Regulatory Activities of Accounting Enforcers in 2017.
2910 Chapter 33
The report includes (at paragraph 31) the following: ‘Around 16% of issuers disclosed, in
addition to basic and diluted earnings per share, amounts per share using a reported
component of the statement of comprehensive income other than required by IAS 33.’
The document goes on to observe that of these, 54% presented the information ‘in the
notes rather than on the face of the statement’.
From this we infer that, of the sample examined by ESMA, approximately half of entities
disclosing alternative EPS presented the information on the face of the income statement.
6
DILUTED EARNINGS PER SHARE
6.1
The need for diluted EPS
The presentation of basic EPS seeks to show a performance measure, by computing
how much profit an entity has earned for each of the shares in issue for the period.
Entities often enter into commitments to issue shares in the future which would result
in a change in basic EPS. IAS 33 refers to such commitments as potential ordinary
shares, which it defines as ‘a financial instrument or other contract that may entitle its
holder to ordinary shares’. [IAS 33.5].
Examples of potential ordinary shares given by IAS 33 are:
(a) financial liabilities or equity instruments, including preference shares, that are
convertible into ordinary shares;
(b) options and warrants (whether accounted for under IAS 32 or IFRS 2);
(c) shares that would be issued upon the satisfaction of conditions resulting from
contractual arrangements, such as the purchase of a business or other assets.
[IAS 33.7].
When potential shares are actually issued, the impact on basic EPS will be two-fold.
First, the number of shares in issue will change; second, profits could be affected, for
example by lower interest charges or the return made on cash inflows. Scenarios
whereby such an adjustment to basic EPS is unfavourable are described by the standard
as dilution, defined as ‘a reduction in earnings per share or an increase in loss per share
resulting from the assumption that convertible instruments are converted, that options
or warrants are exercised, or that ordinary shares are issued upon the satisfaction of
specified conditions’. [IAS 33.5]. This potential fall in EPS is quantified by computing
diluted EPS, and as a result:
(a) profit or loss attributable to equity holders is increased by the after-tax amount of
dividends and interest recognised in the period in respect of the dilutive potential
ordinary shares and is adjusted for any other changes in income or expense that
would result from the conversion of the dilutive potential ordinary shares; and
(b) the weighted average number of ordinary shares outstanding is increased by the
weighted average number of additional ordinary shares that would have been
outstanding assuming the conversion of all dilutive potential ordinary shares.
[IAS 33.32].
Earnings per share 2911
6.2
Calculation of diluted EPS
IAS 33 requires a diluted EPS figure to be calculated for the profit or loss attributable to
ordinary equity holders of the parent and, if presented, profit or loss from continuing
operations attributable to them. [IAS 33.30]. For these purposes, the profit or loss
attributable to ordinary equity holders and the weighted average number of shares
outstanding should be adjusted for the effects of all potential ordinary shares. [IAS 33.31]. In
calculating diluted EPS, the number of shares should be that used in calculating basic EPS,
plus the weighted average number of shares that would be issued on the conversion of all
the dilutive potential ordinary shares into ordinary shares. As is the case for outstanding
shares in the basic EPS calculation, potential ordinary shares should be weighted for the
period they are outstanding. [IAS 33.36, 38]. Accordingly, potential ordinary shares:
• should be deemed to have been converted into ordinary shares at the beginning of
the period or, if not in existence at the beginning of the period, the date of their
issue; [IAS 33.36]
• which are cancelled or allowed to lapse should be included only for the period
they are outstanding; and
�
�� which convert into ordinary shares during the period are included up until the date
of conversion (from which point they will be included in the basic EPS). [IAS 33.38].
The number of dilutive potential ordinary shares should be determined independently
for each period presented, and not subsequently revisited. In particular, prior periods’
EPS are not restated for changes in assumptions about the conversion of potential shares
into shares. IAS 33 also stresses that the number of dilutive potential ordinary shares
included in the year-to-date period is not a weighted average of the dilutive potential
ordinary shares included in each interim computation. [IAS 33.37, 65].
6.2.1 Diluted
earnings
The earnings figure should be that used for basic EPS adjusted to reflect any changes
that would arise if the potential shares outstanding in the period were actually issued.
Adjustment is to be made for the post-tax effects of:
(a) any dividends or other items related to dilutive potential ordinary shares deducted
in arriving at the earnings figure used for basic EPS;
(b) any interest recognised in the period related to dilutive potential ordinary shares; and
(c) any other changes in income or expense that would result from the conversion of
the dilutive potential ordinary shares. [IAS 33.33].
These adjustments will also include any amounts charged in accordance with the
effective interest method prescribed by IAS 39 – Financial Instruments: Recognition
and Measurement – as a result of allocating transaction costs, premiums or discounts
over the term of the instrument. [IAS 33.34]. Instruments with a choice of settlement
method may also require adjustments to the numerator as discussed at 6.2.2 below.
The standard notes that certain earnings adjustments directly attributable to the
instrument could also affect other items of income or expense which will need to be
accounted for. For example, the lower interest charge following conversion of
convertible debt could lead to higher charges under profit sharing schemes. [IAS 33.35].
2912 Chapter 33
No imputed earnings are taken into account in respect of the proceeds to be received
on exercise of share options or warrants. The effect of such potential ordinary shares
on the diluted EPS is reflected in the computation of the denominator. This is discussed
at 6.4.2 below.
6.2.2
Diluted number of shares
IAS 33 discusses a number of specific types of potential ordinary shares and how they
should be brought into the calculation; these are discussed at 6.4 below.
More generally, the standard also discusses scenarios where the method of conversion or
settlement of potential ordinary shares is at the discretion of one of the parties, as follows:
(a) the number of shares that would be issued on conversion should be determined
from the terms of the potential ordinary shares. When more than one basis of
conversion exists, the calculation should assume the most advantageous
conversion rate or exercise price from the standpoint of the holder of the potential
ordinary shares; [IAS 33.39]
(b) when an entity has issued a contract that may be settled in shares or cash at its option,
it should presume that the contract will be settled in shares. The resulting potential
ordinary shares would be included in diluted earnings per share if the effect is dilutive.
[IAS 33.58]. When such a contract is presented for accounting purposes as an asset or a
liability, or has an equity component and a liability component, the numerator should
be adjusted for any changes in profit or loss that would have resulted during the
period if the contract had been classified wholly as an equity instrument. That
adjustment is similar to the adjustments discussed at 6.2.1 above; [IAS 33.59] and
(c) for contracts that may be settled in ordinary shares or cash at the holder’s option,
the more dilutive of cash settlement and share settlement should be used in
calculating diluted earnings per share. [IAS 33.60].
An example of an instrument covered by (b) above is a debt instrument that, on maturity,
gives the issuer the unrestricted right to settle the principal amount in cash or in its own
ordinary shares (see Example 33.10 at 6.4.1.A below). An example of an instrument
covered by (c) is a written put option that gives the holder a choice of settling in ordinary
shares or cash. [IAS 33.61].
In our view, the requirements of the standard in (b) and (c) above relating to settlement
options are somewhat confused. In particular they seem to envisage a binary accounting
model based on the strict legal form of settlement (cash or shares). However, IAS 32 sets out
rules for three different settlement methods – net cash, net shares and gross physical
settlement (discussed in Chapter 43 at 5). One consequence of the above is that, if taken
literally, the numerator is only required to be adjusted to remove items of income or expense
arising from a liability when there is a choice of settlement method. However, mandatory net
share settlement also gives rise to a liability and income/expense under IAS 32. In our view
any such income statement items should be removed for diluted EPS purposes.
6.3
Dilutive potential ordinary shares
Only those potential shares whose issue would have a dilutive effect on EPS are brought
into the calculation. Potential ordinary shares are ‘antidilutive’ when their conversion
Earnings per share 2913
to ordinary shares would increase earnings per share or decrease loss per share.
[IAS 33.5, 43]. The calculation of diluted earnings per share should not assume conversion,
exercise, or other issue of potential ordinary shares that would have an antidilutive
effect on earnings per share. [IAS 33.43]. The standard gives detailed guidance for
determining which potential shares are deemed to be dilutive, and hence brought into
the diluted EPS calculation. This guidance covers the element of profit which needs to
be diluted to trigger inclusion, and the sequence in which potential shares are tested to
establish cumulative dilution. Each is discussed below.
6.3.1
Dilution judged by effect on profits from continuing operations
Potential ordinary shares are only to be treated as dilutive if their conversion to ordinary
shares would decrease earnings per share or increase loss per share from continuing
operations. The ‘control number’ that this focuses on is therefore the net result from
continuing operations, which is the net profit or loss attributable to the parent entity,
after deducting items relating to preference shares (see 5.2 above) and after excluding
items relating to discontinued operations. [IAS 33.42]. The same denominator is required
to be used to compute diluted EPS from continuing operations and total diluted EPS.
Determining which potential shares are to be included by reference to their impact on
continuing EPS can produce some slightly curious results for total EPS. For example, it
is possible to exclude instruments which would dilute basic EPS (but not continuing
EPS), and include items which are anti-dilutive as regards total profit. This latter point
is acknowledged by the standard as follows.
‘To illustrate the applicatio
n of the control number notion ... assume that an entity
has profit from continuing operations attributable to the parent entity of CU 4,800,
a loss from discontinued operations attributable to the parent entity of (CU 7,200),
a loss attributable to the parent entity of (CU 2,400), and 2,000 ordinary shares and
400 potential ordinary shares outstanding. The entity’s basic earnings per share is
CU 2.40 for continuing operations, (CU 3.60) for discontinued operations and
(CU 1.20) for the loss. The 400 potential ordinary shares are included in the diluted
earnings per share calculation because the resulting CU 2.00 earnings per share for
continuing operations is dilutive, assuming no profit or loss impact of those 400
potential ordinary shares. Because profit from continuing operations attributable
to the parent entity is the control number, the entity also includes those 400
potential ordinary shares in the calculation of the other earnings per share
amounts, even though the resulting earnings per share amounts are antidilutive to
their comparable basic earnings per share amounts, i.e. the loss per share is less
[(CU 3.00) per share for the loss from discontinued operations and (CU 1.00) per
share for the loss].’ [IAS 33.A3].
6.3.2
Dilution judged by the cumulative impact of potential shares
Where an entity has a number of different potential ordinary shares, in deciding
whether they are dilutive (and hence reflected in the calculation), each issue or series
of potential ordinary shares is to be considered in sequence from the most to the least
dilutive. Only those potential shares which produce a cumulative dilution are to be
included. This means that some potential shares which would dilute basic EPS if viewed
on their own may need to be excluded. This results in a diluted EPS showing the
2914 Chapter 33
maximum overall dilution of basic EPS. The standard observes that options and
warrants should generally be included first as they do not affect the numerator in the
diluted EPS calculation (but see the discussion at 6.4.2 below). [IAS 33.44]. The way this is
to be done is illustrated in the following example. [IAS 33.IE9].
Example 33.8: Calculation of weighted average number of shares: determining
the order in which to include dilutive instruments
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 579