International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
Page 580
Earnings
€
Profit from continuing operations attributable to the parent entity
16,400,000
Less dividends on preference shares
(6,400,000)
Profit from continuing operations attributable to ordinary equity holders of the parent entity
10,000,000
Loss from discontinued operations attributable to the parent entity
(4,000,000)
Profit attributable to ordinary equity holders of the parent entity
6,000,000
Ordinary shares outstanding
2,000,000
Average market price of one ordinary share during year
€75.00
Potential Ordinary Shares
Options
100,000 with exercise price of €60
Convertible
800,000 shares with a par value of €100 entitled to a cumulative dividend of €8 per
preference shares
share. Each preference share is convertible to two ordinary shares.
5% convertible
Nominal amount €100,000,000. Each €1,000 bond is convertible to 20 ordinary
bonds
shares. There is no amortisation of premium or discount affecting the determination
of interest expense.
Tax rate
40%
Increase in Earnings Attributable to Ordinary Equity Holders on Conversion of Potential Ordinary Shares
Increase in
number of Earnings per
Increase in
ordinary
incremental
earnings
shares
share
€
€
Options
Increase in earnings
Nil
Incremental shares issued for no consideration
100,000 × (€75 – €60) ÷ €75 =
20,000
Nil
Convertible preference shares
Increase in earnings
€800,000 × 100 × 0.08 =
6,400,000
Incremental shares
2 × 800,000 =
1,600,000
4.00
5% convertible bonds
Increase in earnings
€100,000,000 × 0.05 × (1 – 0.40) =
3,000,000
Incremental shares
100,000 × 20 =
2,000,000
1.50
The order in which to include the dilutive instruments is therefore:
(1) Options
(2) 5% convertible bonds
(3) Convertible preference shares
Earnings per share 2915
Calculation of Diluted Earnings per Share
Profit from continuing operations
attributable to ordinary equity holders
Ordinary
of the parent entity (control number)
shares
Per share
€
€
As reported
10,000,000
2,000,000
5.00
Options
–
20,000
10,000,000
2,020,000
4.95
Dilutive
5% convertible bonds
3,000,000
2,000,000
13,000,000
4,020,000
3.23
Dilutive
Convertible preference shares
6,400,000
1,600,000
19,400,000
5,620,000
3.45
Antidilutive
Because diluted earnings per share is increased when taking the convertible preference shares into
account (from €3.23 to €3.45), the convertible preference shares are antidilutive and are ignored in the
calculation of diluted earnings per share. Therefore, diluted earnings per share for profit from continuing
operations is €3.23:
Basic EPS
Diluted EPS
€
€
Profit from continuing operations attributable to ordinary equity
holders of the parent entity
5.00
3.23
Loss from discontinued operations attributable to ordinary equity
holders of the parent entity
(2.00) (a)
(0.99) (b)
Profit attributable to ordinary equity holders of the parent entity
3.00
(c)
2.24 (d)
(a)
(€4,000,000) ÷ 2,000,000 = (€2.00)
(b) (€4,000,000) ÷ 4,020,000 = (€0.99)
(c)
€6,000,000 ÷ 2,000,000 = €3.00
(d) (€6,000,000 + €3,000,000) ÷ 4,020,000 = €2.24
This example does not illustrate the classification of the components of convertible financial instruments as
liabilities and equity or the classification of related interest and dividends as expenses and equity as required
by IAS 32.
6.4
Particular types of dilutive instruments
6.4.1 Convertible
instruments
In order to secure a lower rate of interest, entities sometimes attach benefits to loan
stock, debentures or preference shares in the form of conversion rights. These permit
the holder to convert his holding in whole or part into equity capital. The right is
normally exercisable between specified dates. The ultimate conversion of the
instrument will have the following effects:
(a) there will be an increase in earnings by the amount of the interest (or items relating
to preference shares) no longer payable. As interest is normally allowable for tax
purposes, the effect on earnings may be net of a tax deduction relating to some or
all of the items; and
(b) the number of ordinary shares in issue will increase. The diluted EPS should be
calculated assuming that the instrument is converted into the maximum possible
number of shares. [IAS 33.49].
2916 Chapter 33
Convertible preference shares will be antidilutive whenever the amount of the dividend
on such shares declared in or accumulated for the current period per ordinary share
obtainable on conversion exceeds basic earnings per share. Similarly, convertible debt will
be antidilutive whenever its interest (net of tax and other changes in income or expense)
per ordinary share obtainable on conversion exceeds basic earnings per share. [IAS 33.50].
6.4.1.A Convertible
debt
The EPS calculation for convertible bonds is illustrated in the following example:
[IAS 33.IE6]
Example 33.9: Treatment of convertible bonds in diluted EPS calculations
Profit attributable to ordinary equity holders of the parent entity
€1,004
Ordinary shares outstanding
1,000
Basic earnings per share
€1.00
Convertible bonds
100
Each block of 10 bonds is convertible into three ordinary shares
Interest expense for the current year relating to the liability component of the convertible bonds
€10
Current and deferred tax relating to that interest expense
€4
Note: the interest expense includes amortisation of the discount arising on initial recognition of the liability
component (see IAS 32).
Adjusted profit attributable to ordinary equity holders of the parent entity
€1,004 + €10 – €4 = €1,010
Number of ordinary shares resulting from conversion of bonds
30
Number of ordinary shares used to calculate diluted earnings per share
1,000 + 30 = 1,030
Diluted earnings per share
€1,010 ÷ 1,030 = €0.98
This example does not illustrate the classification of the components of convertible financial instruments as
liabilities and equity or the classification of related interest and dividends as expenses and equity as required
by IAS 32.
As discussed at 6.2.2 above, the standard also discusses the impact on diluted EPS of
different settlement options. As discussed earlier, we believe this should be taken to
mean that for diluted EPS purposes earnings should be adjusted to remove any items
that arose from an instrument being classified as an asset or liability rather than equity.
The standard illustrates settlement options with the following example. [IAS 33.IE8].
Example 33.10: Convertible bonds settled in shares or cash at the issuer’s option
An entity issues 2,000 convertible bonds at the beginning of Year 1. The bonds have a three-year term, and
are issued at par with a face value of €1,000 per bond, giving total proceeds of €2,000,000. Interest is payable
annually in arrears at a nominal annual interest rate of 6 per cent. Each bond is convertible at any time up to
maturity into 250 common shares.
When the bonds are issued, the prevailing market interest rate for similar debt without a conversion option is
9 per cent. At the issue date, the market price of one common share is €3. Income tax is ignored.
Profit attributable to ordinary equity holders of the parent entity Year 1
€1,000,000
Ordinary shares outstanding
1,200,000
Convertible bonds outstanding
2,000
Allocation of proceeds of the bond issue:
Liability component *
€1,848,122
Equity component €151,878
€2,000,000
Earnings per share 2917
The liability and equity components would be determined in accordance with IAS 32. These amounts are
recognised as the initial carrying amounts of the liability and equity components. The amount assigned to
the issuer conversion option equity element is an addition to equity and is not adjusted.
*
This represents the present value of the principal and interest discounted at 9% – €2,000,000 payable
at the end of three years; €120,000 payable annually in arrears for three years.
Basic earnings per share Year 1:
€1,000,000
=
€0.83 per ordinary share
1,200,000
Diluted earnings per share Year 1:
It is presumed that the issuer will be required to settle the contract by the issue of ordinary shares. The
dilutive effect is therefore calculated in accordance with paragraph 59 of the Standard.
€1,000,000 + €166,331(a)
= €0.69 per ordinary share
1,200,000 + 500,000(b)
(a) Profit is adjusted for the accretion of €166,331 (€1,848,122 × 9%) of the liability because of the passage
of time.
(b) 500,000 ordinary shares = 250 ordinary shares × 2,000 convertible bonds
6.4.1.B
Convertible preference shares
The rules for convertible preference shares are very similar to those detailed above in
the case of convertible debt, i.e. dividends and other returns to preference shareholders
are added back to earnings used for basic EPS and the maximum number of ordinary
shares that could be issued on conversion should be used in the calculation.
As discussed at 5.2 above, one possible return to preference shareholders is a premium
payable on redemption or induced early conversion in excess of the original terms.
IAS 33 notes that the redemption or induced conversion of convertible preference
shares may affect only a portion of the previously outstanding convertible preference
shares. In such cases, the standard makes clear that any excess consideration is
attributed to those shares that are redeemed or converted for the purpose of
determining whether the remaining outstanding preference shares are dilutive. In other
words, the shares redeemed or converted are considered separately from those shares
that are not redeemed or converted. [IAS 33.51].
6.4.1.C
Participating equity instruments and two class shares with conversion
rights
The treatment for basic EPS of participating equity instruments and two class shares is
discussed at 5.4 above. When discussing these instruments the standard observes that
when calculating diluted EPS:
• conversion is assumed for those instruments that are convertible into ordinary
shares if the effect is dilutive;
• for those that are not convertible into a class of ordinary shares, profit or loss for
the period is allocated to the different classes of shares and participating equity
instruments in accordance with their dividend rights or other rights to participate
in undistributed earnings. [IAS 33.A14].
2918 Chapter 33
What the standard seems to be hinting at here, without directly addressing, is how to
present EPS for two or more classes of ordinary shares (say, class A and class B) when
one class can convert into another (say, class B can convert into class A). In this scenario,
in our view the basic EPS for each class should be calculated based on profit entitlement
(see 5.4 above). For diluted EPS it would be necessary to attribute to class A the profits
attributed to class B in the basic EPS – if the overall effect were dilutive to class A,
conversion should be assumed.
6.4.2
Options, warrants and their equivalents
6.4.2.A The
numerator
IAS 33 contains detailed guidance on the treatment for diluted EPS purposes of options,
warrants and their equivalents which it defines as ‘financial instruments that give the
holder the right to purchase ordinary shares’. [IAS 33.5]. However, it was largely written
before the significant developments in accounting for such instruments (IFRS 2 and
IAS 32). As a result, individual facts and circumstances must be considered and judgment
is required in some circumstances to address the dilutive effects on EPS.
IAS 33 clearly states that ‘Options and warrants ... do not affect the numerator of the
calculation’ [IAS 33.44] and this text was added in 2003 as part of the improvements project,
so clearly drafted against the back drop of the impending move to expensing share-based
payments and also the (then) recent changes to IAS 32 regarding accounting for derivatives
over an entity’s own shares. As regards employee share options in particular, neither IAS 33
(as updated by IFRS 2) nor the worked example appended to it (see Example 33.13 at 6.4.5
below) make reference to removing either some or all the charge when computing diluted
EPS. However, this seems to sit somewhat awkwardly (particularly for options outside the
scope of IFRS 2) with the general requirement for calculating diluted EPS that earnings be
adjusted for the effects of ‘any other changes in income or expense that would result from
the conversion of the dilutive potential ordinary shares’. [IAS 33.33]. Furthermore, IAS 33
explicitly requires an adjustment to the numerator in some circumstances:
(a) as discussed at 6.2.2 above, adj
ustment to the numerator may be required for a
contract (which could include options and warrants) that may be settled in ordinary
shares or cash at the entity’s option when such a contract is presented for
accounting purposes as an asset or a liability, or has an equity component and a
liability component. In such a case, the standard requires that ‘the entity shall
adjust the numerator 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’. 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 shall be
used in calculating diluted earnings per share’; [IAS 33.59-60]
(b) where an option agreement requires or permits the tendering of debt in payment of
the exercise price (and, if the holder could choose to pay cash, that tendering debt is
more advantageous to him) the numerator should be adjusted for the after tax
amount of any such debt assumed to be tendered (see 6.4.2.E below); [IAS 33.A7] and
(c) where option proceeds are required to be applied to redeem debt or other
instruments of the entity (see 6.4.2.F below). [IAS 33.A9].
Earnings per share 2919
For situations covered by (b) and (c) above the specific requirements of the standard for
adjusting the numerator should be followed. In other circumstances, the interaction of
these complex and conflicting requirements with each other and with IFRS 2 and IAS 32
lead to the following requirements when computing the numerator for diluted EPS:
(a) for instruments accounted for under IAS 32:
(i) for a contract classified wholly as an equity instrument, no adjustment to the
numerator will be necessary; and
(ii) for a contract not classified wholly as an equity instrument, the numerator