should be adjusted for any changes in profit or loss that would have resulted
if it had been classified wholly as an equity instrument; and
(b) for instruments accounted for under IFRS 2:
(i) for those treated as equity-settled, the IFRS 2 charge should not be adjusted
for; and
(ii) for those treated as cash-settled, the numerator should be adjusted for any
changes in profit or loss that would have resulted if the instrument had been
classified wholly as an equity instrument.
In respect of (b), part (i) is supported by the IASB’s view regarding share-based payments
as follows.
‘Some argue that any cost arising from share-based payment transactions is already
recognised in the dilution of earnings per share (EPS). If an expense were recognised in
the income statement, EPS would be “hit twice”.
‘However, the Board noted that this result is appropriate. For example, if the entity paid
the employees in cash for their services and the cash was then returned to the entity, as
consideration for the issue of share options, the effect on EPS would be the same as
issuing those options direct to the employees.
‘The dual effect on EPS simply reflects the two economic events that have occurred:
the entity has issued shares or share options, thereby increasing the number of shares
included in the EPS calculation – although, in the case of options, only to the extent
that the options are regarded as dilutive – and it has also consumed the resources it
received for those options, thereby decreasing earnings. ...
‘In summary, the Board concluded that the dual effect on diluted EPS is not double-
counting the effects of a share or share option grant – the same effect is not counted
twice. Rather, two different effects are each counted once.’ [IFRS 2.BC54-BC57].
As for part (ii) of (b) above, this is the explicit requirement of IAS 33 when the entity
can choose cash or share settlement. It is also implicit in the requirement of the
standard that 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. This would also explain why IFRS 2
requires the computation of grant date fair values for cash-settled share-based
payments when that information is not actually required for accounting purposes
(see Chapter 30 at 9.3.2).
2920 Chapter 33
6.4.2.B
Written call options
Entities may issue options or warrants which give holders the right to subscribe for shares
at fixed prices on specified future dates. If the options or warrants are exercised then:
(a) the number of shares in issue will be increased; and
(b) funds will flow into the company and these will produce income.
For calculating diluted EPS, IAS 33 requires the exercise of all dilutive options and
warrants to be assumed. [IAS 33.45]. Options and warrants are considered dilutive when
they would result in the issue of ordinary shares for less than the average market price of
ordinary shares during the period. The amount of the dilution is taken to be the average
market price of ordinary shares during the period minus the issue price. [IAS 33.46].
Under IAS 33 the effects of such potential ordinary shares on the diluted EPS are
reflected in the computation of the denominator using a method sometimes called the
‘treasury stock method’.
For this purpose, the weighted average number of shares used in calculating the basic
EPS is increased, but not by the full number of shares that would be issued on exercise
of the instruments. To determine how many additional shares to include in the
denominator, the assumed proceeds from these issues are to be treated as having been
received in exchange for:
• a certain number of shares at their average market price for the period (i.e. no EPS
impact); and
• the remainder for no consideration (i.e. full dilution). [IAS 33.45-46].
This means that the excess of the total number of potential shares over the number that
could be issued at their average market price for the period out of the issue proceeds is
included within the denominator; the calculation is illustrated as follows: [IAS 33.IE5]
Example 33.11: Effects of share options on diluted earnings per share
Profit attributable to ordinary equity holders of the parent entity for year
€1,200,000
Weighted average number of ordinary shares outstanding during year
500,000 shares
Average market price of one ordinary share during year
€20.00
Weighted average number of shares under option during year
100,000 shares
Exercise price for shares under option during year
€15.00
Calculation of earnings per share
Earnings
Shares Per
share
Profit attributable to ordinary equity holders of the parent
entity for year
€1,200,000
Weighted average shares outstanding during year
500,000
Basic earnings per share
€2.40
Weighted average number of shares under option
100,000
Weighted average number of shares that would have been
issued at average market price:
(100,000 × €15.00) ÷ €20.00
*
(75,000)
Diluted earnings per share
€1,200,000
525,000 €2.29
*
Earnings have not increased because the total number of shares has increased only by the number of
shares (25,000) deemed to have been issued for no consideration.
Earnings per share 2921
The number of shares viewed as fairly priced (and hence neither dilutive nor
antidilutive) for this purpose is calculated on the basis of the average price of the
ordinary shares during the reporting period. [IAS 33.46]. The standard observes that, in
theory, calculating an average share price for the period could include every market
transaction in the shares. However, it notes that as a practical matter an average (weekly
or monthly) will usually be adequate. [IAS 33.A4]. The individual prices used should
generally be the closing market price unless prices fluctuate widely, in which case the
average of high and low prices may be more representative. Whatever method is
adopted, it should be used consistently unless it ceases to yield a representative price.
For example, closing prices may have been used consistently in a series of relatively
stable periods then a change to high/low average could be appropriate when prices
begin to fluctuate more widely. [IAS 33.A5].
The shares would be deemed to have been issued at the beginning of the period or, if
later, the date of issue of the warrants or options. Options which are exercised or lapse
in the period are included for the portion of the period during which they
were outstanding. [IAS 33.36, 38].
Although the standard seems to require that the fair value used should be the average for
the reporting period for all outstanding options or warrants, in our view, for instruments
issued, lapsed or exercised during the period a credible case could b
e made for using an
average price for that part of the reporting period that the instrument was outstanding.
Indeed, this view is supported by the comprehensive example included in the standard
(see the appendix to this chapter), where in computing the number of warrants to be
included in calculating the diluted EPS for the full year, the average price used was not
that for the full year, but only for the period that the warrants were outstanding.
One practical problem with this requirement is that the average market price of ordinary
shares for the reporting period may not be available. Examples would include an entity
only listed for part of the period, or an unlisted entity giving voluntary disclosures. In
such cases estimates of the market price would need to be made.
6.4.2.C
Written put options and forward purchase agreements
Contracts that require the entity to repurchase its own shares, such as written put options
and forward purchase contracts, should be reflected in the calculation of diluted earnings
per share if the effect is dilutive. If these contracts are ‘in the money’ during the period
(i.e. the exercise or settlement price is above the average market price for that period),
IAS 33 requires the potential dilutive effect on EPS to be calculated as follows:
• it should be assumed that at the beginning of the period sufficient ordinary shares
are issued (at the average market price during the period) to raise proceeds to
satisfy the contract;
• the proceeds from the issue are then assumed to be used to satisfy the contract (i.e.
to buy back ordinary shares); and
• the incremental ordinary shares (the difference between the number of ordinary
shares assumed issued and the number of ordinary shares received from satisfying
the contract) should be included in the calculation of diluted earnings per share.
[IAS 33.63].
2922 Chapter 33
The standard illustrates this methodology as follows: ‘... assume that an entity has
outstanding 120 written put options on its ordinary shares with an exercise price of
CU 35. The average market price of its ordinary shares for the period is CU 28. In
calculating diluted earnings per share, the entity assumes that it issued 150 shares at
CU 28 per share at the beginning of the period to satisfy its put obligation of CU 4,200.
The difference between the 150 ordinary shares issued and the 120 ordinary shares
received from satisfying the put option (30 incremental ordinary shares) is added to the
denominator in calculating diluted earnings per share.’ [IAS 33.A10].
6.4.2.D
Options over convertible instruments
Although not common, it is possible that an entity grants options or warrants to acquire
not ordinary shares directly but other instruments convertible into them (such as
convertible preference shares or debt). In this scenario, IAS 33 sets a dual test:
• exercise is assumed whenever the average prices of both the convertible
instrument and the ordinary shares obtainable upon conversion are above the
exercise price of the options or warrants; but
• exercise is not assumed unless conversion of similar outstanding convertible
instruments, if any, is also assumed. [IAS 33.A6].
6.4.2.E
Settlement of option exercise price with debt or other instruments of the
entity
The standard notes that options or warrants may permit or require the tendering of debt
or other instruments of the entity (or its parent or a subsidiary) in payment of all or a
portion of the exercise price. In the calculation of diluted earnings per share, those
options or warrants have a dilutive effect if (a) the average market price of the related
ordinary shares for the period exceeds the exercise price or (b) the selling price of the
instrument to be tendered is below that at which the instrument may be tendered under
the option or warrant agreement and the resulting discount establishes an effective
exercise price below the market price of the ordinary shares obtainable upon exercise.
In the calculation of diluted EPS, those options or warrants should be assumed to be
exercised and the debt or other instruments assumed to be tendered. If tendering cash
is more advantageous to the option or warrant holder and the contract permits it,
tendering of cash should be assumed. Interest (net of tax) on any debt assumed to be
tendered is added back as an adjustment to the numerator. [IAS 33.A7].
Similar treatment is given to preference shares that have similar provisions or to other
instruments that have conversion options that permit the investor to pay cash for a more
favourable conversion rate. [IAS 33.A8].
6.4.2.F Specified
application of option proceeds
IAS 33 observes that the underlying terms of certain options or warrants may require
the proceeds received from the exercise of those instruments to be applied to redeem
debt or other instruments of the entity (or its parent or a subsidiary). In which case it
requires that in ‘the calculation of diluted earnings per share, those options or warrants
are assumed to be exercised and the proceeds applied to purchase the debt at its average
market price rather than to purchase ordinary shares. However, the excess proceeds
Earnings per share 2923
received from the assumed exercise over the amount used for the assumed purchase of
debt are considered (i.e. assumed to be used to buy back ordinary shares) in the diluted
earnings per share calculation. Interest (net of tax) on any debt assumed to be purchased
is added back as an adjustment to the numerator.’ [IAS 33.A9].
6.4.3
Purchased options and warrants
IAS 33 states that a holding by an entity of options over its own shares will always be
antidilutive because:
• put options would only be exercised if the exercise price were higher than the
market price; and
• call options would only be exercised if the exercise price were lower than the
market price.
Accordingly, the standard requires that such instruments are not included in the
calculation of diluted EPS. [IAS 33.62].
However, depending upon the settlement mechanism and the share price at the
beginning and end of the period, the option could have resulted in a gain being reported
(see Chapter 43 at 5). It is therefore possible that the removal of any such gain from the
numerator could have a greater dilutive effect than the reduction in the denominator
and hence render the option dilutive. In that circumstance, the option should be
included in the diluted EPS calculation.
6.4.4
Partly paid shares
As noted at 3.2 above, shares issued in partly paid form are to be included in the basic EPS
as a fraction of a share, based on dividend participation. As regards diluted EPS they are
to be treated, to the extent that they are not entitled to participate in dividends, as the
equivalent of options or warrants. The unpaid balance is assumed to represent proceeds
used to purchase ordinary shares. The number of shares included in diluted earnings per
share is the difference between the number of shares subscribed and the number of shares
assumed to be purchased. [IAS 33.A16]. The mechan
ics of this treatment are not further spelt
out in the standard, but the phrase ‘treated as a fraction of an ordinary share’ is not
repeated. Instead, it is ‘the number of shares subscribed’ which the standard says should
be compared to the number assumed purchased to measure dilution. However, ‘the
number of shares subscribed’ is not defined. Whilst this could be read to mean that the
remaining unpaid consideration is to be treated as the exercise price for options over all
of the shares issued in partly paid form, we believe the better interpretation is that the
unpaid capital should be viewed as the exercise price for options over the proportion of
the shares not reflected in the basic EPS. This would mean that if the average share price
for the period were the same as the total issue price, then no dilution would be reported.
Furthermore, an issue of partly paid shares, say 50% paid with 50% dividend entitlement
is economically identical to an issue of half the quantity as fully paid (with full dividend
entitlement) and a forward contract for the remaining half. In that scenario, the issued
shares would be incorporated into the basic and diluted EPS in full from the date of issue.
The forward contract would be included in diluted EPS calculation by comparing the
contracted number of shares with the number of shares that could be bought out of
proceeds based on the average share price for the period. In our view, these economically
2924 Chapter 33
identical transactions should produce the same diluted EPS – that would be achieved by
interpreting ‘the number of shares subscribed’ as the number economically subscribed,
i.e. the proportion of part-paid shares not already included in basic EPS.
An illustration of what the calculation would look like is as follows:
Example 33.12: Partly paid shares
Capital structure
Issued share capital as at 31 December 2018:
2,000,000 ordinary shares of 10c each
Issued on 1 January 2019:
500,000 part paid ordinary shares of 10c each. Full consideration of 50c per share (being fair value at
1 January 2019) paid up 50% on issue. Dividend participation 50% until fully paid. New shares remain part
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 581