paid at 31 December 2019.
Average fair value of one ordinary share for the period 60c.
Trading results
Net profit attributable to ordinary shareholders for the year ended 31 December 2019: €100,000.
Computation of basic and diluted EPS
Net profit attributable to
Ordinary
Per
ordinary shareholders
shares
share
€
No.
Fully paid shares
2,000,000
Partly paid shares (1)
250,000
Basic EPS
100,000
2,250,000
4.44c
Dilutive effect of partly paid shares (2)
41,667
Diluted EPS
100,000
2,291,667
4.36c
(1) 50% dividend rights for 500,000 shares.
(2) Outstanding consideration of €125,000 (500,000 × 25c), using fair value of 60c this equates to
208,333 shares, hence the number of dilutive shares deemed issued for free is 41,667 (250,000 – 208,333).
The example assumes the fair value of the shares over the year is higher than the issue
price, which explains why some extra shares are included in the diluted EPS. If the
average fair value remained at the issue price of 50c then no additional shares would be
included for diluted EPS.
6.4.5 Share-based
payments
Share options and other incentive schemes are a common feature of employee
remuneration, and can come in many forms. For diluted EPS purposes, IAS 33 identifies
two categories and specifies the diluted EPS treatment for each. The categories are:
(a) performance-based employee share options; and
(b) employee share options with fixed or determinable terms and non-vested ordinary
shares. [IAS 33.48].
Before moving on to the diluted EPS treatment, it is worth noting an issue that arises from
the way IAS 33 phrases this categorisation and subsequent guidance. Although not clearly
stated in the standard, we believe all schemes should be treated as either category (a) or
category (b). Any arrangements where entitlement is subject to future performance would
fall into category (a) with category (b) being the default for all other arrangements.
Earnings per share 2925
Schemes in the first category are to be treated as contingently issuable shares (see 6.4.6
below) because their issue is contingent upon satisfying specified conditions in addition
to the passage of time. [IAS 33.48].
Those in the second category are to be treated as options (see 6.4.2 above). They should
be regarded as outstanding from the grant date, even if they vest, and hence can be
realised by the employees, at some later date. [IAS 33.48]. An example would be an
unexpired loyalty period. This means that some shares may be included in diluted EPS
which never, in fact, get issued to employees because they fail to remain with the
company for this period. Furthermore, for share options and other share-based
payment arrangements to which IFRS 2 applies, the proceeds figure to be used in
calculating the dilution under such schemes should include the fair value (as determined
in accordance with IFRS 2) of any goods or services to be supplied to the entity in the
future under the arrangement. [IAS 33.47A]. An example illustrating the latter point is as
follows: [IAS 33.IE5A]
Example 33.13: Determining the exercise price of employee share options
Weighted average number of unvested share options per employee
1,000
Weighted average amount per employee to be recognised over the remainder of the vesting
period for employee services to be rendered as consideration for the share options, determined
in accordance with IFRS 2
€1,200.00
Cash exercise price of unvested share options
€15.00
Calculation of adjusted exercise price
Fair value of services yet to be rendered per employee:
€1,200.00
Fair value of services yet to be rendered per option: (€1,200 ÷ 1,000)
€1.20
Total exercise price of share options: (€15.00 + €1.20)
€16.20
Whilst the standard requires that the additional deemed proceeds is the fair value of
goods or services yet to be received, the example clarifies that it is the IFRS 2 expense
yet to be charged to income.
What this requirement seeks to reflect is that for such options the issuer will receive not
just the cash proceeds (if any) under the option when it is exercised but also valuable
goods and services over its life. This will result in the dilutive effect of the options
increasing over time as the deemed proceeds on exercise of the options reduces.
6.4.6
Contingently issuable shares
IAS 33 contains considerable detailed guidance, including a numerical worked example,
on contingently issuable shares. Contingently issuable ordinary shares are defined as
‘ordinary shares issuable for little or no cash or other consideration upon satisfaction of
specified conditions in a contingent share agreement.’ A contingent share agreement is
defined by the standard as ‘an agreement to issue shares that is dependent on the
satisfaction of specified conditions.’ [IAS 33.5]. The basic rule is that the number of
contingently issuable shares to be included in the diluted EPS calculation is ‘based on
the number of shares that would be issuable if the end of the period were the end of the
contingency period’. [IAS 33.52]. This requirement to look at the status of the contingency
at the end of the reporting period, rather than to consider the most likely outcome,
seems to have the overall result of reducing the amount of dilution disclosed.
2926 Chapter 33
The discussions in the standard cover three broad categories: earnings-based
contingencies, share price-based contingencies, and other contingencies. These are
discussed in turn below.
The number of shares contingently issuable may depend on future earnings and future
prices of the ordinary shares. In such cases, the standard makes clear that the number
of shares included in the diluted EPS calculation is based on both conditions (i.e.
earnings to date and the current market price at the end of the reporting period). In
other words, contingently issuable shares are not included in the diluted EPS calculation
unless both conditions are met. [IAS 33.55].
6.4.6.A Earnings-based
contingencies
The standard discusses the scenario where shares would be issued contingent upon the
attainment or maintenance of a specified amount of earnings for a period. In such a case
the standard requires that ‘if that amount has been attained at the end of the reporting
period but must be maintained beyond the end of the reporting period for an additional
period, then the additional ordinary shares are treated as outstanding, if the effect is
dilutive, when calculating diluted earnings per share. In that case, the calculation of diluted
earnings per share is based on the number of ordinary shares that would be issued if the
amount of earnings at the end of the reporting period were the amount of earnings at the
end of the contingency period’. [IAS 33.53]. As
a result, earnings-based contingencies need
to be viewed as an absolute cumulative hurdle which either is met or not met at the
reporting date. Often, such contingencies may be contractually expressed in terms of
annual performance over a number of years, say an average of €1million profit per year
for three years. In our view, ‘the attainment or maintenance of a specified amount of
earnings for a period’ in this scenario would mean generating a total of €3million of profits.
If that is achieved by the end of a reporting period, the shares are outstanding for diluted
EPS purposes and included in the computation if the effect is dilutive. It could, perhaps,
be argued that the potential shares should be considered outstanding if profits of €1million
were generated at the end of the first year. However, the requirement that the calculation
be ‘based on the number of ordinary shares that would be issued if the amount of earnings
at the end of the reporting period were the amount of earnings at the end of the
contingency period’ means that the test must be: would shares be issued if the current
earnings of €1million were all the profits earned by the end of the three year contingency
period? In this example the answer is no, as that amount of earnings would fall short of
averaging €1million per year. The standard then notes that, because earnings may change
in a future period, the calculation of basic EPS does not include such contingently issuable
shares until the end of the contingency period because not all necessary conditions have
been satisfied. [IAS 33.53].
An earnings-based contingency is illustrated in the following example: [IAS 33.IE7]
Example 33.14: Contingently issuable shares
Ordinary shares outstanding during 2019:
1,000,000 (there were no options, warrants or
convertible instruments outstanding during the period)
An agreement related to a recent business
5,000 additional ordinary shares for each new retail site
combination provides for the issue of additional
opened during 2019
Earnings per share 2927
Ordinary shares based on the following
1,000 additional ordinary shares for each €1,000 of
conditions:
consolidated profit in excess of €2,000,000 for the year
ended 31 December 2019
Retail sites opened during the year:
one on 1 May 2019
one on 1 September 2019
Consolidated year-to-date profit attributable to
€1,100,000 as of 31 March 2019
ordinary equity holders of the parent entity:
€2,300,000 as of 30 June 2019
€1,900,000 as of 30 September 2019 (including a
€450,000 loss from a discontinued operation)
€2,900,000 as of 31 December 2019
Basic earnings per share
First
Second
Third
Fourth
quarter
quarter
quarter
quarter Full
year
Numerator (€)
1,100,000
1,200,000
(400,000)
1,000,000 2,900,000
Denominator:
Ordinary shares outstanding
1,000,000
1,000,000
1,000,000
1,000,000 1,000,000
Retail site contingency
–
3,333 (a)
6,667 (b)
10,000 5,000
(c)
Earnings contingency (d)
–
–
–
– –
Total shares
1,000,000
1,003,333
1,006,667
1,010,000 1,005,000
Basic earnings per share (€)
1.10
1.20
(0.40)
0.99
2.89
(a)
5,000 shares × 2/3
(b)
5,000 shares + (5,000 shares × 1/3)
(c)
(5,000 shares × 8/12) + (5,000 shares × 4/12)
(d)
The earnings contingency has no effect on basic earnings per share because it is not certain that the
condition is satisfied until the end of the contingency period. The effect is negligible for the fourth-
quarter and full-year calculations because it is not certain that the condition is met until the last day
of the period.
Diluted earnings per share
First
Second
Third
Fourth
quarter
quarter
quarter
quarter
Full year
Numerator (€)
1,100,000
1,200,000
(400,000)
1,000,000
2,900,000
Denominator:
Ordinary shares
outstanding 1,000,000
1,000,000
1,000,000
1,000,000
1,000,000
Retail site contingency
–
5,000
10,000
10,000
10,000
Earnings contingency
– (e)
300,000 (f)
– (g)
900,000 (h) 900,000 (h)
Total shares
1,000,000
1,305,000
1,010,000
1,910,000 1,910,000
Diluted earnings per
share (€)
1.10
0.92
(0.40) (i)
0.52
1.52
(e) Year-to-date profits do not exceed €2,000,000 at 31 March 2019. The Standard does not permit
projecting future earnings levels and including the related contingent shares.
(f)
[(€2,300,000 – €2,000,000) ÷ 1,000] × 1,000 shares = 300,000 shares.
(g) Year-to-date profit is less than €2,000,000.
(h)
[(€2,900,000 – €2,000,000) ÷ 1,000] × 1,000 shares = 900,000 shares.
(i)
Because the loss during the third quarter is attributable to a loss from a discontinued operation, the
antidilution rules do not apply. The control number (i.e. profit or loss from continuing operations
attributable to the equity holders of the parent entity) is positive. Accordingly, the effect of potential
ordinary shares is included in the calculation of diluted earnings per share.
2928 Chapter 33
This example from IAS 33 illustrates quarterly financial reporting. However, the
principles are the same whether the reporting period is illustrated as three months or
one year. The example does illustrate that the earnings target is a cumulative hurdle
over the entire contingency period (four reporting periods in the example) rather than
including potential shares based on the assumption that the level of quarterly profit
would be maintained for the four quarters.
The standard only discusses earnings criteria based on absolute measures; in the
example above a cumulative profit in excess of €2,000,000. In our experience such
criteria are rare. In practice criteria are often phrased in terms of relative performance
against an external benchmark. Examples would be earnings growth targets of inflation
plus 2% or EPS growth being in the top quartile of a group of competitors. For
contingencies such as these it is impossible to establi
sh an absolute target in order to ask
whether it is met at the period end. For example, consider the earnings contingency in
IAS 33, discussed above, to achieve profits in excess of €2,000,000 over four quarters.
If this instead required the profits to be €2,000,000 adjusted in line with inflation, it
would be impossible to know how many shares would be issued if the cumulative profit
at the end of the second quarter of €2,300,000 were the amount of earnings at the end
of the contingency period. Until the end of the year the absolute level of profit required
would be unknown; it would be more or less than €2,000,000 depending on the level
of inflation or deflation over the period.
There would seem to be (at least) two different ways of interpreting the requirements
of IAS 33 in such a scenario, each resulting in a different diluted EPS figure. One
approach would be to consider such criteria as being based on ‘a condition other than
earnings or market price’. That would mean (as discussed at 6.4.6.C below) that the
number of shares brought into diluted EPS would be based on the status of the condition
at the end of the reporting period. [IAS 33.56]. So, if the target was earnings for the year in
excess of €2,000,000 adjusted in line with inflation and at the end of the second quarter
inflation had been 4%, then the target would become €2,080,000 and hence
220,000 shares would be included for diluted EPS for the second quarter. An alternative
approach would be to regard it as an earnings-based contingency and make an
assumption as to future inflation over the contingency period. This would allow a
cumulative hurdle to be calculated and compared with actual earnings to date. So if at
the end of the second quarter it was estimated that the annual inflation for the year was
5%, then the target would become €2,100,000 and hence 200,000 shares would be
included for diluted EPS for the second quarter. Given the lack of clarity in the standard,
it seems likely that either of the above approaches may be selected in practice.
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 582