Workbook on IAS 33 Earnings per share

IAS 33 STUDENT HANDBOOK

Earnings Per Share Made Simple

A Practical Guide for Finance Graduates Current Standard

INTRODUCTION

Welcome to your comprehensive guide to IAS 33 - Earnings Per Share! This handbook is designed specifically for finance graduates who need to understand and apply EPS calculations in their professional careers.

Why EPS Matters

Earnings Per Share is one of the most widely watched financial metrics by investors, analysts, and management. It shows how much profit each share has earned and is crucial for:

• Valuing companies
• Comparing performance across companies
• Making investment decisions
• Executive compensation decisions

What You'll Learn

• Basic and Diluted EPS calculations
• Real-world examples and scenarios
• Common pitfalls and how to avoid them
• Practical implementation tips

1. KEY DEFINITIONS

Essential Terms You Must Know

Ordinary Shares (Common Stock) The basic equity shares that have voting rights and participate in profits after all other claims are satisfied.

Basic EPS Net income available to ordinary shareholders ÷ Weighted average ordinary shares outstanding

Diluted EPS Shows EPS if all dilutive potential ordinary shares were converted to actual shares.

Potential Ordinary Shares Financial instruments that could become ordinary shares, such as:

• Stock options
• Convertible bonds
• Convertible preferred shares
• Warrants

Dilutive vs. Anti-dilutive

• Dilutive: Decreases EPS (bad for shareholders)
• Anti-dilutive: Increases EPS (good for shareholders) - excluded from diluted EPS

2. BASIC EPS - THE FOUNDATION

The Basic Formula

Step-by-Step Calculation

Step 1: Calculate the Numerator

Net Income                           $1,000,000
Less: Preferred dividends paid         (50,000)
Net income available to ordinary    $  950,000
shareholders

Step 2: Calculate the Denominator

Weighted average ordinary shares     100,000 shares

Step 3: Calculate Basic EPS

Basic EPS = $950,000 ÷ 100,000 = $9.50 per share

Simple Example

ABC Company - Year Ended December 31, 2024

Calculation:

• Net income available to ordinary shareholders = $500,000 - $30,000 = $470,000
• Basic EPS = $470,000 ÷ 50,000 = $9.40 per share

3. WEIGHTED AVERAGE SHARES - GETTING THE DENOMINATOR RIGHT

Why Weighted Average?

If a company issues or buys back shares during the year, we need to weight them by the time they were outstanding.

Example: Share Issues During the Year

XYZ Company:

• January 1: 40,000 shares outstanding
• April 1: Issued 20,000 new shares
• October 1: Bought back 10,000 shares

Weighted Average = 52,500 shares

Bonus Shares and Stock Splits

Important Rule: Bonus shares and stock splits are treated as if they occurred at the beginning of the year.

Example:

• Company had 10,000 shares outstanding all year
• December 15: 2-for-1 stock split
• Weighted average shares = 10,000 × 2 = 20,000 shares

4. DILUTED EPS - THE COMPLETE PICTURE

The Concept

Diluted EPS answers the question: "What would EPS be if all potential shares became actual shares?"

Basic Approach

1. Adjust the numerator (add back any income effects)
2. Adjust the denominator (add potential shares)
3. Test for dilution (only include if EPS decreases)

The Treasury Stock Method (For Options)

Assumption: Company uses cash from option exercises to buy back shares at average market price.

Example: Stock Options

DEF Company:

• Basic EPS: $10.00
• 1,000 stock options outstanding
• Exercise price: $15 per share
• Average market price: $25 per share

Calculation:

Cash from exercise: 1,000 × $15 = $15,000
Shares bought back: $15,000 ÷ $25 = 600 shares
Net increase in shares: 1,000 - 600 = 400 shares

Diluted EPS denominator = Basic shares + 400 = Diluted shares

5. COMMON DILUTIVE INSTRUMENTS

1. Stock Options and Warrants

Key Points:

• Only dilutive if market price > exercise price
• Use treasury stock method
• Based on average market price during period

Example:

2. Convertible Bonds

Approach:

• Add back interest expense (after tax) to numerator
• Add converted shares to denominator

Example: Convertible Bond

GHI Company:

• $1,000,000 convertible bonds
• 6% interest rate
• Tax rate: 25%
• Conversion ratio: 50 shares per $1,000 bond

Adjustments:

Interest saved (after tax): $1,000,000 × 6% × (1-25%) = $45,000
Shares if converted: $1,000,000 ÷ $1,000 × 50 = 50,000 shares

3. Convertible Preferred Shares

Approach:

• Add back preferred dividends to numerator
• Add converted shares to denominator

Example:

6. PRESENTATION AND DISCLOSURE

Required Presentation

On the Face of the Income Statement:

Required Disclosures in Notes

1. Numerator reconciliation
2. Denominator reconciliation
3. Description of potential ordinary shares
4. Anti-dilutive instruments excluded
5. Post-balance sheet events affecting shares

Example Note Disclosure

Note 15: Earnings Per Share

Numerator:

Denominator:

7. PRACTICAL EXAMPLES AND CASE STUDIES

Case Study 1: Technology Company

TechCorp Inc. - Annual Results

Basic Information:

• Net income: $2,400,000
• Preferred dividends: $120,000
• Shares outstanding Jan 1: 200,000
• Issued 60,000 shares on July 1
• Tax rate: 30%

Outstanding Securities:

1. 10,000 stock options (exercise price $40, average market price $60)
2. $500,000 convertible bonds (8% interest, convertible to 25,000 shares)

Solution:

Basic EPS Calculation:

Numerator: $2,400,000 - $120,000 = $2,280,000
Denominator: 200,000 + (60,000 × 6/12) = 230,000 shares
Basic EPS = $2,280,000 ÷ 230,000 = $9.91

Diluted EPS Calculation:

Adjusted numerator: $2,280,000 + ($500,000 × 8% × 70%) = $2,308,000
Stock options: 10,000 - (10,000 × $40 ÷ $60) = 3,333 shares
Convertible bonds: 25,000 shares
Adjusted denominator: 230,000 + 3,333 + 25,000 = 258,333 shares
Diluted EPS = $2,308,000 ÷ 258,333 = $8.94

Case Study 2: Manufacturing Company

ManufCo Ltd. - Complex Scenario

Situation:

• Net loss: $(500,000)
• No preferred dividends
• Basic shares: 100,000
• Stock options outstanding: 5,000 (exercise $30, market $25)
• Convertible preferred: Would add 20,000 shares and $50,000 dividends

Solution:

Basic EPS = $(500,000) ÷ 100,000 = $(5.00) per share

Diluted EPS: Same as Basic EPS = $(5.00)

• Stock options are anti-dilutive (market < exercise price)
• Convertible preferred is anti-dilutive (would improve loss per share)

8. COMMON MISTAKES TO AVOID

❌ Mistake 1: Wrong Numerator

Wrong: Using net income instead of net income available to ordinary shareholders Right: Always deduct preferred dividends from net income

❌ Mistake 2: Ignoring Time Weighting

Wrong: Simple average of shares outstanding Right: Weight shares by time outstanding

❌ Mistake 3: Including Anti-dilutive Items

Wrong: Including all potential shares in diluted EPS Right: Only include items that decrease EPS (increase loss per share)

❌ Mistake 4: Incorrect Option Calculation

Wrong: Adding all option shares to denominator Right: Use treasury stock method (add net shares after buyback)

❌ Mistake 5: Forgetting Tax Effects

Wrong: Adding full interest on convertible bonds Right: Add after-tax interest savings

9. QUICK REFERENCE GUIDE

EPS Calculation Checklist

Basic EPS:

• [ ] Calculate net income available to ordinary shareholders
• [ ] Calculate weighted average shares outstanding
• [ ] Adjust for bonus issues/stock splits retrospectively
• [ ] Divide numerator by denominator

Diluted EPS:

• [ ] Start with basic EPS amounts
• [ ] Test each potential ordinary share for dilution
• [ ] Apply treasury stock method for options/warrants
• [ ] Apply if-converted method for convertible securities
• [ ] Only include dilutive items
• [ ] Calculate final diluted EPS

Key Formulas

When to Use Each Method

CONCLUSION

Key Takeaways for Practice

1. Accuracy Matters: EPS is heavily scrutinized - double-check calculations
2. Documentation is Key: Keep detailed working papers for auditors
3. Stay Updated: Monitor new equity instruments and their treatment
4. Professional Judgment: Apply anti-dilution tests consistently
5. Clear Communication: Explain complex EPS calculations to stakeholders

Next Steps in Your Career

• Financial Analysis: Use EPS trends for company valuation
• Investment Banking: Apply EPS in IPO and M&A analyses
• Corporate Finance: Help management understand EPS impact of financing decisions
• Audit: Ensure EPS calculations comply with IAS 33

Final Tips

✅ Practice regularly with different scenarios ✅ Understand the business behind the numbers ✅ Question unusual results - they often reveal calculation errors ✅ Keep current with amendments to IAS 33

This handbook provides a solid foundation for applying IAS 33 in practice. Remember: precision and professional skepticism are your best tools when calculating EPS.

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