IAS 33 Diluted Earnings Per Share

Sometimes a company may have securities that do not have a claim on equity earnings but
may do so in the future. These securities include:
• Separate classes of equity shares,
• Convertible loan stock or convertible preference shares,
• Options or warrants.

These securities have the potential to increase the number of shares ranking for dividend, thus
reducing the EPS. A dilutive potential ordinary share is one which decreases net profit, or
increases net loss per share.

To calculate the Diluted earnings per share we need to calculate the after tax effects of:
(a) Any dividends or other items related to dilutive ordinary shares deducted in arriving
at profit or loss attributable to ordinary equity holders of the entity,
(b) Any interest recognised in the period related to dilutive ordinary shares and
(c) Any other changes in income or expense that would result from the conversion of the
dilutive potential ordinary shares.

Convertible Convertible Loan Options or Warrants

Preference Shares Stock or Preference
Shares
Adjust Basic Add Back Preference Add back loan stock Nil
Earnings (i.e.net Dividend interest net of
profit after interest Corporation tax (or
and preference preference dividend
dividends) by saved)
Adjust Basic Number Add shares that will Add additional Add additional
of Shares rank in future periods shares on conversion shares issued at nil
(using maximum consideration
dilution available
after the year end)

Example – Share Options

Net Profit for 2004 2,500,000
Weighted Average No of Ordinary Shares for 2004 12,500,000
Average Fair Value of one ordinary share 5.00
Weighted Average no of Shares under options during 2004 2,500,000
Exercise price for shares under option in 2004 3.00

Solution – share options

No of Ordinary Shares 12,500,000
No of Options 2,500,000
Deduct 2.5m X 3/5 (1,500,000) 1,000,000
Total Shares 13,500,000
Diluted EPS: 2,500,000 / 13,500,000 = 18.52c

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Options have no impact on the earnings as neither dividend or interest payments are made

Class Example – Share Options

Net Profit for 2014 3,500,000

Weighted Average No of Ordinary Shares for 2014 14,500,000
Average Fair Value of one ordinary share 4.00
Weighted Average no of Shares under options during 2014 2,000,000
Exercise price for shares under option in 2014 1.00

Example – Employee Share Option (Non Performance Related)

A company runs an employee share option scheme based on the employee’s length of service
with the company.

Date of Grant 1st January 2002

Market Price at date of Grant 3.00
Exercise price of option 2.00
Date of Vesting 31st December 2004
Number of Shares under option 2 million
Net profit for year 2002 1,500,000
Weighted Average Number of Ordinary Shares 8 million
Average Fair value of an ordinary share 4.00

Solution – Employee Share Option

Basic EPS - 1.5m / 8.0m = 18.75 cent

No of Ordinary Shares 8,000,000

No of Options 2,000,000
Deduct 2m X 2/4 (1,000,000) 1,000,000
Total Shares 9,000,000

Diluted EPS: 1,500,000 / 9,000,000 = 16.67c

Class Example – Employee Share Option (Non Performance Related)

A company runs an employee share option scheme based on the employee’s length of service
with the company.

Date of Grant 1st January 2012

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Market Price at date of Grant 4.00
Exercise price of option 3.00
Date of Vesting 31st December 2014
Number of Shares under option 3 million
Net profit for year 12 1,800,000
Weighted Average Number of Ordinary Shares 8 million
Average Fair value of an ordinary share 5.00

Example – Convertible Bonds

Net Profit 20,000
Ordinary Shares in issue 100,000

Basic EPS (20,000 / 100,000) 20c

Convertible 10% Bonds 10,000

Each block of 10 bonds is convertible to 5 ordinary shares. The tax rate is 30%.

Solution – Convertible Bonds

Net Profit 20,000

Interest (10,000 X 10%) 1,000
Tax ( 300) 700
Adjusted Profit 20,700

Shares at start of Year 100,000

Loan 10,000 X 5 / 10 5,000
105,000
Diluted EPS : 20,700 / 105,000 = 19.71c

Class Example – Convertible Bonds

Net Profit 50,000
Ordinary Shares in issue 200,000

Basic EPS (50,000 / 200,000) 25c

Convertible 10% Bonds 60,000

Each block of 10 bonds is convertible to 20 ordinary shares. The tax rate is 30%.

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Example – Dilutive and Anti-dilutive securities

Net Profit attributable to Ordinary Shares €30m

Net Profit from Discontinued Operations € 6m
Ordinary Shares Outstanding 100m
Average Fair Value of one ordinary shares €4.00

Potential Ordinary Shares

Convertible preference Shares 2,000,000 entitled to a cumulative dividend of €2.50. Each is
convertible to 5 shares.

5% Convertible Bond – Nominal amount €20m. Each €5,000 bond is convertible to 200
shares. There is no amortisation of premium or discounting affecting the interest expense.

Options – 5 million with an exercise price of €2.00.

Tax Rate – 25%

Solution – Dilutive and Anti-dilutive securities

1. Conversion of Preference shares

Dividend Saved 2m X 2.50 5,000,000
Additional Shares 2m X 5 10,000,000
Incremental EPS 5m / 10m 50c

2. Convertible Bond

Interest Saved 20m X 5% 1,000,000

Tax @ 25% ( 250,000)
750,000
Incremental Shares
(20m / 5,000) X 200 Shares 800,000
Incremental EPS 750k / 800k 93.75c

3. Options

No of Options 5,000,000

Deduct 5m X 2/4 (2,500,000)

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Shares - Free 2,500,000

Diluted EPS: 0 / 2,500,000 = 0c

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Class Example – Dilutive and Anti-dilutive securities

Net Profit attributable to Ordinary Shares €40m

Net Profit from Discontinued Operations € 5m
Ordinary Shares Outstanding 200m
Average Fair Value of one ordinary shares €5.00

Potential Ordinary Shares

Convertible preference Shares 3,000,000 entitled to a cumulative dividend of €3.50. Each is
convertible to 10 shares.

5% Convertible Bond – Nominal amount €10m. Each €2,000 bond is convertible to 500
shares. There is no amortisation of premium or discounting affecting the interest expense.

Options – 5 million with an exercise price of €3.00.

Tax Rate – 25%

Disclosure Requirements
➢ Disclose Diluted EPS on the face of the Income Statement
➢ Comparative Figures also required
➢ Amounts used as numerators in calculating the diluted earnings per share, reconciled
to actual net profit /(loss) for the period.

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On 1st January 2005, BELLS plc(“BELLS) had 1,000,000 €/£1 ordinary shares and 500,000
6% €/£ 1 convertible preference shares in issue. BELLS’ profit after tax for the year ended
31st December 2005 was:
Profit after Tax €/£’000
Continuing Operations 3,500

On 1st April 2005, BELLS issued a further 500,000 €/£ 1 ordinary shares at full market price.
Warrants to purchase 450,000 €/£ 1 ordinary shares were issued on 31st May 2005 at €/£ 3
per share. While the warrants due to expire on 31st May 2009, all were exercised on 28th
February 2006.

Convertible Loan Stock of €/£800,000 at an interest rate of 6% per annum was issued at par
on 30th June 2004. Each €/£100 loan stock is convertible into 10 €/£ 1 ordinary shares at any
time at the option of the holder. Interest is paid half yearly on 31st December and 30th June
each year. On 1st July 2005, €/£300,000 of loan stock was converted when the market price
was €/£ 4 per share.
The preference shares are convertible into ordinary shares at the option of the holder on the
basis of 1 €/£ 1 ordinary share for every 4 convertible preference shares held. Holders of
200,000 preference shares converted them into ordinary shares on 1st October 2005.
The average market price of BELLS’ ordinary shares during the year ended 31st December
2005 was €/£5 per share, and the tax rate is 25%.
BELLS’ financial statements for the year ended 31st December 2005 were approved on 31st
March 2006.

Requirement
Calculate the basic and diluted Earnings per Share for BELLS for the year ended 31st
December 2005 in accordance with IAS 33 Earnings per Share.

Solution – see power point slides