Earnings per share

Professional Level – Financial Reporting · HKICPA QP (Hong Kong CPA) · 5 min read

Hello! If you’ve ever wondered how investors compare a giant company like HSBC with a smaller tech startup, the answer often lies in Earnings Per Share (EPS). Think of EPS as the "profit per slice" of a company's total earnings pizza. It helps investors understand how much money the company is making for every single share they own.

In this chapter, we will follow HKAS 33 Earnings per Share. Don't worry if it seems a bit math-heavy at first; we will break it down into simple, logical steps. By the end of these notes, you'll be able to calculate Basic and Diluted EPS like a pro!

1. The Basics: What is Basic EPS?

The goal of Basic EPS is to provide a measure of the interests of each ordinary share in the performance of the entity during the reporting period.

The Formula:
\( \text{Basic EPS} = \frac{\text{Earnings}}{\text{Weighted Average Number of Ordinary Shares (WASC)}} \)

A. The Numerator: Earnings

We don't just use the total "Net Profit." We need the profit available to ordinary shareholders. This means we must subtract Preference Dividends from the Profit After Tax.

Quick Review: Dealing with Preference Dividends
- Non-cumulative: Deduct only if declared during the period.
- Cumulative: Deduct the full amount due for the period, whether they were declared or not!

B. The Denominator: Weighted Average Number of Ordinary Shares (WASC)

Shares often change throughout the year (new issues, buybacks). We can't just use the year-end balance. We use a time-weighting factor.

Example: If a company has 1,000 shares for 6 months and then issues another 1,000 shares, the WASC isn't 2,000; it’s 1,500 (\( 1,000 \times 6/12 + 2,000 \times 6/12 \)).

Key Takeaway

Basic EPS tells us how much of this year's actual profit belongs to each share currently in existence.

Not all share issues are created equal. Some bring in new cash (Issue at Full Market Price), while others don't (Bonus Issue).

A. Issue at Full Market Price

This is straightforward. Use the time-apportionment method from the date the cash is receivable.

B. Bonus Issues and Share Splits

In a Bonus Issue, the company gives away free shares. No new cash comes in. Because of this, HKAS 33 requires us to treat these shares as if they always existed.

The Trick:
1. Adjust the current year WASC by multiplying the shares held before the issue by the Bonus Factor.
2. Restate last year's EPS (Comparative EPS) so investors can make a fair "apples-to-apples" comparison.

Bonus Factor Formula: \( \frac{\text{Number of shares AFTER bonus}}{\text{Number of shares BEFORE bonus}} \)

C. Rights Issues (The "Hybrid" Issue)

A rights issue is when a company offers shares to existing owners at a discount. It’s part "full price issue" and part "bonus issue." This is usually the part students find trickiest, so let's use a step-by-step approach.

Step 1: Calculate the Theoretical Ex-Rights Price (TERP)
\( \text{TERP} = \frac{(\text{Shares already held} \times \text{Market Price}) + (\text{New Shares} \times \text{Issue Price})}{\text{Total shares after the issue}} \)

Step 2: Calculate the Bonus Factor
\( \text{Bonus Factor} = \frac{\text{Market Price BEFORE the rights issue}}{\text{TERP}} \)

Step 3: Apply to WASC
Apply the bonus factor to all shares held prior to the rights issue.

Did you know?

We restate the prior year's EPS for bonus issues and rights issues because the number of shares increased without a proportional increase in resources. It prevents the company from looking like its performance dropped just because they issued more shares!

3. Diluted EPS: Looking into the Future

Diluted EPS is a "warning" to shareholders. It shows what the EPS would be if all "potential" ordinary shares (like convertible bonds or employee share options) were actually turned into real shares.

The Concept: "Worst Case Scenario"
If the potential shares are dilutive (meaning they would decrease EPS), we must report them. If they would increase EPS, they are "anti-dilutive" and we ignore them.

A. Convertible Bonds/Preference Shares

If these are converted:
1. Numerator increases: We save on the interest expense (net of tax) or preference dividends.
2. Denominator increases: More shares are issued.

\( \text{Diluted EPS} = \frac{\text{Earnings} + \text{Interest Saved (Net of Tax)}}{\text{WASC} + \text{New Shares from Conversion}} \)

B. Share Options and Warrants

Options are slightly different because the "new" shares aren't free—the employees pay the exercise price. We only count the "free" element as dilutive.

Step-by-step for Options:
1. Calculate how much cash the company receives from the option exercise.
2. Calculate how many shares the company could have bought back from the market at average market price using that cash.
3. The difference between the shares issued and the shares "bought back" is the bonus element added to the denominator.

Memory Aid: "What-If"

Always ask yourself: "What if this happened on the first day of the year?" If a convertible bond was issued mid-year, you only calculate the "what-if" from that date onwards!

4. Common Mistakes to Avoid

1. Forgetting Tax on Interest: When adding back interest for convertible bonds in Diluted EPS, always multiply by \( (1 - \text{Tax Rate}) \). The government was sharing the interest cost via tax relief; if you save the interest, you lose the tax relief!

2. Wrong Bonus Factor: In a rights issue, the Bonus Factor is Market Price / TERP. Students often flip this upside down. Remember, the factor should be greater than 1 because you are adjusting for a "bonus" element.

3. Including Anti-dilutive Shares: If the "Diluted EPS" calculation results in a number higher than Basic EPS, you stop! You simply report the Diluted EPS as equal to the Basic EPS.

5. Presentation and Disclosure

Entities must present Basic and Diluted EPS on the face of the Statement of Profit or Loss with equal prominence for each class of ordinary shares. Even if the figures are negative (a loss per share), you must still show them!

Quick Review Box

Basic EPS: Actual performance of current shares.
Bonus Issue: No cash, adjust WASC retrospectively, restate comparatives.
Rights Issue: Partial cash, calculate TERP, use bonus factor.
Diluted EPS: Potential future performance; include if EPS goes down.
Numerator: Always use profit after preference dividends.

Don't worry if this seems tricky at first! EPS is all about following a set of logical steps. Practice calculating the TERP and the WASC weighting, and the rest will fall into place. You've got this!

Quick check

Can you answer these now?

Open each question to check the key ideas from this chapter.

What is the general formula for Basic Earnings per Share (EPS)?

\( \text{Basic EPS} = \frac{\text{Earnings}}{\text{Weighted Average Number of Ordinary Shares (WASC)}} \)

How are preference dividends treated when calculating the EPS numerator?

Preference dividends are subtracted from Profit After Tax. Non-cumulative dividends are deducted only if declared; cumulative dividends are deducted for the full amount due, whether declared or not.

What is the purpose of the Weighted Average Number of Ordinary Shares (WASC) in the EPS denominator?

WASC uses a time-weighting factor to reflect that share capital changes throughout the year, ensuring the denominator accurately represents the period the capital was actually available.

How does a Bonus Issue affect the EPS calculation and comparative figures?

Bonus shares are treated as if they always existed. The current year's WASC is adjusted by a bonus factor, and the prior year's EPS is restated for comparability.

What is the Theoretical Ex-Rights Price (TERP)?

\( \text{TERP} = \frac{(\text{Shares already held} \times \text{Market Price}) + (\text{New Shares} \times \text{Issue Price})}{\text{Total shares after the issue}} \)

How is the Bonus Factor for a Rights Issue calculated?

\( \text{Bonus Factor} = \frac{\text{Market Price BEFORE the rights issue}}{\text{TERP}} \)

What is the core concept behind Diluted EPS?

Diluted EPS represents a "worst-case scenario," showing what the EPS would be if all dilutive potential ordinary shares (like convertibles or options) were converted into actual shares.

How do convertible bonds affect the Diluted EPS calculation?

The numerator is increased by the interest saved (net of tax), and the denominator is increased by the maximum number of shares that would be issued upon conversion.

How are share options treated in the Diluted EPS calculation?

Only the "bonus element" of the options is added to the denominator. This is the difference between the number of shares issued and the number of shares that could be repurchased at average market price using the exercise proceeds.

What is the rule regarding anti-dilutive instruments in EPS reporting?

If the calculation of Diluted EPS results in a figure higher than Basic EPS, the instrument is anti-dilutive and must be ignored; Diluted EPS is then reported as equal to Basic EPS.

What are the presentation requirements for Basic and Diluted EPS?

Both Basic and Diluted EPS must be presented on the face of the Statement of Profit or Loss with equal prominence, even if the figures are negative (a loss).

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