Chapter 15

Earnings Per Share

1
Outline

Introduction
Basic Earnings Per Share
Earnings calculation
Number of shares calculation
Shares issued or redeemed during the Year
Adjustment for a bonus issue or a stock split

2
 Outline (Cont’d)

Diluted Earnings Per Share

Diluted EPS Calculation
Dilutive Future Shares
Dilution Test
Disclosure Rules
Summary

3
 Introduction
Earnings per share (EPS)
shows the profit attributable to each ordinary share
and is considered by many investors to be an
important measure of profitability
forms a basis for calculating the Price/Earnings Ratio
(P/E ratio), which is market price of ordinary share per
share divided by EPS and provides a basis for
comparative purposes with the performance of other
companies
It is important for the accountancy profession to
identify a uniform method of computing and
disclosing the EPS figure
4
 Introduction (Cont’d)
HKAS 33 “Earnings Per Share” (Previously known
as HKSSAP 5; issued March 1984; revised March
1995, May 1998 and March 2004) states that
listed companies must disclose basic and
diluted EPS in their financial statements and this
disclosure is made on a consistent basis between
companies
Compliance with this statement ensures
compliance with IAS 33 “Earnings Per Share”

5
 Introduction (Cont’d)
The basic EPS computation uses the results of actual
transactions to determine the numerator and the
denominator in the EPS calculation

Diluted EPS is computed by making assumptions

regarding equity transactions that have not occurred, but
will likely to occur in the future given the current
information

Given the importance of EPS to investors and other users

of financial statements, it is desirable that the effect of
dilution on EPS should also be properly reported if a
company has a significant number of dilutive securities in
its capital structure 6
 Introduction (Cont’d)
Differentiate between simple and complex capital
structures
Simple Capital Structure
No potentially dilutive securities
Disclose basic EPS only
Complex Capital Structure
Potentially dilutive securities such as options, warrants, or
convertible securities
Stock options: granted to employees as incentive payments
Warrants: sold by companies for cash, generally in conjunction
with the issuance of another security
Disclose both basic and diluted EPS
7
 Introduction (Cont’d)
Dilutive securities are securities that would lead to a
reduction (increase) in earnings (loss) per share as a
result of the conversion of the securities or the exercise
of the options to acquire ordinary shares.

Dilutive EPS measure the maximum potential dilution

that could occur if all dilutive securities were turned into
equity shares and ranked for dividend. In other words,
diluted EPS is computed by assuming that all equity
transactions that will likely to occur in the future have
already happened in the current period.

The computation of both basic and diluted EPS provides

financial statement users with endpoints as to EPS. 8
 Basic Earnings Per Share

Basic EPS is calculated by dividing the earnings

(or, more specifically, profits for the year
attributable to ordinary shares) of the company
for the financial period by the weighted average
number of ordinary shares in issue during that
financial period.

EPS = Earnings/Weighted average number of

ordinary shares outstanding
9
 Basic Earnings Per Share (Cont’d)

The guidelines in HKAS 33 outline earnings

as:
consolidated profit or loss for the year after
tax and extraordinary items;
less minority interests (if the reporting entity is
the holding company of a group);
less preference dividends declared (you must
deduct dividends to cumulative preference
shareholders even if they have not been
declared).
10
 Earnings Available to Ordinary
Shareholders

Net income
Less: Current period’s cumulative preference share*
dividends (whether or not declared)
Less: Noncumulative preference share* dividends (only if
declared)
Net income available to ordinary shareholders
*Or more senior classes of shareholders

11
Basic Earnings Per Share (Cont’d)

Remarks:
In this course, we will not deal with group accounting to make our
life easier. Group Accounting will be discussed in ACCT4104
Advanced Financial Accounting.
Before the May 1998 provision, HKSSAP 5 specifies that earnings
means the profit available for ordinary shares without taking into
account extraordinary items. Possible arguments for the change
in HKAS 33 are that inclusion of extraordinary items (1) ensures
the financial statement users will not overlook them; and (2)
prevents management manipulation of profits through intentional
misclassification.
Basic EPS reflects only income available to ordinary shareholders
and does not include preference shares. (Recall that ordinary
shares participate in the net profit for the period only after other
types of shares such as preference shares).

12
Basic Earnings Per Share (Cont’d)

Number of shares calculation

The number of shares to include when
calculating the basic EPS is the weighted
average number of ordinary shares (WANOS) in
issue during the period.

13
 Basic Earnings Per Share (Cont’d)

Shares issued or redeemed during the year

In addition to the shares in issue at the beginning of the year,
shares may have been issued or redeemed during the year.
In this case, you need to include the shares issued or redeemed,
weighted for the time in the year they are in issue.
HKAS 33 recommends that the shares should be weighted in
accordance with the number of days that they are in issue, but it is
also acceptable to use the number of months.
Remark:
In this course, we assume that the shares are weighted in
accordance with the number of months that they are in issue. If
share transactions occurred during the month, the weighted
average computation is assumed to be made to the nearest
month.
14
 What is WANOS – new issuance

Compute the weighted average number

of shares of ordinary share outstanding.

Date Description No. of Shares

Jan 1 Balance 100,000
Apr 1 Issued 50,000
Oct 1 Issued 10,000

15
 What is WANOS – new issuance

“income statement” approach

Jan 1 April 1 Oct 1

100,000 shares +50,000 shares +10,000 shares
12 months 9 months 3 months

Annual Annual
Weighting Weighting
100,000 + [50,000 × (9/12)] + [10,000 × (3/12)] = 140,000
Shares New New
at Jan. 1 Shares Shares

16
 What is WANOS – new issuance

“Balance sheet” approach

Jan 1 April 1 Oct 1

100,000 shares 150,000 shares 160,000 shares
3 months 9 months 3 months

100,000 × (3/12) + [150,000 × (6/12)] + [160,000 × (3/12)] = 140,000

Shares Shares Shares
at Jan. 1 at April 1 on Oct 1

17
 Share Buy-Back

Compute the weighted-average number of shares of ordinary

share outstanding.

Date Description No. of Shares

Jan 1 Balance 100,000
Apr 1 Issued 50,000
May 1 Repurchased shares 12,000

Annual Annual
Weighting Weighting
100,000 + [50,000 × (9/12)] - [12,000 × (8/12)] = 129,500
Shares New Retired
on Jan. 1 Shares Shares 18
on April 1 on May 1
Basic Earnings Per Share (Cont’d)

Adjustment for a bonus issue or a stock split

Bonus issue:
A bonus issue (stock dividend) is a distribution of additional shares of
a corporation’s own capital share on a pro-rata basis to its
shareholders at no cost (i.e., each shareholder receives additional
shares equal to the percentage of shares already held).
A bonus issue is regarded as a capitalization of profits because it is
used to transfer retained income to permanent capital and thus
remove such earnings from cash dividend availability (if the company
chooses to do so).
Dr. Retained profits xxx
Cr. Share capital – ordinary shares xxx

(no journal entry for the alternative treatment when not to capitalize the retained
earnings – just increase the number of shares issued based on the bonus shares)
19
 Basic Earnings Per Share (Cont’d)

Stock splits:
Stock splits are usually larger than stock dividends, but theoretically the
same, i.e., both of them are distribution of a proportional amount of
shares to shareholders.
In a stock split, the total number of shares is increased by a specified
amount, such as a two-for-one split.
No accounting entry is needed.
In contrast to a stock dividend, a stock split usually does not result in a
transfer of retained profits to share capital.
Thus, there is no change in the total share capital or the retained profits
balance.

20
 Basic Earnings Per Share (Cont’d)

Earnings effect of a bonus issue or a stock split:

Since ordinary shares are issued to existing
shareholders for no additional consideration in a
bonus issue or stock split, no additional earnings will
accrue as a result of the issue.

21
 Basic Earnings Per Share (Cont’d)

Effect on EPS of a bonus issue or a stock split:

However, since the additional shares rank for dividend, they should be
treated as being in issue for the whole period and the earnings should be
apportioned over the number of shares ranking for dividend after the bonus
issue or stock split.
Therefore, you need to include this issue in your calculation by adjusting the
number of ordinary shares outstanding before the bonus issue or stock split
by the proportionate change in the number of ordinary shares outstanding as
if the bonus issue or the stock split had occurred at the beginning of the
period (or the date of issue of the ordinary shares if later).
Amounts disclosed for prior periods are also adjusted. Only when the
retroactive recognition of changes in the number of shares can EPS
presentations for prior periods be stated on a basis comparable with the EPS
presentation for the current period.

22
 Bonus Issues and Share Splits

Compute the weighted-average number of shares of ordinary

share outstanding.
Date Description No. of Shares
Jan 1 Balance 100,000
Apr 1 Issued 50,000
May 1 Bonus Issue (1:1) 150,000
Annual
Weighting
100,000 × (2.00) + [50,000 × (9/12) × 2.00] = 275,000
Shares New
at Jan. 1 Shares

bonus issue
23
adjustment
 Apple stock split history
Split ratio Price before split

16 June 1987 2:1 $79 (31 May 1987)

21 June 2000 2:1 $111 (31 May 2000)

28 February 2005 2:1 $90 (31 January 2005)

9 June 2014 7:1 $656 (31 May 2014)

24
 Basic Earnings Per Share (Cont’d)

Compute the EPS for 2019 with the following information:

Number of ordinary shares outstanding as of January 1 2,000

Number of non-cumulative 10% preference shares as of January 1 with $1 par 1,000
Sale of ordinary shares for cash on October 1 1,600
Redemption of ordinary shares on November 1 600

Net income in 2019 is $2,000 and a $100 dividend is

declared and paid to preference shareholders.

25
 Basic Earnings Per Share (Cont’d)

1. What is the weighted average number of ordinary

shares outstanding (WANOS)?

Jan 1 to Sept 30 2,000 x 9/12 = 1,500 shares

Oct 1 to Oct 30 (2,000 + 1,600) x 1/12 = 300
Nov 1 to Dec 31 (3,600 – 600) x 2/12 = 500
WANOS = 2,300 shares

or WANOS = 2000 + 1600 x3/12 – 600 x 2/12 = 2,300

2. What is the net income to ordinary shareholders?
$2,000 - $100 = $1,900
3. What should be the basic EPS?
$1,900/2,300 shares = $0.83 26
Basic Earnings Per Share (Cont’d)

Following the previous example with the following

additional changes:
(a) No preference share dividends are declared to the
shareholders.
However, the preference share dividends are cumulative.
(b) A 10% bonus issue is made on April 1.
(c) A 2-for-1 stock split is made on December 1.

Compute the EPS for 2019.

27
 Basic Earnings Per Share (Cont’d)

Bonus Stock Portion of Weighted

Dates Shares outstanding
issue split year average
Jan 1 – MAR 31 2,000 1.1 2.0 3/12 1,100 shares

Apr 1 – Sept 30 2,000 x 1.1 = 2,200 2.0 6/12 2,200

Oct 1 – Oct 31 2,200 + 1,600 = 3,800 2.0 1/12 633

Nov 1 – Nov 31 3,800 – 600 = 3,200 2.0 1/12 533

Dec 1 – Dec 31 3,200 x 2 1/12 533

WANOS 5,000

or WANOS = 2000 x 1.1 x 2 + 1600 x 2 x 3/12 – 600 x 2 x 2/12 = 5,000

Basic EPS = $1,900/5,000 shares = $0.38

28
Diluted Earnings Per Share

Where a listed company has potential ordinary

shares outstanding, you need to address whether
the potential ordinary shares are dilutive.

Definition: A potential ordinary share is a financial

instrument or other contract that may entitle its
holder to ordinary shares. Common examples are:
Convertible preference share
Convertible bonds
Share options or warrants

29
 Diluted Earnings Per Share

Potential Ordinary Shares: Complex Capital Structure

• Securities that are not common share but might (Dual EPS)
become common share through their exercise or
conversion

Share Convertible
Options securities

Contingently Treasury share If-converted

issuable method method
shares

Dilution/Antidilution Test

May Report Basic and Diluted Earnings Per Share 30

Diluted Earnings Per Share (Cont’d)

Why report diluted EPS?

Investors are concerned not only with the past performance
but the forecasting future EPS, it is important to disclose
the effect of any future dilution.
Therefore, you should calculate the diluted EPS figure,
taking into account potential ordinary shares that are
dilutive.
HKAS 33 and IAS 33 state that dilution occurs if inclusion of
a potentially dilutive security reduces the basic EPS or
increases the basic loss per share. If the opposite results,
the securities is classified as an antidilutive securities.
Antidilutive securities are not included in computing diluted
EPS.
31
Diluted Earnings Per Share (Cont’d)

Diluted EPS Calculation

The diluted EPS should be calculated on the
assumption that the maximum number of new
shares had been issued under the terms of the
contract, and that these had been exercised on
the first day of the period (or the date of issue
of the contract if later).

32
 Diluted Earnings Per Share (Cont’d)

The denominator in the diluted EPS calculation is the total of:

the weighted average number of ordinary shares of the company
during the financial year (as per basic EPS)
the weighted average number of potential ordinary shares that are
dilutive
The numerator must be similarly adjusted.

NOTE:
If potential ordinary shares were issued or converted to part way
through the accounting period, be careful to only adjust for the part of
the period they were in issue.
33
Diluted Earnings Per Share (Cont’d)

Dilutive future shares

A listed company may have a number of
potential ordinary shares in issue during a
financial year. If so, the diluted EPS should
take into account only those potential ordinary
shares which have a diluting effect, i.e., those
that reduce net profit per share (or increase
the loss per share).

34
 Diluted Earnings Per Share (Cont’d)

Stock options and warrants

Companies may grant options to directors and senior executives or
issue warrants which give holders the right to subscribe for shares
at fixed prices on specified future dates.
If the options or warrants are assumed to be exercised, then we
need to make an assumption on how the cash proceeds from the
exercise of the stock options or warrants be used. The generally
accepted assumption is that earnings will not be affected but the
number of ordinary shares will increase.
Under this assumption (this is often referred to as the treasury
stock method), the shares ranking for dividend will be increased
by the number of shares under options or warrants, net of the
number of shares that would have been redeemed from the
market at fair value by using the assumed cash proceeds from the
exercise of options or warrants.

35
 Options and Warrants

The treasury share method Proceeds

assumes that proceeds from
the exercise of options are At
used to purchase treasury average Used to
shares. This method usually market
results in a net increase in price
shares included in the
denominator of the Purchase
calculation of diluted treasury
earnings per share. shares

36
 Diluted Earnings Per Share (Cont’d)

Fair value for this purpose is calculated on the basis of

the average price of the ordinary shares during the period.
The diluted EPS should be calculated on the assumption
that the maximum number of new shares had been
issued under the terms of the options or warrants and
that these had been exercised on the first day of the
period (or the date of issue of the options or warrants if
later).

37
 Options and Warrants

Determine new shares from assumed exercise of share

options.
Proceeds from assumed exercise = Options x Exercise Price
Average-of-period market price of share

Compute shares purchased for the treasury to issue to

option holders
Compute the incremental shares assumed outstanding.
New shares from assumed exercise (1)
Less: Treasury shares assumed purchased (2)
Net increase in shares outstanding (3)
38
 Diluted Earnings Per Share (Cont’d)

Compute the basic and diluted EPS with the following

information for 2019:

Net income of the year $500

Ordinary shares outstanding (no change in 2019) 1,000
Options outstanding at the beginning of the year to purchase
equivalent shares (no change in 2019) 400
Exercise price per share on options $4
Average market price during the period of ordinary share $10

1. What is the basic EPS?

$500/1,000 shares = $0.5

39
 Diluted Earnings Per Share (Cont’d)

2. What is the diluted EPS?

(i) What should be the WANOS?
a. Proceeds from exercise of options
= 400 options x $4 = $1,600
b. # of shares assumed to be purchased
= $1,600/$10 = 160 shares
c. # of new shares to be issued
= 400 shares – 160 shares = 240 shares

(ii) Diluted EPS = $500/(1,000 shares + 240 shares)

= $0.40

40
Diluted Earnings Per Share (Cont’d)

Now, suppose that the options were issued on April 1,

2019, compute the diluted EPS for 2015.
$500/(1,000 x 3/12 + 1,240 x 9/12)
= $0.42

41
Diluted Earnings Per Share (Cont’d)

Convertible securities
In order to secure a lower rate of interest or dividend, companies
sometimes attach benefits to bonds and preference shares in the
form of conversion rights. These permit the owner of such
convertible securities to convert his/her holdings in whole or part
into ordinary share capital. The right is normally exercisable
between specified dates. The ultimate conversion of these securities
will have the following effects:
There will be an increase in earnings by the amount of interest
expenses on bonds or preference dividends no longer accrued.
Moreover, if the convertible securities are bonds, the effect on
earnings will be net of tax because interests on bonds are
allowable for profit tax purposes.
The number of shares ranking for ordinary dividend will increase.
42
 Diluted Earnings Per Share (Cont’d)

Therefore, where a company has convertible securities at

any time during the period, the diluted EPS should be
calculated on the assumption that the maximum number
of new ordinary shares had been issued on conversion
and that this conversion had taken place on the first day
of the period (or on the date of issue of the convertible
securities if later).
The earnings for the period should be adjusted by adding
back the assumed saving of dividend on convertible
preference shares or the assumed saving of interest on
the convertible bonds, net of tax.

43
 Diluted Earnings Per Share (Cont’d)

Compute the basic and diluted EPS with the following

information for 2019:
Net income of the year $500
Ordinary shares outstanding (no change in 2019) 1,000
Convertible bonds (stated interest at 10%) outstanding
at the beginning of the year $500
Conversion terms of convertible bonds: 0.8 shares for
each $1 bond
Tax rate 20%

1. Basic EPS = $500/1,000 shares = $0.5

44
Diluted Earnings Per Share (Cont’d)

Assumed saving on interest, net of tax

500 * 10% * (1-20%)

500 * 0.8 shares

Assumed number of shares converted from bonds

45
 Diluted Earnings Per Share (Cont’d)

Now suppose interest dates are on Jan 1, and July 1, and the convertible
bonds were issued on Oct 1. Compute the diluted EPS.

46
 Diluted Earnings Per Share (Cont’d)

Effect of Actual Conversion

Recall that if additional shares are issued as a result of securities
being converted, those newly issued shares would be included in
the computation of the weighted average number of shares
outstanding for the period (for both the basic and the diluted
EPS).
In addition, an adjustment must be made to reflect what EPS
would have been if conversion had taken place at the beginning
of the period or issuance date, whichever comes later. This
adjustment is required for all securities actually converted during
the period for computing diluted EPS whether dilutive or not.

47
 Convertible Securities

The assumed conversion of convertible bonds or

preference shares has two effects on dilutive earnings per
share:
increases the denominator by the number of
ordinary shares issuable upon conversion;
increases the numerator by decreasing after-tax
interest expense on convertible bonds, and
dividends on convertible preference shares.

48
 Diluted Earnings Per Share (Cont’d)
Continued with basic information below but it is now assumed that
$300 of the bonds are actually converted on October 1, 2019 and the
interest savings are already included in the net income of $500.
Compute the basic and diluted EPS.
Net income of the year $500
Ordinary shares outstanding (no change in 2019) 1,000
Convertible bonds (stated interest at 10%) outstanding at the beginning of the year $500
Conversion terms of convertible bonds: 0.8 shares for each $1 bond
Tax rate 20%

Jan 1 Oct 1 Dec 31

(i) The $300 could have been (i) $300 actually converted to 240
converted to 240 shares on Jan 1 shares
(ii) $200 could have converted to (ii) $200 not converted to 160
160 shares on Jan 1 shares 49
 Diluted Earnings Per Share (Cont’d)

Diluted EPS partial conversion on Oct 1 of the year

Diluted EPS no conversion on Oct 1 of the year

50
Diluted Earnings Per Share (Cont’d)

the increase of the increase of

income (net of tax) income (net of tax)
due to the interest due to the interest
expense incurred for expense incurred for
the $500 when the $200 not
nothing is converted converted till the end
interest of the year

The number of shares

outstanding (1,000) plus The number of shares
400 shares that could outstanding (1,240) + the
have been converted ( number of shares that
including the 240 shares could have been
converted and 160 not converted
converted). 51
Diluted Earnings Per Share (Cont’d)

Dilution Test
It is possible to determine if a potential ordinary
share is dilutive or antidilutive without actually
computing the diluted EPS assuming conversion.
The test for dilution of stock options and warrants
is simply to compare the average market price
during the financial period with the exercise price.
If the market price exceed the exercise price, the options
are dilutive and would be included “as if” exercised in
computing diluted EPS.

52
Diluted Earnings Per Share (Cont’d)

The test for dilution of each convertible security is

performed by computing what the conversion contributes
to per share earnings.
If the conversion of the convertible security contributes
less per share than preconversion basic EPS, the
convertible security is dilutive.

53
Diluted Earnings Per Share (Cont’d)

HKU Corporation has basic earnings per ordinary share

of $2.09 for the period ended December 31, 2015. For
each of the following examples, decide whether the
convertible security would be dilutive or antidilutive in
computing the diluted EPS. Consider each example
individually. The tax rate is 30%.

54
 Diluted Earnings Per Share (Cont’d)

(a) 8½% debentures, $1,000,000 face value, are

convertible into ordinary shares at the rate of 40 shares for
each $1,000 bond.

After tax interest saving

= $1,000,000 x 8.5% x (1-0.3) = $59,500

Contribution per share

= $59,500/(1,000 x 40 shares) = $1.49 dilutive

55
 Diluted Earnings Per Share (Cont’d)

(b) $5 cumulative preference shares (no par) are convertible

into ordinary shares at the rate of 2 ordinary shares for 1
preference share. There are 50,000 preference shares
outstanding.

Contribution per share

= (50,000 shares x $5)/50,000 x 2 shares = $2.5
antidilutive

56
 Diluted Earnings Per Share (Cont’d)

(c) Options to purchase 200,000 ordinary shares are

outstanding. The exercise price is $25 per share. Average
market price is $20 per share.

Exercise price ($25) > average market price ($20)

antidilutive

57
 Diluted Earnings Per Share (Cont’d)

Steps in diluted EPS calculation when there are

multiple potentially dilutive securities
When a company has several different potential ordinary
shares, each issue of potential ordinary shares is
considered in sequence from the most dilutive to the
least dilutive such that the lowest possible EPS figure is
obtained. The steps in computing basic and diluted EPS
are summarized as follows:
Step 1: Calculate basic EPS using a weighted average
number of shares for ordinary shares outstanding during
the year.

58
 Diluted Earnings Per Share (Cont’d)

Step 2: Determine whether stock options,

warrants, and convertible securities are dilutive.
Stock options and warrants are dilutive if the exercise
price is less than the average market price of the
ordinary shares.
For convertible securities, compute incremental EPS for
each security individually. Those with an incremental
value greater than the basic EPS after considering any
stock options or warrants are antidilutive and are
excluded.
59
 Diluted Earnings Per Share (Cont’d)

Step 3: Calculate diluted EPS:

Include all dilutive stock options and warrants first. Apply the
assumed cash proceeds at the average market price to compute
incremental shares.
Include dilutive convertible securities one at a time, beginning with
the security that has the smallest incremental EPS (contribution per
share). Compute a new EPS figure. Continue selecting and applying
convertible securities until the next security in the list has an
incremental EPS value greater than the last computed EPS.
Discontinue the process at that point. All other securities in the list
are antidilutive for purposes of computing the lowest possible
diluted EPS figure.
Step 4: Report basic and diluted EPS on the face of the income
statement.
60
 Convertible Bonds
Sovran Financial Corporation reported net income of $154 million in 2021 (tax rate 20 percent).
Its capital structure included:
Ordinary Shares
January 1 60 million ordinary shares were outstanding
March 1 12 million new shares were sold
June 17 A 10 percent stock dividend was distributed
October 1 8 million shares were reacquired as treasury stock
(The average market price of the ordinary shares during 2021 was $25 per share.)
Preference Shares Nonconvertible
January 1 to December 31 5 million shares 8 percent, $10 par
Incentive Stock Options
Executive stock options granted in 2016, exercisable after 2020 for 15 million ordinary shares at an
exercise price of $20 per share
Convertible Bonds
Effective interest of 10 percent, $300 million carrying amount on Jan 1, 2021, debt issued in 2021,
convertible into 12 million ordinary shares 61
 Disclosure Rules

HKAS 33 recommends the following be disclosed in the

financial statements:
On the face of the Income Statement/Profit and Loss Account:
basic and diluted EPS for each class of ordinary shares that has a
different right to share in the net profit for the period.
these amounts should be shown for both the current and the previous
accounting periods appeared in the Income Statement.
In the footnotes:
the amounts used as the numerators in calculating basic and diluted
EPS, and a reconciliation of those amounts to the net profit or loss for
the period.
the WANOS used as the denominator in calculating basic and diluted
EPS, and a reconciliation of these denominators to each other.

62
Summary

63
 Summary

Dilutive Effect Shown?

Potential Ordinary Shares Basic EPS Diluted EPS
Share options or warrants no yes
Restricted shares no yes
Convertible securities (bonds, notes,
preference shares) no yes
Contingently issuable shares no yes

64
 Summary:Diluted EPS
Potential Ordinary Shares Numerator Denominator
Add incremental
Share options or warrants None
shares
Add shares created
by vesting, reduced
Restricted shares None by repurchased
shares at the
average stock price

Add shares
Add after tax
Convertible bonds or notes issuable upon
interest
conversion
Add shares
Add back
Convertible preference shares issuable upon
dividends declared
conversion
Contingently issuable shares
Add shares
Conditions being currently met None
issuable
Conditions not being met None None
65
Summary (Cont’d)

66
 Comprehensive example:
Calculation of diluted EPS

Sovran Financial Corporation reported net income of $154 million in 2021 (tax rate 20 percent). Its
capital structure included:
Ordinary Shares
January 1: 60 million ordinary shares were outstanding
March 1: 12 million new shares were sold
June 17: A 10 percent stock dividend was distributed
October 1: 8 million shares were reacquired as treasury stock
Assume the average market price of the ordinary shares during 2021 was $25 per share.)
Preference Shares Nonconvertible
January 1 to December 31: 5 million shares 8 percent, $10 par
Incentive Stock Options
Executive stock options granted in 2016, exercisable after 2020 for 15 million ordinary shares at an
exercise price of $20 per share
Convertible Bonds
Effective interest of 10 percent, $300 million carrying amount on Jan 1, 2021, debt issued in 2021,
convertible into 12 million ordinary shares
67
 Calculation of diluted EPS

Weighted
Bonus Portion average
Dates Shares outstanding ( in ‘000)
issue of year ( in 000)

Jan 1 – Feb 28 60,000 1.1 2/12 11,000

Mar 1 – June 30 72,000 1.1 4/12 26,400

July 1 – Sept 30 72,000 x 1.1 = 79,200 3/12 19,800

Oct 1 – Dec 31 79,200 – 8,000 = 71,200 3/12 17,800

WANOS 75,000

or WANOS = 60,000 x 1.1 + 12,000 x 1.1 x 10/12 – 8,000 x 3/12 = 75,000

Basic EPS = $(154,000 – 4,000)/75,000 shares = $2.00

68
 Dilutive EPS
Dilution test: $25 market price > $20 exercise price

Incentive stock option (in ‘000)

a. Proceeds from exercise of options
= 15,000 options x $20 = $300,000
b. # of shares assumed to be purchased
= $300,000/$25 = 12,000 shares
c. # of new shares to be issued
= 15,000 shares – 12,000 shares = 3,000 shares
WANOS = 60,000 x 1.1 + 12,000 x 1.1 x 10/12 – 8,000 x 3/12 + 3,000 = 78,000
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 Dilutive EPS

Convertible bonds
a. Dilution test
= ($30,000 – 40% x 30,000)/12,000 = 18,000/12,000
= 1.5

WANOS = 60,000 x 1.1 + 12,000 x 1.1 x 10/12 – 8,000 x 3/12 + 3,000 + 120,000
= 90,000

Diluted EPS = $(154,000 – 4,000 + 18,000)/90,000 shares

= 168,000/90,000 = $1.87

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 Multiple dilutive securities – Dilutive
EPS calculation

On December 31, 2018, MedX Corporation had

outstanding 200,000 shares of ordinary share. Also
outstanding were 120,000 shares of preference share
convertible into 64,000 ordinary shares and bonds
convertible into 27,000 ordinary shares. The carrying
amount of the bonds on January 1, 2018 was $1,800,000
and the interest rate on a pure bond without a conversion
option was 10%. MedX's net income for the year ended
December 31, 2018 is $1,040,000. The income tax rate is
40%. MedX paid dividends of $2 per share on its
preference share during 2018.
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 Multiple dilutive securities – Dilutive
EPS calculation

Basic EPS
Net income Preference dividends
$800
$1,040 −240* = = $4.00
200 shares on January 1 200

Two convertible securities

120,000 preferred shares convertible to 64,000 ordinary
shares, $2 per share preferred dividends
1,800,000 convertible bonds to 27,000 ordinary shares

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 Dilution test
The incremental effect
Convertible preferred shares
Δ net income / Δ # shares = 240 / 64 = $3.75
Convertible bonds
Δ net income / Δ # shares = (180 x (1-0.4)) / 27 = $4.00
Dilutive EPS (without conversion of bonds)
= (1,040 – 240 + 240) / (200 + 64) = 3.94 dilutive
Dilutive EPS (with conversion of bonds)
= (1,040 – 240 + 240 + 180 x 0.6) / (200 + 64 + 27) = 3.95 antidilutive

we omit the convertible bonds from the calculation and diluted EPS is $3.94

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