17 Accounting Standard-20

ACCOUNTING STANDARD – 20ACCOUNTING STANDARD – 20

EARNINGS PER SHAREEARNINGS PER SHARE

By : By : CA Chandrashekhar CA Chandrashekhar

Shetty SShetty SB.Com, PGDCA, PGDFM, DISA, ACS, ACWA, B.Com, PGDCA, PGDFM, DISA, ACS, ACWA,

FCAFCA

DISCUSSION ON :DISCUSSION ON :

- Why EPS ?- Why EPS ?

- For Whom EPS ?- For Whom EPS ?

- What is EPS ?- What is EPS ?

- How EPS ?- How EPS ?

- When EPS ?- When EPS ?

EPS – An OverviewEPS – An Overview

Popular measure of the performance of a company and a factor in the valuation of its shares.

It is the reward of an investor for making his investment and it is the best measure of performance of a firm.

Ordinary investors make their investment

decision based on EPS.

Objective of financial management to maximize the EPS-----

-- from the view point of both the investor and investee

---maximization of value measure in terms of market price of equity share

Effects Of EPSEffects Of EPS

EPS affects the following:

– Value of a Share (Price Earning Ratio) Market Price = EPS * P/E ratio

– Valuation of the Business as a whole– Expectations of the Investors– Dividend Payout Ratio etc……

Legal FrameworkLegal Framework

Accounting Standard - 20 issued by ICAI– Commenced on 1-4-2001– Mandatory for Companies

Accounting Standard Interpretation – 12

International Accounting Standard – 33

Legal FrameworkLegal Framework

To provide for uniform computational To provide for uniform computational methodology AS – 20 was issued.methodology AS – 20 was issued.

Its mandatory for-Its mandatory for-– Enterprises whose equity shares or potential equity Enterprises whose equity shares or potential equity

shares are listed in India.shares are listed in India.– Enterprises whose shares are not so listed and are Enterprises whose shares are not so listed and are

willing to disclose the EPSwilling to disclose the EPS– Requirement of Part IV to Schedule VI of the Requirement of Part IV to Schedule VI of the

Companies Act, 1956Companies Act, 1956– Applicable for Level I Enterprises.Applicable for Level I Enterprises.

– Level II and Level III Enterprises – No Level II and Level III Enterprises – No Diluted EPS and Disclosure as per 48(ii)Diluted EPS and Disclosure as per 48(ii)

ACCOUNTING STANDARDS ACCOUNTING STANDARDS INTERPRETATION - 12INTERPRETATION - 12

APPLICABILITY OF AS 20 APPLICABILITY OF AS 20 Every company, which is required to Every company, which is required to

give information under Part IV of give information under Part IV of Schedule VI to the Companies Act, Schedule VI to the Companies Act, 1956, should calculate and disclose 1956, should calculate and disclose EPS in accordance with AS 20, whether EPS in accordance with AS 20, whether or not its equity shares or potential or not its equity shares or potential equity shares are listed.equity shares are listed.

ACCOUNTING STANDARDS ACCOUNTING STANDARDS INTERPRETATION - 12INTERPRETATION - 12

APPLICABILITY OF AS 20 APPLICABILITY OF AS 20

Basis For ConclusionsBasis For Conclusions AS 20 does not mandate an enterprise, AS 20 does not mandate an enterprise,

which has neither equity shares nor which has neither equity shares nor potential equity shares which are so listed, potential equity shares which are so listed, to calculate and disclose EPS, but, if that to calculate and disclose EPS, but, if that enterprise discloses EPS for complying with enterprise discloses EPS for complying with the requirement of any statute, it should the requirement of any statute, it should calculate and disclose EPS in accordance calculate and disclose EPS in accordance with AS 20with AS 20

Areas of Concern :Areas of Concern :

11 Whether applicable for Banking Whether applicable for Banking and insurance companies?and insurance companies?

2. Disclosure in Part IV – only Basic 2. Disclosure in Part IV – only Basic or Both Basic and Diluted?or Both Basic and Diluted?

Practical Issues FY 05-06Practical Issues FY 05-06

Banking Banking SectorSector

Vijaya BankVijaya Bank ING VYSYA Syndicate ING VYSYA Syndicate

BankBank

EPS on the EPS on the face of P&Lface of P&L

No (But in No (But in Notes On Notes On A/C)A/C)

Yes YesYes Yes

Balance Balance Sheet Sheet Abstract Abstract (Part IV)(Part IV)

No No Yes No Yes No

Practical Issues FY 05-06Practical Issues FY 05-06

OthersOthers

ITLITL WIPROWIPRO

Separate Disclosure Separate Disclosure of Extra-ordinary of Extra-ordinary itemitem

YesYes NoNo

Part IV Diluted Part IV Diluted EPSEPS

YesYes NoNo

Part IV – Segregation Part IV – Segregation of Extraordinary of Extraordinary items items

NoNo NoNo

Objectives of AS 20Objectives of AS 20

Prescribes principles for the Prescribes principles for the determination and presentation of determination and presentation of EPS.EPS.

The focus of this statement is on The focus of this statement is on the denominator of the EPS the denominator of the EPS calculation.calculation.

Presentation-Para 8 Presentation-Para 8 and 9and 9 An enterprise should present earnings per share An enterprise should present earnings per share for all for all

periods presented.periods presented.

Presentation on the Face of P & L A/c.Presentation on the Face of P & L A/c.

Separately for each class of equity share that has a Separately for each class of equity share that has a different right to share in profitdifferent right to share in profit

Types of EPS- Basic EPS Diluted EPS

A ) Whether disclosure is must when Profit is Negative? A ) Whether disclosure is must when Profit is Negative?

B ) If yes, whether both Basic and Diluted EPS have to be B ) If yes, whether both Basic and Diluted EPS have to be presented?presented?

MeasurementMeasurement

I. BASIC EARNINGS PER SHAREI. BASIC EARNINGS PER SHARE

A. Earnings – BasicA. Earnings – Basic = PAT – Pref. Div. incl. CDT = PAT – Pref. Div. incl. CDT

Points to Be Noted - Numerator Points to Be Noted - Numerator 1.1. Tax and impact of AS -22Tax and impact of AS -222.2. AS – 5 – Include Extraordinary items AS – 5 – Include Extraordinary items 3.3. Preference Dividend –Non Cumulative – Deduct Preference Dividend –Non Cumulative – Deduct

if providedif provided -- Cumulative - Full -- Cumulative - Full

Dividend ( only of current year)Dividend ( only of current year)4.4. > one class of equity shares – apportion the > one class of equity shares – apportion the

profits as per dividend rightsprofits as per dividend rights

B. Per Share - BasicB. Per Share - Basic - -

= Earnings / Weighted avg. No. Of Eq. shares= Earnings / Weighted avg. No. Of Eq. shares

Points to PonderPoints to Ponder - - DenominatorDenominator 1. Consider the weighted average no. of equity shares o/s. 1. Consider the weighted average no. of equity shares o/s.

during the period – time weighting factor - Refer Table Iduring the period – time weighting factor - Refer Table I2. AS- 14 : Transferee company 2. AS- 14 : Transferee company a. Purchase method – from the date of acquisitiona. Purchase method – from the date of acquisition b. Merger method – b. Merger method – From the beginning of the reporting From the beginning of the reporting

periodperiod3. 3. Partly paid shares - proportion to div rights – Refer Table IIPartly paid shares - proportion to div rights – Refer Table II4. Rights issue – consider the bonus element – Refer – Table III4. Rights issue – consider the bonus element – Refer – Table III5. Bonus issue or share split - Increase in shares without 5. Bonus issue or share split - Increase in shares without

increase in resources - Computation is from the beginning increase in resources - Computation is from the beginning of the earliest period reported – Refer Table IVof the earliest period reported – Refer Table IV

NO of NO of Shares Shares IssuedIssued

No. of No. of Shares Shares Bought Bought BackBack

No. of No. of Shares Shares OutstandinOutstandingg

11stst January, January, 20012001

Balance at Balance at beginning beginning of yearof year

18001800 -- 18001800

3131stst May, May, 20012001

Issue of Issue of shares for shares for cashcash

600600 -- 24002400

1st Nov, 1st Nov, 20012001

Buy Back Buy Back of Sharesof Shares

-- 300300 21002100

3131stst Dec, Dec, 20012001

Balance at Balance at end of yearend of year

24002400 300300 21002100

Table I - Weighted Average Number Of SharesTable I - Weighted Average Number Of Shares (Accounting year 01-01-2001 to 31-12-2001)(Accounting year 01-01-2001 to 31-12-2001)

Computation of Weighted Average No :Computation of Weighted Average No :

(1800*5/12) + (2400*5/12) +(2100*2/12) = (1800*5/12) + (2400*5/12) +(2100*2/12) = 2100 shares2100 shares

The weighted average number of shares can The weighted average number of shares can alternatively be computed as follows :alternatively be computed as follows :

(1800*12/12) + (600*7/12) – (300*2/12) = (1800*12/12) + (600*7/12) – (300*2/12) = 2100 shares2100 shares

Table II – Partly paid sharesTable II – Partly paid shares (Accounting year 01-01-2001 to 31-12-2001)(Accounting year 01-01-2001 to 31-12-2001)

No. of No. of shares shares issuedissued

Nominal Nominal value of value of shares shares

Amount paidAmount paid

11stst Jan, 2001 Jan, 2001 Balance at Balance at beginning of beginning of yearyear

18001800 Rs 10Rs 10 Rs 10Rs 10

3131stst October, October, 20012001

Issue of Issue of sharesshares

600600 Rs 10Rs 10 Rs 5Rs 5

Assuming that partly paid shares are entitled to participate in the Assuming that partly paid shares are entitled to participate in the dividend to the extent of amount paid, number of partly paid equitydividend to the extent of amount paid, number of partly paid equity shares would be taken as 300 for the purpose of calculation of EPS.shares would be taken as 300 for the purpose of calculation of EPS.Computation of Weighted Average would be as follows :Computation of Weighted Average would be as follows :(1800*12/12) + (300*2/12) = 1850 shares (1800*12/12) + (300*2/12) = 1850 shares

Table III – Right IssueTable III – Right Issue (Accounting year 01-01-2000 to 31-12-(Accounting year 01-01-2000 to 31-12-2000)2000)

Net ProfitNet Profit Year 20*0 : Rs 11,00,000Year 20*0 : Rs 11,00,000

Year 20*1 : Rs 15,00,000Year 20*1 : Rs 15,00,000

No. of shares outstanding prior No. of shares outstanding prior to rights issueto rights issue

5,00,000 shares5,00,000 shares

Rights issueRights issue One new share for each five One new share for each five outstanding (i.e. 1,00,000 new outstanding (i.e. 1,00,000 new shares)shares)

Rights issue price : Rs 15.00Rights issue price : Rs 15.00

Fair value of one equity share Fair value of one equity share immediately prior to exercise immediately prior to exercise of rights on 1of rights on 1stst March 2001 March 2001

Rs 21.00Rs 21.00

Computation of theoretical ex-rights fair Computation of theoretical ex-rights fair value per sharevalue per share Fair value of all outstanding shares immediately prior to Fair value of all outstanding shares immediately prior to exercise of rights + total amount received from exerciseexercise of rights + total amount received from exercise

Number of shares outstanding prior to exercise + number Number of shares outstanding prior to exercise + number of shares issued in the exerciseof shares issued in the exercise

(Rs 21 * 5,00,000 shares) + (Rs 15 * 1,00,000 shares) / (Rs 21 * 5,00,000 shares) + (Rs 15 * 1,00,000 shares) / 5,00,000 + 1,00,000 shares 5,00,000 + 1,00,000 shares

Theoretical ex-rights fair value per share = Rs 20.00Theoretical ex-rights fair value per share = Rs 20.00

Computation of Adjustment factorComputation of Adjustment factorRs 21.00 (Fair value per share prior to exercise of rights) / Rs 21.00 (Fair value per share prior to exercise of rights) / Rs 20.00(Theoretical ex-rights value per share) = 1.05 Rs 20.00(Theoretical ex-rights value per share) = 1.05

Computation of EPSComputation of EPS

Year 2000Year 2000 Year 2001Year 2001EPS for the year EPS for the year 2000 as originally 2000 as originally reported : reported :

Rs Rs 11,00,000/5,00,000 11,00,000/5,00,000 sharesshares

Rs 2.20Rs 2.20

EPS for the year EPS for the year 2000 restated for 2000 restated for rights issue : rights issue :

Rs 11,00,000 / Rs 11,00,000 / (5,00,000 shares * (5,00,000 shares * 1.05)1.05)

Rs 2.10Rs 2.10

EPS for the year EPS for the year 2001 including 2001 including effects of rights effects of rights issueissue

Rs 15,00,000 / Rs 15,00,000 / (5,00,000 * 1.05 * (5,00,000 * 1.05 * 2/12) + (6,00,000 * 2/12) + (6,00,000 * 10/12)10/12)

Rs 2.55Rs 2.55

Table IV – Bonus IssueTable IV – Bonus Issue(Accounting year 01-01-2000 to 31-12-2000)(Accounting year 01-01-2000 to 31-12-2000)

Net profit for the year 2000Net profit for the year 2000 Rs 18,00,000Rs 18,00,000

Net profit for the year 2001Net profit for the year 2001 Rs 60,00,000Rs 60,00,000

No. of equity shares No. of equity shares outstanding until 30outstanding until 30thth September 2001September 2001

20,00,00020,00,000

Bonus issue 1Bonus issue 1stst Oct 2001 Oct 2001 2 equity shares for each equity 2 equity shares for each equity share outstanding at 30share outstanding at 30thth Sept, Sept, 20*120*1

20,00,000*2=40,00,00020,00,000*2=40,00,000

Earnings per share for the Earnings per share for the year 2001year 2001

60,00,000/(20,00,000 + 60,00,000/(20,00,000 + 40,00,000) = Rs 1.0040,00,000) = Rs 1.00

Adjusted EPS for the year Adjusted EPS for the year 20002000

18,00,000/(20,00,000+40,00,000) 18,00,000/(20,00,000+40,00,000) = Rs 0.3= Rs 0.3

Since the Bonus issue is an issue without consideration, the issue is Since the Bonus issue is an issue without consideration, the issue is treated as if it had occurred prior to the beginning of the year 2000, thetreated as if it had occurred prior to the beginning of the year 2000, the earliest period reported.earliest period reported.

Table V - Determining the Order in Which to Table V - Determining the Order in Which to Include Dilutive Securities in the Computing of Include Dilutive Securities in the Computing of Weighted Average Number Of SharesWeighted Average Number Of Shares

Earnings, i.e., Net profit Earnings, i.e., Net profit attributable to equity attributable to equity shareholdersshareholders

Rs 1,00,00,000Rs 1,00,00,000

No. of equity shares No. of equity shares outstandingoutstanding

20,00,00020,00,000

Average fair value of one Average fair value of one equity share during the yearequity share during the year

Rs 75.00Rs 75.00

Potential Equity Potential Equity SharesSharesOptions Options 1,00,000 with exercise price of 1,00,000 with exercise price of

Rs 60Rs 60

Convertible Preference sharesConvertible Preference shares

Attributable tax, e.g., Attributable tax, e.g., corporate dividend taxcorporate dividend tax

8,00,000 shares entitled to a 8,00,000 shares entitled to a cumulative dividend of Rs 8 cumulative dividend of Rs 8 per sahre. Each preference per sahre. Each preference share is convertible into 2 share is convertible into 2 equity shares.equity shares.

10%10%

12% Convertible Debentures 12% Convertible Debentures of Rs 100 eachof Rs 100 each

Nominal amount Rs Nominal amount Rs 10,00,00,000. Each debenture 10,00,00,000. Each debenture is convertible into 4 equity is convertible into 4 equity shares.shares.

Tax rateTax rate 30%30%

Increase in Earnings Attributable to Increase in Earnings Attributable to Equity Shareholders on Conversion of Equity Shareholders on Conversion of Potential Equity SharesPotential Equity Shares

Increase in Increase in EarningsEarnings

Increase in Increase in no. of Equity no. of Equity SharesShares

Earnings per Earnings per Incremental Incremental shareshare

OptionsOptions Increase in Increase in earningsearnings

Nil Nil

No. of No. of incremental incremental shares issued shares issued for no for no consideration{consideration{1.00,000*(75-1.00,000*(75-60)/75}60)/75}

20,00020,000 Nil Nil

Convertible Convertible Preference Preference

sharesshares

Increase in net Increase in net profit profit attributable to attributable to equity equity shareholders shareholders as adjusted by as adjusted by attributable attributable tax [Rs tax [Rs 8*8,00,000)+18*8,00,000)+10%(8*8,00,000%(8*8,00,000)]0)]

Rs 70,40,000Rs 70,40,000

No. of No. of incremental incremental shares{2*8,00shares{2*8,00,000)],000)]

16,00,00016,00,000 Rs 4.40Rs 4.40

12% 12% Convertible Convertible DebenturesDebentures

Increase in net Increase in net profit {Rs profit {Rs 10,00,00,000*10,00,00,000*0.12*( 1 – 0.12*( 1 – 0.30)}0.30)}

Rs 84,00,000Rs 84,00,000

No. of No. of incremental incremental shares{10,00,shares{10,00,000*4}000*4}

40,00,00040,00,000 Rs 2.10Rs 2.10

It may be noted from the above that options are most dilutive as their earnings perIt may be noted from the above that options are most dilutive as their earnings perIncremental shares is nil. Hence, for the purpose of computation of diluted EPS, options Incremental shares is nil. Hence, for the purpose of computation of diluted EPS, options will be considered first. 12% convertible debentures being second most dilutive will be will be considered first. 12% convertible debentures being second most dilutive will be considered next and thereafter convertible preference shares will be considered (see paraconsidered next and thereafter convertible preference shares will be considered (see para42)42)

Computation of Diluted EPSComputation of Diluted EPSNet Profit Net Profit AttributablAttributable (Rs)e (Rs)

No. of No. of Equity Equity sharesshares

Net profit Net profit attributable attributable per share per share (Rs)(Rs)

As As reportedreported

1,00,0001,00,000 20,00,00020,00,000 5.005.00

OptionsOptions 20,00020,000

1,00,00,001,00,00,0000

20,20,00020,20,000 4.954.95 Dilutive Dilutive

12% 12% Convertible Convertible DebentureDebenturess

84,00,00084,00,000 40,00,00040,00,000

1,84,00,001,84,00,0000

60,20,00060,20,000 3.063.06 DilutiveDilutive

Convertible Convertible Pref sharesPref shares

70,40,00070,40,000 16,00,00016,00,000

2,54,40,002,54,40,0000

76,20,00076,20,000 3.343.34 Ati-DilutiveAti-DilutiveSince diluted EPS is increased when taking the convertible pref shares in A/C (fromSince diluted EPS is increased when taking the convertible pref shares in A/C (fromRs 3.06 to Rs 3.34), the convertible pref shares are anti-dilutive and are ignored in theRs 3.06 to Rs 3.34), the convertible pref shares are anti-dilutive and are ignored in the calculation of diluted EPS. Therefore, diluted EPS is Rs 3.06. calculation of diluted EPS. Therefore, diluted EPS is Rs 3.06.

II. DILUTED EARNINGS PER SHAREII. DILUTED EARNINGS PER SHARE A. Earnings – DilutedA. Earnings – DilutedPoints to PonderPoints to Ponder1.1. Nr and Dr. – adjusted for effects of dilutive Nr and Dr. – adjusted for effects of dilutive

potential equity shares.potential equity shares. - - Potential equity share is a financial instrument or other Potential equity share is a financial instrument or other

contract that entitles, or may entitle, its holder to equity contract that entitles, or may entitle, its holder to equity sharesshares

-Potential equity shares should be treated as -Potential equity shares should be treated as dilutive dilutive when, and only when, when, and only when, their conversion to their conversion to equity shares would decrease net profit per share equity shares would decrease net profit per share from continuing ordinary operations from continuing ordinary operations (PARA 39)(PARA 39)

--Ignore Anti-dilutive potential equity shares`--Ignore Anti-dilutive potential equity shares`

Net Profit for the period attributable Net Profit for the period attributable to equity sharesto equity shares

- increased by dividends and tax- increased by dividends and tax

- increased by interest subject - increased by interest subject to to tax tax

- any other item affecting profits- any other item affecting profits

B. Per Share – DilutedB. Per Share – Diluted Dilutive potential equity shares should be Dilutive potential equity shares should be

deemed to have been converted into equity deemed to have been converted into equity shares at the beginning of the period or, if issued shares at the beginning of the period or, if issued later, the date of the issue of the potential equity later, the date of the issue of the potential equity shares.shares.

--Share application money or advance share Share application money or advance share application money is to be treated in same application money is to be treated in same manner as dilutive potential equity shares.manner as dilutive potential equity shares.

Steps : Para 35 to 37Steps : Para 35 to 37 1. Assume the exercise of dilutuve securities e.g. 1. Assume the exercise of dilutuve securities e.g.

ESOPESOP 2. Determine the fair value of share( e.g. avg. of last 6 2. Determine the fair value of share( e.g. avg. of last 6

months’ weekly closing prices)months’ weekly closing prices) 3. Determine the exercise price3. Determine the exercise price 4. Shares issued for no consideration = Step 2 - Step 4. Shares issued for no consideration = Step 2 - Step

33 5. Dilutive shares only to the extent of Step No. 4 5. Dilutive shares only to the extent of Step No. 4

( Refer Table V)( Refer Table V) 6. Sequence – Most dilutive to least dilutive 6. Sequence – Most dilutive to least dilutive

Most Dilutive = Earnings per Incremental Share is Most Dilutive = Earnings per Incremental Share is leastleast

Free shares Free shares consideredconsidered A. Right and Buy back--- Both for A. Right and Buy back--- Both for

Basic and DilutedBasic and Diluted

B. Options -- Only for Diluted B. Options -- Only for Diluted ( Potential shares)( Potential shares)

Factors Affecting EPSFactors Affecting EPS

Bonus issues, stock-splits and reverse Bonus issues, stock-splits and reverse stock-splits (consolidation of shares) stock-splits (consolidation of shares) change the number of outstanding change the number of outstanding shares without changing the resources shares without changing the resources available to the firm. Therefore, available to the firm. Therefore, companies adjust the number of equity companies adjust the number of equity shares outstanding for those periods for shares outstanding for those periods for bonus issues, stock-splits and reverse bonus issues, stock-splits and reverse stock-splits while calculating the EPS.stock-splits while calculating the EPS.

RESTATEMENTRESTATEMENT

If the shares outstanding increases as a If the shares outstanding increases as a result of a bonus issue or decreases as a result of a bonus issue or decreases as a result of basic and diluted earnings per share result of basic and diluted earnings per share should be adjusted for should be adjusted for all the periodsall the periods presented.presented.

An enterprise does An enterprise does not restate diluted not restate diluted earnings per share of any prior periodearnings per share of any prior period presented for changes in the assumptions presented for changes in the assumptions used or for the conversion of potential equity used or for the conversion of potential equity shares into equity shares outstanding.shares into equity shares outstanding.

Normally, EPS is not adjusted for transaction Normally, EPS is not adjusted for transaction occurring after the balance sheet date – no occurring after the balance sheet date – no effect on capital used.effect on capital used.

ExampleExample

A firm XYZ whose net profit attributable to A firm XYZ whose net profit attributable to equity share holders for 2005 was Rs equity share holders for 2005 was Rs 10,00,000 and the number of outstanding 10,00,000 and the number of outstanding shares 50,000. The EPS for 2005 will be 20.shares 50,000. The EPS for 2005 will be 20.

In the year 2006 if the profit is 15,00,000 and In the year 2006 if the profit is 15,00,000 and company issues 1:1 bonus.company issues 1:1 bonus.

In the financial statement of 2006 the EPS for In the financial statement of 2006 the EPS for 2005 would be readjusted to Rs 10 2005 would be readjusted to Rs 10 (Rs10,00,000/1,00,000) to ensure (Rs10,00,000/1,00,000) to ensure comparability, even though it was reported comparability, even though it was reported at Rs 20 in financial statements for the year at Rs 20 in financial statements for the year 2005.2005.

DISCLOSURE - Para 48 DISCLOSURE - Para 48 to 51 to 51 48 (i)Where the statement of 48 (i)Where the statement of

profit or loss includes profit or loss includes extraordinary items, the extraordinary items, the enterprise should disclose basic enterprise should disclose basic and diluted EPS computed on the and diluted EPS computed on the basis of earnings basis of earnings excluding excluding extraordinary itemsextraordinary items

--- Prior period items ?--- Prior period items ?

DISCLOSUREDISCLOSURE

48( ii) (a)the amounts used as 48( ii) (a)the amounts used as numerators, and a reconciliation numerators, and a reconciliation of those amounts to net profits or of those amounts to net profits or loss;loss;

(b) the weighted average number (b) the weighted average number of equity shares used as the of equity shares used as the denominator;denominator;

© the © the nominal valuenominal value of shares of shares along with EPS figures.along with EPS figures.

AS – 20 and other AS - AS – 20 and other AS - InterconnectionInterconnection As - 1As - 1 AS – 2AS – 2 AS – 4AS – 4 AS – 5AS – 5 AS – 6AS – 6 AS – 7AS – 7

AS – 9AS – 9 AS – 10 AS – 10 AS -11AS -11 AS – 12AS – 12 AS – 13AS – 13 AS – 14AS – 14 AS – 15AS – 15

AS – 19AS – 19 AS – 21AS – 21 AS – 22AS – 22 AS – 24AS – 24 AS – 25AS – 25 AS – 28AS – 28 AS – 29AS – 29

Other Matters :Other Matters :IAS – 33IAS – 33January 1996 Exposure Draft -- January 1996 Exposure Draft -- Earnings Per ShareEarnings Per Share

18 December Revised version of IAS 33 issued by the 18 December Revised version of IAS 33 issued by the

IASBIASB 20032003

1 January 20051 January 2005 Effective date of IAS 33 (Revised 2003)Effective date of IAS 33 (Revised 2003)

February 1997 IAS 33 Share Earnings Per

1 January 1999 Effective Date of IAS 33 (1997)

Objective of IAS 33Objective of IAS 33

to improve performance comparisons to improve performance comparisons between different enterprises in the between different enterprises in the same period and between different same period and between different accounting periods for the same accounting periods for the same enterpriseenterprise. .

Scope Scope

IAS 33 applies to entities whose IAS 33 applies to entities whose securities are publicly traded or that securities are publicly traded or that are in the process of issuing securities are in the process of issuing securities to the public. [IAS 33.2] Other entities to the public. [IAS 33.2] Other entities that choose to present EPS information that choose to present EPS information must also comply with IAS 33. [IAS must also comply with IAS 33. [IAS 33.3]33.3]

Shortcomings of EPSShortcomings of EPS

Does not consider the opportunity Does not consider the opportunity cost of capital and can be cost of capital and can be manipulated by short-term manipulated by short-term actions.actions.

Let us take an example. Assume that a Let us take an example. Assume that a company has 20,000 outstanding shares and company has 20,000 outstanding shares and earnings available to shareholders is Rs earnings available to shareholders is Rs 200,000. The EPS is (Rs 2,00,000/ 20,000), or 200,000. The EPS is (Rs 2,00,000/ 20,000), or Rs 10. Assume that the company borrows Rs Rs 10. Assume that the company borrows Rs 10,00,000 at an interest rate of 8 per cent to 10,00,000 at an interest rate of 8 per cent to buy back 10,000 shares. Assuming an income buy back 10,000 shares. Assuming an income tax rate of 40 per cent, the earnings available tax rate of 40 per cent, the earnings available to shareholders after the shares are bought to shareholders after the shares are bought back will be [Rs 2,00,000 - (1.00 - 0.40) x Rs. back will be [Rs 2,00,000 - (1.00 - 0.40) x Rs. 80,000] or 1.52,000. Accordingly, EPS will be 80,000] or 1.52,000. Accordingly, EPS will be reported at [Rs 1,52,000/10,000] or Rs 15.20. reported at [Rs 1,52,000/10,000] or Rs 15.20.

Shortcomings of EPSShortcomings of EPS

Indeed, financial economics tells us that (in the first Indeed, financial economics tells us that (in the first approximation) these two effects cancel out exactly and the approximation) these two effects cancel out exactly and the return on invested capital (ROIC) and the cost of capital do return on invested capital (ROIC) and the cost of capital do not change with a change in the capital structure. not change with a change in the capital structure. Accordingly, economic profit (often called EVA) too does not Accordingly, economic profit (often called EVA) too does not change with the change in the capital structure. Yet, the change with the change in the capital structure. Yet, the example above shows that the EPS can increase in such example above shows that the EPS can increase in such circumstances.circumstances.

Therefore, it is not correct to conclude that the increase in Therefore, it is not correct to conclude that the increase in EPS always reflects better performance by the company.EPS always reflects better performance by the company.

For example, if a company finances a new project For example, if a company finances a new project totally by debt, EPS will increase if the project totally by debt, EPS will increase if the project returns are higher than the after-tax cost of debt, returns are higher than the after-tax cost of debt, even if the project earns a return lower than the cost even if the project earns a return lower than the cost of capital (WACC) of the company. Although the EPS of capital (WACC) of the company. Although the EPS increases, such a project destroys value.increases, such a project destroys value.

Shortcomings of EPSShortcomings of EPS

Another important shortcoming of Another important shortcoming of EPS is that it does not relate EPS EPS is that it does not relate EPS with the invested capital. For with the invested capital. For example, two companies may have example, two companies may have same EPS, even if one company has same EPS, even if one company has lower invested capital as compared lower invested capital as compared to the other. to the other.

Ignores the Scale and size of Ignores the Scale and size of operationsoperations

Problems with EPS Problems with EPS Reporting StandardsReporting Standards Complex Computation mechanism

of Diluted EPS Basic EPS is subject to replacement

on the income statement by two hypothetical EPS numbers.

The test used to identify common stock equivalent securities is among the most controversial of those rules

Inability to pinpoint the meaning of common stock equivalency

Changing relationships between the terms of particular securities and prevailing market conditions are not considered in the computational rules for EPS.

Do these complicated EPS disclosures assist investors and creditors in decision making? The answer is unclear. Millar, et. al., report in the September-October, 1987 Financial Analysts journal that basic EPS and cash flow per share numbers are more closely related to stock returns than either primary or fully diluted EPS. Additional research is needed to ascertain the relative usefulness of basic, primary and fully diluted EPS.

In the mean time, accountants and auditors are saddled with complicated rules of questionable usefulness.

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