Chapter 18: Earnings Per Share

Perspective and Issues

Investors and other consumers of corporate financial information are generally anxious to identify a "shorthand" means of measuring an entity's performance, notwithstanding oftvoiced concerns that any condensed gauge of earnings inevitably runs the risk of being an incomplete picture of results for the period. The accounting profession long opposed publications of earnings per share data, because of the perceived peril of offering a distorted picture of entity performance. Nonetheless, investors in particular are devoted users of earning per share data which is taken to be a predictor of the entity's future performance. Ultimately, recognizing that such statistics were being computed in various ways and then widely disseminated, the accounting standard setters decided to at least impose uniform practices.

The international standard addressing earnings per share (EPS) is IAS 33. It requires that one, or two if there is a complex capital structure, measures be presented each period for which an income statement is reported. The principal goal in these measures is to ensure that the number of shares used in the computation(s) fully reflects the impact of dilutive securities, including those which may not be outstanding during the period, but which, if they were to become outstanding, would affect the real future earnings available to be allocated to current shareholders.

When the entity's capital structure is uncomplicated, EPS is computed by simply dividing net income (or loss) by the average number of outstanding equity shares. The computation becomes more complicated with the existence of securities that, while not presently equity shares, have the potential of causing additional equity shares to be issued in future, thereby diluting each currently outstanding share's claim to future earnings. Examples include convertible preference shares and convertible debt, as well as various options and warrants. It was long recognized that if calculated earnings per share were to ignore these potentially dilutive securities, there would be a great risk for misleading implications.

The IAS on EPS computations was the result of a joint international effort to refine EPS measurements then extant. It largely presaged the latest iteration of the requirement under US GAAP, which is set forth in SFAS 128. The purpose of IAS 33 is to prescribe the ground rules for the determination and presentation of earnings per share.

As the name indicates, EPS is derived by dividing a measure of earnings by a measure of number of common shares. The standard emphasizes the denominator of the earnings per share calculation and notes that even though EPS calculations have limitations, because different accounting policies typically can be used in the determination of earnings, which is in the numerator of the equation, a consistently determined denominator enhances financial reporting.

IAS 33 states that the standard's applicability is to both enterprises whose ordinary shares or potential ordinary shares are publicly traded, and enterprises that are in the process of issuing ordinary shares or potential ordinary shares in public securities markets. While it is not defined at what point in the share issuance process these requirements become effective, in practice this ambiguity has not been a source of confusion.

Some private entities wish to report a statistical measure of performance, and often choose to use EPS as the well-understood yardstick to employ. While these entities are not required to issue EPS data, when they elect to do so they must comply with IAS 33.

In situations when both parent company and consolidated financial statements are presented, IAS 33 requires that the information called for by this standard need only be presented based on the consolidated information. The reason for this rule is that users of financial statements of a parent company are interested in the results of operations of the group as a whole, as opposed to the parent company on a stand-alone basis. Of course, nothing prevents the enterprise from also presenting the parent-only information, including EPS, should it choose to do so. Again, the requirements of IAS 33 would have to be met.

Sources of IAS

IAS 33

SIC 24