Earnings Per Share in financial reporting /f7

Introduction to International Financial Accounting Standards

International Financial Reporting Standards (IFRS), which have now been accepted by the majority of the world’s major financial markets, replaced International Accounting Standards (IAS), a set of regulations for financial statements, in 2001. IASB, or the International Accounting Standards Board “Regarding the IASB.”

 The International Accounting Standards Board (IASB), an impartial organization with headquarters in London, released both sets of standards.

Earnings Per Share: IAS 33 (International Accounting Standards)

The International Accounting Standards Board (IASB) published International Accounting Standard 33 (IAS 33), a standard that offers instructions for calculating and presenting earnings per share (EPS) in financial statements.

The measurement of company value commonly used is earnings per share, or EPS. It can be characterized as the amount of earnings per outstanding share of the company’s common stock. By displaying the amount of money a firm produces for each share of its stock, earnings per share serve as an indicator of its profitability.

To calculate earnings per share, we take the company’s net earnings (profit) and divide it by the total number of outstanding shares. The result is a per-share earnings figure

An investor can determine the value of a firm by dividing its share price by its earnings per share. This metric shows how much the market is prepared to pay for each dollar of earnings.

Different Usage of International Accounting Standards

• To be able to compare the earnings per share of different entities
• To be able to compare the earnings per share of the same entity in different accounting periods

 Even after reading a full definition of earning per share, if you are still unable to grasp the concept, do not hesitate to listen to Sir Mustafa’s lectures (Faculty at Mirchawala’s Hub Of Accountancy ) on IAS 33.

 A Practical Example Related to Earnings Per Share (IAS 33)

 ABC Ltd. earned $2 million in net income in the third quarter. The corporation declares a dividend of $350,000. The total number of outstanding shares is 11,000,000. Because each share receives an equal piece of the net income pie, they would each receive $0.15.

The Significance of Earnings Per Share

• Performance Measurement 
• Analyzing comparisons
• Track Record
• Stock appraisal

Performance Measurement: EPS lets investors analyze how well a firm is functioning and whether it is profitable for its shareholders.

Comparative Analysis: EPS can be used by investors to analyze the profitability of companies in the same sector or business field.

Track Record: Tracking a company’s earnings per share (EPS) over time provides insight into its financial stability as well as development trends.

 Stock valuation: Earnings per share (EPS) is an important factor in establishing a stock’s fair market value and growth potential.

 Formula :

Basic Earning per Share = (Net Earnings – Preferred Dividends) / Weighted Average Number of Common Shares Outstanding

 Criticisms and Limitations of Earnings Per Share

 The limitations of EPS may be listed below as follows:

• EPS will rise as profit rises in times of rising prices; hence, any gain in EPS should be regarded in the context of the influence of the price level shift.
• EPS is affected by judgment-based factors.
• EPS should never be used as the sole key performance indicator.
• EPS cannot be used to compare companies since the number of shares issued in any given company is unrelated to the quantity of capital employed.
• When a fresh share issue for cash occurs in the midst of the year, the new shares are included for half of the year on the assumption that earnings will increase for the other half of the year. In practice, however, a new project backed by those funds will not begin to yield a regular return right away, causing EPS to fall.
• It is inappropriate to compare firms based on EPS because each company uses various accounting policies to keep its records.
• Because EPS is based on previous records, it cannot be used to forecast future earnings.

Types of EPS in financial reporting (ACCA F7)

• Basic EPS
• Diluted EPS (DEPS

Basic Earnings Per Share

Basic earnings per share are the foundation of EPS. To compute it, simply divide the company’s net earnings (profit) by the total number of outstanding shares.

Diluted EPS (DEPS)

Because of current circumstances, equity share capital may expand in the future. When this happens, the earnings per share will be reduced or diluted. The provision of a diluted EPS number alerts shareholders to the potential impact of these additional shares on EPS.

Examples of dilutive factors are

• Convertible loans
• Subscription price for warrants

Diluted earning per share is calculated as earning plus notional extra earnings divided by several shares plus notional extra shares.

The Importance of Diluted Earnings Per Share

The basic EPS figure generated above may be misleading to users if the number of shares in issue increases in the future without an in-proportion growth in resources. For example, if an entity issues bonds that are convertible into ordinary shares at a later date, the number of ordinary shares will increase, but no new capital will be received by the entity. Earnings will rise, though, because interest on bonds is no longer payable. Often, the increase in earnings is less than the increase in the number of shares in issue. This is known as dilution, and the shares that will be issued are known as dilutive potential ordinary shares.

As a result, IAS 33 requires an organization to declare both the DEPS and the basic EPS, which are calculated using current earnings but assuming that the maximum potential dilution has already occurred.

Existing shareholders can use the DEPS to assess how existing commitments affect current profitability. ‘ The number of ordinary shares used to calculate DEPS shall be the weighted average number of ordinary shares calculated as for basic EPS plus the weighted average number of ordinary shares that would be issued if all dilutive potential ordinary shares were converted into ordinary shares.

Dilutive prospective ordinary shares are considered to have been converted into ordinary shares at the start of the period or, if later, on the date of conversion.

DEPS is important for the following reasons:

• It shows what the current year’s EPS would be if all dilutive potential ordinary shares in issue were converted.
• It can be used to assess trends in past performance.
• It serves as a warning to equity shareholders that the return on their investment may fall in future periods.

DEPS as an extra metric of prior performance

DEPS, as required by IAS 33, is not a forward-looking measure but rather an extra measure of previous performance. When computing DEPS with warrants or options, for example, fair value is calculated on the average price of an ordinary share for the reporting period rather than the market price at the end of the period. As a result, DEPS has limited utility as a predictor of future EPS.

IAS 33 Earnings Per Share, ICAEW (Institute of Chartered Accountants in England and Wales)

 A global perspective on technical accounting issues with work examples and illustrations from published financial reports of major listed companies from around the world This chapter discusses IAS 33.

A consequential amendment to IAS 33 would delete the current guidance on EPS calculated using measures other than those prescribed by IAS 33. It would be replaced by alternative guidance that refers to the requirements of the new IFRS-source: ICAEW.COM

Syllabus learning objective: Earnings Per Share

Kaplan study text

• Calculate the EPS in accordance with relevant accounting standards (dealing with bonus issues, full market value issues, and rights issues).
• Explain the relevance of the diluted EPS and calculate the diluted EPS involving convertible debt and share options (warrants).

The trend in earnings per share:

Although EPS is based on profit from ordinary activities after taxation, the trend in EPS may be a more accurate performance indicator than the trend in profit.

EPS measures performance from the perspective of investors and potential investors and shows the amount of earnings available to each ordinary shareholder so that it indicates the potential return on individual investments.

 The trend in EPS-illustration 7

The stock market places great emphasis on a company’s P/E ratio, and therefore a standard form of measurement of EPS is required.

Where an entity has increased its profits after issuing a large number of new ordinary shares, comparing the reported profits from year to year would not give a true picture. However, a more accurate indication of profitability would be obtained by examining the trend of EPS reported for each accounting period.

Conclusion 

Earnings per share (EPS) is an important financial metric used to evaluate a company’s profitability from an investor’s standpoint. This topic is taught by Sir Mustafa Mirchawala at the beginning of the Financial Reporting-FR ACCA exam course. While it provides insight into a company’s potential return on investment, it is important to note that EPS alone is not enough to assess a company’s overall financial performance. Investors should consider multiple financial ratios, which are taught in the ACCA course outline, to give students practical knowledge that they will implement in their forthcoming careers. It ensures that students make informed decisions about buying or selling stock if they are interested in doing that, which they should do because gaining knowledge about stock is crucial in developing a successful finance career. Understanding EPS and its role in financial reporting is also essential for anyone interested in investing in the stock market.

 Frequently Asked Questions (FAQs) on earnings per share

Let’s address some common questions about earnings per share or international accounting standards:

 Q1. What’s the significance of EPS for investors?

EPS helps investors assess a company’s profitability and make informed decisions about buying or selling its stock.

 Q2. How can a company increase its EPS?

Companies can boost EPS by increasing profits, buying back shares, managing debt, or making strategic acquisitions.

Q3. What’s the difference between basic and diluted EPS?

Basic EPS only considers common shares, while diluted EPS accounts for potentially dilutive securities like stock options.

Q4. Why is adjusted EPS important?

Adjusted EPS corrects for extraordinary events or one-time expenses, providing a more accurate picture of a company’s performance.

Q5. How can investors use forward EPS?

Forward EPS helps investors gauge a company’s future potential, aiding in long-term investment decisions.

Written by : Warisha Shehzadi – ACCA student at Mirchawala’s Hub Of Accountancy