Learning Outcomes
After reading this article, you will be able to calculate basic Earnings per Share (EPS) under IAS 33, incorporating adjustments for bonus and rights issues. You will understand how to identify and apply the correct bonus fraction, calculate the weighted average number of shares, restate comparative EPS figures, and explain why these adjustments are critical for correct performance assessment.
ACCA Financial Reporting (FR) Syllabus
For ACCA Financial Reporting (FR), you are required to understand how share issues impact the EPS calculation. Revision should focus on:
- The basic formula for Earnings per Share (EPS)
- Calculating weighted average shares in issue during the period
- Incorporating bonus issues and rights issues into EPS calculations
- Restating prior year EPS for the effects of bonus and rights issues
- Applying the concept of the bonus fraction
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- Which type of share issue requires the comparative period's EPS to be restated: a bonus issue, a rights issue, or a full-market price issue?
- What is a bonus fraction, and how is it applied in an EPS calculation?
- True or false? When a rights issue includes a bonus element, only the shares issued at a discount are time-apportioned in the weighted average number of shares.
- Why is it necessary to restate prior year EPS after a bonus or rights issue?
Introduction
IAS 33 Earnings per Share prescribes how to calculate and present EPS to allow users of financial statements to assess performance per share consistently across different entities and periods. Where an entity has issued shares by way of bonus or rights issues during the period—or in comparative periods—it is essential to adjust the EPS calculation to maintain comparability. The correct treatment depends on the nature of the issue and whether it includes a “bonus” (free) element.
Key Term: earnings per share (EPS)
Profit or loss attributable to each ordinary share during a period, calculated by dividing profit after tax (and after preference dividends, if any) by the weighted average number of ordinary shares in issue.
Share issues and adjustments to EPS
EPS provides a key indicator of performance for each share held. However, the calculation must be carefully adjusted for bonus and rights issues to avoid misleading trends.
Bonus issues (scrip or capitalisation issues)
A bonus issue increases the number of shares in issue, usually without raising new funds from shareholders. Each shareholder receives additional shares in proportion to their existing holding.
- No new resources are contributed to the entity.
- All shares are deemed to have been in issue since the start of the earliest period presented.
- Comparative EPS figures are restated using a bonus fraction.
Key Term: bonus fraction
A factor applied to prior period EPS to reflect the change in shares resulting from a bonus or rights issue, ensuring comparability over time.
Rights issues
A rights issue allows existing shareholders to acquire new shares, usually at a price below the current market value. This gives the transaction both a “funds raised” element and a “bonus” element (the discount).
- The bonus element (free shares) must be identified and reflected by applying a bonus fraction up to the date of issue.
- The “funds raised” element is time-apportioned in the weighted average shares calculation.
Key Term: theoretical ex-rights price (TERP)
The weighted average price per share after a rights issue, assuming all shareholders take up their rights, calculated based on pre-rights market price and new shares issued.
Worked Example 1.1
A company had 1,000,000 shares in issue at 1 January. On 1 July it made a 1-for-4 bonus issue and on 1 October it made an issue of 600,000 new shares at full market price. Profit after tax for the year was $220,000. Calculate the basic EPS and show what EPS should be for the comparative period (prior year profit was $180,000 with 1,000,000 shares throughout).
Answer:
Step 1 – Calculate bonus fraction:
New shares after bonus: 1,250,000 (1,000,000 + 250,000). Bonus fraction = 1,250,000 / 1,000,000 = 1.25.Step 2 – Calculate weighted average shares:
- 1 Jan – 30 June: 1,000,000 × 1.25 × 6/12 = 625,000
- 1 July – 30 September: 1,250,000 × 3/12 = 312,500
- 1 Oct – 31 Dec: (1,250,000 + 600,000) × 3/12 = 462,500
- Total weighted average = 1,400,000 shares
Step 3 – Basic EPS for current year:
EPS = $220,000 / 1,400,000 = $0.157 (15.7c)Step 4 – Restate prior year EPS:
Prior year EPS unadjusted: $180,000 / 1,000,000 = $0.18 (18c)
Restate using bonus fraction: $0.18 × (1,000,000 / 1,250,000) = $0.144 (14.4c)
Rights issue adjustment: Theoretical ex-rights price and bonus fraction
A rights issue, where shares are offered at a discount, requires calculation of the theoretical ex-rights price (TERP) and a bonus fraction.
Step 1: Compute TERP
E.g., rights issue of 1 new for 5 at $4, with pre-rights price $5:
Existing 5 shares × $5 = $25
1 new share × $4 = $4
Total 6 shares = $29
TERP = $29 / 6 = $4.83
Step 2: Bonus fraction = pre-rights price / TERP
Here: $5 / $4.83 ≈ 1.035
Step 3: Apply this factor to restate comparatives and in calculating weighted average shares.
Worked Example 1.2
A company has 2,000,000 shares in issue at 1 January. On 1 July it makes a 1-for-4 rights issue at $3 (pre-issue market price $5). Profit after tax is $450,000. Calculate the current year EPS and restated EPS for the previous year (when there were 2,000,000 shares and $400,000 profit).
Answer:
Step 1 – Calculate TERP:
Old shares: 4 × $5 = $20
Rights shares: 1 × $3 = $3
Total: $23 for 5 shares, so TERP = $23 / 5 = $4.60Step 2 – Bonus fraction:
$5 / $4.60 = 1.087Step 3 – Weighted average shares:
- 1 Jan – 30 June: 2,000,000 × 1.087 × 6/12 = 1,087,000
- 1 July – 31 Dec: (2,000,000 + 500,000) × 6/12 = 1,250,000 Weighted average: 1,087,000 + 1,250,000 = 2,337,000
Step 4 – Current year EPS:
EPS = $450,000 / 2,337,000 = $0.193 (19.3c)Step 5 – Restate prior year EPS:
EPS = $400,000 / 2,000,000 = $0.20 × (1 / 1.087) ≈ $0.184 (18.4c)
Exam Warning
Do not restate the prior year's EPS following a share issue at full market price. Restatement applies only to bonus and rights issues. Forgetting to recalculate weighted average shares or to apply the bonus fraction to comparatives is a common exam error.
Summary
Calculating EPS after bonus or rights issues requires correct identification and calculation of the bonus fraction and correct weighting of shares issued for consideration. EPS must reflect the economic reality across time, allowing users comparability between periods and entities. After a bonus or rights issue, prior period EPS figures must be restated using the calculated bonus fraction.
Key Point Checklist
This article has covered the following key knowledge points:
- Calculate earnings per share (EPS) under IAS 33
- Explain when and how to restate EPS for bonus and rights issues
- Compute bonus fractions, including for rights issues using TERP
- Calculate weighted average shares for all share issues
- Apply EPS restatement to prior periods for bonus and rights issues only
- State why bonus and rights issue adjustments are essential for comparability
Key Terms and Concepts
- earnings per share (EPS)
- bonus fraction
- theoretical ex-rights price (TERP)