Ch 6 - EPS and Distributable Profits Flashcards
Why is EPS regarded one of the most important indicators of the company’s performance?
It is important that users of the FS
Are able to compare the EPS of different entities
Are able to compare the EPS of the same entity, in diff acc periods
What is EPS used to do?
- Assess the ongoing fin perf of the company year to year
- Compute the major stock market indicator of perf - Price Earnings ratio (PE ratio)
PE ratio = Market value of the share / EPS
As the PE ratio is an important stock market ratio, it is important that EPS is calculated in a standard way
Who must apply IAS 33 EPS
FRS 102 Section 1.4 requires an entity whose shares are publicly traded to apply IAS 33 Earnings Per Share
How does IAS 33 EPS achieve comparability?
Defining earnings
Prescribing methods for determining the number of shares to be included in the calc of EPS
Requiring standard presentation and disclosures
The basic EPS is required to be shown on the face of the P&L
How do you calc basic EPS?
Earnings/shares where
Earnings - net prof/loss for the period attributable to ordinary equity holders of the parent entity (para 9)
Shares are the weighted average number of ordinary shares outstanding.. during a period (para10)
Define earnings for calculating EPS
Earnings - net prof/loss for the period attributable to ordinary equity holders of the parent entity (para 9)
Define shares for calculating EPS
Shares are the weighted average number of ordinary shares outstanding.. during a period (para10)
What must you be aware of when calculating shares for EPS?
Beware of the type of preference shares you are dealing with
- Redeemable preference shares are treated as debt in FS and the fin cost will already be included in P&L
- Irredeemable pref shares (without cumulative/mandatory dividends) are treated as equity, so the dividend must be deducted from net profit in P&L to arrive at earnings
- For cumulative preference shares, always pretend dividends have been paid in the correct period
How are redeemable shares used for calculating EPS?
Redeemable preference shares are treated as debt in FS and the fin cost will already be included in P&L
How are irredeemable pref shares without cum/mandatory dividends treated for calculating EPS?
are treated as equity, so the dividend must be deducted from net profit in P&L to arrive at earnings
How are cumulative preference shares treated when calculating EPS?
always pretend dividends have been paid in the correct period
If a company has a net prof of £400k at y/e, and £1m of £1 ordinary shares and £1m of 5% irredeemable preference shares in equity. Calc the basic EPS
Total net profit/ shares = £400,000 - dividend from irredeemable preference shares
EPS = £400,000 - £1,000,000*5% / 100,000 shares
EPS = 35.0p
What impact does the issue of new share capital at full market price have on the FS?
When a company issues new share capital at full market value, it will increase earnings and share capital, although not necessarily proportionally
How do you correctly calc EPS when there has been an issue of shares in the year
To calc the correct EPS figure, earnings should be apportioned over the weighted average number of equity shares
i.e. taking into account when shares are issued in the year
What is a bonus issue of shares?
where shares are offered to existing SH for free and therefore doesn’t provide additional resources to the issuer
Means that the shareholder owns the same proportion of the business before and after the issue
How do bonus issues of shares impact EPS?
They would skew comparability
How do you correct the impact of Bonus share issues on EPS?
The bonus shares are deemed to have been issued at the start of the year
Comparative figures are restated to allow for the proportional increase in share capital caused by the bonus issue
i.e. pretend the bonus issue has always been in place
What are the steps taken to correct a Bonus Share issue?
- Calc the bonus fraction = shares after issue / shares before the issue
E.g. if there is a 1 for 5 bonus issue, the bonus fraction = 6/5 - In the weighted average no. of shares calc, adjust all shares in existence BEFORE the bonus issue with the bonus fraction
- Calculate EPS and re-state prior year comparatives
What is a rights issue?
When a company makes a rights issue, it issues shares to existing SH in proportion to their SH and at a price lower than the market value
What problems do rights issues present
Rights issues present special problems
They contribute additional resources but
They are normally priced below full market price
Therefore, they combine characteristics of issues at full market price and bonus issues
What is required to be corrected for rights issues?
In order to allow comparability year on year, an adjustment needs to be made for the bonus element of a rights issues
- Calculate theoretical ex-rights price (TERP)
- Calculate bonus fraction on the rights issue = market price before the rights issue/TERP
- Calculate weighted average no of shares by adjusting all shares in existence before the rights issue by the bonus fraction
- Calculate EPS and re-state prior year comparatives
What are the steps for dealing with a rights issue?
- Calculate theoretical ex-rights price (TERP)
- Calculate bonus fraction on the rights issue = market price before the rights issue/TERP
- Calculate weighted average no of shares by adjusting all shares in existence before the rights issue by the bonus fraction
- Calculate EPS and re-state prior year comparatives
What is a treasury issue?
Treasury issues reduce the number of shares in issue
However share capital remains the same as treasury shares are a separate part of equity
An adjustment is required to the weighted average number of shares, similar to a ‘reverse’ of a full market value issue
What can dividends only be paid out from?
Profits that are available for that purpose - which are accumulated, realised profits less accumulated realised losses
Generally equates to RE, but some adjustments may be required
Define accumulated
with means that the balance of prof/loss from previous years must be taken into account as well as profits in the current period
Define realised
when realised int he form of cash or when the realisation to cash is reasonably certain
How is the distributable profit figure calculated?
Based on indiv company FS rather than consolidated FS
What are the rules for companies re distributable profits per CA 2006?
The following are detailed rules from CA 2006
A provision made in the accounts is a realised loss
A revaluation surplus is an unrealised profit
If fixed assets are revalued, and as a result, depreciation increases, the additional depr may be treated as part of the realised profit for dividend purposes
On the disposal of a revalued set, any unrealised surplus/loss on valuation immediately becomes realised
What is the impact when a revaluation takes place
Gains are unrealised unless they reverse a loss previously treated as realised
Losses are realised except where the loss
- Offsets a surplus on that asset
- Arises from the reassessment of the value of all NCAs
- Arises from a reassessment of some NCAs where the assets not revalued are worth at least their book value
What are the additional rules for public companies re distributable profits?
In addition to the rules set out above, a public company may not reduce its net assets below the aggregate amount of its called-up share capital and undistributable reserves
Undistributable reserves are
The share premium account
Excess unrealised profits over unrealised losses
Any other reserve which the company is prohibited from distributing by any statute or by its memorandum or articles of association
What are undistributable reserves?
The share premium account
Excess unrealised profits over unrealised losses
Any other reserve which the company is prohibited from distributing by any statute or by its memorandum or articles of association
How can distributable profits for a company be calculated?
Net assets
Less called-up share capital
Less undistributable reserves
= Distributable profits for a public company
OR
Distributable profits for a private co (accumulated realised profits less accumulated realised losses)
Less: excess of unrealised losses over realised profits (if any)
= Distributable profits for a public company
