Chapter 13 Earnings per share and distributable profits

Question 1

1.1 Basic earnings per share

Answer 1

Earnings per share (EPS) is used to assess the ongoing financial performance of a company from year to year, and to compute the major stock market indicator of performance, the Price earnings ratio. The calculation for the PE is (market value of share / EPS).
IAS 33 achieves comparability by defining earnings, giving methods for determining the number of shares included in the EPS calculation and requiring standard presentation and disclosures. The EPS is required to be shown on the P+L. compliance with IAS 33 is only mandatory for the separate accounts of entities whose ordinary shares and publicly traded or in the process of being issued in public markets and the consolidated accounts for groups whose parent has shares similarly traded/ being issued.
Basic earnings per share is (earnings / shares). IAS 33 states earnings are net profit or loss in the period attributable to ordinary equity holders of the parent entity. Shares are the weighted average number of ordinary shares outstanding during the period.
Redeemable preference shares will already be included in the P+L, irredeemable preference shares are equity so the dividend must be deducted from net profit in the P+L to arrive at earnings and for cumulative preference shares always pretend dividends have been paid in the correct period.

Question 2

1.2 Issue of shares at full market price

Answer 2

When a company issues new share capital at full market vale it will increase earnings and share capital. To calculate the correct EPS figure, earnings should be apportioned over the weight average number of equity shares.

Question 3

1.3 Bonus issue of shares

Answer 3

A bonus issue is where shares are offered to existing shareholder for free and therefore does not provide additional resources to the issuer and the shareholder owns the same proportion before and after the issue. In the calculation of EPS, bonus shares are deemed to have been issued at the start of the year and comparative figures are restated to allow for a proportional increase in share capital caused by the bonus issue. The steps are calculate bonus fraction (shares after issue / shares before issue), then in the weighted average number of shares calculation adjust all shares in existence before the bonus issue with the bonus fraction and then calculate EPS and re-state the prior year comparative.

Question 4

1.4 Rights issue

Answer 4

The company issues shares to existing shareholders in proportion to their shareholding at a price lower than the market value. Rights issues contribute additional resources but are normally priced below full market price. To allow comparability each year, an adjustment needs to be made for the bonus element of a rights issue. The steps are calculating theoretical ex-rights price (TERP), calculate bonus fraction on rights issue (market price before / TERP), calculate weighted average number of shares by adjusting all shares in existence before the rights issue by the bonus fraction and calculate EPS and re-state the prior year comparative.

Question 5

1.5 Treasury shares

Answer 5

They 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.

Question 6

2.1 Distributable profits

Answer 6

All companies are prohibited from paying dividends except out of profits available for that purpose. Profits available for dividend are accumulated, realised profits less accumulated, realised losses. Accumulated means the balance of P+L from previous years must be taken into account as well as profits in current period. Generally, this equates to the retained earnings balance, but some adjustments may be required. The distributable profit figure is calculated based on individual company financial statements rather than consolidated financial statements.

Question 7

2.2 Rules for all companies

Answer 7

Companies Act 2006 states a provision made in the accounts is a realised loss, a revaluation surplus is an unrealised profit, if non-current assets are revalued, as a result, depreciation increases, the additional depreciation may be treated as part of the realised profit for dividend purposes and on the disposal of a revalued asset any unrealised surplus or loss on valuation immediately becomes realised.

Question 8

2.3 Revaluations

Answer 8

When a revaluation of non-current assets 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 a reassessment of the value of all non-current assets and arises from a reassessment of some non-current assets where the asset not revalued are worth at least their book value.

Question 9

2.4 Additional rules for public companies

Answer 9

A public company may not reduce its net assets below the aggregate amount of its called-up share capital and undistributable reserves. Net assets less called-up share capital less undistributable reserves = distributable profits for a public company
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. Distributable profits for a public company can also be calculated as distributable profits for a private company (accumulated realised profits less accumulated realised losses) less excess of unrealised losses over unrealised profits.