IAS 33 – Earnings Per Share (EPS): Calculation & Dilution Logic

Earnings per share (EPS) is one of the most widely used indicators of a company's profitability and is of significant interest to investors and stakeholders. IAS 33 – Earnings Per Share under IFRS provides the principles for calculating both basic and diluted EPS. This blog explores the standard in detail, covering definitions, calculation methods, and practical examples.

What is the impact of convertible bonds on diluted EPS?

Diluted EPS uncovers what your earnings could become if all convertible instruments were exercised. Transparency in reporting builds trust and informed decisions.

1. Introduction to IAS 33

IAS 33 applies to entities whose shares are publicly traded or are in the process of issuing shares in public markets. The primary objective of IAS 33 is to prescribe principles for calculating and presenting earnings per share, ensuring comparability and transparency for investors.

Key Focus Areas of IAS 33:

• Basic EPS calculation
• Diluted EPS calculation
• Disclosure requirements
• Treatment of potential ordinary shares

2. Key Definitions

• Ordinary Shares: Shares that carry the right to participate in profits and assets of the company after other obligations are met.
• Potential Ordinary Shares: Financial instruments or arrangements that may convert into ordinary shares, such as:
  • Convertible bonds
  • Convertible preference shares
  • Stock options and warrants
• Profit or Loss Attributable to Ordinary Shareholders: The portion of net profit or loss that belongs to ordinary shareholders after considering dividends on preference shares and other adjustments.

3. Basic EPS Calculation

Basic EPS measures the earnings attributable to each ordinary share without considering the effect of potential dilution.

Formula:

Basic EPS = Profit or Loss attributable to ordinary shareholders / Weighted Average Number of Ordinary Shares Outstanding

Steps to Calculate Basic EPS:

• Determine the profit/loss attributable to ordinary shareholders.
• Compute the weighted average number of ordinary shares outstanding during the reporting period.
• Divide the profit by the weighted average number of shares.

Example:

• Net profit: $500,000
• Preference dividend: $50,000
• Weighted average ordinary shares: 100,000

Basic EPS = (500,000 - 50,000) / 100,000 = 4.50 per share

4. Diluted EPS Calculation

Diluted EPS reflects the potential decrease in EPS if all dilutive potential ordinary shares are exercised or converted.

Formula:

Diluted EPS = (Profit or Loss attributable to ordinary shareholders adjusted for dilutive effects) / (Weighted Average Number of Shares + Dilutive Potential Shares)

Key Principles:

• Only dilutive instruments (reducing EPS) are considered.
• Adjust profit/loss for any interest or dividends saved if convertible instruments are converted.
• Compute weighted average potential shares for the period.

Example:

• Basic EPS: $4.50 per share
• Convertible bonds can convert into 20,000 shares, saving $10,000 in interest

Adjusted profit = 500,000 - 50,000 + 10,000 = 460,000

Diluted EPS = 460,000 / (100,000 + 20,000) = 3.83 per share

5. Types of Dilutive Instruments

• Convertible Debt: Bonds that can be converted into shares.
• Convertible Preference Shares: Preference shares that can be converted to ordinary shares.
• Stock Options and Warrants: Rights to purchase ordinary shares at a predetermined price.

Only include instruments if they decrease EPS (i.e., are dilutive).

6. Disclosure Requirements under IAS 33

IAS 33 mandates that entities disclose:

• Basic and diluted EPS for:
  • Profit/loss from continuing operations
  • Profit/loss attributable to ordinary shareholders
• Reconciliation between numerator and denominator of basic and diluted EPS
• Potential dilutive instruments that were not included and why

Tip: Companies often present EPS on the face of the income statement for better transparency.

7. Differences Between Basic and Diluted EPS

8. Practical Importance of IAS 33

• Investors: Provides a consistent way to compare profitability per share.
• Management: Helps in decision-making on capital structure, stock options, and debt conversion.
• Regulatory Compliance: Ensures companies meet IFRS reporting standards for publicly traded entities.

9. Summary

IAS 33 ensures that both basic and diluted EPS are calculated and disclosed consistently. While basic EPS shows the earnings per existing shares, diluted EPS shows the potential reduction in earnings per share if all convertible instruments were exercised. Proper application of IAS 33 enhances transparency and provides investors with critical insights into a company's financial performance.

Key Takeaways:

• Always separate profit for EPS calculation from non-controlling interests.
• Include all potential dilutive shares unless they are anti-dilutive.
• Provide clear disclosure of both basic and diluted EPS in financial statements.