IAS 33 Earnings per Share

Earnings per share is the only ratio in this paper with an accounting standard of its own. IAS 33 Earnings per Share exists because the figure matters enough to investors that leaving each company to compute it as it liked would have made it useless — and because the obvious calculation, profit divided by the number of shares at the year end, is wrong.

YouTube videoLoad YouTube video

1 Why earnings per share matters

Earnings is the headline figure, and on its own it can mislead. Consider a company reporting three years of rising profit:

Profit rises every year, so on the headline the company is doing well and better each time. But in year 3 it raised fresh cash through a 1-for-1 rights issue, doubling the shares in issue. That cash should have been put to work generating profit — and it did generate some, profit rose from $12,000 to $15,000 — but nowhere near enough for the money raised. Earnings per share fell by nearly half.

That is the point of the ratio: it measures profit against the equity finance used to produce it, so it cannot be flattered simply by raising more capital. It is also the denominator of the price/earnings ratio, which is how investors judge whether a share is expensive or cheap, so the calculation has to be one everybody performs the same way.

IAS 33 requires two figures — basic earnings per share, which looks at the shares actually in issue during the year, and diluted earnings per share, which looks ahead to commitments that will increase the share count in the future. Neither involves a debit or a credit: this is a calculation chapter, not a bookkeeping one.

2 Basic earnings per share

Basic EPS = Profit attributable to the ordinary equity holders of the parent ÷ Weighted average number of ordinary shares in issue during the period

2.1 The numerator: earnings

Earnings is the profit or loss for the period attributable to the ordinary equity holders of the parent. Two adjustments get students their marks:

• In a group, start from the profit for the year attributable to the owners of the parent — the figure at the foot of the consolidated statement of profit or loss, after the non-controlling interests' share has been split out. The parent's shareholders are the people the ratio is reported to, so the NCI share is not theirs.

• Deduct irredeemable preference dividends. Preference shareholders are entitled only to their preference dividend, so it is not available to the ordinary shareholders. An irredeemable preference share is equity, so its dividend is taken in the statement of changes in equity and has not already been deducted in arriving at profit for the year — deduct it here.

• Do not deduct redeemable preference dividends. A redeemable preference share is a liability, so its dividend is a finance cost and is already in the statement of profit or loss. Deducting it again would be double counting.

2.2 The denominator: a weighted average, not a year-end count

Profits accrue across the year. Shares issued for cash in the last month of the year have had almost no time to earn anything, so counting them in full would depress earnings per share for no economic reason; shares issued in the first month have had eleven months to work. The denominator is therefore weighted by the number of months each block of shares was in issue.

Three kinds of change to share capital can occur, and they are handled differently because they differ in one respect only — whether cash came in:

2.3 Issue at full market price

The company receives the full market value in cash, and can put it to work from the date it arrives. Weight the new shares from the date of issue, on a months basis. Prior-year figures are unaffected and are not restated — last year's shareholders got last year's profit on last year's shares.

2.4 Bonus issue

A bonus issue gives existing shareholders extra shares for nothing: share capital is credited and a reserve debited, and no cash moves. Earnings are therefore completely unaffected by it, and the date of the issue is irrelevant. Treat the bonus shares as though they had been in issue for the whole of the current year — and for every earlier year as well.

Because the shares went up and the earnings did not, earnings per share falls. The comparative figures must therefore be restated by the reciprocal of the bonus fraction, so that the two years are compared on the same share base. For a 1-for-4 bonus the current-year share count is multiplied by 5/4 and last year's earnings per share by 4/5.

2.5 Rights issue

A rights issue is the awkward one, because it is both of the other two at once. Cash comes in, so a weighted average is needed — but the shares are offered below market price, so part of the issue is effectively a bonus. That free element has to be spread over the whole year, exactly as a bonus issue is.

The size of the free element is measured by comparing the market price immediately before the issue with the theoretical ex-rights price — the price the share would settle at if the market simply averaged the old shares and the new cheap ones:

TERP = [(Shares held before × cum-rights price) + (New shares × issue price)] ÷ Total number of shares after the issue

The shares in issue before the rights issue are then multiplied by the rights issue fraction:

Rights issue fraction = Cum-rights price ÷ Theoretical ex-rights price

2.6 Restating comparatives

Where a bonus issue, a share split or the bonus element of a rights issue has occurred, the earnings per share figures for every period presented are adjusted retrospectively. The point is comparability: without the restatement the fall in earnings per share would look like a fall in performance, when nothing has happened except that the same profit is now spread over more shares.

The same treatment applies if such an issue happens after the reporting date but before the financial statements are authorised for issue — the calculations for all periods are based on the new number of shares.

YouTube videoLoad YouTube video

YouTube videoLoad YouTube video

3 Diluted earnings per share

A company may have commitments in existence at the year end that will increase the number of ordinary shares in the future without any corresponding increase in earnings — convertible loan stock that will be exchanged for shares, and share options that will be exercised. Those are its potential ordinary shares. Diluted earnings per share warns shareholders how far the present figure would fall if all of them were converted.

Diluted EPS = (Earnings + post-tax effect of the dilutive potential ordinary shares) ÷ (Weighted average number of shares + shares issuable on conversion of them all)

Note that both halves of the fraction can move. The share count always rises; the earnings figure rises too where conversion would save the company an expense.

3.1 Convertible instruments

When convertible loan stock is converted, the company stops paying interest on it. Earnings therefore rise by the interest saved — but the company then pays tax on that extra profit, so the adjustment is the interest saving net of tax:

Increase in earnings = Nominal value × coupon rate × (1 − tax rate)

The share count rises by the number of shares that would be issued on conversion. Where the terms offer different conversion ratios at different dates, take the terms most favourable to the holder — the largest number of shares. Diluted earnings per share is a worst-case measure, so it always assumes the outcome that dilutes the most.

3.2 Share options

Option holders pay for their shares, but at a price below the market value — otherwise the option would be worthless. IAS 33 splits the exercise into two parts: the shares the option holders effectively pay full price for, which are ignored because the cash received matches their value, and the remainder, which they get for nothing:

Free shares = Shares under option − (Shares under option × Exercise price) ÷ Average market price of a share

Only the free shares are added to the denominator, and there is no adjustment to earnings. Share options are therefore always dilutive: the numerator is unchanged and the denominator can only rise.

3.3 Which potential ordinary shares count: the dilution test

Potential ordinary shares are included only if they are dilutive — that is, only if converting them would reduce earnings per share from continuing operations. Some would raise it: deeply out-of-the-money options, or a convertible whose interest saving per new share exceeds the current earnings per share. Those are antidilutive and are ignored.

Test each class separately by its incremental earnings per share, and compare it with the basic figure:

Incremental EPS = Increase in earnings ÷ Increase in number of shares

Where more than one class is dilutive, include them in order from the most dilutive to the least — lowest incremental earnings per share first — so that the diluted figure reported is the lowest that any combination produces.

4 Presentation and disclosure

Basic and diluted earnings per share are presented on the face of the statement of profit or loss, for every period presented, and with equal prominence. They are given for profit or loss from continuing operations and for profit or loss attributable to the ordinary equity holders of the parent; where the entity reports a discontinued operation, they are given for that too, on the face or in the notes.

They are presented even when the amounts are negative — a loss per share is still disclosed.

4.1 Additional per-share figures from 2027

IAS 33 itself is not rewritten by IFRS 18 Presentation and Disclosure in Financial Statements, which applies for accounting periods beginning on or after 1 January 2027 and replaces IAS 1 Presentation of Financial Statements. Basic and diluted earnings per share are computed and presented exactly as above. There is one consequential amendment, and it is worth knowing because it links this chapter to the IFRS 18 presentation material:

The totals and subtotals IFRS 18 specifies include its two new required subtotals, operating profit and profit before financing and income taxes. So a company may still publish an “adjusted earnings per share” — but only if what sits on top of the fraction is a governed number: either one of the standard's own subtotals, or a management-defined performance measure, which itself has to be defined, explained, reconciled to the most directly comparable IFRS subtotal and tax- and non-controlling-interest-effected in a single note. The days of an unexplained “underlying EPS” alongside the statutory one are over. IFRS 18 and management-defined performance measures are taught in the presentation material, not here.

5 Limitations of earnings per share

Earnings per share is a better performance measure than earnings, but it is still one number derived from a set of accounts, and it inherits every weakness of those accounts.

• Historic — it reports transactions and events that have already happened. It is used as an indicator of what is to come, but it is not a forecast.

• Mismatched with the share price — the price/earnings ratio divides a share price that changes daily by an earnings figure calculated once a year. If the price has moved sharply since the year end, a current price is being divided by a stale earnings figure and the result means little.

• Post-tax — earnings are struck after tax, so two companies subject to materially different tax regimes are not comparable on this measure, however similar their trading.

• Accounting policies — the profit figure depends on the policies chosen. A company using the revaluation model for property carries a higher depreciation charge, and so lower earnings, than an otherwise identical company using cost. The same applies to the choice between fair value through profit or loss and fair value through other comprehensive income for financial assets, where one company's gains hit earnings and the other's do not.

• Different accounting standards — comparability falls further where the companies being compared report under different frameworks, so the profits themselves are measured on different rules.

• It says nothing about cash, risk or the capital used — a company can raise earnings per share by buying back shares without earning a penny more. Read it alongside the other ratios, not instead of them.

6 Test your knowledge