Earnings per share (‘EPS’), as the name suggests comprises of two factors:
1. The net profit or loss for the year/period attributable to the ordinary shareholders, and
2. The weighted average number of ordinary shares outstanding during the year/period.
While the first component of EPS is easy to determine, the second may pose various challenges especially when there is movement in the ordinary shares during the year/period for which EPS is to be calculated.
Issue of ordinary shares during the year can be in the form of fresh issue at fair value, bonus issue without any consideration received, issue of shares to the existing holders in lieu of dividends, right issue to the existing holders of ordinary shares at a price which is equal to or less than the fair value and so on and so forth.
This article specifically deals with impact of right issue at a price which is less than the fair value on calculation of EPS for the current as well as previous year.
In a right issue, existing ordinary shareholders can purchase additional ordinary shares generally on a pro rata basis and at price which is either equal to or less than the fair value of the shares.
For e.g.: Company A Ltd offers all its ordinary shareholders the right to purchase 1 ordinary share for every 4 ordinary shares held by them, at a discount of 25% on the fair value.
Now, if company A Ltd has 1000 ordinary shares and the fair value of its share is Rs. 10 per share, then the right issue will comprise of 250 ordinary shares at a price of Rs. 7.5 per share.
The difference between the issue price i.e. Rs. 7.5 and the fair value i.e. Rs. 10 amounting to Rs. 2.5 is the bonus element which needs to be considered in the calculation of the EPS.
When there is bonus element involved in any issue, Ind AS 33 requires retrospective adjustment to the weighted average number of ordinary shares.
This adjustment is called the ‘Bonus Factor’ and is calculated using the following formula:
Bonus factor =
Let’s understand the above components involved in the bonus factor formula:
Fair value per share immediately before the exercise of rights
This is the market price of the shares immediately before it becomes “ex-rights” or last day when the shares are traded together with the rights i.e. “cum-rights”
2. Theoretical ex-rights fair value per share
This number is calculated using the following formula:
Let us now understand this complex formula with the help of an easy illustration:
Taking forward our above illustration of Company A Ltd issuing 250 right issue at a discounted price of Rs. 7.5, the following are the additional information available:
With these facts let us know calculate the EPS (for simplicity only basic EPS is considered in the computation)
Step 1: Calculate the numerator i.e. net profit attributable to the ordinary shareholders for EPS:
As discussed above the first factor or the numerator to be considered for EPS is the net profit attributable to the ordinary shareholders which is:
Step 2: Calculate the bonus factor:
1. The first component is the market value of the shares on the last day when the shares are traded cum rights which is Rs. 10
2. The second component which is theoretical ex-rights fair value per share, further, has two components i.e. the numerator and the denominator:
Numerator is now equal to Rs. 11,875 (Rs. 10,000 + Rs. 1,875)
Denominator is equal to number of shares outstanding after the right issue which is equal to 1250 (1000 shares before the right issue plus 250 right shares issued)
Thus Bonus factor = 10/9.5 = 1.053
Step 3: Calculate the denominator i.e. the weighted average number of ordinary shares for EPS
For this we need to deal with two reporting periods i.e. the previous year 20X0 and the current year 20X1.
As the rights issue happened in the current year and not in the previous year we just need to adjust the weighted average number of ordinary shares for the full year 20X0 with the bonus factor.
Adjusted weighted average number of ordinary shares= 1000*1.053 = 1053 shares
For the current year as the rights issue happened during the year i.e. on 1 April 20X1, we need to do time apportionment as below:
|Dates||Time proportion i.e. number of months/12 (A)||Number of shares
|Adjusted number of shares
|Weighted average number of shares
|1 Jan to 31 March||3/12||1000||1.053||1053||263|
|1 April to 31 December||9/12||1250||1*||1250||938|
*no adjustment for bonus factor is required after the shares in rights issue are actually issued. We need to adjust the period only before the rights issue for bonus factor
Step 4: Calculate EPS
The EPS for the previous year 20X0 and current year 20X1 is as below:
|Year||Earnings as per Step 1
|Weighted average number of ordinary shares as per Step 3
|EPS = A * B|