Topic list Syllabus reference

Contingently issuable (potential) ordinary shares are treated as for basic EPS; if the conditions

have not been met, the number of contingently issuable shares included in the computation is based on the number of shares that would be issuable if the end of the reporting period was the end of the contingency period. Restatement is not allowed if the conditions are not met when the contingency period expires. (IAS 33: para. 52)

4. 
   Example: diluted EPS
   

In 20X7 Farrah Co had a basic EPS of $1.05 based on earnings of $105,000 and 100,000 ordinary $1 shares. It also had in issue $40,000 15% convertible loan stock which is convertible in two years' time at the rate of 4 ordinary shares for every $5 of stock. The rate of tax is 30%.
Required
Calculate the diluted EPS.
Solution
Diluted EPS is calculated as follows.
Step 1 Number of shares: the additional equity on conversion of the loan stock will be 40,000 x 4/5 = 32,000 shares.
Step 2 Earnings: Farrah Co will save interest payments of $6,000 (40,000 x 15%) but this increase in profits will be taxed. Hence the earnings figure may be recalculated:
(105,000 + (6,000 x 70%)) = $109,200
Step 3 Calculation: Diluted EPS = ^$109,200 = $0.83 132,000
Step 4 Dilution: the dilution in earnings would be $1.05 - $0.83 = $0.22 per share.
Question
Ardent Co has 5,000,000 ordinary shares of 25 cents each in issue, and also had in issue in 20X4:

1. 
   $1,000,000 of 14% convertible loan stock, convertible in three years' time at the rate of two shares per $10 of stock
   
2. 
   $2,000,000 of 10% convertible loan stock, convertible in one year's time at the rate of three shares per $5 of stock
   

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The total earnings in 20X4 were $1,750,000.
The rate of income tax is 35%.
Required
Calculate the basic EPS and diluted EPS.
Answer

1. 
   Basic EPS = —^750,000 = $0.35
   

5 million

2. 
   We must decide which of the potential ordinary shares (ie the loan stocks) are dilutive (ie would decrease the EPS if converted).
   

For the 14% loan stock, incremental EPS = 0-65 x $140,000 _ 200,000 shares
For the 10% loan stock, incremental EPS = 065 ^x $200,000 ₌ 1,2m shares
The effect of converting the 14% loan stock is therefore to increase the EPS figure, since the incremental EPS of $0.46 is greater than the basic EPS of $0.35. The 14% loan stock is not dilutive and is therefore excluded from the diluted EPS calculation.
The 10% loan stock is dilutive.
Diluted EPS = . _$0.3
5m + 1.2m