IAS 33 Earnings Per Share: Basic, Diluted and Antidilutive Securities

IAS 33 Earnings Per Share: Basic, Diluted and Antidilutive Securities

By Sai Manikanta Pedamallu (ACCA, CMA US, CSCA US, CGMA, ACMA, Dip IFRS, M.Com, MBA, MA)

Lead Instructor, Global Fin X | www.globalfinx.in/manikanta

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Earnings per share is the most widely quoted number in equity analysis and one of the most tightly regulated calculations in IFRS. That combination is not accidental. Because EPS drives price-earnings multiples, analyst models, and management incentive schemes, it is precisely the number a company would most like to influence, and IAS 33 exists to remove almost every degree of freedom from how it is computed.

The standard achieves this by being unusually prescriptive. There is one permitted numerator, one permitted denominator, one method for handling each type of dilutive instrument, and a mandatory rule for what to exclude. Where most IFRS standards set principles and leave application to judgment, IAS 33 sets rules and leaves very little.

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Scope: Who Must Present EPS

IAS 33 applies to entities whose ordinary shares or potential ordinary shares are publicly traded, and to entities in the process of issuing such shares in public markets.

Entities outside this scope are not required to present EPS. Where they choose to do so voluntarily, they must comply with IAS 33 in full, since the value of a standardised metric depends entirely on it being calculated the standard way.

For consolidated financial statements, EPS is based on consolidated figures. Where an entity presents both consolidated and separate financial statements, the EPS disclosures required by IAS 33 need only be presented on the basis of the consolidated information.

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Basic EPS: The Numerator

Basic EPS is profit or loss attributable to ordinary equity holders of the parent, divided by the weighted average number of ordinary shares outstanding during the period.

The numerator starts with profit or loss after tax attributable to the parent, and then deducts:

Preference dividends. For non-cumulative preference shares, only dividends declared in respect of the period are deducted. For cumulative preference shares, the dividend for the period is deducted whether or not it has been declared, since the entitlement accrues regardless.

Any premium or discount arising on the settlement or repurchase of preference shares. Where preference shares are repurchased above their carrying amount, the excess is a return to preference shareholders and reduces the amount attributable to ordinary holders.

Note the exclusion that follows from this: dividends on ordinary shares are not deducted. Ordinary dividends are a distribution of the earnings attributable to ordinary holders, not a claim ranking ahead of them.

Where an entity reports discontinued operations, IAS 33 requires basic and diluted EPS to be presented for continuing operations, and separately for the discontinued operation, either on the face of the statement of profit or loss or in the notes.

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Basic EPS: The Weighted Average Denominator

The denominator is the weighted average number of ordinary shares outstanding during the period, being the number outstanding at the beginning of the period adjusted for shares issued or bought back during the period, weighted by the fraction of the period they were outstanding.

The logic is a matching one: shares issued halfway through the year were only available to generate half the year's earnings, so they count as half a share. Equally, shares repurchased partway through the year cease counting from the repurchase date, because the cash spent reacquiring them is no longer working in the business.

Shares are included from the date consideration is receivable, which is generally the date of issue. Shares issued in exchange for cash are included when the cash is receivable; shares issued for the settlement of a liability are included from the settlement date; shares issued as consideration in a business combination are included from the acquisition date.

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Bonus Issues and Share Splits: The Retrospective Rule

Bonus issues, scrip dividends, share splits, and share consolidations share a defining feature: the number of shares changes but no consideration is received or paid. Resources available to the business are unchanged; only the number of pieces the ownership is divided into has changed.

Because no economic change has occurred, IAS 33 requires these to be treated as if they had occurred at the beginning of the earliest period presented. There is no time apportionment. The adjusted share count is applied to the current period in full and to every comparative period presented, and prior period EPS figures are restated accordingly.

The reason is comparability. If a company doubles its share count through a 1:1 bonus issue in September, and EPS were calculated by time-weighting the new shares from September, the prior year comparative would appear on a completely different share base, making any year-on-year EPS comparison meaningless.

Indian companies make heavy use of bonus issues. Infosys, TCS, and Wipro have each issued bonus shares multiple times over their listed histories, in each case triggering full retrospective restatement of prior period EPS figures in the year of issue.

The adjustment factor for a pure bonus issue or split is simply shares after divided by shares before. A 1:1 bonus issue gives a factor of 2, halving all previously reported EPS figures. A 2-for-1 split gives the same factor and the same effect.

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Rights Issues: The Bonus Element

A rights issue is more complicated, because it combines two things: an issue of shares for consideration, and a discount to market price that is economically equivalent to a bonus issue.

IAS 33 treats a rights issue as exactly that combination. The shares are first treated as a normal issue for consideration, time-apportioned in the usual way. A bonus factor is then calculated and applied retrospectively to all periods before the rights issue, to capture the discount element.

The bonus factor is the fair value per share immediately before the exercise of rights (the cum-rights price), divided by the theoretical ex-rights price per share.

The theoretical ex-rights price (TERP) is calculated as:

(Aggregate fair value of shares immediately before the rights exercise + total amount received from the rights exercise) / Number of shares outstanding after the exercise

Worked Example: Rights Issue

A company has 2,000,000 ordinary shares in issue at the start of the year. On 30 June, it makes a 1-for-2 rights issue at Rs. 300 per share, fully subscribed. The cum-rights market price immediately before the issue is Rs. 400 per share. Profit attributable to ordinary shareholders for the year is Rs. 18 crore. Prior year basic EPS as originally reported was Rs. 8.00.

Step 1: Theoretical ex-rights price

TERP = Rs. 110,00,00,000 / 3,000,000 = Rs. 366.67 per share

Step 2: Bonus factor

Bonus factor = Cum-rights price / TERP = Rs. 400 / Rs. 366.67 = 1.0909

Step 3: Weighted average shares

Shares before the rights issue are inflated by the bonus factor for the period they were outstanding:

2,000,000 x 6/12 x 1.0909 = 1,090,900

3,000,000 x 6/12 = 1,500,000

Weighted average: 2,590,900 shares

Step 4: Basic EPS for the current year

Rs. 18,00,00,000 / 2,590,900 = Rs. 6.95

Step 5: Restate the prior year comparative

Prior year EPS as originally reported: Rs. 8.00

Restated: Rs. 8.00 / 1.0909 = Rs. 7.33

Without the restatement, the year-on-year movement would appear to be a fall from Rs. 8.00 to Rs. 6.95, a decline of 13%. After restatement, the comparison is Rs. 7.33 to Rs. 6.95, a decline of 5%. The difference is entirely an artefact of the discount embedded in the rights issue, and the restatement removes it.

Indian rights issues are frequently large and heavily discounted. Reliance Industries' 2020 rights issue, one of the largest in Indian corporate history, was priced at a meaningful discount to the prevailing market price, producing exactly the kind of bonus element that requires this treatment.

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Diluted EPS: The Principle

Diluted EPS answers a specific question: what would EPS be if every instrument capable of becoming an ordinary share actually did so?

It is calculated by adjusting both the numerator and the denominator for the effects of all dilutive potential ordinary shares. The numerator is adjusted for any post-tax change in income or expense that would result from conversion. The denominator is increased by the weighted average number of additional ordinary shares that would be issued on conversion.

Potential ordinary shares include convertible debentures, convertible preference shares, share options, warrants, contingently issuable shares, and any contract that may be settled in ordinary shares.

The word "may" in that last category is deliberate. Contracts that result in ordinary shares only if specified conditions are met, and contracts that are not always settled in shares but that may be, both fall within scope and require assessment.

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Options and Warrants: The Treasury Stock Method

Options and warrants are dilutive when their exercise price is below the average market price of ordinary shares during the period. Where the exercise price exceeds the average market price, exercise would be irrational and the instruments are not dilutive.

The mechanism, commonly called the treasury stock method, assumes that the proceeds from exercise are used to buy back shares at the average market price. Only the net additional shares, the "free" element, enter the diluted denominator.

Illustration. A company has 500,000 options outstanding with an exercise price of Rs. 60. The average market price during the year is Rs. 100.

Proceeds on exercise: 500,000 x Rs. 60 = Rs. 3,00,00,000

Shares that could be repurchased at average market price: Rs. 3,00,00,000 / Rs. 100 = 300,000 shares

Incremental shares added to the diluted denominator: 500,000 less 300,000 = 200,000

No adjustment is made to the numerator, since options generate no income or expense that would change on exercise.

Where options are outstanding for only part of the period, the incremental shares are time-weighted for that portion.

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Convertible Instruments

For convertible debentures, the numerator is increased by the post-tax interest that would no longer be payable if conversion had occurred, and the denominator is increased by the shares that would be issued on conversion.

For convertible preference shares, the numerator is increased by the preference dividend that was deducted in arriving at basic EPS, since on conversion no preference dividend would be payable, and the denominator increases by the conversion shares.

Illustration. A company has Rs. 10 crore of 10% convertible debentures outstanding for the full year, each Rs. 100 debenture convertible into 8 ordinary shares. The tax rate is 25%.

Numerator adjustment: Rs. 10 crore x 10% x (1 less 0.25) = Rs. 75 lakh added

Denominator adjustment: (Rs. 10 crore / Rs. 100) x 8 = 8,00,000 shares added

Whether this is dilutive depends on the resulting incremental EPS, discussed next.

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Antidilution: The Rule That Catches Candidates

Potential ordinary shares are included in diluted EPS only if they are dilutive, meaning their inclusion decreases EPS from continuing operations or increases loss per share.

Instruments whose inclusion would increase EPS or decrease a loss per share are antidilutive and must be excluded. This is not a choice; excluding them is mandatory.

The IAS 33 illustrative examples make the mechanism explicit: where diluted EPS increases when convertible preference shares are taken into account, moving from one figure to a higher one, those preference shares are antidilutive and are ignored entirely in the diluted calculation.

The Control Number

The test for whether an instrument is dilutive is applied by reference to profit or loss from continuing operations attributable to the parent entity. This is the control number.

Using continuing operations rather than total profit prevents a discontinued operation, which by definition will not recur, from distorting the assessment of whether an instrument dilutes ongoing earnings.

The Sequencing Rule

Where an entity has several classes of potential ordinary shares, they must be considered in sequence from the most dilutive to the least dilutive, rather than all together or in an arbitrary order.

The reason is arithmetic. Including a less dilutive instrument first can raise the running EPS enough to make a genuinely dilutive instrument appear antidilutive, understating the dilution. Ranking by incremental EPS, which is the numerator adjustment divided by the denominator adjustment for each instrument, ensures the most dilutive are absorbed first and the calculation reaches the correct maximum dilution.

Loss-Making Entities

In a loss-making period, potential ordinary shares are almost always antidilutive, because adding shares to the denominator reduces the loss per share, which is an improvement rather than a dilution.

The consequence is that a loss-making company typically reports diluted loss per share equal to basic loss per share, with the outstanding options and convertibles disclosed as potentially dilutive in future but excluded from the current calculation.

This produces a genuine oddity that analysts should understand: a company that swings from a small loss to a small profit can show a sharp fall in diluted EPS relative to basic EPS in the profitable year, simply because the instruments that were excluded as antidilutive in the loss year now enter the calculation.

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Presentation and Disclosure

Basic and diluted EPS must be presented with equal prominence on the face of the statement of profit or loss, for each class of ordinary share with a different right to share in profit for the period, and for all periods presented.

Both figures are presented even where they are equal, and even where the amount is a loss per share.

Required disclosures include: the amounts used as numerators for basic and diluted EPS and a reconciliation to profit or loss attributable to the parent; the weighted average number of shares used as denominators and a reconciliation between the basic and diluted denominators; a description of instruments that could potentially dilute EPS in future but were excluded because they were antidilutive; and a description of ordinary share transactions occurring after the reporting period that would have significantly changed the EPS calculation had they occurred before the period end.

That final disclosure is important. A large bonus issue or share split announced after year end does not change the reported EPS figures, but does require disclosure, since a user comparing next year's figures will otherwise face an unexplained discontinuity.

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The IFRS 18 Amendments

IFRS 18, issued in April 2024 and covered in Posts 4 through 6 of this series, amended IAS 33 as part of its wider changes to the presentation of the statement of profit or loss.

The core EPS mechanics are unchanged: the numerator, the weighted average denominator, the treasury stock method, and the antidilution rules all continue to operate as described. What changes is the presentation environment in which EPS sits, given IFRS 18's new required subtotals and its framework for management performance measures.

For Indian entities, the practical relevance arrives when Ind AS adopts the IFRS 18 changes, at which point the interaction between EPS presentation and the new income statement structure will need to be worked through in detail.

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Ind AS 33 vs IAS 33

The quarterly requirement under SEBI's listing regulations is the most practically significant Indian difference. Indian listed companies compute and publish basic and diluted EPS every quarter, which means every bonus issue, rights issue, split, or ESOP exercise during a quarter requires the calculation to be reworked and prior quarters restated where a bonus element is involved.

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What Big 4 Auditors Focus On

Retrospective restatement completeness. Where a bonus issue, split, or rights issue has occurred, auditors verify that all comparative periods presented have been restated, including quarterly comparatives for Indian listed entities, and that the restatement uses the correct factor.

The TERP calculation for rights issues. Auditors test that the cum-rights price used is the market price on the last day the shares traded cum-rights, not an average or a later price, and recalculate the TERP and resulting bonus factor.

Antidilution assessment and the control number. Auditors verify that the dilution test has been applied against profit from continuing operations, and that instruments assessed as antidilutive have genuinely been excluded rather than included with a note.

Sequencing where multiple instrument classes exist. For entities with several categories of potential ordinary shares, auditors test that the sequencing from most to least dilutive has been applied, since aggregating them can materially understate dilution.

Options and warrants: use of average market price. Auditors confirm that the treasury stock method uses the average market price for the period rather than the closing or exercise-date price, and that options outstanding for part of the period only have been time-weighted.

Post-period-end share transactions. Auditors test whether significant share transactions after the reporting date have been identified and disclosed, since these are easily missed in the year-end close.

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Dip IFRS Exam Angle

IAS 33 is heavily and reliably examined, almost always as a calculation with several deliberate complications layered in.

Most tested areas:

Computing the weighted average number of shares with multiple share transactions during the period, correctly time-apportioning issues for consideration while applying bonus issues and splits retrospectively without time apportionment.

Calculating the TERP and bonus factor for a rights issue, applying the factor to pre-issue shares, and restating the prior period comparative.

Applying the treasury stock method to options and warrants, deriving only the incremental free shares.

Adjusting the numerator for convertible instruments, remembering that the interest add-back is post-tax.

Testing each potential ordinary share class for dilution against the control number and excluding antidilutive instruments.

Common traps:

Time-apportioning a bonus issue. Bonus issues and splits are applied retrospectively from the beginning of the earliest period presented, with no time weighting at all.

Failing to restate the prior period comparative after a bonus issue, split, or the bonus element of a rights issue.

Including all options in the diluted denominator rather than only the incremental free shares under the treasury stock method.

Adding back pre-tax interest for convertible debentures rather than post-tax.

Including antidilutive instruments in diluted EPS. Exclusion is mandatory, not optional.

Applying the dilution test against total profit rather than profit from continuing operations.

Treating options as dilutive when the exercise price exceeds the average market price. Such options are out of the money and are not dilutive.

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FAQ

Are ordinary dividends deducted in calculating basic EPS?

No. Only preference dividends are deducted, because they represent a claim ranking ahead of ordinary shareholders. Ordinary dividends are a distribution of the earnings already attributable to ordinary holders.

How are cumulative preference dividends treated if not declared?

They are still deducted from the numerator. The entitlement accrues whether or not the dividend is declared, so the amount attributable to ordinary shareholders is reduced regardless. Non-cumulative preference dividends are deducted only if declared for the period.

Why is a bonus issue not time-apportioned?

Because no consideration is received and no additional resources become available to generate earnings. Only the division of existing ownership has changed. Time-apportioning would produce EPS figures that are not comparable across periods, which defeats the purpose of the metric.

Can diluted EPS ever be higher than basic EPS?

No. Because antidilutive instruments must be excluded, diluted EPS can never exceed basic EPS. Where a calculation produces a higher figure, the instrument causing it is antidilutive and should have been excluded.

Why do loss-making companies usually report identical basic and diluted loss per share?

Because adding shares to the denominator in a loss period reduces the loss per share, which is antidilutive. The potential ordinary shares are therefore excluded, leaving diluted loss per share equal to basic loss per share, with the excluded instruments disclosed.

What is the control number and why does it matter?

It is profit or loss from continuing operations attributable to the parent, used as the reference point for testing whether each potential ordinary share is dilutive. Using continuing operations prevents a non-recurring discontinued operation from distorting the assessment of dilution on ongoing earnings.

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Enroll with Global Fin X

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This is Post 66 of the Global Fin X IFRS Series. Previous: IAS 23: Borrowing Costs, Qualifying Assets, Capitalisation Period and Suspension. Next: Post 67: IAS 34 Interim Financial Reporting: Minimum Content and Discrete vs Integral Approach.