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EPS explained

Richard Clarke

ACCA FR Exam Tips: EPS and Diluted EPS

Understanding Basic EPS

Basic EPS is calculated using the formula:

Basic EPS = Net profit or loss attributable to equity shareholders / Weighted average number of ordinary shares outstanding during the period

Steps to Calculate Basic EPS:

  1. Determine the net profit or loss attributable to equity shareholders.
  2. Calculate the weighted average number of ordinary shares outstanding during the period.

Understanding Diluted EPS

Diluted EPS takes into account the potential dilution that could occur if convertible securities (like options, warrants, or convertible bonds) were exercised. The formula is:

Diluted EPS = (Net profit or loss attributable to equity shareholders + After-tax interest on convertible debt) / (Weighted average number of ordinary shares + Potential ordinary shares from conversion)

Steps to Calculate Diluted EPS:

  1. Calculate the basic EPS as described above.
  2. Identify all potential dilutive securities (e.g., options, convertible bonds).
  3. Adjust the numerator by adding back any after-tax interest on convertible debt.
  4. Adjust the denominator by adding the number of shares that would be issued on conversion of all dilutive potential ordinary shares.

Weighted Average Shares for Bonus and Rights Issues

Bonus Issues:

A bonus issue is when additional shares are given to existing shareholders for free. These are treated as if they were in issue from the beginning of the year.

Steps to Calculate Weighted Average Shares for Bonus Issues:

  1. Calculate the bonus fraction: Bonus fraction = Number of shares after the bonus issue / Number of shares before the bonus issue
  2. Apply the bonus fraction to the shares outstanding before the bonus issue to adjust the weighted average number of shares.

Rights Issues:

A rights issue allows existing shareholders to buy additional shares at a discount. The calculation involves adjusting for the theoretical ex-rights price (TERP).

Steps to Calculate Weighted Average Shares for Rights Issues:

  1. Calculate the rights fraction: Rights fraction = Cum-rights price / TERP
  2. Adjust the number of shares before the rights issue by multiplying by the rights fraction.

Example Calculation:

Suppose a company had 100 shares at the beginning of the year, issued 400 shares at full market price on May 1, and issued a 1-for-5 bonus issue on July 1.

Date Total Shares Time (months) Bonus Fraction Weighted Average
1st Jan 100 4/12 6/5 40
1st May 500 2/12 6/5 100
1st July 600 6/12 1 300
Total 440

Weighted Average = 40 + 100 + 300 = 440

Tips for Remembering EPS and Diluted EPS:

  • Understand the formulas and the logic behind them.
  • Practice with examples to get comfortable with the calculations.
  • Watch classroom videos to reinforce your understanding.

By breaking down the steps and practicing regularly, you can master the concepts of EPS and Diluted EPS. Good luck with your exam!