FR – Nov 2022 – L2 – Q6a – Potential Ordinary Shares in EPS Calculation

Explain potential ordinary shares with three examples as per IAS 33.

Question

IAS 33 – Earnings Per Share (EPS) requires entities to calculate basic and diluted earnings per share. However, diluted EPS and basic EPS will usually differ when there are potential ordinary shares in existence.
Required:

i. Explain the term “potential ordinary share” and provide THREE examples as stated in IAS 33. (3 Marks)
ii. Describe the procedure for ranking when there are several types of potential ordinary share in issue when calculating diluted EPS.
(3 Marks)

Answer

Potential ordinary share

Financial liabilities or equity instruments that are convertible into new ordinary shares at some time in the future, such as convertible
Share options and warrants. Options and warrants are financial
instruments that give the holders the right, but not the obligation, to purchase new ordinary shares at some time in the future at a fixed price;
and
Shares that will be issued if certain contractual conditions are met, such
as contractual conditions relating to the purchase of a business.

ii. Procedure for ranking potential ordinary share

When there are several types of potential ordinary shares in issue, they should be ranked in order of dilution, with the most dilutive potential ordinary shares ranked first;
In order to carry out the ranking the earnings per incremental share is found for each potential ordinary share. This is the earnings adjustment
that would be necessary, divided by the number of shares that would come into being if the shares were included in the calculation of diluted
EPS; and
The money options and warrants always rank first as they increase the number of shares in the calculation without affecting the earnings.

Tags: Basic EPS, Convertible Bonds, Diluted EPS, Potential Ordinary Shares, Share Options
Level: Level 2

Topic: Earnings Per Share (IAS 33)
Series: NOV 2022

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