ACCA P2 (INT) Corporate Reporting - Study text

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Chapter 13: Reporting requirements for listed companies

the date of the contingent agreement if later. If the conditions are not currently met,

then no dilution should take place.

Employee incentive schemes

Employees of a company may be offered share options as part of their remuneration

package. These options should be treated as having a dilutive effect from the date

they are issued (the ‘grant date’).

The right of an employee to exercise his or her options may be dependent on the

employee staying with the company for a number of years. However, for the

purpose of calculating the diluted EPS, it should be assumed that this condition (the

‘vesting condition’) will be met.

If the options are performance-linked, then they should be treated as contingently-

issuable shares in the manner described above.

2.6 Dealing with multiple dilutions

A company may have several different types of potential ordinary shares. If so,

some of its potential ordinary shares will be more dilutive than others. Some might

not be dilutive at all. Although each one individually dilutes the EPS, taken together

this may not be true.

Diluted EPS should only be calculated for potential ordinary shares that are

dilutive. When a company has several different types of potential ordinary shares, it

is necessary to rank them in order of their dilutive effect, and calculate the diluted

EPS in stages:

 First, calculate the diluted EPS taking only the most dilutive type of potential

ordinary shares

 Next, calculate the diluted EPS taking only the two most dilutive types of

potential ordinary shares.

 Next, calculate the diluted EPS taking only the three most dilutive types of

potential ordinary shares.

 Repeat this process until you calculate a diluted EPS for all the types of potential

ordinary shares.

The diluted EPS to report in the financial statements is the lowest amount for

diluted EPS that you calculate.

This process is set out in a step-by-step approach below.

Step 1: rank the potential ordinary shares in order of dilution

For each potential ordinary share that could have a dilutive effect on EPS:

 calculate the extra earnings that each new share would provide (saving in

preference dividend or interest net of tax / new shares issued).

 Rank these instruments from most dilutive to least dilutive.

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Step 2: Find the maximum potential dilution to EPS

Starting with the most dilutive type of potential ordinary share, calculate the diluted

EPS. Adding each type of potential ordinary share in order of ranking, re-calculate

the diluted EPS. Repeat this process until the maximum potential dilution to EPS is

found. This may arise before the last type of potential ordinary share in the order of

ranking is considered.

The lowest diluted EPS that is calculated in this step-by-step process is the diluted

EPS that must be reported in the financial statements.



Example

A company has 2 million ordinary shares in issue and earnings of $8 million.

It has in issue the following potential ordinary shares:

(1) 100,000 5% convertible preference shares of $100 each

Conversion terms are 1 for 2. The preference shares pay a dividend of

$5/share.

(2) $500,000 10% convertible bonds

Conversion terms are 250 shares per $1,000.

The company pays tax at 33%.

Required

Calculate the diluted EPS.



Answer

Step 1: Ranking

We need to rank the preference shares and convertible bonds in order of

‘dilutiveness’.

Increasedearnings

(A)

Newshares

(B)

ExtraEPS

(A)÷(B)

Convertiblepreferenceshares



Dividendsaved 500,000

Ordinarysharescreated

50,000 $10

Convertiblebonds

Interestsaved 50,000

Taxrelieflost(at33%) (16,500)

33,500

Ordinaryshares

125,000 $0.27

Chapter 13: Reporting requirements for listed companies

The convertible bonds are the most dilutive, because the extra EPS they will add for

each new share created is lower than the extra EPS that the preference shares would

create. The convertible bonds should therefore be taken first when calculating the

maximum potential dilution.

Step 2: Find the maximum potential dilution

Earnings

Number

ofshares

EPS

BasicEPS 8,000,000 2,000,000 $4.00

Iftheconvertiblebondsareconverted:

changeintotalearnings

33,500 125,000

8,033,500 2,125,000 $3.78

Convertiblepreferencesharesareconverted:

changeintotalearnings

500,000 50,000

$8,533,500 2,175,000 $3.92

The diluted EPS is $3.78, because this is the maximum dilution that occurs. The

effect of the convertible preference shares is anti-dilutive, as they increase the EPS

up to $3.92. The preference shares should therefore be ignored.

2.7 Diluted losses

If a company has made a loss, its EPS is negative. IAS 33 requires the disclosure of

basic and diluted losses per share, in the same way as EPS when there is a profit.

Dilution means making a profit smaller or a loss larger.

If the basic EPS is negative (a loss), then the diluted EPS calculated by the methods

described above will normally make the negative EPS smaller. When this happens,

there is no dilution. The diluted EPS that is reported should then be the same as the

basic EPS.

2.8 ED: Simplifying Earnings per Share

In 2008, an Exposure Draft ‘Simplifying Earnings per Share’ was issued, proposing

amendments to IAS33. The ED was issued as part of the convergence project with

the US Financial Accounting Standards Board (FASB). In addition to working

towards convergence between international and US standards, the ED also makes

proposals for clarifying and simplifying the calculation of EPS.

The main proposals for simplification are as follows.

 If an entity has issued a financial instrument whose value is measured at fair

value through profit or loss

(in accordance with IAS 39), this instrument should

excluded from the calculation of diluted EPS. This is because changes in fair

value of these instruments are reported through profit or loss, and no further

adjustment for potential dilution is appropriate. Only instruments that are

not

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measured at fair value through profit or loss should be included in the

calculation of diluted EPS.

 In calculating diluted EPS for options and warrants, the current requirement of

IAS33 is to make an assumption that the money raised from exercise of the

options or warrants would be used to buy back shares of the company at their

average market price for the period. (This was explained earlier.) To simplify the

calculation, the ED proposes that the

end-of-period market price for the shares

should be used, rather than the average market price for the period.

 For the first time, it is proposed that potentially dilutive instruments should

include

forward contracts entered into by an entity to sell its own shares

Examples of ‘potential ordinary shares’ are therefore ‘options, warrants, forward

contracts and convertible instruments’.

 (Note: The inclusion of forward contracts in potential ordinary shares applies to

forward contracts for the sale of the entity’s shares at a fixed price, but not to

forward contracts for the repurchase its own shares. It is proposed in the ED that

contracts to repurchase the entity’s own shares should be excluded from the

calculation of diluted EPS.)

Chapter 13: Reporting requirements for listed companies

IAS 34: Interim financial reporting

 Scope of IAS 34

 Form and content of interim financial statements

 Recognition and measurement

 Use of estimates in interim financial statements

 IFRIC Interpreation 10: Interim financial reporting and impairment

3 IAS 34: Interim financial reporting

3.1 Scope of IAS 34

IAS 1 requires that financial statements should be produced at least annually. Many

companies are required by national regulations to produce accounts on a half-yearly

basis or sometimes on a quarterly basis. For example, in the UK the Financial

Services Authority requires listed companies whose shares are traded on the

London Stock Exchange to produce accounts at the half year stage (‘interim

accounts’) and at the year end (‘annual report’). This is one of their conditions of

listing.

IAS 34 Interim financial reporting does not specify the frequency of interim

reporting: this is a matter for national regulations, which may vary between

countries. IAS 34 focuses on providing guidance on the form and content of these

interim accounts.

It encourages publicly-traded companies to prepare interim accounts and to file

them with the national authority no later than 60 days after the end of the interim

period.

3.2 Form and content of interim financial statements

IAS 34 requires that, as a minimum, an interim financial report should include:

 a condensed statement of financial position

 a condensed statement of comprehensive income, presented as either a

condensed single statement or a condensed separate income statement followed

by a condensed statement of comprehensive income

 a condensed statement of changes in equity

 a condensed statement of cash flows, and

 selected explanatory notes.

In the statement that presents the components of profit or loss (the statement of

comprehensive income or the separate income statement), an entity should present

the basic and diluted EPS for the period.

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An entity could provide a full set of financial statements or additional selected

information if it wishes to do so. If it chooses to produce a full set of financial

statements for its interim accounts, the entity must comply with IAS 1.

The interim statements are designed to provide an update on the performance and

position of the entity. It should focus on new activities, events, and circumstances

that have occurred since the previous annual financial statements were issued. They

should not duplicate information that has already been reported in the past.

3.3 Recognition and measurement

An entity should use the same accounting policies in the interim accounts that it

uses in the annual financial statements.

Measurement for interim purposes should be made on a year-to-date basis. For

example, suppose that a company uses quarterly reporting and in the first quarter of

the year, it writes down some inventory to $nil. If it is then able to sell the inventory

in the next quarter, the results for the six-month period require no write-down of

inventory, and the write-down of inventory should be reversed for the purpose of

preparing the interim accounts for the first six months of the year.

An appendix to IAS 34 gives some guidance on applying the general recognition

and measurement rules from the IASB Framework to the interim accounts. Some

examples are given below.

Intangible assets

The guidance in IAS 34 states that an entity should follow the normal recognition

criteria when accounting for intangible assets. If development costs have been

incurred, which at the interim date do not meet the recognition criteria, then they

should be expensed. It is not appropriate to capitalise them as an intangible asset in

the belief that the criteria will be met by the end of the annual reporting period.

Tax

Interim period tax should be accrued using the tax rate that would be applicable to

expected total earnings.

3.4 Use of estimates in interim financial statements

The interim financial statements should be reliable and relevant. However IAS 34

recognises that the preparation of interim accounts will generally rely more heavily

on estimates than the annual financial statements. An appendix of IAS 34 provides

examples.

Pensions

A company is not expected to obtain an actuarial valuation of its pension liabilities

at the interim date. The guidance suggests that the most recent valuation should be

rolled forward and used in the interim accounts.

Chapter 13: Reporting requirements for listed companies

Provisions

The calculation of some provisions requires the assistance of an expert. IAS 34

recognises that this would be too costly and time-consuming for the interim

accounts. IAS 34 therefore states that the figure included in the annual financial

statements for the previous year should be updated without reference to an expert.

Inventories

A full count of inventory may not be necessary at the interim reporting date. It may

be sufficient to make estimates based on sales margins to establish a valuation for

the interim accounts.

3.5 IFRIC Interpretation10: Interim financial reporting and impairment

IFRIC 10 addresses the question of whether an entity should reverse impairment

losses recognised in an interim period if the loss would not have happened or

would have been smaller when measured at the end of the annual reporting period.

This specifically refers to goodwill, investments in equity instruments and in

financial assets carried at cost.

IFRIC 10 states that impairment losses cannot be reversed if they have been

recognised in a previous interim period.

Paper P2: Corporate Reporting (International)

Paper P2 (INT)

Corporate Reporting

CHAPTER

Employee benefits and

share-based payments

Contents

1 IAS 19: Employee benefits

2 IFRS 2: Share-based payment

Paper P2: Corporate Reporting (International)

IAS 19:

Employee benefits

 The scope and basic principles of IAS 19

 Short-term employee benefits

 Post-employment benefits

 Defined contribution pension schemes

 Defined benefit pension schemes

 Definitions: defined benefit schemes

 Accounting treatment of defined benefit pension schemes

 Accounting for the actuarial difference

 Past service costs

 ED 2009/10 Discount rate for employee benefits (withdrawn in October 2009)

1 IAS 19: Employee benefits

1.1 The scope and basic principles of IAS 19

A company may reward its employees in ways other than payment of a basic salary.

Employers often provide entitlements to paid holidays, or pay an annual cash bonus

to some employees, or provide employees with a company car, medical insurance

and pension benefits. (Some employees also receive share options under company

pension schemes: these are classified as share-based payments.)

IAS 19 provides guidance on accounting for all forms of employee benefits, except

for share based payments. Share-based payments are dealt with by IFRS 2.

The basic principle in IAS 19 is that the cost of providing benefits to employees

should be matched with the period during which the employees work to earn the

benefits. This principle applies even when the benefits are payable in the future,

such as pension benefits.

IAS 19 requires an entity:

 to recognise a liability when an employee has provided a service in exchange for

a benefit that will be paid in the future, and

 to recognise an expense when the entity makes use of the service provided by

the employee.

The basic double entry may therefore be (depending on the nature of the employee

benefits):

 Debit: Employment cost (charged as an expense in the income statement)

 Credit: Liability for employee benefits

ACCA P2 (INT) Corporate Reporting - Study text - 2010 (Emile Woolf)

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