Theory of Accounts

Diluted Earnings per Share

QUESTION

Explain dilution and antidilution.

ANSWER
Dilution arises when the inclusion of the potential ordinary shares descreases the basic earnings per share
or increases the basic loss per share.

In this case, the potential ordinary shares are dilutive securities.

On the other hand, antidilution arises when the inclusion of the potential ordinary shares increases basic
earnings per share or decreases basic loss per share.

In this case, the potential ordinary shares are considered as antidilutive and therefore ignored in
computing diluted earnings per share.
 QUESTION
Explain diluted earnings per share.

ANSWER
The computation of diluted earnings per share is based on the “as if” scenario:
a. “As if” the convertible bond payable is converted into ordinary share.

b. “As if” the convertible preference share is converted into ordinary share.
c. “As if” the share options and warrants are exercised.
Accordingly, the ordinary shares outstanding are increased with a consequent dilution in the basic earnings
per share.

QUESTION
Explain the inclusion of "convertible bond payable" and “convertible preference shares” in the computation
of diluted earnings per share.

ANSWER
If there is a convertible bond payable, the bond payable is assumed to be converted into ordinary shares.
Accordingly, the net income is adjusted by adding back the interest expense on the bond payable, net of tax.
The number of ordinary shares outstanding is increased by the number of ordinary shares that would have
been issued upon conversion of the bond payable.

If there are convertible preference shares, the preference shares are assumed to be converted into ordinary
shares.
Accordingly, the net income is not réduced by the amount of preference dividend.
The number of ordinary shares outstanding is increased by the number of ordinary shares that would have
been issued upon conversion of the preference shares.

QUESTION
Explain the inclusion of share options and warrants in the computation of diluted earnings per share.

ANSWER
Options and warrants are included in the computation of diluted earnings per share only when they are dilutive.
Options and warrants are dilutive when the exercise price or option price is less than the average market price
of the ordinary share.
QUESTION
Define contingent ordinary shares.

ANSWER
Contingent ordinary shares are ordinary shares issuable for little or no cash or other consideration
upon satisfaction of specified conditions in a contingent share agreement.

A contingent share agreement is an agreement to issue ordinary shares that is dependent on the
satisfaction of specified conditions.

Contingent ordinary shares are treated as outstanding and included in the computation of both basic
and diluted earnings per share if the conditions are satisfied.

The difference lies in the number of contingent shares that would be included in the computation of earnings
per share.

Contingent ordinary shares are included in the calculation of basic earnings per share from the date the
condition is satisfied.

Contingent ordinary shares are included in the computation of diluted earnings per share from the beginning
of the period or from the date of the contingent share agreement, if later.
QUESTION
What are written put options?

ANSWER

Written put options are contracts that require the entity to repurchase its own ordinary shares at a specified
price during a definite period.

Written put options are actually contracts to acquire treasury shares at a specified price during a definite period.
Written put options are reflected in the calculation of diluted earnings per share if the effect is dilutive.

The written put options are dilutive if the put options are "in the money', meaning the exercise or settlement
price is higher than the average market price.

Determination of potential ordinary shares

a. It is assumed that at the beginning of the period suffcient ordinary shares will be issued at the average
market price.

b. It is assumed that the proceeds from the issue are used to satisfy the contract or buy back the ordinary
shares covered by the written put options.

c. The difference between the number of ordinary shares assumed issued and the number of ordinary shares
repurchased under the written put options represents the potential ordinary shares.

d. The potential ordinary shares shall be included in the calculation of diluted earnings per share.

QUESTION Multiple choice (PAS 33)

1. Potential ordinary shares include all of the following, except

a. Financial liabilities or equity ingtruments that are nonconvertible into ordinary shares
b. Share warrants
c. Share options or employees plans that allow employees to receive ordinary shares as part of their
remuneration
d. Shares which would be issued upon the satisfaction of certain conditions resulting from contractual
arrangements, such as purchase of a business

2. Options and warrants are dilutive if

a. The exercise price is lower than the average market price.

b. The price is higher than the average market price.

c. The exercise price is equal to the average market price.

d. The option shares represent 20% of the ordinary shares actually outstanding.

3. When applying the treasury share method for diluted earnings per share, the market price of the ordinary
share used for the assumed acquisition of treasury shares is the
a. Market price at the end of the year
b. Average market price during the year
c. Market price at the beginning of the year
d. Average market price over a two-year period

4. Under the treasury share method, the number of potential ordinary shares is equal to

a. Option shares
b. Option shares minus assumed treasury share acquired
c. Assumed treasury shares acquired
d. Option shares actually issued during the year

5. In determining diluted earnings per share, interest expense, net of income tax, on dilutive
convertible bond payable should be

a. Added back to weighted average shares outstanding for diluted earnings per share.
b. Added back to net income for diluted earnings per share.
c. Deducted from net income for diluted earnings per share.
d. Deducted from weighted average shares outstandng for diluted earnings per share.

6. In computing diluted EPS, dividends on convertible cumulative preference shares should be

a. Ignored
b. Deducted from net income, whether declared or not
c. Deducted from net income only when declared
d. Added to net income net of tax

7. A written put option is a contract that required an entity to repurchase its own ordinary shares at
a specified price. Which statement is incorrect if the written put options are “in the money”?

a. It is assumed that at the beginning of the period sufficient ordinary shares will be issued at the
average market price to raise the proceeds to satisfy the contract.
b. It is assumed that the proceeds from the issue are used to buy back the ordinary shares covered
by the written put options.
c. The resulting incremental ordinary shares shall be included in computing diluted earnings per
share.
d. The resulting incremental ordinary shares shall be included in computing basic earnings per
share.

8. All of the following must be disclosed in relation to earnings per share, except
a. Forecast earnings per share for the following year.
b. Instruments that could potentially dilute basic earnings per share in the future but not included in the
diluted EPS because they are antidilutive in the current period.
c. The weighted average number of ordinary shares used.
d. The earnings figures used in calculating EPS

9. Dilution of EPS is defined as

a. Decrease earnings per share when any financial instrument is converted to any form of share
capital.
b. Decrease in share capital.
 c. Decrease in earnings per share when convertible instruments are-converted to ordinary shares.
d. Decrease in earnings per share when share capital is converted to debt capital.

10. If a share option is converted on March 31

a. The potential ordinary shares are included in diluted EPS up to March 31, and in basic EPS from the
date converted to the year-end, both weighted accordingly.
b. The ordinary shares are not included in diluted EPS.
c. The ordinary shares are not included in basic EPS.
d. The effects of the share option are included only in previous yeds EPS calculation

11. In calculating whether potential ordinary shared are dilutive, the profit figure used as the
“control number" is
a. Net profit after tax including disconfinued operations
b. Net profit from confinuing operations
c. Net profit before tax including discontinued operations
d. Retained profit for the year after dividends

12. How will the annual interest or preference dividend affect net earnings available to ordinary
shareholders?
a. Annual net earnings available to ordinary shareholders are reduced by annual interest but not by
preference dividends.
b. Annual net earnings available to ordinary shareholders are reduced by preference dividends but not by
annual interest.

c. Annual net earnings available to ordinary shareholders are reduced by both annual interest and
preference dividends.

d. Annual net earnings available to ordinary shareholders are not reduced by annual interest or preference
dividends.

13. The "if converted" method of computing earnings per share assumes conversion of convertible bonds
payable at

a. Beginning of the earliest period reported or at time of issuance, if later.

b. Beginning of the earliest period reported regardless of time of issuance.

c. Middle of the earliest period reported regardless of the time issuance

d. Ending of the earliest period reported regardless of the time of issuance

14. The nature of diluted earnings per share involving adjustment for share options can be described as

a. Historical because earnings are historical

b. Historical because it indicates an entitys valuation

c. Proforma because it indicates potential changes in number of shares
d. Proforma because it indicates potential changes in earnings

15. What is the justification underlying the concept of potential ordinary shares in an EPS computation?
a. Form over substance
b. Substance over form
c. Form and substance considered equally
d. Accounting practice

16. Antidilutive securities

a. Should be included in the computation of diluted earnings per share but not basic earnings per
share.

b. Are those whose inclusion in earnings per share computation would cause basic earnings per
share to exceed diluted earnings per share.

c. Include share options and warrants whose options price is less than the average market price.

d. Should be disregarded in all EPS computations.

17. When there are multiple dilutive convertible securities, the one that should be used first to calculate
dilutive earnings per share is security with the

a. Largest earnings adjustment

b. Largest earnings per share adjustment
c. Smallest earnings adjustment
d. Smallest earnings per share adjustment

18. For an entity having several different issues of convertible securities, share options and warrants, the
standard requires selection of the combination of securities producing
a. The lowest possible earnings per share
b. The highest possible earnings per share
c. The earnings per share figure midway between the lowest possible and the highest possible earnings
per share
d. Any earnings per share figure between the lowest possible and the highest possible earnings per share.

19. The purpose of diluted earnings per share is to

a. Provide a comparison figure for debt holders.
b. Indicate earnings shareholders shall receive in future periods.
c. Distinguish between entities with a complex capital structure and entities with a simple capital
structure.
d. Show the maximum possible dilution of earnings

20. In calculating diluted earnings per share, which of the following should not be considered?
a. The weighted average number of ordinary shares outstanding
b. The amount of dividends declared on cumulative preference shares
c. The amount of cash dividends declared on ordinary shares
d. The number of ordinary shares resulting from the assumed conversion of bonds payable outstanding
21. Which statement is correct in relation to EPS?
a. If preference share is outstanding, dividend declared on the preference share is always deducted from ret
income in calculating EPS
b. EPS can never be negative.
c. If income from continuing operations is lees than zero, potentially dilutive securities are antidilutive.
d. All issues convertible to ordinary shares must be included in the calculation of diluted EPS.

22. An entity already has calculated the basic earnings per share. In determining diluted earnings per
share, the annual dividend on convertible cumulative preference share which is dilutive should be

a. Added back to the numerator of basic EPS whether declared or not.

b. Deducted from the numerator of basic EPS only if declared.

c. Added back to the numerator of basic EPS only if declared.
d. Deducted from the numerator of basic EPS whether declared or not.

23. In determining diluted earnings per share, dividends on nonconvertible cumulative preference shares
should be
a. Disregarded
b. Added back to net income whether declared or not
c. Deducted from net income only if declared
d. Deducted from net income whether declared or not