SIC-24: Earnings Per Share – Financial Instruments and Other Contracts that May Be Settled in Shares is a standard issued by the International Accounting Standards Committee (IASC) that provides guidance on the calculation and presentation of earnings per share (EPS) for entities that have financial instruments or other contracts that may be settled in shares.
Definitions:
Earnings Per Share (EPS):
EPS is a financial ratio that measures the profitability of a company on a per-share basis. It is calculated by dividing the company’s net profit or loss attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during a specific period.
Financial Instruments:
Financial instruments are contracts that give rise to a financial asset of one entity and a financial liability or equity instrument of another entity. Examples of financial instruments include shares, bonds, options, and derivatives.
Contracts Settled in Shares:
Contracts settled in shares are agreements or arrangements that require or permit an entity to settle a financial obligation by delivering a variable number of its own equity instruments, such as shares of common stock.
Explanations:
Under SIC-24, when a company has financial instruments or other contracts that may be settled in shares, the calculation of EPS requires special consideration. The standard provides guidance on how to determine the appropriate number of shares to be used in the calculation of EPS, taking into account the potential dilution effect of these instruments or contracts on the earnings per share.
SIC-24 outlines two methods for calculating EPS: the basic EPS and the diluted EPS. The basic EPS is calculated by dividing the net profit or loss attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the period. The diluted EPS, on the other hand, takes into consideration the potential dilution effect of financial instruments or other contracts that may be settled in shares. These instruments or contracts could potentially increase the number of shares outstanding, thereby reducing the EPS.
Examples:
Let’s consider some examples to illustrate the calculation of basic EPS and diluted EPS under SIC-24:
Example 1:
Company A has a net profit attributable to ordinary shareholders of $1,000,000 for the year ended December 31, 2022. The weighted average number of ordinary shares outstanding during the year is 1,000,000 shares. Company A does not have any financial instruments or contracts that may be settled in shares. The calculation of basic EPS would be as follows:
Basic EPS = Net profit attributable to ordinary shareholders / Weighted average number of ordinary shares outstanding
= $1,000,000 / 1,000,000 = $1.00 per share
Example 2:
Company B has a net profit attributable to ordinary shareholders of $1,000,000 for the year ended December 31, 2022. The weighted average number of ordinary shares outstanding during the year is 1,000,000 shares. In addition, Company B has 100,000 stock options outstanding that are exercisable into ordinary shares at a strike price of $10 per share. The average market price of the ordinary shares during the year was $15 per share. The calculation of diluted EPS would be as follows:
Diluted EPS = (Net profit attributable to ordinary shareholders + Adjustment for potential dilution) / (Weighted average number of ordinary shares outstanding + Potential dilutive shares)
= ($1,000,000 + ($15 – $10) x 100,000) / (1,000,000 + 100,000)
= $1,400,000 / 1,100,000 = $1.27 per share
In this example, the potential dilution effect of the stock options is considered in the calculation of diluted EPS. The adjustment for potential dilution is calculated by multiplying the difference between the average market price of the ordinary shares and the strike price of the stock options by the number of potential dilutive shares (100,000 shares in this case). The diluted EPS is then calculated by adding this adjustment to the net profit attributable to ordinary shareholders and dividing by the weighted average number of ordinary shares outstanding plus the potential dilutive shares.
Case Studies:
Let’s look at some case studies that further illustrate the application of SIC-24:
Case Study 1:
Company C has issued convertible bonds with a face value of $1,000,000. The bonds are convertible into 100,000 ordinary shares of the company. The company’s net profit attributable to ordinary shareholders for the year is $500,000, and the weighted average number of ordinary shares outstanding during the year is 1,000,000 shares. The average market price of the ordinary shares during the year was $8 per share. The calculation of diluted EPS would be as follows:
Diluted EPS = (Net profit attributable to ordinary shareholders + Adjustment for potential dilution) / (Weighted average number of ordinary shares outstanding + Potential dilutive shares)
= ($500,000 + ($8 – $0) x 100,000) / (1,000,000 + 100,000)
= $600,000 / 1,100,000 = $0.55 per share
In this case, the potential dilution effect of the convertible bonds is considered in the calculation of diluted EPS. The adjustment for potential dilution is calculated by multiplying the difference between the average market price of the ordinary shares and the conversion price of the convertible bonds (which is $0 as they are convertible at par value) by the number of potential dilutive shares (100,000 shares in this case).
Case Study 2:
Company D has issued stock options to its employees, which are exercisable into 50,000 ordinary shares of the company. The stock options have a strike price of $20 per share, and the average market price of the ordinary shares during the year was $25 per share. The company’s net profit attributable to ordinary shareholders for the year is $1,200,000, and the weighted average number of ordinary shares outstanding during the year is 1,000,000 shares. The calculation of diluted EPS would be as follows:
Diluted EPS = (Net profit attributable to ordinary shareholders + Adjustment for potential dilution) / (Weighted average number of ordinary shares outstanding + Potential dilutive shares)
= ($1,200,000 + ($25 – $20) x 50,000) / (1,000,000 + 50,000)
= $1,400,000 / 1,050,000 = $1.33 per share
In this case, the potential dilution effect of the stock options is considered in the calculation of diluted EPS. The adjustment for potential dilution is calculated by multiplying the difference between the average market price of the ordinary shares and the strike price of the stock options by the number of potential dilutive shares (50,000 shares in this case).
In all these case studies, the application of SIC-24 requires careful consideration of the potential dilution effect of financial instruments or other contracts that may be settled in shares, and proper adjustments need to be made in the calculation of diluted EPS to reflect this potential dilution.
In conclusion, SIC-24: Earnings Per Share – Financial Instruments and Other Contracts that May Be Settled in Shares provides guidance on the calculation and presentation of EPS for entities that have financial instruments or other contracts that may be settled in shares.