## Convertible instruments in EPS calculations

Convertible instruments are instruments other than stand-alone options that by their terms may be converted in whole or in part into the ordinary shares of an entity, such as convertible bonds or convertible preference shares.

This narrative builds on the basic principles introduced in EPS or earnings per share, and sets out the specific basic and diluted EPS implications of the following types of instrument(s).

If these instruments fall in the scope of IAS 32 Financial Instruments: Presentation, then they can contain a derivative recognised at fair value through profit or loss, a financial liability and/or equity components, depending on their terms. For example, a bond with an embedded option to convert it into ordinary shares of the issuer is a compound instrument, containing a financial liability and an equity component, if the conversion option is classified as equity. [IAS 32.26–32]

Although this is less common, a convertible instrument may fall in the scope of IFRS 2 Share-based Payment if it is issued in exchange for goods or services. In this case, the convertible instrument is generally regarded as a share-based payment with a choice of settlement. If the entity has the settlement choice, then the instrument is classified as either equity-settled or cash-settled, depending on whether the entity has a present obligation to settle in cash. If the holder has the settlement choice, then the instrument is classified as a compound instrument. [IFRS 2.34–43]

## EPS Calculation

Here is full example of an EPS Calculation. This narrative builds on the basic principles introduced in the narrative EPS, and sets out the specific basic and diluted EPS calculation rules as per IAS 33 Earnings per share.

### Case

Company P earns a consolidated net profit of 4,600,000 during the year ended 31 December Year 1 and 5,600,000 during the year ended 31 December Year 2. The total number of ordinary shares outstanding on 1 January Year 1 is 3,000,000.

Various POSs are issued before 1 January Year 1 and during the years ended 31 December Year 1 and Year 2. During this period, the outstanding number of ordinary shares also changes.

The statement of changes in equity below summarises only the actual movements in the outstanding number of ordinary shares, followed by detailed information about such movements and POSs outstanding during the periods.

### Details of the instruments and ordinary share transactions during Year 1 and Year 2

#### 1. Convertible preference shares

At 1 January Year 1, P has 500,000 outstanding convertible preference shares. Dividends on these shares are discretionary and non-cumulative. Each preference share is convertible into two ordinary shares at the holder’s option.

The preference shares are classified as equity in P’s financial statements.

On 15 October Year 1, a dividend of 1.20 per preference share is declared. The dividend is paid in cash on 15 December Year 1. Preference dividends are not tax-deductible.

## Contracts settled in shares or cash

Contracts that may be settled in shares or in cash deals with contracts that contain settlement alternatives at the issuing entity’s or the holder’s option. An example of such contracts is a share warrant that can be settled either gross in ordinary shares or net in cash.

If the contract falls under IFRS 2 Share-based Payment, then the classification depends on which party holds the settlement choice. If the issuing entity has that choice, then the contract is classified wholly as either equity-settled or cash-settled, depending on whether the entity has a present obligation to settle in cash. If the counterparty has the choice of settlement, then the contract is classified as a compound instrument. [IFRS 2.34–43]

If such a contract falls in the scope of IAS 32 Financial Instruments: Presentation, then it can contain a derivative, a liability and/or an equity component, depending on its terms. For example, a conversion option in a convertible bond that on exercise can be settled in shares or net in cash would generally mean that the whole instrument is a liability. [IAS 32.26–27, IAS 33.IE8]

This narrative covers the EPS implications of contracts that may be settled in shares or in cash in general. Additional considerations in the context of specific instruments are set out in the following chapters:

• instruments under share-based payment arrangements: see Chapter 5.17; and
• convertible instruments: see Chapter 5.11.

## IFRS 10 Special control approach

IFRS 10 Special control approach

– determines which entities are consolidated in a parent’s financial statements and therefore affects a group’s reported results, cash flows and financial position – and the activities that are ‘on’ and ‘off’ the group’s balance sheet. Under IFRS, this control assessment is accounted for in accordance with IFRS 10 ‘Consolidated financial statements’.

Some of the challenges of applying the IFRS 10 Special control approach include:

• identifying the investee’s returns, which in turn involves identifying its assets and liabilities. This may appear straightforward but complications arise when the legal ownership of assets diverges from the accounting depiction (for example, in financial asset transfers that ‘fail’ de-recognition, and in finance leases). In general, the assessment of the investee’s assets and returns should be consistent with the accounting depiction in accordance with IFRS
• it may not always be clear whether contracts and other arrangements between an investor and an investee
• create rights or exposure to a variable return from the investee’s performance for the investor; or
• transfer risk or variability from the investor to the investee IFRS 10 Special control approach
• the relevant activities of an SPE may not be obvious, especially when its activities have been narrowly specified in its purpose and design IFRS 10 Special control approach
• the rights to direct those activities might also be difficult to identify, because for example, they arise only in particular circumstances or from contracts that are outside the legal boundary of the SPE (but closely related to its activities).

IFRS 10 Special control approach sets out requirements for how to apply the control principle in less straight forward circumstances, which are detailed below:  IFRS 10 Special control approach

• when voting rights or similar rights give an investor power, including situations where the investor holds less than a majority of voting rights and in circumstances involving potential voting rights
• when an investee is designed so that voting rights are not the dominant factor in deciding who controls the investee, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements IFRS 10 Special control approach
• involving agency relationships IFRS 10 Special control approach
• when the investor has control only over specified assets of an investee
• franchises. IFRS 10 Special control approach

# Compound financial instruments – An incredible shift in accounting concepts

Compound financial instruments contain elements which are representative of both equity and liability classification.

A common example is a convertible bond, which typically (but not always, see ‘2 Convertible bonds‘ below) consists of a liability component in relation to a contractual arrangement to deliver cash or another financial asset) and an equity instrument (a call option granting the holder the right, for a specified period of time, to convert the bond into a fixed number of ordinary shares of the entity).

Other examples of possible compound financial instruments include instruments with rights to a fixed minimum dividend and additional discretionary dividends, and instruments with fixed dividend rights but … Read more

## Costs to issue or buy back issued shares

The accounting rule: Costs to issue or buy back issued shares by the issuing entity are accounted for as a deduction from equity, net of any related income tax benefit (the issue or buy back not being part of a business combination).

An entity typically incurs various costs in issuing or acquiring its own equity instruments. Those costs might include registration and other regulatory fees, amounts paid to legal, accounting and other professional advisers, printing costs and stamp duties. The transaction costs of an equity transaction are accounted for as a deduction from equity (net of any related income tax benefit) to the extent they are incremental costs directly attributable to the equity transaction that otherwise would have been avoided. … Read more

## Potential voting rights

Potential voting rights – An investor may hold instruments that (if exercised or converted), give the investor power to direct the relevant activities. These are called ‘potential voting rights’ and may be held through ownership of the following types of instrument:

• share options and warrants Potential voting rights
• convertible bonds Potential voting rights
• convertible preference shares. Potential voting rights

Potential voting rights can contribute to control of an investee in combination with current voting rights, or even confer control on their own. However, IFRS 10 requires an assessment to determine whether potential voting rights are substantive. IFRS 10 has no bright lines and so judgment will be required.

IFRS 10’s ‘substantive’ assessment takes into account both:

• the general guidance