Proposed changes to the definition of earnings per share (EPS) in AASB 133 Earnings per Share are relevant to executive remuneration for at least two reasons:

1. EPS is the second most popular long term incentive (LTI) performance measure after relative total shareholder return, and
2. The changes would mean that unvested shares, rights and options granted under LTI plans would no longer be counted when calculating diluted EPS, which would increase the diluted EPS figure

Under AASB 133 Earnings per Share, EPS is calculated as:

Profit or loss attributable to ordinary shareholders (the numerator) ÷ the weighted average number of shares in the parent entity outstanding for the period (the denominator)

Full details of the proposed amendments to AASB 133 are set out in Australian Accounting Standards Board (AASB) Exposure Draft ED 166 Simplifying Earnings per Share: Proposed Amendments to AASB 133 (available HERE). 

The AASB is seeking public comment on the proposed changes by 31 October 2008 so that it can incorporate these in its response to the IASB, which is due by 5 December 2008.

AASB 133 replicates a similar exposure draft issued by the International Accounting Standards Board (IASB) proposing amendments to IAS 33 Earnings per Share (on which the Australian standard is based) as part of the IASB’s “convergence” project to reduce differences between international financial reporting standards (IFRSs) and US generally accepted accounting principles (GAAP).  The US Financial Accounting Standards Board (FASB) is proposing to adopt the same principles in amendments to US Statement of Financial Accounting Standards No. 128 Earnings per Share.

From an executive remuneration perspective, key points to note about the principles for calculating EPS, as they would apply under the revised IAS 33/AASB 133, include:

• Basic EPS is calculated by dividing the numerator by the weighted average number of ordinary shares outstanding (the denominator) during the period.  In addition to ordinary shares, the denominator should also include other instruments that give (or are deemed to give) their holder the right to share in profit or loss of the period with ordinary equity holders, such as ordinary shares issuable for little or no cash or other consideration (this means unvested performance shares, rights or options granted under LTI plans will not reduce basic EPS as long as they do not carry a right to dividends during the performance/vesting period – this is unusual in Australia, but not unheard of)

• To calculate diluted EPS, an entity adjusts basic EPS for the effects of all dilutive potential ordinary shares that are not measured at fair value through profit or loss. 

• No adjustments should be made to the numerator or the denominator of the undiluted EPS calculation for an instrument that is measured at fair value through profit or loss because changes in the fair value of such instruments reflect the economic effect of the instrument on current equity holders for the period, and the numerator of the EPS calculation includes those changes. 

[It is worth noting that one of the arguments against the introduction of expensing for options/share-based payments was the reverse of this – i.e. expensing would result in double counting because the dilutive effect of options was already reflected in the denominator of diluted EPS!]

• For the purpose of calculating diluted EPS, share-based payments that are recognised (or will be recognised) as a liability and measured in accordance with IAS 2/AASB 2 Share-based Payment shall be treated in the same way as instruments that are measured at fair value through profit or loss i.e. no adjustments should be made – which means unvested LTI grants will not reduce diluted EPS

If the proposed amendments are approved by the IASB, and subsequently by the AASB, the revised IFRS and AASB standards are expected to apply from the same time.

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