# Earnings Per Share calculation involving Share Consolidation Arrangement

Basic EPS involving share consolidation (reverse share split issue):

## 1. Share Consolidation: Definition & Explanation

Share consolidation transactions, also known as reverse share split arrangements, involve the reduction of number of shares of an entity without affecting the total value of share capital. For example, a 1 for 2 share consolidation would entitle a shareholder with 10 existing ordinary shares with nominal value of $10 each with 5 new shares having nominal value of $20 each. The shareholder would have the same net interest in the company of $100 but his interest would be represented by a smaller number of shares. Share consolidation arrangements are rare in practice and may be undertaken by companies to reduce the number of shareholders in order to drive ownership of the company towards institutional investors.

## 2. Share Consolidation Adjustment in EPS

EPS calculation involving share consolidation transaction is the mirror image of the EPS calculation that involves a share split transaction, i.e. the weighted average shares are reduced by the number of shares that are absorbed into the consolidated shares as if the transaction took place at the start of the period. Similarly, EPS of comparative prior periods is restated by incorporating a similar adjustment to the weighted average shares of that period. View Example >

If no adjustment is incorporated in the weighted average shares in respect of the share consolidation, earnings per share would appear to have considerably increased in the year in which the share consolidation takes place as compared against the EPS of previous years even if the financial results of the entity do not change. This would not present an objective depiction of the company's performance over a period of time also because the earning per share would appear to have increased even though the entity had not paid any consideration for the reduction in number of shares as in the case of EPS calculation involving shares redemption.

Hence, an adjustment is made to reduce the number of shares as a result of the share consolidation in the current period (i.e. the year in which share consolidation takes place) and also in the prior period comparative EPS presented in the current period financial statements. This helps in drawing a fair comparison of the company's performance over a period of time as indicated in its EPS ratios.

## 3. Formulae

Following formulae demonstrate how share consolidation adjustment is included in the Basic Earnings Per Share calculation:

EPS for the year (X) | = | Earnings attributable to ordinary share holders for the year |

[Weighted Average Shares (excluding bonus) - Shares Reduction] |

EPS for the year (X-1) | = | Earnings attributable to ordinary share holders for the year |

[Weighted Average Shares (excluding bonus) - Shares Reduction] |

EPS for the year (X+1) | = | Earnings attributable to ordinary share holders for the year |

[Weighted Average Shares (excluding bonus) - Shares Reduction] |

Where:

Year (X) | = | Year in which share consolidation takes effect (current period) |

Year (X-1) | = | Year preceding the period in which share consolidation occurs (prior period comparative) |

Year (X+1) | = | Year subsequent to the period in which share consolidation is carried out (subsequent period) |

Weighted Average Shares | = | Number of shares at the start of the year PLUS Shares issued for consideration x (time apportionment) MINUS Shares redeemed during the year x (time apportionment) |

Shares Reduction | = | Number of issued shares that are reduced as a result of the share consolidation arrangement. The reduction is subtracted from the weighted average share computation without any consideration for time apportionment so that the effect of share consolidation transaction on EPS is constant for current, prior period comparatives and subsequent periods in order to facilitate comparisons over time. |

## 4. Example

ABC PLC, which has a year end of 31st December 2012, carried out a 2 for 3 share consolidation transaction on 30th June 2012.

Following information relates to ABC PLC:

Ordinary Shares as on 1st January 20116,000,000

Earnings attributable to ordinary shareholders:

2011 $4,000,000

2012 $4,000,000

Calculation of Earning Per Share for 2011 and 2012 for presentation in financial statements for the year ended 31st December 2012 would be as follows:

Step 1: | Calculate the reduction in number of shares | |

Number of shares prior to consolidation | 6,000,000 | |

Reduction in shares (6m - 6m x 2/3) | 2,000,000 | |

Step 2: | Calculate Weighted Average Shares | |

2011 Shares at the start of the year | 6,000,000 | |

Less: Share Reduction (Step 1) | (2,000,000) | |

Weighted Average Shares | 4,000,000 | |

2012 Shares at the start of the year | 6,000,000 | |

Less: Share Reduction (Step 1) | (2,000,000) | |

Weighted Average Shares | 4,000,000 |

*Note that even though the reduction in number of shares from the share consolidation occurred mid way through 2012, they are included in the calculation of weighted average shares without time apportionment for both 2012 and 2011 (i.e. as if the reduction in shares occurred before the start of the accounting periods).*

Step 3: | Calculate Earnings Per Share | |

2011 Earnings attributable to ordinary share holders | $4,000,000 | |

Weighted Average Shares (Step 2) | 4,000,000 | |

Earnings Per Share ($ 6,000,000 / 6,000,000) | $1 | |

2012 Earnings attributable to ordinary share holders | $4,000,000 | |

Weighted Average Shares (Step 2) | 4,000,000 | |

Earnings Per Share ($ 6,000,000 / 6,000,000) | $1 |

*Note that despite the share consolidation transaction in 2012 earnings per share for the two years has remained the same as there is no variation in the ABC PLC's earnings. The effect of shares reduction caused from the share consolidation is therefore eliminated by deflating the weighted average shares for both years by the same number of shares.*

*Earnings per share as calculated above reveals that the underlying performance of ABC PLC has remained unchanged over the past two years. Had no adjustment for the reduced shares been made, EPS for 2012 would have been higher than 2011 despite the fact that there is no difference in the company's earnings and nor did ABC PLC pay any consideration for the reduction in shares which would warrant an increase in EPS as in the case of EPS calculation involving redemption of share capital. Failing to adjust EPS regarding the share consolidation in prior period comparatives would therefore not present a true and fair view of the performance of ABC PLC.*

*Calculation of weighted average shares for subsequent periods will also incorporate the reduction in shares in a similar manner (i.e. subtracted in full without time apportionment).*