The draft financial statements of Hendrix plc for year ended $31$ December $2008$ include the

following:

$$

Profit before tax $2,323,000$

Less Taxation

Corporation Tax $1,035,000$

Under provision for $200723,0001,058,000$

Profit after tax $1,265,000$

Transfer to reserves $115,000$

Dividends $($See Note below$)$

Paid preference interim dividend $138,000$

Paid ordinary interim dividend $184,000$

Proposed preference final dividend $138,000$

Proposed ordinary final dividend $230,000805,000$

Retained profit $460,000$

On $1$ January $2008$ the issued share capital of Hendrix plc was $4,600,0006\%$ preference

shares of $1$ each and $4,140,000$ ordinary shares of $1$ each. The proposed dividends were

approved by the shareholders during the year ended $31$ December $2008.$

Requirement

$($a$)$ Calculate the basic and diluted earnings per share for Hendrix plc in respect of the year

ended $31$ December $2008$ for each of the following circumstances $($each of the four

circumstances $($i$)$ to $($iv$)$ should be dealt with separately$)$:

$($i$)$ On the basis that there was no change in the issued share capital of the company

during the year ended $31$ December $2008.$

$($ii$)$ On the basis that the company made a bonus issue on $1$ October $2008$ of one ordinary

share for every four shares in issue at $30$ September $2008.$

$($iii$)$ On the basis that the company made a rights issue of $1$ ordinary shares on $1$ October

$2$

$2008$ in the proportion of $1$ for every $5$ shares held, at a price of $1\mathrm{.}20.$ The middle

market price for the shares on the last day of quotation cum rights was $1\mathrm{.}80$ per

share.

$($iv$)$ On the basis that the company made no new issue of shares during the year ended $31$

December $2008$ but on that date it had in issue $1,150,00010\%$ convertible loan

stock $2009-2012.$ This loan stock will be convertible into ordinary $1$ shares as

follows:

$2009901$ shares for $100$ nominal value loan stock

$2010851$ shares for $100$ nominal value loan stock

$2011801$ shares for $100$ nominal value loan stock

$2012751$ shares for $100$ nominal value loan stock

$($Assume tax at $50\%.)$

$15$ Marks

$($b$)$ Accounting regulators believe that undue emphasis is placed on earnings per share and

that this leads to simplistic interpretation of financial performance. Many chief executives

believe that their share price does not reflect the value of their company and yet are pre$-$

occupied with earnings$-$based ratios. It appears that if chief executives shared the views

of the regulators then they may disclose more meaningful information than earnings per

share to the market, which may then reduce the $$reporting gap$$ and lead to higher share

valuations. The $$reporting gap$$ can be said to be the difference between the information

required by the stock market in order to evaluate the performance of a company and the

actual information disclosed.

$($i$)$ Discuss the potential problems of placing undue emphasis on the earnings per share

figure.

$5$ Marks

$($ii$)$ Discuss the nature of the $$reporting gap$$ and how the gap might be eliminated.

$5$ Marks

Total $25$ Marks

Note

Dividends should not be shown on the face of the SPLOCI, but should be debited directly to

equity and disclosed in the SCE. They are presented in this manner in this question for clarity.

Furthermore, the presentation of shares in financial statements can be problematic. As a broad

generalisation, an ordinary share, where the shareholder has no contractual right to any form

of regular payment of dividends, is classified as equity. A preference share, where there is a

contractual right to set dividend payments or if shares are redeemable at the option of the

holder, will generally be treated as a liability. The grey area is the classification of the $$in$-$

between shares$$ which may have both equity and liability components. These shares should

be treated as compound financial instruments with both an equity and liability component

with the value of the equity component being the residual amount after deducting the

separately determined liability component from the fair value of the instrument as a whole.

Presentation therefore results in substantially all of the carrying value of these shares being

allocated to the liability component and the $$dividend$$ being treated as a finance cost in

arriving at profit $/$ loss.

$3$

In this question, the $$preference dividends$$ have NOT yet been charged in arriving at profit

before tax $($albeit that the preference shares are likely to be classified as non$-$current liabilities

and therefore the $$dividend$$ would be classified as a finance cost$).$