Part 1 - What is HEPS and why the need for it

HEPS is a bit different to your normal accounting standards covered under International Financial Reporting Standards (IFRS). This is because there are no accounting standards that address HEPS as the calculation of HEPS is required by the JSE Limited listing requirements and not IFRS. It is important to note that as HEPS is not an IFRS requirement, it is incorrect to disclose HEPS on the face of the statement of comprehensive income, and HEPS should rather be disclosed in the notes to the annual financial statements.

As HEPS is not addressed by IFRS, it is not a topic that is often covered during your studying and it is often only heard about for the first time in the working environment.

The current circular guiding HEPS is Circular 3/2012 which replaced Circular 3/2009 for all periods ending on or after 31 July 2012.

There were two changes made from Circular 3/2009 to Circular 3/2012 and these were:

  1. Better alignment of the tax treatment of a re-measurement; and

  2. Clarity relating to compensation from third parties for items of property, plant and equipment that were impaired, lost or given up.

So what is HEPS? Circular 3/2012 defines headline earnings as:

“an additional earnings number that is permitted by IAS 33. The starting point is earnings as determined by IAS 33, excluding “separately identifiable re-measurements” (as defined), net of related tax (both current and deferred) and related non-controlling interest, other than re-measurements specifically included in headline earnings “including re-measurements” (as defined).

A re-measurement is an amount recognised in profit or loss relating to any change (whether realised or unrealised) in the carrying amount of an asset or liability that arose after initial recognition of such asset or liability.

Why the need for HEPS? The JSE Limited is fully supportive of IFRS and full compliance is required by the JSE Limited for all listed entities. So why the requirement for a separate earnings calculation?

As per Circular 3/2012:

“The focus of most IFRSs is on the recognition of assets and liabilities. Some may argue that this approach results in performance being assessed largely as the difference between two statements of financial positions and not as a stand-alone profit or loss figure. In addition, some standards require gains and losses to be recognised directly in other comprehensive income and then, in some instances, reclassified to profit or loss at a later stage. This means that not all gains and losses are necessarily recognised in the reported net profit figure, or that some gains and losses are not recognised in the period in which they arise.

The International Accounting Standards Board (IASB) is of the view that there is no single number that encapsulates the performance of an entity. Investors and analysts worldwide have expressed this view for some time. The market takes note of a wider information set. Nevertheless, there is still the call from users for a single earnings number that can be used as an unambiguous reference point.

The headline earnings survey was carried out by SAICA in 2006 as well as subsequent interviews with various user groups, including fund managers, analysts and financial institutions. These showed a large demand from users in general for a clearly defined reference number (other than the earnings per share number in terms of IAS 33 – Earnings per Share), which can be used for reporting and comparative purposes.

One of the main uses of a single earnings number in South Africa is in the calculation of a consistent price earnings (P/E) ratio. A P/E ratio is a useful analysis tool for comparing the market ratings of companies and for trend analysis of the valuations of companies and sectors over time, even though the earnings of the various companies are not necessarily calculated using the same accounting policies.

It should be noted however that headline earnings should not be seen as a divergence or departure from the recognition criteria for revenue, expenses, gains and losses in IFRS. Instead, it is a way of dividing the IFRS reported profit between re-measurements that are more closely aligned to the operating/trading activities of the entity and the platform used to create those results.

Headline earnings is not a means for an entity to adjust its financial results for disagreements it might have with the application of IFRS or to circumvent the correct accounting treatment.

In Part 2 of the HEPS discussion I will go through the calculation of HEPS based on what was discussed in this article.

Michael Steenkamp

Audit Partner , Johannesburg