Diluted EPS: Which Method Do You Use?
Start with basic EPS, then identify what potentially dilutive security the question gives you.
Convertible debt
Think if-converted method. Assume conversion under the applicable calculation, adjust the numerator for interest that would not have existed after conversion, generally considering taxes, and increase the denominator for assumed shares.
Convertible preferred stock
Use if-converted logic. Add back preferred dividends that would not have been paid after conversion and add the corresponding shares.
Options and warrants
Think treasury stock method. Assume exercise, then use the proceeds to repurchase shares at the applicable average market price. Only incremental shares increase diluted weighted-average shares.
Antidilution
A potential common share is included only when it is dilutive under the applicable rules. Do not include a security merely because it can convert.
Sequence
- Calculate basic EPS.
- Identify potential common shares.
- Calculate incremental effects.
- Exclude antidilutive items.
- Calculate diluted EPS.
The takeaway
Convertibles usually point to if-converted. Options and warrants point to treasury stock.
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FAQ
Do convertible bonds affect the numerator?
They can, because assumed conversion removes related interest expense.
Are all options included?
No. Antidilutive instruments are excluded.
Should I calculate basic EPS first?
Yes.