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how do I calculate diluted earnings per share? — Business Ready

how do I calculate diluted earnings per share?

General & AdminThe Basic Earnings Per Share calculation is actually very straightforward:

take the net income or loss for the period and divide it by the time weighted average number of common shares outstanding during the period.

What becomes tricky is the Diluted Earnings Per Share which includes the dilutive effect of outstanding call options and warrants and their equivalents by application of the Treasury Stock method. Per the CICA Handbook, Section 3500.48, under the Treasury Stock method:

  1. Exercise of options, warrants and their equivalents should be assumed at the beginning of the period (or at time of issuance, if later) and common shares should be assumed to be issued;
  2. The proceeds from exercise should be assumed to be used to purchase common shares at the average market price during the period;
  3. The incremental shares (the difference between the number of shares assumed issued and the number of shares assumed purchased) should be included in the denominator of the diluted earnings per share computation.

You should also keep in mind:

  • Options and warrants only have a dilutive effect when they are ‘in the money’ (e.g. the average market price of the common shares exceeds the exercise price of the options or warrants) [CICA 3500.39];
  • Non-vested stock, stock options or other stock-based payments subject to performance that are settled in stock are included whether vested or not [CICA 3500.40];
  • When there is a year-to-date loss, potential common shares (e.g. options and warrants) are not included in the year to date diluted earnings per share because to do so would be anti-dilutive [CICA 3500.42].

You should refer to the CICA handbook in its entirety for the fine print but a simple step through the procedure would be:

  1. Determine the weighted average number of common shares.
  2. Determine the average price for the common shares (an average of the weekly or daily close prices for the period).
  3. Determine which of the options or warrants during the period were in the money (e.g. the average price of the common shares exceeds the exercise price).
  4. For those in the money, take the number of options/warrants granted and subtract the number of shares purchasable (where shares purchasable = number of options granted * exercise price / average share price). Add this number to the weighted average number of shares for the period and use this as the denominator for the Diluted Earnings per Share calculation.

If this seems quite laborious or confusing, try using the Business Ready template for Earnings Per Share Calculation to help guide you through.

For US GAAP, please refer to FAS Statement No. 128, Earnings per Share, for similar treatment.

8 comments ↓

#1
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Owner's Equity: Keeping Paid-in Capital Separate from Earned Capital
on 05.31.10 at 10:08 pm

[...] the earning capabilities of the firm. Diluted earnings show a more detailed explanation of basic earnings per share calculations, including the impacts that dilutive securities can have on [...]

#2
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sajid
on 07.28.10 at 1:22 pm

so nice …….. i have fully understand

#3
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Richard
on 05.17.11 at 7:16 pm

Nice one Wendy, you were able to explain a difficult topic in a simple way. The basic EPS is pretty easy to find, the tricky part is testing the warrants stocks and convertible stocks to the basic EPS. then adding them back if they pass the test figuring out if the warrants stocks convertible stocks are dilutive or anti-dilutive. Over all challenging yet fun topic.

#4
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Houch
on 02.05.12 at 6:38 pm

hi!!!

#5
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Jimson Mwakitalu
on 05.23.12 at 4:14 pm

your thought is great,thanks because now things are clear!!

#6
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safety auditors
on 02.22.13 at 5:36 pm

Thanks - Enjoyed this article, how can I make is so that I get an email
whenever you make a new article?

#7
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Phoenix, AZ CPA Firm: Owner's Equity: Keeping Paid-in Capital Separate from Earned Capital
on 05.26.13 at 9:47 am

[...] the earning capabilities of the firm. Diluted earnings show a more detailed explanation of basic earnings per share calculations, including the impacts that dilutive securities can have on [...]

#8
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PIT37
on 08.31.13 at 5:34 am

Howdy just wanted to give you a quick heads up. The words in your content seem to be running off the screen in
Internet explorer. I’m not sure if this is a formatting issue or something to do with internet browser compatibility but I figured I’d post to let you know.

The layout look great though! Hope you get the problem fixed soon.
Kudos

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