Earnings Per Share Computation: Basic and Diluted EPS Explained

Earnings Per Share (EPS) is one of the most commonly cited metrics in financial reporting. It represents how much profit is attributable to each share of common stock, providing insight into a company’s profitability and shareholder value.

Accurately computing EPS is essential for investors, analysts, and regulators — especially because it affects valuation models, executive compensation, and headline earnings in financial statements.

This article provides a complete overview of Basic and Diluted EPS computation, covering definitions, formulas, and step-by-step numerical examples.

1. What Is Earnings Per Share (EPS)?

EPS answers the question: How much of a company’s earnings is available to each common shareholder?

It’s used to compare profitability across companies and periods, and is a key input in valuation metrics like the price-to-earnings (P/E) ratio.

There are two types of EPS:

✦ Basic EPS – measures earnings per share using only common shares actually outstanding during the period

✦ Diluted EPS – includes the effect of potential shares from stock options, convertibles, and other dilutive instruments

2. Basic EPS Computation

Formula:

Basic EPS = (Net Income – Preferred Dividends) ÷ Weighted Average Number of Common Shares Outstanding

Key Concepts:

✦ Net income is after tax, but before preferred dividends✦ Only common shares outstanding during the period are included✦ Shares are time-weighted if issued or repurchased during the year

Example:

• Net income: $5,000,000

• Preferred dividends: $200,000

• Weighted average shares: 2,500,000

Basic EPS = (5,000,000 – 200,000) ÷ 2,500,000 = 4.80

3. Diluted EPS Computation

Diluted EPS reflects the worst-case scenario for existing shareholders — it includes shares that could be created from convertible securities, options, and warrants.

Formula:

Diluted EPS = Adjusted Net Income ÷ Adjusted Weighted Average Shares (Including Dilution)

Step-by-Step:

① Start with basic EPS numerator (net income – preferred dividends)

② Add back interest (net of tax) on convertible debt if converted

③ Add convertible preferred dividends back if preferred stock is assumed converted

④ Adjust denominator to include dilutive shares: From stock options using the treasury stock method From convertible securities using the if-converted method

4. Numerical Example: Basic and Diluted EPS

Scenario:

• Net income: $5,000,000

• Preferred dividends: $200,000

• Weighted average common shares: 2,500,000

• Convertible bonds: $1,000,000 at 5%, convertible into 100,000 shares

• Tax rate: 25%

• Stock options outstanding: 200,000 options at $20 exercise price

• Average market price of shares during the year: $25

Basic EPS:

Basic EPS = (5,000,000 – 200,000) ÷ 2,500,000 = 4.80

Diluted EPS:

Step 1: Adjust net income

Interest on convertible bonds = $1,000,000 × 5% = $50,000

After-tax interest = $50,000 × (1 – 0.25) = $37,500

Adjusted net income = $5,000,000 – $200,000 + $37,500 = $4,837,500

Step 2: Adjust shares for conversion

Add 100,000 shares from convertible bonds

Step 3: Add net shares from stock options (treasury stock method)

Proceeds from options = 200,000 × $20 = $4,000,000

Shares bought back at $25 = 160,000

Net new shares = 200,000 – 160,000 = 40,000

Adjusted shares = 2,500,000 + 100,000 + 40,000 = 2,640,000

Diluted EPS = 4,837,500 ÷ 2,640,000 = 1.83

5. Summary of EPS Computation

Type	Formula	Use
Basic EPS	(Net Income – Preferred Dividends) ÷ Weighted Average Shares	Required for all public companies
Diluted EPS	Adjusted Net Income ÷ Adjusted Weighted Average Shares (with dilution)	Shows “worst case” impact on earnings per share

6. Presentation and Disclosure Requirements

Both ASC 260 (U.S. GAAP) and IAS 33 (IFRS) require:

✦ EPS for net income, continuing operations, and discontinued operations

✦ EPS figures to be shown on the face of the income statement

✦ Reconciliation of numerators and denominators for basic and diluted EPS

✦ Disclosure of antidilutive securities excluded from diluted EPS

7. Common EPS Calculation Pitfalls

✦ Including antidilutive securities in diluted EPS

✦ Using year-end share counts instead of weighted average

✦ Failing to adjust net income for after-tax interest on convertibles

✦ Ignoring stock splits or dividends requiring retroactive adjustment

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Earnings Per Share (EPS) is a headline metric in corporate reporting. Proper computation of basic and diluted EPS ensures transparency and comparability.

To compute EPS accurately:

✦ Understand share movements throughout the year

✦ Adjust net income for convertible effects

✦ Apply the treasury stock and if-converted methods correctly

✦ Comply with disclosure requirements under ASC 260 and IAS 33