Basic vs Diluted EPS: Worked Example
Worked Example · Intermediate Accounting
Basic vs Diluted EPS
Basic EPS = (net income − preferred dividends) ÷ weighted-average common shares. Diluted EPS asks a “what if”: if convertibles and options became shares, how low could EPS go? Because it adds shares, diluted EPS is always ≤ basic — and it’s an exam favourite.
Worked example
Net income $104,000, no preferred shares, 40,000 weighted-average common shares. The company also has $150,000 of 6% convertible bonds (convertible into 10,000 shares), tax rate 30%.
Steps
- Basic EPS = 104,000 ÷ 40,000 = $2.60
- If-converted add-back = 150,000 × 6% × (1 − 0.30) = $6,300
- Diluted numerator = 104,000 + 6,300 = 110,300
- Diluted denominator = 40,000 + 10,000 = 50,000
- Diluted EPS = 110,300 ÷ 50,000 = $2.21
| Numerator | Denominator | EPS | |
|---|---|---|---|
| Basic | 104,000 | 40,000 | $2.60 |
| Diluted | 110,300 | 50,000 | $2.21 |
Testing your own security for dilution? A tutor can walk your own numbers — book a session.
The mistake that costs marks
Adding shares from an anti-dilutive security. If a security’s incremental EPS is above basic EPS, including it would raise EPS — so you exclude it. Always test before you add.
Frequently asked questions
What are weighted-average shares?
Shares outstanding weighted by the fraction of the year they existed — a mid-year issue counts only for the months it was outstanding.
Why subtract preferred dividends?
Basic EPS measures earnings available to common shareholders, so preferred dividends come out of the numerator first.
Which securities are dilutive?
Convertible bonds/preferreds (if-converted) and options/warrants (treasury-stock) — but only when they lower EPS.
