Basic EPS and Diluted EPS; CPA Exam Simulation

In this video, I review basic and diluted EPS in a form of a CPA exam simulation.
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Earnings Per Share (EPS) is a key financial metric used to assess a company's profitability on a per-share basis. It is calculated in two forms: Basic EPS and Diluted EPS.

Basic EPS
Definition: Basic EPS measures the amount of a company's profit that can be allocated to each outstanding share of common stock. It does not consider the effects of any potential dilutive securities.

Components:
Net Income: The total profit of the company after all expenses and taxes.
Preferred Dividends: Dividends that must be paid to preferred shareholders. These are subtracted from net income because Basic EPS applies only to common stock.
Weighted Average Number of Common Shares Outstanding: Reflects any changes in the number of shares over the reporting period.
Diluted EPS
Definition: Diluted EPS takes into account the potential dilution that could occur if convertible securities were exercised or converted into common stock. This provides a more conservative measure of profitability.

All Potential Dilutive Shares: Includes all convertible securities, such as convertible bonds, convertible preferred shares, stock options, and warrants.
Key Differences
Potential Dilution: Basic EPS does not account for any additional shares that could be created, while Diluted EPS considers all possible shares that could exist if dilutive securities were converted.
Conservatism: Diluted EPS is usually lower than Basic EPS, as it assumes a worst-case scenario where all convertible securities are converted to common stock, increasing the share count.
Investor Insight: Basic EPS is useful for understanding the current earnings per share, whereas Diluted EPS helps investors understand the potential for earnings dilution.
In summary, Basic EPS provides a straightforward view of earnings relative to the number of shares currently outstanding, while Diluted EPS provides a more conservative view, considering the potential increase in shares from dilutive securities. Both metrics are crucial for investors in assessing a company's profitability and comparing it with peers.



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