Earning and Diluted Earnings per Share. CPA Exam & Intermediate Accounting

In this video, we cover the computation for the basic and diluted earning per share.
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Earnings Per Share (EPS) is a key financial metric used to measure a company's profitability on a per-share basis, providing insight into the amount of income a company generates for each share of its stock. It's calculated by dividing the company's net income (profits or earnings) by the number of outstanding shares of its common stock. EPS is a widely used indicator of a company's financial health and is of particular interest to its shareholders and potential investors.

There are two main types of EPS:

1. Basic Earnings Per Share: This measures the amount of a company's net income (profit after all expenses have been deducted) available to each share of common stock. The calculation for basic EPS does not take into account any potentially dilutive securities. It's calculated as follows:

Basic EPS = Net Income - Preferred Dividends\Weighted Average Number of Common Shares Outstanding

Here, preferred dividends are subtracted from net income because basic EPS focuses on earnings available to common shareholders. The denominator, the weighted average number of common shares outstanding, accounts for any changes in the share count throughout the reporting period.

2. Diluted Earnings Per Share: This calculation considers the impact of all potential shares that could be created from conversions of convertible preferred shares, convertible debt, stock options, and warrants into common stock. Diluted EPS provides a "worst-case" scenario view of EPS, showing what earnings per share would be if all potential common shares were issued. It's calculated as follows:

Diluted EPS =Net Income - Preferred Dividends +Convertible Preferred Dividends+ Interest on Convertible Debt (net of tax)/Weighted Average Shares} + All Potential Dilutive Common Shares

The numerator may be adjusted by adding back convertible preferred dividends and interest on convertible debt (net of tax), assuming these would not be paid if the securities were converted into common stock. The denominator increases by the number of additional common shares that would have been outstanding if the dilutive potential shares had been converted.

Diluted EPS is particularly important because it shows the effect of dilutive securities on earnings per share, providing a more conservative view of a company's earnings performance. Investors and analysts often compare basic and diluted EPS to assess the potential impact of convertible securities on the company's earnings per share and to understand the company's financial health from different angles.

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