What does diluted earnings per share mean on the CPA exam?
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Diluted earnings per share. Earnings per share computed as though every dilutive potential common share had been issued; antidilutive securities are excluded. Required of entities whose common or potential common stock trades publicly or is being registered, and that have more than common stock outstanding.
Defined against ASC 260-10-45-16, 45-17, 15-2.
Worked example
A listed company reports net income of $2,400,000. It has no preferred stock, and its common shares averaged 1,000,000 over the year. Employees hold 100,000 fully vested options, outstanding all year and exercisable at $40 a share, with all their compensation cost already recognized. Its shares traded at an average of $50 across the year.
What are basic and diluted earnings per share?
| Basic earnings per share2,400,000 / 1,000,000 | 2.40 |
| Proceeds if every option were exercised100,000 x 40 | 4,000,000 |
| Shares those proceeds buy back at the average price4,000,000 / 50 | 80,000 |
| Incremental shares added to the denominator100,000 - 80,000 | 20,000 |
| Diluted earnings per share2,400,000 / 1,020,000 | 2.35 |
Answer: Basic earnings per share is $2.40 and diluted is $2.35. Only the 20,000 net new shares enter the diluted count, because the exercise proceeds are assumed to buy back the rest.
The trap: Adding all 100,000 option shares to the denominator, which gives $2.18, or including options whose exercise price is above the average market price. Those would raise earnings per share, so they are antidilutive and left out.
Based on ASC 260-10-45-16; ASC 260-10-45-17.
Which CPA exam sections use diluted earnings per share?
Diluted earnings per share appears in the FAR section of the CPA exam.
Other terms defined against ASC 260-10
- preferred dividends: Dividends owed to preferred shareholders before common receives anything.
Other names for diluted earnings per share
diluted EPS
Related terms
- additional paid-in capital: Amounts received from shareholders above the par or stated value of the shares issued, reported as a separate equity caption.
- prior period adjustment: A correction of a material error in previously issued statements.
- straight debt: A written unconditional promise to pay a sum certain whose interest is not contingent on profits, which is not convertible into stock, and whose creditor is an individual other than a nonresident alien, an estate, qualifying trust, or regular lender.
- accumulated earnings and profits: The C corporation earnings and profits an S corporation carries into S status.
- earnings and profits: A corporation's cumulative economic capacity to pay a distribution out of earnings rather than out of capital.
- equity method: Used when the investor can exercise significant influence, presumed at 20% or more of the voting stock.