Fully Diluted Earnings Per Share (EPS)

Definition

Fully Diluted Earnings Per Share (EPS) is a financial metric used to measure a company’s earnings per share if all convertible securities, such as stock options, convertible debt, and warrants, were exercised. It provides investors a more comprehensive view of a company’s potential earnings per share, considering the potential dilution from these securities.

International Accounting Standard 33 mandates that fully diluted EPS be disclosed on the face of the profit and loss account in conjunction with basic EPS, ensuring transparency and uniformity in financial reporting.

Examples

Company A has 1,000,000 common shares outstanding and reported net earnings of $2,000,000. Basic EPS would be $2.

However, if Company A has 200,000 stock options outstanding and 100,000 convertible bonds that can be converted into common shares, we need to account for these in the fully diluted EPS.

New total shares: 1,000,000 + 200,000 + 100,000 = 1,300,000 shares.

Fully Diluted EPS = $2,000,000 / 1,300,000 = $1.538.
Company B has net earnings of $500,000 and 500,000 shares outstanding, resulting in a basic EPS of $1.

Plus, Company B has some liabilities in the form of convertible loans and options that could potentially add another 100,000 shares.

New total shares: 500,000 + 100,000 = 600,000 shares.

Fully Diluted EPS = $500,000 / 600,000 = $0.833.

Frequently Asked Questions (FAQ)

What is the main difference between basic EPS and fully diluted EPS?

Basic EPS measures earnings based on the current number of shares. Fully Diluted EPS takes into account all potential dilution from securities like stock options, convertible debt, and warrants, providing a more conservative view of earnings per share.

Why is disclosing fully diluted EPS important?

Fully diluted EPS is important because it offers a more comprehensive understanding of a company’s potential earnings per share in scenarios where all dilutive securities are converted to shares, which can significantly affect investors’ evaluation of the company’s financial health.

How are convertible securities accounted for in fully diluted EPS?

Convertible securities like stock options, convertible bonds, and warrants are assumed to be exercised, increasing the total number of shares, which typically reduces the EPS value when fully diluted EPS is calculated.

How does International Accounting Standard (IAS) 33 relate to EPS?

IAS 33 sets the guidelines for the calculation and presentation of both basic and diluted EPS to ensure transparency and comparability across companies’ financial statements.

Can fully diluted EPS be higher than basic EPS?

Typically no. Fully diluted EPS should be lower than or equal to basic EPS because it accounts for the potential increase in the number of shares due to dilutive securities, which usually decreases the earnings per share.

Basic Earnings Per Share (EPS): The amount of earnings per share calculated by dividing net earnings by the current number of shares outstanding.
Convertible Securities: Financial instruments like bonds or preferred shares that can be converted into a fixed number of common shares.
Stock Options: Contracts that give the holder the right to buy or sell shares at a predetermined price before a specified date.
International Accounting Standards (IAS): Standards designed to ensure global uniformity in corporate financial statements.

Online References

Suggested Books for Further Studies

“Financial Statement Analysis and Security Valuation” by Stephen H. Penman
“International Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
“Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
“Financial Accounting for Dummies” by Maire Loughran

### Does fully diluted EPS consider convertible securities? - [x] Yes - [ ] No - [ ] Only in certain circumstances - [ ] Only if the company has convertible debt > **Explanation:** Yes, fully diluted EPS takes into account convertible securities like stock options, warrants, and convertible bonds, assuming they are exercised. ### Which standard requires companies to disclose fully diluted EPS? - [ ] FAS 52 - [x] IAS 33 - [ ] GAAP 15 - [ ] AS 106 > **Explanation:** IAS 33 requires companies to disclose fully diluted EPS on the face of the profit and loss account as well as basic EPS. ### What happens to EPS when convertible securities are exercised? - [ ] It generally increases - [ ] It remains constant - [x] It generally decreases - [ ] It doubles > **Explanation:** When convertible securities are exercised, the number of shares increases, which typically lowers the EPS since earnings are spread over a larger number of shares. ### Basic EPS is calculated using: - [ ] Only preferred shares - [ ] Fully diluted shares - [x] Only the current number of shares outstanding - [ ] Future issue of shares > **Explanation:** Basic EPS is calculated by dividing net earnings by the current number of shares outstanding, without accounting for potential dilution from other securities. ### Which of the following is NOT considered in fully diluted EPS? - [ ] Convertible bonds - [ ] Stock options - [ ] Warrants - [x] Dividends > **Explanation:** Dividends are not considered in the calculation of fully diluted EPS; it focuses on possible increases in share count from convertible securities. ### Why do investors care about fully diluted EPS? - [ ] It predicts future profits - [x] It provides a comprehensive view of potential dilution - [ ] It decreases overall risk - [ ] Reflects market share price > **Explanation:** Investors care about fully diluted EPS because it provides them with a comprehensive view of how potential dilution could impact earnings per share, affecting investment decisions. ### Whose interests are served by disclosing fully diluted EPS? - [ ] Only the company's executives - [ ] Only financial auditors - [x] Both investors and regulatory bodies - [ ] Only stockholders > **Explanation:** Disclosing fully diluted EPS serves the interests of both investors and regulatory bodies by ensuring transparency and aiding informed decision-making. ### Fully diluted EPS should be disclosed: - [ ] Only in quarterly reports - [ ] Only in annual reports under U.S. GAAP - [x] On the face of the profit and loss account as required by IAS 33 - [ ] Only when requested by shareholders > **Explanation:** IAS 33 requires that fully diluted EPS be disclosed on the face of the profit and loss account alongside basic EPS. ### A company has basic EPS of $1.00. If their fully diluted EPS calculation results in $0.85, what does this indicate? - [ ] The company's share price will increase. - [ ] The company can issue more dividends. - [x] The company has dilutive securities that reduce EPS. - [ ] The company’s debt level is very high. > **Explanation:** This indicates that the company's fully diluted EPS calculation results in a lower value, meaning there are dilutive securities reducing the earnings per share. ### What type of accounting does EPS relate to primarily? - [ ] Managerial accounting - [ ] Cost accounting - [ ] Auditing standards - [x] Financial accounting > **Explanation:** EPS relates primarily to financial accounting as it focuses on understanding and reporting a company's financial performance for investors.

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