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To understand the concept of Earning per share and Dilute Earning per share ratios,, read lecture # 33,34 and 35 respectively :)

Graded Discussion Board (GDB)

Earnings per Share (EPS) and Diluted Earnings per Share (DEPS) are major reflectors of economic health of any company. Normally, investors prefer these accounting ratios in their investment decisions. International Accounting Standard (IAS) 33 has been developed to cope with the problems associated with EPS and Diluted EPS and provides standards, rules and guidance to professionals for creating harmony in accounting practices all over the world.

All the listed companies calculate not only EPS but also diluted EPS except Small and Medium Size Companies, as defined by a notification.  Some investors prefer EPS which others that DEPS for different reasons and justifications. Assume that you are a potential investor and want to invest in a company. You are a rational and risk adverse investor and have concern for future earning and equity position of the company. You have performed an analysis of the ratios over a business cycle and found a huge difference between EPS and DEPS of the Company. Which of the ratios would be more suitable in your decision making and why?  Provide your comments with solid arguments in the favor of your decision.

Diluted earnings per share (diluted EPS) is essentially the earnings made on every share of a public company that is calculated assuming that all the securities that are convertible were duly exercised. Instead of taking only the existing common stock into consideration, Diluted Earnings Per Share assumes that all the securities including convertible bonds, convertible preferred shares, stock options, warrants as well as other things, which can be altered into common stock is altered actually.

Diluted EPS is important for shareholders simply because it lays down the earnings that a shareholder would get in the worst of the scenarios. If a public listed entity has more of different stock types in its capital framework, it should provide information pertaining to both diluted EPS and Basic EPS. This presentation of information should be for both net income and existing operations and is provided on the income statement of the company.

Diluted Earnings per Share Formula

In order to calculate diluted EPS, one must include the impact of all the common shares that are dilutive. Thus, it is basically the company’s net income that needs to be divided by the total sum of a company’s average shares as well as other instruments that are convertible. While, the net income of a company can be acquired through the income statement prepared by it, the average share of a company is basically the weighted common shares average for the entire year. Thus, the weights of each and every factor typically include the duration for which each common share would have remained outstanding.

For example, if an entity has hundred common shares that are outstanding for a period of nine months and hundred and twenty common shares, which are outstanding for three months. The respective weights of nine months as well as three months would stand at .75 and .25. This further represents three-fourth of a year and one-fourth of a year. Therefore, the formula would be .75 (100) plus .25 (120) that would be equal to a weighted average of hundred and five common shares for the complete year.

A company may have to make 2 adjustments to the numerator of this entire calculation and they include, elimination of any interest based expense that is related to dilutive common stock and adjusting of after-tax effect of dividends or any other type of dilutive common shares

For companies that have a complex capital structure (that is, they have issued potential dilutive securities), diluted EPS is considered to be a more precise metric than basic EPS. Diluted EPS takes into account all of the outstanding dilutive securities that could potentially be exercised (such as stock options and convertible preferred stock) and shows how such an action would impact earnings per share. Companies with a complex capital structure must report both basic EPS and diluted EPS to provide a more accurate picture of their earnings per share; basic EPS will always be the higher of the two. If the company has a simple capital structure, it only needs to report basic EPS.

thanx  Motto ghoplooo to share ur idea

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