Definition
Basic earnings per share is net income less preferred dividends, divided by the weighted-average number of common shares outstanding. Diluted earnings per share adds the effect of potential common shares. Options and warrants use the treasury stock method, convertible securities use the if-converted method, and participating securities may require the two-class method. ASC 260-10 applies to entities whose common stock trades publicly or that are filing to sell it, so many private companies do not present it.
Why it matters in an audit or review
Earnings per share is a headline metric for public entities, so the denominator needs the same rigor as the numerator. Auditors recompute the weighted-average shares from the equity rollforward, check that share issuances and buybacks are dated correctly, and test that every dilutive instrument is included.
Example
Illustrative: net income of $1,200,000 less preferred dividends of $100,000 is $1,100,000. Shares are 900,000 on January 1 and 300,000 more are issued July 1, so the weighted average is 900,000 + 150,000 = 1,050,000 and basic EPS is $1.05. With 100,000 options at a $20 exercise price and an average market price of $25, the treasury stock method adds 20,000 shares, giving 1,070,000 shares and diluted EPS of $1.03.
Common mistakes
- Using year-end shares instead of a time-weighted average.
- Adding antidilutive securities, which are excluded.
Sources
- FASB ASC 260-10, Earnings Per Share, Overall (scope, basic and diluted computation, treasury stock and if-converted methods)
- Deloitte DART, Roadmap: Earnings per Share (dart.deloitte.com/USDART/home/codification/presentation/asc260-10/roadmap-earnings-per-share)
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error