Calculate diluted earnings per share using the if-converted method. Professor Farhat works through convertible bonds and convertible preferred stock, including a midyear issue, after-tax interest, cumulative dividends and an antidilution check.

For intermediate accounting students and CPA FAR and CMA candidates. Start with basic EPS, then adjust the income available to common shareholders and weighted-average common shares for qualifying assumed conversions.

HOW DOES THE IF-CONVERTED METHOD WORK?
Assume conversion at the start of the period or the issue date, if later. Add the potential common shares for the relevant period. For the bonds in this example, add back interest × (1 − tax rate). For preferred shares, reverse the applicable preferred-dividend deduction. This dividend adjustment does not increase the company’s net income.

CONVERTIBLE BONDS: CHECK YOUR ANSWER
• Basic EPS: $400,000 ÷ 1,000,000 = $0.40.
• January 1 bond: $1,000,000 × 6% × 79% = $47,400 after-tax interest; add 300,000 shares.
• April 1 bond: $1,000,000 × 10% × 9/12 × 79% = $59,250; add 400,000 × 9/12 = 300,000 shares.
• Diluted EPS: ($400,000 + $47,400 + $59,250) ÷ 1,600,000 = $0.31665625, or $0.32 rounded.
The 21% tax rate is an example assumption. Study corrections: basic EPS is $0.40, not the spoken $0.30; the second add-back is $59,250. The final bond calculation is DILUTED EPS despite its “Basic EPS” slide label.

CONVERTIBLE PREFERRED STOCK: CHECK YOUR ANSWER
The slide uses $1,500,000 net income and 750,000 common shares.
• Current cumulative dividend: 40,000 × $50 × 10% = $200,000.
• Basic EPS: ($1,500,000 − $200,000) ÷ 750,000 = $1.73 rounded.
• Ten-for-one conversion: $1,500,000 ÷ (750,000 + 400,000) = $1.30 rounded.
• Two-for-one conversion: $1,500,000 ÷ (750,000 + 80,000) = $1.81 rounded. Exclude this antidilutive conversion; in this isolated case, diluted EPS remains $1.73.

DO YOU OMIT DILUTED EPS WHEN IT EQUALS BASIC EPS?
No. Exclude antidilutive conversion effects from the calculation; do not simply omit required diluted-EPS presentation. Required basic and diluted amounts can be equal. Multiple instruments require a sequential dilution assessment, using income from continuing operations available to common shareholders as the control number. This video illustrates straightforward convertible instruments; treasury-stock calculations are a separate lesson.
ASC 260 presentation: https://dart.deloitte.com/USDART/home/codification/presentation/asc260-10/roadmap-earnings-per-share/chapter-9-presentation-disclosure/9-1-presentation
If-converted guidance: https://storage.fasb.org/ASU_2020-06.pdf

CHAPTERS
00:00 Basic EPS versus diluted EPS
00:27 Complex capital structures and potential shares
01:16 Start with basic EPS
01:53 Dilution and antidilution
02:10 If-converted versus treasury stock methods
02:29 Assumed conversion date and after-tax interest
03:25 Supplemental accounting study resources
04:26 Two convertible bonds: example facts
05:09 Basic EPS and denominator adjustments
06:04 Prorate the April 1 issue for nine months
07:05 Adjust the numerator for interest
08:49 After-tax interest formula
09:24 Second bond and final diluted EPS
10:29 Convertible preferred stock example
11:07 Deduct cumulative preferred dividends
12:03 Ten-for-one conversion and diluted EPS
13:08 Two-for-one conversion: antidilutive result
13:56 Further practice

CONTINUE LEARNING
Diluted EPS lessons: https://www.youtube.com/playlist?list=PLTFh9BwapNJ4
Basic and diluted EPS course: https://www.youtube.com/playlist?list=PLxP0KZzCGFYNkazWT9pnjUXBSVqGQBm2P
Additional practice: https://farhatlectures.com

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