How do you calculate basic and dilutive earnings per share? This CPA Exam (FAR) simulation walks accounting students and intermediate accounting learners through computing basic and diluted EPS for a company with a complex capital structure that includes convertible bonds. Professor Farhat shows the numerator and denominator adjustments and how to prorate when bonds are issued mid-year.

Try it free at farhatlectures.com — interactive exercises, lectures, simulations, cases, multiple choice, and AI tools for CPA, CMA, EA and students.

Video Timeline & Key Concepts:
0:00 — Introduction
0:35 — Complex capital structures and when to report dilutive EPS
2:41 — Example: convertible bonds outstanding the full year
3:36 — Basic EPS calculation
4:42 — Numerator adjustment: add back interest expense net of tax
6:03 — Denominator adjustment: add potential converted shares
6:35 — Bonds issued during the year: prorating interest and shares

Frequently Asked Questions:

Q: What is the difference between basic and diluted EPS?

A: Basic EPS divides net income available to common shareholders by the weighted average common shares outstanding, while diluted EPS additionally assumes potentially dilutive securities such as convertible bonds are converted into common stock.

Q: How do you calculate basic EPS?

A: Basic EPS equals net income after tax divided by the weighted average number of common shares outstanding during the period.

Q: Why is interest added back net of tax in diluted EPS?

A: If convertible bonds are assumed converted, the company would no longer pay that interest, so the after-tax interest expense is added back to the numerator to reflect the higher income available to common shares.

Q: How do you adjust the denominator for diluted EPS?

A: You add the additional common shares that would be created if the convertible bonds were converted into stock.

Q: How are convertible bonds handled when issued mid-year?

A: Both the interest expense added back and the potential shares added to the denominator are prorated for the portion of the year the bonds were outstanding.

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