Diluted earnings per share (EPS) CPA Exam simulation for the FAR section: this lecture walks a full diluted EPS calculation using the "what-if" approach, testing convertible bonds, convertible preferred stock, options, and warrants for dilutive vs. anti-dilutive effect. Built for CPA candidates practicing dilutive securities simulations and for intermediate accounting students and practitioners who need to compute a conservative, worst-case EPS.

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Video Timeline & Key Concepts:
0:00 Introduction to diluted EPS as a conservative, worst-case earnings measure
0:48 Purpose of diluted EPS: potential shares from bonds, preferred stock, options, and warrants
2:03 The "what-if" method: testing each security as dilutive or anti-dilutive
7:07 Computing basic EPS as the starting point (net income less preferred dividends / weighted average shares)
8:06 Analyzing convertible bonds: adding back after-tax interest and new shares
10:54 Analyzing convertible preferred stock and identifying an anti-dilutive result
13:44 Final diluted EPS including only dilutive securities

Frequently Asked Questions:

How is diluted EPS calculated?

Diluted EPS starts from basic EPS, then adjusts the numerator and denominator for each dilutive security. For convertible bonds you add back the after-tax interest saved and add the shares that would be issued on conversion; for convertible preferred you add back the preferred dividends and the new shares. Only securities that reduce EPS are included.

What is the difference between dilutive and anti-dilutive securities?

A dilutive security lowers EPS when converted, while an anti-dilutive security would raise it. Anti-dilutive securities are excluded from the diluted EPS calculation because including them would overstate earnings per share and violate the conservatism principle.

Why is interest expense adjusted net of tax for convertible bonds?

If bonds were converted to stock, the company would no longer pay that interest, but it would also lose the related tax deduction. Adding back the interest net of tax reflects the true increase in income available to common shareholders after the tax effect.

Why can convertible preferred stock be anti-dilutive?

When the preferred dividends added back to the numerator are large relative to the new common shares added to the denominator, the resulting ratio can be higher than basic EPS. In that case the security increases EPS, so it is anti-dilutive and left out of the final figure.

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