How do you calculate basic and diluted EPS for a complex capital structure? In this intermediate accounting lecture, Professor Farhat works through a comprehensive earnings per share example for a company with convertible bonds, convertible preferred stock, and stock options, demonstrating the ranking method used to test dilutive securities in sequence. Essential FAR exam material for CPA candidates and accounting students.

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Video Timeline & Key Concepts:
0:00 — Introduction
1:01 — Identifying potentially dilutive securities
2:42 — Computing basic EPS
4:30 — The ranking method for dilutive securities
6:14 — Testing options and convertible bonds
16:05 — Sequencing and testing convertible preferred stock
23:53 — Final basic and diluted EPS

Frequently Asked Questions:

How is basic EPS calculated?

Basic EPS equals net income minus preferred dividends, divided by the weighted average number of common shares outstanding. For this example, basic EPS is 3.00 dollars per share.

What is the ranking method for diluted EPS?

When multiple dilutive securities exist, you rank them by their individual per-share effect from smallest to largest, then add them one at a time to make sure each one continues to reduce EPS.

What makes a security anti-dilutive?

A security is anti-dilutive if including it would increase EPS rather than decrease it. Such securities are excluded from diluted EPS, which is why testing stops when a security no longer lowers EPS.

What was the final result in the example?

After testing, the options and both convertible bonds were dilutive while the convertible preferred stock was not, resulting in a diluted EPS of 2.47 dollars versus a basic EPS of 3.00 dollars.

Is this tested on the CPA exam?

Yes. Earnings per share is heavily tested in the FAR section as part of intermediate accounting.

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