Liabilities and equity
The EPS Engine
Basic is income minus preferred dividends over weighted shares; diluted adds each security only if it dilutes, most dilutive first.
How the exam words it
- -The stem asks 'what is diluted EPS?' and points you to the treasury stock method or convertible securities.
- -Cumulative preferred stock is outstanding and it asks 'what amount of preferred dividends is deducted' from the numerator.
- -Options are outstanding and it asks 'what incremental shares are added to the diluted EPS denominator?'.
- -Multiple dilutive securities exist and it asks 'in what order should these be included'.
The playbook
- 1Basic EPS = (net income - preferred dividends) / weighted-average shares, deducting the current year's cumulative preferred dividend whether or not declared.
- 2Weight shares by months outstanding, and apply splits and stock dividends retroactively to the start of every period presented.
- 3Options use the treasury stock method: incremental shares = options x (1 - exercise price / average market price); convertibles use if-converted with an after-tax interest add-back.
- 4Rank securities by incremental EPS, add the most dilutive first, and drop anything that would push EPS back up (antidilutive).
The trap
Skipping the preferred dividend deduction because nothing was declared. Cumulative preferred dividends reduce the basic EPS numerator whether or not declared.
How the exam varies it
The same pattern, re-skinned along these axes:
Basic versus dilutedOptions (treasury stock method) versus convertibles (if-converted)Weighted-share mechanics versus the antidilution screen and ordering
Drill this pattern
8 questions of The EPS Engine from across the AUD topics. Clear it by getting 5 right with a streak of 3.