Earnings Per Share (EPS): Formula, Basic vs. Diluted, Example

What Is Earnings Per Share (EPS)?

Earnings per share (EPS) is the portion of a company’s net income allocated to each share of common stock. Basic EPS equals net income minus preferred dividends, divided by the weighted-average common shares outstanding. Diluted EPS adds shares from convertible securities, options, and warrants, but only when they lower EPS. Public companies report EPS under FASB ASC 260.

Quick example: A company reports net income of $500,000, pays $50,000 in preferred dividends, and has a weighted average of 100,000 common shares outstanding. Its basic EPS is ($500,000 − $50,000) ÷ 100,000 = $4.50 per share.

Below, you’ll learn how to calculate basic and diluted EPS step by step, how to handle stock splits, convertible securities, and stock options, and which mistakes students make most often. Prefer video? Professor Farhat walks through a full basic EPS example in the lesson below.

Who Has to Report EPS?

EPS reporting is governed by FASB ASC Topic 260, Earnings Per Share. (New to the Codification? See our guide to FASB Codification.) It applies to companies whose common stock, or securities that can become common stock, trade in a public market, plus companies in the process of going public. Private companies don’t have to report EPS.

Simple capital structure: a company with only common stock, and nothing that could become common stock, reports basic EPS only.
Complex capital structure: a company with convertible bonds, convertible preferred stock, stock options, or warrants reports both basic and diluted EPS, with equal prominence, on the face of the income statement.
What gets reported: EPS for income from continuing operations and for net income. EPS for discontinued operations can go on the face of the income statement or in the notes.

Companies that follow IFRS use IAS 33, Earnings per Share, which works much the same way.

On the CPA exam, EPS is tested in FAR. The AICPA CPA Exam Blueprints list calculating basic and diluted EPS under Area I, Public Company Reporting Topics. CMA candidates also use EPS in Part 2, where it feeds ratios like the price/earnings ratio and the dividend payout ratio.

How Do You Calculate Basic EPS?

The basic formula for calculating EPS is:

Basic EPS = (Net income − Preferred dividends) ÷ Weighted-average common shares outstanding

The top part of the formula (net income minus preferred dividends) is called income available to common shareholders.

Net Income: This is the total profit of the company after all expenses, taxes, and costs have been subtracted from total revenue. It’s also referred to as the bottom line or net earnings. Net income provides a straightforward insight into the overall profitability of the company over a specific period, typically a fiscal quarter or year. If the company has a noncontrolling interest (outside owners of a subsidiary), use net income attributable to the parent company’s shareholders, not total consolidated net income.
Preferred Dividends: Preferred shareholders get paid before common shareholders, so their share of earnings comes out first. What’s left is income available to common shareholders, which is what EPS measures. The amount you subtract depends on the type of preferred stock:
- Cumulative preferred stock: subtract the current year’s dividend whether or not the board declared it. Dividends in arrears from earlier years are not subtracted again.
- Noncumulative preferred stock: subtract only the dividends actually declared during the year.
If the company has no preferred stock, skip this step.
Weighted-Average Common Shares Outstanding: This is the average number of common shares held by investors during the period, weighted by how long each share was outstanding. Shares issued during the year count only from the issue date. Shares the company buys back (treasury stock) stop counting on the repurchase date, and treasury shares are never included. Stock splits and stock dividends work differently: they are treated as if they happened at the start of the year, and prior periods shown are restated too, because they change the number of shares without bringing in any new money.

Video Lesson: Calculating Basic Earnings Per Share

Professor Farhat explains basic EPS with a worked example, including preferred dividends and weighted-average common shares outstanding. Review this calculation before comparing basic and diluted EPS below.

Jump to a section of this 16-minute lesson:

Example: Weighted-Average Shares and Basic EPS

Cedar Co. starts the year with 100,000 common shares. On April 1, it issues 20,000 new shares for cash. On July 1, it distributes a 10% stock dividend. On October 1, it buys back 6,000 shares as treasury stock. Net income is $400,000, and the company declared $25,000 of dividends on its noncumulative preferred stock.

The stock dividend is applied to the share counts before July 1 as well, as if it had happened on January 1.

Period	Shares outstanding	Stock dividend adjustment	Fraction of year	Weighted shares
Jan 1 to Mar 31	100,000	× 1.10	3/12	27,500
Apr 1 to Jun 30	120,000	× 1.10	3/12	33,000
Jul 1 to Sep 30	132,000	none	3/12	33,000
Oct 1 to Dec 31	126,000	none	3/12	31,500
Total				125,000

Basic EPS = ($400,000 − $25,000) ÷ 125,000 = $375,000 ÷ 125,000 = $3.00 per share

Basic EPS vs. Diluted EPS: What’s the Difference?

When evaluating a company’s earnings per share (EPS), investors often look at two key figures: Basic EPS and Diluted EPS. Both metrics offer insight into the company’s profitability, but they do so from slightly different perspectives. Understanding the distinction between the two is crucial for investors, as it can significantly impact the perceived value of a company.

Basic EPS: Calculates earnings per share without considering potential dilution from convertible securities.
Diluted EPS: Shows what EPS would be if every dilutive potential common share became common stock. Potential common shares are securities that could turn into common stock, such as convertible bonds, convertible preferred stock, stock options, and warrants. Dilutive means including the security lowers EPS. Securities that would raise EPS are called antidilutive, and they are left out.

Diluted EPS = (Net income − Preferred dividends + Adjustments for dilutive securities) ÷ (Weighted-average common shares + Incremental shares from dilutive securities)

The adjustments add back what the company would no longer pay if the securities were converted: after-tax interest on convertible bonds, and dividends on convertible preferred stock.

How the extra shares are counted: ASC 260 uses two main methods.

If-converted method (convertible bonds and convertible preferred stock): assume conversion at the start of the year, or on the issue date if later. Add the new common shares to the denominator, then add back the after-tax bond interest or the preferred dividends to the numerator.
Treasury stock method (stock options and warrants): assume the options are exercised and the cash received is used to buy back shares at the average market price for the period. Only the net new shares go into the denominator. Options count only when the average market price is higher than the exercise price.

Use income from continuing operations available to common shareholders as the control number for the antidilution test. Rank potential common shares from most dilutive to least dilutive using incremental earnings per incremental share, then test them sequentially. Exclude a security if it increases EPS from continuing operations or reduces a loss per share. Use the same included securities to calculate diluted EPS for net income and discontinued operations; do not retest those components independently.

Example: How Stock Options Affect Diluted EPS

Back to Cedar Co. Suppose employees hold fully vested options to buy 10,000 shares at $20 per share, outstanding all year, and the average market price for the year is $25. The option count, exercise price, and average market price are stated on a basis adjusted for the stock dividend. Assume there is no unrecognized compensation cost or other additional assumed proceeds.

Cash from exercise: 10,000 × $20 = $200,000
Shares the company could buy back: $200,000 ÷ $25 = 8,000
Net new shares: 10,000 − 8,000 = 2,000

Diluted EPS = $375,000 ÷ (125,000 + 2,000) = $375,000 ÷ 127,000 = $2.95 per share

That’s lower than basic EPS of $3.00, so the options are dilutive and get included. If the average market price had been $20 or less, the options would add no net shares and would be left out.

Interpretation: Diluted EPS reflects potential common shares that pass the continuing-operations dilution test. It is a calculation based on specified assumptions, rather than a forecast of actual conversions. In the examples here, all income is from continuing operations. When continuing operations available to common shareholders shows a loss, potential common shares that reduce that loss per share are antidilutive and are excluded.

For additional instruction and practice, explore the Intermediate Accounting course.

Worked Example: Basic and Diluted EPS Step by Step

Here’s a full example that pulls everything together, including the antidilution test that trips up so many CPA candidates.

The Facts

Net income: $1,200,000
Preferred stock: 100,000 shares of cumulative, convertible preferred stock. The annual dividend is $200,000, and each preferred share converts into 2 common shares (200,000 common shares in total).
Common shares outstanding on January 1: 800,000
Stock split: 2-for-1 in the middle of the year
Stock dividend: 10%, issued at the end of the year
Convertible bonds: $1,000,000 face value, 5% interest, issued at face value and outstanding all year, convertible into 100,000 common shares
Income tax rate: 30%
The conversion terms above already reflect the stock split and stock dividend.

Step 1: Find the Weighted-Average Common Shares

Stock splits and stock dividends are applied retroactively, as if they happened on January 1. No shares were issued or bought back for cash this year, so:

800,000 × 2 × 1.10 = 1,760,000 weighted-average common shares

Step 2: Calculate Basic EPS

The preferred stock is cumulative, so subtract the full $200,000 dividend for the year:

Basic EPS = ($1,200,000 − $200,000) ÷ 1,760,000 = $1,000,000 ÷ 1,760,000 = $0.568 per share

Step 3: Rank Each Convertible Security by Its Per-Share Effect

For each security, divide what you would add to the numerator by the shares you would add to the denominator. The lower the result, the more dilutive the security.

Security	Add to numerator	Add to denominator	Effect per share
Convertible bonds	$50,000 interest × (1 − 30%) = $35,000	100,000 shares	$0.35
Convertible preferred stock	$200,000 preferred dividends	200,000 shares	$1.00

The bonds are the most dilutive, so they go first.

Step 4: Add Securities One at a Time and Test for Antidilution

Start with basic EPS: $1,000,000 ÷ 1,760,000 = $0.568
Add the bonds: ($1,000,000 + $35,000) ÷ (1,760,000 + 100,000) = $1,035,000 ÷ 1,860,000 = $0.556. EPS went down, so the bonds are dilutive. Keep them.
Add the preferred stock: ($1,035,000 + $200,000) ÷ (1,860,000 + 200,000) = $1,235,000 ÷ 2,060,000 = $0.600. EPS went up, so the preferred stock is antidilutive. Leave it out.

The Answer

Basic EPS: $0.568 per share (reported as $0.57)
Diluted EPS: $0.556 per share (reported as $0.56)

Why is the preferred stock left out? Its per-share effect ($1.00) is higher than EPS after adding the bonds ($0.556). Including it would make EPS look better, not worse, so the preferred stock fails the dilution test in this example.

Watch out for this trap: if you add the 200,000 preferred shares to the denominator but forget to add the $200,000 of preferred dividends back to the numerator, you get $1,035,000 ÷ 2,060,000 = $0.502. That answer mixes two assumptions that don’t fit together, and it’s one of the most common EPS mistakes.

Common EPS Mistakes on the CPA Exam

These are the errors students make most often:

Weighting a stock split or stock dividend from its date instead of applying it retroactively to the whole year.
Subtracting noncumulative preferred dividends that were never declared, or forgetting to subtract cumulative preferred dividends that weren’t declared.
Adding convertible preferred shares to the denominator without adding the preferred dividends back to the numerator.
Adding back the full bond interest instead of the after-tax amount.
Including securities that fail the continuing-operations antidilution test.
Counting treasury shares as outstanding.
Using total consolidated net income instead of net income attributable to the parent.

Quick Check

A company has net income of $900,000 and 300,000 weighted-average common shares. It also has 50,000 shares of noncumulative preferred stock with a $2 annual dividend, but the board did not declare a preferred dividend this year. What is basic EPS?

Answer: $3.00. The preferred stock is noncumulative and no dividend was declared, so nothing is subtracted: $900,000 ÷ 300,000 = $3.00. If the preferred stock were cumulative, you would subtract $100,000 (50,000 × $2), and basic EPS would be $800,000 ÷ 300,000 = $2.67.

Ready to practice? Work through basic EPS, the weighted-average shares exercise, and a CPA exam simulation on diluted EPS. For EPS alongside the P/E ratio and dividend yield, see this lesson. New here? Try the free sample course.

How Should Investors Interpret EPS?

EPS connects earnings available to common shareholders with the share count. Evaluate its trend alongside revenue, net income, cash flows, and changes in shares outstanding. A share repurchase can increase EPS even when total earnings remain unchanged; issuing shares can reduce EPS if earnings do not increase proportionately.

Raw EPS amounts are not directly comparable across companies with different share counts. The price/earnings ratio relates share price to EPS, but neither a high EPS nor a low P/E ratio establishes that a stock is attractive. Consider growth expectations, risk, industry conditions, and the quality of earnings.

What Are the Limitations of EPS?

EPS measures accrual earnings rather than cash flow. A profitable company may still have cash shortages. EPS reflects interest expense and the share count, but it does not separately measure financing risk, liquidity, or how efficiently assets generate income.

Accounting estimates and permitted policy differences can affect earnings. Revenue recognition and the capitalization or expensing of costs must comply with applicable accounting standards; management cannot freely select a treatment simply to increase EPS. Compare accounting policies, unusual transactions, and disclosures before drawing conclusions.

What Is Adjusted EPS?

Adjusted EPS is a non-GAAP performance measure with no single standardized calculation. Companies may exclude items such as restructuring charges, acquisition-related amortization, asset-sale gains, or stock-based compensation. Review each adjustment and its consistency over time; an expense described as unusual may recur.

Adding back stock-based compensation increases adjusted earnings, but does not eliminate the potential dilution from equity awards. The adjusted earnings numerator and the diluted share denominator remain separate considerations.

Compare adjusted EPS with GAAP EPS and examine the reconciliation. SEC Regulation G requires reconciliation to the most directly comparable GAAP measure, subject to applicable exceptions. SEC filings and earnings releases subject to Item 10(e) also require equal or greater prominence for the comparable GAAP measure. See the SEC guidance on non-GAAP financial measures.

How Does EPS Relate to Dividends?

For positive earnings, dividends per common share divided by EPS gives the dividend payout ratio. For example, dividends of $1 per share and EPS of $4 produce a 25% payout ratio. A ratio based on zero or negative EPS is not a useful conventional measure of dividend coverage.

Dividend sustainability also depends on operating cash flows, cash balances, debt covenants, legal restrictions, and investment needs. Higher EPS alone does not establish that cash is available for dividends, and retained earnings is an equity balance rather than a cash reserve.

Key Takeaways

EPS equals income available to common shareholders divided by weighted-average common shares outstanding.
Subtract the current year’s cumulative preferred dividends whether or not they were declared; subtract noncumulative preferred dividends only if declared.
Stock splits and stock dividends are applied retroactively. Share issuances and buybacks are weighted by time outstanding.
Diluted EPS includes only dilutive securities, using the if-converted method for convertibles and the treasury stock method for options and warrants.
Diluted EPS from continuing operations cannot exceed the corresponding basic EPS; the continuing-operations control number determines which securities are included for all reported EPS components.
Public companies report EPS under FASB ASC 260 (IAS 33 under IFRS). Adjusted EPS is a non-GAAP measure.

Frequently Asked Questions About EPS

What is a good EPS?

There’s no single EPS number that counts as good, because EPS depends on how many shares a company has issued. What matters more is whether EPS is growing over time and how it compares with the stock price, which is what the price/earnings (P/E) ratio measures.

Can EPS be negative?

Yes. A loss available to common shareholders produces negative EPS, or loss per share. Income from continuing operations available to common shareholders controls the dilution test. Potential common shares that reduce a continuing-operations loss per share are excluded; a net loss caused by discontinued operations does not by itself determine which securities are included.

Why is diluted EPS lower than basic EPS?

Diluted EPS includes potential common shares only when they pass the continuing-operations dilution test. Options generally increase only the denominator under the treasury stock method. Convertible bonds and preferred stock may increase both the numerator and denominator through interest or dividend addbacks and additional shares. Diluted EPS from continuing operations is equal to or lower than the corresponding basic EPS.

Do you subtract preferred dividends that were not declared?

Only for cumulative preferred stock. Subtract the current year’s cumulative preferred dividend whether or not the board declared it. For noncumulative preferred stock, subtract only the dividends actually declared during the year.

Is EPS tested on the CPA exam?

Yes. EPS is tested in the FAR section. The AICPA blueprint lists calculating basic and diluted EPS under Area I, Public Company Reporting Topics, so be ready to calculate both.

About the Author

Mansour Farhat, CPA, CIA, DBA, teaches the video lectures on Farhat Lectures, which offers interactive exercises, simulations, cases, and multiple-choice practice for CPA, CMA, and EA candidates and accounting students. You can connect with Professor Farhat on LinkedIn.