Although primary earnings per share (EPS) is less than simple EPS, and fully diluted EPS is less than primary EPS, additional testing must be done to assure that maximum dilution has occurred. Anti-dilutive securities should be excluded from calculations.
The only potentially anti-dilutive securities that influence the calculation of primary EPS are bonds.
The interest savings per issuable common share are $1.04, which was found by dividing the total savings ($62,400) by the number of issuable shares (60,000). This result is far below primary EPS without it ($1.68).
The second number above was found by dividing the earnings adjusted for preferred dividends ($2,005,000) by 1,191,726 (the number of outstanding shares plus the net number issuable from warrants). Thus, the bonds are dilutive for primary EPS.
Fully Diluted EPS
The identification of anti-dilutive effects in fully diluted EPS is more complicated than in primary EPS because there are three factors to consider:
- Preferred stock
- Contingent issuance agreement
The first phase is to calculate the additional earnings per issuable share of each of them. These results are shown below.
The EPS result before considering these factors is $1.68, which is found by dividing the adjusted reported income by the number of outstanding shares plus shares issuable from the warrants (1,194,117), as shown in the example below.
Thus, none of the three is obviously anti-dilutive and the next phase must be performed.
At this stage, each security is included in the calculation in order of most to least dilutive. The first step includes the bonds.
The numerator equals the $2,005,000 seen above plus $62,400 of interest savings. The denominator is the 1,194,117 seen above plus 60,000 shares. The result is $1.65 per share, as shown in the second column of the above example.
At the next step, the preferred dividends saving per share ($1.13) is seen to be dilutive of the $1.65 EPS from step 1. Thus, it should be included.
The calculations are shown in the third column of the above example. The numerator is not adjusted for preferred dividends paid and the denominator is increased by the 150,000 shares of common that would be issued. The result is $1.59 per share.
The third step is the comparison of this result with the additional EPS provided by the contingent agreement ($1.65).
Since its effect per share is greater than $1.59, the agreement is anti-dilutive and it should be omitted. As confirmation, observe that the $1.59 is lower than the preliminary result of $1.60 seen in the above example.
Before determining what EPS disclosures are to be provided, these preliminary results must be tested for the materiality of the dilution.
The test shows that fully diluted EPS ($1.59) is only 93% of simple EPS ($1.71). Therefore, in this case, the company in question must report both primary and fully diluted EPS.