Corporate Accounting and Auditing · Earnings per Share (Ind AS 33)

Diluted EPS and Potential Ordinary Shares (Ind AS 33)

Updated 10 October 2026 · Fact-checked

Diluted EPS shows earnings per share if all dilutive potential ordinary shares were converted. Add back post-tax interest or preference dividend to profit, add the extra shares to the denominator, and include an instrument only if it lowers EPS. Test instruments from lowest to highest incremental EPS.

Understand Diluted EPS and Potential Ordinary Shares

Basic EPS uses only shares already issued. But a company may have instruments that can become equity shares later: convertible debentures, convertible preference shares, share options, warrants, and shares issuable on conditions. These are potential ordinary shares. If they convert, existing shareholders own a smaller slice of profit. Diluted EPS warns them about this.

The idea is simple. Assume the conversion has happened. Profit rises because the interest or preference dividend on that instrument is no longer paid. Shares also rise. So you change both the numerator and the denominator.

Options and warrants work differently. They bring in cash at the exercise price. Ind AS 33 assumes that cash buys shares at the average market price. Only the extra shares, issued for no consideration, enter the denominator. This is the treasury stock method. If the exercise price is above the average market price, the options are not dilutive and you ignore them.

Contingently issuable shares are issued only if a condition is met, such as a profit target. Include them only if the condition would be met had the end of the reporting period been the end of the contingency period.

Only dilutive instruments count. An instrument that would increase EPS (or reduce loss per share) is anti-dilutive and is left out. With several instruments, rank them by earnings per incremental share, lowest first, and stop when diluted EPS starts to rise.

Key rules to remember

Diluted EPS: Diluted EPS = (Profit attributable to equity holders + adjustments) ÷ (Weighted average equity shares + dilutive potential shares); The profit is after preference dividend on non-convertible preference shares. Apply the same weighted average logic as in basic EPS.
Numerator adjustment for convertible debentures: Add back: Interest × (1 − tax rate); Also add back any other income or expense that would change on conversion, such as amortisation of issue cost, net of tax.
Convertible preference shares: Add back: Preference dividend on the convertible shares; Add back the dividend on the convertible preference shares that was deducted to arrive at profit for basic EPS, together with any related tax effect. Where the dividend is not tax-deductible, no tax adjustment arises.
Treasury stock method for options and warrants: Incremental shares = N × (Average market price − Exercise price) ÷ Average market price; N is the number of shares under option. Use only when average market price is above the exercise price. There is no numerator adjustment.
Incremental EPS (for ranking): Incremental EPS = Numerator adjustment ÷ Incremental shares; Rank from lowest to highest. Options and warrants with no earnings effect have zero and come first.
Dilution test: Include the instrument only if it reduces EPS (or increases loss per share) from continuing operations; The test uses profit from continuing operations attributable to the parent's equity holders as the control figure.
Timing of conversion: Assume conversion at the start of the period, or the date of issue of the instrument if later; If issued during the year, weight the shares for the part of the year the instrument existed.

How to solve Diluted EPS and Potential Ordinary Shares questions

Use this order for any diluted EPS question. Do basic EPS first, because every dilution test compares against it.

1Compute basic EPS: profit attributable to equity holders less preference dividend, divided by the weighted average equity shares.
2List every potential ordinary share: convertible debentures, convertible preference shares, options, warrants, contingent shares.
3For each one, find the numerator adjustment (post-tax interest or preference dividend) and the incremental shares. For options use the treasury stock method; skip them if the exercise price is above the average market price.
4Weight the shares if the instrument was issued during the year. Otherwise assume conversion at the start of the year.
5Compute incremental EPS for each and rank from lowest to highest.
6Add the instruments one at a time in that order. After each, recompute EPS. Keep the instrument only if EPS falls.
7Stop at the first instrument that raises EPS. All later instruments are also left out because they have higher incremental EPS.
8State diluted EPS to two decimals and say which instruments were treated as anti-dilutive.

Quickest way: Ranking table method

When to use it: Use when the question has two or more potential share instruments and you must decide which are dilutive.

Draw columns: Instrument, Earnings adjustment, Incremental shares, Incremental EPS.
Fill the options row first. Its earnings adjustment is nil, so its incremental EPS is 0.
Sort the rows by incremental EPS, lowest first.
Start from basic profit and basic shares. Add one row at a time and divide.
Drop any row where the new EPS is higher than the previous line. Your last falling EPS is the answer.

Common mistakes in Diluted EPS and Potential Ordinary Shares

Adding back full interest instead of post-tax interest on convertible debentures.
Students remember to add back interest but forget that the tax saving is lost on conversion.
Fix: Always compute Interest × (1 − tax rate). Check whether the question gives the tax rate.
Adding the total number of options to the denominator.
Students treat options like convertible debentures, which issue shares for the full conversion.
Fix: Use the treasury stock method. Only the shares issued for no consideration are incremental: N × (Average price − Exercise price) ÷ Average price.
Including options whose exercise price is above the average market price.
Students skip the check and apply the formula, getting a negative number or an anti-dilutive result.
Fix: Compare exercise price with average market price first. If exercise price is higher, the options have no dilutive effect.
Testing each instrument only against basic EPS and not in sequence.
An instrument may look dilutive alone but become anti-dilutive after more dilutive ones are included.
Fix: Rank by incremental EPS and recompute diluted EPS cumulatively. Drop the instrument if the cumulative EPS rises.
Using the full year's shares for an instrument issued mid-year.
Students forget that potential shares are weighted from the date of issue.
Fix: Weight the incremental shares by months outstanding ÷ 12. Use the start of the year only for instruments issued earlier.
Showing diluted EPS higher than basic EPS.
Anti-dilutive items were included by mistake.
Fix: Anti-dilutive instruments are excluded, so diluted EPS from continuing operations is normally not higher than basic EPS from continuing operations. If your answer is higher, check whether you included an anti-dilutive instrument.

Worked examples

Example 1

Bharat Textiles Ltd has net profit of ₹12,00,000 for the year, all attributable to equity holders. It had 2,00,000 equity shares throughout the year. It also has ₹10,00,000 of 10% convertible debentures issued in an earlier year, convertible into 50,000 equity shares. The tax rate is 25%. Compute basic and diluted EPS.

Show the solution

Basic EPS = ₹12,00,000 ÷ 2,00,000 = ₹6.00.
Interest on debentures = 10% × ₹10,00,000 = ₹1,00,000.
Post-tax interest = ₹1,00,000 × (1 − 0.25) = ₹75,000.
Incremental EPS = ₹75,000 ÷ 50,000 = ₹1.50. This is below basic EPS of ₹6.00, so the debentures are dilutive.
Adjusted profit = ₹12,00,000 + ₹75,000 = ₹12,75,000.
Adjusted shares = 2,00,000 + 50,000 = 2,50,000.
Diluted EPS = ₹12,75,000 ÷ 2,50,000 = ₹5.10.

Answer: Basic EPS is ₹6.00 and diluted EPS is ₹5.10.

Example 2

Kaveri Industries Ltd has profit attributable to equity holders of ₹10,00,000 and 1,00,000 equity shares throughout the year. It has: (a) 20,000 share options with exercise price ₹60; average market price during the year is ₹80; (b) convertible preference shares carrying dividend of ₹50,000 (already deducted in arriving at the profit), convertible into 20,000 equity shares; (c) convertible debentures with post-tax interest of ₹1,20,000, convertible into 10,000 equity shares. Compute basic and diluted EPS.

Show the solution

Basic EPS = ₹10,00,000 ÷ 1,00,000 = ₹10.00.
Options: incremental shares = 20,000 × (80 − 60) ÷ 80 = 5,000. Earnings adjustment is nil, so incremental EPS = 0.
Preference shares: incremental EPS = ₹50,000 ÷ 20,000 = ₹2.50.
Debentures: incremental EPS = ₹1,20,000 ÷ 10,000 = ₹12.00.
Ranking, lowest first: options (0), preference shares (2.50), debentures (12.00).
Add options: ₹10,00,000 ÷ (1,00,000 + 5,000) = ₹10,00,000 ÷ 1,05,000 = ₹9.52. EPS falls, so keep.
Add preference shares: (₹10,00,000 + ₹50,000) ÷ (1,05,000 + 20,000) = ₹10,50,000 ÷ 1,25,000 = ₹8.40. EPS falls, so keep.
Add debentures: (₹10,50,000 + ₹1,20,000) ÷ (1,25,000 + 10,000) = ₹11,70,000 ÷ 1,35,000 = ₹8.67. EPS rises above ₹8.40, so the debentures are anti-dilutive. Exclude them.

Answer: Basic EPS is ₹10.00. Diluted EPS is ₹8.40. The options and convertible preference shares are dilutive; the convertible debentures are anti-dilutive and ignored.

Exam tips

Always write basic EPS first. Examiners give marks for it, and you need it for the dilution test.
In a multi-instrument question, show the ranking table. Step marks are given for incremental EPS and for the cumulative test.
State the tax rate treatment and the assumption of conversion at the start of the year in one line each. These are easy marks.
For MCQs, check three traps quickly: post-tax interest, treasury stock method for options, and anti-dilution. Most wrong options are built on these.
Write a final line naming which instruments were anti-dilutive and why. It shows the examiner you know the rule.

Practice questions from Earnings per Share (Ind AS 33)

Diluted EPS and Potential Ordinary Shares in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Diluted EPS and Potential Ordinary Shares: frequently asked questions

How do I calculate diluted EPS with convertible debentures?

Add post-tax interest on the debentures to the profit. Add the shares that would be issued on conversion to the weighted average shares. Include them only if the incremental EPS is below the basic EPS.

How does the treasury stock method work for options and warrants?

Assume the options are exercised and the cash received buys shares at the average market price. The extra shares are N × (Average price − Exercise price) ÷ Average price. These go into the denominator and the profit does not change.

What is an anti-dilutive potential ordinary share?

It is one whose inclusion would increase EPS or reduce loss per share. You leave it out of diluted EPS. Ind AS 33 tests potential shares in sequence from the most dilutive (lowest earnings per incremental share) to the least dilutive.

Can diluted EPS be more than basic EPS?

Normally not. Anti-dilutive instruments are excluded, so diluted EPS from continuing operations is normally not higher than basic EPS from continuing operations. If your answer is higher, recheck your ranking and tests.