AS 20 – Diluted EPS: Convertible Preference Shares

## Diluted EPS — Convertible Preference Shares

### Why Convertible Preference Shares Are Potential Equity Shares (PES)

Convertible preference shares can be exchanged for equity shares at a pre-agreed ratio. Because they may become equity shares in the future, they are classified as Potential Equity Shares (PES) and must be considered when computing diluted EPS.

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### Effect on the Two Components of Diluted EPS

> Critical rule — No tax adjustment on preference dividend savings. Preference dividend is declared and paid from post-tax profits. Unlike interest on debentures (which reduces taxable income), preference dividend creates no tax shield. Therefore, the full dividend amount is added back without any tax grossing-up.

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### Step-by-Step Process

Step 1 — Basic EPS

$$\text{Basic EPS} = \frac{\text{EAFESH}}{\text{WANES}}$$

Step 2 — Diluted EPS (Working Notes)

WN 1 — Adjusted Numerator:

$$\text{Adj. EAFESH} = \text{EAFESH} + (\text{Pref. Shares} \times \text{Face Value} \times \text{Dividend Rate})$$

WN 2 — Adjusted Denominator:

$$\text{Adj. WANES} = \text{WANES} + (\text{Pref. Shares} \times \text{Conversion Ratio})$$

Step 3 — Compute and Test

$$\text{Diluted EPS} = \frac{\text{Adj. EAFESH}}{\text{Adj. WANES}}$$

• If Diluted EPS < Basic EPS → Dilutive → include in reported diluted EPS
• If Diluted EPS > Basic EPS → Anti-Dilutive → exclude; report Basic EPS = Diluted EPS

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### Contrast: Preference Dividend vs. Debenture Interest (Tax Treatment)

For debentures: Adj. EAFESH = EAFESH + Interest × (1 − Tax Rate)