AS 20 – Diluted EPS with Multiple Potential Equity Shares (Ranking Method)

# Diluted EPS — Multiple Potential Equity Shares (Ranking Method)

## Why a Ranking Step Is Needed

When a company has more than one class of potential equity shares (PES) — e.g., warrants, convertible debentures, and convertible preference shares all outstanding simultaneously — blindly adding every class to the denominator is wrong. An antidilutive security would raise reported EPS, violating the "worst-case" purpose of diluted EPS.

The rule (AS 20, Para 38): Include each class of PES one at a time, ordered from most dilutive → least dilutive. Stop the moment any class turns antidilutive; exclude it and everything ranked below it.

---

## The 3-Step Framework

### Step 1 — Compute Incremental EPS for Each PES Class

For every class, isolate only the marginal impact it would add:

$$\text{Incremental EPS} = \frac{\text{Δ Numerator}}{\text{Δ Denominator}}$$

#### Treasury Stock Method (Warrants/Options)

Only the net incremental shares count — as if proceeds from exercise were used to buy back shares at market price:

$$\text{Dilutive Shares} = \text{Total Warrants} \times \frac{\text{Market Price} - \text{Exercise Price}}{\text{Market Price}}$$

Because the Δ numerator = 0, warrants always have the lowest incremental EPS (= 0) and always rank first.

---

### Step 2 — Rank from Lowest to Highest Incremental EPS

Sort all classes ascending by their incremental EPS. Warrants/options always sit at Rank I.

---

### Step 3 — Build the Conclusion Table

Start with Basic EPS figures. Add each ranked class in order and recompute the running EPS after each addition:

Reported Diluted EPS = the last running EPS before the first antidilutive class.

---

## Key Definitions

• EAFESH — Earnings Available For Equity Shareholders (PAT − Preference Dividend)
• WANES — Weighted Average Number of Equity Shares
• EAFESH (diluted) — EAFESH adjusted for post-tax interest savings on convertible debt and preference dividend savings on convertible preference shares
• Antidilutive — any PES whose addition increases EPS rather than decreasing it