IAS 33: Earnings Per Share (EPS) requires listed entities to disclose basic earnings per share as well as diluted earnings per share. In calculating diluted earnings per share, any financial instrument which potentially dilutes earnings per share should be taken into account.
The importance of disclosing diluted Earnings Per Share (DEPS.
Many entities issue financial instruments that allow the holder to buy shares at a price that is less than the market price. Such instruments include convertible debt, options and warrants. When the holders exercise their rights and obtain the equity, the original EPS measure will be diluted. This is because the shares have been issued at below their market price and so will provide the entity with less cash and so less earnings per share. IAS 33 requires disclosure of both the basic and diluted EPS. The diluted earnings per share figure is calculated using the current earnings and assuming the worst dilution arises. This will assist existing and prospective investors with their investment decisions.
For example, a convertible bond provides the holder with a regular coupon plus the option to convert the bonds into ordinary shares at during a certain time frame. Most investors will probably choose to convert rather than to redeem their bonds and hence this will affect the EPS. Firstly, the number of shares in issue will increase; secondly, the earnings will increase because the coupon will no longer need to be paid, Typically, convertible bonds will be issued at a low coupon because of the opportunity to take the shares. Therefore, the impact on earnings is minimal, and the EPS will typically decrease.