IAS 33 Diluted Earnings per Share: Convertibles, Options and Presentation

Basic earnings per share looks at the shares in issue now. But a company may have promised to issue more shares in future: loan notes that convert, options granted to staff, warrants sold to investors. When those shares are issued, the same profit will be spread across more shares, and earnings per share will fall. Users should be warned.

International Accounting Standard (IAS) 33 Earnings per Share therefore requires a second figure, diluted earnings per share, that shows what basic earnings per share would be if all dilutive potential shares had already been issued. This topic covers potential ordinary shares, the adjustments to earnings and shares for convertibles and options, the test for dilution and the order of inclusion, and presentation, including alternative measures. The next topic covers foreign currency transactions.

The topic is examined directly. In November Diet, 2023, Question 4 asked for the purpose of the dilutive measures and three types of dilution (8 marks), for basic and diluted earnings per share for a company with convertible loan notes (8 marks), and for two conditions for presenting an alternative measure of earnings per share (4 marks). Read basic earnings per share first.

Potential ordinary shares

A potential ordinary share is a financial instrument or other contract that may entitle its holder to ordinary shares. Dilution is a reduction in earnings per share (or an increase in loss per share) resulting from the assumption that convertible instruments are converted, options or warrants are exercised, or ordinary shares are issued on the satisfaction of specified conditions. The main types are:

• Convertible instruments: convertible loan notes and convertible preference shares, which holders may exchange for ordinary shares.
• Options and warrants: rights to buy ordinary shares at a fixed price, including share options granted to employees.
• Contingently issuable shares: shares issuable for little or no cash if specified conditions are met, such as achieving a profit target or a share price.

The purpose of diluted earnings per share is to warn current investors of the potential fall in earnings per share. Because it is based on current earnings and not on forecast earnings, it is not a prediction of future earnings per share.

Convertible instruments

It is assumed that the instrument was converted at the start of the period (or the date of issue if later). The adjustments are:

1. Earnings: add back the interest that would not have been paid, net of tax (and any other related changes in income or expense).
2. Shares: add the shares that would be issued on conversion. If conversion terms vary, use the terms most favourable to the holder, which give the largest number of shares.

For example, a company has 12,000,000 shares and earnings of ₦9,000,000, so basic earnings per share is 75 kobo. It also has ₦4,000,000 of 5% convertible loan notes, convertible at 30 shares per ₦100 of notes at the end of next year and at 25 shares per ₦100 a year later. The most favourable terms give 4,000,000 ÷ 100 × 30 = 1,200,000 shares. Interest is 5% × ₦4,000,000 = ₦200,000, which is ₦140,000 after 30% tax. Diluted earnings = ₦9,000,000 + ₦140,000 = ₦9,140,000, and diluted shares = 12,000,000 + 1,200,000 = 13,200,000. Diluted earnings per share is ₦9,140,000 ÷ 13,200,000 = 69.24 kobo.

Options and warrants

Options and warrants are dilutive only when the average market price of ordinary shares in the period is above the exercise price. The assumption is that the cash received on exercise is used to buy shares at the average market price, so only the shares issued for no consideration are dilutive:

Incremental shares = number of options × (1 − exercise price ÷ average market price). Earnings are not adjusted.

For example, there are 1,000,000 options with an exercise price of ₦1.20, and the average market price is ₦2.00. The incremental shares are 1,000,000 × (1 − 1.20 ÷ 2.00) = 400,000. Diluted earnings per share is ₦9,000,000 ÷ 12,400,000 = 72.58 kobo. If the exercise price were above the average market price, the options would be antidilutive and would be ignored.

The dilution test and order

Potential ordinary shares are treated as dilutive only when their conversion or exercise would reduce earnings per share from continuing operations. A potential share that would increase earnings per share is antidilutive and is ignored, so diluted earnings per share is never higher than basic.

Each issue or series of potential shares is considered separately, in sequence from the most dilutive to the least dilutive, that is from the lowest earnings per incremental share. Options, which add no earnings, are first.

For example, earnings are ₦9,000,000 and the shares 12,000,000 (basic 75 kobo). The options add 400,000 shares and no earnings (earnings per incremental share nil). The convertible adds ₦140,000 and 1,200,000 shares (11.67 kobo per incremental share). Step 1, options: ₦9,000,000 ÷ 12,400,000 = 72.58 kobo, dilutive. Step 2, convertible: ₦9,140,000 ÷ 13,600,000 = 67.21 kobo, still lower, so dilutive. Diluted earnings per share is 67.21 kobo. As an antidilutive example, earnings of ₦5,000,000 on 10,000,000 shares give basic 50 kobo.

A convertible adding ₦700,000 of after-tax interest and 1,000,000 shares gives ₦5,700,000 ÷ 11,000,000 = 51.8 kobo, higher than basic, so it is ignored.

Presentation and disclosure

• An entity presents basic and diluted earnings per share on the face of the statement of profit or loss and other comprehensive income for each class of ordinary shares, with equal prominence, for profit or loss from continuing operations and for the profit or loss for the period. Per-share amounts for discontinued operations may be presented in the notes.
• Comparative figures are shown. If basic and diluted figures are the same, they may be shown on one line.
• Disclosures include the amounts used as the numerators and a reconciliation to profit or loss, the weighted average number of shares used for each, instruments that could dilute in future but were excluded as antidilutive. Transactions after the reporting date that would significantly change the number of shares.
• Earnings per share is restated for bonus issues, rights issues and share splits, and for the correction of errors.

Alternative measures of earnings per share

An entity may disclose additional per-share amounts using a different measure of earnings, for example earnings before an exceptional item. The conditions are:

• the weighted average number of shares is the same as that used for the standard measure, and basic and diluted amounts are given with equal prominence;
• the amounts are disclosed in the notes, and not on the face of the statement of profit or loss and other comprehensive income;
• the basis on which the numerator is determined is explained, including whether it is before or after tax; and
• the numerator is reconciled to a line item reported in the statement of profit or loss and other comprehensive income.

The ideas in more depth

Why only dilutive items are included

The aim is a warning of the worst effect on current shareholders. An instrument that would raise earnings per share does not warn anyone of anything, so including it would hide the real range.

Why options use the treasury share method

A holder who exercises pays the exercise price. If that money were used to buy shares at the market price, those shares could be issued to the holder. Only the remaining shares are issued free of charge, and they are the ones that dilute.

Sources and references

• IAS 33 Earnings per Share: diluted earnings per share, potential ordinary shares, the dilution test, presentation and disclosure.

These points are stated as at 5 November 2026.

Worked examples

1. Basic.
   ₦9,000,000 ÷ 12,000,000 = 75 kobo.
2. Shares.
   The most favourable terms: 4,000,000 ÷ 100 × 30 = 1,200,000.
3. Interest after tax.
   5% × ₦4,000,000 × 70% = ₦140,000.
4. Diluted.
   (₦9,000,000 + ₦140,000) ÷ (12,000,000 + 1,200,000) = 69.24 kobo.

1. Incremental shares.
   1,000,000 × (1 − 1.20 ÷ 2.00) = 400,000.
2. Diluted.
   ₦9,000,000 ÷ 12,400,000 = 72.58 kobo.

1. Basic.
   ₦5,000,000 ÷ 10,000,000 = 50 kobo.
2. With conversion.
   ₦5,700,000 ÷ 11,000,000 = 51.8 kobo, which is higher.
3. Result. It is antidilutive and excluded. Diluted earnings per share is 50 kobo.

How to answer in the exam

• Start with basic. State it, then list each potential share.
• Compute the increments. Add after-tax interest and shares for convertibles. Use the formula for options.
• Rank and test. Lowest earnings per incremental share first. Stop if a step raises earnings per share.
• Present. Basic and diluted with equal prominence; alternatives in the notes only, with a reconciliation.

Common mistakes in the exam

• Adding back interest before tax instead of after tax.
• Using the number of options as the incremental shares instead of the free shares.
• Including antidilutive instruments.
• Using the least favourable conversion terms.
• Adjusting earnings for options.
• Presenting an alternative measure on the face of the statement.

Quick revision

• Potential shares: convertibles, options and warrants, contingently issuable shares.
• Convertible: add interest after tax and the new shares (most favourable terms).
• Options: incremental shares = options × (1 − exercise price ÷ average market price); no earnings change.
• Include only if dilutive; most dilutive first.
• Alternative measure: notes only, same shares, basis explained, reconciled.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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