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which is net income minus preferred stock dividend requirements. Thus in the numerator, deduct the preferred dividends actually declared. If the preferred stock is cumulative, deduct the preferred dividends current year preference as to dividends even if no dividends were declared. Dividends in arrears for prior years have no effect on the current year's basic EPS calculations. Note that dividends declared and/or paid during the year on common stock have no effect on this computation. Also if there is a net loss rather than a net income, the amount of the loss is increased by the preferred dividends.

STEP 3: Compute Diluted Earnings per share.

A. The basic formula is adjusted as follows:

Net Income Preferred dividends +/ adjustments

___________________ ________________________

Weighe d Average Number of Common shares Outstanding +

Weighted Average Number of Potential Common shares

B. Treatment of convertibles: Use the IF CONVERTED method

For a better understanding: Convertible securities are corporate securities usually preferred shares or bonds that are exchangeable for a set number of another form (usually common shares) at a restated price. Convertibles are appropriate for investors who want higher income that is available from common stock, together with appreciation potential than regular bond offers. The convertible feature is usually designed as a sweetness measure to boost the marketability of the stock or preferred stock.

FIRST: Assume the convertible is converted to common stock, if the effect of that assumption is dilutive.

A quick test to determine if a CONVERTIBLE DEBT instrument is antidilutive is as follows: if the amount of interest net of taxes per common share obtainable upon conversion exceeds basic EPS, the effect is antidilutive that is, it increases earnings per share amounts.

A quick test to determine if a CONVERTIBLE PREFERRED STOCK is antidilutive as follows: if the amount of preferred dividends per common share obtainable on conversion exceeds basic EPS, the effect is antidilutive.

SECOND: For a CONVERTIBLE PREFERRED STOCK add back the preferred dividends, (that had been deducted in the basic formula) in the numerator and add an appropriate weighted average number of potential common shares (assumed to be outstanding) in the denominator of the diluted EPS formula.

THIRD: For CONVERTIBLE DEBT, add back interest and deduct tax savings due to interest in the numerator and add an appropriate weight average number of potential common shares in the denominator.

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