When do you add back interest for diluted EPS?

Only for convertible bonds under the if-converted method. You add the after-tax interest to the numerator because conversion would eliminate that interest expense.

What makes a security antidilutive?

A potential common share is antidilutive if including it increases EPS rather than decreasing it. Antidilutive securities are excluded from the diluted EPS calculation.

Diluted EPS on the CFA Exam (FRA)

Diluted earnings per share is a reliable Financial Reporting and Analysis (FRA) question type at CFA Level 1 and 2. The mechanics are stable, so it is high-leverage to master once.

Key Takeaways

Diluted EPS asks what EPS would be if all dilutive potential shares converted to common stock.
For convertible bonds, add back after-tax interest to the numerator and the converted shares to the denominator (if-converted method).
For options/warrants, only the net new shares from the treasury stock method hit the denominator.
A security is included only if it's dilutive — test from most to least dilutive and stop once including another security would raise EPS.

Start with basic EPS

Basic EPS = (Net income − Preferred dividends) / Weighted average shares outstanding

Diluted EPS asks: what would EPS be if all dilutive potential shares converted into common stock?

Convertible bonds — the if-converted method

For convertible debt you reverse the cost of the debt and add the new shares:

Numerator: add back the bond's after-tax interest (interest × (1 − tax rate)), because if converted, the company would not pay that interest.
Denominator: add the common shares the bonds would convert into.

Worked example. Net income $2,000,000; 1,000,000 weighted shares; $1,000,000 of 5% convertible bonds convertible into 50,000 shares; tax rate 30%.

Basic EPS = 2,000,000 / 1,000,000 = $2.00
After-tax interest added back = 50,000 × (1 − 0.30) = 35,000
Diluted EPS = (2,000,000 + 35,000) / (1,000,000 + 50,000) = 2,035,000 / 1,050,000 ≈ $1.94

Options and warrants — the treasury stock method

Assume options are exercised at the strike price and the proceeds are used to repurchase shares at the average market price. Only the net new shares hit the denominator; the numerator is unchanged.

Always run the antidilution check

A potential security is included only if it reduces EPS. If adding a convertible raises EPS, it is antidilutive and excluded. When multiple potentially dilutive securities exist, rank them from most to least dilutive (smallest EPS impact per incremental share first) and add them to the calculation one at a time, recomputing EPS after each. Stop including additional securities the moment doing so would increase EPS — the lowest cumulative EPS along that path is the reported diluted EPS.

Practice FRA questions like this in our diagnostic Q-bank, and see which course covers FRA best in our CFA prep course comparison.

Educational overview only. Confirm computational rules against current CFA Institute FRA materials. Not affiliated with CFA Institute.