How Convertible Bonds Impact Diluted Earnings Per Share Calculation

What is the impact of convertible bonds on diluted earnings per share?

When calculating diluted earnings per share, what happens with convertible bonds?

Convertible Bonds and Diluted EPS

Convertible bonds are financial instruments that can be converted into common stock of a company. When included in the calculation of diluted earnings per share (EPS), convertible bonds can cause a decrease in diluted EPS.

When a company calculates diluted EPS, it considers the potential dilution effect of convertible securities like bonds that can be converted into common shares. By converting these bonds into common stock, more shares are added to the denominator of the EPS formula, thus diluting the earnings per share.

However, in many cases, convertible bonds are ignored when calculating diluted EPS to provide a conservative estimate. This approach assumes that convertible bonds were not converted into common stock, resulting in a higher diluted EPS compared to if they were included.

By ignoring the potential share dilution effects of convertible bonds, companies can present a more conservative estimate of their diluted earnings per share, which may be preferred by investors.