If-Converted Method

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The if-converted method is a way of calculating diluted earnings per share that assumes convertible securities, such as convertible bonds or preferred shares, were converted into ordinary shares at the start of the period.

Convertible securities can become ordinary shares, diluting existing shareholders. The if-converted method shows what earnings per share would be if conversion had happened.

Two adjustments are made. The extra shares from conversion are added to the share count. And because converted bonds no longer pay interest, the after-tax interest saved is added back to earnings.

For example, a company has net income of 40,000,000 and 20,000,000 shares, giving basic earnings per share of 2.00. It also has convertible bonds of 100,000,000 paying 5% interest, convertible into 4,000,000 shares. If converted, it saves 5,000,000 of interest, or 3,750,000 after 25% tax. Diluted earnings per share is 43,750,000 divided by 24,000,000, or about 1.82.

The convertibles are included only if they reduce earnings per share. If including them would increase it, they are excluded as anti-dilutive. The method is required under both IFRS and US GAAP.

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