Treasury Stock Method
AdvancedThe treasury stock method is a way of calculating the dilution from stock options and warrants, assuming they are exercised and the company uses the cash received to buy back shares at the current market price.
When in-the-money options are exercised, the company issues new shares but also receives the exercise price. The treasury stock method assumes this cash is used to repurchase shares, so only the net increase in shares counts as dilution.
For example, a company has 2,000,000 options with an exercise price of 30, and its share price is 40. If exercised, the options bring in 60,000,000, which buys back 1,500,000 shares at 40. The net increase in shares is 500,000.
Options with an exercise price above the market price are ignored, because they would not be exercised.
The treasury stock method is used to calculate fully diluted shares in valuations and diluted earnings per share in financial statements under IFRS and US GAAP. For accounting purposes, the average share price for the period is used, while valuations typically use the current price. Convertible bonds are handled separately, usually with the if-converted method.
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