Fixing diluted earnings per share: Recognising the dilutive effects of employee stock options

This paper proposes changes to the calculation of diluted earnings per share (DEPS). The existing IAS 33 approach is flawed as it ignores the time value of options and treats equity-settled options differently to cash-settled options. We derive an alternative method and then compare this with the IAS 33 calculation using examples based on a simple firm as well as a small sample of ASX companies. Our method best describes the change in economic value of the current shareholders and provides a similar result at a DEPS level for both cash- and equity-settled options. It is superior to the existing IAS 33 method and can easily be extended to deal with other dilutive instruments.