Good question.
For Basic EPS, preferred dividends are subtracted because Basic EPS
Good question.
For Basic EPS, preferred dividends are subtracted because Basic EPS measures earnings available to common shareholders only:
Basic EPS = (Net Income − Preferred Dividends) / Weighted Average Common Shares
For Diluted EPS, if the preferred shares are convertible preferred shares and are assumed to be converted under the if-converted method, those preferred dividends would no longer be paid. Therefore, we add back the preferred dividends to the numerator rather than subtract them.
So:
- Basic EPS → subtract preferred dividends.
- Diluted EPS (assuming conversion) → add back preferred dividends because the preferred shares are assumed to have become common shares.
The key idea is consistency: if you assume conversion and increase the denominator by adding common shares, you must also adjust the numerator by removing the preferred dividend deduction.
Check Example 15 carefully to see whether the preferred shares are being treated as convertible under the if-converted method. That is usually the reason for the difference.
Madhusudan Chandarasekaran, CFA, FRM