Query- Loan Limited (the company) has taken a secured loan of 2100 million from the bank. The loan agreement contains various covenants, which need to be complied with over the period of the loan. The loan agreement gives the bank a right to get the whole or a part of its loan converted into fully paid-up equity shares of the company at par, if the company fails to comply with one or more of the loan covenants. At the balance sheet date, the company has not committed any default in complying with these loan covenants. The management believes that since the company has not defaulted in compliance with loan covenants, the conversion option is superfluous and should not be considered in the calculation of diluted earnings per share (EPS). Is the management view tenable?


AS 20 Earnings Per Share defines the term “potential equity shares” as “a financial instrument or other contract that entitles, or may entitle, its holder to equity shares.” According to paragraph 7 of AS 20, the shares that will be issued on the satisfaction of certain conditions resulting from the contractual arrangements (contingently issuable shares) are an example of potential equity shares.

Paragraph 26 of AS 20 requires that for calculating diluted EPS, the net profit or loss for the period attributable to equity shareholders and the weighted average number of shares outstanding during the period should be adjusted for the effects of all dilutive potential equity shares. According to Paragraph 34 of AS 20:

“Equity shares which are issuable upon the satisfaction of certain conditions resulting from contractual arrangements (contingently issuable shares) are considered outstanding and included in the computation of both the basic earnings per share and diluted earnings per share from the date when the conditions under a contract are met. If the conditions have not been met, for computing the diluted earnings per share, contingently issuable shares are included as of the beginning of the period (or as of the date of the contingent share agreement, if later)…”

Keeping in view the above, we believe that the company should include additional equity shares issuable on the conversion of loan in calculating diluted EPS, if these shares are dilutive. This is irrespective of the fact that the company has not committed any default in complying with the loan covenants at the reporting date.

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September 2021