# Treasury Stock Method Explained - Calculating Diluted EPS with Examples

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## What Is the Treasury Stock Method?

The treasury stock method is an approach companies use to compute the number of new shares that may potentially be created by unexercised in-the-money warrants and options, where the exercise price is less than the current share price. Additional shares obtained through the treasury stock method factor into the calculation of the diluted earnings per share (EPS). It assumes the company uses proceeds from in-the-money option exercises to buy back common shares.

### Key Takeaways

*   The treasury stock method calculates new shares from unexercised in-the-money options and warrants.  
    
*   Exercise proceeds from these options are used to repurchase shares on the market.  
    
*   This method is crucial for calculating a company's diluted earnings per share (EPS).  
    
*   Assumes options and warrants are exercised at the period's start with shares repurchased at the average market price.  
    
*   Helps identify the net increase in shares affecting the diluted share count and EPS.

## Detailed Explanation of the Treasury Stock Method

The treasury stock method states that the basic share count used in calculating a company's earnings per share (EPS) must be increased as a result of outstanding [in-the-money options](https://www.investopedia.com/terms/i/inthemoney.asp) and warrants, which entitle their holders to purchase common shares at an exercise price that's below the current market price. To comply with generally accepted accounting principles (GAAP), companies must use the treasury stock method to calculate diluted earnings per share (EPS).

It assumes options and warrants are exercised at the start of the period, and the company uses proceeds to buy shares at the average market price. Calculate the additional shares by finding the difference between assumed issued shares from option exercises and shares bought in the market.

## Real-World Example of Using the Treasury Stock Method

Consider a company that reports 100,000 basic [shares outstanding](https://www.investopedia.com/terms/o/outstandingshares.asp), $500,000 in net income for the past year, and 10,000 in-the-money options and warrants, with an average exercise price of $50. Let's assume that the average market price for the shares in the last year was $100. Using the basic share count of the 100,000 common shares, the company's basic EPS is $5 calculated as the net income of $500,000 divided by 100,000 shares. But this number ignores the fact that 10,000 shares can be immediately issued if the in-the-money options and warrants are exercised.

Using the treasury stock method, the company earns $500,000 from exercising options (10,000 times $50) and may repurchase 5,000 shares at $100 each.

The additional 5,000 shares (the difference between 10,000 assumed issued shares, and 5,000 assumed repurchased shares) represent the net newly-issued shares resulting from the potential options and warrants exercise.

The [diluted share count](https://www.investopedia.com/terms/f/fullydilutedshares.asp) is 105,000 = 100,000 basic shares + 5,000 additional shares. The diluted EPS is then equal to $4.76 = $500,000 net income ÷ 105,000 diluted shares.

> **Important**
>
> The number of additional shares that must be added back to the basic share count is calculated as the difference between the assumed share count from the options and warrants exercise and the share count that could have been purchased on the open market.