A decrease in earnings per share (EPS) or an increase in loss per share (LPS) that results from the possibility (or actuality) that convertible instruments or exercisable instruments (options or warrants) would be converted into equity (common stock or ordinary shares), or that new ordinary shares are issued in the specific case where all relevant conditions have been met. This would have the effect of deteriorating the existing shareholder’s rights in terms of respective share in an entity’s earnings.

An entity facing such a situation would have to calculated the so-called diluted earnings per share, which take into consideration the effects of all dilutive potential common shares. In other words, it has to increase the number of shares outstanding by the additional shares issued or granted (specifically, the weighted average number of additional common shares). This figure in addition to all dilutive potential common shares will be used as a denominator of the calculation formula:

Diluted EPS = earnings/ number of shares outstanding

Where:

Earnings: profit or loss attributable to common shareholders of a parent company plus after-tax interest on convertible debt plus convertible preferred dividends.
Number of shares outstanding: weighted average number of common shares outstanding during the period plus all dilutive potential common stock.

This type of dilution is also known as an accounting dilution or an EPS dilution.

There is an opposite case known as anti-dilution (in which EPS increases and LPS decreases, resulting in an opposite effect).

Other types of dilution include economic dilution and control dilution.