The treasury stock method must be factored into the diluted shares earnings in order to meet the generally accepted accounting principles (GAAP). It simply means that when a company is figuring out diluted shares it has to also figure out the shares that can be created due to in the money options and need to be added into the equation.
The formula looks like this.
(number of In The Money Shares)– (number of shares that can be repurchased)
For example company XYZ owns 1000 in the money options at $10 and the stock is trading at $20. This allows them to repurchase 1000 shares of the company. The proceeds the company will receive is $10,000 ($10 x 1000).
This means that the company will be able to repurchase 500 shares ($10,000/20). That means the new shares added is (1000 added – 500 repurchased or) 500 new shares.
