Chapter 12 — Presentation
Chapter 12 — Presentation
This chapter discusses presentation matters related to the statement of financial position, statement of operations, statement of cash flows, and EPS.
12.1 Statement of Financial Position
12.1.1 Receivables
ASC 505-10
Receivables for Issuance of Equity
45-2 An entity may receive a note, rather than cash, as a contribution to its equity. The transaction may be a sale of capital stock or a contribution to paid-in capital. Reporting the note as an asset is generally not appropriate, except in very limited circumstances in which there is substantial evidence of ability and intent to pay within a reasonably short period of time, for example, as discussed for public entities in paragraph 210-10-S99-1 (paragraphs 27 through 29), which requires a deduction of the receivable from equity. However, such notes may be recorded as an asset if collected in cash before the financial statements are issued or are available to be issued (as discussed in Section 855-10-25).
SEC Staff Accounting Bulletins
SAB Topic 4.E, Receivables
From Sale of Stock [Reproduced in ASC
310-10-S99-2]
Facts:
Capital stock is sometimes issued to officers or
other employees before the cash payment is
received.
Question: How should the receivables from the
officers or other employees be presented in the
balance sheet?
Interpretive Response: The
amount recorded as a receivable should be
presented in the balance sheet as a deduction from
stockholders’ equity. This is generally consistent
with Rule 5-02.30 of Regulation S-X which states
that accounts or notes receivable arising from
transactions involving the registrant’s capital
stock should be presented as deductions from
stockholders’ equity and not as assets.
It should be noted generally
that all amounts receivable from officers and
directors resulting from sales of stock or from
other transactions (other than expense advances or
sales on normal trade terms) should be separately
stated in the balance sheet irrespective of
whether such amounts may be shown as assets or are
required to be reported as deductions from
stockholders’ equity.
The staff will not suggest
that a receivable from an officer or director be
deducted from stockholders’ equity if the
receivable was paid in cash prior to the
publication of the financial statements and the
payment date is stated in a note to the financial
statements. However, the staff would consider the
subsequent return of such cash payment to the
officer or director to be part of a scheme or plan
to evade the registration or reporting
requirements of the securities laws.
Generally, receivables that result from the issuance of shares classified as permanent or mezzanine equity should be presented as a reduction of each respective class of stock (i.e., contra-equity). That is, receivables that result from the issuance of shares classified as permanent equity generally should be presented as a reduction of permanent equity in accordance with ASC 505-10-45-2. Similarly, receivables that result from the issuance of shares classified as mezzanine equity should be presented as a reduction of mezzanine equity.
SAB Topic 4.E (reproduced in ASC 310-10-S99-2) generally requires entities to classify any outstanding receivables from officers or other employees related to the issuance of stock to officers or other employees as a deduction from stockholders’ equity rather than as an asset.
Asset classification of such receivables may be appropriate only when the receivable is fully repaid in cash before the financial statements are issued. The date of payment must be disclosed in the notes to the financial statements. SAB Topic 4.E cautions, however, that the SEC staff would consider any subsequent return of cash to the officer or employee as potentially representing an effort “to evade the registration or reporting requirements of the securities laws.” Further, receivables of this nature must be disclosed separately regardless of whether they are classified as an asset or as a deduction from equity. Entities preparing to file a registration statement with the SEC should be particularly cognizant of the potential legal ramifications associated with loans to employees and should consult with their legal counsel to address any issues well before their public offering.
In addition, an entity that allows an employee to finance the purchase of shares should consider whether recourse or nonrecourse notes have been tendered. Nonrecourse notes are not recognized because such a financing is accounted for, in substance, as stock options. See Section 3.11.
12.1.2 Deferred Tax Assets
As discussed in Section 4.12.2, NQSOs are options that do not qualify for treatment as ISOs or ESPPs under the provisions of IRC Sections 421 through 424. NQSOs give employers more flexibility than ISOs.
In accordance with ASC 740-10-45-4, an entity must classify the DTA as
noncurrent on the balance sheet.
See Chapter 10 of Deloitte’s Roadmap
Income Taxes for a discussion
of the income tax effects of share-based
payments.
12.1.3 Capitalization of Inventory
SEC Staff Accounting Bulletins
SAB Topic 14.I, Capitalization
of Compensation Cost Related to Share-Based
Payment Arrangements
Facts: Company K is a manufacturing company
that grants share options to its production
employees. Company K has determined that the cost
of the production employees’ service is an
inventoriable cost. As such, Company K is required
to initially capitalize the cost of the share
option grants to these production employees as
inventory and later recognize the cost in the
income statement when the inventory is
consumed.85
Question: If Company K elects to adjust its
period end inventory balance for the allocable
amount of share-option cost through a period end
adjustment to its financial statements, instead of
incorporating the share-option cost through its
inventory costing system, would this be considered
a deficiency in internal controls?
Interpretive Response: No. FASB ASC Topic
718, Compensation — Stock Compensation, does not
prescribe the mechanism a company should use to
incorporate a portion of share-option costs in an
inventory-costing system. The staff believes
Company K may accomplish this through a period end
adjustment to its financial statements. Company K
should establish appropriate controls surrounding
the calculation and recording of this period end
adjustment, as it would any other period end
adjustment. The fact that the entry is recorded as
a period end adjustment, by itself, should not
impact managements ability to determine that the
internal control over financial reporting, as
defined by the SEC’s rules implementing Section
404 of the Sarbanes-Oxley Act of
2002,86 is effective.
______________________________
85 FASB ASC
paragraph 718-10-25-2A.
86 Release No.
34-47986, June 5, 2003, Management’s Report on
Internal Control Over Financial Reporting and
Certification of Disclosure in Exchange Act Period
Reports.
If compensation cost associated with share-based payment awards is part of the cost of inventory, an entity should initially capitalize it as inventory and later recognize it in the income statement when the inventory is consumed. However, the SEC staff has indicated that it may be reasonable for an entity instead to adjust the period-end inventory balance for compensation cost through a period-end adjustment and not incorporate the cost in its inventory costing system.
12.1.4 Fully Vested Nonemployee Awards
ASC 718-10
Classification of Assets Other Than a Note or a Receivable for Nonemployee Awards
45-3 As discussed in paragraph 718-10-35-1B, a grantor may conclude that an asset (other than a note or a receivable) has been received in return for fully vested, nonforfeitable, nonemployee share-based payment awards that are issued at the date the grantor and nonemployee enter into an agreement for goods or services (and no specific performance is required by the nonemployee to retain those equity instruments). Such an asset shall not be displayed as contra-equity by the grantor of the award. The transferability (or lack thereof) of the awards shall not affect the balance sheet display of the asset. This guidance is limited to transactions in which awards are transferred to nonemployees in exchange for goods or services.
For additional information about the classification of assets, other than a note
or a receivable, that are received in exchange for fully vested, nonforfeitable
equity instruments, see Section 9.7.
12.1.5 Presentation of Awards With Repurchase Features That Function as Vesting Conditions
As discussed in Section
3.4.3, repurchase features included in
a share-based payment award may at times function
in substance as vesting conditions. For example, a
stock option or similar instrument may be “early
exercised” and include such repurchase features.
An early exercise of a stock option or similar
instrument refers to a grantee’s ability to change
his or her tax position by exercising an option or
similar instrument and receiving shares before the
award is vested. The early exercise of the stock
option is generally not considered substantive for
accounting purposes given the repurchase features
included in such awards. However, the shares
issued to a grantee upon an early exercise of a
stock option or similar instrument may be
considered legally outstanding common stock. In
accordance with SEC Regulation S-X, Rule 5-02(29),
SEC registrants are required to disclose the
number of common shares outstanding on the balance
sheet. If the shares are deemed to be legally
outstanding, the number of shares disclosed as
outstanding on the balance sheet may differ from
the number of shares outstanding for accounting
purposes. Entities should consider whether
disclosing this difference is necessary on the
basis of their facts and circumstances. These
considerations also apply to restricted stock or
nonvested shares with repurchase features that
function as vesting conditions.
12.2 Statement of Operations
ASC 718 requires compensation cost from share-based payment awards to be (1) recorded in net income, (2) either expensed or capitalized (and subsequently expensed) in an entity’s financial statements, and (3) classified appropriately as either equity or a liability in accordance with the classification criteria in ASC 718 (see Chapter 5). However, ASC 718 provides little guidance on how compensation cost associated with share-based payment awards should be presented in the statement of operations.
12.2.1 Classification of Compensation Expense
SEC Staff Accounting Bulletins
SAB Topic 14.F, Classification of
Compensation Expense Associated With Share-Based Payment
Arrangements
Facts: Company
G utilizes both cash and share-based payment
arrangements to compensate its employees and nonemployee
service providers. Company G would like to emphasize in
its income statement the amount of its compensation that
did not involve a cash outlay.
Question: How
should Company G present in its income statement the
non-cash nature of its expense related to share-based
payment arrangements?
Interpretive
Response: The staff believes Company G should
present the expense related to share-based payment
arrangements in the same line or lines as cash
compensation paid to the same employees or
nonemployees.84 The staff believes a
company could consider disclosing the amount of expense
related to share-based payment arrangements included in
specific line items in the financial statements.
Disclosure of this information might be appropriate in a
parenthetical note to the appropriate income statement
line items, on the cash flow statement, in the footnotes
to the financial statements, or within MD&A.
______________________________
84 FASB ASC Topic 718 does
not identify a specific line item in the income
statement for presentation of the expense related to
share-based payment arrangements, with the exception of
the guidance in ASC 718-10-15-5A on share-based payment
awards granted to a customer.
The SEC staff believes that compensation expense related to share-based payment arrangements (e.g., cost of sales, R&D, selling and administrative expenses) should be presented within the appropriate line items on the face of the statement of operations and not separately within a single share-based compensation line item. That is, presentation in the statement of operations should not be governed by the form of consideration paid (e.g., cash or share-based payment). The staff believes that instead, an entity could consider disclosing the amount of expense related to share-based payment arrangements presented within specific line items in the financial statements. Disclosure of this information might be appropriate in a parenthetical note to the appropriate income statement line items, in the cash flow statement, in the footnotes to the financial statements, or in MD&A.
The following is an example of an acceptable
disclosure of share-based compensation expense presented within specific line
items:
12.2.2 Share-Based Payment Awards Granted to Employees and Nonemployees of an Equity Method Investee
ASC 323-10
Stock-Based Compensation Granted to Employees and Nonemployees of an Equity Method Investee
25-3 Paragraphs 323-10-25-4
through 25-6 provide guidance on accounting for
share-based payment awards granted by an investor to
employees or nonemployees of an equity method investee
that provide goods or services to the investee that are
used or consumed in the investee’s operations when no
proportionate funding by the other investors occurs and
the investor does not receive any increase in the
investor’s relative ownership percentage of the
investee. That guidance assumes that the investor’s
grant of share-based payment awards to employees or
nonemployees of the equity method investee was not
agreed to in connection with the investor’s acquisition
of an interest in the investee. That guidance applies to
share-based payment awards granted to employees or
nonemployees of an investee by an investor based on that
investor's stock (that is, stock of the investor or
other equity instruments indexed to, and potentially
settled in, stock of the investor).
25-4 In
the circumstances described in paragraph 323-10-25-3, a
contributing investor shall expense the cost of
share-based payment awards granted to employees and
nonemployees of an equity method investee as incurred
(that is, in the same period the costs are recognized by
the investee) to the extent that the investor’s claim on
the investee’s book value has not been increased.
25-5 In the circumstances
described in paragraph 323-10-25-3, other equity method
investors in an investee (that is, noncontributing
investors) shall recognize income equal to the amount
that their interest in the investee’s net book value has
increased (that is, their percentage share of the
contributed capital recognized by the investee) as a
result of the disproportionate funding of the
compensation costs. Further, those other equity method
investors shall recognize their percentage share of
earnings or losses in the investee (inclusive of any
expense recognized by the investee for the share-based
compensation funded on its behalf).
SEC Observer Comment: Accounting by an Investor for Stock-Based Compensation Granted to Employees of an Equity Method Investee
S99-4 The following is the
text of SEC Observer Comment: Accounting by an Investor
for Stock-Based Compensation Granted to Employees of an
Equity Method Investee.
Paragraph
323-10-25-3 provides guidance on the accounting by an
investor for stock-based compensation based on the
investor’s stock granted to employees of an equity
method investee. Investors that are SEC registrants
should classify any income or expense resulting from
application of this guidance in the same income
statement caption as the equity in earnings (or losses)
of the investee.
ASC 323 provides guidance on share-based payment awards granted by an investor to employees and nonemployees of an equity method investee. Generally, investors of the equity method investee (both the contributing investor and noncontributing investors) classify any income or expense associated with the awards in the same caption as the equity in earnings of the investee.
12.2.3 Nonemployee Awards Issued in Exchange for Goods or Services
The SEC staff has reviewed a number of cases in which entities have issued share-based payment awards (e.g., warrants, shares, or convertible instruments) to suppliers, service providers, customers, or partners. The staff has generally held as follows:
- When share-based payment awards are issued to customers or potential customers in arrangements in which the awards will not vest or become exercisable without purchases by the recipient, the related cost must be reported as a sales discount — in other words, as a reduction of revenue.
- When awards are issued to suppliers or potential suppliers and they will not vest or become exercisable unless the recipient provides goods or services to the issuer, the cost of the award should be reported as a cost of the related goods or services.
- Separate line items in the statement of operations should not be presented for the apparent purpose of emphasizing that a portion of the sales discounts or expenses did not involve a cash outlay. This requirement is consistent with the guidance in SAB Topic 14.F (see Section 12.2.1).
- Awards that do not require any performance from the counterparty are related to past transactions and should therefore be classified appropriately (e.g., as cost of sales or reduction of revenue and not as marketing or nonoperating expenses).
12.2.4 Payroll Taxes
ASC 718-10
25-23 Payroll taxes, even though directly related to the appreciation on stock options, are operating expenses and shall be reflected as such in the statement of operations.
Employer payroll taxes incurred as a result of share-based payment transactions
should be reflected as operating expenses.
12.3 Statement of Cash Flows
Because the receipt of goods or services in exchange for a share-based payment award is a noncash item, the award is not presented as a direct cash outflow in the statement of cash flows. However, under the indirect method, an entity would present the compensation cost recognized in net income as a reconciling item in arriving at cash flows from operations.
In addition, an entity presents other effects of share-based payment awards as follows:
- Any cash paid by a grantee (e.g., the exercise price of a stock option) to the entity for an award is classified as a cash inflow from financing activities.
- Any cash paid to settle an equity-classified award that does not exceed the fair-value-based measure of the award on the repurchase date is classified as a cash outflow for financing activities. The amount paid in excess of the fair-value-based measure of the award on the repurchase date is recognized as compensation cost and classified as a cash outflow for operating activities.
- Any cash paid to settle a liability-classified award represents compensation and is classified as a cash outflow for operating activities. An entity may enter into an agreement to repurchase (or offer to repurchase) an equity-classified award for cash. Depending on the facts and circumstances, the agreement to repurchase (or offer to repurchase) may be accounted for as either (1) a settlement of the equity-classified award as discussed in the previous bullet point or (2) a modification of the equity-classified award that changes the award’s classification from equity to liability, followed by a settlement of the now liability-classified award.
- Regardless of whether an entity meets an employee’s statutory tax withholding requirement through either a net settlement feature or a repurchase of shares, the entity must account for the withholding as, in substance, two transactions in the statement of cash flows. First, the gross issuance of shares is presented as a financing activity (any cash received from the employee is classified as a cash inflow from financing activities, and if no cash is received, the gross issuance of shares is presented as a noncash financing activity). Second, the entity is deemed to have repurchased a portion of the shares. While the employee does not receive cash directly, the entity has, in substance, repurchased shares from the employee and remitted the cash consideration to the tax authority on the employee’s behalf. Because the cash payment is related to a repurchase of stock, it is classified as a cash outflow for financing activities.
- Any income tax benefit received for an award is classified as operating activities in the same manner as other cash flows related to income taxes.
For additional information about classifying the effects of share-based payment
awards in the statement of cash flows, see Section 7.3 of Deloitte’s Roadmap Statement of Cash
Flows.
12.4 Earnings per Share
ASC 718-10
Earnings per Share
45-1 Topic 260 requires that equity share options, nonvested shares, and similar equity instruments granted under share-based payment transactions be treated as potential common shares in computing diluted earnings per share (EPS). Diluted EPS shall be based on the actual number of options or shares granted and not yet forfeited regardless of the entity’s accounting policy for forfeitures in accordance with paragraphs 718-10-35-1D and 718-10-35-3, unless doing so would be antidilutive. If vesting in or the ability to exercise (or retain) an award is contingent on a performance or market condition, such as the level of future earnings, the shares or share options shall be treated as contingently issuable shares in accordance with paragraphs 260-10-45-48 through 45-57. If equity share options or other equity instruments are outstanding for only part of a period, the shares issuable shall be weighted to reflect the portion of the period during which the equity instruments are outstanding.
45-2 Paragraphs 260-10-45-29 through 45-34 and Example 8 (see
paragraph 260-10-55-68) provide guidance on applying the treasury stock method for equity
instruments granted in share-based payment transactions in determining diluted EPS.
In calculating EPS, an entity should consider how a share-based payment award
may affect (1) income available to common shareholders (i.e., the numerator
in the EPS calculation) and (2) the weighted-average number of common shares
or dilutive potential common shares (i.e., the denominator in the EPS
calculation). Because an entity recognizes the fair-value-based measure of
an award as compensation cost (or as a reduction of revenue) in arriving at
the entity’s income available to common shareholders, awards granted in
return for goods or services or as a sales incentive to a customer will
typically affect the EPS numerator.
12.4.1 Basic EPS
ASC 260-10
Computation of Basic EPS
45-10 Basic EPS shall be computed by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Shares issued during the period and shares reacquired during the period shall be weighted for the portion of the period that they were outstanding. See Example 1 (paragraph 260-10-55-38) for an illustration of this guidance.
During the requisite service period or nonemployee’s vesting period, share-based
payment awards do not affect the calculation of basic EPS (other than
the effect of compensation cost as a reduction of income available to
common shareholders) unless such awards are participating securities.
An entity must apply the two-class method when calculating basic and
diluted EPS for such awards (see Section 12.4.3).
Once the good has been delivered, the service has been rendered, or the revenue
related to the sales incentive has been recognized, vested awards that
are considered outstanding common shares affect the denominator in the
calculation of basic EPS. That is, such awards will be included in the
weighted-average number of common shares from the date on which they
become vested outstanding common shares. If the awards do not become
outstanding common shares during the period and are not considered
participating securities, they generally are not included in the
calculation of basic EPS. However, contingently issuable shares should
be included in the denominator of basic EPS when there are no
circumstances in which those shares would not be issued.
Connecting the Dots
Employee awards of shares that vest when the
grantee becomes eligible for retirement must be considered
outstanding shares in the denominator of basic EPS as of
the date on which the grantee is eligible to retire and
retain the shares. This is because, once the employee is
eligible to retire, there are no conditions that must be
met for the common stock to be issued. Such shares are not
considered contingently issuable shares since an agreement
that requires an entity to issue common shares only after
the mere passage of time is not considered a contingently
issuable share arrangement. In other words, no remaining
service period is associated with the issuance of the
shares since the holder can retire at any time and receive
the shares.
Share-based payment awards often contain clawback features. See Section 3.9 for a discussion of such features. Because clawback features are protective provisions, ASC 718 requires that the effect of a clawback feature be accounted for only when the contingent event that triggers the clawback occurs. In a manner consistent with this guidance, vested common shares issued in a share-based payment transaction should be considered outstanding shares in the calculation of basic EPS from the date vesting is complete. It would not be appropriate to exclude such common shares from the denominator of the calculation of basic EPS on the basis of the guidance in ASC 260 on contingently issuable (returnable) shares. This conclusion is consistent with paragraph 92 of the Background Information and Basis for Conclusions of FASB Statement 128, which indicates that vested shares for which the consideration has been received should be included in the calculation of basic EPS. It is also consistent with informal discussions with the FASB staff.
12.4.2 Diluted EPS
ASC 260-10
Computation of Diluted EPS
45-16 The computation of
diluted EPS is similar to the computation of basic
EPS except that the denominator is increased to
include the number of additional common shares
that would have been outstanding if the dilutive
potential common shares had been issued. In
computing the dilutive effect of convertible
securities, the numerator is adjusted in
accordance with the guidance in paragraph
260-10-45-40. Adjustments also may be necessary
for certain contracts that provide the issuer or
holder with a choice between settlement methods.
See Example 1 (paragraph 260-10-55-38) for an
illustration of this guidance.
No Antidilution
45-17 The computation of diluted EPS shall not assume conversion, exercise, or contingent issuance of securities that would have an antidilutive effect on EPS. Shares issued on actual conversion, exercise, or satisfaction of certain conditions for which the underlying potential common shares were antidilutive shall be included in the computation as outstanding common shares from the date of conversion, exercise, or satisfaction of those conditions, respectively. In determining whether potential common shares are dilutive or antidilutive, each issue or series of issues of potential common shares shall be considered separately rather than in the aggregate.
45-18 Convertible securities
may be dilutive on their own but antidilutive when
included with other potential common shares in
computing diluted EPS. To reflect maximum
potential dilution, each issue or series of issues
of potential common shares shall be considered in
sequence from the most dilutive to the least
dilutive. That is, dilutive potential common
shares with the lowest earnings per incremental
share shall be included in diluted EPS before
those with a higher earnings per incremental
share. Example 4 (see paragraph 260-10-55-57)
illustrates that provision. Options and warrants
generally will be included first because use of
the treasury stock method does not affect the
numerator of the computation. An entity that
reports a discontinued operation in a period shall
use income from continuing operations (adjusted
for preferred dividends as described in paragraph
260-10-45-11) as the control number in determining
whether those potential common shares are dilutive
or antidilutive. That is, the same number of
potential common shares used in computing the
diluted per-share amount for income from
continuing operations shall be used in computing
all other reported diluted per-share amounts even
if those amounts will be antidilutive to their
respective basic per-share amounts. (See paragraph
260-10-45-3.) The control number excludes income
from continuing operations attributable to the
noncontrolling interest in a subsidiary in
accordance with paragraph 260-10-45-11A. Example
14 (see paragraph 260-10-55-90) provides an
illustration of this guidance.
45-19 Including potential common shares in the denominator of a diluted per-share computation for continuing operations always will result in an antidilutive per-share amount when an entity has a loss from continuing operations or a loss from continuing operations available to common stockholders (that is, after any preferred dividend deductions). Although including those potential common shares in the other diluted per-share computations may be dilutive to their comparable basic per-share amounts, no potential common shares shall be included in the computation of any diluted per-share amount when a loss from continuing operations exists, even if the entity reports net income.
45-20 The control number for determining whether including potential common shares in the diluted EPS computation would be antidilutive should be income from continuing operations (or a similar line item above net income if it appears on the income statement). As a result, if there is a loss from continuing operations, diluted EPS would be computed in the same manner as basic EPS is computed, even if an entity has net income after adjusting for a discontinued operation. Similarly, if an entity has income from continuing operations but its preferred dividend adjustment made in computing income available to common stockholders in accordance with paragraph 260-10-45-11 results in a loss from continuing operations available to common stockholders, diluted EPS would be computed in the same manner as basic EPS.
Conversion Rate or Exercise Price
45-21A
Changes in an entity’s share price may affect the
exercise price of a financial instrument or the
number of shares that would be used to settle the
financial instrument. For example, when the
principal of a convertible debt instrument is
required to be settled in cash but the conversion
premium is required to (or may) be settled in
shares, the number of shares to be included in the
diluted EPS denominator is affected by the
entity’s share price. In applying both the
treasury stock method and the if-converted method
of calculating diluted EPS, the average market
price shall be used for purposes of calculating
the denominator for diluted EPS when the number of
shares that may be issued is variable, except for
contingently issuable shares within the scope of
the guidance in paragraphs 260-10-45-48 through
45-57. See paragraphs 260-10-55-4 through 55-5 for
implementation guidance on determining an average
market price.
While share-based payment awards do not affect the calculation of basic EPS
(other than the effect of compensation cost as a reduction of income
available to common shareholders) during the requisite service period
or nonemployee’s vesting period (unless the award is a participating
security), an entity generally includes them in the denominator when
calculating diluted EPS if the effect is dilutive on the basis of the
antidilution sequencing requirements of ASC 260. Further, awards
(e.g., stock options or warrants) that do not become outstanding
common shares when the good is delivered or the service is rendered,
and that are not considered participating securities, are not included
in the calculation of basic EPS but may be included in the denominator
of diluted EPS before they are settled (e.g., are exercised, are
canceled, or expire).
An entity may change the terms or conditions of a
share-based payment award. ASC 718-20-35-3 states, in part, that
“[e]xcept as described in paragraph 718-20-35-2A, a modification of
the terms or conditions of an equity award shall be treated as an
exchange of the original award for a new award.” ASC 718-30-35-5
contains similar guidance for liability-classified awards and states,
in part, that “[a] modification of a liability award is accounted for
as the exchange of the original award for a new award.” In accordance
with this guidance, a modification of a share-based payment award that
is not subject to the exception in ASC 718-20-35-2A is treated as a
cancellation of the existing award and the issuance of a new award. In
a manner consistent with the guidance in ASC 718, an entity should
treat the original and modified awards as two separate awards in
calculating diluted EPS. Thus, when the treasury stock method applies
to a modified share-based payment award, an entity would perform the
following two treasury stock method calculations:
-
Calculations based on the terms of the award and the average market price of the entity’s common stock for the period during the financial reporting period before the modification (weighted, as appropriate, for the period).
-
Calculations based on the terms of the award and the average market price of the entity’s common stock for the period during the financial reporting period after the modification (weighted, as appropriate, for the period).
The sum of these two calculations will equal the incremental common
shares that are included in the calculation of diluted EPS for the
period.
ASC 718-20-35-2A addresses situations in which an entity modifies a
share-based payment award but is not required to apply modification
accounting. Entities will need to consider the specific facts and
circumstances associated with such types of modifications to determine
whether they should be treated as a single award or two separate
awards in the calculation of diluted EPS in the period that includes
the change to the terms or conditions of the award.
12.4.2.1 Treasury Stock Method
ASC 260-10
Options, Warrants, and Their Equivalents and the Treasury Stock Method
45-22 The dilutive effect of outstanding call options and warrants (and their equivalents) issued by the reporting entity shall be reflected in diluted EPS by application of the treasury stock method unless the provisions of paragraphs 260-10-45-35 through 45-36 and 260-10-55-8 through 55-11 require that another method be applied. Equivalents of options and warrants include nonvested stock granted under a share-based payment arrangement, stock purchase contracts, and partially paid stock subscriptions (see paragraph 260-10-55-23). Antidilutive contracts, such as purchased put options and purchased call options, shall be excluded from diluted EPS.
45-23 Under the treasury
stock method:
- Exercise of options and warrants shall be assumed at the beginning of the period (or at time of issuance, if later) and common shares shall be assumed to be issued.
- The proceeds from exercise shall be assumed to be used to purchase common stock at the average market price during the period. (See paragraphs 260-10-45-29 and 260-10-55-4 through 55-5.)
- The incremental shares (the difference between the number of shares assumed issued and the number of shares assumed purchased) shall be included in the denominator of the diluted EPS computation.
Example 15 (see paragraph
260-10-55-92) provides an illustration of this
guidance. See paragraph 260-10-45-21A if the
exercise price of a financial instrument or the
number of shares that would be used to settle the
financial instrument is variable.
45-24 Paragraph not used.
45-25 Options and warrants will have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options or warrants (they are in the money). Previously reported EPS data shall not be retroactively adjusted as a result of changes in market prices of common stock.
45-26 Dilutive options or warrants that are issued during a period or that expire or are cancelled during a period shall be included in the denominator of diluted EPS for the period that they were outstanding. Likewise, dilutive options or warrants exercised during the period shall be included in the denominator for the period prior to actual exercise. The common shares issued upon exercise of options or warrants shall be included in the denominator for the period after the exercise date. Consequently, incremental shares assumed issued shall be weighted for the period the options or warrants were outstanding, and common shares actually issued shall be weighted for the period the shares were outstanding.
45-27 Paragraphs 260-10-55-3 through 55-11 provide additional guidance on the application of the treasury stock method.
Share-Based Payment Arrangements
45-28 The provisions in
paragraphs 260-10-45-28A through 45-31 apply to
share-based awards issued to grantees under a
share-based payment arrangement in exchange for
goods and services or as consideration payable to
a customer.
45-28A Awards of share options and nonvested shares (as defined in Topic 718) to be issued to a grantee under a share-based payment arrangement are considered options for purposes of computing diluted EPS. Such share-based awards shall be considered to be outstanding as of the grant date for purposes of computing diluted EPS even though their exercise may be contingent upon vesting. Those share-based awards are included in the diluted EPS computation even if the grantee may not receive (or be able to sell) the stock until some future date. Accordingly, all shares to be issued shall be included in computing diluted EPS if the effect is dilutive. The dilutive effect of share-based payment arrangements shall be computed using the treasury stock method. If the equity share options or other equity instruments are outstanding for only part of a period, the shares issuable shall be weighted to reflect the portion of the period during which the equity instruments were outstanding. See Example 8 (paragraph 260-10-55-68).
45-28B In applying the treasury stock method, all dilutive potential common shares, regardless of whether they are exercisable, are treated as if they had been exercised. The treasury stock method assumes that the proceeds upon exercise are used to repurchase the entity’s stock, reducing the number of shares to be added to outstanding common stock in computing EPS.
An entity generally includes the dilutive effect of share-based payment awards
(e.g., restricted stock, stock options) in the denominator of
the calculation of diluted EPS by applying the treasury stock
method, under which it is assumed that any service condition
will be met. When applying the treasury stock method to a stock
option, the entity assumes that two hypothetical transactions
have occurred. The first is the hypothetical exercise of the
award (or, for a restricted stock award, the hypothetical
vesting of the award); the second is the hypothetical repurchase
of shares at the average market price during the period by using
the assumed proceeds that will be generated from the
hypothetical exercise of the award (or, for a restricted stock
award, the hypothetical vesting for the award). The incremental
shares that would be hypothetically issued are the number of
shares assumed to be issued upon exercise of the award (or, for
a restricted stock award, the vesting of the award) in excess of
the number of shares assumed to be repurchased with the assumed
proceeds. The incremental shares are included in the number of
diluted potential common shares as a component of the
denominator in the calculation of diluted EPS.
While the treasury stock method applies to both vested and unvested stock
options, it is used for such awards only when the average market
price of the entity’s common stock during the period exceeds the
exercise price of the awards (i.e., the award is in-the-money)
on an award-by-award basis. Thus, an entity needs to perform a
separate treasury stock method calculation for each individual
in-the-money award. An entity would perform the same calculation
for awards that are granted on the same day with the same terms
and conditions (the awards would presumably have the same
grant-date fair-value-based measure). Out-of-the-money awards
are considered antidilutive and excluded from the denominator in
the calculation of diluted EPS. The determination of whether an
award is in-the-money or out-of-the-money is made on an
individual-award basis.
12.4.2.1.1 Assumed Proceeds
ASC 260-10
45-29 In applying the treasury stock method described in
paragraph 260-10-45-23, the assumed proceeds shall be the sum of both of the following:
-
The amount, if any, the grantee must pay upon exercise.
-
The amount of cost attributed to share-based payment awards (within the scope of Topic 718 on stock compensation) not yet recognized. This amount includes share-based payment awards that are not contingent upon satisfying certain conditions as described in paragraph 260-10-45-32 and contingently issuable shares that have been determined to be included in the computation of diluted EPS as described in paragraphs 260-10-45-48 through 45-57.
-
Subparagraph superseded by Accounting Standards Update No. 2016-09.
45-29A Under paragraphs 718-10-35-1D and 718-10-35-3, the effect of forfeitures is taken into account by recognizing compensation cost for those instruments for which the employee’s requisite service has been rendered or the nonemployee’s vesting conditions have been met and no compensation cost shall be recognized for instruments that grantees forfeit because a service or performance condition is not satisfied. See Example 8 (paragraph 260-10-55-68) for an illustration of this guidance.
When determining the amount of assumed proceeds that a share-based payment award
will generate, an entity aggregates (1) the exercise price
of the award, if any, and (2) the average amount of
compensation cost attributed to share-based payment awards
not yet recognized.1 Because there is no exercise price for restricted
stock awards, the entity includes in the assumed proceeds
only the average amount of unrecognized compensation cost
attributed to future goods or services not yet
recognized.
12.4.2.1.2 Period Outstanding
An entity must take into account the amount of time a share-based payment award
was outstanding during the reporting period. If an award
was outstanding for the entire reporting period, the
incremental shares determined under the treasury stock
method are included in the calculation of diluted EPS for
the entire reporting period. By contrast, if an award was
exercised (or, for a restricted stock award, becomes
vested) or forfeited during the reporting period, the
incremental shares are included only for the period in
which the award was outstanding when the treasury stock
method is applied. Once the award is exercised (or, for a
restricted stock award, becomes vested), the shares issued
are considered outstanding common shares and are included
in the weighted-average number of common shares
outstanding (i.e., the denominator in the calculation of
basic and diluted EPS).
12.4.2.1.3 Quarter-to-Date Versus Year-to-Date Calculations
ASC 260-10
Applying the Treasury Stock Method:
Year-to-Date Computations
55-3 The number of
incremental shares included in quarterly diluted
EPS shall be computed using the average market
prices during the three months included in the
reporting period. For year-to-date diluted EPS,
the number of incremental shares to be included in
the denominator shall be determined by computing a
year-to-date weighted average of the number of
incremental shares included in each quarterly
diluted EPS computation. Example 1 (see paragraph
260-10-55-38) provides an illustration of that
provision.
55-3A Computation of year-to-date diluted EPS when an entity has a year-to-date loss from continuing operations including one or more quarters with income from continuing operations and when in-the-money options or warrants were not included in one or more quarterly diluted EPS computations because there was a loss from continuing operations in those quarters is as follows. In computing year-to-date diluted EPS, year-to-date income (or loss) from continuing operations shall be the basis for determining whether or not dilutive potential common shares not included in one or more quarterly computations of diluted EPS shall be included in the year-to-date computation.
55-3B Therefore:
- When there is a year-to-date loss, potential common shares should never be included in the computation of diluted EPS, because to do so would be antidilutive.
- When there is year-to-date income, if in-the-money options or warrants were excluded from one or more quarterly diluted EPS computations because the effect was antidilutive (there was a loss from continuing operations in those periods), then those options or warrants should be included in the diluted EPS denominator (on a weighted-average basis) in the year-to-date computation as long as the effect is not antidilutive. Similarly, contingent shares that were excluded from a quarterly computation solely because there was a loss from continuing operations should be included in the year-to-date computation unless the effect is antidilutive.
Example 12 (see paragraph 260-10-55-85) illustrates this guidance.
When applying the treasury stock method to a quarterly period, an entity should
use the average market price for the period to determine
the number of incremental shares to include in the
denominator of the calculation of diluted EPS. That is,
the entity calculates the number of incremental shares for
the quarterly period as though that period is a discrete
period. By contrast, in the denominator of the calculation
of diluted EPS for the year-to-date period, an entity
includes a weighted-average number of incremental shares
for each of the quarterly periods. The average market
price for the year-to-date period is not used as though
the year-to-date period was a separate discrete period.
Example 1 in ASC 260-10-55-38 through 55-50 and Example 12
in ASC 260-10-55-85 through 55-87 illustrate
quarter-to-date and year-to-date EPS calculations.
12.4.2.1.4 Forfeitures
ASC 718 allows an entity to make an entity-wide accounting policy election to
either (1) estimate the number of awards that are expected
to vest or (2) account for forfeitures when they occur.
The entity’s election will affect the amount of
compensation cost included in income available to common
shareholders (the numerator in the calculation of diluted
EPS). However, regardless of the entity’s policy election,
the denominator in the calculation of diluted EPS is based
on the actual number of awards
outstanding (i.e., the number of awards is reduced only
for actual forfeitures) in a given reporting period
provided that the effect is dilutive. Once an entity has
determined the number of outstanding awards that will have
a dilutive effect on the calculation of diluted EPS, the
entity then uses the treasury stock method to determine
the number of incremental shares to include in the
denominator of the calculation of diluted EPS.
For example, an entity that elects to estimate forfeitures may determine that
only 90 percent of the share-based payment awards issued
to grantees are expected to eventually vest even though
none have actually been forfeited yet. Accordingly, only
90 percent of the awards’ fair-value-based measure is
recognized as compensation cost over the requisite service
period or nonemployee’s vesting period. However, when
determining the number of incremental shares to include in
the denominator of the calculation of diluted EPS, an
entity must assume that all
outstanding dilutive awards that contain only a service
condition will vest or become exercisable. Therefore, when
calculating diluted EPS, the entity must (1) determine the
number of all outstanding awards that are dilutive and (2)
apply the treasury stock method.
When the treasury stock method is applied, the assumed proceeds are also
calculated on the basis of the actual number of all outstanding dilutive awards
regardless of the entity’s forfeiture policy election or
whether certain of those awards are not expected to
eventually vest. The amount of average unrecognized cost
is therefore based on the total number of outstanding
dilutive awards at the beginning of the period and at the
end of the period.
12.4.2.1.5 Treasury Stock Method Examples
The examples below illustrate the application of the treasury stock method to
share-based payment awards in the calculation of diluted
EPS.
ASC 260-10
Example 8: Application of the Treasury Stock Method to a Share-Based Payment Arrangement
55-68 This Example illustrates the guidance in paragraph 260-10-45-28A for the application of the treasury stock method when share options are forfeited.
55-69 Entity A adopted a share option plan on January 1, 20X7, and granted 900,000 at-the-money share options with an exercise price of $30. All share options vest at the end of three years (cliff vesting). Entity A’s accounting policy is to estimate the number of forfeitures expected to occur in accordance with paragraph 718-10-35-1D or 718-10-35-3. At the grant date, Entity A assumes an annual forfeiture rate of 3 percent and therefore expects to receive the service for 821,406 [900,000 × (.97 to the third power)] share options. On January 1, 20X7, the fair value of each share option granted is $14.69. Grantees forfeited 15,000 stock options ratably during 20X7.
55-69A The average stock price during 20X7 is $44. Net income for the period is $97,385,602. For the year ended December 31, 20X7, there are 25,000,000 weighted-average common shares outstanding. This guidance also applies if the service inception date precedes the grant date.
55-70 The following table illustrates computation of basic and diluted EPS for the year ended December 31, 20X7.
Example 12-1
Employee Stock Options — No Exercises or
Forfeitures During the Period
Assume the following about Entity A:
-
Entity A has net income of $5 million, as well as 1 million common shares outstanding, for the entire year ended December 31, 20X2.
-
As of December 31, 20X2, A also has 100,000 employee stock options outstanding. All the stock options were granted on January 1, 20X1, and vest solely on the basis of a two-year service condition. On December 31, 20X1, 50,000 stock options vested. The remaining 50,000 stock options vest on December 31, 20X2. All options are still outstanding on December 31, 20X2 (i.e., none have been exercised).
-
All the stock options have an exercise price of $10 per option and a grant-date fair-value-based measure of $2 per option.
-
Entity A recognizes compensation cost for these stock options on a straight-line basis over the service period from January 1, 20X1, to December 31, 20X2.
-
The average market price of A’s common stock for the year ended December 31, 20X2, was $15 per share.
Note that in the above calculation of diluted EPS, year-to-date amounts are used
for simplicity. ASC 260-10-55-3 states, in part,
“For year-to-date diluted EPS, the number of
incremental shares to be included in the
denominator shall be determined by computing a
year-to-date weighted average of the number of
incremental shares included in each quarterly
diluted EPS computation.” For example, assume that
when applying the treasury stock method, A
determined that it must include 10,000 and 15,000
incremental shares in the denominator of the
calculation of diluted EPS for its first and
second quarter, respectively. When calculating the
number of incremental shares to include in the
denominator for the year-to-date six-month period,
A would assign equal weight to the 10,000 and
15,000 incremental shares. Therefore, 12,500
incremental shares [(10,000 + 15,000) ÷ 2] are
included in the denominator of the calculation of
diluted EPS for the year-to-date six-month
period.
The example below illustrates the application of the treasury stock method to
stock option awards when a portion of the awards was
exercised during the period. Once the awards are
exercised, the shares issued are considered outstanding
common shares and are included in the weighted-average
number of common shares outstanding (i.e., the denominator
in the calculation of basic EPS).
Example 12-2
Employee Stock Options — Exercises During
the Period
Assume the same facts as in Example 12-1, except that the 50,000 employee stock options that vested on December 31, 20X1, were exercised on June 30, 20X2.
Entity A calculates diluted EPS as follows:
As noted in Example 12-1, the above
calculation of diluted EPS is a simplified annual
calculation that does not take into account
interim calculations of diluted EPS as required by
ASC 260-10-55-3. The above calculation is further
simplified because of how exercises during the
period are factored into the calculation. In the
above example, the “weighting” effect on
incremental common shares for stock options
exercised during the period is factored into the
calculation by weighting the number of stock
options outstanding during the entire period
(i.e., one treasury stock method calculation is
performed to calculate the diluted impact of all
stock options). A more precise way to factor in
stock options exercised during the period is to
perform two calculations under the treasury stock
method — one for stock options that were
outstanding for the entire period and one for
stock options that were exercised during the
period. Under this approach, the “weighting”
effect on incremental common shares for stock
options exercised during the period is captured by
multiplying the incremental common shares by a
factor (i.e., percentage) that is determined on
the basis of the period during which the options
were outstanding.
While the more precise calculation may yield
results that do not differ from those under the
simplified approach, an entity should consider its
specific facts and circumstances in determining
when a simplified approach is appropriate. In some
circumstances, a simplified approach could result
in exclusion of the dilutive effect of awards that
were not outstanding during the entire period
because of a difference between the average stock
price during the entire reporting period and the
average stock price during the period in which the
awards were outstanding.
The example below illustrates the application of the treasury stock method to
stock option awards when there is a forfeiture during the
period.
Example 12-3
Employee Stock Options — Forfeitures During
the Period
Assume the following:
- Entity A has net income of $1 million for the quarter ended March 31, 20X1, as well as 100,000 common shares outstanding for the entire period from January 1, 20X1, to March 31, 20X1.
- On January 1, 20X1, A granted 10,000 employee stock options to 10 employees (1,000 stock options each).
- All the stock options have an exercise price of $5 per option and a grant-date fair-value-based measure of $1 per option, and they cliff vest after two years of service.
- The average market price of A’s common stock for the three-month period ended March 31, 20X1, was $6.50 per share.
- Entity A has a policy of estimating forfeitures, and it estimates that 8,000 of the stock options will eventually vest. It therefore has accrued compensation cost on the basis of this forfeiture estimate.
- On February 1, 20X1, an employee terminates and forfeits 1,000 stock options.
Entity A calculates the number of incremental shares to include in the
denominator of the calculation of diluted EPS
under the treasury stock method, as well as
diluted EPS (for the three-month period ended
March 31, 20X1), as follows:
Note that A must base the calculation of diluted EPS on the actual number of
awards outstanding (i.e., actual forfeitures) in a
given reporting period rather than on its estimate
of the number of awards expected to forfeit. In
addition, note that the above calculation is
simplified because of how forfeitures during the
period are factored into the calculation. In the
above example, the “weighting” effect on
incremental common shares for stock options
forfeited during the period is factored into the
calculation by weighting the number of stock
options outstanding during the entire period
(i.e., one treasury stock method calculation is
performed to calculate the diluted impact of all
stock options). A more precise way to factor in
stock options forfeited during the period is to
perform two calculations under the treasury stock
method — one for stock options that were
outstanding for the entire period and one for
stock options that were forfeited during the
period. Under this approach, the “weighting”
effect on incremental common shares for stock
options forfeited during the period is captured by
multiplying the incremental common shares by a
factor (i.e., percentage) that is determined on
the basis of the period during which the options
were outstanding.
While the more precise calculation may yield
results that do not differ significantly from
those under the simplified approach, an entity
should consider its specific facts and
circumstances in determining when a simplified
approach is appropriate. In some circumstances, a
simplified approach could result in exclusion of
the dilutive effect of awards that were not
outstanding during the entire period because of a
difference between the average stock price during
the entire reporting period and the average stock
price during the period in which the awards were
outstanding.
12.4.2.2 Service Conditions
ASC 260-10
Treatment of Contingently Issuable Shares in
Weighted-Average Shares Outstanding
45-12C
Contractual agreements (usually associated with
purchase business combinations) sometimes provide
for the issuance of additional common shares
contingent upon certain conditions being met.
Consistent with the objective that basic EPS
should represent a measure of the performance of
an entity over a specific reporting period,
contingently issuable shares should be included in
basic EPS only when there is no circumstance under
which those shares would not be issued and basic
EPS should not be restated for changed
circumstances.
45-13 Shares issuable for little or no cash consideration upon the satisfaction of certain conditions (contingently issuable shares) shall be considered outstanding common shares and included in the computation of basic EPS as of the date that all necessary conditions have been satisfied (in essence, when issuance of the shares is no longer contingent). Outstanding common shares that are contingently returnable (that is, subject to recall) shall be treated in the same manner as contingently issuable shares. Thus, contingently issuable shares include shares that meet any of the following criteria:
- They will be issued in the future upon the satisfaction of specified conditions.
- They have been placed in escrow and all or part must be returned if specified conditions are not met.
- They have been issued but the holder must return all or part if specified conditions are not met.
Share-Based Payment Arrangements
45-32 Fixed grantee stock options (fixed awards) and nonvested stock (including restricted stock) shall be included in the computation of diluted EPS based on the provisions for options and warrants in paragraphs 260-10-45-22 through 45-27. Even though their issuance may be contingent upon vesting, they shall not be considered to be contingently issuable shares (see Section 815-15-55 and paragraph 260-10-45-48). However, because issuance of performance-based stock options (and performance-based nonvested stock) is contingent upon satisfying conditions in addition to the mere passage of time, those options and nonvested stock shall be considered to be contingently issuable shares in the computation of diluted EPS. A distinction shall be made only between time-related contingencies and contingencies requiring specific achievement.
Generally, an entity will use the treasury stock method to determine the number
of common shares related to share-based payment awards with only
a service condition (i.e., no performance or market condition)
to include in the denominator of the calculation of diluted EPS
provided that the awards are dilutive. (See Section
12.4.2.1.5 for examples illustrating the
application of the treasury stock method to share-based payment
awards.)
A restricted stock award is not included in the
denominator of the calculation of basic EPS during the award’s
requisite service period or before the nonemployee award has
vested, even if the shares of stock have been legally issued.
Such shares are considered contingently returnable shares as
described in ASC 260-10-45-13. For example, if the grantee does
not deliver the good or render the service, the shares are
returned to the entity. Once the vesting conditions have been
satisfied, the shares are considered outstanding common shares
and therefore are included in the weighted-average number of
common shares outstanding (i.e., the denominator in the
calculation of basic EPS).
In addition, an unexercised stock option award is not
included in the denominator of the calculation of basic EPS even
if the award is vested. That is, even if an award’s vesting
conditions have been satisfied, an unexercised stock option
(containing an exercise price that is not nominal) is not an
outstanding common share until it is exercised.
However, an award that contains a right to nonforfeitable dividends or dividend
equivalents that participate in undistributed earnings with
common stock is a participating security even before the award’s
vesting conditions are satisfied (i.e., during the vesting
period). Therefore, the issuer is required to apply the
two-class method discussed in Section 12.4.3 when
calculating basic and diluted EPS. When calculating diluted EPS
for unvested awards that are considered participating
securities, an entity must determine which is more dilutive to
apply, the treasury stock method or the two-class method.
In the calculation of diluted EPS, unvested awards and unexercised stock option
awards that vest solely on the basis of a service condition are
included in the denominator of the calculation of diluted EPS
during their requisite service period (or before the nonemployee
award has vested) or during the period the options are
unexercised under the treasury stock method. (See Section
12.4.2.1 for a discussion of the application of
the treasury stock method to share-based payment awards.)
12.4.2.3 Performance and Market Conditions
ASC 260-10
45-31 Awards with a market condition, a performance condition, or any combination thereof (as defined in Topic 718) shall be included in diluted EPS pursuant to the contingent share provisions in paragraphs 260-10-45-48 through 45-57.
45-32 Fixed grantee stock options (fixed awards) and nonvested stock (including restricted stock) shall be included in the computation of diluted EPS based on the provisions for options and warrants in paragraphs 260-10-45-22 through 45-27. Even though their issuance may be contingent upon vesting, they shall not be considered to be contingently issuable shares (see Section 815-15-55 and paragraph 260-10-45-48). However, because issuance of performance-based stock options (and performance-based nonvested stock) is contingent upon satisfying conditions in addition to the mere passage of time, those options and nonvested stock shall be considered to be contingently issuable shares in the computation of diluted EPS. A distinction shall be made only between time-related contingencies and contingencies requiring specific achievement.
Contingently Issuable Shares
45-48 Shares whose issuance is contingent upon the satisfaction of certain conditions shall be considered outstanding and included in the computation of diluted EPS as follows:
- If all necessary conditions have been satisfied by the end of the period (the events have occurred), those shares shall be included as of the beginning of the period in which the conditions were satisfied (or as of the date of the contingent stock agreement, if later).
- If all necessary conditions have not been satisfied by the end of the period, the number of contingently issuable shares included in diluted EPS shall be based on the number of shares, if any, that would be issuable if the end of the reporting period were the end of the contingency period (for example, the number of shares that would be issuable based on current period earnings or period-end market price) and if the result would be dilutive. Those contingently issuable shares shall be included in the denominator of diluted EPS as of the beginning of the period (or as of the date of the contingent stock agreement, if later).
45-49 For year-to-date computations, contingent shares shall be included on a weighted-average basis. That is, contingent shares shall be weighted for the interim periods in which they were included in the computation of diluted EPS.
45-50 Paragraphs 260-10-45-51 through 45-54 provide general guidelines that shall be applied in determining the EPS impact of different types of contingencies that may be included in contingent stock agreements.
45-55 Contingently issuable potential common shares (other than those covered by a contingent stock agreement, such as contingently issuable convertible securities) shall be included in diluted EPS as follows:
- An entity shall determine whether the potential common shares may be assumed to be issuable based on the conditions specified for their issuance pursuant to the contingent share provisions in paragraphs 260-10-45-48 through 45-54.
- If those potential common shares should be reflected in diluted EPS, an entity shall determine their impact on the computation of diluted EPS by following the provisions for options and warrants in paragraphs 260-10-45-22 through 45-37, the provisions for convertible securities in paragraphs 260-10-45-40 through 45-42, and the provisions for contracts that may be settled in stock or cash in paragraph 260-10-45-45, as appropriate.
For share-based payment awards with a performance or market condition, an entity
must first apply the guidance on contingently issuable shares in
ASC 260-10-45-48 through 45-55 to determine whether the awards
should be included in the calculation of diluted EPS for the
reporting period. That is, the entity needs to determine the
number of shares, if any, that would be issuable at the end of
the reporting period if the end of the reporting period were the
end of the contingency period. Once the entity has determined
that the award should be included in the calculation of diluted
EPS for the reporting period, the entity must use the treasury
stock method to determine the number of incremental shares to
include in the denominator of the calculation of diluted
EPS.
An entity may be recording compensation cost for an award that only contains a
performance or market condition because the entity believes that
it is probable that the award will vest (performance condition)
or, for example, that the employee will remain employed for the
derived service period (market condition). However, in such
cases, the incremental shares that would be included in the
denominator of the calculation of diluted EPS would be excluded
if the performance or market condition (i.e., the contingency)
has not been achieved as of the end of that particular reporting
period, under an assumption that the end of the reporting period
is the end of the contingency period.
12.4.2.3.1 Performance-Based Awards
ASC 260-10
45-51 If attainment or maintenance of a specified amount of earnings is the condition and if that amount has been attained, the additional shares shall be considered to be outstanding for the purpose of computing diluted EPS if the effect is dilutive. The diluted EPS computation shall include those shares that would be issued under the conditions of the contract based on the assumption that the current amount of earnings will remain unchanged until the end of the agreement, but only if the effect would be dilutive. Because the amount of earnings may change in a future period, basic EPS shall not include such contingently issuable shares because all necessary conditions have not been satisfied. Example 3 (see paragraph 260-10-55-53) illustrates that provision.
45-54 If the contingency is based on a condition other than earnings or market price (for example, opening a certain number of retail stores), the contingent shares shall be included in the computation of diluted EPS based on the assumption that the current status of the condition will remain unchanged until the end of the contingency period. Example 3 (see paragraph 260-10-55-53) illustrates that provision.
Assume that a stock award legally vests only if an entity’s cumulative net
income at the end of the third annual reporting period
exceeds $10 million. At the end of each reporting period,
the entity assesses whether cumulative net income has
exceeded $10 million as if that reporting date were the
end of the third annual reporting period. If the
performance condition has been met at the end of a
reporting period, the entity includes the award in the
calculation of diluted EPS. To determine the number of
incremental shares of stock to include in the denominator
of the calculation of diluted EPS, the entity applies the
treasury stock method if the effect is dilutive on the
basis of the antidilution sequencing requirements of ASC
260.
However, if the entity’s cumulative net income has not exceeded $10 million at
the end of the reporting period, the entity does not
include the award in the calculation of diluted EPS even
if it is recording compensation cost because it believes
that it is probable that the award will vest (i.e., it is
probable that the performance target will be achieved).
The entity excludes the award from the calculation of
diluted EPS because the performance condition (i.e., the
contingency) has not been met as of the end of that
reporting period.
Example 12-4
Calculating Diluted EPS When Vesting of
Stock Options Is Contingent on Future
Earnings
Assume the following:
- Entity A has net income of $12 million and $5 million for the year and quarter ended December 31, 20X1, respectively, as well as 5 million common shares outstanding for the quarter ended December 31, 20X1.
- On January 1, 20X1, A granted 1 million employee stock options. The stock options vest on December 31, 20X2, if the recipients remain employed and A’s cumulative net income for the two-year period ended December 31, 20X2, equals or exceeds $10 million.
- As of December 31, 20X1, all the stock options remain outstanding.
- The stock options have an exercise price of $10 per option and a grant-date fair-value-based measure of $2 per option.
- The average market price of A’s common stock for the year ended December 31, 20X1, was $15 per share.
If the end of the reporting period (December 31, 20X1) is considered the end of
the contingency period, the performance target is
deemed to be achieved. As a result, A includes the
employee stock options in the calculation of
diluted EPS for the quarter ended December 31,
20X1. To determine the number of incremental
shares to include in the calculation’s
denominator, A must then apply the treasury stock
method if the effect is dilutive.
Entity A calculates diluted EPS under the treasury stock method for the
quarterly period ended December 31, 20X1, as
follows:
Alternatively, assume that A had generated net income of less than $10 million for the year ended
December 31, 20X1. In that case, A excludes the employee stock
options from the calculation of diluted EPS
because the contingency is not deemed to have been
met as of the end of the reporting period.
Therefore, A is not required to determine the
number of incremental shares to include in the
denominator of the calculation of diluted EPS
under the treasury stock method. However, if A
believes that it is probable that the performance
target will be attained by the end of the
performance period (December 31, 20X2), A
recognizes compensation cost over the requisite
service period for the number of awards expected
to vest.
There may be other circumstances in which an entity issues performance-based
awards for which performance is calculated on the basis of
an average metric over several periods. When calculating
whether contingently issuable shares for such awards
should be included in the calculation of diluted EPS, an
entity applies ASC 260-10-45-51 and ASC 260-10-45-54,
which require the entity to assume that the current status
of the condition (e.g., the current amount of earnings)
will remain unchanged until the end of the contingency
period. In addition, footnote (f) to Example 3 in ASC
260-10-55-56 states, in part, that “[p]rojecting future
earnings levels and including the related contingent
shares are not permitted.” While footnote (f) to Example 3
is associated with the calculation of diluted EPS for an
interim period, we believe that it is appropriate to apply
the guidance to both interim and annual periods. Because
the guidance precludes the projection of future earnings
levels, earnings (or any other metric) in future periods
would be presumed to be zero. See further discussion in
Section 4.5.2.3 of Deloitte’s Roadmap
Earnings per Share. See also
the example below.
Example 12-5
Calculating Diluted EPS for an Award That
Vests on the Basis of Average Metrics
On January 1, 20X1, Entity A granted 1 million performance-based RSUs to a group
of its key employees. The RSUs cliff vest on December 31, 20X3, if the recipients
remain employed and A achieves two performance metrics during the three-year period
from January 20X1 to December 20X3: (1) a three-year average revenue growth rate of at
least 10 percent and (2) a three-year average operating margin of at least 6
percent.
The number of contingently issuable shares that
are included in the calculation of diluted EPS is
determined on the basis of the three-year averages
of both the revenue growth rate and operating
margins, which are calculated as follows: (1) the
actual revenue growth rate and operating margin
attained to date and (2) an assumption of zero
revenue growth rate and zero operating margin for
any remaining periods.
Entity A determines the number of shares to include in the calculation of diluted EPS by using the following
assumptions:
December 31, 20X1
No shares are included in the calculation of diluted EPS because:
- The three-year average revenue growth rate of 4 percent [(12% for 20X1 + 0% for 20X2 + 0% for 20X3) ÷ 3 years] is below 10 percent.
- The three-year average operating margin of 2 percent [(6% for 20X1 + 0% for 20X2 + 0% for 20X3) ÷ 3 years] is below 6 percent.
December 31, 20X2
No shares are included in the calculation of diluted EPS because:
- The three-year average revenue growth rate of 7 percent [(12% for 20X1 + 9% for 20X2 + 0% for 20X3) ÷ 3 years] is below 10 percent.
- The three-year average operating margin of 4 percent [(6% for 20X1 + 6% for 20X2 + 0% for 20X3) ÷ 3 years] is below 6 percent.
December 31, 20X3
The 1 million shares are included in the calculation of diluted EPS because:
- The three-year average revenue growth rate of 11 percent [(12% for 20X1 + 9% for 20X2 + 12% for 20X3) ÷ 3 years] is above 10 percent.
- The three-year average operating margin of 7 percent [(6% for 20X1 + 6% for 20X2 + 9% for 20X3) ÷ 3 years] is above 6 percent.
As noted in Example 12-1, in the above example, year-to-date amounts are used for simplicity.
12.4.2.3.2 Market-Based Awards
ASC 260-10
45-52 The number of shares contingently issuable may depend on the market price of the stock at a future date. In that case, computations of diluted EPS shall reflect the number of shares that would be issued based on the current market price at the end of the period being reported on if the effect is dilutive. If the condition is based on an average of market prices over some period of time, the average for that period shall be used. Because the market price may change in a future period, basic EPS shall not include such contingently issuable shares because all necessary conditions have not been satisfied.
45-53 In some cases, the number of shares contingently issuable may depend on both future earnings and future prices of the shares. In that case, the determination of the number of shares included in diluted EPS shall be based on both conditions, that is, earnings to date and current market price — as they exist at the end of each reporting period. If both conditions are not met at the end of the reporting period, no contingently issuable shares shall be included in diluted EPS.
Assume that an award legally vests only if the entity’s share price increases by
more than 20 percent after the grant date. At the end of
each reporting period, the entity would assess whether its
share price has, in fact, increased by more than 20
percent after the grant date. If, at the end of a
reporting period, the market condition has been met, the
entity includes the award in the calculation of diluted
EPS. To determine the number of incremental shares to
include in the denominator of the calculation of diluted
EPS, the entity applies the treasury stock method if the
effect is dilutive on the basis of the antidilution
sequencing requirements of ASC 260.
However, if the entity’s share price has not increased by more than 20 percent
at the end of the reporting period, the award is not
included in the calculation of diluted EPS even if the
entity is recording compensation cost because it believes
that, for example, the employee will remain employed for
the derived service period. The award is excluded because
the market condition (i.e., the contingency) has not been
met as of the end of that reporting period. Moreover, if
an employee does remain employed for the derived service
period, the employee is deemed to have earned (i.e.,
vested in) the award. In this circumstance, the entity
will not reverse any previously recognized compensation
cost even if the market condition is never satisfied. If
the market condition is never satisfied, the shares
issuable under the award will never become issued and
outstanding. Therefore, the shares will never be included
in the weighted-average number of common shares (i.e., the
denominator in the calculation of basic and diluted
EPS).
12.4.3 Participating Securities and the Two-Class Method
ASC 260-10
Participating Securities and the Two-Class Method
45-59A The capital structures of some entities include:
a. Securities that may participate in dividends with common stocks according to a predetermined formula (for example, two for one) with, at times, an upper limit on the extent of participation (for example, up to, but not beyond, a specified amount per share)
b. A class of common stock with different dividend rates from those of another class of common stock but without prior or senior rights.
45-60 The two-class method is an earnings allocation formula that treats a participating security as having rights to earnings that otherwise would have been available to common shareholders but does not require the presentation of basic and diluted EPS for securities other than common stock. The presentation of basic and diluted EPS for a participating security other than common stock is not precluded.
45-60A All securities that meet the definition of a participating security, irrespective of whether the securities are convertible, nonconvertible, or potential common stock securities, shall be included in the computation of basic EPS using the two-class method.
45-60B Under the two-class method:
- Income from continuing operations (or net income) shall be reduced by the amount of dividends declared in the current period for each class of stock and by the contractual amount of dividends (or interest on participating income bonds) that must be paid for the current period (for example, unpaid cumulative dividends). Dividends declared in the current period do not include dividends declared in respect of prior-year unpaid cumulative dividends. Preferred dividends that are cumulative only if earned are deducted only to the extent that they are earned.
- The remaining earnings shall be allocated to common stock and participating securities to the extent that each security may share in earnings as if all of the earnings for the period had been distributed. The total earnings allocated to each security shall be determined by adding together the amount allocated for dividends and the amount allocated for a participation feature.
- The total earnings allocated to each security shall be divided by the number of outstanding shares of the security to which the earnings are allocated to determine the EPS for the security.
- Basic and diluted EPS data shall be presented for each class of common stock.
For the diluted EPS computation, outstanding common shares shall include all potential common shares assumed issued. Example 6 (see paragraph 260-10-55-62) illustrates the two-class method.
45-61 Fully vested
share-based compensation subject to the provisions
of Topic 718, including fully vested options and
fully vested stock, that contain a right to
receive dividends declared on the common stock of
the issuer, are subject to the guidance in
paragraph 260-10-45-60A.
45-61A Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method under the requirements of paragraph 260-10-45-60A.
45-62 Dividends or dividend equivalents transferred to the holder of a convertible security in the form of a reduction to the conversion price or an increase in the conversion ratio of the security do not represent participation rights. This guidance applies similarly to other contracts (securities) to issue an entity’s common stock if these contracts (securities) provide for an adjustment to the exercise price that is tied to the declaration of dividends by the issuer. The scope of the guidance in this paragraph excludes forward contracts to issue an entity’s own equity shares.
45-63 In a forward contract to issue an entity’s own equity shares, a provision that reduces the contract price per share when dividends are declared on the issuing entity’s common stock represents a participation right. Such a provision constitutes a participation right because it results in a noncontingent transfer of value to the holder of the forward contract for dividends declared during the forward contract period. That is, the forward contract holder has a right to participate in the undistributed earnings of the issuing entity because a dividend declaration by the issuing entity results in a transfer of value to the holder of the forward contract through a reduction in the forward purchase price per share. Because that value transfer is not contingent — as opposed to a similar reduction in the exercise price of an option or warrant — the forward contract is a participating security, regardless of whether, during the period the contract is outstanding, a dividend is declared.
45-64 Paragraph superseded by
Accounting Standards Update No. 2020-06.
45-65 Undistributed earnings for a period shall be allocated to a participating security based on the contractual participation rights of the security to share in those current earnings as if all of the earnings for the period had been distributed. If the terms of the participating security do not specify objectively determinable, nondiscretionary participation rights, then undistributed earnings would not be allocated based on arbitrary assumptions. For example, if an entity could avoid distribution of earnings to a participating security, even if all of the earnings for the year were distributed, then no allocation of that period’s earnings to the participating security would be made. Paragraphs 260-10-55-24 through 55-31 provide additional guidance on participating securities and undistributed earnings.
45-66 Under the two-class method the remaining earnings shall be allocated to common stock and participating securities to the extent that each security may share in earnings as if all of the earnings for the period had been distributed. This allocation is required despite its pro forma nature and that it may not reflect the economic probabilities of actual distributions to the participating security holders.
45-67 An entity would allocate losses to a nonconvertible participating security in periods of net loss if, based on the contractual terms of the participating security, the security had not only the right to participate in the earnings of the issuer, but also a contractual obligation to share in the losses of the issuing entity on a basis that was objectively determinable. Determination of whether a participating security holder has an obligation to share in the losses of the issuing entity in a given period shall be made on a period-by-period basis, based on the contractual rights and obligations of the participating security. The holder of a participating security would have a contractual obligation to share in the losses of the issuing entity if either of the following conditions is present:
- The holder is obligated to fund the losses of the issuing entity (that is, the holder is obligated to transfer assets to the issuer in excess of the holder’s initial investment in the participating security without any corresponding increase in the holder’s investment interest).
- The contractual principal or mandatory redemption amount of the participating security is reduced as a result of losses incurred by the issuing entity.
45-68 A convertible participating security should be included in the computation of basic EPS in periods of net loss if, based on its contractual terms, the convertible participating security has the contractual obligation to share in the losses of the issuing entity on a basis that is objectively determinable. The guidance in this paragraph also applies to the inclusion of convertible participating securities in basic EPS, irrespective of the differences that may exist between convertible and nonconvertible securities. That is, an entity should not automatically exclude a convertible participating security from the computation of basic EPS if an entity has a net loss from continuing operations. Determination of whether a participating security holder has an obligation to share in the losses of the issuing entity in a given period shall be made on a period-by-period basis, based on the contractual rights and obligations of the participating security.
45-68A Paragraph not used.
45-68B Paragraph 718-10-55-45 requires that nonrefundable dividends or dividend equivalents paid on awards for which the requisite service is not (or is not expected to be) rendered be recognized as additional compensation cost and that dividends or dividend equivalents paid on awards for which the requisite service is (or is expected to be) rendered be charged to retained earnings. As a result, an entity shall not include dividends or dividend equivalents that are accounted for as compensation cost in the earnings allocation in computing EPS. To do so would include the dividend as a reduction of earnings available to common shareholders from both compensation cost and distributed earnings. Undistributed earnings shall be allocated to all share-based payment awards outstanding during the period, including those for which the requisite service is not expected to be rendered (or is not rendered because of forfeiture during the period, if an entity elects to account for forfeitures when they occur in accordance with paragraph 718-10-35-3). An entity’s estimate of the number of awards for which the requisite service is not expected to be rendered (or no estimate, if the entity has elected to account for forfeitures when they occur in accordance with paragraph 718-10-35-3) for the purpose of determining EPS under this Topic shall be consistent with the estimate used for the purposes of recognizing compensation cost under Topic 718. Paragraph 718-10-35-3 requires that an entity apply a change in the estimate of the number of awards for which the requisite service is not expected to be rendered in the period that the change in estimate occurs. This change in estimate will affect net income in the current period; however, a current-period change in an entity’s expected forfeiture rate would not affect prior-period EPS calculations. See Example 9 for an illustration of this guidance.
45-69 Paragraph not used.
45-70 See Example 9 (paragraph 260-10-55-71) for an illustration of this guidance.
The two-class method is an earnings allocation formula under which a
participating security is treated as having rights to earnings that
would have otherwise been available to common shareholders. Entities
are required to use the two-class method to calculate basic and
diluted EPS if their capital structure includes common stock and
either (1) participating securities or (2) multiple classes of common
stock.
12.4.3.1 Participating Securities
ASC Master Glossary
Participating Security
A security that may participate in
undistributed earnings with common stock, whether
that participation is conditioned upon the
occurrence of a specified event or not. The form
of such participation does not have to be a
dividend — that is, any form of participation in
undistributed earnings would constitute
participation by that security, regardless of
whether the payment to the security holder was
referred to as a dividend.
Provided that an instrument’s participation feature is nondiscretionary and
objectively determinable, the instrument’s classification as a
participating security depends on the participation mechanism
and the nature of the participating instrument. The table below
discusses whether instruments typically included in capital
structures are considered participating securities.
Instrument | Form of “Participation” | Is the Instrument a Participating Security? |
|---|---|---|
Debt instruments | Potential participation is paid in cash or the contractual maturity amount is
increased according to a formula tied to dividends
on common stock. | Yes |
|
Preferred stock
|
Potential participation is paid in cash
according to a formula tied to dividends on common
stock.
|
Yes
|
|
Holders of preferred stock are
entitled to receive a current-period dividend
before holders of common stock can be paid
dividends.
|
No
| |
|
Convertible debt and preferred
stock
| For convertible debt, potential participation is paid in cash or the contractual
maturity amount is increased according to a
formula tied to dividends on common stock.
For convertible preferred stock, potential
participation is paid in cash according to a
formula tied to dividends on common stock.
Preferred stockholders may also be entitled to a
stated return in addition to the dividend
participation. | Yes |
For
convertible debt, potential participation is
achieved through a reduction of the conversion
price or an increase in the conversion ratio.
For convertible preferred stock, potential
conversion is achieved through a reduction of the
conversion price (i.e., an increase in the
conversion ratio). |
No
| |
|
Options or warrants to sell
common stock
| Potential participation is paid in cash according to a formula tied to dividends
on common stock. |
Yes
|
|
Potential participation is
achieved through a reduction of the exercise price
or an increase in the number of shares upon
exercise.
|
No
| |
|
Forward contract to sell
common stock
| Potential participation is achieved through a reduction of the forward price or
an increase in the number of shares under the
forward contract. | It depends. A facts-and-circumstances analysis must be performed |
A formula that adjusts the forward price and the number of shares under the
forward contract, depending on the market price of
the stock as of the date the forward contract is
settled. | It depends. A facts-and-circumstances analysis must be performed |
As noted in the ASC master glossary definition of a participating security, participation does not
need to be in the form of a dividend. Any participation by a
security in the distribution of a company’s earnings (under an
assumption that there is a full distribution of earnings) would
constitute participation, regardless of whether a cash payment
is, or would be accounted for as, a dividend.
Example 12-6
Warrants
on Common Stock With Yield Rights
Entity J issues warrants to
sell common stock that entitle the counterparty to
a yield right, payable in cash, equal to 25
percent of the dividends J pays on its common
stock for each common share into which the
warrants are exercisable. Although the yield right
is not labeled as a dividend, it is a
participation right because the holder of the
warrants is entitled to share in dividends
declared on J’s common stock without exercising
the warrants. Therefore, the two-class method of
calculating EPS must be applied to the warrants.
Regardless of whether J declared any dividends
during the period, it must allocate undistributed
earnings to the warrants.
Note that in this example, the warrants are
considered participating securities regardless of
the extent of participation. That is, because of
the holders’ entitlement to any participation in
dividends (i.e., between 1 and 100 percent), the
warrants meet the definition of a participating
security. However, if dividends paid by an entity
are held in abeyance and paid to a warrant holder
only upon exercise, such warrants would not be
considered participating securities.
12.4.3.1.1 Dividend-Paying Share-Based Payment Awards — Before Vesting
An award is a participating security if, during the vesting period, it contains
a nonforfeitable right to
dividends or dividend equivalents that participate in the
distribution of earnings with common stock. That is, an
award is considered a participating security if it accrues
cash dividends (whether paid or unpaid) any time the
common shareholders receive dividends — when those
dividends do not need to be returned to an entity if the
grantee forfeits the awards. The entity is required to
apply the two-class method when calculating basic and
diluted EPS. By contrast, if the right to dividends or
dividend equivalents is forfeitable with the underlying
award, the award is not considered a participating
security.
12.4.3.1.2 Dividend-Paying Share-Based Payment Awards — After Vesting
ASC 260-10-45-61 states:
Fully vested share-based compensation subject to the provisions of Topic 718,
including fully vested options and fully vested
stock, that contain a right to receive dividends
declared on the common stock of the issuer, are
subject to the guidance in paragraph
260-10-45-60A.
After an award has vested, it is a participating security if it contains a right
to receive dividends or dividend equivalents with common
shareholders, because the right is nonforfeitable when the
award vests. Therefore, an entity must apply the two-class
method when calculating basic and diluted EPS unless the
shares become outstanding common shares. For example, the
two-class method does not apply to a restricted stock
award after a grantee receives outstanding common shares
because the good has been delivered or the service has
been rendered. Once the award becomes outstanding common
shares, the entity includes those shares in the
weighted-average number of common shares outstanding
(i.e., the denominator in the calculation of basic
EPS).
12.4.3.2 Calculation Under the Two-Class Method
When an entity’s capital structure includes
participating securities but only a single class of common
stock, the entity uses the following three-step process to
calculate basic and diluted EPS:
Step 1 | Use the two-class method to calculate basic EPS.2 |
Step 2 | Use the total earnings allocated to the common stock in step 1 to determine
diluted EPS. If the participating security is also
a potential common share, separately perform steps
2a and 2b to determine the dilutive effect. |
Step 2a | Assume that the participating security has been exercised, converted, or issued;
that is, apply the treasury stock method, the
if-converted method, or the contingently issuable
share method. |
Step 2b | Add back the undistributed earnings allocated to the participating security (or
securities) in arriving at basic EPS, and assume
that all other dilutive potential common shares
have been exercised, converted, or issued in the
order in which they are antidilutive. Next,
reallocate the undistributed earnings, including
any additional income that would result from the
exercise, conversion, or issuance of potential
common shares, to the (1) common shares and
potential common shares and (2) participating
security (or securities). |
Step 3 | Determine which step — 2a or 2b — results in the more dilutive effect. |
While an entity is required to present on the face of the income statement basic and diluted EPS for its common stock, the entity is permitted, but not required, to present basic and diluted EPS for a participating security.
The examples below illustrate (1) the calculation of basic and diluted EPS under the two-class method and (2) the use of this three-step process to determine diluted EPS.
Example 12-7
Use of the Two-Class Method to Calculate Basic and Diluted
EPS — Participating Convertible Preferred
Stock
Assume that Entity A has 1 million weighted-average shares of common stock
outstanding for the fiscal year ended December 31,
20X1; a current-period net income of $5 million;
and an effective tax rate of 40 percent.
On January 1, 20X1, A issues 100,000 convertible preferred securities. Each
preferred share is convertible into two shares of
A’s common stock. The preferred shareholders are
entitled to a noncumulative annual dividend of $5
per share before any dividend is paid to the
common shareholders. After the common shareholders
are paid a dividend of $2 per share, the preferred
shareholders participate in any remaining
undistributed earnings on a 40:60 per-share basis
with the common shareholders. Accordingly, the
preferred securities are participating securities
for which A must use the two-class method to
calculate basic and diluted EPS. In fiscal year
20X1, A declares and pays $2.5 million in
dividends (or a $5 dividend for preferred
shareholders and a $2 dividend for common
shareholders).
The calculations under the two-class method are as follows:
Step 1 — Use the two-class method to
calculate basic EPS.
Allocation of undistributed earnings:
|
To participating convertible preferred
shares:
{(0.4 × 100,000 preferred
shares*) ÷ [(0.4 × 100,000 preferred shares*) +
(0.6 × 1,000,000 common shares**)]} × $2,500,000
undistributed earnings*** = $156,250
$156,250 ÷ 100,000
preferred shares* = $1.56 per share
To common shares:
{(0.6 × 1,000,000 common
shares**) ÷ [(0.4 × 100,000 preferred shares*) +
(0.6 × 1,000,000 common shares**)]} × $2,500,000
undistributed earnings*** = $2,343,750
$2,343,750 ÷ 1,000,000
common shares** = $2.34 per share
|
|
* Weighted-average number of participating
convertible preferred shares outstanding.
** Weighted-average number of common shares
outstanding.
*** Total undistributed earnings for the
period.
|
Basic EPS amounts:
Step 2 — Determine diluted EPS.
Step 2a — Use the treasury stock method, the if-converted method, or the
contingently issuable share method to determine
diluted EPS.
Determine the antidilution sequencing:
Since there are no potential common shares other than the participating
convertible preferred shares, A determines that
antidilution sequencing is not required.
Calculation of diluted EPS for the common shares in which the use of the
if-converted method for the participating
convertible preferred shares is assumed:
Step 2b — Use the two-class method to determine diluted EPS.
Because A’s capital structure only includes common shares and participating convertible preferred shares (i.e., there are no other potential common shares), basic and diluted EPS would be the same under the two-class method ($4.34).
Step 3 — Determine which step — 2a or 2b — results in the
more dilutive effect.
In this example, A would disclose an amount of diluted EPS per common share that
would result from applying the if-converted method
($4.17) because that amount is more dilutive than
the amount that would result from applying the
two-class method ($4.34). In accordance with ASC
260-10-45-60, A would be permitted, but not
required, to present basic and diluted EPS for the
participating convertible preferred shares on the
face of the income statement.
Example 12-8
Use of the
Two-Class Method to Calculate Basic and Diluted
EPS — Participating Convertible Preferred Stock
With Convertible Debt and Warrants
Assume that Entity B has 1
million weighted-average common shares stock
outstanding for the fiscal year ended December 31,
20X1; a current-period net income of $5 million;
and an effective tax rate of 40 percent.
On January 1, 20X1, B issues 100,000
convertible preferred securities. Each preferred
share is convertible into two shares of B’s common
stock. The preferred shareholders are entitled to
a noncumulative annual dividend of $5 per share
before any dividend is paid to the common
shareholders. After the common shareholders are
paid a dividend of $2 per share, the preferred
shareholders participate in any remaining
undistributed earnings on a 40:60 per-share basis
with the common shareholders. Accordingly, the
preferred securities are participating securities
for which B must use the two-class method to
calculate basic and diluted EPS. In fiscal year
20X1, B declares and pays $2.5 million in
dividends (or a $5 dividend for preferred
shareholders and a $2 dividend for common
shareholders).
In addition, assume the
following:
-
On January 1, 20X1, B issues warrants to purchase 100,000 shares of its common stock at $50 per share for a period of five years. The average market price of B’s stock price for 20X1 was $60 per share. The warrants do not meet the definition of a participating security.
-
On January 1, 20X1, B issues 10,000 units of convertible bonds with an aggregate par value of $1 million. Each bond is convertible into 10 shares of B’s common stock and bears an interest rate of 3 percent. The convertible bonds do not meet the definition of a participating security.
The calculations under the
two-class method are as follows:
Step 1
— Use the two-class method to calculate basic
EPS.
Allocation of undistributed earnings:
|
To participating convertible
preferred shares:
{(0.4 ×
100,000 preferred shares*) ÷ [(0.4 × 100,000
preferred shares*) + (0.6 × 1,000,000 common
shares**)]} × $2,500,000 undistributed earnings***
= $156,250
$156,250
÷ 100,000 preferred shares* = $1.56 per share
To common shares:
{(0.6 ×
1,000,000 common shares**) ÷ [(0.4 × 100,000
preferred shares*) + (0.6 × 1,000,000 common
shares**)]} × $2,500,000 undistributed earnings***
= $2,343,750
$2,343,750 ÷ 1,000,000 common shares** = $2.34
per share
|
|
* Weighted-average number of
participating convertible preferred shares
outstanding.
** Weighted-average number of
common shares outstanding.
*** Total undistributed
earnings for the period.
|
Basic EPS amounts:
This calculation is the same
as the calculation of basic EPS in Example
12-7, because basic EPS is not affected
by the warrants and convertible debt since neither
security is a participating security.
Step 2
— Determine diluted EPS.
Step 2a — Use the treasury
stock method, the if-converted method, or the
contingently issuable share method to determine
diluted EPS.
Determine the antidilution
sequencing:
Calculation of diluted EPS for
the common shares in which the use of the
if-converted method for the participating
convertible preferred shares is assumed:
Step 2b — Use the two-class
method to determine diluted EPS.
Step 3
— Determine which Step — 2a or 2b — results in the
more dilutive effect.
In this example, B would
disclose an amount of diluted EPS per common share
that would result from applying the if-converted
methods ($3.81) because that amount is more
dilutive than the amount that would result from
applying the two-class method ($3.92). In
accordance with ASC 260-10-45-60, B would be
permitted, but not required, to present basic and
diluted EPS for the participating convertible
preferred shares on the face of the income
statement.
Example 12-9
Use of the Two-Class Method to Calculate Basic and Diluted
EPS — Participating Nonvested Share-Based Payment
Awards
Assume that Entity C has 1 million weighted-average shares of common stock
outstanding for the fiscal year ended December 31,
20X1; a current-period net income of $5 million;
and an effective tax rate of 40 percent.
On January 1, 20X1, C issues 250,000 nonvested share-based payment awards to its
employees. The nonvested shares have a grant-date
fair-value-based measure of $50 per share and vest
at the end of the fourth year of service (i.e.,
cliff vesting). The average market price of A’s
stock price for 20X1 was $60 per share.
Holders of nonvested shares have a nonforfeitable right to receive cash
dividends on a 1:1 per-share basis with the common
shareholders. Accordingly, the nonvested shares
are participating securities for which C must use
the two-class method in calculating basic and
diluted EPS. In fiscal year 20X1, C declares and
pays $2.5 million in dividends for both the common
shares and the nonvested shares.
Step 1 — Use
the two-class method to calculate
basic EPS.
Allocation of undistributed earnings:
|
To shares of restricted stock:
[250,000 shares of
restricted stock* ÷ (250,000 shares of restricted
stock* + 1,000,000 common shares**)] × $2,500,000
undistributed earnings*** = $500,000
$500,000 ÷ 250,000 shares
of restricted stock* = $2.00 per share
To common shares:
[1,000,000 common shares**
÷ (250,000 shares of restricted stock* + 1,000,000
common shares**] × $2,500,000 undistributed
earnings*** = $2,000,000
$2,000,000 ÷ 1,000,000
common shares** = $2.00 per share
|
|
* Weighted-average number of participating
restricted shares outstanding.
** Weighted-average number of common shares
outstanding.
*** Total undistributed earnings for the
period.
|
Basic EPS amounts:
Step 2 — Determine diluted EPS.
Step 2a — Use the treasury stock method, the if-converted method, or the
contingently issuable share method to determine
diluted EPS.
Determine the antidilution sequencing:
Because there are no potential common shares other than the participating
nonvested shares, antidilution sequencing is not
required.
Calculation of diluted EPS for the common shares in which the use of the
treasury stock method for the participating
nonvested shares is assumed:
Step 2b — Use the Two-Class Method to Determine Diluted EPS.
Because A’s capital structure only includes common shares and the participating shares of restricted stock (i.e., there are no other potential common shares), basic and diluted EPS would be the same under the two-class method ($4.00).
Step 3 — Determine which step — 2a or 2b — results in the
more dilutive effect.
In this example, C would disclose an amount of diluted EPS per common share that
would result from applying the two-class method
($4.00) because that amount is more dilutive than
the amount that would result from applying the
treasury stock method ($4.68). In accordance with
ASC 260-10-45-60, C would be permitted, but not
required, to present basic and diluted EPS for the
participating shares of restricted stock on the
face of the income statement.
Example 12-10
Use of the
Two-Class Method to Calculate Basic and Diluted
EPS — Participating Nonvested Share-Based Payment
Awards With Convertible Debt and Warrants
Assume that Entity D has 1 million
weighted-average shares of common stock
outstanding for the fiscal year ended December 31,
20X1; a current-period net income of $5 million;
and an effective tax rate of 40 percent.
On January 1, 20X1, D issues 250,000 nonvested
share-based payment awards to its employees. The
nonvested shares have a grant-date
fair-value-based measure of $50 per share and vest
at the end of the fourth year of service (i.e.,
cliff vesting). The average market price of D’s
stock price for 20X1 is $60 per share. Holders of
nonvested shares have a nonforfeitable right to
receive cash dividends on a 1:1 per-share basis
with the common shareholders. Accordingly, the
nonvested shares are participating securities for
which D must use the two-class method in
calculating basic and diluted EPS. In fiscal year
20X1, D declares and pays $2.5 million in
dividends for both the common shares and the
nonvested shares.
In addition, assume the
following:
-
On January 1, 20X1, D issues warrants to purchase 100,000 shares of its common stock at $40 per share for a period of five years. The warrants do not meet the definition of a participating security.
-
On January 1, 20X1, D issues 10,000 units of convertible bonds with an aggregate par value of $1 million. Each bond is convertible into 10 shares of D’s common stock and bears an interest rate of 3 percent.
Step 1
— Use the two-class Method to compute basic
EPS.
Allocation of undistributed earnings:
|
To shares of restricted stock:
[250,000 shares of
restricted stock* ÷ (250,000 shares of restricted
stock* + 1,000,000 common shares**)] × $2,500,000
undistributed earnings*** = $500,000
$500,000 ÷ 250,000 shares
of restricted stock* = $2.00 per share
To common shares:
[1,000,000 common shares**
÷ (250,000 shares of restricted stock* + 1,000,000
common shares**)] × $2,500,000 undistributed
earnings*** = $2,000,000
$2,000,000 ÷ 1,000,000
common shares** = $2.00 per share
|
|
* Weighted-average number of participating
restricted shares outstanding.
** Weighted-average number of common shares
outstanding.
*** Total undistributed earnings for the
period.
|
Basic EPS amounts:
Note that this calculation is
the same as the calculation of basic EPS in
Example 12-9 because basic EPS is not
affected by the warrants and convertible debt
since neither security is a participating
security.
Step 2
— Determine diluted EPS.
Step 2a — Use the treasury
stock method, the if-converted method, or the
contingently issuable share method to determine
diluted EPS
Determine the antidilution
sequencing:
Calculation of diluted EPS for
the common shares in which the use of the treasury
stock method for the participating nonvested
shares is assumed:
Step 2b — Use the two-class
method to determine diluted EPS.
Step 3
— Determine which Step — 2a or 2b — results in the
more dilutive Effect
In this example, D would use
the two-class method to disclose diluted EPS per
common share ($3.58) because that amount is more
dilutive than the amount that would result from
applying the if-converted method ($4.18). In
accordance with ASC 260-10-45-60, D would be
permitted, but not required, to present basic and
diluted EPS for the participating shares of
restricted stock on the face of the income
statement.
12.4.4 Settlement in Shares or Cash
ASC 260-10
Share-Based Payment
Arrangements
45-30 If share-based payment
arrangements are payable in common stock or in
cash at the election of either the entity or the
grantee, the determination of whether such
share-based awards are potential common shares
shall be made based on the provisions in paragraph
260-10-45-45. If an entity has a tandem award (as
defined in Topic 718) that allows the entity or
the grantee to make an election involving two or
more types of equity instruments, diluted EPS for
the period shall be computed based on the terms
used in the computation of compensation cost for
that period.
Contracts That May Be Settled in Stock or Cash
45-45 The
effect of potential share settlement shall be
included in the diluted EPS calculation (if the
effect is more dilutive) for an otherwise
cash-settleable instrument that contains a
provision that requires or permits share
settlement (regardless of whether the election is
at the option of an entity or the holder, or the
entity has a history or policy of cash
settlement). An example of such a contract
accounted for in accordance with this paragraph
and paragraph 260-10-45-46 is a written call
option that gives the holder a choice of settling
in common stock or in cash. An election to share
settle an instrument, for purposes of applying the
guidance in this paragraph, does not include
circumstances in which share settlement is
contingent upon the occurrence of a specified
event or circumstance (such as contingently
issuable shares). In those circumstances (other
than if the contingency is an entity’s own share
price), the guidance on contingently issuable
shares should first be applied, and, if the
contingency would be considered met, then the
guidance in this paragraph should be applied.
Share-based payment arrangements that are payable
in common stock or in cash at the election of
either the entity or the grantee shall be
accounted for pursuant to this paragraph and
paragraph 260-10- 45-46, unless the share-based
payment arrangement is classified as a liability
because of the requirements in paragraph
718-10-25-15 (see paragraph 260-10-45-45A for
guidance for those instruments). If the payment of
cash is required only upon the final liquidation
of an entity, then the entity shall include the
effect of potential share settlement in the
diluted EPS calculation until the liquidation
occurs.
45-45A For a
share-based payment arrangement that is classified
as a liability because of the requirements in
paragraph 718-10-25-15 and may be settled in
common stock or in cash at the election of either
the entity or the holder, determining whether that
contract shall be reflected in the computation of
diluted EPS shall be prepared on the basis of the
facts available each period. It shall be presumed
that the contract will be settled in common stock
and the resulting potential common shares included
in diluted EPS (in accordance with the relevant
guidance of this Topic) if the effect is more
dilutive. The presumption that the contract will
be settled in common stock may be overcome if past
experience or a stated policy provides a
reasonable basis to conclude that the contract
will be paid partially or wholly in cash.
45-46 A contract that is
reported as an asset or liability for accounting
purposes may require an adjustment to the
numerator for any changes in income or loss that
would result if the contract had been reported as
an equity instrument for accounting purposes
during the period. That adjustment is similar to
the adjustments required for convertible debt in
paragraph 260-10-45-40(b).
45-47 Paragraphs 260-10-55-32 through 55-36A provide additional guidance on contracts that may be settled in stock or cash.
Contracts That May Be Settled in Stock or Cash
55-32
Adjustments shall be made to the numerator for
contracts that are asset or liability classified,
in accordance with Section 815-40-25, but for
which the potential common shares are included in
the denominator in accordance with the guidance in
paragraph 260-10-45-45. For purposes of computing
diluted EPS, the adjustments to the numerator are
only permitted for instruments for which the
effect on net income (the numerator) is different
depending on whether the instrument is accounted
for as an equity instrument or as an asset or
liability (for example, those that are within the
scope of Subtopics 480-10 and 815-40).
Share-based payment awards that cannot be settled in the entity’s shares (e.g.,
liability-classified, cash-settled SARs) are not included in the
denominator of basic or diluted EPS. That is, share-based payment
awards that always must be settled in cash are
not included in the denominator in the EPS calculation. However, the
compensation cost recorded in net income (and therefore income
available to common shareholders) will affect the numerator in the EPS
calculation.
Conversely, a share-based payment award that can be settled in cash or shares is
evaluated under ASC 260-10-45-45 through 45-47. Subject to one
exception, regardless of whether the election to settle in cash or
shares is at the option of the issuing entity or the holder, the
entity must include the incremental number of shares that results from
applying the treasury stock method in the denominator of the
calculation of diluted EPS if the effect is dilutive on the basis of
the antidilution sequencing requirements of ASC 260. If the award is
classified as a liability, an entity may be required to adjust the
numerator in accordance with ASC 260-10-45-46. This adjustment is made
to remove the incremental effect of accounting for the award as a
liability (i.e., so that the numerator reflects only the compensation
cost that would have been recognized if the award had been classified
as equity). In addition, in calculating the average unrecognized cost
of the arrangement under the treasury stock method, the entity should
use the amount of cost that would have been left unrecognized if the
award had been classified as equity.
The one exception to the requirement to assume share settlement is
related to a share-based payment award that is classified as a
liability because of the requirements in ASC 718-10-25-15. For these
awards, if past experience or a stated policy provides a reasonable
basis for an entity to conclude that the arrangement will be settled
in cash, no incremental shares need to be included in the denominator
of the calculation of diluted EPS.3 In addition, no adjustment to the numerator is needed since the
assumed settlement for diluted EPS is aligned with the accounting
classification. See ASC 260-10-45-45A for additional discussion.
Changing Lanes
ASU 2020-06 eliminated the ability to
overcome the presumption of share settlement for contracts
other than share-based payment arrangements. For
share-based payment arrangements, the FASB decided to
retain the existing guidance. Paragraph BC114 of ASU
2020-06 states:
The classification
guidance in Topic 718 is different from the
classification guidance in Subtopic 815-40.
Specifically, the guidance in paragraph 718-10-25-15
states that “. . . if an entity that nominally has
the choice of settling awards by issuing stock
predominantly settles in cash or if the entity
usually settles in cash whenever a grantee asks for
cash settlement, the entity is settling a
substantive liability rather than repurchasing an
equity instrument.” Under current GAAP, a
liability-classified stock-based compensation
arrangement may not be included in diluted EPS
because of the existing guidance on contracts that
may be settled in cash or shares. The Board decided
to retain the current guidance for calculating
diluted EPS for stock-based compensation because
those arrangements are not within the scope of this
project.
12.4.5 Early Exercise of Stock Options
An early exercise refers to a grantee’s ability to change his or her tax position by exercising an option or similar instrument and receiving shares before the good has been delivered or the service has been rendered (i.e., before the award vests). If the employee terminates employment before rendering the requisite service (or a nonemployee forfeits the award before completion of the vesting period), the entity usually can repurchase the shares for either of the following:
- The lesser of the fair value of the shares on the repurchase date or the exercise price of the award.
- The exercise price of the award.
The purpose of the repurchase feature is effectively to require the grantee to satisfy the vesting conditions to receive any economic benefit from the award. Early exercise is therefore not considered to be a substantive exercise for accounting purposes. See Section 3.4.3 for additional information.
12.4.5.1 Basic EPS
The shares issued to a grantee upon an award’s early exercise would not be
considered outstanding for basic EPS purposes until the award’s
vesting conditions have been satisfied. This conclusion is
consistent with the intent of ASC 260-10- 45-13, which is that
shares that are subject to a contingent repurchase provision, as
described above, are excluded from the calculation of basic EPS
until the shares are no longer contingently returnable (i.e.,
the entity’s call option lapses).
However, if the shares subject to repurchase contain nonforfeitable rights to
dividends or dividend equivalents, the shares are participating
securities. That is, an award is considered a participating
security if it accrues cash dividends (whether paid or unpaid)
any time the common shareholders receive dividends that do not
need to be returned to the entity if the grantee forfeits the
award. If legally issued shares are considered participating
securities, the entity must use the two-class method to
calculate basic EPS. See Section 12.4.3 for a
discussion of the two-class method.
12.4.5.2 Diluted EPS
After a grantee early exercises an option, the entity continues to use the
treasury stock method to calculate diluted EPS. When using this
method to calculate the number of incremental shares to be
included in diluted EPS, the entity normally is required to
include the exercise price of the award in the calculation of
assumed proceeds in accordance with ASC 260-10-45-29. (See
Section
12.4.2.1 for a discussion of the application of
the treasury stock method to share-based payment awards.)
However, in this case, because the grantee has early exercised
the award and has therefore already paid cash, (1) there is no
cash that will be received from the grantee in the future and
(2) the cash received hypothetically could have already been
used to repurchase shares during the requisite service period
(or before the nonemployee award has vested). As a result, the
cash received is not included in the calculation of assumed
proceeds.
When calculating diluted EPS for an early exercised award that is considered a
participating security, an entity must determine whether the
treasury stock method or the two-class method is more
dilutive.
12.4.6 Employee Stock Purchase Plans
12.4.6.1 General
An ESPP is a share-based payment plan that is
usually offered to a broad base of employees so that they can
participate in ownership of the entity, generally at a
discounted price. Employees contribute to the plan through
payroll deductions during the purchase period (e.g., six
months). At the end of the purchase period, the employer’s stock
is purchased at the purchase price, which is generally a
discounted price. See Chapter 8 for a
discussion of ESPPs.
The effect that an ESPP has on an entity’s EPS
depends on the terms of the plan. Generally, the participating
employees can choose not to purchase the shares and can have
their withholdings during the purchase period refunded because
either (1) the employees can elect to have previous withholdings
refunded before the end of the purchase period or (2) the shares
will not be purchased if the employee fails to provide the
requisite service (i.e., if the employee terminates employment
before the end of the purchase period). In practice, it is
atypical for an employee’s withholdings during the purchase
period not to be refundable because participants are generally
not allowed to purchase shares at the end of the purchase period
if they are no longer employed by the entity. However, the
section below addresses the EPS accounting for ESPPs for which
the participating employees are unable to receive a refund of
withholdings made during the purchase period.
12.4.6.2 Withholdings Are Not Refundable
If the terms of the ESPP do not allow employees to
choose not to purchase the shares (i.e., an employee’s
participation is irrevocable because the employee is not
entitled to a refund of amounts previously withheld during the
purchase period, regardless of whether the employee is
terminated), the guidance on contingently issuable shares
applies to the calculation of basic and diluted EPS. According
to this guidance, the number of shares, if any, that would be
issuable at the end of the reporting period, under the
assumption that the end of the reporting period is the end of
the purchase period (this number is based on the amounts
withheld by the entity to date), is included in the
weighted-average number of common shares outstanding for basic
and diluted EPS.
12.4.6.3 Withholdings Are Refundable
12.4.6.3.1 Basic EPS
If the terms of the ESPP allow employees to
choose not to purchase the shares (i.e., employees are
entitled to a refund of amounts previously withheld during
the purchase period either at their election or upon
termination of employment), the shares issuable under the
ESPP are treated as employee stock options that are
granted as of the beginning of the purchase period.
Accordingly, the shares issuable under the ESPP are not
included in the denominator of the calculation of basic
EPS until they have been actually issued. The fact that
the shares issuable under the ESPP are not included in
basic EPS during the purchase period is based on the
guidance in ASC 260-10-45-12C on contingently issuable
shares.
12.4.6.3.2 Diluted EPS
As discussed in the previous section, when
the terms of the ESPP allow employees to choose not to
purchase the shares, the shares issuable under the ESPP
are treated as employee stock options that are granted as
of the beginning of the purchase period. Accordingly, the
shares issuable under the ESPP are included in the
denominator of diluted EPS under the treasury stock
method, as discussed in ASC 260-10-45-22 through 45-29A.
To apply the treasury stock method to an ESPP, an entity
must also apply the guidance on contingently issuable
shares, as discussed in ASC 260-10-45-48 and 45-49 and ASC
260-10-45-52.
Because the participants’ ability to purchase shares under an
ESPP is based on a service condition, the grant date and
service inception date are the start date of the purchase
period provided that all conditions for establishing a
grant date have been met. The withholding of amounts from
the employees’ pay during the purchase period merely
represents the funding mechanism for the eventual payment
of the exercise price. This withholding mechanism does not
affect the grant date or service inception date of the
ESPP.
The number of incremental common shares to be included in the
calculation of diluted EPS is based on the number of
shares that would be issuable if the reporting date were
the end of the contingency period (i.e., the purchase
period) in accordance with ASC 260-10-45-52, net of the
hypothetical shares that could be repurchased in
accordance with the treasury stock method. Therefore, the
sponsor of an ESPP must consider each of the following to
calculate the effect of the ESPP on diluted EPS:
- Employee withholdings —
The amount of employee withholdings represents the
exercise price for the shares to be purchased by
employees and is also used to calculate the number
of shares assumed to be issued during the purchase
period. For diluted EPS purposes, this amount
should represent the total amount of employee
withholdings expected to be made during the entire
purchase period.4 To estimate this amount, entities should
consider the elections made by participating
employees. Expected forfeitures may affect the amount of recognized compensation cost during the purchase period but should not be factored into the estimation of employee withholdings. As discussed in Section 12.4.2.1.4, regardless of an entity’s accounting policy election related to how it reflects forfeitures in the recognition of compensation cost, the denominator in the calculation of diluted EPS is based on the actual number of awards outstanding (i.e., the number of awards is reduced only for actual forfeitures) in a given reporting period provided that the effect is dilutive.Changes to employee withholding elections during the purchase period are treated as modifications and are only reflected in EPS prospectively.
- Purchase price formula — The purchase price of an ESPP is generally based on the lesser of the stock price at the beginning of the purchase period and that at the end of the purchase period; therefore, the sponsor will need to consider its stock price as of both the beginning of the purchase period and the end of the reporting period. The stock price as of the end of the reporting period is used as the proxy for the stock price as of the end of the purchase period in accordance with the guidance in ASC 260-10-45-52 on contingently issuable shares. The sponsor would use the lower of these two stock prices to calculate the purchase price when the ESPP allows employees to purchase shares on the basis of a formula that incorporates the lesser of the stock price at the beginning and that at the end of the purchase period.
- Average unrecognized compensation cost — The average amount of unrecognized compensation cost attributable to future service, if any, is a component of the assumed proceeds under the treasury stock method.
The incremental number of common shares
included in diluted EPS is calculated as follows (see also
Example 12-11):
Number of shares assumed issued under the ESPP:
Employee withholdings
(item 1 above) ÷ purchase price (item 2
above)
less
Number of shares assumed repurchased:
Assumed proceeds (i.e.,
employee withholdings [item 1 above] plus average
unrecognized compensation cost [item 3 above]) ÷
average market price of the issuer’s stock for the
reporting period
Connecting the Dots
Unlike an entity’s accounting for diluted EPS for
early exercised stock options, an entity may
include the money withheld (and expected to be
withheld during the remaining purchase period)
from employees’ pay as a component of the assumed
proceeds in calculating diluted EPS for ESPPs.
These withholdings are not considered a prepayment
of the exercise price for diluted EPS purposes
because the entity must refund such amounts to
employees that do not ultimately purchase shares
under the ESPP. (This requirement differs from the
terms of early exercised stock options.)
Example
12-11
Diluted EPS for
ESPP
On July 1, 20X1, Entity A establishes a
qualified ESPP that allows its employees to
purchase shares of its common stock during a
six-month purchase period that begins on July 1,
20X1, and ends on December 31, 20X1. The ESPP
permits A’s employees to elect to withhold up to
10 percent of their salary to purchase A’s common
stock at the end of the purchase period. Employees
may make their election at any time during the
purchase period, but once the election is made it
cannot be changed during the purchase period. The
shares will be purchased at a price per share that
is equal to the lesser of (1) 90 percent of A’s
stock price as of July 1, 20X1, or (2) 90 percent
of A’s stock price as of December 31, 20X1.
Participants are allowed to withdraw from the ESPP
at any time before the end of the purchase period
and are automatically withdrawn if they are
terminated before the end of the purchase period.
For any such withdrawals, A must refund the
amounts withheld from the participant’s pay.
Shares are issued under the ESPP on January 1,
20X2.
Assumptions related to A’s calculation of
diluted EPS for the quarterly period ended
September 30, 20X1, include the following:
- Common stock prices per share:
- July 1, 20X1 — $50.
- September 30, 20X1 — $40.
- Average market price during the period beginning on July 1, 20X1, and ending on September 30, 20X1 — $45.
- Employee payroll withholdings:
- Actual through September 30, 20X1 — $3.5 million.
- Expected from October 1, 20X1, through December 31, 20X1 — $3.7 million.
- Average unrecognized compensation cost for the period — $1.3 million.
The effect on diluted EPS of the ESPP for the
quarterly period ended September 30, 20X1, is
calculated as follows:
The shares issuable under the
ESPP would be included in basic EPS prospectively
once they are issued (i.e., on January 1, 20X2).
While not relevant to this example, if the
purchase period ended during a quarterly financial
reporting period, in addition to including the
shares as outstanding on a weighted-average basis
for the period, an entity would need to include
incremental shares in diluted EPS on a
weighted-average basis for the portion of the
quarterly period for which the shares had not yet
been issued. See Section
4.2.2.1.3.1 of Deloitte’s Roadmap
Earnings per
Share for further discussion.
Connecting the Dots
ASC 260-10-45-21A states:
Changes in an entity’s share
price may affect the exercise price of a financial
instrument or the number of shares that would be
used to settle the financial instrument. For
example, when the principal of a convertible debt
instrument is required to be settled in cash but
the conversion premium is required to (or may) be
settled in shares, the number of shares to be
included in the diluted EPS denominator is
affected by the entity’s share price. In applying
both the treasury stock method and the
if-converted method of calculating diluted EPS,
the average market price shall be used for
purposes of calculating the denominator for
diluted EPS when the number of shares that may be
issued is variable, except for contingently
issuable shares within the scope of the guidance
in paragraphs 260-10-45-48 through 45-57. See
paragraphs 260-10-55-4 through 55-5 for
implementation guidance on determining an average
market price.
In accordance with this guidance, the number of
shares assumed to be issued under an ESPP would be
calculated by using the average market price of
the entity’s stock. However, before ASC
260-10-45-21A was added by ASU 2020-06, entities
applied the guidance on contingently issuable
shares in ASC 260-10-45-52 to calculate the number
of shares assumed to be issued under an ESPP (as
noted in the guidance and example above). This
guidance is consistent with footnote 1 of FASB
Technical Bulletin 97-1 (superseded), which
indicated that an entity applies the guidance on
contingently issuable shares to determine the
accounting for diluted EPS.
On the basis of informal discussions with the
FASB staff, we understand that the amendments made
to ASC 260 by ASU 2020-06 (i.e., the addition of
ASC 260-10-45-21A) were not intended to address
when the guidance on contingently issuable shares
applies to the calculation of diluted EPS. Indeed,
ASC 260-10-45-21A specifically states that these
amendments do not apply to contingently issuable
shares. Therefore, we believe that the accounting
for diluted EPS that entities applied in practice
before adopting ASU 2020-06 is still acceptable.
However, because it is often difficult to
determine when to apply the guidance on
contingently issuable shares in ASC 260, it would
also be acceptable for an entity to apply the
guidance in ASC 260-10-45-21A on variable
denominators to calculate the number of shares
assumed to be issued under an ESPP. Such
accounting for diluted EPS would represent an
accounting policy election that must be applied
consistently.
If ASC 260-10-45-21A is applied
to calculate the number of shares assumed to be
issued in Example 12-11,
the number of shares would equal 177,778 (i.e.,
total expected withholdings of $7,200,000 divided
by $40.50 [$45 average market price for the period
multiplied by 90 percent]). As a result, the ESPP
would be antidilutive for the period since the
number of shares assumed to be repurchased would
be greater than the number of shares assumed to be
issued. This example illustrates that an entity’s
application of ASC 260-10-45-21A to calculate the
number of shares assumed to be issued in an ESPP
would result in less dilution (or no dilution)
compared with application of the contingently
issuable share method.
12.4.7 Redeemable Awards
ASC 260-10
Certain Redeemable Financial Instruments
45-70A Paragraph 480-10-45-4 provides guidance on calculating basic and diluted EPS if an entity has mandatorily redeemable shares of common stock or has entered into certain forward contracts that require physical settlement by repurchase of a fixed number of the issuer’s equity shares of common stock.
ASC 480-10
EPS
45-4 Entities that have
issued mandatorily redeemable shares of common
stock or entered into forward contracts that
require physical settlement by repurchase of a
fixed number of the issuer’s equity shares of
common stock in exchange for cash shall exclude
the common shares that are to be redeemed or
repurchased in calculating basic and diluted
earnings per share (EPS). Any amounts, including
contractual (accumulated) dividends and
participation rights in undistributed earnings,
attributable to shares that are to be redeemed or
repurchased that have not been recognized as
interest costs in accordance with paragraph
480-10-35-3 shall be deducted in computing income
available to common shareholders (the numerator of
the EPS calculation), consistently with the
two-class method set forth in paragraphs
260-10-45-60 through 45-70.
ASC 480-10 — SEC Materials — SEC Staff Guidance
SEC Staff Announcement: Classification and Measurement of Redeemable Securities
S99-3A(21) Common stock instruments issued by a parent (or single reporting entity). Regardless of the accounting method selected in paragraph 15, the resulting increases or decreases in the carrying amount of redeemable common stock should be treated in the same manner as dividends on nonredeemable stock and should be effected by charges against retained earnings or, in the absence of retained earnings, by charges against paid-in capital. However, increases or decreases in the carrying amount of a redeemable common stock should not affect income available to common stockholders. Rather, the SEC staff believes that to the extent that a common shareholder has a contractual right to receive at share redemption (in other than a liquidation event that meets the exception in paragraph 3(f)) an amount that is other than the fair value of the issuer’s common shares, then that common shareholder has, in substance, received a distribution different from other common shareholders. Under Paragraph 260-10-45-59A, entities with capital structures that include a class of common stock with different dividend rates from those of another class of common stock but without prior or senior rights, should apply the two-class method of calculating earnings per share. Therefore, when a class of common stock is redeemable at other than fair value, increases or decreases in the carrying amount of the redeemable instrument should be reflected in earnings per share using the two-class method.FN17 For common stock redeemable at fair valueFN18, the SEC staff would not expect the use of the two-class method, as a redemption at fair value does not amount to a distribution different from other common shareholders.FN19
________________________________________
FN17 The two-class method of computing earnings per share is addressed in Section 260-10-45. The SEC staff believes that there are two acceptable approaches for allocating earnings under the two-class method when a common stock instrument is redeemable at other than fair value. The registrant may elect to: (a) treat the entire periodic adjustment to the instrument’s carrying amount (from the application of paragraphs 14–16) as being akin to a dividend or (b) treat only the portion of the periodic adjustment to the instrument’s carrying amount (from the application of paragraphs 14–16) that reflects a redemption in excess of fair value as being akin to a dividend. Under either approach, decreases in the instrument’s carrying amount should be reflected in the application of the two-class method only to the extent they represent recoveries of amounts previously reflected in the application of the two-class method.
FN18 Common stock that is redeemable based on a specified formula is considered to be redeemable at fair value if the formula is designed to equal or reasonably approximate fair value. The SEC staff believes that a formula based solely on a fixed multiple of earnings (or other similar measure) is not considered to be designed to equal or reasonably approximate fair value.
FN19 Similarly, the two-class method is not required when share-based payment awards granted to employees are redeemable at fair value (provided those awards are in the form of common shares or options on common shares). However, those share-based payment awards may still be subject to the two-class method pursuant to Section 260-10-45.
SAB Topic 14.E requires public entities to consider the requirements of ASR 268 (FRR Section 211) and ASC 480-10-S99-3A for redeemable share-based payment awards. See Section 5.10 for a discussion of the recognition and measurement requirements for redeemable share-based payment awards.
12.4.7.1 Share-Based Payment Awards Redeemable at Fair Value
Share-based payment awards on common shares that are redeemable at fair value
are accounted for in the same manner as common shares that are
redeemable at fair value. In ASC 480-10-S99-3A, the SEC staff
clarified that increases or decreases in the carrying amount of
common shares that are redeemable at fair value do not affect
income available to common shareholders. That is, changes in the
redemption amount do not affect income available to common
shareholders (the numerator in the calculation of basic EPS) if
the redemption value of redeemable shares is based on the fair
value of the shares. When calculating diluted EPS, an entity
must apply the treasury stock method to determine the number of
incremental shares to include in the calculation’s denominator.
See Section
12.4.2.1 for a discussion of the application of
the treasury stock method to share-based payment awards.
12.4.7.2 Share-Based Payment Awards Redeemable at an Amount Other Than Fair Value
Share-based payment awards on common shares that are redeemable at an amount
other than fair value are accounted for in the same manner as
common shares that are redeemable at an amount other than fair
value (e.g., formula price). That is, increases or decreases in
the carrying amount of redeemable share-based payment awards are
reflected in EPS under the two-class method, as discussed in ASC
260-10-45-59A through 45-70. The increase or decrease in the
carrying amount of redeemable share-based payment awards is
treated similarly to the reduction in income from continuing
operations (or net income) from current-period distributions.
See Section
12.4.3 for a discussion of the application of
the two-class method. In calculating diluted EPS, an entity must
determine whether the treasury stock method or the two-class
method is more dilutive. See Section 12.4.2.1 for a
discussion of the application of the treasury stock method to
share-based payment awards.
12.4.7.3 Share-Based Payment Awards Redeemable at Intrinsic Value
The SEC’s guidance in ASC 480-10-S99-3A does not address the EPS treatment of share-based payment awards with a redemption amount that is based on an award’s intrinsic value. Entities may therefore make a policy decision to (1) analogize to the guidance in ASC 480-10-S99-3A on common shares that are redeemable at fair value or (2) treat the increases or decreases in the carrying amount of these awards as an additive or subtractive amount in arriving at income available to common shareholders.
Under the first alternative, the increase or decrease in the carrying amount of
the redeemable share-based payment award (i.e., changes in the
redemption amount) does not affect income available to common
shareholders (the numerator in the calculation of basic EPS).
Under the second alternative, however, such increase or decrease
is treated like a preferential distribution. That is, the entity
accounts for the current-period change in the carrying amount of
the redeemable share-based payment award as an additive or
subtractive amount in arriving at income available to common
shareholders (the numerator in the calculation of basic EPS).
Regardless of the alternative selected, the entity must apply
the treasury stock method to determine the number of incremental
shares to include in the denominator of the calculation of
diluted EPS. See Section 12.4.2.1 for a
discussion of the application of the treasury stock method to
share-based payment awards.
12.4.7.4 Contingently Redeemable Share-Based Payment Awards
Share-based payment awards on common shares that are contingently redeemable at
fair value or at an amount other than the awards’ fair value
(e.g., redeemable upon a change in control) do not affect income
available to common shareholders (the numerator in the
calculation of basic EPS) until it is probable that the
contingency will occur. That is, awards that are contingently
redeemable are not remeasured to their redemption amount until
it is deemed probable that the contingency will occur. When
calculating diluted EPS, an entity must apply the treasury stock
method to determine the number of incremental shares to include
in the denominator of the calculation. See Section
12.4.2.1 for a discussion of the application of
the treasury stock method to share-based payment awards.
12.4.8 Awards of a Consolidated Subsidiary
12.4.8.1 Share-Based Payment Awards Issued by a Consolidated Subsidiary and Settled in the Subsidiary’s Common Shares
ASC 260-10
Securities of Subsidiaries
55-20 The effect on
consolidated EPS of options, warrants, and
convertible securities issued by a subsidiary
depends on whether the securities issued by the
subsidiary enable their holders to obtain common
stock of the subsidiary or common stock of the
parent entity. The following general guidelines
shall be used for computing consolidated diluted
EPS by entities with subsidiaries that have issued
common stock or potential common shares to parties
other than the parent entity
-
Securities issued by a subsidiary that enable their holders to obtain the subsidiary’s common stock shall be included in computing the subsidiary’s EPS data. Those per-share earnings of the subsidiary shall then be included in the consolidated EPS computations based on the consolidated group’s holding of the subsidiary’s securities. Example 7 (see paragraph 260-10-55-64) illustrates that provision.
-
Securities of a subsidiary that are convertible into its parent entity’s common stock shall be considered among the potential common shares of the parent entity for the purpose of computing consolidated diluted EPS. Likewise, a subsidiary’s options or warrants to purchase common stock of the parent entity shall be considered among the potential common shares of the parent entity in computing consolidated diluted EPS. Example 7 (see paragraph 260-10-55-64) illustrates that provision.
55-21 The preceding provisions also apply to investments in common stock of corporate joint ventures and investee companies accounted for under the equity method.
55-22 The if-converted method shall be used in determining the EPS impact of securities issued by a parent entity that are convertible into common stock of a subsidiary or an investee entity accounted for under the equity method. That is, the securities shall be assumed to be converted and the numerator (income available to common stockholders) adjusted as necessary in accordance with the provisions in paragraph 260-10-45-40(a) through (b). In addition to those adjustments, the numerator shall be adjusted appropriately for any change in the income recorded by the parent (such as dividend income or equity method income) due to the increase in the number of common shares of the subsidiary or equity method investee outstanding as a result of the assumed conversion. The denominator of the diluted EPS computation would not be affected because the number of shares of parent entity common stock outstanding would not change upon assumed conversion.
Example 7: Securities of a Subsidiary — Computation of Basic and Diluted EPS
55-64 This Example
illustrates the EPS computations for a
subsidiary’s securities that enable their holders
to obtain the subsidiary’s common stock based on
the provisions in paragraph 260-10-55-20. The
facts assumed are as follows:
55-65 Parent Entity:
- Net income was $10,000 (excluding any earnings of or dividends paid by the subsidiary).
- 10,000 shares of common stock were outstanding; the parent entity had not issued any other securities.
- The parent entity owned 900 common shares of a domestic subsidiary entity.
- The parent entity owned 40 warrants issued by the subsidiary.
- The parent entity owned 100 shares of convertible preferred stock issued by the subsidiary.
55-66 Subsidiary Entity:
- Net income was $3,600.
- 1,000 shares of common stock were outstanding.
- Warrants exercisable to purchase 200 shares of its common stock at $10 per share (assume $20 average market price for common stock) were outstanding.
- 200 shares of convertible preferred stock were outstanding. Each share is convertible into two shares of common stock.
- The convertible preferred stock paid a dividend of $1.50 per share.
- No interentity eliminations or adjustments were necessary except for dividends.
- Income taxes have been ignored for simplicity.
55-67 The following table illustrates subsidiary’s EPS.
Share-based payment awards issued by a consolidated subsidiary that are settled
by issuing the subsidiary’s common shares affect not only the
subsidiary’s calculation of diluted EPS but also the calculation
of the parent’s diluted EPS, as described in ASC 260-10-55-20
through 55-22 and illustrated in Example 7 in ASC 260-10-55-64
through 55-67.
While such awards do not affect the weighted-average number of common shares
outstanding (i.e., the denominator in the calculation of basic
EPS for either the subsidiary or the parent), the compensation
cost associated with these awards (during the requisite service
period or nonemployee’s vesting period) will generally affect
both the subsidiary’s and the parent’s net income or loss.
To calculate the parent’s diluted EPS, the subsidiary must first calculate its
own diluted EPS (regardless of whether the subsidiary reports
EPS). The amount of the subsidiary’s diluted EPS is then
multiplied by the number of the subsidiary’s shares that the
parent is assumed to own (after the hypothetical exercise of the
awards is taken into consideration). The product of those two
amounts is then included in the numerator (as a substitute for
the parent’s proportionate share of the subsidiary’s earnings)
of the calculation of the parent’s diluted EPS.
As noted in ASC 260-10-55-21, the guidance in ASC 260-10-55-20 also applies to investments in common stock of corporate joint ventures and investee companies that are accounted for under the equity method.
Example 12-12
Impact on EPS of Share-Based Payment Awards
Issued by a Subsidiary
Assume that the following apply to Parent P:
- Its net income is $100, excluding any net income or loss of Subsidiary A (i.e., as if A is unconsolidated).
- Throughout the period, 100 shares of its common stock were outstanding. No other securities have been issued.
- It owns 90 of A’s common shares (out of 100 outstanding).
Assume that the following apply to A:
- Its net income is $100 (after intercompany eliminations, etc.).
- Throughout the period, 100 shares of its common stock were outstanding.
- At the beginning of the period, it granted 10 fully vested stock options to its employees to purchase 10 shares of its common stock at $1 per share.
- The average market price of its common stock during the period is $2 per share.
The calculation of A’s diluted EPS is as follows:
The calculation of P’s consolidated diluted EPS is as follows:
12.4.8.2 Share-Based Payment Awards Issued by a Subsidiary but Settled in the Parent’s Common Shares
Share-based payment awards issued by a consolidated subsidiary that are settled
by issuing the parent’s common shares will not affect the
subsidiary’s denominator in the calculation of diluted EPS
because the awards do not represent potential common shares of
the subsidiary. However, during the employee’s requisite service
period or nonemployee’s vesting period, the compensation cost
associated with these awards will affect the subsidiary’s net
income or loss. (See Sections 2.8 and
2.9 for a discussion of the accounting for
share-based payment awards issued by a subsidiary but settled in
the parent’s common shares.)
By contrast, for the parent, the share-based payment awards do represent
potential common shares in the calculation of diluted EPS.
Therefore, the awards are included in the parent’s denominator
of the calculation of diluted EPS under the treasury stock
method. (See Section 12.4.2.1 for a discussion of the
application of the treasury stock method to share-based payment
awards.) Because the subsidiary is recording compensation cost
in its financial statements for these awards during the
requisite service period or nonemployee’s vesting period, the
parent’s proportionate share of the compensation cost will have
been included in the parent’s net income or loss.
Footnotes
1
The inclusion of the average
amount of unrecognized compensation cost
attributed to future goods or services not yet
recognized is unique to share-based payment
awards. That is, this component is only included
in the assumed proceeds for share-based payment
awards.
2
Undistributed losses would
generally not be allocated to share-based payment
awards in accordance with ASC 260-10-45-67 because
such awards typically would not have a
“contractual obligation to share in the losses of
the issuing entity on a basis that was objectively
determinable.” See Example 6 in ASC 260-10-55-62
and 55-63 for an illustration of the use of the
two-class method for calculating basic EPS.
3
An entity would need to have a sufficient
past practice of cash settlement as well as evidence of
its intent to cash-settle the arrangement.
4
The entire purchase period is
considered in the calculation of diluted EPS
because the shares to be purchased under the ESPP
are treated as employee stock options. Therefore,
all amounts to be withheld from employees’ pay to
purchase shares under the ESPP (i.e., withholdings
to date and expected future withholdings during
the remaining purchase period) must be considered
in the calculation of diluted EPS.