10.5 Repurchases and Settlements of Other Equity Instruments
10.5.1 Preferred Stock
ASC 260-10 — SEC Materials — SEC Staff Guidance
SEC Staff Announcement: The Effect on the Calculation of
Earnings per Share for a Period That Includes the
Redemption or Induced Conversion of Preferred Stock . .
.
S99-2 . .
.
The Effect on Income Available to Common Stockholders
of a Redemption or Induced Conversion of Preferred
Stock
If a registrant redeems its preferred stock, the SEC
staff believes that the difference between (1) the fair
value of the consideration transferred to the holders of
the preferred stock and (2) the carrying amount of the
preferred stock in the registrant’s balance sheet (net
of issuance costs) should be subtracted from (or added
to) net income to arrive at income available to common
stockholders in the calculation of earnings per share.
The SEC staff believes that the difference between the
fair value of the consideration transferred to the
holders of the preferred stock and the carrying amount
of the preferred stock in the registrant’s balance sheet
represents a return to (from) the preferred stockholder
that should be treated in a manner similar to the
treatment of dividends paid on preferred stock. This
calculation guidance applies to redemptions of
convertible preferred stock regardless of whether the
embedded conversion feature is “in-the-money” or
“out-of-the-money” at the time of redemption. The fair
value of the consideration transferred is reduced by the
commitment date intrinsic value of the conversion option
if the redemption includes the reacquisition of a
previously recognized beneficial conversion feature in a
convertible preferred stock instrument.
If an SEC registrant redeems a preferred security, the
difference between (1) the fair value of the consideration transferred and (2)
the carrying amount of the preferred security (net of issuance costs) is
subtracted from (or added to) net income to arrive at income available to common
stockholders in the calculation of EPS.14 If the fair value of the consideration transferred exceeds the net
carrying amount of the preferred stock, the excess consideration (the premium
paid) represents a return to the preferred stockholders and is deducted from net
income to arrive at income available to common stockholders (a “deemed
dividend”). If the fair value of the consideration transferred is less than the
net carrying amount of the preferred stock, the discount is added to net income
in arriving at income available to common stockholders (a “deemed
contribution”).
Under ASC 260-10-S99-2, it is presumed that the fair value of the consideration
transferred to holders to redeem a preferred stock instrument reflects the fair
value of the preferred stock that is being redeemed. If the fair value of the
consideration transferred to preferred stockholders does not reflect the fair
value of the redeemed shares, the transaction involves other elements that
should be accounted for in accordance with other GAAP (see Section
10.3.2).
Redemptions of preferred stock include all of the following:
-
A redemption or other settlement of a preferred stock instrument that is classified in equity (whether permanent equity or temporary equity) in return for cash, other securities issued by the entity, or other consideration that is not a conversion, including a redemption or other settlement of a convertible preferred stock instrument that is classified in equity, regardless of whether the embedded conversion option is in-the-money or out-of-the-money on the settlement date.
-
A redemption or other settlement of a derivative instrument indexed to a preferred stock instrument that is classified in equity in return for cash, other securities issued by the entity, or other consideration that is not an exercise in accordance with the instrument’s contractual terms.
-
A modification or exchange of a preferred stock instrument classified in equity (whether permanent equity or temporary equity) that is treated as an extinguishment.
-
A modification or exchange of a freestanding or embedded equity-classified derivative indexed to a preferred stock instrument that is treated as an extinguishment.
-
A reclassification of a preferred stock instrument, including a freestanding derivative indexed to such an instrument, from equity to a liability.
Connecting the Dots
A conditionally redeemable preferred security may become mandatorily
redeemable because of the resolution of a condition associated with
redemption. For example, a convertible preferred share may become
mandatorily redeemable on the date the conversion feature lapses (see
ASC 505-10-35-1). In these situations, the preferred security must be
reclassified from equity (generally, temporary equity) to a liability,
which is initially recognized at fair value in accordance with ASC
480-10-30-2. A reclassification of a preferred security from equity to a
liability is considered a redemption under ASC 260-10-S99-2.
For more information about the accounting for redemptions of preferred stock, see
Section 9.7.1 as well as Section
3.2.2.6 of Deloitte’s Roadmap Earnings per Share.
10.5.2 Contracts on an Entity’s Own Equity
A redemption or settlement of an equity-classified contract on
an entity’s common stock is recognized solely as an equity transaction unless
the amount of the cash or fair value of the other consideration transferred by
the entity exceeds the fair value of the contract on the date of settlement. In
these situations, any excess amount that is not subject to other authoritative
literature must be recognized as either a dividend or an expense (see Section 10.3.2). A redemption or settlement of
an equity-classified contract on an entity’s preferred stock is accounted for in
the same manner as a redemption or settlement of a preferred stock instrument
(see Section 10.5.1).
Footnotes
14
For discussion of excise taxes incurred in conjunction
with redemptions of preferred stock, see Section 10.4.3.2.