9.6 EPS Considerations
9.6.1 Preferred Stock
ASC 480-10 — SEC Materials — SEC Staff Guidance
SEC Staff Announcement: Classification and Measurement of Redeemable Securities
S99-3A(20)
Preferred stock instruments issued by a parent (or
single reporting entity). Regardless of the
accounting method selected in paragraph 15 and the
redemption terms (that is, fixed price or fair value),
the resulting increases or decreases in the carrying
amount of a redeemable instrument other than 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. Increases
or decreases in the carrying amount should reduce or
increase income available to common stockholders in the
calculation of earnings per share . . . . Additionally,
Paragraph 260-10-S99-2, provides guidance on the
accounting at the date of a redemption or induced
conversion of a preferred stock instrument.
SEC Staff Accounting Bulletins
SAB Topic 3.C, Redeemable Preferred
Stock [Reproduced in ASC 480-10-S99-2]
Facts: Rule
5-02.27 of Regulation S-X states that redeemable
preferred stocks are not to be included in amounts
reported as stockholders’ equity, and that their
redemption amounts are to be shown on the face of the
balance sheet. However, the Commission’s rules and
regulations do not address the carrying amount at which
redeemable preferred stock should be reported, or how
changes in its carrying amount should be treated in
calculations of earnings per share . . . .
Question 2: How
should periodic increases in the carrying amount of
redeemable preferred stock be treated in calculations of
earnings per share . . . ?
Interpretive
Response: Each type of increase in carrying
amount described in the Interpretive Response to
Question 1 should be treated in the same manner as
dividends on nonredeemable preferred stock.
In the EPS calculation, changes in the carrying amount of preferred stock
classified as temporary equity are treated as an adjustment to income available
to common stockholders. Thus, an increase in the carrying amount decreases
income available to common stockholders, and a decrease in the carrying amount
increases it. However, the carrying amount generally cannot be reduced to an
amount below the initial carrying amount (see Section 9.5.2). For additional discussion
of the EPS treatment of redeemable preferred stock, see Sections 3.2.2.4 and
4.8.4.3 of
Deloitte’s Roadmap Earnings
per Share.
9.6.2 Common Stock
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
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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.
Changes in the carrying amount of common stock classified as temporary equity (other than a
noncontrolling interest) do not affect income available to common stockholders in the calculation of
EPS. Instead, an entity uses the two-class method under ASC 260-10-45 to reflect such changes unless
the redemption right is for an amount equal to the fair value of the common shares. Accordingly, the
two-class method:
- Applies if the redemption right is for an amount other than fair value (e.g., a fixed price or a price determined on the basis of a non-fair-value formula), because such a right effectively represents a holder right to a distribution (upon redemption) that is different from the distributions to holders of nonredeemable common stock.
- Does not apply if the redemption right is at an amount equal to the fair value of the common stock, because the issuer’s purchase of common stock at fair value conceptually does not represent an economically preferential distribution. While a redemption right at fair value provides the holder with an ability to exit its investment at its current fair value (i.e., liquidity), a redemption would not transfer any value to or from the holder of the redeemable instrument. Accordingly, if the redemption right is at fair value, adjustments to the carrying amount do not affect the calculation of EPS.
If the common stock is redeemable at a fixed amount, it would not be considered redeemable at fair
value, because there is no assurance the fair value on the redemption date will equal the fixed amount.
If the common stock is redeemable at an amount determined on the basis of a formula, it would not be
considered redeemable at fair value unless “the formula is designed to equal or reasonably approximate
fair value.” The SEC does not consider formulas based solely on a fixed multiple of the issuer’s earnings
(e.g., 10 times the issuer’s most recent EBITDA or an average EBITDA) as designed to equal or reasonably
approximate fair value because the appropriate multiple may change over time as a result of changes
in market conditions and entity-specific factors. A formula that is based on the average trading price
of the common stock price for a short period before redemption potentially could be viewed as one
that was designed to reasonably approximate fair value. For a common equity instrument issued by an
investment fund (e.g., noncontrolling interests in consolidated investment funds), the net asset value
(NAV) per share calculated in a manner consistent with the measurement principles of ASC 946 as of the
reporting entity’s measurement date may be a reasonable approximation of fair value (see ASC 820-10-
35-59) depending on whether there are restrictions on redemptions and whether the NAV would have
qualified as a fair value measurement under the practical expedient in ASC 820-15-35-59.
The SEC staff permits an entity that applies the two-class method to common stock redeemable at an
amount other than fair value to choose between the following two approaches of allocating earnings to
the redeemable common stock:
- Treat the entire change in the carrying amount of the redeemable common stock as a dividend to the holders of such stock.
- Treat only the portion of the change in the carrying amount of the redeemable common stock that reflects a redemption in excess of its fair value as a dividend to holders of such stock (e.g., if the redemption value exceeded fair value by $7 at the beginning of the period and $12 at the end of the period, the entity would analyze the increase in the excess of $5 during the period as a distribution to the holders of the redeemable common stock during that period).
Note that the carrying amount generally cannot be reduced to an amount below the initial carrying
amount (see Section 9.5.2).
For additional discussion of the EPS treatment of redeemable common stock, see
Sections
3.2.4.2, 3.3.2.1, 4.8.4.3, 5.4.2, and 5.5.3.1 of Deloitte’s Roadmap Earnings per Share.
9.6.3 Noncontrolling Interests
9.6.3.1 Noncontrolling Interests in the Form of Preferred Stock
ASC 480-10 — SEC Materials — SEC Staff Guidance
SEC Staff Announcement: Classification and Measurement of Redeemable Securities
S99-3A(22) . . . The SEC
staff believes the guidance in paragraphs 20 and 21
should be applied to noncontrolling interests as
follows:
-
Noncontrolling interest in the form of preferred stock instrument. The impact on income available to common stockholders of the parent arising from adjustments to the carrying amount of a redeemable noncontrolling interest other than common stock depends upon whether the redemption feature in the equity instrument was issued, or is guaranteed, by the parent. If the redemption feature was issued, or is guaranteed, by the parent, the entire adjustment under paragraph 20 reduces or increases income available to common stockholders of the parent. Otherwise, the adjustment is attributed to the parent and the noncontrolling interest in accordance with Paragraphs 260-10-55-64 through 55-67. . . .
When a noncontrolling interest in the form of preferred stock is presented in temporary equity, the calculation of EPS depends on whether the redemption feature that triggers temporary equity classification has been issued or guaranteed by the parent entity:
- If the redemption feature has been issued or guaranteed by the parent entity, the EPS treatment is similar to that of a redeemable preferred share issued directly by the parent (see Section 9.6.1), and changes in the carrying amount of the redeemable noncontrolling interest are treated as an adjustment to income available to common stockholders. Thus, an increase in the carrying amount decreases income available to common stockholders, and a decrease in the carrying amount increases income available to common stockholders.
- If the redemption feature has not been issued or guaranteed by the parent entity (i.e., the redemption feature was issued by the subsidiary and has not been guaranteed by the parent), changes in the carrying amount of the redeemable noncontrolling interest are allocated between the parent and the noncontrolling interest.
Redemption features that may be considered issued or guaranteed by the parent include, but are not limited to, (1) put options issued by a parent to the holder of preferred shares issued by the parent’s subsidiary if the put options are considered embedded in the noncontrolling interest at the consolidated level (see Section 3.3) and (2) put features that are embedded in preferred shares issued by a subsidiary if they are subject to a guarantee by its parent.
For additional discussion of the EPS treatment of noncontrolling interest in the
form of redeemable preferred stock, see Sections 3.2.3.3.1 and 8.8.4 of Deloitte’s
Roadmap Earnings per
Share.
9.6.3.2 Noncontrolling Interests in the Form of Common Stock
ASC 480-10 — SEC Materials — SEC Staff Guidance
SEC Staff Announcement: Classification and Measurement of Redeemable Securities
S99-3A(22) . . . The SEC
staff believes the guidance in paragraphs 20 and 21
should be applied to noncontrolling interests as
follows: . . .
b. Noncontrolling interest in the form of
common stock instrument. Adjustments to the
carrying amount of a noncontrolling interest
issued in the form of a common stock instrument to
reflect a fair value redemption feature do not
impact earnings per share. Adjustments to the
carrying amount of a noncontrolling interest
issued in the form of a common stock instrument to
reflect a non-fair value redemption feature do
impact earnings per share; however, the manner in
which those adjustments reduce or increase income
available to common stockholders of the parent may
differ.FN20 If the terms of the
redemption feature are fully considered in the
attribution of net income under Paragraph 810-
10-45-21, application of the two-class method is
unnecessary. If the terms of the redemption
feature are not fully considered in the
attribution of net income under Paragraph
810-10-45-20, application of the two-class method
at the subsidiary level is necessary in order to
determine net income available to common
stockholders of the parent.
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FN20 Subtopic 810-10 does not
provide detailed guidance on the attribution of
net income to the parent and the noncontrolling
interest. The SEC staff understands that when a
noncontrolling interest is redeemable at other
than fair value some registrants consider the
terms of the redemption feature in the calculation
of net income attributable to the parent (as
reported on the face of the income statement),
while others only consider the impact of the
redemption feature in the calculation of income
available to common stockholders of the parent
(which is the control number for earnings per
share purposes).
An entity uses the two-class method under ASC 260-10-45 to reflect measurement adjustments made under ASC 480-10-S99-3A related to a noncontrolling interest in the form of redeemable common shares unless either (1) the redemption right is for an amount equal to the fair value of the common shares or (2) the entity fully considers the terms of the redemption feature in the attribution of net income under ASC 810-10-45.
The SEC staff permits an entity that applies the two-class method to common stock redeemable at an amount other than fair value to choose between the following two approaches of allocating earnings to the stock:
- Treat the entire measurement adjustment under ASC 480-10-S99-3A as a dividend to the holders of such stock.
- Treat only the portion of the measurement adjustment under ASC 480-10-S99-3A that reflects a redemption in excess of its fair value as a dividend to holders of such stock.
For additional discussion of the EPS treatment of noncontrolling interest in the
form of redeemable common stock, see Sections 3.2.3.3.2 and 8.8.4 of Deloitte’s
Roadmap Earnings per
Share.
9.6.4 Convertible Debt With Separated Equity Component
ASC 480-10 — SEC Materials — SEC Staff Guidance
SEC Staff Announcement: Classification and Measurement of Redeemable Securities
S99-3A(23)
Convertible debt instruments that contain a
separately classified equity component. For
convertible debt instruments subject to ASR 268 (see
paragraph 3(e)), there should be no incremental earnings
per share accounting from the application of this SEC
staff announcement. Subtopic 260-10 addresses the
earnings per share accounting.
There is no incremental EPS impact associated with the classification of all or
part of an equity component in convertible debt as temporary equity.