B.3 Calculating Pro Forma EPS
B.3.1 General
Article 11 and Section
3200 of the FRM include computational guidance related to pro
forma EPS. However, there is no such computational guidance in U.S. GAAP.
SEC Regulation S-X, Rule 11-02(b)(9)(i), contains the following description of
the pro forma EPS information that must be included in pro forma financial
statements:
Historical and pro forma basic and diluted per share amounts
based on continuing operations attributable to the controlling interests and
the number of shares used to calculate such per share amounts must be
presented on the face of the pro forma condensed statement of comprehensive
income and only give effect to Transaction Accounting Adjustments and
Autonomous Entity Adjustments.
In addition to describing the pro forma EPS information to be included in pro
forma financial statements, SEC Regulation S-X, Rule 11-02(b)(9)(ii), discusses
the calculation of pro forma EPS and states:
The number of
shares used in the calculation of the pro forma per share amounts must be
based on the weighted average number of shares outstanding during the period
adjusted to give effect to the number of shares issued or to be issued to
consummate the transaction, or if applicable whose proceeds will be used to
consummate the transaction as if the shares were outstanding as of the
beginning of the period presented. Calculate the pro forma effect of
potential common stock being issued in the transaction (e.g., a convertible
security), or the proceeds of which will be used to consummate the
transaction, on pro forma earnings per share in accordance with U.S. GAAP or
IFRS-IASB, as applicable, as if the potential common stock were outstanding
as of the beginning of the period presented.
Under Article 11, an entity will generally include in the denominator of pro forma EPS only those common shares whose proceeds are being reflected in pro forma adjustments in the income statements, such as proceeds used for debt repayment or business acquisitions. However, an entity may be required to reflect in its pro forma EPS calculation incremental shares arising from an offering whose proceeds are assumed to pay a distribution/dividend to shareholders, even if such a distribution is not reflected in the pro forma income statement. See further discussion in Section B.3.2.
Regardless of the reason for presenting or disclosing pro forma EPS in a filing with the SEC, the pro forma EPS amounts should be accompanied by transparent disclosure of how such amounts were calculated.
Connecting the Dots
The presentation of pro forma EPS should not alter in any way the calculations
of historical basic and diluted EPS under ASC 260. That is, calculations
of basic and diluted EPS under ASC 260 should not incorporate any of the
assumptions about the use of offering proceeds or other transactions
that have not yet occurred but that may trigger a requirement to present
or disclose pro forma EPS. Rather, transactions affecting EPS should be
reflected in EPS calculations under ASC 260 only after they have
occurred.
B.3.2 Distributions From the Proceeds of an Offering
The objective of calculating pro forma EPS is to include an additional number of
common shares in the denominator to reflect that the entity would have to raise
proceeds through the issuance of common stock to fund dividends that exceed
current-period earnings. That is, pro forma EPS should be calculated by
including an incremental number of common shares (not to exceed the total number
of common shares being offered) that, on the basis of the offering price, would
be needed to pay the portion of the dividend that exceeds earnings. See
Example B-1 for
an illustration.
B.3.3 Change in Capitalization at or Before Closing of an IPO
When outstanding securities, such as convertible securities or restricted share-based units, will be converted into common stock in conjunction with an IPO, and that conversion will occur after the latest balance sheet presented and result in a material reduction of EPS (excluding the effects of the offering), pro forma EPS amounts should reflect the conversion of the securities into common stock. The pro forma EPS amounts should not, however, reflect any additional shares of common stock being offered in the IPO.
The nature of the pro forma adjustments to the historical EPS amounts will depend on the specific facts and circumstances. Such adjustments may include adjustments to the numerator in addition to the inclusion of additional common shares in the denominator. If the security to be converted is a participating security, an entity would be required to adjust the numerator to remove the effects of such participation from the historical EPS amounts. Moreover, for convertible securities, the numerator for basic EPS would need to be adjusted to remove any interest or dividends that reduced income available to common stockholders. A similar type of adjustment may also be required in the calculation of pro forma diluted EPS. However, in some cases, diluted EPS and pro forma diluted EPS will be the same. See Example B-2 for an illustration.
B.3.4 Use of Proceeds From Offering of Convertible Securities to Extinguish Preferred Stock or Debt
The pro forma adjustments required under SAB Topic 3.A will depend on the circumstances associated with the existing security being extinguished, the offered security, and other equity or participating securities in the entity’s capital structure. In certain situations, the pro forma adjustments will involve the initial application, alteration, or cessation of the two-class method of calculating EPS. This may be the case when (1) the extinguished security was a participating security, (2) the offered security is a participating security, or (3) the entity has other participating securities or multiple classes of common stock. Regardless of the facts and circumstances related to the extinguished security, the offered security, or the other equity or participating securities in the entity’s capital structure, the following are always true in the calculation of pro forma EPS:
- The pro forma adjustments to the denominator as a result of the offered security should be limited to the portion of the offering proceeds that will be used to extinguish the existing security. This amount will be determined by considering both the redemption price of the existing security and the proceeds that must be raised in the offering to repay that redemption price. The quantity of securities needed to pay the redemption price of the existing security should be based on the offering price in the registration statement. Additional proceeds raised in the offering that will be used for general corporate purposes do not affect the calculations of pro forma EPS.
- The pro forma adjustments should be calculated in a manner that reflects only the time during which the existing security or offered security was (or would be) outstanding during the financial reporting period. For example, if an entity is retiring nonconvertible debt that was issued at the beginning of the second quarter of a fiscal year with the proceeds from an offering of convertible securities at or after the end of the fiscal year, the adjustments to the numerator would only reflect interest expense on the existing debt for three quarters. Similarly, the adjustments to the numerator and the incremental potential common shares added to the denominator of the calculation of pro forma diluted EPS under the if-converted method would also be weighted for three quarters during the annual period.
The table below discusses various other matters not specifically addressed in
the SEC’s computational guidance that may be relevant to the calculation of pro
forma EPS under SAB Topic 3.A.1
Table B-1
|
Additional Matter
|
Additional Considerations
|
|---|---|
|
The existing security that is being
extinguished was accounted for at fair value through
earnings.
|
The mark-to-market adjustments should be
reversed since they would not have been recorded if the
existing security was extinguished.
|
|
The existing security that is being
extinguished contained an embedded derivative that was
separately recognized under ASC 815.
|
The mark-to-market adjustments on the
embedded derivative should be reversed since they would
not have been recorded if the existing security was
extinguished.
|
|
The existing security that is being
extinguished was preferred stock that was classified in
temporary equity and remeasured to its redemption
amount.
|
The adjustments previously recognized
for changes in the redemption amount should be reversed
since they would not have been recorded if the existing
security was extinguished (i.e., the amounts that
reduced income available to common stockholders would be
added back to the numerator).
|
|
The existing security allowed for
conversion to be settled in cash or common stock.
|
The adjustments to historical EPS should
be based on an assumption that the security would be
share-settled.
|
|
The offered security will be accounted
for at fair value through earnings.
|
If potential mark-to-market adjustments
on the offered security that will be recognized after
the issuance of the security are not included in the
calculation of pro forma EPS amounts for the period
after the issuance of the offered security, the
disclosure should indicate that these adjustments are
not included in the calculation of pro forma EPS because
such amounts are not reasonably determinable.
|
|
The offered security will contain an
embedded derivative that must be separated under ASC
815.
|
Management should estimate the initial
fair value of the embedded derivative to calculate the
interest expense or dividends on the host contract for
the offered security under the interest method. If
potential mark-to-market adjustments on the embedded
derivative that will be recognized after the issuance of
the security are not included in the calculation of pro
forma EPS amounts for the period after the issuance of
the offered security, the disclosure should indicate
that these adjustments are not included in the
calculation of pro forma EPS because such amounts are
not reasonably determinable.
|
|
The interest or dividends on the offered
security are variable.
|
The entity should use judgment on the
basis of the specific terms and other GAAP. If the
variability is based solely on a market index, the
relevant spot index should be used.
|
|
The interest or dividends on the offered
security are at an increasing rate or contain other
unique terms.
|
The entity should consider the interest
or dividend terms in the offering document in
determining the application of the interest method.
|
|
The offered security is puttable or
callable.
|
Such calls or puts should not be
considered to result in a life of the offered security
that is shorter than the period during which the
existing security was outstanding. Entities should use
judgment and consider the requirements of other GAAP in
evaluating whether the puts or calls affect the interest
or dividend yield on the offered security.
|
|
The offered security will need to be
classified in temporary equity and remeasured to its
redemption amount.
|
In assessing the impact of potential
redemption amount adjustments on the calculation of pro
forma EPS, an entity will need to use judgment and
consider the facts and circumstances as well as its
selected accounting policies under ASC 480-10-S99-3A.
For example:
If the redemption price is variable, the
entity should consider the nature of the variability to
determine the redemption amount adjustments or should
disclose that such an estimate is not reasonably
determinable.
|
|
The offered security is a convertible
security for which a conversion may be settled in cash
or stock.
|
Entities are required to assume share
settlement when calculating pro forma EPS.
|
|
The entity historically applied the
two-class method as a result of the existence of other
participating securities or multiple classes of common
stock (i.e., in the absence of the existing security or
offered security, the two-class method of EPS is
required).
|
The adjustments to historical basic and
diluted EPS arising from the extinguishment of the
existing security and the offered security may affect
the historical application of the two-class method
(e.g., the allocation of undistributed earnings); thus,
an entity will be required to take additional
considerations into account in calculating pro forma
EPS.
|
B.3.5 Changes in Tax Status in Conjunction With an IPO
The financial statements presented in a registration statement on Form S-1 for
the periods in which an entity was a nontaxable entity should not be restated
for the effects of income taxes. Rather, as discussed in paragraph 3410.1 of the
FRM, the entity should provide pro forma disclosures to illustrate the effect of
income taxes on those years in accordance with Article 11. Section 3270 of the FRM
states that the tax rate used for the pro forma calculations should normally
equal the “statutory rate in effect during the periods for which the pro forma
income statements are presented.”
For more information about the implications of a change in tax status, see
Deloitte’s Roadmap Income
Taxes. Note that there are several ways in which an
entity’s tax and legal structure may change as a result of the IPO process, all
of which may have unique impacts on income tax measurement, presentation, and
disclosures. Management should consult with tax advisers in determining the
income tax implications of such changes well in advance of the IPO.
Footnotes
1
The matters discussed below may also be relevant to
certain changes in capitalization in conjunction with an IPO.