3.1 Background

ASC 260-10

Basic EPS

10-1 The objective of basic earnings per share (EPS) is to measure the performance of an entity over the reporting period.

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.

As noted in ASC 260-10-45-10, basic EPS is calculated “by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the [reporting] period.” For illustrations of the calculation of basic EPS for entities with simple and more complex capital structures, see the example below and Example 3-32, respectively. The remainder of this chapter addresses matters that affect the numerator and denominator in the calculation of basic EPS.

Example 3-1

Basic EPS for Entity With Simple Capital Structure

This example illustrates the first-quarter calculation of basic EPS for Company A, which has a simple capital structure. Assume the following facts:

Income from continuing operations and net income for the first quarter was $10 million.
At the beginning of the period, A had 500,000 shares of common stock outstanding.
On March 1, A issued 100,000 shares of common stock in a secondary offering.
Company A only has shares of common stock outstanding. There is no noncontrolling interest (NCI) in A.

Weighted-average shares outstanding are calculated as follows:

The discussion in this chapter is generally in the context of an entity that presents only one basic EPS amount (i.e., the entity does not have any discontinued operations). Unless otherwise noted, in this chapter, “net income” encompasses net income or net loss and refers to (1) consolidated net income for an entity that does not have an NCI and (2) income attributable to the parent for an entity with an NCI. “Income available to common stockholders,” which is defined in ASC 260-10-20, refers to income available or loss attributable to common stockholders for (1) an entity that does not have an NCI and (2) the parent for an entity that has an NCI. Sections 8.6.3, 8.7.1, and 8.7.2 discuss the accounting and presentation of EPS for an entity that presents a discontinued operation and include an example of the presentation of EPS for an entity that reports an NCI in a discontinued operation.

3.1.1 Treating Capital Stock as Common Stock or Preferred Stock

3.1.1.1 Corporate Entities

ASC 260-10-20 defines common stock as “stock that is subordinate to all other stock of the issuer.” ASC 260 does not provide any other interpretive guidance on identifying whether a class of capital stock should be treated as common or preferred stock. However, the distinction is important for both the determination of the classes of capital stock for which the presentation of EPS is required and the calculation of basic and diluted EPS for those classes of capital stock. With respect to the presentation of EPS, as noted in Section 5.4.1, an entity with multiple classes of common stock is required to present basic and diluted EPS for each of these classes. Regarding the calculation of EPS, as discussed in this chapter, there are significant differences between the accounting for common stock and the accounting for preferred stock. Such differences may include the following:

Dividends on preferred stock affect the numerator in the calculation of EPS, whereas dividends on common stock generally have no impact on EPS unless the two-class method of calculating EPS is required.
While the classification and measurement guidance in ASC 480-10-S99-3A applies to all equity-classified redeemable securities, the EPS impact of adjustments to the redemption amount of redeemable securities for preferred stock significantly differs from that for common stock.
According to ASC 260-10-S99-2, the difference between the fair value of consideration paid and the net carrying amount of preferred stock is treated as a dividend when preferred stock is redeemed; ASC 260-10-S99-2 does not apply to common stock.

Securities issued by corporations will typically be considered common stock or preferred stock on the basis of their existing legal form. However, in the calculation of basic EPS, securities should be evaluated on the basis of their substance rather than just their current legal form. A security that is a preferred instrument in legal form, shares the same characteristics as common stock, and has no substantive preference attributed to it should be considered a class of common stock in the calculation of EPS, regardless of its legal form. Similarly, a security that is a common instrument in legal form and shares the same characteristics as preferred stock because of a substantive preference in dividends and liquidation (without any participation with common shareholders in the distribution of assets on liquidation) should be considered a class of preferred stock in the calculation of EPS, regardless of its legal form. The laws in certain jurisdictions do not allow certain types of entities to issue preference shares; however, those entities may issue common securities in legal form that have all the characteristics of preferred stock. The two examples below illustrate these concepts.

Example 3-2

Preferred Stock With Characteristics of Common Stock

Company B issues, to Company C, Series A convertible preferred stock (the “Series A stock”) whose terms are substantially the same as those of common stock. The relevant terms of the Series A stock are as follows:

No rights to preferential or cumulative dividends; holders of the Series A stock share ratably with common stockholders in the payment of any dividends.
Not publicly traded. (B’s common stock is publicly traded.)
Voting rights are consistent with the rights of the common stock.
Nominal preference in liquidation of $0.01 per share.
Each share is convertible into one share of common stock at any time upon the transfer of the Series A stock by C to a third party.
Antidilution provisions are limited to stock splits and dividends.

There is no substantive difference between the Series A stock and the common stock. As a holder of the Series A stock, C can sell these shares to a third party at any time, at which point the Series A stock would convert into common stock with all the characteristics of the current outstanding common stock. The sale of the Series A stock is completely outside B’s control, and there are no restrictions on the sale of the Series A stock. Further, the Series A stock has the exact same rights to receive dividends as common stock and has no substantive preference (i.e., the liquidation preference of $0.01 per share is not substantive). Therefore, the Series A stock should be treated as a class of common stock.

Example 3-3

Common Stock With Characteristics of Preferred Stock

Company X is a limited liability company (LLC) domiciled and organized under the laws of The People’s Republic of China (PRC). According to PRC law, an LLC cannot issue preference shares. Therefore, X has issued two classes of shares — ordinary shares and Series A shares, which is a special class of ordinary shares. The Series A shares contain preferential rights that are akin to preferred stock but are not legally preferred securities because preference shares cannot be issued by an LLC under PRC law. The Series A shares result in the economic equivalent of a preferred security. For such a security, there is a priority related to dividend rights and distributions on liquidation and no ability to participate with ordinary shareholders in the distribution of assets on liquidation.

Although the Series A shares, like the ordinary shares, legally reflect common stock, the Series A shares should be considered preferred stock and the ordinary shares should be considered common stock under ASC 260. This is consistent with the definition of common stock in ASC 260-10-20, which refers to “stock that is subordinate to all other stock of the issuer.”

Section 3.3.2.2 discusses the treatment of instruments that are mandatorily convertible into common stock but that do not reflect common stock in substance before their conversion.

3.1.1.2 Limited Partnerships and Similar Entities

In a typical limited partnership, the general partner or partners own an insignificant amount of partnership interests and there is a single class of limited partnership interests that represents substantially all of the equity of the limited partnership. In these situations, the limited partnership interests will be treated as common stock. In other situations, the general partnership interest or interests represent a majority of the equity of the limited partnership or the limited partnership has issued multiple classes of limited partnership interests. In these circumstances, the determination of whether the limited partnership interests should be considered akin to common stock or preferred stock should be based on the substance of the instruments. We understand that the SEC staff believes that if an issued and outstanding equity interest is not in the legal form of common stock or preferred stock, which may include limited partnerships and similar entities as well as other forms of organization in foreign jurisdictions, the entity should evaluate the economic characteristics and risks of the equity interest, within the context of the entity’s other capital instruments, to determine whether the interest is more akin to common stock or preferred stock. The primary focus should be on whether the interest has a priority in dividends and a substantive preference in liquidation.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.