3.2 Income Available to Common Stockholders

3.2.1 General

ASC 260-10

Income Available to Common Stockholders and Preferred Dividends

45-11 Income available to common stockholders shall be computed by deducting both the dividends declared in the period on preferred stock (whether or not paid) and the dividends accumulated for the period on cumulative preferred stock (whether or not earned) from income from continuing operations (if that amount appears in the income statement) and also from net income. If there is a loss from continuing operations or a net loss, the amount of the loss shall be increased by those preferred dividends. An adjustment to net income or loss for preferred stock dividends is required for all preferred stock dividends, regardless of the form of payment. Preferred dividends that are cumulative only if earned shall be deducted only to the extent that they are earned.

45-11A For purposes of computing EPS in consolidated financial statements (both basic and diluted), if one or more less-than-wholly-owned subsidiaries are included in the consolidated group, income from continuing operations and net income shall exclude the income attributable to the noncontrolling interest in subsidiaries. Example 7 (see paragraph 260-10-55-64) provides an example of calculating EPS when there is a noncontrolling interest in a subsidiary in the consolidated group.

45-12 Preferred stock dividends that an issuer has paid or intends to pay in its own common shares shall be deducted from net income (or added to the amount of a net loss) in computing income available to common stockholders. In certain cases, the dividends may be payable in common shares or cash at the issuer’s option. The adjustment to net income (or net loss) for preferred stock dividends payable in common stock in computing income available to common stockholders is consistent with the treatment of common stock issued for goods or services.

ASC 260-10-45-11 through 45-12 contain general guidance on calculating the numerator for basic EPS. Generally speaking, income available to common stockholders is calculated as net income less dividends on preferred stock. However, there are a number of matters for an entity to consider in performing this calculation. Below is a summary of the relevant considerations related to the calculation of the numerator for basic EPS along with references to the sections in this chapter where these matters are discussed. Chapter 6 contains additional guidance on calculating basic EPS for convertible debt instruments. See Section 9.1.6 for discussion of the requirement for an SEC registrant to report income or loss applicable to common stock on the face of the income statement.

The table below discusses the impact that various items generally have on the calculation of income available to common stockholders in the calculation of basic EPS. Because the table focuses on income available to common stockholders, it does not address the allocation of such income to multiple classes of common stock, in which case an entity is required to apply the two-class method of calculating basic EPS. Each of the items in the table below is discussed in detail in the sections that follow.

Table 3-1

Generally Affects Income Available to Common Stockholders1	Generally Does Not Affect Income Available to Common Stockholders
Dividends on cumulative preferred stock (whether or not declared). Dividends on noncumulative preferred stock that have been declared. Accretion of increasing-rate dividends. Dividends on participating preferred stock. Adjustments to the redemption amount of redeemable preferred stock, including redeemable NCIs in the form of preferred stock (whether redeemable at fair value or a non–fair value amount). Redemptions of preferred stock (whether the redemption price exceeds or is less than the carrying amount). Modifications or exchanges of preferred stock that increase fair value. Induced conversions of preferred stock or convertible debt. Income available to common stockholders of a less-than-wholly-owned consolidated subsidiary. Adjustments to the redemption amount of NCIs in the form of common stock that are redeemable at a non–fair value amount. Participating securities, including share-based payment awards and certain NCIs. Certain redemptions of common stock and tracking stock. Modifications of share-based payment awards and other equity-linked instruments that increase the fair value of the instrument. Down-round features (when triggered), except for down-round features in convertible debt instruments.	Dividends on cumulative preferred stock that have not yet been earned. Dividends on noncumulative preferred stock that have not been declared. Conversions of preferred stock into common stock on the basis of their stated conversion terms. Modifications or exchanges of preferred stock that do not increase fair value. Contingent dividends on preferred stock (if the contingency has not been met). Liquidating dividends on preferred stock. Conversions of debt into common stock on the basis of their stated conversion terms (provided that the convertible debt does not contain a separately recognized equity component). Adjustments of the redemption amount on NCIs in the form of common stock that are redeemable at fair value. Certain redemptions of common stock and tracking stock. Modifications of share-based payment awards and other equity-linked instruments that do not increase the fair value of the instrument. Down-round features (when not yet triggered). Down-round features (when triggered) in convertible debt instruments.

Generally Affects Income Available to Common Stockholders1

Generally Does Not Affect Income Available to Common Stockholders

Dividends on cumulative preferred stock (whether or not declared).
Dividends on noncumulative preferred stock that have been declared.
Accretion of increasing-rate dividends.
Dividends on participating preferred stock.
Adjustments to the redemption amount of redeemable preferred stock, including redeemable NCIs in the form of preferred stock (whether redeemable at fair value or a non–fair value amount).
Redemptions of preferred stock (whether the redemption price exceeds or is less than the carrying amount).
Modifications or exchanges of preferred stock that increase fair value.
Induced conversions of preferred stock or convertible debt.
Income available to common stockholders of a less-than-wholly-owned consolidated subsidiary.
Adjustments to the redemption amount of NCIs in the form of common stock that are redeemable at a non–fair value amount.
Participating securities, including share-based payment awards and certain NCIs.
Certain redemptions of common stock and tracking stock.
Modifications of share-based payment awards and other equity-linked instruments that increase the fair value of the instrument.
Down-round features (when triggered), except for down-round features in convertible debt instruments.

Dividends on cumulative preferred stock that have not yet been earned.
Dividends on noncumulative preferred stock that have not been declared.
Conversions of preferred stock into common stock on the basis of their stated conversion terms.
Modifications or exchanges of preferred stock that do not increase fair value.
Contingent dividends on preferred stock (if the contingency has not been met).
Liquidating dividends on preferred stock.
Conversions of debt into common stock on the basis of their stated conversion terms (provided that the convertible debt does not contain a separately recognized equity component).
Adjustments of the redemption amount on NCIs in the form of common stock that are redeemable at fair value.
Certain redemptions of common stock and tracking stock.
Modifications of share-based payment awards and other equity-linked instruments that do not increase the fair value of the instrument.
Down-round features (when not yet triggered).
Down-round features (when triggered) in convertible debt instruments.

3.2.2 Dividends on Preferred Stock

3.2.2.1 General

Dividends on preferred stock are deducted from income from continuing operations (if that amount appears on the income statement), as well as from net income, to arrive at income available to common stockholders, which is the numerator in the calculation of basic EPS. Only dividends associated with the current financial reporting period are deducted from income from continuing operations (if that amount appears on the income statement), as well as from net income, to arrive at income available to common stockholders for the period. For example, as discussed in ASC 260-10-45-60B(a), if dividends on cumulative preferred stock are declared in the current period but are related to prior-period unpaid cumulative dividends, those dividends are not associated with the current financial reporting period. Only dividends that accumulated during the current period affect income available to common stockholders.

As noted in Section 8.7, if an entity reports a discontinued operation, it must calculate basic EPS for both income from continuing operations and net income (thus, income available to common stockholders should be calculated for both income from continuing operations and net income). While an entity may have any combination of one or more of income from continuing operations, loss from continuing operations, net income, or net loss, the remaining discussion in this chapter generally refers simply to a requirement to deduct dividends from “net income” to arrive at “income available to common stockholders.” This reference is intended to encompass (1) the addition of dividends to net loss to arrive at loss attributable to common stockholders when an entity reports a net loss, (2) the deduction of dividends from income from continuing operations when an entity reports income and has a discontinued operation, and (3) the addition of dividends to loss from continuing operations when an entity reports a loss and has a discontinued operation.

As discussed in the remaining subsections of Section 3.2.2, dividends that reduce net income in arriving at income available to common stockholders include all of the following:

Dividends accumulated on cumulative preferred stock that are paid in cash.
Dividends declared on noncumulative preferred stock that are paid in cash.
Dividends accumulated on cumulative preferred stock that are paid in additional shares of preferred stock or in common stock.
Dividends declared on noncumulative preferred stock that are paid in additional shares of preferred stock or in common stock.
Contingent dividends on cumulative and noncumulative preferred stock when the contingency that requires the payment of those dividends occurs.
Liquidating dividends upon the occurrence of the liquidation event.
The accretion of dividends on certain increasing-rate preferred stock instruments.
“Deemed dividends” that result from the remeasurement of preferred stock to its redemption amount under ASC 480-10-S99-3A.
Dividends that result from a down-round feature that has been triggered.
“Deemed dividends” that result from the application of ASC 260-10-S99-2 to a redemption or induced conversion of preferred stock.
Dividends on participating preferred stock.
“Deemed dividends” from the reclassification of preferred stock to a liability.

3.2.2.2 Cumulative Versus Noncumulative Preferred Stock

3.2.2.2.1 Dividends on Cumulative Preferred Stock

Although the ASC master glossary does not define “cumulative preferred stock,” preferred stock that must receive dividend payments for all prior years before any dividend payments are made to common shareholders are described as cumulative; those without this right are noncumulative. Thus, for cumulative preferred stock, the dividends accumulate on the basis of the dividend payment terms and all accumulated dividends must be paid before any dividends may be paid on common stock.

ASC 260-10-45-11 requires an entity to deduct from net income the amount of dividends accumulated during a period on cumulative preferred stock. This is required regardless of whether (1) the form of payment is cash or stock or (2) the dividends have been declared or paid. However, preferred dividends that are cumulative only if earned are treated as contingent dividends (see Connecting the Dots below). Section 3.2.2.3 addresses dividends on increasing-rate preferred stock. Section 3.2.2.4 addresses dividends on redeemable preferred stock. Section 3.2.2.7 addresses the EPS accounting for cumulative preferred stock that meets the definition of a participating security.

While cumulative dividends on preferred stock are deducted from the numerator in the calculation of basic EPS, such dividends are not necessarily recognized on the balance sheet. For example, if an entity has issued redeemable preferred stock that is classified in temporary equity, but remeasurement of the preferred stock to its redemption amount is not required under ASC 480-10-S99-3A, cumulative undeclared dividends on the preferred stock will have been reflected in the calculation of basic EPS; however, those dividends would not be reflected in the measurement of the temporary-equity classified preferred stock under ASC 480-10-S99-3A. The fact that remeasurement of redeemable preferred stock is not required under ASC 480-10-S99-3A does not negate the requirement in ASC 260 to deduct cumulative dividends on the preferred stock in the calculation of basic EPS.

Connecting the Dots

The language in ASC 260-10-45-11 that refers to whether dividends on cumulative preferred stock are “earned” can be confusing. The first sentence in ASC 260-10-45-11 requires an entity to deduct dividends that accumulate on cumulative preferred stock for the period “whether or not earned”; however, the last sentence of that paragraph states that preferred dividends are cumulative only “if earned” and therefore should be deducted “only to the extent that they are earned.” The discussion in ASC 260-10-45-11 regarding whether dividends on cumulative preferred stock are “earned” should be interpreted as signifying that such dividends for the period should be deducted from net income to arrive at income available to common stockholders unless the dividends are contingent upon the occurrence of an event outside the control of the preferred stockholders that did not occur (e.g., dividends that are indexed to the entity’s earnings). For further discussion, see Section 3.2.2.2.5.

3.2.2.2.2 Dividends on Noncumulative Preferred Stock

Noncumulative dividends do not accrue to the preferred stockholder if they are not declared for the period. However, the preferred stockholders are entitled to receive payment of the current period’s dividend before any dividends can be declared on common stock. As explained in the nonauthoritative guidance of AICPA Technical Q&As Section 4210.04, if preferred stock dividends are noncumulative, “only the dividends declared should be deducted [from net income].” Therefore, dividends on a noncumulative preferred stock instrument that is not remeasured to its redemption amount under ASC 480-10-S99-3A and that does not meet the definition of a participating security should not affect the calculation of basic or diluted EPS for periods in which such dividends have not been declared or otherwise paid. Section 3.2.2.4 addresses dividends on redeemable preferred stock. Section 3.2.2.7 addresses the EPS accounting for noncumulative preferred stock that meets the definition of a participating security.

3.2.2.2.3 Dividends Paid in Shares of Preferred Stock

Dividends on preferred stock may be paid in additional shares of preferred stock; such dividends are referred to as dividends that are “paid in-kind” (PIK). Determining the appropriate measurement of PIK dividends is important because the measured amount of these dividends reduces net income in arriving at income available to common stockholders.

PIK dividends on preferred stock should be measured at fair value as of the commitment date for the payment of such dividends. If PIK dividends are nondiscretionary (i.e., neither the issuer nor the holder may elect to pay dividends in cash or in kind), the commitment date for the original preferred stock instrument is also the commitment date for the PIK dividends. If, however, the issuer or the holder can elect to have dividends paid in cash or in kind, those dividends are discretionary. Therefore, the commitment date for such dividends is the date on which they become nondiscretionary (i.e., the date on which the dividends become payable in kind).

The table below summarizes the measurement guidance related to PIK dividends. See Section 9.5.5.1 of Deloitte’s Roadmap Distinguishing Liabilities From Equity for additional considerations related to determining whether PIK dividends are discretionary or nondiscretionary.

Table 3-2

Measurement of PIK Dividends That Reduces Numerator in EPS Calculation
Commitment date is the same as the commitment date for the original preferred stock (i.e., nondiscretionary PIK dividends)	PIK dividends should be measured at the fair value of the original preferred stock on its commitment date. Generally, this will be on the issuance date of the original preferred stock.
Commitment date is not the same as the commitment date for the original preferred stock (i.e., discretionary PIK dividends)	For cumulative preferred stock, PIK dividends should be measured at their fair value as of the date they accumulate. If the accumulation date differs from the declaration or payment date and the entity does not recognize the dividends on the balance sheet as additional shares of preferred stock until that later date, an adjustment to the dividend amount previously recorded should be recognized as of the date the additional shares of preferred stock are recognized on the balance sheet.2 This adjustment will affect income available to common stockholders in the period in which it is recognized. For noncumulative preferred stock, PIK dividends should be measured at their fair value as of the date they are declared.

Measurement of PIK Dividends That Reduces Numerator in EPS Calculation

Commitment date is the same as the commitment date for the original preferred stock (i.e., nondiscretionary PIK dividends)

PIK dividends should be measured at the fair value of the original preferred stock on its commitment date. Generally, this will be on the issuance date of the original preferred stock.

Commitment date is not the same as the commitment date for the original preferred stock (i.e., discretionary PIK dividends)

For cumulative preferred stock, PIK dividends should be measured at their fair value as of the date they accumulate. If the accumulation date differs from the declaration or payment date and the entity does not recognize the dividends on the balance sheet as additional shares of preferred stock until that later date, an adjustment to the dividend amount previously recorded should be recognized as of the date the additional shares of preferred stock are recognized on the balance sheet.2 This adjustment will affect income available to common stockholders in the period in which it is recognized.

For noncumulative preferred stock, PIK dividends should be measured at their fair value as of the date they are declared.

3.2.2.2.4 Dividends Paid in Shares of Common Stock

ASC 260-10

Income Available to Common Stockholders and Preferred Dividends

In accordance with ASC 260-10-45-12, when an entity has paid or intends to pay dividends on preferred stock in shares of common stock, the adjustment to the numerator in the calculation of basic EPS should be “consistent with the treatment of common stock issued for goods or services.” ASC 260-10-45-45 does not apply to the calculation of basic EPS when an entity has the option of paying dividends in cash or common stock because ASC 260-10-45-45 only applies to the calculation of diluted EPS. In accordance with ASC 260-10-45-12, the accounting for basic EPS depends on whether an entity “has paid or intends to pay” dividends on preferred stock in common stock.

For dividends on cumulative preferred stock, the amount of dividends that reduces net income in arriving at income available to common stockholders should be measured at the fair value of the shares of common stock expected to be delivered in satisfaction of those dividends. For dividends on noncumulative preferred stock, the amount of dividends that reduces net income in arriving at income available to common stockholders should be measured at the fair value of the shares of common stock that the entity has agreed to pay as a dividend as of the dividend declaration date. The two examples below illustrate the application of these requirements to cumulative preferred stock.

Example 3-4

Monetary Value of Dividends Is the Same, Whether Paid in Cash or Shares of Common Stock

On January 1, 20X1, Entity A issues $10 million of cumulative preferred stock. The terms of the preferred stock stipulate that dividends accumulate quarterly, regardless of whether they are declared, at a per annum rate of 10 percent. Entity A has the option of paying dividends in either cash or a number of shares of common stock equal to the cash amount. If A elects payment in shares of common stock, the number of such shares is determined as of the date the dividends are paid.

Because the monetary amount of the dividends is the same regardless of the form of consideration, A should recognize, as a reduction of the numerator in the calculation of EPS, a dividend on preferred stock of $250,000 in each quarterly financial reporting period ($10,000,000 × 10% × 1/4 = $250,000).

Example 3-5

Monetary Value of Dividends Is Not the Same, Whether Paid in Cash or Shares of Common Stock

On January 1, 20X1, Entity B issues $10 million of cumulative preferred stock. The terms of the preferred stock stipulate that dividends accumulate quarterly, regardless of whether they are declared, at a per annum rate of 10 percent. Entity B has the option of paying dividends in either cash or common stock. If B elects to pay dividends in common stock, it must deliver a number of shares of common stock that is equal to the cash amount of the dividends as of the date the preferred stock was issued. The fair value of B’s common stock as of the date the preferred stock was issued was $10 per share. Thus, in any period for which dividends are declared and paid in common stock, B must deliver to the holder 25,000 shares of common stock. Assume that the option of paying dividends is not an embedded derivative that must be accounted for separately under ASC 815-15.

Further assume the following:

During the first two years in which the preferred stock was outstanding, B had the intent to and did pay the dividends in cash on a quarterly basis.
Beginning on January 1, 20X3, B needs to conserve cash for other business reasons and has decided to declare and pay the dividends on the preferred stock in shares of common stock during the year ended December 31, 20X3. The dividends accumulate and are declared on March 15, June 15, September 15, and December 15 of each year. The dividends are then paid within 30 days after declaration.
On March 15, 20X3, the price of B’s common shares was $11 per share.
On April 15, 20X3, when the dividends were paid, the price of B’s common shares was $12 per share.
Entity B has a calendar year-end.

In calculating basic EPS for the first quarter ended March 31, 20X3, B should recognize a reduction from net income of $275,000 to arrive at income available to common stockholders (25,000 shares × $11.00 per share). Since the obligation to deliver 25,000 shares of common stock is considered to have occurred on March 15, 20X3, B would not subsequently adjust the dividend amount to reflect the incremental $1.00 per share increase in the fair value of its common stock.

3.2.2.2.5 Contingent Dividends

While ASC 260-10-45-11 states that dividends should be deducted from net income to arrive at income available to common stockholders, which is the numerator in the calculation of basic EPS, it does not specifically address how to account for dividend payments that are contingent on future events. The only guidance in ASC 260-10-45-11 that is relevant to this matter is that “[p]referred dividends that are cumulative only if earned shall be deducted only to the extent that they are earned.”

In such circumstances, an entity must consider the facts and circumstances associated with each contingently payable dividend. Generally, the impact of contingently payable dividends on the calculation of basic EPS depends on the nature of the contingency. See further discussion in the table below.

Table 3-3

Nature of Contingency3	Type of Preferred Stock	Treatment
Dividends are payable solely after the passage of time provided that the contingent event does not occur	Cumulative	Dividends should be reflected — as they accumulate and without regard to the contingency — as a reduction of net income in arriving at income available to common stockholders. If the contingent event occurs and the amount of the dividends changes as a result (i.e., an increase or decrease in, or an elimination of, the dividend amount), an entity may recognize an adjustment to the numerator in the calculation of basic EPS in the period in which the contingent event occurred. Prior reported EPS amounts should not be revised.
	Noncumulative	Dividends should be reflected, when declared, as a reduction of net income in arriving at income available to common stockholders. A contingency of this type that could affect the amount of the dividends after they are declared should not affect the amount of dividends that are reduced from net income to arrive at income available to common stockholders before the occurrence of the contingency. If the contingent event occurs and the amount of dividends changes as a result (i.e., an increase or decrease in, or an elimination of, the dividend amount), an entity may recognize an adjustment to the numerator in the calculation of basic EPS in the period in which the contingent event occurred. Prior reported EPS amounts should not be revised.
Dividends become payable only if the contingent event does occur	Cumulative	Dividends that become payable only upon the occurrence of a contingent event (i.e., that will not be payable upon the mere passage of time provided that no changes in circumstances or events occur) should not affect the numerator in the calculation of EPS until and unless the contingency occurs.
	Noncumulative	Dividends that become payable only upon the occurrence of a contingent event (i.e., that will not be payable upon the mere passage of time with no changes in circumstances or events) should not affect the numerator in the calculation of EPS until the contingency occurs and the dividend has been declared.

The example below illustrates the accounting for contingent dividends.

Example 3-6

Contingent Dividends on Cumulative Convertible Preferred Stock

Company X issued, to Company Y, convertible preferred stock that earns a 7 percent annual dividend on a cumulative basis. The terms of the preferred stock state that if Y were to convert the preferred stock into common stock, Y would not receive any preferred stock dividends, including any in arrears. Conversion is based on the initial issuance price of $1,000 per share of preferred stock divided by the 30-day average market price of X’s common stock. If, however, X redeems the shares from Y, Y would receive dividends, including any in arrears.

The dividends potentially will be paid in the future unless Y elects to convert the preferred stock into common stock, in which case it would no longer have the right to receive the preferred stock dividends, including any in arrears. Therefore, in the calculation of basic EPS, cumulative dividends on the preferred stock should be subtracted from net income in arriving at income available to common stockholders until the conversion occurs. If conversion occurs, thereby removing Y’s right to receive the dividends, including those in arrears, the calculation of basic EPS may reflect the reversal of previously accumulated dividends in the quarter in which conversion occurs. Company X should not revise previously reported EPS amounts.

3.2.2.2.6 Liquidating Dividends

A liquidating dividend represents a type of distribution made by an entity to its equity owners during its partial or complete liquidation. Liquidating dividends are not paid solely out of the entity’s profits. Preferred stock has a liquidation preference, which represents a right of preference over common shareholders (and potentially preferences with respect to other classes of preferred securities) in the event that the issuing entity is liquidated. As with the treatment of contingent dividends (see Section 3.2.2.2.5), the calculation of income available to common stockholders should not be affected by a liquidating dividend until a liquidation event occurs. Similarly, changes to the liquidation preference of preferred stock that have no other impact on the preferred stock (i.e., the change is only relevant in the event of a liquidation of the issuing entity and does not affect the dividends on the preferred stock before such liquidation) should also have no impact on income available to common stockholders unless such changes result in a “deemed dividend” that must be accounted for as a result of a modification to the terms of the preferred stock (see Section 3.2.6.1).4 The example below illustrates the accounting for a liquidating dividend on cumulative preferred stock.

Example 3-7

Impact of Liquidating Dividends on Cumulative Convertible Preferred Stock

Assume the following facts:

Company X issues 100,000 shares of Series A nonvoting convertible preferred stock for $1,000 per share (i.e., total proceeds of $100 million).
The preferred stock pays cumulative dividends at a rate of 12 percent per annum from the issuance date.
The liquidation preference of the preferred stock is equal to $1,000 per share, plus dividends accumulated and unpaid at a rate of 12 percent per annum, plus additional dividends at a rate of 5 percent per annum of the issuance price.
The additional 5 percent that is added to the liquidation preference does not represent a cumulative dividend because it only represents a right of preference in liquidation of X. Company X can pay dividends on common stock provided that it has declared and paid all the cumulative dividends at a rate of 12 percent per annum.
Company X can call the preferred stock at the end of five years from the issuance date, and on each successive date that is five years thereafter, at a redemption price equal to the issuance price per share, plus unpaid cumulative dividends at the 12 percent rate per annum.

In the calculation of basic EPS, net income should be reduced by the 12 percent cumulative dividends, regardless of whether they have been declared or paid. The additional 5 percent per annum amount that is added to the liquidation preference is not considered a cumulative dividend even though it accumulates and is added to the total liquidation preference. Rather, that amount is considered a liquidating dividend that merely increases the liquidation preference of the preferred stock. That amount should have no impact on EPS because it is not reflected for accounting purposes unless there is a liquidation of X.

If the additional 5 percent was also payable upon a deemed liquidation of X (i.e., a change of control or sale of all or substantially all of X’s assets), the conclusion would not change because this dividend amount would still be considered a contingent dividend. See also Table 3-3.

3.2.2.3 Increasing-Rate Preferred Stock

SEC Staff Accounting Bulletins

SAB Topic 5.Q, Increasing Rate Preferred Stock [Reproduced in ASC 505-10-S99-7]

Facts: A registrant issues Class A and Class B nonredeemable preferred stock19 on 1/1/X1. Class A, by its terms, will pay no dividends during the years 20X1 through 20X3. Class B, by its terms, will pay dividends at annual rates of $2, $4 and $6 per share in the years 20X1, 20X2 and 20X3, respectively. Beginning in the year 20X4 and thereafter as long as they remain outstanding, each instrument will pay dividends at an annual rate of $8 per share. In all periods, the scheduled dividends are cumulative.

At the time of issuance, eight percent per annum was considered to be a market rate for dividend yield on Class A, given its characteristics other than scheduled cash dividend entitlements (voting rights, liquidation preference, etc.), as well as the registrant’s financial condition and future economic prospects. Thus, the registrant could have expected to receive proceeds of approximately $100 per share for Class A if the dividend rate of $8 per share (the “perpetual dividend”) had been in effect at date of issuance. In consideration of the dividend payment terms, however, Class A was issued for proceeds of $79 3/8 per share. The difference, $20 5/8, approximated the value of the absence of $8 per share dividends annually for three years, discounted at 8%.

The issuance price of Class B shares was determined by a similar approach, based on the terms and characteristics of the Class B shares.

Question 1: How should preferred stocks of this general type (referred to as “increasing rate preferred stocks”) be reported in the balance sheet?

Interpretive Response: As is normally the case with other types of securities, increasing rate preferred stock should be recorded initially at its fair value on date of issuance. Thereafter, the carrying amount should be increased periodically as discussed in the Interpretive Response to Question 2.

Question 2: Is it acceptable to recognize the dividend costs of increasing rate preferred stocks according to their stated dividend schedules?

Interpretive Response: No. The staff believes that when consideration received for preferred stocks reflects expectations of future dividend streams, as is normally the case with cumulative preferred stocks, any discount due to an absence of dividends (as with Class A) or gradually increasing dividends (as with Class B) for an initial period represents prepaid, unstated dividend cost.20 Recognizing the dividend cost of these instruments according to their stated dividend schedules would report Class A as being cost-free, and would report the cost of Class B at less than its effective cost, from the standpoint of common stock interests (i.e., for purposes of computing income applicable to common stock and earnings per common share) during the years 20X1 through 20X3.

Accordingly, the staff believes that discounts on increasing rate preferred stock should be amortized over the period(s) preceding commencement of the perpetual dividend, by charging imputed dividend cost against retained earnings and increasing the carrying amount of the preferred stock by a corresponding amount. The discount at time of issuance should be computed as the present value of the difference between (a) dividends that will be payable, if any, in the period(s) preceding commencement of the perpetual dividend; and (b) the perpetual dividend amount for a corresponding number of periods; discounted at a market rate for dividend yield on preferred stocks that are comparable (other than with respect to dividend payment schedules) from an investment standpoint. The amortization in each period should be the amount which, together with any stated dividend for the period (ignoring fluctuations in stated dividend amounts that might result from variable rates,21 results in a constant rate of effective cost vis-a-vis the carrying amount of the preferred stock (the market rate that was used to compute the discount).

Simplified (ignoring quarterly calculations) application of this accounting to the Class A preferred stock described in the “Facts” section of this bulletin would produce the following results on a per share basis:

During 20X4 and thereafter, the stated dividend of $8 measured against the carrying amount of $10022 would reflect dividend cost of 8%, the market rate at time of issuance.

The staff believes that existing authoritative literature, while not explicitly addressing increasing rate preferred stocks, implicitly calls for the accounting described in this bulletin.

The pervasive, fundamental principle of accrual accounting would, in the staff’s view, preclude registrants from recognizing the dividend cost on the basis of whatever cash payment schedule might be arranged. Furthermore, recognition of the effective cost of unstated rights and privileges is well-established in accounting, and is specifically called for by FASB ASC Subtopic 835-30, Interest — Imputation of Interest, and Topic 3.C of this codification for unstated interest costs of debt capital and unstated dividend costs of redeemable preferred stock capital, respectively. The staff believes that the requirement to recognize the effective periodic cost of capital applies also to nonredeemable preferred stocks because, for that purpose, the distinction between debt capital and preferred equity capital (whether redeemable23 or nonredeemable) is irrelevant from the standpoint of common stock interests.

Question 3: Would the accounting for discounts on increasing rate preferred stock be affected by variable stated dividend rates?

Interpretive Response: No. If stated dividends on an increasing rate preferred stock are variable, computations of initial discount and subsequent amortization should be based on the value of the applicable index at date of issuance and should not be affected by subsequent changes in the index.

For example, assume that a preferred stock issued 1/1/X1 is scheduled to pay dividends at annual rates, applied to the stock’s par value, equal to 20% of the actual (fluctuating) market yield on a particular Treasury security in 20X1 and 20X2, and 90% of the fluctuating market yield in 20X3 and thereafter. The discount would be computed as the present value of a two-year dividend stream equal to 70% (90% less 20%) of the 1/1/X1 Treasury security yield, annually, on the stock’s par value. The discount would be amortized in years 20X1 and 20X2 so that, together with 20% of the 1/1/X1 Treasury yield on the stock’s par value, a constant rate of cost vis-a-vis the stock’s carrying amount would result. Changes in the Treasury security yield during 20X1 and 20X2 would, of course, cause the rate of total reported preferred dividend cost (amortization of discount plus cash dividends) in those years to be more or less than the rate indicated by discount amortization plus 20% of the 1/1/X1 Treasury security yield. However, the fluctuations would be due solely to the impact of changes in the index on the stated dividends for those periods.

____________________

19 “Nonredeemable” preferred stock, as used in this SAB, refers to preferred stocks which are not redeemable or are redeemable only at the option of the issuer.

20 As described in the “Facts” section of this issue, a registrant would receive less in proceeds for a preferred stock, if the stock were to pay less than its perpetual dividend for some initial period(s), than if it were to pay the perpetual dividend from date of issuance. The staff views the discount on increasing rate preferred stock as equivalent to a prepayment of dividends by the issuer, as though the issuer had concurrently (a) issued the stock with the perpetual dividend being payable from date of issuance, and (b) returned to the investor a portion of the proceeds representing the present value of certain future dividend entitlements which the investor agreed to forgo.

21 See Question 3 regarding variable increasing rate preferred stocks.

22 It should be noted that the $100 per share amount used in this issue is for illustrative purposes, and is not intended to imply that application of this issue will necessarily result in the carrying amount of a nonredeemable preferred stock being accreted to its par value, stated value, voluntary redemption value or involuntary liquidation value.

23 Application of the interest method with respect to redeemable preferred stocks pursuant to Topic 3.C results in accounting consistent with the provisions of this bulletin irrespective of whether the redeemable preferred stocks have constant or increasing stated dividend rates. The interest method, as described in FASB ASC Subtopic 835-30, produces a constant effective periodic rate of cost that is comprised of amortization of discount as well as the stated cost in each period.

In accordance with SAB Topic 5.Q, the SEC staff believes that an entity must use the interest method to recognize dividends on increasing-rate preferred stock. Although SAB Topic 5.Q specifically discusses preferred stock issued at a discount to its liquidation preference, with stated dividends that increase over time, the guidance also applies to preferred stock issued at its liquidation preference that contains a stated dividend rate that increases over time. Further, the guidance applies to both redeemable and nonredeemable preferred stock.

The specific terms of preferred stock must be analyzed to determine whether the instrument is considered increasing-rate preferred stock to which SAB Topic 5.Q must be applied. The table below discusses the application of SAB Topic 5.Q to certain types of preferred stock instruments, including the interaction between SAB Topic 5.Q and the SEC’s guidance on redeemable preferred stock in ASC 480-10-S99-3A. The discussion in the table assumes that no issuance costs are capitalized into the initial carrying amount of the preferred stock and that any discount on the preferred stock arises solely from an issuance price that is less than the preferred stock’s stated liquidation preference. In the table, it is also assumed that callable preferred stock is called by the issuer before the dividend “step-up.” If the preferred stock is not called, a reassessment of the accounting may be necessary.

Table 3-4

Type of Preferred Stock	Example	Application of SAB Topic 5.Q
1. Noncumulative preferred stock	Entity A issues noncumulative preferred stock with a $1,000 liquidation preference and receives $900. The stated dividends on the preferred stock increase over time. The preferred stock may be callable or puttable.	SAB Topic 5.Q does not apply to preferred stock with noncumulative dividends even if the preferred stock was issued at a discount to its liquidation preference or has a stated rate of dividends that increase over time. Dividends on noncumulative preferred stock should be recognized as a reduction of net income to arrive at income available to common stockholders only when declared. There is no requirement to amortize any discount between the issuance price and liquidation preference of the preferred stock unless the preferred stock is a redeemable security subject to the remeasurement requirements of ASC 480-10-S99-3A.
2. Cumulative preferred stock with fixed-rate dividends that do not increase over time	Entity B issues cumulative, 8 percent preferred stock with a $1,000 liquidation preference and receives $900. The preferred stock may be callable or puttable.	SAB Topic 5.Q does not apply to preferred stock with cumulative dividends at a stated rate that do not increase over time even if the preferred stock was issued at a discount to its liquidation preference. (For this purpose, dividends would be considered to be at a stated rate that does not increase over time if the potential to increase is due solely to an increase in a market variable rate.) Dividends on the cumulative preferred stock should be recognized at the stated rate as a reduction of net income to arrive at income available to common stockholders as the dividends accumulate, regardless of whether they are declared. There is no requirement to amortize any discount between the issuance price and liquidation preference of the preferred stock unless the preferred stock is a redeemable security subject to the remeasurement requirements of ASC 480-10-S99-3A.
3. Cumulative preferred stock with fixed-rate dividends that increase over time		SAB Topic 5.Q applies to preferred stock with cumulative dividends that increase over time if the instrument was issued at a discount to its liquidation preference or the “step-up” in the stated dividends occurs before the date on which the issuer may call the instrument.(a)
3a. Perpetual preferred stock	Entity C issues perpetual cumulative preferred stock with a $1,000 liquidation preference. The dividends on the preferred stock initially accumulate at 5 percent per annum and periodically increase thereafter. The preferred stock may be issued at its liquidation preference or at a discount to its liquidation preference.(a)	SAB Topic 5.Q applies to perpetual preferred stock that is issued at its liquidation preference or at a discount to its liquidation preference if the stated dividends on the preferred stock increase over time. Dividends on the cumulative preferred stock should be recognized as a reduction of net income to arrive at income available to common stockholders as they accumulate, regardless of whether the dividends are declared, on the basis of the interest method. If the preferred stock was issued at a discount to the liquidation preference, that discount should be included with the increasing-rate dividends in the recognition of dividends under the interest method.(b) The accretion of any such discount affects the carrying amount of the preferred stock on the balance sheet (i.e., the accretion is not just for EPS purposes).
3b. Puttable preferred stock	Entity D issues puttable cumulative preferred stock with a $1,000 liquidation preference. The dividends on the preferred stock initially accumulate at 5 percent per annum and periodically increase thereafter. The preferred stock may be issued at its liquidation preference or at a discount to its liquidation preference.(a) The preferred stock may also be callable by the issuer.	The application of SAB Topic 5.Q depends on whether the preferred stock was issued at a discount to the liquidation preference or whether the issuer can call the preferred stock before the “step-up” in the stated dividend rate. The fact that the holder may put the instrument does not obviate the need to apply SAB Topic 5.Q, since the issuer does not control the holder’s decision to put the instrument; however, the put feature could affect how SAB Topic 5.Q is applied. Dividends on the cumulative preferred stock should be recognized as a reduction of net income to arrive at income available to common stockholders as they accumulate, regardless of whether they are declared, as follows: Issuer cannot call the preferred stock at the liquidation preference and the preferred stock was issued at a discount to the liquidation preference — SAB Topic 5.Q applies to the discount from the liquidation preference and the dividend “step-up” feature. ASC 480-10-S99-3A applies to the put option.(c) Issuer cannot call the preferred stock at the liquidation preference and the preferred stock was not issued at a discount to the liquidation preference — SAB Topic 5.Q applies to the dividend “step-up” feature. ASC 480-10- S99-3A applies to the put option.(c) Issuer can call the preferred stock at the liquidation preference before the dividend “step-up” and the preferred stock was issued at a discount to the liquidation preference — SAB Topic 5.Q applies to the discount between the issuance price and the liquidation preference because, to avoid paying dividends at the increased rate, the issuer must call the preferred stock at a premium to its issuance price. SAB Topic 5.Q does not apply to the dividend “step-up” because the issuer can avoid paying dividends at the increased rate by calling the preferred stock at the liquidation preference. The issuer should use the interest method to accrete the discount (i.e., the difference between the issuance price and the call price, which may include unpaid dividends) on the basis of the period between the issuance date and the call date.(d),(e) ASC 480-10-S99-3A applies to the put option.(c) Issuer can call the preferred stock at the liquidation preference before the dividend “step-up” and the preferred stock was not issued at a discount to the liquidation preference — SAB Topic 5.Q does not apply because the issuer can avoid paying dividends at the increased rate by calling the preferred stock for the liquidation preference without paying a premium to the issuance price (i.e., the call price equals the initial carrying amount of the preferred stock). ASC 480-10-S99-3A applies to the put option.(c) Issuer can call the preferred stock at the liquidation preference after the dividend “step-up” and the preferred stock was issued at a discount to the liquidation preference — SAB Topic 5.Q applies to the discount between the issuance price and the liquidation preference because, to avoid paying dividends at the increased rate once the call becomes exercisable, the issuer must redeem the preferred stock at a premium to its issuance price. SAB Topic 5.Q also applies to the dividend “step-up” before the first call date because the issuer cannot avoid paying these increased dividends.(d) ASC 480-10-S99-3A applies to the put option.(c) Issuer can call the preferred stock at the liquidation preference after the dividend “step-up” and the preferred stock was not issued at a discount to the liquidation preference — SAB Topic 5.Q applies to the dividend “step-up” but only to the first call date. SAB Topic 5.Q does not apply to the dividend “step-up” after the first call date because the issuer can avoid paying dividends at the increased rate by calling the preferred stock at its liquidation preference without paying a premium to the issuance price (i.e., the call price equals the initial carrying amount of the preferred stock). ASC 480-10-S99-3A applies to the put option.(c)
3c. Callable preferred stock	Entity E issues callable cumulative preferred stock with a $1,000 liquidation preference. The dividends on the preferred stock initially accumulate at 5 percent per annum and periodically increase thereafter starting at the beginning of year 5. The issuer can call the preferred stock for its liquidation preference at the beginning of year 5. The preferred stock may be issued at its liquidation preference or at a discount to its liquidation preference.(a) The preferred stock is not puttable by the holder.(f)	The application of SAB Topic 5.Q depends on whether the preferred stock was issued at a discount to the liquidation preference and when the issuer can call the preferred stock. Dividends on the cumulative preferred stock should be recognized as a reduction of net income to arrive at income available to common stockholders as they accumulate, regardless of whether they are declared, as follows: Issuer can call the preferred stock at the liquidation preference before the dividend “step-up” and the preferred stock was not issued at a discount to the liquidation preference — SAB Topic 5.Q does not apply because the issuer can avoid paying dividends at the increased rate by calling the preferred stock for the liquidation preference without paying a premium to the issuance price (i.e., the call price equals the initial carrying amount of the preferred stock). Issuer can call the preferred stock at the liquidation preference before the dividend “step-up” and the preferred stock was issued at a discount to the liquidation preference — SAB Topic 5.Q applies to the discount between the issuance price and the liquidation preference because, to avoid paying dividends at the increased rate, the issuer must call the preferred stock at a premium to its issuance price. SAB Topic 5.Q does not apply to the dividend “step-up” because the issuer can avoid paying dividends at the increased rate by calling the preferred stock at the liquidation preference. The issuer should use the interest method to accrete the discount (i.e., the difference between the issuance price and the call price, which may include unpaid dividends) on the basis of the period between the issuance date and the call date.(d),(e) Issuer can call the preferred stock at the liquidation preference after the dividend “step-up” and the preferred stock was not issued at a discount to the liquidation preference — SAB Topic 5.Q applies to the dividend “step-up,” but only to the first call date. SAB Topic 5.Q does not apply to the dividend “step-up” after the first call date because the issuer can avoid paying dividends at the increased rate by calling the preferred stock at its liquidation preference without paying a premium to the issuance price (i.e., the call price equals the initial carrying amount of the preferred stock). Issuer can call the preferred stock at the liquidation preference after the dividend “step-up” and the preferred stock was issued at a discount to the liquidation preference — SAB Topic 5.Q applies to the discount between the issuance price and the liquidation preference because, to avoid paying dividends at the increased rate once the call becomes exercisable, the issuer must redeem the preferred stock at a premium to its issuance price. SAB Topic 5.Q also applies to the dividend “step-up” before the first call date because the issuer cannot avoid paying these increased dividends.(d)
4. Cumulative preferred stock with fixed-rate dividends that increase over time only if a contingent event occurs	Entity F issues cumulative preferred stock with a $1,000 liquidation preference. Dividends on the preferred stock accumulate at a rate of 6 percent per annum. The preferred stock is puttable at the option of the holder upon the occurrence of a specified contingency that is outside the control of the investor.(g) If the holder elects to put the preferred stock upon the occurrence of the specified contingency, F can either redeem the preferred stock at an amount equal to 130 percent of the liquidation preference or not redeem the instrument, in which case the dividend rate on the preferred stock increases to 10 percent per annum.	SAB Topic 5.Q does not address situations in which the dividend increase results from a substantive contingency that is outside the control of the investor. In a manner consistent with the accounting for contingent dividends (see Section 3.2.2.2.5), if the “step-up” in the dividend rate will not be operative upon the mere passage of time and the investor does not control the conditions that would result in an increase in the dividend rate, dividends should accumulate and reduce net income in arriving at income available to common stockholders on the basis of the stated rate, provided that the contingent event that results in an increase in dividends does not occur. The additional contingent dividends should be deducted from net income in arriving at income available to common stockholders only when the contingent event that requires such payment occurs.
Notes to Table: (a) Preferred stock is generally considered to have been issued at a discount to its liquidation preference at any time the issuance price (i.e., proceeds received from the investor before direct issuance costs paid to third parties) is less than the preference that the holder of the preferred stock has in liquidation of the issuing entity. For example, preferred stock that is issued to an investor for $1 million that is redeemable for $1 million plus a premium (whether in accordance with a call option or put option) is considered to have been issued at a discount to its liquidation preference. As another example, preferred stock is considered to have been issued at a discount to its liquidation preference when the preferred stock is issued with other freestanding financial statements (e.g., detachable warrants) and the allocation of the proceeds to the preferred stock results in an initial carrying amount that is less than its liquidation preference. However, the mere fact that preferred stock has been issued at a discount to its liquidation preference does not mean that SAB Topic 5.Q applies to the recognition of dividends. (b) The issuer may need to estimate (or derive) a life to calculate an effective yield under the interest method. (c) ASC 480-10-S99-3A may require remeasurement of the preferred stock to its redemption amount if the redemption amount exceeds the net carrying amount of the preferred stock before application of ASC 480-10-S99-3A. (d) If the issuer does not intend to call the preferred stock on the first dividend “step-up” date (or when the preferred stock is otherwise first callable) because it is not economically advantageous to call the preferred stock in considering the discount to the liquidation preference and the increased dividends, SAB Topic 5.Q may be applied differently. The application of SAB Topic 5.Q to the discount and the “step-feature” will depend on the particular facts and circumstances. For example, an application of the interest method on the basis of the expected life of the instrument, as discussed in the second approach under footnote (e), may be appropriate. (e) When an issuer expects to exercise a call option to avoid paying any dividends at a higher or “stepped-up” rate (i.e., the call option may be exercised before the date the dividends increase), it is generally most appropriate for the issuer to use the interest method to amortize the entire discount between the issuance price and liquidation preference over a period that ends with the call date. However, prior informal discussions with the SEC staff have revealed that other approaches may also be acceptable, including the following: Amortization of the discount between the issuance price and liquidation preference by the amount necessary to produce a constant effective yield that is equal to the dividend rate after the initial dividend rate increases. For example, assume that an entity issues cumulative preferred stock that pays dividends at 5 percent per annum for the first five years and 9 percent per annum in all periods thereafter. Further assume that the issuer can call the preferred stock instrument in year 5 or anytime thereafter. The entity may amortize a portion of the discount during the first five years to produce a 9 percent constant yield over the first five years, thereby resulting in a 9 percent yield over the entire life of the instrument. This approach may not result in full amortization of the discount on the call date. Thus, if the entity redeems the preferred stock on this date or thereafter, it would incur a charge or credit under ASC 260-10-S99-2. See Section 3.2.2.6 for discussion of the application of ASC 260-10-S99-2. The preferred stock is subsequently measured by using a constant effective yield calculated on the basis of the expected life of the preferred stock as of the issuance date (i.e., the interest method, taking into account the discount between the issuance price and liquidation preference and the stated dividends, including the “step-up” amounts). The expected life would not be reassessed after inception. Application of this approach may result in a charge or credit under ASC 260-10-S99-2 on any redemption date depending on the expected life at inception and the date of redemption of the preferred stock. See Section 3.2.2.6 for discussion of the application of ASC 260-10-S99-2. (f) If the preferred stock were puttable, the issuer would also need to consider ASC 480-10-S99-3A. (g) The increased dividends may result from penalty payments upon the issuer’s failure to take certain actions (e.g., failure to deliver common shares upon conversion within a stated period) or declines in the issuer’s creditworthiness. If the investor controls the occurrence of the events that result in the requirement for the issuer to either redeem the preferred stock at a premium or increase the dividends, the preferred stock would not be considered to have contingent increasing-rate dividends. Therefore, the issuer would need to accrete the preferred stock instrument on the basis of the greater of the redemption price or the increased dividend rate.

Connecting the Dots

An issuer cannot avoid applying the SEC’s guidance on increasing-rate preferred stock on the basis that the holder may convert a preferred stock instrument into the issuer’s common shares before the stated dividend rate increases. The issuer does not control the ability to require the instrument to be converted into common stock and therefore does not have the unilateral ability to avoid an increase in the dividend rate. The same conclusion applies to a convertible preferred stock instrument that is mandatorily convertible into the issuer’s common shares if the issuer’s stock price increases to a stated amount per share.

Although ASC 480-10-S99-3A(15) gives an entity the option of recognizing redemption-amount measurement adjustments related to redeemable preferred stock by using one of two methods when preferred stock is not redeemable on the balance sheet date but it is probable that it will become redeemable (i.e., an accretion method or a method that assumes the preferred stock is redeemable on the balance sheet date), the entity must apply the effective yield method when SAB Topic 5.Q applies. Under SAB Topic 5.Q, it is not appropriate to immediately recognize the entire discount between the issuance price and the liquidation preference related to increasing-rate preferred stock. Rather, an entity applies the SEC’s guidance on increasing-rate preferred stock independently from the guidance on redeemable equity securities. However, some preferred stock instruments may be subject to both sets of requirements.

3.2.2.4 Redeemable Preferred Stock

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 1: How should the carrying amount of redeemable preferred stock be determined?

Interpretive Response: The initial carrying amount of redeemable preferred stock should be its fair value at date of issue. Where fair value at date of issue is less than the mandatory redemption amount, the carrying amount shall be increased by periodic accretions, using the interest method, so that the carrying amount will equal the mandatory redemption amount at the mandatory redemption date. The carrying amount shall be further periodically increased by amounts representing dividends not currently declared or paid, but which will be payable under the mandatory redemption features, or for which ultimate payment is not solely within the control of the registrant (e.g., dividends that will be payable out of future earnings). Each type of increase in carrying amount shall be effected by charges against retained earnings or, in the absence of retained earnings, by charges against paid-in capital.

The accounting described in the preceding paragraph would apply irrespective of whether the redeemable preferred stock may be voluntarily redeemed by the issuer prior to the mandatory redemption date, or whether it may be converted into another class of securities by the holder. Companies also should consider the guidance in FASB ASC paragraph 480-10-S99-3A (Distinguishing Liabilities from Equity Topic).

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.

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.

In accordance with ASR 268, as interpreted by SAB Topic 3.C and ASC 480-10-S99-3A, preferred stock that is redeemable at the option of the holder or upon the occurrence of an event outside the issuer’s control, other than an ordinary liquidation, must be classified in temporary equity by an SEC registrant. Furthermore, if the preferred stock is currently redeemable or it is probable that it will become redeemable, the preferred stock must be periodically remeasured to its redemption amount. Regardless of whether the redemption price represents a fair value or non–fair value amount upon redemption, adjustments to remeasure redeemable preferred stock to its redemption amount represent “deemed dividends” that must be reduced from net income in arriving at income available to common stockholders.

ASC 480-10-S99-3A(14) states, in part, that when preferred stock “is currently redeemable (for example, at the option of the holder), it should be adjusted to its maximum redemption amount at the balance sheet date.” If the preferred stock is not currently redeemable, but it is probable that it will become redeemable (for example, when the redemption depends solely on the passage of time), an entity can select one of two methods to remeasure the preferred stock to its redemption amount. ASC 480-10-S99-3A(15) describes these two methods as follows:

Accrete changes in the redemption value over the period from the date of issuance (or from the date that it becomes probable that the instrument will become redeemable, if later) to the earliest redemption date of the instrument using an appropriate methodology, usually the interest method. Changes in the redemption value are considered to be changes in accounting estimates.
Recognize changes in the redemption value (for example, fair value) immediately as they occur and adjust the carrying amount of the instrument to equal the redemption value at the end of each reporting period. This method would view the end of the reporting period as if it were also the redemption date for the instrument.

The method applied under ASC 480-10-S99-3A(15) to remeasure preferred stock to its redemption amount will affect the periodic amount of “deemed dividends” that reduce net income in arriving at income available to common stockholders. ASC 480-10-S99-3A(16)(e) stipulates that decreases to the carrying amount that result from the application of ASC 480-10-S99-3A may only be recognized to the extent that such decreases reflect recoveries of previously recognized increases to the carrying amount as a result of the application of ASC 480-10-S99-3A. For additional guidance on applying the SEC’s guidance on redeemable securities, see Chapter 9 of Deloitte’s Roadmap Distinguishing Liabilities From Equity.

Connecting the Dots

The redemption amount of redeemable preferred stock may vary (e.g., it may be the fair value of the preferred stock or it may be based on an index). In these situations, ASC 480-10-S99-3A allows an entity to reverse prior increases in the carrying amount of the preferred stock that resulted from the application of the subsequent-measurement guidance in ASC 480-10-S99-3A. These increases would reverse the “deemed dividends” recorded in prior periods and would be treated as a “deemed contribution” by the preferred stockholder. Thus, the adjustment to net income to arrive at income available to common stockholders in a particular period could be positive (i.e., a “credit” resulting from the reduction of the redemption amount of redeemable preferred stock). However, on a cumulative basis, adjustments to remeasure redeemable preferred stock to its redemption amount may not be negative (i.e., cumulatively, there cannot be a positive adjustment to net income in arriving at income available to common stockholders). ASC 480-10-S99-3A(16)(e) states:

[R]egardless of the accounting method applied [the immediate or accretion method], the amount presented in temporary equity should be no less than the initial amount reported in temporary equity for the instrument. That is, reductions in the carrying amount of a redeemable equity instrument from the application of [the immediate method or accretion method] are appropriate only to the extent that the registrant has previously recorded increases in the carrying amount of the redeemable equity instrument from the application of [the immediate method or accretion method].

See Section 3.2.2.6.2.2 for discussion of the accounting for a redemption of redeemable preferred stock that has been remeasured under ASC 480-10-S99-3A.

3.2.2.5 Convertible Preferred Stock

3.2.2.5.1 Convertible Preferred Stock That Contains a Down-Round Feature

ASC 260-10

Financial Instruments That Include a Down Round Feature

25-1 An entity that presents earnings per share (EPS) in accordance with this Topic shall recognize the value of the effect of a down round feature in an equity-classified freestanding financial instrument and an equity-classified convertible preferred stock (if the conversion feature has not been bifurcated in accordance with other guidance) when the down round feature is triggered. That effect shall be treated as a dividend and as a reduction of income available to common stockholders in basic earnings per share, in accordance with the guidance in paragraph 260-10-45-12B. See paragraphs 260-10-55-95 through 55-97 for an illustration of this guidance.

Financial Instruments That Include a Down Round Feature

30-1 As of the date that a down round feature is triggered (that is, upon the occurrence of the triggering event that results in a reduction of the strike price) in an equity-classified freestanding financial instrument and an equity-classified convertible preferred stock (if the conversion feature has not been bifurcated in accordance with other guidance), an entity shall measure the value of the effect of the feature as the difference between the following amounts determined immediately after the down round feature is triggered:

The fair value of the financial instrument (without the down round feature) with a strike price corresponding to the currently stated strike price of the issued instrument (that is, before the strike price reduction)
The fair value of the financial instrument (without the down round feature) with a strike price corresponding to the reduced strike price upon the down round feature being triggered.

30-2 The fair values of the financial instruments in paragraph 260-10-30-1 shall be measured in accordance with the guidance in Topic 820 on fair value measurement. See paragraph 260-10-45-12B for related earnings per share guidance and paragraphs 505-10-50-3 through 50-3A for related disclosure guidance.

Financial Instruments That Include a Down Round Feature

35-1 An entity shall recognize the value of the effect of a down round feature in an equity-classified freestanding financial instrument and an equity-classified convertible preferred stock (if the conversion feature has not been bifurcated in accordance with other guidance) each time it is triggered but shall not otherwise subsequently remeasure the value of a down round feature that it has recognized and measured in accordance with paragraphs 260-10-25-1 and 260-10-30-1 through 30-2. An entity shall not subsequently amortize the amount in additional paid-in capital arising from recognizing the value of the effect of the down round feature.

Freestanding Equity-Classified Financial Instrument With a Down Round Feature

45-12B For a freestanding equity-classified financial instrument and an equity-classified convertible preferred stock (if the conversion feature has not been bifurcated in accordance with other guidance) with a down round feature, an entity shall deduct the value of the effect of a down round feature (as recognized in accordance with paragraph 260-10-25-1 and measured in accordance with paragraphs 260-10-30-1 through 30-2) in computing income available to common stockholders when that feature has been triggered (that is, upon the occurrence of the triggering event that results in a reduction of the strike price).

Under ASC 260, when a down-round feature in convertible preferred stock is triggered (i.e., when the conversion price is adjusted), an entity must immediately recognize a dividend (which reduces the numerator in the calculation of basic EPS) on the basis of the increase in the fair value of the instrument. This accounting is the same as the treatment of a down-round feature in a freestanding equity-linked financial instrument, such as a warrant (see Section 3.2.5.3). However, down-round features in convertible debt instruments do not affect EPS (i.e., they are not recognized as dividends when they are triggered).

3.2.2.5.2 Redeemable Convertible Preferred Stock

The guidance in ASC 480-10-S99-3A on the subsequent measurement of redeemable equity securities applies to convertible preferred stock that (1) is currently redeemable or (2) it is probable will become redeemable. See Section 3.2.2.4 for discussion of the application of ASC 480-10-S99-3A to redeemable preferred stock. See Sections 3.2.5.2.4 and 3.2.5.2.5 for additional guidance on redeemable convertible preferred stock that contains a separately classified equity component.

3.2.2.5.3 Participating Convertible Preferred Stock

Section 3.2.2.7 discusses the EPS accounting for participating convertible preferred stock.

3.2.2.5.4 Accounting for a Conversion of Convertible Preferred Stock

A settlement of convertible preferred stock through the issuance of common shares in accordance with the stated conversion privileges in the convertible preferred stock agreement is not subject to ASC 260-10-S99-2 and has no incremental impact on income available to common stockholders in the calculation of basic EPS, provided that (1) the settlement is considered a “conversion” and (2) no component of the convertible preferred stock instrument is separately classified either as a derivative liability or within stockholders’ equity. Section 3.2.2.6.2.1 discusses whether a settlement of convertible preferred stock is treated as a “conversion” or a redemption. Section 3.2.2.5.4.1 discusses the EPS accounting for a settlement of a preferred stock host contract and an embedded conversion option liability when the settlement is considered a “conversion.” Section 3.2.2.5.4.2 discusses the EPS accounting for a settlement of convertible preferred stock that contains a separately recognized equity component when the settlement is considered a “conversion.” Section 3.2.2.6.3 discusses the EPS accounting for a settlement of convertible preferred stock that arises from an induced conversion.

3.2.2.5.4.1 Convertible Preferred Stock That Contains an Embedded Conversion Option Accounted for as a Derivative Liability

The Codification does not specifically address the accounting for a settlement of a preferred stock host contract and a separated embedded conversion option liability through the issuance of common stock under the original conversion terms of the instrument. As a result, there may be alternative views on the accounting upon a settlement. The acceptable alternative views, when the settlement is considered a conversion according to the original conversion privileges, as opposed to a redemption or an induced conversion, are as follows:5

Redemption accounting — Even though the settlement occurred in accordance with the contractual conversion terms, it is treated as a redemption since the embedded conversion option was separated as a liability. As a result, an adjustment is made to net income in arriving at income available to common stockholders in accordance with ASC 260-10-S99-2. That adjustment, which is recognized in retained earnings, will equal the difference between the settlement-date fair value of the common stock issued on conversion and the aggregate of the carrying amounts of the preferred stock host contract and the separated embedded conversion option liability, as adjusted immediately before redemption accounting is applied.

When entities use this approach, there is diversity in practice related to the adjustment to the carrying amount of the separated liability for the embedded conversion option that is made immediately before redemption accounting is applied. Some entities will adjust the liability for the embedded conversion option to its fair value under ASC 820 immediately before applying redemption accounting. Other entities will adjust the liability for the embedded conversion option to the fair value of the common stock issued upon conversion, or its “intrinsic value,” immediately before applying redemption accounting. While the final adjustment to the embedded conversion option liability may result in a gain or loss that is recognized in earnings under either approach, entities that apply the latter approach will recognize a larger gain or a smaller loss in earnings as a result of the reversal of any remaining time value in the embedded conversion option liability. Even if the latter view is applied to the adjustment of the carrying amount of the embedded conversion option liability, an adjustment will still be required under ASC 260-10-S99-2 if there is any unamortized discount or premium on the convertible preferred stock host contract. The accounting becomes more complex if the convertible preferred stock instrument is a redeemable security subject to the subsequent-measurement guidance in ASC 480-10-S99-3A. In these circumstances, the carrying amount of the preferred stock host contract must also be remeasured in accordance with the recognition and measurement guidance in ASC 480-10-S99-3A immediately before redemption accounting is applied.
Conversion accounting — Since the settlement occurred in accordance with the contractual conversion terms, it is treated in the same manner as a conversion of convertible preferred stock that has no separately recognized amount for the embedded conversion option. Common stockholders’ equity is increased by the sum of the carrying amount of the preferred stock host and embedded conversion option liability. As with the accounting for a conversion when the embedded conversion option is not separated from the hybrid convertible preferred stock instrument, ASC 260-10-S99-2 does not apply to the settlement. However, if the convertible preferred stock instrument is classified in temporary equity and is being remeasured to its redemption amount, an adjustment in accordance with the entity’s accounting policy for remeasuring redeemable securities under ASC 480-10-S99-3A should be recognized immediately before conversion accounting is applied.
Partial redemption/partial conversion accounting — This view underscores aspects of both redemption accounting and conversion accounting. Any unamortized discount on the preferred stock host contract is immediately amortized into retained earnings and considered a “deemed dividend” that reduces net income in arriving at income available to common stockholders. This approach is consistent with the accounting for a conversion of convertible preferred stock that contains a separately recognized equity component. Common stockholders’ equity is then increased by the sum of the carrying amounts of the preferred stock host contract and separated embedded conversion option liability in a manner similar to the accounting for a conversion. Under this approach, if no unamortized discount remains on the host contract, no adjustment will be needed upon settlement for the redemption accounting aspect. Further, if the convertible preferred stock is a redeemable security that is being remeasured to its redemption amount under ASC 480-10-S99-3A, an entity should remeasure the carrying amount of the preferred stock host contract in accordance with the recognition and measurement guidance in ASC 480-10-S99-3A immediately before accounting for the settlement of the instrument.

Section 3.2.2.6.2.1.1 discusses the EPS accounting for a redemption of convertible preferred stock that contains a separately recognized embedded conversion option derivative liability.

3.2.2.5.4.2 Convertible Preferred Stock That Contains a Separately Classified Equity Component

Section 3.2.5.2.4 discusses the EPS accounting for a settlement of convertible preferred stock that contains a separately classified equity component related to the embedded conversion option when the settlement is considered a “conversion.” As discussed in that section, upon conversion, any remaining unamortized discount on the convertible preferred stock should be immediately recognized as a dividend, which reduces net income in arriving at income available to common stockholders. The adjusted carrying amount of the convertible preferred stock and the carrying amount of the separately recognized equity component should then be recognized in stockholders’ equity to reflect the conversion. This entry has no impact on income available to common stockholders. The accounting upon conversion will also be affected by the application of ASC 480-10-S99-3A if the convertible preferred stock instrument is a redeemable equity security that is subject to the subsequent-measurement guidance in ASC 480-10-S99-3A. See further discussion in Sections 3.2.5.2.4 and 3.2.5.2.5.

3.2.2.6 Redemption or Induced Conversion of Preferred Stock

3.2.2.6.1 General

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 following is the text of SEC Staff Announcement: The Effect on Calculation of Earnings per Share for a Period That Includes the Redemption or Induced Conversion of Preferred Stock.

Scope

This SEC staff announcement applies to redemptions and induced conversions of equity-classified preferred stock instruments. For purposes of this announcement:

Modifications and exchanges of preferred stock instruments that are accounted for as extinguishments, resulting in a new basis of accounting for the modified or exchanged preferred stock instrument, are considered redemptions.
A preferred stock instrument classified within temporary equity pursuant to the guidance in ASR 268 and paragraph 480-10-S99-3A is considered equity-classified, and redemptions and induced conversions of such securities would be subject to this guidance.
If an equity-classified security is subsequently required to be reclassified as a liability based on the provisions of other GAAP (for example, because a preferred share becomes mandatorily redeemable pursuant to Subtopic 480-10), the reclassification is considered a redemption of equity by issuance of a debt instrument.

The accounting for conversions of preferred stock instruments into other equity-classified securities pursuant to conversion privileges provided in the terms of the instruments at issuance is not affected by this announcement.

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 convertible preferred stock is converted into other securities issued by the registrant pursuant to an inducement offer, the SEC staff believes that the excess of (1) the fair value of all securities and other consideration transferred in the transaction by the registrant to the holders of the convertible preferred stock over (2) the fair value of securities issuable pursuant to the original conversion terms should be subtracted from net income to arrive at income available to common stockholders in the calculation of earnings per share. Registrants should consider the guidance provided in Subtopic 470-20 to determine whether the conversion of preferred stock is pursuant to an inducement offer.

The scope of ASC 260-10-S99-2 includes the following two types of transactions:

Redemptions of preferred stock, which include any 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, 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.
- 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.
Induced conversions of convertible preferred stock instruments classified in equity (whether permanent equity or temporary equity).

ASC 260-10-S99-2 does not address the accounting for any of the following transactions:

A conversion of a convertible preferred stock instrument in accordance with its stated conversion privileges.6
A modification or exchange of a preferred stock instrument that is classified in equity (whether permanent equity or temporary equity) that is not treated as an extinguishment, including a modification or exchange of a freestanding or embedded derivative instrument indexed to a preferred stock instrument that is classified in equity that is not treated as an extinguishment.
A redemption, modification, exchange, conversion, or other settlement of common stock.
A redemption, modification, exchange, exercise, or other settlement of a freestanding financial instrument that is indexed to common stock and classified in equity.
A redemption, modification, exchange, conversion, exercise, or other settlement of an embedded derivative indexed to common stock that has an associated amount classified in equity.7
A redemption, modification, exchange, conversion, or other settlement of an embedded derivative indexed to common stock that is not separated from a hybrid financial instrument.
A redemption, modification, exchange, conversion, or other settlement of any liability-classified instrument (e.g., convertible debt).

For transactions not within the scope of ASC 260-10-S99-2, an entity should consider other relevant guidance to determine the effect, if any, on net income or income available to common stockholders. Section 3.2 discusses transactions subject to ASC 260-10-S99-2 as well as certain transactions that are not subject to ASC 260-10-S99-2. Although the requirement in ASC 260-10-S99-2 specifically concerns SEC registrants, nonregistrants that present EPS should also apply it.

The table below summarizes the types of transactions involving preferred stock that are considered redemptions to which ASC 260-10-S99-2 would be applied.

Table 3-5

Instrument	Transaction	Considered Redemption Requiring Application of ASC 260-10-S99-2?
Preferred stock classified in permanent or temporary equity	Extinguishment for cash, other assets, or shares not pursuant to a “conversion” in accordance with the stated conversion privileges: Stated redemption feature in instrument. Open market repurchase. Negotiated redemption between issuer and investor.	Yes.
	Modification or exchange that is accounted for as an extinguishment.	Yes.
	Modification or exchange that is not accounted for as an extinguishment.	No. ASC 260-10-S99-2 does not apply to a modification or exchange of an equity-classified preferred stock instrument that is not accounted for as an extinguishment. However, a similar concept is applied when the modification or exchange provides incremental value to the preferred stockholder. See Section 3.2.6.1 for considerations related to the impact on EPS for a modification or exchange of preferred stock that is not accounted for as an extinguishment.
	Reclassification from equity to a liability.	Yes.
	Conversion into common stock according to the stated conversion privileges that is considered a “conversion.”	No. However, if the conversion is considered an induced conversion, the guidance in ASC 260-10-S99-2 on induced conversions applies (see Section 3.2.2.6.3). See also Sections 3.2.5.2.4 and 3.2.5.2.5 if the preferred stock contains a separately recognized equity component.
Preferred stock classified as liability	Extinguishment for cash, other assets, or shares not pursuant to “conversion” in accordance with the stated conversion privileges: Stated redemption feature in instrument. Open market repurchase. Negotiated redemption between issuer and investor.	No. ASC 405-20 and ASC 470-50 provides accounting and reporting guidance on extinguishments of liabilities.
	Modification or exchange that is accounted for as an extinguishment.	No. ASC 470-50 provides accounting and reporting guidance on modifications and exchanges of liabilities.
	Modification or exchange that is not accounted for as an extinguishment.	No. ASC 470-50 provides accounting and reporting guidance on modifications and exchanges of liabilities.
	Conversion into common stock according to the stated conversion privileges that is considered a “conversion.”	No. ASC 470-20 provides accounting and reporting guidance on the conversion of convertible debt into common stock. That guidance also addresses the accounting for induced conversions.

3.2.2.6.2 Redemption of Preferred Stock

In a redemption of preferred stock that is classified in permanent or temporary equity, any difference between the fair value of consideration transferred to redeem the preferred stock and the net carrying amount of the preferred stock on the issuer’s balance sheet will affect net income available to common stockholders regardless of whether the redemption is at a premium or a discount to the net carrying amount. The SEC staff believes that this difference 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 (i.e., a “deemed dividend” or a “deemed contribution”). 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”).

The table below addresses certain matters related to the redemption of preferred stock.

Issue	Application
Scope	The SEC staff’s view on redemptions of preferred stock in ASC 260-10-S99-2, must be applied to all extinguishments of preferred stock by SEC registrants. It should also be applied by nonregistrants that report EPS under ASC 260. ASC 260-10-S99-2 applies to the redemption of convertible preferred stock regardless of whether the conversion feature is “in-the-money” or “out-of-the-money” as of the redemption date (see Section 3.2.2.6.2.1). ASC 260-10-S99-2 also applies to the reclassification of preferred stock as a liability (see Sections 3.2.2.8 and 3.2.3.5.1) and the redemption of preferred stock that is classified as an NCI (see Sections 3.2.3.2.1 and 3.2.3.3.1).
Consideration transferred to redeem preferred stock	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. Publicly traded companies that repurchase preferred stock may be obligated to pay a 1 percent excise tax under Internal Revenue Code (IRC) Section 4501, which was added by the Inflation Reduction Act of 2022. This excise tax should be included in the adjustment to retained earnings that is recognized for the redemption of the preferred stock in accordance with ASC 260-10-S99-2. See Deloitte’s April 27, 2023, Heads Up for more information about the accounting for this excise tax.
Net carrying amount of preferred stock redeemed	Direct issuance costs capitalized at issuance of preferred stock — Under ASC 260-10-S99-2, the net carrying amount of preferred stock, which is used to calculate the adjustment to the numerator upon a redemption of preferred stock, must include issuance costs that were capitalized into the initial carrying amount of preferred stock. Such costs reduce the net carrying amount of the preferred stock, and the excess of the consideration transferred over this adjusted net carrying amount reduces net income in arriving at income available to common stockholders in the calculation of basic EPS. Because most entities have capitalized issuance costs associated with preferred stock, the numerator in the calculation of basic EPS will generally be adjusted in the period of a redemption of preferred stock unless the preferred stock has already been remeasured to its redemption amount under ASC 480-10-S99-3A (see Section 3.2.2.6.2.2). Undeclared cumulative dividends — To calculate the adjustment to net income to arrive at income available to common stockholders upon a redemption of preferred stock, an entity should add any undeclared cumulative dividends previously considered in the calculation of basic EPS to the net carrying amount of the preferred stock being redeemed when such amounts are not already included in the net carrying amount of the preferred stock. In other words, when the redemption price includes the payment of accumulated but undeclared cumulative dividends that have already been included in the calculation of income available to common stockholders in a prior period but that are not recognized as part of the net carrying amount of the preferred stock on the issuer’s balance sheet, an adjustment must be made to the excess of the fair value of consideration transferred over the net carrying amount of the preferred stock so that the impact of such cumulative dividends is not “double counted.” Declared and unpaid dividends (whether cumulative or not) — If an entity has recognized a liability for accrued and unpaid declared dividends, the carrying amount of this liability should be included with the net carrying amount of the preferred stock in calculating the “deemed dividend” or “deemed contribution” that adjusts net income to arrive at income available to common stockholders. Redeemable preferred stock — For a redemption of redeemable preferred stock that is being remeasured to its redemption amount under ASC 480-10-S99-3A, the net carrying amount should be adjusted immediately before the redemption in accordance with the entity’s accounting for remeasurement adjustments under ASC 480-10-S99-3A (see Section 3.2.2.6.2.2). Convertible preferred stock with a separated embedded conversion liability — See Section 3.2.2.6.2.1.1. Convertible preferred stock with a separated equity component — See Section 3.2.2.6.2.1.2.
Modification of preferred stock that is treated as an extinguishment	An entity may incur fees and costs in a modification or exchange of preferred stock that is treated as an extinguishment. Such fees and costs should be treated in the same manner as that described in ASC 470-50-40-17 and 40-18 for modifications and exchanges of debt instruments that are accounted for as extinguishments. Therefore, fees and costs incurred with third parties should be capitalized into the carrying amount of the “new” preferred stock instrument and fees and costs incurred with investors should be considered associated with the “original” preferred stock instrument and included as part of the charge (or credit) to retained earnings for the extinguishment of the original preferred stock instrument. See Section 3.2.6.1 for more information about modifications and exchanges of preferred stock.

Below are some examples illustrating the application of ASC 260-10-S99-2 to redemptions of preferred stock.

Example 3-8

Reacquisition of Preferred Stock on Open Market

Company B has 100,000 shares of outstanding preferred stock that is not mandatorily redeemable but may be called at B’s option at a price of $1,100 per share. Each outstanding share has a liquidation preference of $1,000. The outstanding preferred stock has an aggregate liquidation preference of $100 million and an aggregate net carrying amount of $98 million (or $980 per share). The difference between the aggregate liquidation preference and net carrying amount results from capitalized issuance costs.

The preferred stock is currently trading at $1,075 per share. Company B has recently issued other securities for which it plans to use those proceeds to redeem the outstanding preferred stock. Since it is economically favorable to B to repurchase the preferred stock in the open market in lieu of exercising its redemption option, B acquires 50,000 shares of the outstanding preferred stock for an aggregate price of $54 million, or (50,000 shares × 1,075) + $250,000 in transaction costs.

Company B’s “reacquisition” should be treated as a redemption of preferred stock under ASC 260-10-S99-2 since this guidance applies to all types of redemptions of preferred stock. The adjustment to income available to common stockholders required for the redemption of the 50,000 shares of preferred stock is a $5 million charge. This is treated in the same manner as the payment of a dividend on preferred stock. The $5 million reduction from net income to arrive at income available to common stockholders is calculated as follows:

The $5 million should not be recognized as a loss in the income statement; rather, it is reflected as a reapportionment of equity between common stockholders and preferred stockholders. The $5 million will, however, have the same impact as a loss on the numerator in the calculation of basic EPS.

Example 3-9

Reclassification of Preferred Stock From Equity to Liability

Company D has outstanding preferred stock with the following terms:

The preferred stock is automatically converted into common stock at a conversion price of $25 per share in the event that D effects a qualified IPO within the next five years.
If D does not effect a qualified IPO by the end of the fifth year from the issuance date, the preferred stock becomes mandatorily redeemable in five years.

Company D should not classify the preferred stock as a liability under ASC 480 before the fifth year from the issuance date if it concludes that the conversion upon a qualified IPO is a substantive feature. Furthermore, while D is required to classify the preferred stock within temporary equity under ASC 480-10-S99-3A, it should not remeasure the preferred stock to its redemption amount as long as the occurrence of a qualified IPO by the end of year five is more than remote.

However, if a qualified IPO does not happen by the end of year five, the preferred stock becomes a mandatorily redeemable financial instrument for which reclassification as a liability is required under ASC 480. In this circumstance, in accordance with ASC 480-10-30-2, D should reflect the reclassification by measuring the liability initially at fair value and reducing equity by the same amount without recognizing a gain or loss. This reclassification is treated in the same manner as any other extinguishment of preferred stock under ASC 260-10-S99-2. Therefore, the difference between the initial fair value amount recognized for the preferred stock upon reclassification as a liability and the net carrying amount of the preferred stock (which should be adjusted under other applicable GAAP, including ASC 480-10-S99-3A if applicable, immediately before such reclassification) reflects a charge (or credit) to net income in arriving at income available to common stockholders. See Section 3.2.2.8 for further discussion of the reclassification of preferred stock to a liability.

Example 3-10

Redemption of Subsidiary’s Preferred Stock by Parent

Company P has a wholly owned subsidiary, S, that has outstanding Series A preferred stock held by third parties. The relevant features of the Series A preferred stock are as follows:

Dividends on the preferred stock are cumulative.
The preferred stock is not mandatorily redeemable and therefore is not classified as a liability under ASC 480-10-25-4.
The preferred stock is not redeemable at the option of the holder or upon the occurrence of any event outside S’s control and therefore is not classified in temporary equity.
The preferred stock is redeemable, in whole or in part, on various dates at S’s option, with P’s consent. The redemption price is equal to fixed prices depending on the redemption date, plus any accrued and unpaid cumulative dividends up to the date of redemption. The fixed prices include a premium to the original issuance price.

In accordance with ASC 810-10-45-16, the Series A preferred stock is classified as an NCI and is reported in permanent equity, separately from parent equity, in P’s consolidated balance sheet. Company P treats dividends on the preferred stock as income attributable to the NCI in its consolidated income statement.

Company P is contemplating having S exercise its redemption option, which will result in the redemption of the Series A preferred stock at a premium over the net carrying amount. Because P is not required to remeasure the preferred stock to its redemption amount under ASC 480-10-S99-3A or other GAAP, before a redemption, P is not required to recognize the premium payable on a redemption in its consolidated financial statements. Rather, any redemption will be treated as a capital stock transaction under ASC 810-10-40-1 and 40-2. Thus, before redemption, the only impact that S’s Series A preferred stock has on P’s basic EPS pertains to the dividends that accumulate, which are being recognized in P’s consolidated income statement as income attributable to the NCI, as stated above.

If S’s Series A preferred stock is redeemed, net income should be reduced, in P’s consolidated financial statements, by the amount of the premium paid to redeem the preferred stock to arrive at income available to common stockholders. The adjustment to net income to arrive at income available to common stockholders should be calculated as the fair value of the consideration paid to extinguish the Series A preferred stock (which includes the premium but not dividends that were previously recognized as income attributable to NCI) over the net carrying amount of the preferred stock as reported in NCI.

Under ASC 810, distributions to equity holders, including NCI holders, acting in their capacity as owners should be excluded from the determination of the consolidated entity’s net income. However, ASC 810 does not specifically address whether the parent should treat dividends on a subsidiary’s preferred stock as an attribution of the subsidiary’s income to the NCI or as a direct adjustment to retained earnings. On the basis of informal discussions with the FASB staff, we believe that there are two acceptable alternatives for presenting dividends on a subsidiary’s preferred stock in the parent’s consolidated income statement:

Alternative 1 — The parent presents the subsidiary’s preferred dividends as a component of the attribution of net income to the NCI on the face of the consolidated statement of income. The preferred dividends result in a decrease in consolidated net income attributable to the parent.
Alternative 2 — The parent treats the subsidiary’s preferred dividends as a direct adjustment when calculating income available to the parent’s common stockholders. The preferred dividends do not affect the reported amount of consolidated net income attributable to the parent, which is consistent with the accounting for dividends on preferred stock issued by the parent.

The parent should consistently apply the alternative it selects and should consider disclosing its accounting policy under ASC 235-10-50. In this example, assume that P has elected Alternative 1.

Under either alternative, the subsidiary’s preferred dividends will have the same impact on income available to the parent’s common stockholders, which is the numerator used in the consolidated entity’s EPS calculation. The above guidance also applies to a subsidiary’s preferred securities that are classified in temporary equity under ASC 480-10-S99-3A. The alternative selected should also be applied to remeasurement adjustments under ASC 480-10-S99-3A. For more information about the two alternatives, see Section 6.8 of Deloitte’s Roadmap Noncontrolling Interests.

In this example, the premium on redemption of S’s Series A preferred stock represents a return on investment to the holders of the preferred stock that is not available to common stockholders and affects P’s basic EPS in the same manner as the dividends on S’s Series A preferred stock. However, since P presents dividends on S’s Series A preferred stock as part of income attributable to the NCI, which reduces P’s consolidated net income, the dividends and the premium on redemption are presented differently. The premium on redemption is not treated as an allocation of income attributable to NCI. This guidance is consistent with that in ASC 260-10-S99-2.

3.2.2.6.2.1 Redemption of Convertible Preferred Stock

As discussed in ASC 260-10-S99-2, in a redemption of convertible preferred stock, the difference between the fair value of the consideration transferred and the net carrying amount of the convertible preferred stock must be deducted from net income in arriving at income available to common stockholders, regardless of whether the embedded conversion feature is “in-the-money” or “out-of-the-money” at the time of redemption.

Connecting the Dots

A convertible preferred stock instrument may be redeemed on the basis of a price negotiated between the issuer and the investor. The negotiated price will be affected by whether the conversion option is “in-the-money” or “out-of-the-money” on the date the redemption price is agreed upon. Provided that the convertible preferred stock instrument does not contain any separately recognized derivative liability or equity components, the conversion of the instrument into common stock in accordance with the stated conversion privileges would have no impact on the numerator in the calculation of basic EPS. Furthermore, the issuer could use cash to repurchase the shares of its common stock issued on conversion in open market transactions without having any impact on income available to common stockholders. The combination of the conversion and open market share repurchase may achieve the same or a similar economic outcome as redeeming the convertible preferred stock instrument with the holder for cash. However, even though the economics may be the same or similar, it is not appropriate to account for a redemption as comprising a conversion and then a subsequent repurchase of the common stock. Rather, the redemption must result in a charge (or credit) in the calculation of income available to common stockholders. The example below illustrates this concept.

Example 3-11

Redemption of Convertible Preferred Stock That Contains an “In-the-Money” Conversion Option

Assume the following:

Company X has preferred stock outstanding with a carrying value of $40 million.
Company Y, the holder of the preferred stock, has the right to convert the preferred stock into 1.7 million shares of X’s common stock. Further, Y has the option to require X to redeem the preferred stock during a five-year period at rates declining ratably from 110 percent of par value plus unpaid cumulative dividends in the first year to 100 percent of par value in the fifth year.
The current market value of the common stock is significantly higher than the redemption price of the preferred stock. Therefore, X expects Y to convert its preferred stock into the 1.7 million shares of common stock. Company Y has indicated that it intends to sell the common stock on conversion.
Because of the effect such a large block of stock would have on the market price of X’s common stock if it were sold, X has agreed to pay Y the market price of the common stock in return for the preferred stock.
The embedded conversion option in the convertible preferred stock has not been separated from the hybrid financial instrument.

Although the economic effect of the transaction is similar to what would be achieved on Y’s conversion of its preferred stock followed by X’s reacquisition of such shares as treasury stock, the transaction is viewed as the redemption of preferred stock. ASC 260-10-S99-2 stipulates that, for EPS purposes, the difference between the fair value of the cash consideration paid to Y and the net carrying amount of the preferred stock should be accounted for as a reduction of net income in arriving at income available to common stockholders.

The Codification does not explicitly address whether a settlement of convertible preferred stock in accordance with a stated settlement provision in a preferred stock agreement constitutes a conversion or a redemption. While an entity may need to use judgment and consider the particular facts and circumstances in determining whether a settlement of convertible preferred stock reflects a conversion or redemption, certain guidance in ASC 470-20 on evaluating the settlement of a debt instrument is relevant to this determination by analogy. Specifically, ASC 470-20-40-5 indicates that the issuance of equity securities such as common stock in accordance with an instrument’s original conversion terms to settle a debt instrument that becomes convertible upon the issuer’s exercise of a call option should be treated as a conversion if the instrument contained a substantive conversion feature as of its issuance date; otherwise, the issuance of equity securities should be accounted for as an extinguishment (i.e., a redemption). For convertible preferred stock, an entity evaluates whether settlement occurred in accordance with the terms of a substantive conversion feature by considering the monetary value of the consideration (i.e., the payoff profile) as opposed to the form of consideration (i.e., shares of common stock or cash). For example, some convertible preferred stock instruments contain embedded “conversion terms” that are, in essence, redemption features that are settled by delivery of a variable number of shares of common stock. It is important for an entity to distinguish between embedded features that are conversion options and those that are redemption options since ASC 260-10-S99-2 applies to redemptions of preferred stock even if the consideration transferred to redeem the shares is common stock of the issuer. That is, a “conversion term” that results in the delivery of a variable number of shares of common stock with a fixed monetary amount should be treated as a redemption. Examples 3-12 through 3-14 illustrate the treatment of settlements of convertible preferred stock in accordance with the contractual terms of embedded features.

Example 3-12

Settlement of Convertible Preferred Stock With a Fixed-Price Conversion Feature and a Fixed-Percentage Conversion Feature

Company J has $10 million of preferred stock outstanding with the following conversion terms:

At any point after five years from the issuance date, the holder can convert the preferred stock into shares of common stock at a conversion price of $25 per share (the “fixed-price conversion feature”).
At any point after five years from the issuance date, the issuer can settle the preferred stock by issuing a number of shares of common stock that has a fair value equal to the liquidation preference of the convertible preferred stock, divided by 90 percent and rounded to the closest number of whole shares (the “fixed-percentage conversion feature”). If the issuer elects to exercise this redemption feature, the holder has the right to elect to exercise its conversion option.

Company J has concluded that the preferred stock does not need to be classified as a liability under ASC 480 and has analyzed the conversion terms as consisting of an embedded conversion option with respect to the fixed-price conversion feature and an embedded call option with respect to the fixed-percentage conversion feature. Further, J has concluded that it is not required to separate either of these embedded features under ASC 815-15.

Below is an analysis of J’s EPS accounting depending on which conversion feature constitutes the terms of the settlement of the convertible preferred stock.

Scenario 1 — Fair Value of Common Stock Is $30 per Share

In this scenario, each holder will receive the following number of shares of common stock under each feature:

Fixed-price conversion feature	40 shares	($1,000 ÷ $25 = 40 shares)
Fixed-percentage conversion feature	37 shares	($1,000 ÷ 0.9 = $1,111 ÷ $30 = 37 shares)

The holder will elect to exercise its fixed-price conversion feature since doing so is economically favorable. This settlement reflects a “conversion” in accordance with the original conversion privileges of the convertible preferred stock. ASC 260-10-S99-2 does not apply.

Scenario 2 — Fair Value of Common Stock Is $26 per Share

In this scenario, each holder will receive the following number of shares of common stock under each feature:

Fixed-price conversion feature	40 shares	($1,000 ÷ $25 = 40 shares)
Fixed-percentage conversion feature	43 shares	($1,000 ÷ 0.9 = $1,111 ÷ $26 = 43 shares)

The holder will not elect to exercise its fixed-price conversion feature because that would be economically unfavorable; therefore, settlement will occur on the basis of the fixed-percentage conversion feature (provided that the issuer elects to exercise its redemption option). This settlement reflects a “redemption” of the convertible preferred stock. ASC 260-10-S99-2 does apply. When ASC 260-10-S99-2 is applied, the fair value of the consideration transferred that is used in calculating the adjustment to arrive at income available to common stockholders is $1,111 per share of preferred stock extinguished (i.e., 43 shares × $26 per share = $1,111). Even though a conversion would have provided the holder with a return of $40 per share of preferred stock, which is calculated as ($26 per share – $25 per share) × 40 shares = $40, it would not be appropriate to consider the fair value of the consideration transferred to redeem the preferred stock to be $1,111 less $40 per share.

The conclusions in this example would be unchanged if it was the holder, as opposed to the issuer, that had the right to exercise the fixed-percentage conversion feature.

Example 3-13

Settlement of Redeemable Convertible Preferred Stock in Cash on the Basis of (1) Exercise of Conversion Option or (2) Exercise of Redemption Option

Assume the following facts:

Company H, a nonpublic entity, has issued $25 million of Series B redeemable convertible preferred stock (the “Series B stock”) at its liquidation amount.
The Series B stock contains dividends, payable in cash, that are cumulative and accrue at an annual rate of 8 percent.
The holders of the Series B stock can convert the shares at any time at a fixed conversion rate of 25 shares of H’s common stock per $1,000 liquidation amount of Series B stock. Conversion automatically occurs upon a qualified IPO of H. Company H has the right to elect to settle conversion either entirely in shares of common stock or entirely in cash of an equivalent value. Further, H has sufficient authorized and unissued common shares to settle conversions in shares.
The holders of the Series B stock also have the right to redeem the shares at any time after five years from the issuance date at an amount equal to 102 percent of the liquidation amount per share redeemed, plus any accrued and unpaid cumulative dividends, regardless of whether the dividends are declared. Settlement may occur either entirely in cash or entirely in a variable number of shares of H’s common stock with the same monetary value as the cash settlement amount at the option of the holder.
Company H has the right to redeem the Series B stock at any time after five years from the issuance date at an amount equal to 110 percent of the liquidation amount per share redeemed, plus any accrued and unpaid cumulative dividends, regardless of whether the dividends are declared. Settlement may occur either entirely in cash or entirely in a variable number of shares of H’s common stock with the same monetary value as the cash settlement amount at the option of H.
The Series B stock does not participate in dividends on H’s common stock and did not contain a separated equity component.
Company H has determined that the host contract for the Series B stock is an equity instrument. The embedded conversion feature has not been separated as an embedded derivative because it is considered clearly and closely related to the host contract under ASC 815-15. Neither of the redemption options have been separated from the Series B stock under ASC 815-15 because they must be physically settled and the Series B stock is not readily convertible to cash.
The Series B stock meets the conditions for classification in temporary equity, and H has applied the guidance in ASC 480-10-S99-3A in its financial statements included in a Form S-1 registration statement filed for an IPO. Because H has deemed a qualified IPO as being reasonably possible before the holders can redeem the shares and controls the ability to settle the Series B stock in common stock upon any conversion, the Series B stock is not remeasured to its redemption amount.
Because H’s financial statements are included in a registration statement filed with the SEC, H presents basic and diluted EPS.

Scenario 1 — Settlement of Conversion Option

If settlement of the Series B stock occurs through exercise of the conversion option, ASC 260-10-S99-2 does not apply, regardless of whether the form of settlement is cash or shares of H’s common stock. Since H controls the form of settlement upon conversion, H is also not required to recognize any adjustments to net income under ASC 480-10-S99-3A.

While the Series B stock was not being remeasured to its redemption amount, if the facts were different, the Series B stock may need to be remeasured to its redemption amount under ASC 480-10-S99-3A. For example, assume the same facts as described above except that the holders, rather than H, had the right to elect to settle any conversion in cash in lieu of shares of common stock. In this circumstance, H would be required to remeasure the Series B stock to the maximum amount of cash payable pursuant to the conversion feature or put feature in accordance with its accounting policy applied under ASC 480-10-S99-3A. The remeasurement adjustment would be treated as a “deemed dividend” under ASC 480-10-S99-3A that would have an impact on the numerator in the calculation of basic EPS.

As another example, assume the same facts as described above except that the Series B stock was not mandatorily converted into common stock upon a qualified IPO. In this circumstance, the Series B stock would have needed to be periodically remeasured to its redemption amount under ASC 480-10-S99-3A because the holders control the ability to “put” the Series B stock for cash and not convert it into common stock. Therefore, H would be required to make a remeasurement adjustment in accordance with its accounting policy applied under ASC 480-10-S99-3A. That amount, which would be calculated on the basis of the redemption price underlying the holders’ put option, would be treated as a “deemed dividend” in the calculation of basic EPS. Thus, while ASC 260-10-S99-2 would not apply, the application of ASC 480-10-S99-3A would have still resulted in a reduction of net income in arriving at income available to common stockholders; however, the amount of the adjustment would not have been the same as the adjustment that would have been made if ASC 260-10- S99-2 had applied to the conversion.

The above alternatives illustrate the need for an entity to closely consider the terms and features of preferred stock so that it can appropriately apply ASC 480-10-S99-3A and ASC 260-10-S99-2.

Scenario 2 — Settlement of Redemption Option

If the Series B stock is settled through exercise of either of the redemption options, ASC 260-10-S99-2 does apply regardless of whether the form of settlement is cash or shares of H’s common stock. In calculating the difference between the redemption price and the net carrying amount of the Series B stock, H should exclude the portion of the redemption price that pertains to unpaid cumulative dividends that have already been included as adjustments to net income in arriving at income available to common stockholders in prior reporting periods.

Example 3-14

Preferred Equity Redemption Cumulative Stock

Preferred equity redemption cumulative stock (PERCS) is a form of equity instrument that is automatically converted into shares of common stock on the mandatory conversion date or upon the occurrence of certain other specified events (e.g., a merger, consolidation, or similar extraordinary transaction). The issuer has the option of calling the PERCS at any time before the mandatory conversion date for a specified call price payable in the issuer’s common stock. The call price may decline ratably during the period leading up to the mandatory conversion date.

PERCS is generally issued at a price equal to the issuer’s common stock price and, upon mandatory conversion, is exchanged one-for-one for common stock. However, the investor’s upside potential is “capped” (generally at a level 30–35 percent over the initial issuance price) because the issuer can call the PERCS by delivering fewer common shares to the extent that the cap has been exceeded. In other words, the investor will receive one common share in exchange for each PERCS share provided that the issuer’s common stock price is less than or equal to the capped price. If the issuer’s common stock price exceeds the “capped” price, the issuer will call the instrument and the investor will receive a variable number of shares of common stock that has a monetary value equal to the “capped” price. Thus, upon any call, the investor will always receive less value than it would have received in a conversion.

Generally, the PERCS investor receives a dividend during the period in which the PERCS is outstanding and the dividend is higher than the dividend on the issuer’s common stock. Such a dividend compensates the investor for its limited ability to participate in the appreciation of the common stock as a result of the call option. In substance, the PERCS investor owns the underlying common stock and the issuer holds a call option on this stock.

For example, assume that an entity issues 10 shares of PERCS at $30 per share for an aggregate purchase price of $300 when the fair value of the issuer’s common stock is also $30 per share. Further assume that the PERC has a capped price of $40. Upon settlement, the investor would experience the following outcomes if the fair value of the issuer’s common stock was $20 and $50, respectively:

If the fair value of the issuer’s common stock at maturity was $20 per share, the investor would receive 10 shares of common stock that has an aggregate monetary value of $200. Ignoring dividends paid during the term of the instrument, the investor realizes an economic loss of $100.
If the fair value of the issuer’s common stock at maturity was $50 per share, the investor would receive only 8 shares of common stock because the issuer would call the instrument at $40 per share (i.e., $40 × 10 = $400 ÷ $50 per share = 8 shares). The eight shares received would have an aggregate fair value of $400. Ignoring dividends paid during the term of the instrument, the investor realizes an economic gain of $100.

The impact on the numerator in the calculation of basic EPS for the instrument described above is as follows:

If the issuer settles the PERCS by delivering a number of shares of common stock equal to the number of shares of PERCS shares settled, the numerator is unaffected. This settlement is treated in the same manner as a conversion of preferred stock according to its stated terms, as discussed in Section 3.2.2.5.4. In this example, as long as the fair value of the issuer’s common stock is $40 per share or less, the settlement will be made by delivering one share of common stock for each PERCS share.
If the issuer settles the PERCS by delivering a variable number of shares of common stock that is less than the number of PERCS shares settled, the numerator is unaffected. That is, in an exchange of common stock for outstanding PERCS shares in which the number of shares of common stock exchanged is less than the number of shares of common stock issuable at the 1:1 conversion rate, the issuer is not required to recognize a charge to net income in arriving at income available to common shareholders. ASC 260-10-S99-2 would not be considered applicable in this circumstance because the issuer has, in substance, called underlying common stock at an amount less than fair value. Transactions in the issuer’s common stock between the date of issuance of the PERCS shares and the settlement date would not affect this conclusion provided that such transactions were not targeted to PERCS holders to affect the outcome of the settlement of the PERCS.
If the issuer settles the PERCS by paying cash, other assets, or securities other than its outstanding common stock, either directly with the holder or by repurchasing the PERCS on the open market, this would be considered a redemption of the PERCS and ASC 260-10-S99-2 must be applied. This conclusion is reached on the basis that the settlement of the PERCS occurred in a manner that was outside the contractual terms of the instrument.

The conclusion on the application of ASC 260-10-S99-2 to PERCS is based on the unique terms of the instrument and should not be applied by analogy to other instruments with different terms.

The next section discusses the EPS accounting for a redemption of a preferred stock host contract and the separated embedded derivative conversion option liability. Section 3.2.2.6.2.1.2 discusses the EPS accounting for a redemption of convertible preferred stock that contains a separately recognized equity component. Section 3.2.2.6.2.2 discusses the redemption of preferred stock, including convertible preferred stock, that is classified in temporary equity and is being remeasured to its redemption amount under ASC 480-10-S99-3A.

3.2.2.6.2.1.1 Convertible Preferred Stock That Contains an Embedded Conversion Option Accounted for as a Derivative Liability

When an entity has separated an embedded conversion option from a convertible preferred stock instrument and accounted for the embedded conversion option as a derivative liability under ASC 815-15, any redemption of the convertible preferred stock instrument consists of a redemption of both the preferred stock host contract and the embedded conversion option liability. The redemption of the preferred stock host contract component is within the scope of ASC 260-10-99-2. An entity should apply the following approach to allocate the total consideration paid upon redemption between the preferred stock host contract and the separated embedded conversion option liability:

Step 1 — Remeasure the embedded conversion option liability to its fair value immediately preceding the redemption. Any change in fair value should be recognized in earnings in the financial reporting period that includes the redemption.
Step 2 — If the convertible preferred stock instrument is a redeemable equity security that is subject to remeasurement under ASC 480-10-S99-3A, the entity should apply its accounting policy under ASC 480-10-S99-3A and adjust the carrying amount of the preferred stock host contract to its redemption amount as of the date of the redemption. Any adjustment is considered a “deemed dividend” for which net income is adjusted in arriving at income available to common stockholders in the financial reporting period that includes the redemption.
Step 3 — Compare the fair value of the total consideration paid to redeem the convertible preferred stock instrument with the sum of the carrying amounts of the preferred stock host contract and embedded conversion option liability after those carrying amounts have been adjusted in steps 1 and 2.
- If the total consideration transferred to redeem the convertible preferred stock instrument equals the sum of the carrying amounts of the preferred stock host contract and embedded conversion option liability, there is no incremental amount to be recognized in either earnings or as a “deemed dividend” to account for the redemption.
- If the total consideration transferred to redeem the convertible preferred stock instrument does not equal the sum of the carrying amounts of the preferred stock host and embedded conversion option liability, an allocation of the total consideration transferred on redemption to these two components is required. The total consideration paid to redeem the convertible preferred stock instrument should first be allocated to the embedded conversion option liability in an amount that equals the carrying amount of that component producing no incremental gain or loss. The remaining amount of the total consideration paid to redeem the convertible preferred stock instrument should be allocated to the preferred stock host contract. Any difference between this allocated amount and the carrying amount of the preferred stock host contract is within the scope of ASC 260-10-S99-2. Therefore, this difference should be recognized as a charge (or credit) to net income in arriving at income available to common stockholders in the financial reporting period that includes the redemption.

The example below illustrates a redemption of convertible preferred stock that contains a separated embedded conversion option liability.

Example 3-15

Redemption of Convertible Preferred Stock That Contains a Bifurcated Conversion Option

Company Z has issued and has outstanding redeemable convertible preferred stock. Further, Z remeasures the convertible preferred stock to its redemption amount in each period under ASC 480-10-S99-3A as if the balance sheet date is the redemption date. The embedded conversion option in the convertible preferred stock has been separated as a derivative liability under ASC 815-15 and is being measured at fair value, with changes recognized in earnings. In determining the adjustment needed under the subsequent-measurement guidance in ASC 480-10-S99-3A, Z compares the redemption price with the sum of the carrying amounts of the host preferred stock and derivative liability and recognizes an adjustment only if those aggregate amounts are less than the current redemption amount.

Assume that the convertible preferred stock is redeemed on March 1, 20X1, in accordance with the terms of the redemption feature in the convertible preferred stock. If Z accounts for the settlement in the following order, there will be no additional amounts to recognize under ASC 260-10-S99-2:

First, remeasure the derivative liability to fair value under ASC 820 as of March 1, 20X1, with the adjustment recognized in net income.
Next, remeasure the preferred stock host contract to equal the excess of (1) the redemption amount over (2) the sum of the carrying amounts of the preferred stock host and derivative liability, as remeasured in step 1. This adjustment reflects a “deemed dividend” that affects basic EPS.
Last, recognize the settlement of the convertible preferred stock. The fair value of the total consideration transferred to redeem the convertible preferred stock will equal the adjusted aggregate carrying amounts recognized for the convertible preferred stock, since it was redeemed according to the same contractual redemption feature used to adjust the carrying amount to the redemption amount.

While ASC 260-10-S99-2 does not result in an incremental adjustment, the adjustment recognized in the second step will be treated as a “deemed dividend” (or “deemed contribution”) for which net income is adjusted in arriving at income available to common stockholders.

3.2.2.6.2.1.2 Convertible Preferred Stock That Contains a Separately Classified Equity Component

A convertible preferred stock instrument will have a separately classified equity component only in limited circumstances (e.g., as a result of the recognition of a down-round feature). In these circumstances, the amount separately recognized in equity will affect the accounting for the redemption of the convertible preferred stock under ASC 260-10-S99-2 because the redemption consists of both the previously recognized equity component and the net carrying amount of the convertible preferred stock instrument. See Sections 3.2.5.2.4 and 3.2.5.2.5 for additional discussion of the EPS accounting for a redemption of convertible preferred stock containing a separately recognized equity component. That section also discusses the impact of the accounting for a redemption on remeasurement adjustments related to the convertible preferred stock instrument that are recognized under ASC 480-10-S99-3A.

3.2.2.6.2.2 Redemption of Preferred Stock Subject to Remeasurement Under ASC 480-10-S99-3A

Preferred stock, including convertible preferred stock, may be classified in temporary equity under ASC 480-10-S99-3A as a result of redemption features that allow the holder to redeem the security or allow for redemption upon the occurrence of events outside the issuer’s control, other than an ordinary liquidation. Under ASC 480-10-S99-3A(14) and 3A(15), redeemable preferred stock must be remeasured to its redemption amount either if it is currently redeemable or if it is probable that it will become redeemable.

When an entity redeems preferred stock that is being remeasured to its redemption amount under ASC 480-10-S99-3A, the entity should remeasure the preferred stock to its redemption amount immediately before accounting for the redemption. If the preferred stock is being remeasured to its current redemption amount and the redemption occurs in accordance with the redemption provisions used to remeasure the preferred stock, the application of ASC 260-10-S99-2 may not result in any incremental adjustment to the numerator in the calculation of basic EPS. Rather, the adjustments for the redemption terms of the preferred stock will affect the numerator through the application of ASC 480-10-S99-3A (see Section 3.2.2.4). In other cases, an adjustment may be required under ASC 260-10-S99-2 for the redemption of preferred stock that is classified in temporary equity even if the preferred stock is being remeasured to its redemption amount under ASC 480-10-S99-3A before the redemption. The example below illustrates this point.

Example 3-16

Redemption of Redeemable Preferred Stock

Company Z issues $100 million of preferred stock to various investors. The preferred stock has the following terms:

Dividends are cumulative at a rate of 5 percent per annum.
The preferred stock is redeemable at the holder’s option at any point after five years from the issuance date at a price of $105 per share, or an aggregate amount of $105 million, plus any accumulated dividends that have not been paid.

Company Z incurred direct costs of $5 million in issuing the preferred stock.

Because the preferred stock is redeemable at the option of the holder, it is classified in temporary equity on Z’s balance sheet. Company Z has elected to apply the accounting policy in ASC 480-10-S99-3A(15)(b) and is therefore required to recognize changes in the redemption value immediately as they occur and adjust the carrying amount of the instrument to equal the redemption value at the end of each reporting period. Under this method, the end of the reporting period is viewed as if it were also the redemption date. Thus, in the first financial reporting period after issuance of the preferred stock, Z adjusts the carrying amount of the preferred stock to $105 million. As a result, a “deemed dividend” is recognized in the amount of $10 million, which reduces the numerator in the calculation of basic EPS in the period of issuance of the preferred stock.

Two years after issuance, Z negotiates with the investors to repurchase the preferred stock at an aggregate redemption price of $102 million. There are no unpaid accumulated dividends as of the date of repurchase.

The application of ASC 480-10-S99-3A immediately before the accounting for the redemption has no impact because, according to the contractual terms of the preferred stock, it is still redeemable for an aggregate amount equal to $105 million. Since the $102 million fair value of the consideration transferred is less than the net carrying amount, Z applies ASC 260-10-S99-2 and recognizes a $3 million credit to net income in arriving at income available to common stockholders for the financial reporting period that includes the redemption.

Connecting the Dots

In almost every redemption of preferred stock that is not being remeasured to its current redemption amount under ASC 480-10-S99-3A, net income will be adjusted to arrive at income available to common stockholders in the calculation of basic EPS. Even if the redemption price equals the original issuance price, the fair value of the consideration transferred will almost always differ from the net carrying amount of the preferred stock as a result of direct issuance costs capitalized into the carrying amount of the preferred stock.

3.2.2.6.3 Induced Conversion of Preferred Stock

When convertible preferred stock is converted into common stock under an inducement offer, the excess of (1) the fair value of all securities and other consideration transferred to the holders of the convertible preferred stock over (2) the fair value of securities issuable according to the original conversion terms should be deducted from net income to arrive at income available to common stockholders in the calculation of basic EPS. In effect, an inducement represents the payment of additional value to convertible preferred security holders for their agreement to convert the securities. This additional value is always reflected as a charge to net income in arriving at income available to common stockholders. Unlike the accounting for a redemption of preferred stock, the accounting for an inducement of convertible preferred stock can never involve a credit to net income in arriving at income available to common stockholders.

Induced conversions of convertible debt are discussed in Section 6.6.1. Induced conversions of common stock that is convertible into another class of common stock are addressed in Section 3.2.4.1.

Connecting the Dots

In an induced conversion of convertible preferred stock, the portion of the consideration transferred under the original conversion terms is always accounted for as a conversion; therefore, ASC 260-10-S99-2 is not applicable in such circumstances. Rather, ASC 260-10-S99-2 applies only to the additional value resulting from the inducement offer for the instruments converted in accordance with this offer.

ASC 260-10-S99-2 does not define an inducement but refers to the guidance in ASC 470-20, which discusses whether a conversion of convertible debt represents a conversion under an inducement offer.

ASC 470-20

Recognition of Expense Upon Conversion

40-13 The guidance in paragraph 470-20-40-16 applies to conversions of convertible debt to equity securities pursuant to terms that reflect changes made by the debtor to the conversion privileges provided in the terms of the debt at issuance (including changes that involve the payment of consideration) for the purpose of inducing conversion. That guidance applies only to conversions that both:

Occur pursuant to changed conversion privileges that are exercisable only for a limited period of time (inducements offered without a restrictive time limit on their exercisability are not, by their structure, changes made to induce prompt conversion)
Include the issuance of all of the equity securities issuable pursuant to conversion privileges included in the terms of the debt at issuance for each debt instrument that is converted, regardless of the party that initiates the offer or whether the offer relates to all debt holders.

Induced Conversions

40-14 A conversion includes an exchange of a convertible debt instrument for equity securities or a combination of equity securities and other consideration, whether or not the exchange involves legal exercise of the contractual conversion privileges included in terms of the debt. The preceding paragraph also includes conversions pursuant to amended or altered conversion privileges on such instruments, even though they are literally provided in the terms of the debt at issuance.

40-15 The changed terms may involve any of the following:

A reduction of the original conversion price thereby resulting in the issuance of additional shares of stock
An issuance of warrants or other securities not provided for in the original conversion terms
A payment of cash or other consideration to those debt holders that convert during the specified time period.

The guidance in [ASC 470-20-40-16] does not apply to conversions pursuant to other changes in conversion privileges or to changes in terms of convertible debt instruments that are different from those described in this paragraph.

An entity should apply the guidance in ASC 470-20 to determine whether a conversion of convertible preferred stock has occurred in accordance with an inducement offer. In some cases, the offer may actually represent a modification of the convertible preferred stock instrument rather than an inducement offer (see Section 3.2.6 for discussion of modifications to preferred stock). An inducement offer does not need to be recognized until the date on which it is accepted by the holder, which is normally the date on which the holder converts the convertible preferred stock into common stock or enters into a binding agreement to do so.

The example below illustrates the accounting for an inducement of convertible preferred stock under ASC 260-10-S99-2.

Example 3-17

Inducement of Convertible Preferred Stock

Company X has issued 1,000 shares of convertible preferred stock to Company Y at a liquidation preference and original issuance price of $1,000 per share for total consideration of $1 million. The convertible preferred stock is not within the scope of ASC 480 and therefore is not accounted for as a liability by X. The stated conversion terms allow Y to convert the convertible preferred stock into shares of X’s common stock at a conversion price of $25. Thus, upon conversion of all the shares of convertible preferred stock, X would issue Y a total of 40,000 shares of common stock.

Company X offers Y an inducement to convert all of the convertible preferred stock into X’s shares of common stock. Under the offer, Y has 30 days to convert the convertible preferred stock into X’s shares of common stock at a conversion price of $20 per share of convertible preferred stock in such a way that Y would receive 50,000 shares of common stock upon conversion of all the shares of convertible preferred stock. This conversion would (1) occur in accordance with changed conversion privileges that are exercisable only for a limited time (i.e., 30 days) and (2) involve the issuance of all the shares of common stock issuable according to the conversion privileges included in the terms of the convertible preferred stock at issuance for each share of convertible preferred stock that Y chooses to convert.

If Y accepts the offer and converts the shares of convertible preferred stock in return for 50,000 shares of X’s common stock, the inducement must be accounted for under ASC 260-10-S99-2. If the offer is accepted and X’s common stock price is $15 on the date of the induced conversion, the charge that adjusts net income in arriving at X’s income available to common stockholders is $150,000, calculated as follows:

The conclusion above would be unchanged if the induced conversion occurred under the same inducement offer from Y instead of X.

An inducement of convertible preferred stock will result in a charge to net income in arriving at income available to common stockholders even if the conversion, after consideration of the inducement offer, is “out-of-the-money.” For this reason, it is important to distinguish an inducement from a redemption of convertible preferred stock. If the transaction discussed in the example above reflected a redemption instead of an induced conversion, there would have been a $250,000 credit to net income, as opposed to a $150,000 charge to net income, in arriving at income available to common stockholders.

3.2.2.6.3.1 Induced Conversion of Convertible Preferred Stock That Contains an Embedded Conversion Option Accounted for as a Derivative Liability

ASC 260-10-S99-2 does not address the accounting for an induced conversion of convertible preferred stock that contains an embedded conversion option that has been separated and accounted for as a derivative liability. However, since changes in the fair value of the embedded conversion option are recognized in net income, the effect of the inducement offer will be reflected in net income as part of those fair value changes. This obviates the need to recognize any “deemed dividend” under ASC 260-10-S99-2.

3.2.2.6.3.2 Induced Conversion of Convertible Preferred Stock That Contains a Separately Classified Equity Component

Sections 3.2.5.2.4 and 3.2.5.2.5 address the EPS accounting for an induced conversion of convertible preferred stock that contains a separately recognized equity component related to the embedded conversion option. As discussed in those sections, an entity should first account for the inducement component of the conversion in accordance with ASC 260-10-S99-2, recognizing a “deemed dividend” for the additional value provided as a result of the inducement offer. That “deemed dividend” reduces net income in arriving at income available to common stockholders. Once this accounting is reflected, the entity accounts for the remaining consideration transferred to the holder(s) (i.e., the portion represented by the original conversion terms) as a “conversion” on the basis of the accounting for a conversion of convertible preferred stock in accordance with its original stated conversion privileges. Also, as noted in Sections 3.2.5.2.4 and 3.2.5.2.5, the accounting upon an induced conversion will be affected by the application of ASC 480-10-S99-3A if the convertible preferred stock instrument is a redeemable equity security that is subject to the subsequent-measurement guidance in ASC 480-10-S99-3A.

3.2.2.7 Participating Preferred Stock

ASC 260-10-20 defines a participating security as “[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.” When preferred stock meets the definition of a participating security, income available to common stockholders will be reduced by both of the following:

Dividends on cumulative preferred stock, whether or not declared, and dividends declared on noncumulative preferred stock.
An allocation of the undistributed earnings for the period on the basis of the contractual participation rights of the preferred security. (Losses are generally not allocated to participating preferred stock because such instruments generally only participate in undistributed earnings.)

See Chapter 5 for additional discussion of participating securities and the two-class method.

3.2.2.8 Reclassification of Preferred Stock to a Liability

ASC 480-10

Mandatorily Redeemable Financial Instruments

25-7 If a financial instrument will be redeemed only upon the occurrence of a conditional event, redemption of that instrument is conditional and, therefore, the instrument does not meet the definition of mandatorily redeemable financial instrument in this Subtopic. However, that financial instrument would be assessed at each reporting period to determine whether circumstances have changed such that the instrument now meets the definition of a mandatorily redeemable instrument (that is, the event is no longer conditional). If the event has occurred, the condition is resolved, or the event has become certain to occur, the financial instrument is reclassified as a liability.

A conditionally redeemable preferred stock instrument may become mandatorily redeemable as a result of the resolution of a condition associated with the redemption. In this situation, the preferred stock must be reclassified from equity (generally, from temporary equity) to a liability. ASC 480-10-30-2 specifies that “[i]f a conditionally redeemable instrument becomes mandatorily redeemable, upon reclassification the issuer shall measure that liability initially at fair value and reduce equity by the amount of that initial measure, recognizing no gain or loss.” While this type of reclassification has no impact on net income, as discussed in the scope section of ASC 260-10-S99-2, the reclassification is treated as a redemption of preferred stock. Thus, any difference between the initial fair value amount of the liability recognized under ASC 480-10-30-2 and the net carrying amount of the preferred stock instrument on the reclassification date increases or decreases net income in arriving at income available to common stockholders. If the preferred stock instrument is classified in temporary equity and is being remeasured to its redemption amount, immediately before the reclassification date, which may be a date other than the end date of a financial reporting period, the net carrying amount of the preferred stock should be adjusted in a manner consistent with the entity’s accounting policy for remeasuring redeemable securities under ASC 480-10-S99-3A. See Example 3-9 for an illustration of this point.

See Section 3.2.6 for information about a reclassification of the preferred stock that results from a modification of the instrument.

Connecting the Dots

A preferred stock instrument issued by an SEC registrant that becomes mandatorily redeemable upon the death of the holder is classified as a liability from the inception of the instrument because the death of the holder is an event that is certain to occur and SEC registrants are not subject to the scope exception in ASC 480-10-15-7A. However, a preferred stock instrument that becomes mandatorily redeemable upon the disability of the holder does not need to be classified as a liability because the disability of the holder is not an event that is certain to occur. Such an instrument may also not be classified in temporary equity if the issuer has the ability and intent to maintain a fully funded insurance policy (see ASC 480-10-S99-3A(3)(g)). However, upon the disability of the holder, the preferred stock instrument would need to be reclassified from equity to a liability and the guidance in ASC 260-10-S99-2 would apply.

3.2.3 Noncontrolling Interests

3.2.3.1 General

The numerator in the calculation of the parent’s basic EPS should reflect only income from continuing operations and net income attributable to the parent. In all cases, income attributable to NCIs should be excluded from the numerator in the parent’s calculation of EPS.

3.2.3.2 Nonredeemable NCIs

An entity may have nonredeemable NCIs that are reported in its consolidated financial statements. The NCI may be in the form of common stock or preferred stock issued by a consolidated subsidiary.

3.2.3.2.1 Nonredeemable NCIs in the Form of Preferred Stock

Basic EPS calculated by an entity with a nonredeemable NCI in the form of preferred stock is affected by dividends accumulated or paid on the preferred stock by the subsidiary, as well as “deemed dividends” (or “deemed contributions”) resulting from a modification, redemption, or induced conversion of the preferred stock by the subsidiary.8 The accounting impact of these events and transactions is generally reflected at the subsidiary level, with the subsidiary applying the same accounting that a parent entity would use in such circumstances. Dividends resulting from any of these events or transactions will be treated as reductions to the subsidiary’s net income in arriving at the subsidiary’s income available to common stockholders, which will be included in the numerator of the parent’s calculation of basic EPS. With respect to redemptions and induced conversions of NCIs in the form of preferred stock, the guidance in ASC 260-10-S99-2 should be applied to determine the impact on the parent’s income available to common stockholders in its calculation of basic EPS. In accordance with ASC 260-10-55-64 through 55-67, these adjustments may reflect an allocation of the “deemed dividend” (or “deemed contribution”) between the parent’s interest in the subsidiary’s common stock and any third-party holders of common stock provided that the third-party noncontrolling common interest holders absorbed or received a portion of such adjustments.9 See Section 3.2.2.6 for further discussion of redemptions and induced conversions of preferred stock and Section 3.2.6 for more information about modifications and exchanges of preferred stock. In addition, see Section 8.8.1 for discussion of the application of ASC 260-10-55-64 through 55-67.

Connecting the Dots

When a nonredeemable NCI in the form of preferred stock is extinguished and the subsidiary has other NCIs in the form of common stock, the accounting in the consolidated financial statements of the parent may depend on whether the redemption price was paid by the parent or the subsidiary. Generally speaking, if the redemption was paid by the parent, the entire difference between the net carrying amount of the preferred stock and the redemption amount will increase or reduce net income attributable to the parent in the parent’s calculation of income available to common stockholders. Otherwise, only the parent’s allocable portion of the difference between the net carrying amount of the preferred stock and the redemption amount will increase or reduce net income attributable to the parent in the parent’s calculation of income available to common stockholders.

As noted in Example 3-10, an entity may adopt one of two alternative accounting policies to present dividends on an NCI in the form of preferred stock. The alternatives affect only the presentation. The impact on income available to common stockholders will be the same. Under either presentation, dividends accumulated on cumulative preferred stock and dividends declared on noncumulative preferred stock will be a reduction to income attributable to the parent in arriving at income available to common stockholders. If the consolidated subsidiary that has issued the preferred stock also has outstanding shares of common stock, basic EPS will need to be calculated at the subsidiary level to determine the amount of the subsidiary’s income available to common stockholders that is included in the numerator in the parent’s calculation of basic EPS.

For additional discussion of issues related to dividends on preferred stock that is issued by a subsidiary to (1) third parties or (2) the parent, see Section 8.8.2. For more information about NCIs in the form of preferred stock that represent participating securities, see Section 3.2.3.4.

3.2.3.2.2 Nonredeemable NCIs in the Form of Common Stock

When an entity has nonredeemable NCIs in the form of common stock, the entity will need to calculate EPS at the subsidiary level to determine the portion of the subsidiary’s income available to common stockholders that is included in income available to common stockholders in the parent’s calculation of basic EPS. See Section 8.8 for further discussion of the EPS accounting when a parent has an NCI. See Section 3.2.3.4 for discussion of NCIs in the form of common stock that participate in earnings of the parent. See Section 3.2.4.3 for discussion of the redemption of common stock.

3.2.3.2.3 Multiple Classes of Nonredeemable NCIs in the Form of Common Stock

If a subsidiary has multiple classes of common stock, it is necessary to calculate basic EPS at the subsidiary level by using the two-class method to determine the amount of the subsidiary’s income available to common stockholders that is included in income available to common stockholders in the parent’s calculation of basic EPS. See Chapter 5 for further discussion of participating securities and the two-class method. See Section 3.2.3.4 for discussion of NCIs in the form of common stock that participate in earnings of the parent.

3.2.3.3 Redeemable NCIs

ASC 480-10 — SEC Materials — SEC Staff Guidance

SEC Staff Announcement: Classification and Measurement of Redeemable Securities

S99-3A(22) Noncontrolling interests. Paragraph 810-10-45-23 indicates that changes in a parent’s ownership interest while the parent retains control of its subsidiary are accounted for as equity transactions, and do not impact net income or comprehensive income in the consolidated financial statements. Consistent with Paragraph 810-10-45-23, an adjustment to the carrying amount of a noncontrolling interest from the application of paragraphs 14–16 does not impact net income or comprehensive income in the consolidated financial statements. Rather, such adjustments are treated akin to the repurchase of a noncontrolling interest (although they may be recorded to retained earnings instead of additional paid-in capital). 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.
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 may have redeemable NCIs that are reported in its consolidated financial statements; these interests may be in the form of common stock or preferred stock. The impact of such NCIs on the parent’s calculation of basic EPS depends on whether the redeemable NCI is in the form of preferred stock or common stock and, for common stock, whether the redemption amount is a fair value amount or an amount other than fair value.

3.2.3.3.1 Redeemable NCIs in the Form of Preferred Stock

ASC 480-10-S99-3A addresses when redeemable preferred stock must be remeasured to its redemption amount. The requirements in ASC 480-10-S99-3A for classification and measurement of a redeemable NCI in the form of preferred stock are consistent with the guidance applicable to redeemable preferred stock issued by a parent entity (see Section 3.2.2.4). When remeasurement is required, the adjustment to the carrying amount of the preferred stock is treated in the same manner as a dividend on preferred stock. There are three primary situations involving redeemable NCIs in the form of preferred stock:

The redemption feature is issued or guaranteed by the parent.
The redemption feature is issued by the subsidiary (and not guaranteed by the parent) and all of the subsidiary’s shares of common stock are owned by the parent.
The redemption feature is issued by the subsidiary (and not guaranteed by the parent) and the subsidiary also has NCIs in the form of common stock.

If the redemption feature is issued or guaranteed by the parent, the entire amount of the measurement adjustment (i.e., “deemed dividend”) under ASC 480-10-S99-3A represents an adjustment to income attributable to the parent to arrive at the parent’s income available to common stockholders. This dividend may generally be calculated as part of the parent’s calculation of income available to common stockholders after the inclusion of the parent’s portion of the subsidiary’s income available to common stockholders in the numerator in the parent’s calculation of basic EPS.

Connecting the Dots

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 NCI at the consolidated level and (2) put features that are embedded in preferred shares issued by a subsidiary that are subject to a guarantee by its parent.

If the redemption feature is issued by the subsidiary (and not guaranteed by the parent) and there is no other NCI in the subsidiary, the remeasurement adjustment under ASC 480-10-S99-3A, along with any other dividends on the preferred stock, will be treated as a reduction of the subsidiary’s net income in the parent’s calculation of income available to common stockholders. This situation results in the same impact on the parent’s basic EPS as when the parent issues or guarantees the redemption feature.

If the redemption feature is issued by the subsidiary (and not guaranteed by the parent) and parties other than the parent own shares of common stock in the subsidiary, the remeasurement adjustment under ASC 480-10-S99-3A, along with other dividends on the subsidiary’s preferred stock, will be treated as a reduction of the subsidiary’s net income to arrive at the subsidiary’s income available to common stockholders, which is then used to calculate the parent’s income available to common stockholders. The amount of dividends and “deemed dividends” that reduce the parent’s income available to common stockholders will reflect an allocation between the parent and other common stockholders of the subsidiary. This occurs when the parent includes its portion of the subsidiary’s income available to common stockholders in the numerator to calculate the parent’s basic EPS. See further discussion of this process in Section 8.8.

Example 3-18

Redeemable NCI in the Form of Preferred Stock

Parent A consolidates Subsidiary B under ASC 810. Parent A has 1 million shares of common stock outstanding and reported net income of $10 million for the year ended December 31, 20X1 (excluding B’s income). Subsidiary B has 1 million shares of preferred stock outstanding and 1 million shares of common stock outstanding. For the year ended December 31, 20X1, B reported net income of $5 million. In addition, B paid $100,000 of dividends on the preferred stock and increased the carrying amount of the preferred stock by $200,000 as a result of a measurement adjustment under ASC 480-10-S99-3A. Consider the following three scenarios:

Scenario 1 — A owns all of B’s common stock and guaranteed the redemption feature in B’s preferred stock.
Scenario 2 — A owns all of B’s common stock and did not guarantee the redemption feature in B’s preferred stock.
Scenario 3 — A owns 800,000 shares of B’s common stock and did not guarantee the redemption feature in B’s preferred stock.

Parent A would report the following amounts as the numerator in its calculation of basic EPS:

Scenario 1

Scenario 2

Scenario 3

Connecting the Dots

Under ASC 480-10-S99-3A(16)(e), decreases in the carrying amount of a subsidiary’s redeemable preferred stock may only be recorded to the extent that they reflect recoveries of previous increases to the carrying amount as a result of the application of ASC 480-10-S99-3A.

ASC 260-10-S99-2 applies to the consolidated financial statements of a parent when there is a redemption or an induced conversion of redeemable preferred stock issued by a consolidated subsidiary that is classified as an NCI. However, before accounting for any redemption or induced conversion, an entity must apply the subsequent-measurement guidance in ASC 480-10-S99-3A. That is, immediately before accounting for any redemption or induced conversion of a subsidiary’s preferred stock, the entity should first remeasure the NCI (the subsidiary’s preferred stock) in accordance with its accounting policy for remeasuring redeemable securities under ASC 480-10-S99-3A if the NCI was subject to remeasurement under ASC 480-10-S99-3A. The entity should then apply ASC 260-10-S99-2 to account for the redemption or induced conversion. In applying this guidance, the entity should apply the same concepts as discussed in ASC 480-10-S99-3A(22)(a) if there is also an NCI in the form of common stock in the subsidiary. In certain cases, there will be no incremental “deemed dividend” as a result of the application of ASC 260-10-S99-2 to a redemption of a subsidiary’s preferred stock because the NCI has been remeasured to the redemption amount under ASC 480-10-S99-3A. For additional discussion of the complexities associated with the accounting for redeemable NCIs, see Section 8.8.4.

Redeemable preferred stock issued by a subsidiary may represent a participating security. See Section 3.2.3.4 for more information.

3.2.3.3.2 Redeemable NCIs in the Form of Common Stock

ASC 480-10-S99-3A addresses when redeemable common stock must be remeasured to its redemption amount. The requirements in ASC 480-10-S99-3A for classifying and measuring a redeemable NCI in the form of common stock are consistent with the guidance applicable to redeemable common stock issued by a parent entity (see Section 3.2.4.2). Measurement adjustments under ASC 480-10-S99-3A that are made to the carrying amount of an NCI in the form of common stock that is redeemable at fair value do not affect the parent’s EPS. However, when an NCI in the form of common stock is redeemable at any amount other than fair value, there is an impact on the parent’s EPS. When the redemption amount is other than fair value, the adjustments to the carrying amount of the NCI that are recognized under ASC 480-10-S99-3A are accounted for in one of two ways:

As part of the attribution of the subsidiary’s income between the parent and the NCIs.
As an adjustment to the amount of income available to common stockholders by applying the two-class method of EPS at the subsidiary level.

Although either of these two approaches is acceptable as an accounting policy, they generally do not differ in their ultimate impact on the numerator in the parent’s calculation of basic EPS.

In addition to the alternatives above, there are also two acceptable alternatives for the treatment of adjustments to the carrying amount under ASC 480-10-S99-3A.

Treat the entire adjustment in the same manner as a dividend.
Treat only the portion of the adjustment that reflects a redemption at an amount in excess of fair value in the same manner as a dividend.

In this case, the approach selected will have an impact on the parent’s calculation of basic EPS.

Under ASC 480-10-S99-3A(16)(e), an entity employing any of the alternatives discussed above may only record decreases in the carrying amount to the extent that they reflect recoveries of previous increases to the carrying amount as a result of the application of ASC 480-10-S99-3A. Furthermore, when an NCI in the form of common stock is redeemable and the subsidiary also has common stock issued to third parties that is not redeemable, the parent entity must consider the guidance in ASC 480-10-S99-3A(22)(a). According to that guidance, if the redemption feature in the redeemable NCI in the form of common stock is either issued or guaranteed by the parent, the EPS impact of changes to the redemption amount (i.e., “deemed dividends” under ASC 480-10-S99-3A) should be allocated entirely to the parent.

The example below illustrates the accounting for an NCI in the form of common stock that is redeemable at a non–fair value amount.

Example 3-19

NCI in the Form of Common Stock Redeemable at Non–Fair Value Amount

Assume the following:

Parent A owns 80 percent of the common stock of Subsidiary B and consolidates B under ASC 810. The remaining 20 percent of B’s common stock is held by a third-party NCI holder.
The NCI is redeemable at the option of the holder for an amount that does not represent fair value.
For the reporting period ended December 31, 20X1, before the NCI is remeasured to its redemption amount, the carrying amount of the NCI under ASC 810 is $100,000. This amount reflects an increase of $20,000 as a result of an allocation of 20 percent of B’s net income of $100,000 for the period.
There is a $50,000 incremental adjustment as of the end of the reporting period to recognize the NCI at its current redemption amount.
For the reporting period ended December 31, 20X1, A earned net income (excluding B’s net income) of $500,000.
There were 1 million weighted-average shares of A’s common stock outstanding for the period ended December 31, 20X1.

Parent A applies the recognition and measurement guidance on redeemable equity securities in ASC 480-10-S99-3A and has elected to treat the entire amount of remeasurement adjustments related to the NCI as dividends. Below is A’s consolidated income statement for the reporting period ended December 31, 20X1, depending on whether A elects to (1) treat the remeasurement adjustments as part of the allocation of income to NCI (Alternative 1) or (2) apply the two-class method to calculate income available to common stockholders (Alternative 2).

Connecting the Dots

Although ASC 260-10-S99-2 does not apply to the redemption of an NCI in the form of common stock, the classification, measurement, and EPS guidance in ASC 480-10-S99-3A applies if the NCI is redeemable for cash or other assets. If a redeemable NCI in the form of common stock is being remeasured to its redemption amount under ASC 480-10-S99-3A, immediately before accounting for any redemption of the instrument, the entity should perform a final remeasurement of the NCI in accordance with its accounting policy for remeasuring redeemable securities under ASC 480-10-S99-3A and should apply the EPS guidance in ASC 480-10-S99-3A to that remeasurement. The entity should then apply ASC 810 to account for the repurchase of the NCI.

If an NCI is converted to another security in accordance with an inducement offer, in addition to applying ASC 480-10-S99-3A if the NCI was a redeemable security, the entity should consider the accounting impact of the induced conversion. See Section 3.2.4.1 for further discussion of induced conversions of common stock.

For additional discussion of the complexities associated with the accounting for redeemable NCIs, see Section 8.8.4.

3.2.3.4 Participating NCIs

ASC 260-10-20 defines a participating security as “[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.” NCIs that meet the definition of a participating security generally will fall into one of the following categories:

NCI in the form of common stock that participates in earnings of the parent.
NCI in the form of preferred stock that participates in earnings of the subsidiary.
NCI in the form of preferred stock that participates in earnings of the parent.
NCI in the form of potential common stock that participates in earnings of the subsidiary.
NCI in the form of potential common stock that participates in earnings of the parent.

When an NCI in the form of common stock or potential common stock participates in earnings of the parent, the parent should take the participation into account by applying the two-class method after including its portion of the subsidiary’s income available to common stockholders in its calculation of income available to common stockholders. The effect of the participation should be based on the contractual participating rights of the NCI holder. For example, if the holder only participates in earnings of the parent that exclude the net income of the subsidiary, that fact must be considered in the determination of the amount of the parent’s undistributed earnings that are allocated between the NCI and the parent’s common stockholders. If the NCI that participates in earnings of the parent is also a redeemable NCI, the impact that the redemption provisions have on the calculation of the parent’s basic EPS must be considered. See Section 8.8.4 for additional discussion of the accounting for redeemable NCIs. See Chapter 5 for further details regarding the two-class method of calculating EPS.

An NCI in the form of preferred stock may participate in either the subsidiary’s or the parent’s earnings. If preferred stock of a subsidiary participates in the subsidiary’s earnings, an entity needs to calculate basic EPS at the subsidiary level by using the two-class method to determine the amount of the subsidiary’s income available to common stockholders that is included in the parent’s income available to common stockholders. If preferred stock of a subsidiary participates in the parent’s earnings, the parent should calculate the impact of such participation after including its portion of the subsidiary’s income available to common stockholders in its calculation of income available to common stockholders. The effect of the participation should be based on the contractual participating rights of the NCI holder. For example, if the holder only participates in earnings of the parent that exclude the net income of the subsidiary, that fact must be considered in the determination of the amount of the parent’s undistributed earnings that are allocated between the NCI and the parent’s common stockholders. If the NCI is also a redeemable NCI, the impact that the redemption provisions have on the calculation of the parent’s basic EPS must be considered. See Section 8.8.4 for additional discussion of the accounting for redeemable NCIs. See Chapter 5 for additional discussion of the two-class method of calculating EPS.

Section 5.5.2.5.4 addresses NCIs in the form of potential common stock that participate in earnings of the subsidiary. Section 7.1.3 discusses participating NCIs that are share-based payment awards.

3.2.3.5 Reclassification of NCIs to a Liability

ASC 480-10

Mandatorily Redeemable Financial Instruments

A conditionally redeemable NCI may become mandatorily redeemable as a result of the resolution of a condition associated with redemption. In this situation, the NCI must be reclassified from equity (generally, from temporary equity) to a liability. ASC 480-10-30-2 specifies that “[i]f a conditionally redeemable instrument becomes mandatorily redeemable, upon reclassification the issuer shall measure that liability initially at fair value and reduce equity by the amount of that initial measure, recognizing no gain or loss.” While this type of reclassification has no impact on net income (regardless of whether the form of the NCI is preferred stock or common stock), immediately before the reclassification date (which may a date other than the end date of a financial reporting period), the entity should adjust the carrying amount of the NCI in accordance with its accounting policy for remeasuring redeemable securities under ASC 480-10-S99-3A if the NCI is being remeasured to its redemption amount under ASC 480-10-S99-3A.

Section 3.2.6 addresses reclassifications of the NCI that result from modifications of the instrument.

3.2.3.5.1 NCIs in the Form of Preferred Stock

As discussed in the scope section of ASC 260-10-S99-2, a reclassification of an NCI in the form of preferred stock from equity to a liability is treated as a redemption of preferred stock. See Section 3.2.3.2.1 for discussion of the accounting for a redemption of an NCI in the form of preferred stock.

3.2.3.5.2 NCIs in the Form of Common Stock

A reclassification of an NCI in the form of common stock from equity to a liability has no impact on basic EPS because ASC 260-10-S99-2 does not apply to these types of reclassifications.

3.2.4 Common Stock

3.2.4.1 Multiple Classes of Common Stock

An entity that has multiple classes of common stock is subject to the two-class method of calculating basic EPS. An entity may be deemed to have multiple classes of common stock solely because one class is redeemable (see Section 3.2.4.2). Both basic and diluted EPS must be calculated and presented for each class of common stock. See further discussion of the two-class method in Chapter 5.

If one class of common stock is exchanged or converted into another class of common stock, the entity should consider whether the transaction represents either a redemption or a conversion of common stock. Section 3.2.2.6.2.1 discusses considerations related to distinguishing between a redemption and a conversion. Redemptions of common stock are further addressed in Section 3.2.4.3.

A class of common stock that is convertible into another class of common stock could be converted in accordance with an inducement offer. In an induced conversion from one class of common stock to another, the additional value resulting from the inducement offer should be accounted for in one of two ways. It should be treated either as a dividend in the application of the two-class method of calculating basic EPS or as an expense in a manner consistent with the accounting for reacquisitions of common stock at a price that exceeds fair value. Section 3.2.4.3 provides guidance on redemptions of common stock that can be considered in the determination of whether the additional value resulting from an inducement should be treated as an expense or as a dividend. In making this determination, an entity may also consider the SEC staff’s views on the treatment of the additional value transferred in a modification or exchange of preferred stock that is not accounted for as an extinguishment. See Section 3.2.6 for more information.

If one class of common stock is converted to another class of common stock in accordance with the stated conversion privileges of the instrument and the conversion is not considered either a redemption or an induced conversion, the numerator of basic EPS is unaffected.

3.2.4.2 Redeemable 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.

An SEC registrant that has outstanding redeemable shares of common stock is subject to the guidance in ASC 480-10-S99-3A. According to that guidance, if the common stock is redeemable at the option of the holder or upon the occurrence of any event outside the issuer’s control, other than an ordinary liquidation, the common stock must be classified in temporary equity. As discussed in ASC 480-10-S99-3A(14), if the common stock “is currently redeemable (for example, at the option of the holder), it should be adjusted to its maximum redemption amount at the balance sheet date.” If the common stock is not currently redeemable, but it is probable that it will become redeemable, it must be remeasured to its redemption amount by using one of the following acceptable methods discussed in ASC 480-10-S99-3A(15):

Accrete changes in the redemption value over the period from the date of issuance (or from the date that it becomes probable that the instrument will become redeemable, if later) to the earliest redemption date of the instrument using an appropriate methodology, usually the interest method. Changes in the redemption value are considered to be changes in accounting estimates.
Recognize changes in the redemption value (for example, fair value) immediately as they occur and adjust the carrying amount of the instrument to equal the redemption value at the end of each reporting period. This method would view the end of the reporting period as if it were also the redemption date for the instrument.

ASC 480-10-S99-3A(21) indicates that the adjustments to the carrying amount under the two acceptable methods are treated in the same manner as dividends. If such adjustments pertain to a remeasurement of the carrying amount of common stock that is redeemable at fair value, changes to the carrying amount of the common stock do not affect basic EPS. However, if such adjustments are recognized for common stock redeemable at any amount other than fair value, the entity must apply the two-class method to calculate basic EPS. Increases to the carrying amount of common stock redeemable at a non–fair value amount are treated as dividends (or distributions) in the application of the two-class method. That is, income available to common stockholders would be reduced by actual cash distributions as well as these “deemed dividends” to arrive at undistributed earnings. Decreases to the carrying amount of common stock redeemable at a non–fair value amount, which may only be recognized to the extent the decreases reflect recoveries of previously recognized increases to the carrying amount as a result of the application of ASC 480-10-S99-3A, should be treated as “deemed contributions” when the two-class method is applied. That is, income available to common stockholders should be reduced by actual cash distributions and increased by these “deemed contributions” to arrive at undistributed earnings.

In addition, footnote 17 of ASC 480-10-S99-3A provides the following two acceptable alternative approaches for determining the amount of “deemed dividends” and “deemed contributions” that pertain to ASC 480-10-S99-3A measurement adjustments to the carrying amount of common stock redeemable at an amount other than fair value:

Treat the entire adjustment in the same manner as a dividend.
Treat only the portion of the adjustment that reflects a redemption at an amount in excess of fair value in the same manner as a dividend.

The approach selected will affect the calculation of basic EPS. The two examples below illustrate the application of this guidance. For additional details regarding the application of the SEC’s guidance on redeemable securities, see Chapter 9 of Deloitte’s Roadmap Distinguishing Liabilities From Equity.

Example 3-20

Treatment of Common Stock Redeemable at Fair Value in the Calculation of Basic EPS

Company B issues common stock that contains a redemption provision entitling the holder of the common stock to put the shares at fair value to B five years after the issuance of the shares or at any time thereafter (redeemable common stock). The redeemable common stock represents approximately 20 percent of all outstanding common stock and participates in all the rewards to which other common shareholders are entitled. It is not considered permanent equity but is included in temporary equity on B’s balance sheet in accordance with FRR Section 211 and SEC Regulation S-X, Rule 5-02.27, as interpreted by ASC 480-10-S99-3A. In accordance with ASC 480-10-S99-3A(15)(b), B has chosen to remeasure the redeemable common stock to its redemption amount at the end of each reporting period as if that date was the redemption date.

In B’s calculation of basic EPS, the redeemable common stock should be included as outstanding common stock (i.e., included in the denominator). The redeemable common stock is currently outstanding and participates in all the rewards to which other common shareholders are entitled. Furthermore, since the redeemable common stock has redemption terms requiring a repurchase price at fair value, there is no incremental impact on B’s calculation of basic EPS.

Example 3-21

Impact of Redeemable Common Stock on Basic EPS

Scenario 1

Entity Y has issued common stock with an embedded redemption (“put”) feature. The put allows the common stockholder to exchange its common stock for cash equal to the fair value of the common stock as of the date the put is exercised. The put may be exercised at any time (i.e., the shares are currently redeemable).

Entity Y has evaluated the common stock and the related put and concluded the following:

The put is not a freestanding financial instrument; instead, it is embedded in the common stock. The put does not need to be bifurcated as an embedded derivative under ASC 815-15-25-1 because it qualifies for the scope exception in ASC 815-10-15-74(a) (see also ASC 815-10-15-76).
The common stock subject to the put is not classified as a liability under ASC 480.
The puttable common stock is subject to the guidance in ASC 480-10-S99-3A. Accordingly, the shares are classified in temporary equity in Y’s balance sheet. Because they are currently redeemable, the shares are measured at their redemption amount (fair value) as of each balance sheet date.

Entity Y should not adjust income available to common stockholders for changes in the carrying amount of its puttable common stock when calculating basic EPS. Because the puttable shares represent common stock rather than preferred stock and are redeemable at fair value, changes in their carrying amount do not affect income available to common stockholders in a manner consistent with ASC 480-10-S99-3A(21). In addition, Y should not apply the two-class method of calculating basic EPS as a result of the puttable common stock. ASC 480-10-S99-3A(21) indicates that since a redemption at fair value does not transfer any value to or from the holder of the puttable common stock, the two-class method does not apply.

Although the adjustments to the carrying amount of the puttable common stock have no impact on Y’s calculations of basic EPS, Y is still subject to the guidance in ASC 480-10-S99-3A(16)(e), which indicates that “reductions in the carrying amount of a redeemable equity instrument from the application of paragraphs 14 and 16 are appropriate only to the extent that the registrant has previously recorded increases in the carrying amount of the redeemable equity instrument from the application of paragraphs 14 and 15.”

Scenario 2

Assume the same facts as in Scenario 1 except that the put allows the holders to redeem the common stock at an amount equal to 10 times the most recent 12 months of Y’s EBITDA. In this circumstance, the redemption price is not considered fair value or an amount that is designed to approximate fair value. Footnote 18 of ASC 480-10-S99-3A states, in part, that “[t]he 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.” Thus, because the redemption terms are not at fair value, Y must consider any increases or decreases in the carrying amount of the puttable common stock recognized under ASC 480-10-S99-3A in basic EPS by using the two-class method. Those increases and decreases (limited by the amount of previously recorded increases to the carrying amount, as discussed in ASC 480-10-S99-3A(16)(e)) should be considered dividends (or distributed earnings) under the two-class method. For more information on applying the two-class method, see Chapter 5.

3.2.4.3 Redemption of Common Stock

ASC 505-30

Requirement to Allocate Repurchase Amount

25-3 The facts and circumstances associated with a share repurchase may suggest that the total payment relates to other than the shares repurchased. An entity offering to repurchase shares only from a specific shareholder (or group of shareholders) suggests that the repurchase may involve more than the purchase of treasury shares. Also, if an entity repurchases shares at a price that is different from the price obtainable in transactions in the open market or transactions in which the identity of the selling shareholder is not important, some portion of the amount being paid presumably represents a payment for stated or unstated rights or privileges that shall be given separate accounting recognition. See paragraph 505-30-30-3 for the measurement requirements associated with the different elements identified within such a transaction.

25-4 Payments by an entity to a shareholder or former shareholder attributed, for example, to a standstill agreement, or any agreement in which a shareholder or former shareholder agrees not to purchase additional shares, shall be expensed as incurred. Such payments do not give rise to assets of the entity.

Allocating Repurchase Price to Other Elements of the Repurchase Transaction

30-2 An allocation of repurchase price to other elements of the repurchase transaction may be required if an entity purchases treasury shares at a stated price significantly in excess of the current market price of the shares. An agreement to repurchase shares from a shareholder may also involve the receipt or payment of consideration in exchange for stated or unstated rights or privileges that shall be identified to properly allocate the repurchase price.

30-3 For example, the selling shareholder may agree to abandon certain acquisition plans, forego other planned transactions, settle litigation, settle employment contracts, or restrict voluntarily the ability to purchase shares of the entity or its affiliates within a stated time period. If the purchase of treasury shares includes the receipt of stated or unstated rights, privileges, or agreements in addition to the capital stock, only the amount representing the fair value of the treasury shares at the date the major terms of the agreement to purchase the shares are reached shall be accounted for as the cost of the shares acquired. The price paid in excess of the amount accounted for as the cost of treasury shares shall be attributed to the other elements of the transaction and accounted for according to their substance. If the fair value of those other elements of the transaction is more clearly evident, for example, because an entity’s shares are not publicly traded, that amount shall be assigned to those elements and the difference recorded as the cost of treasury shares. If no stated or unstated consideration in addition to the capital stock can be identified, the entire purchase price shall be accounted for as the cost of treasury shares.

30-4 Transactions do arise, however, in which a reacquisition of an entity’s stock may take place at prices different from routine transactions in the open market. For example, to obtain the desired number of shares in a tender offer to all or most shareholders, the offer may need to be at a price in excess of the current market price. In addition, a block of shares representing a controlling interest will generally trade at a price in excess of market, and a large block of shares may trade at a price above or below the current market price depending on whether the buyer or seller initiates the transaction. An entity’s reacquisition of its shares in those circumstances is solely a treasury stock transaction properly accounted for at the purchase price of the treasury shares. Therefore, in the absence of the receipt of stated or unstated consideration in addition to the capital stock, the entire purchase price shall be accounted for as the cost of treasury shares.

Allocating the Cost of Treasury Shares to Components of Shareholder Equity Upon Formal or Constructive Retirement

30-5 An entity that repurchases its own outstanding common stock may be required under paragraph 505-30-30-3 to allocate a portion of the repurchase price to other elements of the transaction.

30-6 Once the cost of the treasury shares is determined under the requirements of this Section, and if a corporation’s stock is acquired for purposes other than retirement (formal or constructive), or if ultimate disposition has not yet been decided, paragraph 505-30-45-1 permits the cost of acquired stock to either be shown separately as a deduction from the total of capital stock, additional paid-in capital, and retained earnings, or be accorded the following accounting treatment appropriate for retired stock.

30-7 The difference between the cost of the treasury shares and the stated value of a corporation’s common stock repurchased and retired, or repurchased for constructive retirement, shall be reflected in capital.

30-8 When a corporation’s stock is retired, or repurchased for constructive retirement (with or without an intention to retire the stock formally in accordance with applicable laws), an excess of repurchase price over par or stated value may be allocated between additional paid-in capital and retained earnings. Alternatively, the excess may be charged entirely to retained earnings in recognition of the fact that a corporation can always capitalize or allocate retained earnings for such purposes. If a portion of the excess is allocated to additional paid-in capital, it shall be limited to the sum of both of the following:

All additional paid-in capital arising from previous retirements and net gains on sales of treasury stock of the same issue
The pro rata portion of additional paid-in capital, voluntary transfers of retained earnings, capitalization of stock dividends, and so forth, on the same issue. For this purpose, any remaining additional paid-in capital applicable to issues fully retired (formal or constructive) is deemed to be applicable pro rata to shares of common stock.

30-9 When a corporation’s stock is retired, or repurchased for constructive retirement (with or without an intention to retire the stock formally in accordance with applicable laws), an excess of par or stated value over the cost of treasury shares shall be credited to additional paid-in capital.

30-10 Gains on sales of treasury stock not previously accounted for as constructively retired shall be credited to additional paid-in capital; losses may be charged to additional paid-in capital to the extent that previous net gains from sales or retirements of the same class of stock are included therein, otherwise to retained earnings.

ASC 505-30 addresses the accounting for repurchases of common stock. While ASC 260-10-S99-2 does not apply to a reacquisition of common stock, ASC 480-10-S99-3A applies to redeemable common stock. Therefore, the carrying amount of redeemable common stock on the redemption date should reflect the amount that must be recognized under ASC 480-10-S99-3A. That is, an adjustment to the carrying amount should be made in accordance with ASC 480-10-S99-3A immediately before an entity records the reacquisition of the common stock. The accounting guidance in ASC 505-30 would typically apply to redeemable common stock only if the reacquisition occurs outside the terms of the embedded redemption feature in the common stock. In the remaining discussion below, it is assumed that the reacquisition of common stock occurs in accordance with an arrangement other than an embedded redemption option in redeemable common stock.

When the price paid to reacquire shares of common stock is fair value, the repurchase is treated solely as a treasury stock transaction and there is no impact on income available to common stockholders in the calculation of basic EPS. The denominator, however, is affected by the decrease in the number of shares of common stock outstanding. Generally, the reduction in outstanding shares of common stock will affect the weighted-average number of common shares outstanding only from the repurchase date.10

ASC 505-30 states that, in some circumstances, the price paid to repurchase common shares includes other elements, whether stated or unstated, for which separate accounting is required and provides guidance on allocating the repurchase price to these other elements. In accordance with ASC 505-30, when an entity pays an amount in excess of fair value to repurchase its common shares and the excess is attributable to the receipt of stated or unstated rights, privileges, or agreements in addition to the treasury stock transaction, those other elements must be accounted for separately from the treasury stock transaction element. The accounting for the other elements is subject to the requirements of other GAAP. However, in some circumstances, an entity may conclude that other GAAP requirements do not address the accounting for the excess of the repurchase price over fair value and that this excess therefore represents an expense or a dividend to a common shareholder. In reaching such a conclusion, an entity must use judgment and evaluate the specific facts and circumstances associated with the repurchase transaction. If an entity concludes that a payment in excess of fair value is more characteristic of a dividend than an earnings charge (i.e., because the excess represents a pro rata distribution), that dividend should reduce net income in arriving at income available to common stockholders. There could be circumstances in which such a dividend gives rise to the need to apply the two-class method of calculating basic EPS.

Connecting the Dots

ASC 505-30 discusses two important concepts that an entity must consider when paying an amount in excess of the current market price to repurchase shares of common stock.

Excess of repurchase price per share over the current market price is “insignificant” — ASC 505-30-30-2 indicates that an allocation of the repurchase price to other elements of the transaction may be required if an entity purchases treasury shares at a stated price “significantly in excess of the current market price of the shares.” This means that if an entity has determined that there are no other stated or unstated rights or privileges associated with the share repurchase for which separate accounting is required under other GAAP, and the excess of the repurchase price per share over the current market price per share is not significant, no separate accounting for the excess is required (i.e., the excess is part of the price paid in the treasury stock transaction and does not represent a dividend or expense item). However, even if the repurchase price exceeds the current market price of the common shares by an insignificant amount, an entity must still analyze the repurchase transaction to determine whether there are other elements of the repurchase transaction that should be recognized separately under other GAAP. The treasury stock transaction should not include consideration paid to the selling shareholder that must be accounted for under other GAAP. For this purpose, “significant” is generally interpreted in practice as 10 percent or more.
Excess of repurchase price per share over the current market price is “significant” — ASC 505-30-30-4 acknowledges that the excess of the amount paid to repurchase common shares over the current market price may constitute part of the treasury stock transaction even if the repurchase price is significantly “in excess of the current market price“ of the shares. ASC 505-30 focuses on a comparison of the repurchase price per share with the current market price per share; however, this is only the starting point in the analysis. Even if the repurchase price per share exceeds the current market price per share, there are generally no other stated or unstated rights to separately account for if the consideration paid does not exceed the fair value of the shares repurchased. An entity should consider the fair value measurement principles in ASC 820, in particular ASC 820-10-30-2 through 30-3A, in determining whether the repurchase price (i.e., the transaction price) exceeds the fair value of the shares repurchased. A repurchase price per share in excess of the current market price per share may represent an arm’s-length transaction price to just repurchase shares if the consideration paid exceeds the number of shares repurchased times the quoted market price (P × Q) because the shares are thinly traded or the repurchase involves a number of shares that exceed the number the market can readily absorb on a single trading day without significantly affecting the price per share. However, since it is presumed that a significant excess of the amount paid over the current market price represents an element other than a treasury stock transaction, an entity will need sufficient evidence to demonstrate that the repurchase price does not exceed the fair value of the shares repurchased. An entity should consider, among other matters, (1) the relationship it has with the selling shareholder (i.e., whether there is a related-party relationship or another transaction between the entity and the shareholder), (2) the facts and circumstances related to the share repurchase itself, and (3) what it believes to be the fair value of the shares repurchased (i.e., a market price to repurchase the number of shares repurchased). To conclude that the repurchase price represents an arm’s-length transaction when it does not represent P × Q, an entity must be able to determine that the same repurchase price would have been paid to any holder of the shares.11 If an entity cannot conclude that the consideration paid does not exceed the fair value of the shares repurchased, the excess must be associated with something other than the treasury stock transaction. If no other element is identified for which accounting is required under other GAAP, the excess should be treated as a dividend paid to the selling shareholder or as an expense. An entity must use judgment in making this determination and consider the facts and circumstances associated with the excess payment and the relationship between the entity and selling shareholder. When in doubt regarding the treatment of this excess amount, it is generally appropriate for an entity to account for it as an expense.

Example 3-22

Treasury Stock Purchase in Excess of Quoted Market Price

Company T, an entity with publicly traded stock, enters into a transaction to immediately buy shares of its own common stock at a price of $8.75 per share, which is approximately 25 percent above the current quoted market price of $7 per share. The shares to be purchased are currently held by a single corporation and represent approximately 17 percent of T’s outstanding common shares. Company T states three reasons for purchasing the shares at an above-market price:

Although the price is above the quoted market price, it is still an attractive price.
In one transaction, T can effectively decrease dilution.
Bidding for that volume of shares in the market, with such small volumes of trade (average daily trade volume is less than 1 percent of T’s total outstanding common shares), will significantly increase the market price even above the contract price.

Provided that the transaction does not involve the receipt or payment of consideration in exchange for any stated or unstated rights, privileges, or agreements in addition to the shares of common stock repurchased, the entire purchase price should be accounted for as the cost of treasury shares. ASC 505-30-50-3 states the following regarding how a company should account for treasury shares purchased at a stated price significantly in excess of the current market price of the shares:

A repurchase of shares at a price significantly in excess of the current market price creates a presumption that the repurchase price includes amounts attributable to items other than the shares repurchased. A repurchase of shares at a price significantly in excess of the current market price may require an entity to allocate amounts to other elements of the transaction under the requirements of paragraph 505-30-30-2.

If the price paid in excess of the current market price of the shares represented payment for consideration received in the transaction other than the shares, the excess should be attributed to the costs of the other element and accounted for according to the substance of that element.

The purchase of the shares at a price in excess of the current market price creates a presumption that the excess price is attributable to items other than the shares. For the entire purchase price to be accounted for as the costs of the treasury shares, this presumption needs to be overcome by sufficient evidence to the contrary. If the presumption cannot be overcome, the excess price should be attributed to the other items and accounted for according to the substance of those items. Evidence may include, but is not limited to, a valuation from an investment banker supporting the price paid by the company and an analysis of the trading volume indicating that the company could not purchase this volume of shares in a reasonable amount of time without significantly affecting the current market price. For example, T may be able to obtain sufficient evidence to conclude that the price paid is not influenced by the issuer-holder relationship and that the price would be the same if T had acquired that number of shares from another holder (or group of holders).

If there is sufficient evidence to overcome the presumption that the price paid in excess of the current market price of the shares represents payment for consideration received in the transaction other than the shares, T should account for the purchase of the shares in accordance with ASC 505-30-30-4, which indicates that transactions to repurchase shares of common stock in excess of the current market price may occur even if the excess is not attributable to something other than a treasury stock transaction (i.e., the repurchase price was representative of the fair value of the shares of common stock repurchased). In other words, if the presumption is overcome, the entire purchase price should be accounted for as the cost of the treasury shares. Such accounting would generally be appropriate only if an entity concludes that the repurchase price represents a price paid in an arm’s-length transaction for the number of shares repurchased (i.e., a fair value price for the shares repurchased).

The guidance discussed above also applies to the redemption of an NCI in the form of common stock (see also Section 7.1.2.2 of Deloitte’s Roadmap Noncontrolling Interests). If a repurchase of common stock occurs between an entity and an employee, or with a nonemployee that was a customer or provided goods and services to the entity, the guidance in ASC 718 should be considered. (For additional discussion, see Deloitte’s Roadmap Share-Based Payment Awards.) The accounting considerations in Section 3.2.4.1 are relevant if an entity extinguishes common stock that was not issued in a share-based payment arrangement through an induced conversion of one class of common stock to another.12

3.2.4.3.1 Forward to Repurchase Common Stock and Mandatorily Redeemable 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 480-10-45-4 requires an entity to make the following adjustments to the calculation of basic EPS for (1) mandatorily redeemable financial instruments and (2) forward contracts that must be physically settled by repurchase of a fixed number of shares of common stock in exchange for cash:

Numerator (i.e., income available to common stockholders) — The entity uses the two-class method to adjust the numerator for any amounts attributable to such shares that have not been accounted for as interest cost. Under the two-class method, the entity reduces the numerator for the amount of undistributed earnings that are allocable to the shares subject to repurchase.
Denominator (i.e., the number of shares outstanding) — In calculating basic and diluted EPS, an entity excludes from the denominator shares of common stock that will be repurchased (i.e., it treats those shares as retired). See further discussion in Section 3.3.3.2.

Paragraph B68 of FASB Statement 150 states:

The Board decided that the number of outstanding shares associated with physically settled forward purchase contracts measured at the present value of the contract amount should be removed from the denominator in computing basic and diluted earnings per share in the same way as required for mandatorily redeemable shares classified as liabilities. The Board reasoned that, because the accounting for physically settled forward contracts reduces equity, even though the shares are still outstanding, they are effectively accounted for as if retired. Like mandatorily redeemable shares accounted for as liabilities, shares subject to physically settled forward contracts should not be treated as outstanding in earnings per share calculations. The Board noted that amounts paid to holders are interest costs reflected in earnings available to common shareholders, the numerator in calculating earnings per share.

Because ASC 480-10-45-3 requires entities to reflect in interest cost “[a]ny amounts paid or to be paid to holders of [forward repurchase] contracts . . . in excess of the initial measurement amount,” the numerator is not adjusted for such amounts under the two-class method. For example, accrued cumulative dividends should be recognized as interest cost even if they are not declared, as long as the holder is entitled to such dividends during the life of the contract or at settlement. Other amounts attributable to the shares under the two-class method, however, might not have been recognized as interest cost. For example, the holder of a mandatorily redeemable financial instrument may have a participation right in 10 percent of dividends paid on common shares if or when they are declared. An amount may therefore be allocable to the shares subject to repurchase because all earnings for the period are assumed to have been distributed under the two-class method. However, this amount may not have been recognized as interest cost under ASC 480 if the holder is not entitled to it during the life of the contract or at settlement unless the issuer elects to declare a dividend on common stock.

Example 3-23

Calculating EPS When Shares Are Repurchased in a Forward Contract

Company A, a public business entity, has 1,000 outstanding common shares. On January 1, A enters into a forward contract that must be physically settled on December 31 by repurchase of 100 shares in exchange for a fixed amount of $500. The forward contract does not provide for any subsequent adjustment of the repurchase price on the basis of the amount of actual dividends paid. Like other common shares, the 100 shares to be repurchased under the forward contract continue to be entitled to receive any dividends declared on common shares until the repurchase date. However, A declares no dividends during the year.

In calculating basic EPS for the year, A excludes the 100 shares that are to be repurchased from the denominator in accordance with ASC 480-10-45-4. Company A’s earnings for the year are $20,000 (excluding interest cost accrued on the forward contract under ASC 480-10-35-3). In the absence of the forward contract, basic EPS for the year would have been $20 ($20,000 ÷ 1,000).

ASC 480-10-45-4 also requires that A deduct from income available to common stockholders any amounts (including participation rights in undistributed earnings) attributable to shares that are to be repurchased. This requirement is consistent with the two-class method described in ASC 260 (except to the extent that such amounts have already been recognized as interest cost under ASC 480-10-35-3). Because the forward contract in this situation does not return to A the actual dividends paid on the 100 shares to be repurchased, A deducts $2,000 from the EPS numerator to reflect the participation rights in undistributed earnings attributable to the 100 shares being repurchased, or $20,000 × (100 ÷ 1,000). Accordingly, the EPS numerator is $18,000 ($20,000 – $2,000). Because the EPS denominator is 900, basic EPS for the period is still $20 ($18,000 ÷ 900).

See Chapter 5 for additional guidance on applying the two-class method.

3.2.4.3.2 Accelerated Share Repurchase Programs

ASC 505-30

Accelerated Share Repurchase Programs

25-5 An accelerated share repurchase program is a combination of transactions that permits an entity to repurchase a targeted number of shares immediately with the final repurchase price of those shares determined by an average market price over a fixed period of time. An accelerated share repurchase program is intended to combine the immediate share retirement benefits of a tender offer with the market impact and pricing benefits of a disciplined daily open market stock repurchase program.

25-6 An entity shall account for such an accelerated share repurchase program as the following two separate transactions:

As shares of common stock acquired in a treasury stock transaction recorded on the acquisition date
As a forward contract indexed to its own common stock. Subtopic 815-40 provides guidance on the accounting for contracts that are indexed to an entity’s own common stock.

Example 1 (see paragraph 505-30-55-1) provides an illustration of an accelerated share repurchase program that is addressed by this guidance.

As noted in ASC 505-30-25-5, an accelerated share repurchase program consists of two separate elements for accounting purposes — a treasury stock transaction and a forward indexed to the issuer’s own stock. The treasury stock transaction has no impact on the numerator in the calculation of basic EPS but does affect the denominator as the shares of common stock are removed from the shares outstanding from the acquisition date. See Section 8.4 for further discussion of accelerated share repurchase programs.

3.2.4.3.3 Redemption of Tracking Stock

Some entities have issued classes of stock characterized as “tracking” or “targeted” stock, which measures the performance of a specific business unit, activity, or asset of the entity. Shares of tracking stock are traded as separate securities although they typically are not associated with any specific claim on the related assets and may grant limited or no voting rights. According to ASC 260-10-45-60B, an entity with tracking stock, which represents a separate class of stock, must calculate and present EPS for each class of common stock by using the two-class method.

The terms of tracking stock often allow the issuing entity, at its option, to exchange or redeem shares of tracking stock for shares of another tracking stock or the issuer’s main common stock in such a way that the entity would have one less class of common stock outstanding. The terms of this feature generally require an entity to pay a premium to the class being redeemed as a result of the transaction. When the entity pays a premium over fair value to redeem a class of tracking stock, the premium should be treated as a reduction from net income in arriving at income available to common stockholders of the class whose shares are being used for the redemption. The rationale for this treatment is that the holders of the tracking stock being redeemed have received a benefit that constitutes an additional contractual return to them. That benefit is absorbed by the class of common stock for which the entity has issued shares in return for the extinguishment of the class of tracking stock. The example below illustrates the accounting for a redemption of tracking stock.

Example 3-24

Treatment of Redemption of Class of Tracking Stock

Company X has two classes of common stock outstanding that separately track the results of operations of two different businesses, A and B. Company X decided to redeem all outstanding shares of its B tracking stock in exchange for shares of its A tracking stock. The terms of the B stock being redeemed, as disclosed in the Form S-3 filed in connection with the offering of that security, gave X the right to redeem the B stock, at its discretion, by issuing shares of its A stock with a market value equal to a 15 percent premium over the market price of the B stock at the time of redemption. Therefore, the fair value of A stock to be exchanged for the B stock will exceed the fair value of the B stock by 15 percent on the date the redemption is announced. The income available to A stockholders should be reduced by the amount of the 15 percent premium in the calculation of income available for common stockholders of A for EPS purposes for the period.

3.2.4.4 Reclassification of Common Stock to a Liability

ASC 480-10

Mandatorily Redeemable Financial Instruments

A conditionally redeemable common stock instrument may become mandatorily redeemable as a result of the resolution of a condition associated with redemption. In this situation, the common stock must be reclassified from equity (generally, from temporary equity) to a liability. ASC 480-10-30-2 specifies that “[i]f a conditionally redeemable instrument becomes mandatorily redeemable, upon reclassification the issuer shall measure that liability initially at fair value and reduce equity by the amount of that initial measure, recognizing no gain or loss.” This type of reclassification has no impact on net income and is not within the scope of ASC 260-10-S99-2 because that guidance does not apply to common stock instruments. However, redeemable common stock is subject to the classification, measurement, and EPS guidance in ASC 480-10-S99-3A. Therefore, if the common stock is being remeasured to its redemption amount under ASC 480-10-S99-3A, immediately before the reclassification date (which may be a date other than the end date of a financial reporting period), the redeemable common stock instrument should be adjusted to its redemption amount in accordance with the entity’s accounting policy for remeasuring redeemable securities under ASC 480-10-S99-3A. If the common stock was not being remeasured to its redemption amount under ASC 480-10-S99-3A, which may be the case if the redemption was contingent and its occurrence was not probable, the entity must consider whether the amount payable under the mandatory redemption feature exceeds the fair value of the common stock. If so, the entity should consider the guidance on repurchases of common stock at amounts in excess of fair value (see Section 3.2.4.3).

See Section 3.2.6.2 for more information about situations in which the reclassification results from a modification of the instrument.

3.2.4.5 Common Stock Issued in Certain R&D Arrangements

See Section 8.10 for discussion of the impact on net income and income available to common stockholders in certain R&D arrangements.

3.2.4.6 Excise Tax Obligations Related to the Repurchase of Common Stock

Publicly traded companies that repurchase common stock may be obligated to pay a 1 percent excise tax under IRC Section 4501, which was added by the Inflation Reduction Act of 2022. This excise tax obligation related to the repurchase of common stock classified in permanent equity may be accounted for as a cost of the treasury stock transaction (i.e., recorded in equity). Special considerations apply if an entity repurchases common stock that is classified in temporary equity or has share issuance transactions that reduce the total excise tax amount due. See Deloitte’s April 27, 2023, Heads Up for more information about the accounting for this excise tax.

3.2.5 Other Securities

3.2.5.1 Participating Securities

3.2.5.1.1 Share-Based Payments

ASC 260-10

Participating Securities and 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.

In accordance with ASC 260-10-45-61 and 45-61A, the following share-based payment awards represent participating securities to which an entity is required to apply the two-class method of calculating basic EPS:

Vested awards — Awards that do not represent outstanding shares of common stock that contain a right to receive dividends declared on the entity’s common stock.
Unvested awards — Awards that contain a nonforfeitable right to dividends or dividend equivalents.

See Chapter 5 for further details regarding the definition of a participating security and application of the two-class method and Section 7.1.3 for specific discussion related to share-based payment awards.

3.2.5.1.2 Other Participating Securities

An entity may have issued freestanding financial instruments, other than preferred stock and NCIs, that meet the definition of a participating security. The most common types of instruments that may meet the definition of a participating security are:

Options or warrants to purchase common stock.
Forward contracts to purchase or sell common stock.
Convertible debt securities.

See Chapter 5 for further discussion of the definition of a participating security and application of the two-class method.

3.2.5.2 Settlement of Equity-Linked Financial Instruments

An entity may have issued and have outstanding contracts indexed to its equity (i.e., equity-linked instruments). The security underlying these contracts may be common stock or preferred stock. The contracts may be classified as assets or liabilities or in stockholders’ equity. When these contracts are accounted for as assets or liabilities, any difference between the fair value of the consideration paid or received upon settlement and the carrying amount is recognized as a gain or loss in earnings. Thus, the numerator in the calculation of basic EPS is affected through the gains or losses recognized in net income. The settlement of equity-linked contracts classified in stockholders’ equity is discussed below.

3.2.5.2.1 Freestanding Equity-Classified Contracts Indexed to an Entity’s Common Stock

ASC 815-40 addresses the settlement of freestanding equity-classified contracts indexed to an issuer’s common stock. ASC 260-10-S99-2 does not apply to the settlement of such contracts. As discussed in footnote 18 of EITF Topic D-98, the application of ASC 260-10-S99-2 “is limited to preferred stock instruments.”13

The guidance in ASC 815-40 addressing the settlement of contracts indexed to an entity’s common stock does not specifically address either (1) a repurchase of an outstanding instrument at an amount that exceeds the fair value of the instrument on the repurchase date or (2) an inducement offer to exercise the instrument.

When an entity repurchases an outstanding contract indexed to its common stock, the repurchase price is generally equal to the fair value of the contract. However, if an entity pays an amount in excess of fair value, the excess should be accounted for in the same manner as a repurchase of common stock at an amount in excess of the current market price, as discussed in Section 3.2.4.3. Thus, if the consideration transferred upon settlement exceeds the fair value of the equity-linked instrument on the settlement date, the excess consideration may need to be recognized as a dividend or an expense. Any such amount recognized as a dividend will reduce income available to common stockholders in a manner similar to the application of the two-class method.

If an entity settles a contract indexed to its common stock under an inducement offer, the additional value provided as a result of the inducement offer, which is calculated as the fair value of all securities and other consideration transferred in the transaction over the fair value of the capital stock issuable according to the original terms of the contract, should be treated as a dividend or an expense. Any such amount recognized as a dividend will reduce income available to common stockholders in a manner similar to the application of the two-class method. Section 3.2.4.3 provides additional discussion of the treatment of such an amount as a dividend or an expense.

See Section 3.2.5.3 for discussion of the treatment of down-round features in freestanding equity-linked contracts that are classified in stockholders’ equity.

3.2.5.2.2 Freestanding Equity-Classified Contracts Indexed to an Entity’s Preferred Stock

The settlement of an equity-classified freestanding contract that is indexed to an entity’s preferred stock is accounted for in the same way as a settlement of convertible preferred stock that does not contain a separately recognized equity component (see Sections 3.2.2.5.4, 3.2.2.6.2.1, and 3.2.2.6.3). A summary of the accounting, which depends on the nature of the settlement, is as follows:

Exercise — A settlement of an equity-classified freestanding contract indexed to an entity’s preferred stock that occurs on the basis of an exercise of the instrument according to its stated terms is not accounted for under ASC 260-10-S99-2 and has no impact on the numerator in the entity’s calculation of basic EPS.
Redemption — ASC 260-10-S99-2 applies to the redemption of an equity-classified freestanding contract indexed to an entity’s preferred stock regardless of the form of the consideration provided on redemption. Therefore, any difference between the total fair value of the consideration transferred to redeem the instrument and the net carrying amount of the instrument should be treated as an adjustment to net income in arriving at income available to common stockholders.
Inducement — In an inducement, the excess of (1) the fair value of all securities and other consideration transferred in the transaction to the holders of the equity-linked contract over (2) the fair value of securities issuable in accordance with the original exercise terms should be deducted from net income to arrive at income available to common stockholders in the calculation of basic EPS. Once this additional value is recognized, the entity applies the accounting applicable to an exercise of an equity-classified freestanding contract indexed to an entity’s preferred stock. Accordingly, in such situations, there is no additional impact on the numerator in the calculation of basic EPS.

3.2.5.2.3 Convertible Debt That Contains a Separately Classified Equity Component Indexed to an Entity’s Common Stock

ASC 480-10 — SEC Materials — SEC Staff Guidance

SEC Staff Announcement: Classification and Measurement of Redeemable Securities

S99-3A(3)(e) Convertible debt instruments that contain a separately classified equity component. Other applicable GAAP may require a convertible debt instrument to be separated into a liability component and an equity component.FN8 In these situations, the equity-classified component of the convertible debt instrument should be considered redeemable if at the balance sheet date the issuer can be required to settle the convertible debt instrument for cash or other assets (that is, the instrument is currently redeemable or convertible for cash or other assets). For these instruments, an assessment of whether the convertible debt instrument will become redeemable or convertible for cash or other assets at a future date should not be made. For example, a convertible debt instrument that is not redeemable at the balance sheet date but could become redeemable by the holder of the instrument in the future based on the passage of time or upon the occurrence of a contingent event is not considered currently redeemable at the balance sheet date.

S99-3A(12)(d) For convertible debt instruments that contain a separately classified equity component, an amount should initially be presented in temporary equity only if the instrument is currently redeemable or convertible at the issuance date for cash or other assets (see paragraph 3(e)). The portion of the equity-classified component that is presented in temporary equity (if any) is measured as the excess of (1) the amount of cash or other assets that would be required to be paid to the holder upon a redemption or conversion at the issuance date over (2) the carrying amount of the liability-classified component of the convertible debt instrument at the issuance date.

S99-3A(16)(d) For convertible debt instruments that contain a separately classified equity component, an amount should be presented in temporary equity only if the instrument is currently redeemable or convertible at the balance sheet date for cash or other assets (see paragraph 3(e)). The portion of the equity-classified component that is presented in temporary equity (if any) is measured as the excess of (1) the amount of cash or other assets that would be required to be paid to the holder upon a redemption or conversion at the balance sheet date over (2) the carrying amount of the liability-classified component of the convertible debt instrument at the balance sheet date.FN15

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.

____________________

FN8 See Subtopics 470-20 and 470-50; and Paragraph 815-15-35-4.

FN15 ASR 268 does not impact the application of other applicable GAAP to the accounting for the liability component or the accounting upon derecognition of the liability and/or equity component.

A convertible debt instrument will contain a separately recognized component in common stockholders’ equity if the convertible debt:

Has been modified in a transaction that increased the fair value of the embedded conversion option but did not result in an extinguishment (see ASC 470-50-40-15).
Contains an embedded conversion option that has been reclassified from a derivative liability to equity (see ASC 815-15-35-4).
Was issued at a substantial premium (see ASC 470-20-25-13).

The Codification addresses the accounting for a settlement of a convertible debt instrument that contains a separately recognized component in common stockholders’ equity. While the classification and measurement provisions of ASC 480-10-S99-3A apply to convertible debt that contains a separately recognized component classified in common stockholders’ equity, the EPS guidance in ASC 480-10-S99-3A does not apply in such circumstances. Furthermore, ASC 260-10-S99-2 also does not apply to any settlement of a convertible debt instrument that contains a separately recognized component in common stockholders’ equity. This observation is consistent with footnote 18 of EITF Topic D-98, which states:

Topic D-42 also does not apply to convertible debt instruments that contain an embedded conversion option indexed to the issuer’s common stock because the application of Topic D-42 is limited to preferred stock instruments.

While this footnote was not codified, it continues to reflect the SEC staff’s view. Therefore, neither the EPS guidance in ASC 480-10-S99-3A nor the EPS guidance in ASC 260-10-S99-2 applies to any settlement of a convertible debt instrument that contains a separately recognized component in common stockholders’ equity. Rather, only the settlement guidance in other areas of the Codification should be applied (see Sections 6.2.2 and 6.3.2 for additional discussion). This view is premised on the SEC staff’s view that because ASC 260-10-S99-2 applies only to preferred stock instruments, it does not apply to equity-classified components that are indexed to an entity’s common stock.

Connecting the Dots

The view expressed above would also apply to a convertible instrument issued in the legal form of preferred stock that is classified as a liability under ASC 480-10-25-4 (i.e., a convertible preferred stock instrument for which the principal amount must be paid in cash and that gives the issuer the option of paying any excess conversion value in cash or stock).

3.2.5.2.4 Convertible Preferred Stock That Contains a Separated Equity Component Indexed to an Entity’s Common Stock

An entity may have outstanding convertible preferred stock (classified in temporary equity or permanent equity) containing a separated equity component recognized in common stockholders’ equity. As noted in the previous section, ASC 480-10-S99-3A(23) provides special EPS guidance on convertible debt that contains a separate equity component recognized in common stockholders’ equity. Footnote 17 of EITF Topic D-98 states the following regarding applying this special guidance by analogy:

The guidance provided in this paragraph for convertible debt instruments that contain an equity-classified component should not be applied by analogy to other equity instruments that are subject to ASR 268 and this SEC staff announcement.

We think that the SEC staff included the reference to “convertible debt instruments” in this footnote because it believed that EITF Topic D-42 (i.e., ASC 260-10-S99-2) does apply to certain types of settlements of a host preferred stock instrument when the convertible preferred stock contains a separate component recognized in common stockholders’ equity. However, we do not think that the staff believed that the settlement of the equity-classified component indexed to the entity’s common stock is within the scope of ASC 260-10-S99-2 because of its view, as originally expressed in footnote 18 of EITF Topic D-98, that only preferred stock instruments are within the scope of EITF Topic D-42. The table below describes the accounting guidance that applies to convertible preferred stock containing a separately recognized component classified in common stockholders’ equity. The following assumptions apply to the matters discussed in this table:

The embedded conversion option is indexed to the issuer’s common stock.
The embedded conversion option is not accounted for as a derivative liability.
The convertible preferred stock instrument is not classified as a liability.

The table does not comprehensively discuss the application of ASC 480-10-S99-3A, which may affect the accounting.

Table 3-7

Nature of Separately Recognized Equity Component	Accounting for Settlement
Modified embedded conversion option	As discussed in Section 3.2.6.1.1, an entity should generally account for a modification or exchange that affects the embedded conversion option in a convertible preferred stock instrument, and that does not result in an extinguishment, by recognizing any incremental fair value provided to the preferred stockholder(s) as a “deemed dividend” or an expense. However, given the lack of specificity in the accounting literature, an entity may determine that it is appropriate to recognize — as a separate component of common stockholders’ equity by analogy to ASC 470-50-40-15 — an increase in the fair value of the embedded conversion option arising from a modification or exchange affecting the embedded conversion option in a convertible preferred stock instrument. The accounting for a settlement of a convertible preferred stock instrument containing a separately recognized component in common stockholders’ equity that resulted from a modification or exchange that affected the embedded conversion option in a convertible preferred stock instrument depends on the nature of the settlement as follows: Conversion — Neither the Codification nor any SEC staff guidance addresses the accounting upon conversion of a convertible preferred stock instrument that contains a separately recognized component in common stockholders’ equity as a result of a previous modification or exchange affecting the embedded conversion option that did not result in extinguishment accounting. Given the similarities to the accounting for a conversion of a convertible preferred stock instrument that contains a separately recognized component in common stockholders’ equity as a result of a previous reclassification of the embedded conversion option from a liability to equity (discussed below), the same conversion accounting approach should be applied. Thus, any unamortized discount on the convertible preferred stock that remains on the conversion date should be immediately recognized and treated as a “deemed dividend” that reduces net income in arriving at income available to common stockholders. The adjusted carrying amount of the convertible preferred stock and the carrying amount of the equity component should then be recognized in stockholders’ equity to reflect the conversion. This final entry has no impact on income available to common stockholders. Redemption — In a settlement accounted for as a redemption, a portion of the fair value of the consideration transferred to the holder(s) should be allocated to the reacquisition of the separately recognized equity component. Although the Codification and SEC staff guidance do not specifically address the measurement of the portion allocated to the reacquisition of this equity component, an entity should allocate an amount equal to the value that was previously recognized for this separate equity component before it accounts for the redemption of the preferred stock instrument.14 That is, upon extinguishment, the issuer should allocate, to the reacquisition of the embedded conversion option, an amount equal to the value that was previously recognized for that separate equity component. The amount recognized for this component does not reflect a dividend under ASC 260-10-S99-2 and has no impact on income available to common stockholders. The remaining portion of the fair value of the total consideration transferred to redeem the convertible preferred stock instrument should be allocated to the reacquisition of the convertible preferred stock, and any difference between that amount and the carrying amount of the convertible preferred stock should be considered a “deemed dividend” (or “deemed contribution”) under ASC 260-10-S99-2 and an adjustment should be made to net income to arrive at income available to common stockholders for the amount of this dividend. Induced conversion — The accounting specified in ASC 260-10-S99-2 for an induced conversion of convertible preferred stock applies to the inducement component of the settlement. The additional value resulting from the inducement offer is treated as a “deemed dividend” under ASC 260-10-S99-2. Once this accounting has been reflected, the remaining consideration transferred to the holder(s) (i.e., the portion represented by the original conversion terms) is accounted for as a conversion in accordance with the conversion accounting approach described above. ASC 480-10-S99-3A applies to redeemable convertible preferred stock containing a separately recognized component in common stockholders’ equity that resulted from a modification or exchange that affected the embedded conversion option in a convertible preferred stock instrument. The classification of that separate equity component within equity (i.e., as temporary equity or permanent equity) when convertible preferred stock is a redeemable equity security is subject to an accounting policy election for which two views are acceptable: View A— An entity should remeasure the carrying amount of the convertible preferred stock to its current redemption amount (or in accordance with its policy elected under ASC 480-10-S99-3A(15) if the convertible preferred stock is not currently redeemable but it is probable that it will become redeemable) without regard to the amount recognized in permanent equity as a result of the modified or exchanged embedded conversion option (i.e., in making the adjustment under ASC 480-10-S99-3A to remeasure the convertible preferred stock to its redemption amount, an entity ignores the separately recognized equity component). View B — An entity considers the aggregate of the carrying amounts of the convertible preferred stock and the equity component separately recognized as a result of the modification or exchange of the embedded conversion option in determining the amount of any measurement adjustment required under ASC 480-10-S99-3A. While the amount reported in temporary equity for the modified or exchanged embedded conversion option is not subsequently adjusted, that amount will indirectly affect the amount of the ASC 480-10-S99-3A measurement adjustment that needs to be made to the carrying amount of the convertible preferred stock reported in temporary equity. Regardless of which view is applied, if the convertible preferred stock is being remeasured to its redemption amount in accordance with the subsequent-measurement guidance in ASC 480-10-S99-3A, the entity should follow its remeasurement policy under ASC 480-10-S99-3A and recognize the effects of such remeasurement, including the impact on EPS, immediately before accounting for any settlement. This “final” measurement adjustment may affect the carrying amount of the convertible preferred stock and thus the settlement accounting applied to the three settlement types discussed above.
Reclassified embedded conversion option (note that if the reclassification occurs as a result of a modification or exchange, the guidance in Section 3.2.6 applies)	ASC 815-15-35-4, which addresses the accounting for a reclassification of an embedded conversion option in a debt instrument from a liability to equity, states: If an embedded conversion option in a convertible debt instrument no longer meets the bifurcation criteria in this Subtopic, an issuer shall account for the previously bifurcated conversion option by reclassifying the carrying amount of the liability for the conversion option (that is, its fair value on the date of reclassification) to shareholders’ equity. Any debt discount recognized when the conversion option was bifurcated from the convertible debt instrument shall continue to be amortized. This approach should be applied when an embedded conversion option indexed to the entity’s common stock in a preferred stock instrument is reclassified from a derivative liability to equity. Therefore, the fair value of the embedded conversion option liability should be reclassified to stockholders’ equity and reported as a separate component of common stockholders’ equity. The fair value of the embedded conversion option liability should be adjusted, with any change recognized in earnings, immediately before the reclassification so that the reclassified amount reflects the fair value of the embedded conversion option on the reclassification date. The accounting for a settlement of a convertible preferred stock instrument that contains a separately recognized component in common stockholders’ equity that resulted from a reclassification of the embedded conversion option from a liability to equity depends on the nature of the settlement as follows: Conversion — In a manner consistent with the accounting guidance in ASC 815-15-40-1, any unamortized discount on the convertible preferred stock that remains on the conversion date should be immediately recognized as a dividend. The dividend resulting from this immediate recognition reduces net income in arriving at income available to common stockholders. The adjusted carrying amount of the convertible preferred stock and the carrying amount of the equity component for the previously reclassified conversion feature should then be recognized in stockholders’ equity to reflect the conversion. This final entry has no impact on income available to common stockholders. Redemption — In a settlement accounted for as a redemption, an entity should apply the accounting guidance in ASC 815-15-40-4, which pertains to a redemption of convertible debt with a separately classified component in common stockholders’ equity as a result of a prior reclassification of the embedded conversion option from a liability to equity.15 Accordingly, a portion of the reacquisition price equal to the fair value of the embedded conversion option on the redemption date should be allocated to the equity component. The amount recognized for this component does not reflect a dividend under ASC 260-10-S99-2 and has no impact on income available to common stockholders. The remaining portion of the fair value of the total consideration transferred to redeem the convertible preferred stock instrument is associated with the reacquisition of the convertible preferred stock, and any difference between that amount and the carrying amount of the convertible preferred stock should be considered a “deemed dividend” (or “deemed contribution”) under ASC 260-10-S99-2 and an adjustment should be made to net income to arrive at income available to common stockholders for the amount of this dividend. Induced conversion — The accounting specified in ASC 260-10-S99-2 for an induced conversion of convertible preferred stock applies to the inducement component of the settlement. The additional value resulting from the inducement offer is treated as a “deemed dividend” under ASC 260-10-S99-2. Once this accounting has been reflected, the remaining consideration transferred to the holder(s) (i.e., the portion represented by the original conversion terms) is accounted for as a conversion in accordance with the conversion accounting approach described above. ASC 480-10-S99-3A applies to redeemable convertible preferred stock containing a separately recognized component in common stockholders’ equity that resulted from a reclassification of the embedded conversion option from a liability to equity. The classification of that separate equity component within equity (i.e., as temporary equity or permanent equity) when convertible preferred stock is a redeemable equity security is subject to an accounting policy election consistent with the two views discussed above under “modified embedded conversion option.” Regardless of which view is applied, if the convertible preferred stock is being remeasured to its redemption amount in accordance with the subsequent-measurement guidance in ASC 480-10-S99-3A, the entity should follow its remeasurement policy under ASC 480-10-S99-3A and recognize the effects of such remeasurement, including the impact on EPS, immediately before accounting for any settlement. This “final” measurement adjustment may affect the carrying amount of the convertible preferred stock and thus the settlement accounting applied to the three settlement types discussed above.
Down-round feature has been triggered	As discussed in Section 3.2.2.5.1, an entity may recognize a dividend and an increase in APIC (i.e., common stockholders’ equity) as a result of a down-round feature that has been triggered in a convertible preferred stock instrument. The Codification does not specifically address the accounting for a settlement of a convertible preferred stock instrument containing a separately recognized component in common stockholders’ equity that resulted from the recognition of a down-round feature that has been triggered. However, the following accounting would be acceptable under GAAP: Conversion — The accounting that otherwise applies upon the conversion of preferred stock into common stock is not affected since the amount recognized for the down-round feature was previously recorded in APIC. The dividend recognized when the down-round feature was triggered should not be reversed. Redemption — In a settlement accounted for as a redemption, a portion of the fair value of the consideration transferred to the holder(s) should be allocated to the reacquisition of the separately recognized equity component (i.e., the amount previously recognized in APIC because the down-round feature was triggered). Although the Codification and SEC staff guidance do not specifically address the amount to be allocated to the reacquisition of this equity component, the amount initially recognized in APIC as a result of the triggering of the down-round feature should be allocated to the reacquisition of this equity component. The amount recognized for this component does not reflect a dividend under ASC 260-10-S99-2 and does not affect income available to common stockholders (however, the dividend recognized when the down-round feature was triggered should not be reversed). The remaining portion of the fair value of the total consideration transferred to redeem the convertible preferred stock instrument is associated with the reacquisition of the convertible preferred stock, and any difference between that amount and the carrying amount of the convertible preferred stock should be considered a “deemed dividend” (or “deemed contribution”) under ASC 260-10-S99-2. In such circumstances, net income should be adjusted to arrive at income available to common stockholders for the amount of this dividend. Induced conversion — The accounting specified in ASC 260-10-S99-2 for an induced conversion of convertible preferred stock applies to the inducement component of the settlement. The additional value resulting from the inducement offer is treated as a “deemed dividend” under ASC 260-10-S99-2. Once this accounting has been reflected, the remaining consideration transferred to the holder(s) (i.e., the portion represented by the original conversion terms) is accounted for as a conversion in accordance with the conversion accounting approach described above (i.e., no special accounting is required as a result of the amount previously recognized in APIC when the down-round feature was triggered). ASC 480-10-S99-3A applies to redeemable convertible preferred stock containing a separately recognized component in common stockholders’ equity that resulted from a down-round feature that had been previously triggered. On the basis of discussions with the staff in the SEC’s Office of the Chief Accountant (OCA), we understand that the SEC staff will object if an entity classifies the credit entry as APIC within temporary equity. Therefore, if the convertible preferred stock is subject to remeasurement under ASC 480-10-S99-3A, any remeasurement adjustments must be made without regard to the amount recognized in APIC (permanent equity) when the down-round feature was triggered. The SEC staff indicated that SEC registrants must apply this view even though such application may result in “double-counting” the effect on EPS for a convertible preferred share that is being remeasured to its redemption amount for which a down-round feature has been triggered. In addition, we have confirmed with the OCA staff that this view applies only to convertible preferred stock arrangements that are subject to the down-round guidance in ASC 260 -10. Therefore, we believe that it is still acceptable to apply either of the two alternative views discussed above on the classification of the separately recognized equity component in a redeemable convertible preferred share that contains a modified embedded conversion option or an equity component from reclassification of the conversion option. If the convertible preferred stock is being remeasured to its redemption amount in accordance with the subsequent-measurement guidance in ASC 480-10-S99-3A, the entity should follow its remeasurement policy under ASC 480-10-S99-3A and recognize the effects of such remeasurement, including the impact on EPS, immediately before accounting for any settlement. This “final” measurement adjustment may affect the carrying amount of the convertible preferred stock and thus the settlement accounting applied to the three settlement types discussed above.

3.2.5.2.5 Convertible Preferred Stock That Contains a Separated Equity Component Indexed to the Entity’s Preferred Stock

It is unusual to encounter a convertible preferred stock instrument with an embedded conversion option that is indexed to a different class of preferred stock and a separately recognized equity-classified component. However, this situation could exist if an entity reclassified an embedded conversion option indexed to a class of preferred stock from a liability to equity after this feature was bifurcated from a host preferred stock instrument. If this situation does exist, the separately classified equity component must be classified outside of common stockholders’ equity since the embedded conversion option is indexed to the issuer’s preferred stock. The accounting for a settlement of such an instrument depends on the nature of the settlement as follows:

Conversion — In accounting for a conversion, an entity should use the conversion accounting approach specified in Table 3-7. That is, any remaining discount on the convertible preferred stock should be immediately amortized and treated as a “deemed dividend” that reduces net income in arriving at income available to common stockholders.
Redemption — In a redemption, ASC 260-10-S99-2 applies to both the convertible preferred stock instrument and the separated equity component. Thus, the difference between the fair value of the total consideration transferred to redeem the convertible preferred stock over the aggregate carrying amounts of the convertible preferred stock and separately recognized equity component should be treated as a “deemed dividend” (or “deemed contribution”) that results in an adjustment to net income in arriving at income available to common stockholders.
Induced conversion — An induced conversion should be accounted for in a manner consistent with the approach specified in Table 3-7. That is, an entity should employ a two-step approach under which it first applies ASC 260-10-S99-2 to capture the additional value provided by the inducement offer and then applies the accounting specified for a conversion in accordance with the stated conversion privileges.

In line with the discussion in Table 3-7, ASC 480-10-S99-3A applies to convertible preferred stock that contains a separately recognized equity component indexed to an entity’s preferred stock. This separate equity component would generally be classified in temporary equity if the convertible preferred stock is a redeemable equity security subject to ASC 480-10-S99-3A. If the convertible preferred stock is being remeasured to its redemption amount in accordance with the subsequent-measurement guidance in ASC 480-10-S99-3A, the entity should follow its remeasurement policy under ASC 480-10-S99-3A and recognize the effects of such remeasurement, including the impact on EPS, before applying settlement accounting.

3.2.5.3 Down-Round Features in Freestanding Financial Instruments

ASC 260-10

05-1A An entity may issue a freestanding financial instrument (for example, a warrant) with a down round feature that is classified in equity. This Subtopic provides guidance on earnings per share and recognition and measurement of the effect of a down round feature when it is triggered.

Financial Instruments That Include a Down Round Feature

The fair value of the financial instrument (without the down round feature) with a strike price corresponding to the currently stated strike price of the issued instrument (that is, before the strike price reduction)
The fair value of the financial instrument (without the down round feature) with a strike price corresponding to the reduced strike price upon the down round feature being triggered.

Financial Instruments That Include a Down Round Feature

Freestanding Equity-Classified Financial Instrument With a Down Round Feature

Example 16: Equity-Classified Freestanding Financial Instruments That Include a Down Round Feature

55-95 Assume Entity A issues warrants that permit the holder to buy 100 shares of its common stock for $10 per share and that Entity A presents EPS in accordance with the guidance in this Topic. The warrants have a 10-year term, are exercisable at any time, and contain a down round feature. The warrants are classified as equity by Entity A because they are indexed to the entity’s own stock and meet the additional conditions necessary for equity classification in accordance with the guidance in Subtopic 815-40 on derivatives and hedging — contracts in entity’s own equity (see paragraphs 815-40-55-33 through 55-34A for an illustration of the guidance in Subtopic 815-40 applied to a warrant with a down round feature). Because the warrants are an equity-classified freestanding financial instrument, they are within the scope of the recognition and measurement guidance in this Topic. The terms of the down round feature specify that if Entity A issues additional shares of its common stock for an amount less than $10 per share or issues an equity-classified financial instrument with a strike price below $10 per share, the strike price of the warrants would be reduced to the most recent issuance price or strike price, but the terms of the down round feature are such that the strike price cannot be reduced below $8 per share. After issuing the warrants, Entity A issues shares of its common stock at $7 per share. Because of the subsequent round of financing occurring at a share price below the strike price of the warrants, the down round feature in the warrants is triggered and the strike price of the warrants is reduced to $8 per share.

55-96 In accordance with the measurement guidance in paragraphs 260-10-30-1 through 30-2, Entity A determines that the fair value of the warrants (without the down round feature) with a strike price of $10 per share immediately after the down round feature is triggered is $600 and that the fair value of the warrants (without the down round feature) with a strike price of $8 per share immediately after the down round feature is triggered is $750. The increase in the value of $150 is the value of the effect of the triggering of the down round feature.

55-97 The $150 increase is the value of the effect of the down round feature to be recognized in equity in accordance with paragraph 260-10-25-1, as follows:

Additionally, Entity A reduces income available to common stockholders in its basic EPS calculation by $150 in accordance with the guidance in paragraph 260-10-45-12B. Entity A applies the treasury stock method in accordance with paragraphs 260-10-45-23 through 45-27 to calculate diluted EPS. Accordingly, the $150 is added back to income available to common stockholders when calculating diluted EPS. However, the treasury stock method would not be applied if the effect were to be antidilutive.

For equity-classified freestanding financial instruments that contain a down-round feature (including equity-classified convertible preferred stock, as discussed in Section 3.2.2.5.1), an adjustment to income available to common stockholders is required when the down-round feature is triggered. That adjustment is calculated in accordance with ASC 260-10-30-1. No such adjustment is required when a down-round feature in a convertible debt instrument is triggered.

For equity-linked freestanding financial instruments that are classified as a liability (e.g., the instrument does not meet the indexation conditions in ASC 815-40 for reasons other than the down-round feature), the EPS adjustment discussed in ASC 260-10-30-1, as well as the related recognition in equity of the effect of the triggered down-round feature, is not required. Rather, the mark-to-market adjustment that must be recognized in earnings for such liability-classified instruments will reflect the impact of the down-round feature.

3.2.6 Modifications and Exchanges of Equity Instruments

3.2.6.1 Modification or Exchange of Preferred Stock

Modifications or exchanges of preferred stock instruments must be evaluated to determine whether the changes reflect an extinguishment of preferred stock that must be accounted for under ASC 260-10-S99-2. The Codification does not specifically address how to perform this evaluation. However, in his remarks before the 2014 AICPA Conference on Current SEC and PCAOB Developments, Kirk Crews, then a professional accounting fellow in the SEC’s Office of the Chief Accountant, noted that registrants may use one of the following approaches in determining whether an amendment to, or exchange of, an equity-classified preferred stock instrument constitutes a modification or extinguishment:

Qualitative approach — An entity would consider the significance of additions, removals, and changes to existing contractual terms. In addition, the entity would “evaluate the business purpose for the changes and how the changes may influence the economic decisions of the investor.” If the entity determines that the changes are significant, it would treat the amendments or exchange as an extinguishment; otherwise, it would treat the changes as a modification to the preferred stock.
Fair value approach — An entity would compare the fair value of the preferred stock after the amendment or exchange with the fair value of the preferred stock immediately before the amendment or exchange to determine whether the preferred stock is substantially different. If there is a 10 percent or greater change in the fair value of the preferred stock, the entity would consider the preferred stock to be substantially different and account for the amendment or exchange as an extinguishment. If, however, the change is less than 10 percent, a preferred stock modification has occurred.
Cash flow approach — An entity would compare the contractual cash flows of the preferred stock after the amendment or exchange with the contractual cash flows of the preferred stock immediately before the amendment or exchange to determine whether the preferred stock is substantially different. As it would under the fair value approach, the entity would consider a change of 10 percent or greater to be substantially different and would account for the amendment or exchange as an extinguishment. A change of less than 10 percent would be considered a modification. See ASC 470-50-40 for guidance on how to perform the 10 percent cash flow test.

Mr. Crews indicated that the qualitative approach is the “most common approach” observed by the SEC staff.

Connecting the Dots

The cash flow approach is not appropriate unless the preferred stock contains a redemption feature. Without a redemption feature, there are no contractual cash flows to evaluate in a preferred stock instrument.

In addition, Mr. Crews noted that some registrants may be using the legal form approach to determine whether an amendment to, or exchange of, an equity-classified preferred stock constitutes a modification or an extinguishment. Under the legal form approach, an exchange that results in the issuance of new preferred stock would be accounted for as an extinguishment of the exchanged preferred stock. Mr. Crews cautioned registrants that the legal form is merely one factor in the evaluation of whether an amendment or exchange should be accounted for as a modification or an extinguishment and emphasized that the form of the change in and of itself should not be determinative of the accounting outcome.

Connecting the Dots

The three approaches described above are generally not applied to a modification or exchange of preferred stock that is akin to a troubled debt restructuring, since such a modification or exchange is generally not treated as an extinguishment.

Mr. Crews suggested that if a registrant determines that an amendment to, or exchange of, equity-classified preferred stock is a modification, it would be appropriate for the entity to analogize to the modification guidance in ASC 718-20 on modifications to equity-classified share-based payment awards. If the fair value of the instrument after the modification exceeds its fair value before the modification, the entity should recognize the incremental fair value to reflect the modification. Mr. Crews indicated that the SEC staff would not object to an entity’s recognition of the additional fair value in retained earnings as a deemed dividend from the entity to the preferred stockholders. (This means that in calculating EPS, an entity would deduct the incremental fair value from net income in determining income available to common stockholders.) Mr. Crews suggested that in certain unique circumstances, it may be appropriate to recognize the additional fair value as an expense (e.g., if facts and circumstances indicate that it reflects compensation for agreeing to restructure the preferred stock). He noted that the appropriate method for recognizing the additional fair value would depend on “the underlying purpose for and circumstances surrounding the modification.”

Connecting the Dots

The incremental fair value in a modification or exchange of preferred stock that is not considered an extinguishment is generally treated either as a “deemed dividend” that reduces net income in arriving at income available to common stockholders or as an expense that reduces income available to common stockholders through a reduction of net income. Although uncommon, there may be circumstances in which a modification or exchange of preferred stock reflects a transaction that only affects preferred stockholders. If an entity can conclude that a modification or exchange solely reflects a reallocation of shareholder value between preferred shareholder groups, it may be appropriate not to reflect the incremental value provided to one preferred shareholder group since the incremental loss to the corresponding preferred shareholder group is also not recognized. However, if there is any impact on common shareholders, an entity must apply the guidance discussed by the SEC staff to reflect the impact of the incremental fair value provided to preferred stockholders as a result of the modification or exchange of preferred stock.

It is not appropriate to account for a transfer of wealth from a preferred stock investor to common shareholders as an increase to net income in arriving at income available to common stockholders. That is, only increases in fair value of preferred stock instruments are recognized in a modification or exchange of preferred stock (i.e., reductions in fair value are not recognized).

Mr. Crews did not discuss the accounting for fees and costs paid to investors in a modification or exchange of preferred stock that is not treated as an extinguishment. However, these fees and costs should be recognized as charges to retained earnings or net income in a manner consistent with the recognition of the incremental fair value resulting from the modification or exchange. Accordingly, such fees and costs will also reduce income available to common stockholders.

Mr. Crews did not discuss modifications or exchanges that are accounted for as an extinguishment. ASC 260-10-S99-2 provides guidance on the EPS impact of extinguishments (redemptions) of equity-classified preferred stock. Under that guidance, an SEC registrant compares (1) the fair value of the consideration transferred to the holders of the preferred stock (i.e., the fair value of the preferred stock immediately after the modification or exchange along with any other consideration transferred) and (2) the net carrying amount of the preferred stock immediately before the modification or exchange (net of issuance costs). The difference is treated as a return to (or from) the holder of the preferred stock in a manner similar to dividends paid on preferred stock (i.e., the difference is deducted from net income to arrive at income available to common stockholders under ASC 260-10-45-11).

Connecting the Dots

Under ASC 260-10-S99-2, the fair value of the consideration transferred to redeem a preferred stock instrument is presumed to reflect 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.

Below are some examples illustrating modifications and exchanges of preferred stock. As noted above, when the modification or exchange is treated as an extinguishment, ASC 260-10-S99-2 applies.

Example 3-25

Modification to Add Mandatory Redemption Feature

Company A adds a mandatory redemption feature to its redeemable preferred stock. Because the modification results in a requirement to reclassify the modified instrument from equity to a liability, A concludes that the preferred stock has been extinguished since an extinguishment has occurred any time a preferred stock instrument is (1) modified and becomes a liability-classified instrument or (2) exchanged for an instrument that is classified as a liability.

Example 3-26

Exchange of Preferred Stock for Common Stock

Company D exchanges its outstanding preferred stock for common stock. This type of exchange would always be treated as an extinguishment.

ASC 260-10-S99-2 does not apply when a debt instrument is exchanged for a preferred stock instrument. In accordance with ASC 470-50-40-3, this type of transaction must be treated as an extinguishment of debt, with a gain or loss recognized in earnings (unless the transaction reflects a troubled debt restructuring subject to ASC 470-60).

3.2.6.1.1 Modification or Exchange of Convertible Preferred Stock

An entity may modify the terms of the embedded conversion option in a convertible preferred stock instrument or achieve the same results by exchanging convertible preferred stock instruments. An entity may also add or eliminate a substantive conversion option in a preferred stock instrument through a modification or exchange. These types of transactions must be assessed to determine whether they should be treated as an extinguishment.

When a modification or exchange of preferred stock results in the addition of a conversion option that (1) is substantive as of the date of the modification or exchange or (2) results in the elimination of a conversion option that was substantive as of the date of the modification or exchange, the changes to the terms of the preferred stock are qualitatively significant. In these circumstances, application of the qualitative approach discussed by the SEC staff (see Section 3.2.6.1) is appropriate and the modification or exchange is treated as an extinguishment of the existing preferred stock instrument. Application of the fair value approach to a modification or exchange of preferred stock that results in the addition or elimination of a substantive conversion option is generally inappropriate. Application of the cash flow approach to a modification or exchange of preferred stock that results in the addition or elimination of a substantive conversion option is never appropriate because this approach will not reflect any of the value attributable to the impact of the modification or exchange on the conversion feature.

When a modification or exchange of preferred stock affects the embedded conversion option in convertible preferred stock (i.e., the preferred stock contains a substantive conversion feature before and after the modification or exchange), an entity will often choose to apply the fair value approach discussed by the SEC staff (see Section 3.2.6.1). When the modification or exchange affects both the embedded conversion option and the host preferred stock contract, the entity must apply the fair value approach, as explained by Mr. Crews in his speech (see Section 3.2.6.1). That is, under the fair value approach, the fair value of the entire preferred stock instrument is compared on a before-and-after basis to determine whether there is a 10 percent or greater change in the fair value of the entire preferred stock instrument. However, if the overall change in the fair value of the entire preferred stock instrument is less than 10 percent or the modification or exchange is determined to only affect the fair value of the embedded conversion feature, an entity could consider either of the following approaches:

An approach consistent with the approach specified for convertible debt instruments in ASC 470-50-40-10. Under ASC 470-50-40-10, “A modification or an exchange [that] affects the terms of an embedded conversion option, from which the change in the fair value of the embedded conversion option (calculated as the difference between the fair value of the embedded conversion option immediately before and after the modification or exchange) is at least 10 percent of the carrying amount of the original debt instrument immediately before the modification or exchange” is accounted for as an extinguishment. Under this approach, the change in the fair value of the embedded conversion feature arising from the modification or exchange is compared with the carrying amount of the convertible preferred stock instrument.
An approach that focuses on whether the change to the fair value of the conversion option is 10 percent or more, which is similar to the approach described in the SEC staff speech. Under this approach, the fair value of the embedded conversion option immediately before the modification or exchange is compared with the fair value of the embedded conversion option immediately after the modification or exchange.

Because the SEC staff speech and Codification do not specifically address how to evaluate the impact of a modification or exchange of convertible preferred stock that affects the terms of the embedded conversion option, an entity may consider using either or both of these two approaches. However, in a manner consistent with the two-step approach outlined in ASC 470-50 for modifications or exchanges of convertible debt instruments (i.e., a 10 percent cash flow test followed by a fair value test that focuses only on the impact of the modification or exchange on the embedded conversion feature), in any modification or exchange of convertible preferred stock, the evaluation should first focus on the impact of the modification or exchange on the overall hybrid convertible preferred stock instrument; if that analysis does not result in extinguishment accounting, a supplemental analysis should be performed that focuses only on how the modification or exchange affects the terms of the embedded conversion option. The approaches applied in these analyses could be the same (i.e., the fair value approach for both analyses) or different (i.e., qualitative approach for the overall hybrid convertible preferred stock instrument and one or more fair value analyses for the effect on the embedded conversion option). Ultimately, an entity must use judgment and consider all relevant facts and circumstances in determining whether the modification or exchange reflects an extinguishment of the convertible preferred stock instrument. In performing these analyses, the entity should generally apply a consistent approach for similar types of modifications or exchanges.

If, after evaluating a modification or exchange that involves the embedded conversion option in convertible preferred stock, an entity concludes that an extinguishment has not occurred, the entity must determine the appropriate accounting for the modification or exchange. ASC 470-50-40-15, which addresses modifications or exchanges that affect the conversion option embedded in a debt instrument, states:

If a convertible debt instrument is modified or exchanged in a transaction that is not accounted for as an extinguishment, an increase in the fair value of the embedded conversion option (calculated as the difference between the fair value of the embedded conversion option immediately before and after the modification or exchange) shall reduce the carrying amount of the debt instrument (increasing a debt discount or reducing a debt premium) with a corresponding increase in additional paid-in capital. However, a decrease in the fair value of an embedded conversion option resulting from a modification or an exchange shall not be recognized.

This guidance only specifically addresses the accounting for modifications or exchanges that affect an embedded conversion option in a debt instrument. There is no guidance on accounting for a modification or exchange involving an embedded conversion option in a convertible preferred stock instrument that is not accounted for as an extinguishment. The SEC staff speech does, however, discuss modifications and exchanges of preferred stock that are not treated as extinguishments. As noted in Section 3.2.6.1, any incremental fair value provided to the preferred stockholders as a result of the modification or exchange is treated as either a “deemed dividend” or an expense. Considering this guidance, along with the fact that modifications or exchanges of convertible preferred stock that affect the terms of an embedded conversion option generally have an impact on the fair value of the overall hybrid contract that is different from the change in fair value of just the embedded conversion option, it is most appropriate for the entity to calculate the incremental fair value, if any, arising from the modification or exchange by comparing the fair value of the entire convertible preferred stock instrument before and after the modification or exchange. Any incremental fair value would be treated as a “deemed dividend” (or potentially as an expense, as discussed in the SEC staff speech), and the entity would generally not recognize a separate equity component in common stockholders’ equity as it would if the modification or exchange involved a convertible debt instrument. This approach is appropriate given its consistency with the accounting for other types of modifications or exchanges of preferred stock that are not accounted for as an extinguishment (see Section 3.2.6.1).

When a “deemed dividend” is recognized as a result of the incremental fair value of a convertible preferred stock instrument that results from a modification or exchange that involves the embedded conversion option, the amount of the dividend is accounted for as a reduction of net income in arriving at income available to common stockholders and increases the carrying amount of the convertible preferred stock. If the convertible preferred stock is classified in temporary equity and is being remeasured to its redemption amount under ASC 480-10-S99-3A, the adjustment from the modification is generally considered part of the “initial amount” referred to in ASC 480-10-S99-3A(16)(e). That is, any reductions in the carrying amount of the redeemable equity instrument as a result of the application of the remeasurement guidance in ASC 480-10-S99-3A would be appropriate only to the extent that the entity has previously recorded increases in the carrying amount of the redeemable equity instrument as a result of the application of the remeasurement guidance in ASC 480-10-S99-3A.

Below are two examples illustrating the accounting for modifications or exchanges of convertible preferred stock.

Example 3-27

Exchange of Convertible Preferred Stock for Nonconvertible Preferred Stock

Company B exchanges its 5 percent cumulative convertible preferred stock for 10 percent nonconvertible preferred stock. The conversion option in the convertible preferred stock instrument was a substantive conversion option on the date of the exchange. The exchange is treated as an extinguishment because the changes to the terms of the preferred stock include the elimination of a substantive conversion option.

Example 3-28

Modification of Conversion Price of Convertible Preferred Stock

Company C modifies its outstanding 6 percent convertible preferred stock by increasing the conversion price and extending the period over which the investors can convert the preferred stock into common stock. This extension of the period over which the investors can convert the preferred stock into common stock has an impact on the host preferred stock contract because the stated dividend rate does not reflect a market rate as of the date of the modification.

To determine whether this modification reflects an extinguishment of the convertible preferred stock, C applies the following fair-value-based approach:

Step 1 — Company C first evaluates whether the modification results in a significant change in the fair value of the entire convertible preferred stock instrument and concludes that the change in the fair value of this instrument (calculated on the basis of the fair value of the convertible preferred stock instrument immediately before and immediately after the modification) is less than 10 percent; C therefore proceeds to the next step.
Step 2 — Company C evaluates whether the modification results in a significant change in the fair value of the embedded conversion option in the convertible preferred stock instrument and concludes that the change in the fair value of this option (calculated on the basis of the fair value of the embedded conversion option immediately before and immediately after the modification) exceeds 10 percent. As a result, C concludes that the modification should be accounted for as an extinguishment.

In reaching a conclusion about whether a modification such as the one discussed in this example reflects an extinguishment, an entity must use judgment and consider all relevant facts and circumstances. While C has applied only a fair value approach, it is important for an entity to also take qualitative considerations into account. That being said, similar facts and circumstances should result in similar conclusions (i.e., it would not be appropriate to “switch” approaches over time to reach different conclusions regarding whether a modification to convertible preferred stock represents an extinguishment).

3.2.6.2 Modification or Exchange of Common Stock

Modifications and exchanges of common stock are less common than modifications and exchanges of preferred stock. Moreover, the treatment of a modification or exchange of common stock differs from that for preferred stock. As discussed in Section 3.2.4.3, there is no impact on income available to common stockholders upon a redemption of common stock unless the fair value of the consideration transferred exceeds the fair value of the common shares redeemed. Therefore, modifications or exchanges involving common stock do not need to be evaluated for extinguishment accounting. Rather, the focus is on whether the modification or exchange results in the transfer of additional fair value to the holder(s).

When an entity modifies or exchanges common stock and the resulting impact is an increase in fair value, that increase must be treated as either a “deemed dividend” or an expense. The appropriate treatment is determined in a manner similar to the consideration of the appropriate treatment of redemptions of common stock and modifications and exchanges of preferred stock (see Sections 3.2.4.3 and 3.2.6.1, respectively). If a modification or exchange is accounted for as a “deemed dividend” to the holder(s), the impact of this dividend is reflected in the calculation of basic EPS in a manner similar to the application of the two-class method of calculating EPS. Specifically, if the entity has multiple classes of common stock and modifies an entire class, the incremental fair value will be treated as a dividend (i.e., actual distribution) to the modified class, which will reduce the amount of income available to common stockholders for the class of common stock that was not modified. If the entity only has a single class of common stock, it must consider whether the modification results in multiple classes of common stock to which the two-class method should be applied to appropriately reflect the impact of the “deemed dividend.”

3.2.6.3 Modification or Exchange of Share-Based Payment Awards

Under ASC 718, modifications to share-based payment awards that result in an increase in fair value of the award must be accounted for as compensation cost, either immediately or over the remaining vesting period, depending on the facts and circumstances. There is no evaluation of whether the modification or exchange results in an extinguishment of the original award. Furthermore, an entity does not need to make any incremental adjustments to net income to arrive at income available to common stockholders. Any effect of the modification is included in net income. For further discussion of the accounting for modifications of share-based payment awards, see Chapter 6 of Deloitte’s Roadmap Share-Based Payment Awards.

Connecting the Dots

A modification to any award originally issued in a share-based payment arrangement is always accounted for under ASC 718, even if the modification occurs after the holder is no longer an employee (or a nonemployee service provider) and causes the instrument to subsequently become subject to the accounting guidance on financial instruments. For more information, see Chapter 6 of Deloitte’s Roadmap Share-Based Payment Awards.

3.2.6.4 Modification or Exchange of Other Potential Common Stock

The table below outlines the accounting that is generally applied to modifications and exchanges involving other potential common stock instruments that do not represent share-based payment arrangements.

Table 3-8

Instrument Type	Evaluate for Extinguishment Accounting?	Accounting for Modification or Exchange
Convertible debt	Yes	A modification or exchange of convertible debt is accounted for in accordance with ASC 470-50. Whether such a modification or exchange is accounted for as a modification or as an extinguishment, an entity is not required to make any incremental adjustment to net income to arrive at income available to common stockholders. Any effect of the modification or exchange is included in net income. See Chapter 6 for further discussion of the calculation of basic EPS for convertible debt instruments.
Freestanding financial instrument indexed to common stock (e.g., an option or forward to purchase common stock) — classified as an asset or liability	No	A freestanding financial instrument indexed to an entity’s common stock that is classified as an asset or liability will be recognized at fair value, with changes in fair value recognized in earnings. A modification or exchange of such an instrument will be reflected through the change in fair value of the instrument that is recognized in net income.
Freestanding financial instrument indexed to common stock (e.g., an option or forward to purchase common stock) — classified in equity	No	The Codification addresses an issuer’s accounting for a modification or exchange of a freestanding equity-classified written call option that remains equity-classified after the modification or exchange. ASC 260-10-45-15 states: For a modification or an exchange of a freestanding equity-classified written call option described in paragraph 815-40-35-17(d), an entity shall deduct the effect of the modification or exchange (as measured in accordance with paragraph 815-40-35-16) in computing income available to common stockholders when the modification or exchange is executed by the issuer and the holder or unilaterally by the issuer (see paragraph 815-40-15-7H). Under ASC 815-40 a modification or exchange of a freestanding equity-classified written call option that remains equity-classified after the modification or exchange would be accounted for by recognizing “the excess, if any, of the fair value of the modified or exchanged instrument over the fair value of that instrument immediately before it is modified or exchanged. . . . on the basis of the substance of the transaction, in the same manner as if cash had been paid as consideration.” Accordingly, an entity accounts for any incremental fair value provided to the counterparty in a modification or exchange of an equity-classified written call option. This incremental fair value provided to the counterparty would be accounted for as a dividend, expense, or component of a debt modification, or such accounting would otherwise depend on the facts and circumstances (see ASC 815-40-35-17). The Codification does not specifically address the accounting for a modification or exchange of an equity-classified freestanding financial instrument indexed to an entity’s common stock that is not a written call option. ASC 260-10-S99-2 does not apply to freestanding financial instruments indexed to common stock. Rather, it is generally appropriate to apply ASC 718-20-35-3 by analogy and account for any increase in fair value as a “deemed dividend” that reduces net income in arriving at income available to common stockholders (or that is treated as a distribution if the contract is a participating security). However, in some cases, the increase in fair value may need to be accounted for as an expense or in another manner. For considerations related to whether such an amount should be recognized as a “deemed dividend” or as an expense, see Sections 3.2.4.3 and 3.2.6.1, respectively. For more information about modifications or exchanges of freestanding equity-linked instruments, see Sections 6.1.4 and 6.2.4 of Deloitte’s Roadmap Contracts on an Entity’s Own Equity.
Freestanding financial instrument indexed to preferred stock (e.g., an option or forward to purchase preferred stock or convertible preferred stock) — classified as an asset or liability	No	A freestanding financial instrument indexed to an entity’s preferred stock that is classified as an asset or liability will be recognized at fair value, with changes in fair value recognized in earnings. A modification or exchange of such an instrument will be reflected through the change in fair value of the instrument that is recognized in net income.
Freestanding financial instrument indexed to preferred stock (e.g., an option or forward to purchase preferred stock or convertible preferred stock) — classified in equity	Yes	A modification or exchange of a freestanding financial instrument indexed to an entity’s preferred stock that is classified in stockholders’ equity is accounted for in the same manner as a modification or exchange of preferred stock. Therefore, a modification or exchange of such an instrument is first evaluated to determine whether it represents an extinguishment. See Section 3.2.6.1 for guidance on determining whether a modification or exchange of preferred stock is accounted for as an extinguishment. If the modification or exchange is treated as an extinguishment, the difference between the fair value of the “new” instrument and the net carrying amount of the instrument that was modified or exchanged is reflected as an adjustment to net income in arriving at income available to common stockholders in accordance with ASC 260-10-S99-2. If the modification or exchange is not accounted for as an extinguishment, any incremental fair value resulting from the modification or exchange is accounted for as either a “deemed dividend” or an expense. See Section 3.2.6.1 for further discussion of the accounting for a modification of preferred stock.

Connecting the Dots

An equity-classified instrument originally issued in a share-based payment arrangement becomes subject to the accounting literature applicable to financial instruments when it was issued to (1) an employee in exchange for services and its terms are modified when the holder is no longer an employee, (2) a nonemployee in exchange for goods or services and its terms are modified after the nonemployee vests in the award and is no longer providing goods or services, or (3) a grantee that is no longer a customer and its terms are modified after the grantee vests in the award and both of the following conditions are not met: (a) there is no increase in fair value of the award (or the ratio of intrinsic value to the exercise price of the award is preserved — that is, the holder is made whole) or the antidilution provision is not added to the terms of the award in contemplation of an equity restructuring and (b) all holders of the same class of equity instruments (e.g., stock options) are treated in the same manner (see ASC 718-10-35-10).

3.2.6.5 Reclassification of Other Potential Common Stock

The table below describes whether ASC 260-10-S99-2 applies when an embedded conversion option indexed to the reporting entity’s stock is reclassified between an equity instrument and a derivative liability for reasons other than a modification or exchange involving the instrument.

Table 3-9

Instrument Type	Underlying	Reclassification	Whether ASC 260-10-S99-2 Applies as of the Reclassification Date
Convertible debt	Indexed to common stock	From: One liability instrument To: Debt host contract and conversion option derivative liability	No. ASC 815-15 applies to the separation of the embedded conversion option as a derivative liability. ASC 260-10-S99-2 does not apply to the separation of the embedded conversion option. See Chapter 6 for further discussion of the calculation of basic EPS for convertible debt instruments.
		From: Debt host contract and conversion option derivative liability To: Debt host contract and equity component	No. Footnote 18 of EITF Topic D-98 states that “Topic D-42 [which was codified in ASC 260-10-S99-2] also does not apply to convertible debt instruments that contain an embedded conversion option indexed to the issuer’s common stock because the application of EITF Topic D-42 is limited to preferred stock instruments.” Therefore, ASC 260-10-S99-2 does not apply to the reclassification of the embedded conversion option from a separated derivative liability to an equity component. However, ASC 480-10- S99-3A(12)(d) and 3A(16)(d) would apply to the equity component after the reclassification if it is currently redeemable for cash or other assets. See Chapter 6 for further discussion of the calculation of basic EPS for convertible debt instruments.
		From: Debt host component and equity component To: Debt host contract and conversion option derivative liability	No. As indicated in ASC 480-10-S99-3A(23), “there should be no incremental earnings per share accounting from the application of this SEC staff announcement” to convertible debt that contains a separated equity component that is indexed to the issuer’s common stock. Furthermore, footnote 18 of EITF Topic D-98 states that “Topic D-42 [which was codified in ASC 260-10-S99-2] also does not apply to convertible debt instruments that contain an embedded conversion option indexed to the issuer’s common stock because the application of Topic D-42 is limited to preferred stock instruments.” Therefore, ASC 260-10-S99-2 does not apply to this reclassification. While ASC 480-10-S99-3A(12)(d) and 3A(16)(d) would have applied to the equity component in periods before the reclassification if it was currently redeemable for cash or other assets, that guidance would no longer apply after the reclassification since there is no longer any equity component reported for the instrument. See Chapter 6 for further discussion of the calculation of basic EPS for convertible debt instruments.
Convertible preferred stock	Indexed to common stock	From: Debt host component and equity component (i.e., the principal amount of the convertible preferred stock must be settled in cash) To: Debt host contract and conversion option derivative liability	No. Although preferred stock in legal form, since the instrument is classified as a liability, the accounting is the same as the accounting for the reclassification of the equity component of convertible debt that contains a separated equity component to a derivative liability. See Chapter 6 for further discussion of the calculation of basic EPS for convertible debt instruments.
		From: One preferred equity instrument To: Preferred equity host contract and conversion option derivative liability	No. ASC 260-10-S99-2 may seem to apply because, before the separation of the embedded conversion option, the instrument represented preferred stock classified in equity (either permanent or temporary equity) and the separation of the embedded derivative is akin to the transaction discussed in the scope section of ASC 260-10-S99-2 (i.e., when an equity-classified security must be subsequently reclassified as a liability). However, because the entry recognized under ASC 815-15 to separate the conversion option liability is a debit to preferred stock and a credit to a derivative liability at the fair value of the derivative, the application of ASC 260-10-S99-2 would have no impact on the date of separation. The separation could, however, affect the subsequent accounting for the convertible preferred stock instrument under ASC 260-10-S99-2 and ASC 480-10-S99-3A. If the convertible preferred stock is classified in temporary equity and is being remeasured to its redemption amount, the entity should perform one last remeasurement under ASC 480-10-S99-3A immediately before separating the conversion option liability. ASC 480-10-S99-3A would continue to apply to the preferred stock host contract if it was redeemable for cash or other assets. See Sections 3.2.2.5.4.1, 3.2.2.6.2.1.1, and 3.2.2.6.3.1 for discussion of the accounting for the settlement of the instrument.
		From: Preferred equity host contract and equity component classified in common stockholders’ equity To: Preferred equity host contract and conversion option derivative liability	No. Since the equity component is indexed to common stock, the reclassification to a liability is not subject to ASC 260-10-S99-2 because that guidance applies only to preferred stock (as discussed in footnote 18 of EITF Topic D-98). After the reclassification, ASC 480-10-S99-3A may continue to apply to the preferred stock host contract. ASC 480-10-S99-3A may have also been applicable before this reclassification. See Sections 3.2.2.5.4.1, 3.2.2.6.2.1.1, and 3.2.2.6.3.1 for discussion of the accounting for the settlement of the instrument. Note that this type of reclassification would not be common in practice.
		From: Preferred equity host contract and conversion option derivative liability To: Preferred equity host contract and equity component classified in common stockholders’ equity	No. By analogy to ASC 815-15-35-4, the embedded conversion option should be reclassified from a derivative liability to common stockholders’ equity. ASC 260-10-S99-2 does not apply to this reclassification because that guidance does not apply to (1) a conversion option that is indexed to common stock or (2) a reclassification of a liability to an equity instrument, which is not considered a redemption of preferred stock. However, ASC 480-10-S99-3A would apply after the reclassification if the convertible preferred stock is redeemable for cash or other assets. ASC 480-10-S99-3A may have also been applicable before this reclassification. See Section 3.2.5.2.4 for discussion of the accounting for the settlement of the instrument.
	Indexed to preferred stock	From: One preferred equity instrument To: Preferred equity host contract and conversion option derivative liability	No. ASC 260-10-S99-2 may seem to apply because, before the separation of the embedded conversion option, the instrument represented preferred stock classified in equity (either permanent or temporary equity) and the separation of the embedded derivative is akin to the transaction discussed in the scope section of ASC 260-10-S99-2 (i.e., when an equity-classified preferred stock instrument must be subsequently reclassified as a liability). However, because the entry recognized under ASC 815-15 to separate the conversion option liability is a debit to preferred stock and a credit to derivative liability at the fair value of the derivative, the application of ASC 260-10-S99-2 would have no impact on the date of separation. The separation could, however, affect the subsequent accounting for the convertible preferred stock instrument under ASC 260-10-S99-2 and ASC 480-10-S99-3A. If the convertible preferred stock is classified in temporary equity and is being remeasured to its redemption amount, the entity should perform one last remeasurement under ASC 480-10-S99-3A before separating the conversion option liability. ASC 480-10-S99-3A would continue to apply to the preferred stock host contract if it is redeemable for cash or other assets. See Sections 3.2.2.5.4.1, 3.2.2.6.2.1.1, and 3.2.2.6.3.1 for discussion of the accounting for the settlement of the instrument.
	Indexed to preferred stock	From: Preferred equity host contract and conversion option derivative liability To: Preferred equity host contract and equity component classified in preferred stockholders’ equity	No. By analogy to ASC 815-15-35-4, the embedded conversion option should be reclassified from a derivative liability to preferred stockholders’ equity. ASC 260-10-S99-2 does not apply to this reclassification because that guidance does not apply to a reclassification of a liability to an equity instrument, which is not considered a redemption of preferred stock. However, ASC 480-10-S99-3A would apply after the reclassification if the convertible preferred stock is redeemable for cash or other assets. ASC 480-10-S99-3A may have also been applicable before this reclassification. See Section 3.2.5.2.5 for discussion of the accounting for the settlement of the instrument. Note that this type of reclassification would not be common in practice.
Freestanding financial instrument	Indexed to common stock	From: Asset or liability To: Equity	No. The reclassification of the instrument from an asset or liability to an equity-classified instrument is not subject to ASC 260-10-S99-2 because that guidance does not apply to a reclassification of an asset or liability to equity. ASC 815-40-35-10 addresses the reclassification of an equity-linked instrument from an asset or liability to equity. See Section 3.2.5.2.1 for discussion of the accounting for the settlement of the instrument.
	Indexed to common stock	From: Equity To: Asset or liability	No. Footnote 18 of EITF Topic D-98 states, in part, that “the application of Topic D-42 [which was codified in ASC 260-10-S99-2] is limited to preferred stock instruments.” ASC 815-40-35-9 addresses the reclassification of an equity-linked instrument from equity to an asset or liability. See Section 3.2.5.2 for discussion of the accounting for the settlement of the instrument.
	Indexed to preferred stock	From: Asset or liability To: Equity	No. The reclassification of the instrument from an asset or liability to an equity-classified instrument is not subject to ASC 260-10-S99-2 because that guidance does not apply to a reclassification of an asset or liability to equity. See Section 3.2.5.2.2 for discussion of the accounting for the settlement of the instrument.
	Indexed to preferred stock	From: Equity To: Asset or liability	Yes. This type of reclassification is akin to the transaction discussed in the scope section of ASC 260-10-S99-2 (i.e., when an equity-classified preferred stock instrument must be subsequently reclassified as a liability on the basis of the provisions of other GAAP). See further discussion of this type of reclassification in Section 3.2.2.8. See Section 3.2.5.2 for discussion of the accounting for the settlement of the instrument.

3.2.7 Summary of Scope of ASC 260-10-S99-2

The table below summarizes the scope of ASC 260-10-S99-2 with respect to financial instruments that do not represent an NCI. For purposes of the discussion in this table, unless otherwise stated, any embedded conversion option is indexed to and settled in the entity’s common stock and is not accounted for separately from the host contract. While ASC 260-10-S99-2 may not be applicable, for certain transaction types, other relevant GAAP may still result in an impact on net income or income available to common stockholders as a result of the settlement. Although the table below does not discuss the application of ASC 480-10-S99-3A, the sections referred to in the table do discuss such application.

For NCIs, the accounting at the subsidiary level may affect the parent’s EPS. For discussion of NCIs, see Section 3.2.3.

Table 3-10

Transaction Type	Subject to ASC 260-10-S99-2	Not Subject to ASC 260-10-S99-2
Conversion (or exercise)	Convertible preferred stock that has a separated embedded conversion option classified as a liability — when redemption accounting is applied to the conversion (Section 3.2.2.5.4.1).	Convertible debt (Section 3.2.2.6.1 and Chapter 6). Convertible debt that has a separated embedded conversion option classified as an equity instrument (Section 3.2.5.2.3 and Chapter 6). Convertible debt that has a separated embedded conversion option classified as a liability (Section 3.2.2.6.1 and Chapter 6). Convertible preferred stock (Section 3.2.2.5.4). Preferred stock host contract for convertible preferred stock that has a separately recognized equity-classified component indexed to common stock (Section 3.2.5.2.4).16 Equity component for convertible preferred stock that has a separately recognized equity-classified component indexed to common stock (Section 3.2.5.2.4).17 Convertible preferred stock that has a separated embedded conversion option classified as a liability — when partial redemption/partial conversion accounting is applied to the conversion (Section 3.2.2.5.4.1).18 Convertible preferred stock that has a separated embedded conversion option classified as a liability — when conversion accounting is applied to the conversion (Section 3.2.2.5.4.1). Derivative indexed to common stock that is classified as an equity instrument (Section 3.2.5.2.1). Derivative indexed to common stock that is classified as a liability (Section 3.2.5.2). Derivative indexed to preferred stock that is classified as an equity instrument (Section 3.2.5.2.2). Derivative indexed to preferred stock that is classified as a liability (Section 3.2.5.2). Common stock that is convertible into another class of common stock (Section 3.2.4.1).
Redemption (including a modification or exchange accounted for as an extinguishment) Note that any modification or exchange that is not accounted for as an extinguishment is not within the scope of ASC 260-10-S99-2. However, for accounting purposes, an entity generally accounts for such modifications or exchanges when they result in an increase in the fair value of the instrument. The impact depends on the nature of the instrument modified. See Section 3.2.6 for additional information.	Preferred stock (Section 3.2.2.6.2). Convertible preferred stock (Section 3.2.2.6.2.1). Preferred stock host contract for convertible preferred stock that has a separately recognized equity-classified component indexed to common stock (Section 3.2.5.2.4). Preferred stock host contract for convertible preferred stock that has a separated embedded conversion option classified as a liability (Section 3.2.2.6.2.1.1). Derivative indexed to preferred stock that is classified as an equity instrument (Section 3.2.5.2.2).	Convertible debt (Section 3.2.2.6.1 and Chapter 6). Convertible debt that has a separated embedded conversion option classified as an equity instrument (Section 3.2.5.2.3 and Chapter 6). Convertible debt that has a separated embedded conversion option classified as a liability (Section 3.2.2.6.1 and Chapter 6). Equity component of convertible preferred stock that has a separately recognized equity-classified component indexed to common stock (Section 3.2.5.2.4). Liability component of convertible preferred stock that has a separated embedded conversion option classified as a liability (Section 3.2.2.6.2.1.1). Derivative indexed to common stock that is classified as an equity instrument (Section 3.2.5.2.1). Derivative indexed to common stock that is classified as a liability (Section 3.2.5.2). Common stock (Section 3.2.4.3).19
Inducement offer	Convertible preferred stock (Section 3.2.2.6.3). Convertible preferred stock that has a separately recognized equity-classified component indexed to common stock (Section 3.2.2.6.3.2). Derivative indexed to preferred stock that is classified as an equity instrument (Section 3.2.5.2.2).	Convertible debt (Sections 3.2.2.6.1 and 6.6.1).20 Convertible debt that has a separated embedded conversion option classified as an equity instrument (Sections 3.2.5.2.3 and 6.6.1).21 Convertible debt that has a separated embedded conversion option classified as a liability (Section 3.2.2.6.1 and 6.6.1).22 Convertible preferred stock that has a separated embedded conversion option classified as a liability (Section 3.2.2.6.3.1).23 Derivative indexed to common stock that is classified as an equity instrument (Section 3.2.5.2.1).24 Derivative indexed to common stock that is classified as liability (Section 3.2.5.2).25 Derivative indexed to preferred stock that is classified as a liability (Section 3.2.5.2).26 Common stock convertible into another class of common stock (Section 3.2.4.1).27
Reclassification	Preferred stock reclassified to a liability (Section 3.2.2.8). Convertible preferred stock reclassified from one preferred equity instrument to a liability instrument (Section 3.2.2.8). Derivative indexed to preferred stock reclassified from equity to asset or liability (Section 3.2.6.5).	Convertible debt reclassified from one liability instrument to debt host contract and conversion option derivative liability (Section 3.2.6.5 and Chapter 6). Convertible debt reclassified from debt host contract and conversion option derivative liability to debt host contract and equity component (Section 3.2.6.5 and Chapter 6). Convertible debt or convertible preferred stock reclassified from debt host contract and equity component, to debt host contract and conversion option liability (Section 3.2.6.5). Convertible preferred stock reclassified from one preferred equity instrument to a preferred equity host contract and conversion option derivative liability (Section 3.2.6.5). Convertible preferred stock reclassified from preferred equity host contract and equity component classified in common stockholders’ equity to preferred equity host contract and conversion option derivative liability (Section 3.2.6.5). Convertible preferred stock reclassified from preferred equity host contract and conversion option derivative liability to preferred equity host contract and equity component classified in common stockholders’ equity (Section 3.2.6.5). Convertible preferred stock reclassified from preferred equity host contract and conversion option derivative liability to preferred equity host and equity component classified in preferred stockholders’ equity (Section 3.2.6.5). Derivative indexed to common stock or preferred stock reclassified from asset or liability to equity (Section 3.2.6.5). Derivative indexed to common stock reclassified from equity to asset or liability (Section 3.2.6.5). Common stock reclassified to liability (Section 3.2.4.4).

Footnotes

These items affect income available to common stockholders either directly (i.e., adjustments to net income to arrive at income available to common stockholders) or indirectly (i.e., adjustments to net income).

This Roadmap does not address the date on which cumulative dividends must be recognized by an entity as either a liability or shares of stock. The balance sheet recognition of dividends on cumulative preferred stock will depend on the relevant terms of the preferred stock instrument, including whether dividends must be declared before payment. For guidance on when dividend obligations should be recognized as a liability on the balance sheet, see 505-10-05 (Q&A 08) in Deloitte’s FASB Accounting Standards Codification Manual on DART.

A contingency is an event that is not solely within the control of the issuer or holder of the preferred stock.

The preferred stock is not considered increasing-rate preferred stock merely because the carrying amount is at a discount to the liquidation preference. See further discussion in Section 3.2.2.3.

In all circumstances, an entity should adjust the fair value of the derivative liability through net income immediately before accounting for the settlement.

A convertible preferred stock instrument may contain a component that has been separately recognized in common stockholders’ equity. Upon conversion, in conjunction with other relevant guidance, an entity is required to recognize any remaining unamortized discount on the convertible preferred stock as a reduction to net income in arriving at income available to common stockholders. Thus, while ASC 260-10-S99-2 does not apply to a conversion, other guidance requires accounting that results in a “deemed dividend” in a manner similar to the accounting under ASC 260-10-S99-2. See Section 3.2.5.2.4 for further discussion of this guidance, which applies to all entities and not just SEC registrants.

See Section 3.2.5.2.3 for discussion of convertible debt that contains a separately classified equity component.

ASC 260-10-S99-2 applies to the consolidated financial statements of a parent in the period that includes a modification, an extinguishment, or an induced conversion of preferred stock issued by a consolidated subsidiary that is classified as an NCI.

If only the parent absorbed the impact of a dividend or “deemed dividend,” an allocation to NCIs in the form of common stock is not appropriate.

See Section 3.2.4.3.1 for guidance on situations in which the repurchase occurs on the basis of the settlement of a forward contract to repurchase common stock.

For example, assume that the holder of the shares is a private equity firm and that the issuer repurchases the shares to prevent the holder from obtaining additional board representation or other influence over the entity. The entity should compare the repurchase price with the amount that would be paid to a holder of those shares in a transaction that is not executed to prevent additional board representation or other influence over the entity. It would not be appropriate for the issuer to assume that other private equity investors would also demand repurchase at the same price to avoid obtaining additional board representation or other influence over the entity.

Depending on the facts and circumstances, the inducement charge may need to be recognized in earnings rather than being treated as a dividend.

Footnote 18 of EITF Topic D-98 is not codified. See Section 3.2.5.2.3 for further discussion of the applicability of this guidance.

Allocating to the separately recognized equity component an amount equal to the amount initially recognized for that component differs from the accounting for a redemption of a convertible preferred stock instrument that contains an embedded conversion option that has been reclassified from a derivative liability to a separate component of common stockholders’ equity (discussed below). This difference is justified because only the incremental fair value of the embedded conversion option, as opposed to its entire fair value, is recognized as a result of the modification or exchange that affects the embedded conversion option in a convertible preferred stock instrument.

Since the SEC staff has not previously expressed any view on the redemption of convertible preferred stock that contains a separately recognized equity component as a result of a reclassification of the embedded derivative from a liability to equity, it is appropriate to allocate an amount to the equity component on the basis of its fair value on the redemption date in a manner similar to the accounting applied to convertible debt, as discussed in ASC 815-15-40-4.

While ASC 260-10-S99-2 does not apply, as noted in Section 3.2.5.2.4, the issuer in a conversion should immediately amortize any remaining unamortized discount on the preferred stock host, which will be treated as a dividend for which net income is adjusted to arrive at income available to common stockholders.

See footnote 16 for the accounting for the settlement of the host contract component.

While ASC 260-10-S99-2 does not apply, as noted in Section 3.2.2.5.4.1, in a conversion accounted for under this method, the issuer should immediately amortize any remaining unamortized discount on the preferred stock host, which will be treated as a dividend for which net income is adjusted to arrive at income available to common stockholders.

While ASC 260-10-S99-2 does not apply, as noted in Section 3.2.4.3, the recognition of a dividend or an expense may be required for a repurchase of common stock for an amount that exceeds the fair value of the common stock repurchased.

While ASC 260-10-S99-2 does not apply, as noted in Chapter 6, an expense must be recognized for an induced conversion of a convertible debt instrument.

See footnote 20.

While ASC 260-10-S99-2 does not apply, as noted in Section 3.2.2.6.3.1, an inducement will affect net income through the mark-to-market adjustment on the derivative liability.

While ASC 260-10-S99-2 does not apply, if an entity settles an equity-classified contract indexed to its common stock under an inducement offer, the additional value resulting from the inducement should be treated as a dividend or an expense. If the value is recognized as a dividend, the amount of the dividend should result in an adjustment to net income to arrive at income available to common stockholders.

See footnote 23.

While ASC 260-10-S99-2 does not apply, as noted in Section 3.2.4.1, the additional value resulting from an induced conversion of one class of common stock into another should be accounted for as either a dividend through application of the two-class method of calculating basic EPS or as an expense in a manner consistent with the accounting for reacquisitions of common stock at a price that exceeds fair value.

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