4.8 Diluted EPS for Specific Types of Transactions or Events

In a stock dividend, stock split, or reverse stock split, basic and diluted EPS must be retrospectively adjusted for all prior financial reporting periods. See further discussion in Section 8.2.1.

A rights issue represents an offer to existing common stockholders to purchase additional shares of common stock for a specified amount for a given period. A rights issue may contain a bonus element that is akin to a stock dividend, in which case retrospective adjustment to basic and diluted EPS is required for all prior reporting periods. See further discussion in Section 8.2.2.

Stock subscriptions are a mechanism by which an entity can offer employees and other investors the ability to purchase shares of the entity’s common stock typically over a period of time and without a broker’s commission. The impact of a stock subscription agreement on basic and diluted EPS will depend on the extent to which the investor is entitled to participate in dividends before the subscription agreement is fully paid and the shares of common stock are outstanding. See Section 8.3.1 for discussion, including illustrative examples, of the impact on basic and diluted EPS of stock subscription agreements that must be settled in common stock.

The facts and circumstances associated with legally outstanding common stock that was issued in return for a note receivable will vary depending on the contractual terms of the arrangement. ASC 260 does not provide specific guidance on situations in which an entity has issued shares of common stock to an investor that are legally outstanding and not subject to any vesting conditions in return for a note receivable. The determination of whether the common shares issued in return for a note receivable should be considered outstanding and included in the denominator in the calculation of basic EPS, or should be treated as potential common shares and included only in diluted EPS under the treasury stock method, depends on whether the entity has the ability and intent to cancel the shares if the note receivable is not repaid. See further discussion in Section 8.3.2.

Certain entities, particularly real estate investment trusts and other entities that are required to periodically distribute a certain portion of their taxable income, make distributions to common shareholders that give the individual shareholders the ability to elect to receive their entire distribution in cash or common shares of an equivalent value, with a potential limitation on the total amount of cash that shareholders may receive in the aggregate. As discussed in Section 8.3.3, the common stock portion of these types of distributions is accounted for as a share issuance rather than as a stock dividend. While the common stock portion of these dividends will not be reflected in the calculation of basic EPS until the shares are issued, diluted EPS will be affected before the common shares issued for the distribution become outstanding. The impact on diluted EPS must be accounted for in accordance with the guidance in ASC 260-10-45-45 and 45-46 on contracts that may be settled in cash or stock at the option of the counterparty. Under this guidance, the entity must presume that the holders of the entity’s common stock will elect to receive shares. The receipt of shares will always be more dilutive than the receipt of cash because the measurement of the liability for the dividend payable is the same regardless of the settlement method (i.e., the monetary value of the dividends is the same and, therefore, the entity is not required to remeasure the dividend liability). See further discussion in Section 8.3.3.

A nominal issuance of common stock involves a transaction in which the total consideration payable by the party that receives the shares is nominal in relation to the fair value of the common shares issued. A nominal issuance may also be associated with an issuance of potential common stock, such as an option or warrant to purchase common stock. Under ASC 260, nominal issuances of common stock must be treated retrospectively in the same manner as a stock dividend or stock split. See further discussion in Section 8.3.4.

An entity may loan its shares of common stock to an investment bank or investor in conjunction with an issuance of convertible debt. Such shares are “loaned” because the counterparty is unable to borrow shares in the market to hedge its exposure to the conversion option in the convertible debt or because the borrowing cost is prohibitive. As noted in ASC 470-20-45-2A, although loaned shares are legally outstanding, they are generally not considered outstanding common shares in the calculation of diluted EPS. See further discussion in Section 8.5.

Unit structures represent a combination of (1) a debt instrument or a preferred security and (2) a variable-share forward contract to issue common shares or an option to issue common shares to the counterparty. An entity must evaluate the terms of these types of issuances to determine whether one or more of the component instruments is a participating security and whether the if-converted or treasury stock method must be applied to calculate diluted EPS.

An accelerated share repurchase program involves a combination of transactions that includes (1) an immediate repurchase of common shares and (2) a forward contract to either issue common shares or receive additional common shares depending on the volume-weighted average daily purchase prices of the entity’s common stock purchased in the market by the counterparty. The entity can generally choose to settle the forward contract in cash or shares of common stock; however, in some cases, it must receive cash when it is in a gain position. For diluted EPS purposes, the entity must generally apply the treasury stock method to determine the dilutive effect of the forward contract. See Section 8.4.2 for further discussion of the application of the treasury stock method to the forward contract.

An entity may have outstanding equity securities (which include NCIs) that are classified in temporary equity in accordance with ASC 480-10-S99-3A. Redeemable equity securities are discussed in detail in Chapter 3 and Section 8.8.4. While remeasurement adjustments required under ASC 480-10-S99-3A may affect income available to common stockholders in the calculation of basic EPS, there is generally no incremental impact on the denominator of diluted EPS because the settlement of any redemption is in cash rather than the issuance of common shares. However, if the redeemable equity securities are convertible, the if-converted method must be applied in the calculation of diluted EPS.

As discussed in Section 3.2.4.4, a conditionally redeemable common stock instrument may become mandatorily redeemable as a result of the resolution of a condition associated with redemption. In these circumstances, the common shares are removed from the denominator in the calculation of basic EPS as of the reclassification date. There is generally no incremental impact on diluted EPS from such reclassification because removing the common shares as of an earlier date would be antidilutive. If the common stock subject to reclassification is convertible or exchangeable, provided that the event giving rise to the reclassification from an equity instrument to a liability does not affect the conversion or exchange feature, the common stock would continue to be subject to the if-converted method of calculating diluted EPS if this method is more dilutive than the two-class method of calculating diluted EPS. In fact, the common stock may be subject to the if-converted method for periods both before and after reclassification.

Some entities have issued classes of stock characterized as “tracking” or “targeted” stock, which measure 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 do not have any specific claim on the related assets and may have limited or no voting rights. According to ASC 260-10-45-60B, an entity with tracking stock must calculate and present EPS for each class of common stock by using the two-class method.