4.9 Year-to-Date Calculations of Diluted EPS | DART – Deloitte Accounting Research Tool

4.9.1 Treasury Stock Method

ASC 260-10

Applying the Treasury Stock Method

Year-to-Date Computations

55-3 The number of incremental shares included in quarterly diluted EPS shall be computed using the average market prices during the three months included in the reporting period. For year-to-date diluted EPS, the number of incremental shares to be included in the denominator shall be determined by computing a year-to-date weighted average of the number of incremental shares included in each quarterly diluted EPS computation. Example 1 (see paragraph 260-10-55-38) provides an illustration of that provision.

55-3A Computation of year-to-date diluted EPS when an entity has a year-to-date loss from continuing operations including one or more quarters with income from continuing operations and when in-the-money options or warrants were not included in one or more quarterly diluted EPS computations because there was a loss from continuing operations in those quarters is as follows. In computing year-to-date diluted EPS, year-to-date income (or loss) from continuing operations shall be the basis for determining whether or not dilutive potential common shares not included in one or more quarterly computations of diluted EPS shall be included in the year-to-date computation.

55-3B Therefore:

When there is a year-to-date loss, potential common shares should never be included in the computation of diluted EPS, because to do so would be antidilutive.
When there is year-to-date income, if in-the-money options or warrants were excluded from one or more quarterly diluted EPS computations because the effect was antidilutive (there was a loss from continuing operations in those periods), then those options or warrants should be included in the diluted EPS denominator (on a weighted-average basis) in the year-to-date computation as long as the effect is not antidilutive. Similarly, contingent shares that were excluded from a quarterly computation solely because there was a loss from continuing operations should be included in the year-to-date computation unless the effect is antidilutive.

Example 12 (see paragraph 260-10-55-85) illustrates this guidance.

As discussed in ASC 260-10-55-3 through 55-3B, the control number for calculating year-to-date diluted EPS and applying the antidilution sequencing requirements of ASC 260 is year-to-date net income.23 The number of incremental common shares included in the denominator under the treasury stock method, when dilutive, must be based on a year-to-date average of the number of incremental common shares calculated during each quarterly financial reporting period. While incremental common shares may not have been included in diluted EPS during a quarterly financial reporting period because the control number for the period was a loss, to calculate year-to-date diluted EPS in accordance with ASC 260-10-55-3 through 55-3B, an entity is nevertheless required to calculate the number of incremental common shares under the treasury stock method that would have been included in each quarterly calculation of diluted EPS if the effect had been dilutive. In doing so, as discussed in Section 4.2.2.1, the entity does not include out-of-the-money options and warrants in quarterly diluted EPS. Thus, if options or warrants are out-of-the-money in a quarterly financial reporting period, zero incremental common shares will be included for that quarter in the year-to-date average. However, for options or warrants that were in-the-money in a quarterly financial reporting period but not included in diluted EPS because doing so would have been antidilutive on the basis of the antidilution sequencing requirements of ASC 260, such options or warrants may need to be included in year-to-date diluted EPS since the antidilution sequencing requirements in a year-to-date calculation of diluted EPS must be based on the year-to-date reported net income.

Connecting the Dots

It may be intuitive to think that the incremental common shares included in year-to-date diluted EPS should be calculated as if the year-to-date period was a discrete period. However, that approach is not allowed for contracts subject to the treasury stock method. Using a year-to-date approach to calculate the incremental common shares included in year-to-date diluted EPS may be materially inconsistent with the requirements of ASC 260-10-55-3 through 55-3B. Consider the following two examples:

An entity calculating diluted EPS for an annual period that reports net income has 10 million options to sell common shares at $25 per share. The options are classified as equity instruments and must be share-settled. The average market prices of the entity’s common stock for the quarterly reporting periods in the annual period are $24.00, $24.50, $25.00, and $40.00 per share. The average market price of the entity’s common stock for the year is $28.38 per share. Under the approach required in ASC 260-10-55-3 through 55-3B, the incremental common shares added to the denominator would be 937,500, representing the average of the incremental shares for the fourth quarter and zero incremental shares for the first three quarters because the options are not in-the-money. However, when the year-to-date average market price is used, the incremental shares added to the denominator would be 1,190,980.
An entity calculating diluted EPS for an annual period with reported net income has 10 million options to sell common shares at $25 per share. The options are classified as equity instruments and must be share-settled. The average market prices of the entity’s common stock for the quarterly reporting periods in the annual period are $26.00, $26.50, $27.00, and $20.00 per share. The average market price of the entity’s common stock for the year is $24.88 per share. Under the approach required in ASC 260-10-55-3 through 55-3B, the incremental common shares added to the denominator would be 422,849, representing the average of the incremental shares for each of the first three quarters and zero incremental shares for the fourth quarter because the options are not in-the-money. However, when the year-to-date average market price is used, the incremental shares added to the denominator would be zero because the options are not in-the-money.

If an instrument subject to the treasury stock method is a participating security, the more dilutive of the treasury stock method or the two-class method of calculating diluted EPS must be applied, as discussed in Section 5.5.4. See Section 4.9.5 for information about situations in which the settlement method assumed for diluted EPS purposes differs from the accounting classification of a contract subject to the treasury stock method.

4.9.1.1 Example

ASC 260-10

Example 12: Computing Year-to-Date Weighted-Average Shares Outstanding

55-85 The following Cases illustrate the guidance in paragraphs 260-10-55-3A through 55-3B for the quarterly and annual computations of basic and diluted EPS for a company with options outstanding (equal to 20,000 incremental shares) that were in the money for the entire year (for simplicity purposes, this Example assumes that the stock price never changed). Case A addresses year-to-date loss, and Case B addresses year-to-date income. Note that in Case A, due to a loss for the period, zero incremental shares are included because the effect would be antidilutive. Note that in Case B, zero shares included due to loss in the period.

Case A: Year-to-Date Loss

55-86 The following tables illustrate the computation of quarterly and year-to-date EPS.

Case B: Year-to-Date Income

55-87 The following tables illustrate the computation of quarterly and year-to-date EPS.

Note that if the options had been out of the money in any quarter, zero incremental shares would have been included for that quarter in the year-to-date averaging.

4.9.2 Reverse Treasury Stock Method

The same year-to-date approach required for the treasury stock method would apply under the reverse treasury stock method. However, because written put options and forward purchase contracts are classified as liabilities (or assets in some circumstances) and generally recognized at fair value, with changes in fair value recognized in earnings (see Section 4.3.2.1), when the reverse treasury stock method is applied for diluted EPS purposes, these instruments are also subject to the year-to-date guidance on diluted EPS related to contracts that have an assumed settlement method for diluted EPS that differs from the classification for accounting purposes. See further discussion in Section 4.9.5.

4.9.3 If-Converted Method

As with the guidance applicable to the treasury stock method, the control number for year-to-date diluted EPS is net income for the year-to-date period and the antidilution sequencing requirements are applied on the basis of year-to-date net income. The guidance on the weighting of incremental shares provided for contracts subject to the treasury stock method is generally not relevant for convertible securities subject to the if-converted method. See Example 4-32 and Connecting the Dots below for more information.

Connecting the Dots

If the control number for the year-to-date period is a loss, the if-converted method should not be applied because its effect would be antidilutive. If the control number for the year-to-date period is income, an entity should apply the if-converted method, assuming conversion at the beginning of the period or the date of issuance of the convertible security, if later, if the application of this method is dilutive to the year-to-date calculation of diluted EPS on the basis of the antidilution sequencing requirements of ASC 260 as they apply on a year-to-date basis. This is the case even if the if-converted method was not applied in one or more quarterly financial reporting periods because there was a net loss during the period or the convertible security was antidilutive for the period on the basis of the antidilution sequencing requirements in ASC 260.

Questions arise regarding how to calculate diluted EPS under the if-converted method for convertible securities that are contingently convertible on the basis of (1) only a substantive non-market-based contingency or (2) a market price trigger and some other substantive non-market-based contingency. As discussed in Section 4.4.3, for each quarterly financial reporting period, the if-converted method should be applied only if the non-market-based contingency has been met as of the end of the reporting period. If the non-market-based contingency is met as of the reporting date and application of the if-converted method is dilutive, the effect should be included in diluted EPS from the beginning of the quarterly reporting period or the date of issuance, if later. This is consistent with the approach to diluted EPS for contingently issuable shares. While ASC 260 does not specifically address how to calculate year-to-date EPS under the if-converted method when the non-market-based contingency is met for only some of the quarterly periods within a year-to-date period, the approach applied to contingently issuable shares should be used to calculate diluted EPS on a year-to-date basis. Thus, if the control number is income and the effect of conversion is dilutive on the basis of the antidilution sequencing requirements of ASC 260, the common shares included in the denominator would be weighted for the interim periods that were included in the calculation of diluted EPS. The numerator adjustments under ASC 260-10-45-40 would be made only for the interim periods for which the common shares issuable upon conversion were included. See Example 4-33 for more information.

If a convertible security subject to the if-converted method is a participating security, the more dilutive of the if-converted method or the two-class method of calculating diluted EPS must be applied, as discussed in Section 5.5.4. See Section 4.9.5 for further discussion of situations in which the settlement method assumed for diluted EPS purposes differs from the accounting classification of the convertible security subject to the if-converted method.

Connecting the Dots

Under ASC 260-10-45-40, an entity must perform a treasury-stock-type calculation for convertible debt instruments subject to the if-converted method that require the issuer to pay the principal amount in cash upon conversion (i.e., an Instrument C convertible debt instrument). In particular, an entity would determine the effect on diluted EPS by calculating the number of common shares that would be issuable to settle the excess conversion value. The entity would perform this calculation on the basis of its average stock price during the period.

ASC 260-10-55-84 through 55-84B appear to indicate that for calculations of year-to-date diluted EPS, an entity should use its average share price for the year. However, this approach would be inconsistent with the statement in the example that “[t]he conversion premium should be included in diluted earnings per share based on the provisions of paragraphs 260-10-45-45 through 45-46 and 260-10-55-32 through 55-36A.” These paragraphs require an entity to apply ASC 260-10-55-3, which states that in the calculation of year-to-date diluted EPS, “the number of incremental shares to be included in the denominator shall be determined by computing a year-to-date weighted average of the number of incremental shares included in each quarterly diluted EPS computation.” Therefore, although ASC 260-10-55-84 through 55-84B appear to indicate that the average share price for the year should be used in the calculation of diluted EPS, an entity should determine year-to-date diluted EPS for a convertible debt instrument that requires the issuer to pay the principal amount in cash by calculating a year-to-date average of the number of incremental shares included in each calculation of quarterly diluted EPS. Such an approach is consistent with the treasury stock method.

4.9.3.1 Examples

Example 4-32

Application of If-Converted Method to Quarterly and Annual Diluted EPS When There Are Periods of Income and Loss

Company G reports the amounts below during its quarterly financial reporting periods for the year ended December 31, 20X9; G does not report a discontinued operation during the year ended December 31, 20X9.

Assume that G has $5 million of 7.5 percent nonparticipating noncontingently convertible debt securities outstanding for the entire year. The conversion price of the convertible securities is $25.00; therefore, the debt securities are convertible into 200,000 common shares. The convertible securities must be settled in G’s common shares and are accounted for at amortized cost. Company G has a tax rate of 25 percent.

Diluted EPS for each quarter in the year ended December 31, 20X9, would be calculated as follows:

Diluted EPS for the year ended December 31, 20X9, would be calculated as follows:

Note that because G reports a net loss during the third quarter, the annual diluted EPS amount of $1.83 does not equal the sum of the quarterly diluted EPS amounts reported of $1.44 ($0.81 + $0.46 + $(1.00) + $1.17 = $1.44). Further, if G had reported a net loss of $2,000,000 or $4.00 loss per basic share for the third quarter, it would have reported a net loss of $500,000 for the year. Therefore, while the amounts of diluted EPS for the first, second, and fourth quarters above would be unchanged, the diluted EPS for the year ended December 31, 20X9, would have been a $1.00 loss per share, which would have been the same amount reported as basic loss per share.

Example 4-33

Application of If-Converted Method to Quarterly and Annual Diluted EPS for Contingently Convertible Debt

Company H reported the amounts below during its quarterly financial reporting periods for the year ended December 31, 20X4; H did not report a discontinued operation during the year ended December 31, 20X4.

Assume that H has $5 million of 7.5 percent nonparticipating contingently convertible debt securities outstanding for the entire year. The conversion price of the convertible securities is $25.00; therefore, the debt securities are convertible into 200,000 common shares. The convertible securities must be settled in G’s common shares and are accounted for at amortized cost. The convertible securities are only convertible if the following two conditions are met:

The market price of H’s common stock is $41.00 or more.
The occupancy rate of H’s commercial rental properties is 90 percent or more.

Company G has a tax rate of 25 percent.

Assume the following conditions at the end of each quarter in the year ended December 31, 20X4:

In accordance with ASC 260-10-45-44, an entity should include the convertible securities in diluted EPS, assuming dilution, only in periods in which the non-market-based contingency is met. Therefore, the if-converted method applies for the first, second, and fourth quarters of 20X4. The fact that the market price trigger is not met in the second quarter does not preclude the application of the if-converted method for the second quarter since market price triggers are disregarded in the determination of whether the if-converted method applies to contingently convertible debt instruments.

Diluted EPS for each quarter in the year ended December 31, 20X4, would be calculated as follows:

Diluted EPS for the year ended December 31, 20X4, would be calculated as follows:

4.9.4 Contingently Issuable Share Method

ASC 260-10

Contingently Issuable Shares

45-49 For year-to-date computations, contingent shares shall be included on a weighted-average basis. That is, contingent shares shall be weighted for the interim periods in which they were included in the computation of diluted EPS.

The approach to year-to-date diluted EPS that is applied to contingently issuable shares or contingently issuable potential common shares is consistent with that applied to potential common shares subject to the treasury stock method. The incremental shares included in the denominator in the calculation of diluted EPS, if they are dilutive to the calculation of year-to-date diluted EPS on the basis of the antidilution sequencing requirements of ASC 260, are based on a weighted average of the common shares included in each quarterly calculation of diluted EPS. If the control number for the year-to-date period is a loss, no incremental common shares are included in the denominator for the year-to-date period even if incremental common shares were included in one or more quarterly financial reporting periods because of net income for those quarterly periods. Similarly, if the control number for the year-to-date period is income, incremental common shares that were excluded from the denominator for quarterly periods because of quarterly losses are included in the calculation of year-to-date diluted EPS if the approach is dilutive on the basis of the antidilution sequencing requirements in ASC 260. As noted in Section 4.9.1, the antidilution sequencing requirements are applied to a calculation of year-to-date diluted EPS on the basis of year-to-date net income.

If a contingently issuable share arrangement is a participating security, the more dilutive of the contingently issuable share method or the two-class method of calculating diluted EPS must be applied, as discussed in Section 5.5.4. If the settlement method assumed for diluted EPS purposes differs from the accounting classification of a contract subject to the treasury stock method, see Section 4.9.5.

4.9.4.1 Examples

ASC 260-10-55-53 through 55-56 provide an example illustrating the calculation of quarterly and year-to-date diluted EPS for an entity that has contingently issuable common shares based on net income and a nonfinancial performance measure. The example highlights the following requirements of ASC 260:

The number of common shares included in the denominator of quarterly diluted EPS is equal to the number of common shares that would be issued if the end of the reporting period was the end of the contingency period.
Common shares may be included in one quarterly reporting period but not in subsequent quarterly reporting periods; as a result, there may be volatility in the amounts of quarterly diluted EPS.
The calculation of year-to-date diluted EPS is based on the weighted-average common shares that have been assumed to be issuable in each quarterly financial reporting period.

ASC 260-10

Example 3: Contingently Issuable Shares

55-53 This Example illustrates the contingent share provisions described in paragraphs 260-10-45-13 and 260-10-45-48 through 45-57. This Example has the following assumptions:

Entity A had 100,000 shares of common stock outstanding during the entire year ended December 31, 20X1. It had no options, warrants, or convertible securities outstanding during the period.
Terms of a contingent stock agreement related to a recent business combination provided the following to certain shareholders of Entity A:
1. 1,000 additional common shares for each new retail site opened during 20X1
2. 5 additional common shares for each $100 of consolidated, after-tax net income in excess of $500,000 for the year ended December 31, 20X1.
Entity A opened two new retail sites during the year:
1. One on May 1, 20X1
2. One on September 1, 20X1.
Entity A’s consolidated, year-to-date after-tax net income was:
1. $400,000 as of March 31, 20X1
2. $600,000 as of June 30, 20X1
3. $450,000 as of September 30, 20X1
4. $700,000 as of December 31, 20X1.

55-54 Note that in computing diluted EPS for an interim period, contingent shares are included as of the beginning of the period. For year-to-date computations, paragraph 260-10-45-49 requires that contingent shares be included on a weighted-average basis.

55-55 The following table illustrates the quarterly and annual calculation of basic and diluted EPS.

55-56

Example 4-34

Calculating Diluted EPS When Issuance of Shares Is Contingent on Amount of Future Earnings (Single Earnings Target)

For the scenario discussed in Example 4-15, incremental common shares should be included in year-to-date diluted EPS on a weighted-average basis. If it is assumed that X had 200,000 weighted-average common shares outstanding and no other potential common shares and that the contingently issuable shares were not classified as an asset or liability for accounting purposes, the calculation of X’s basic and diluted EPS for the annual period would be as follows:

The weighted-average number of shares added for diluted EPS is calculated as follows:

4.9.5 Contracts That May Be Settled in Cash or Stock

ASC 260-10

Contracts That May Be Settled in Stock or Cash

55-34 Year-to-date diluted EPS calculations may require an adjustment to the numerator in certain circumstances. For example, for contracts that are share settled for EPS purposes, the numerator adjustment is equal to the earnings effect of the change in the fair value of the asset or liability recorded pursuant to Section 815-40-35 during the year-to-date period. In that example, the number of incremental shares included in the denominator should be determined in accordance with the guidance in paragraph 260-10-55-3.

As discussed in Section 4.7.3, a numerator adjustment is required when a contract is classified (in whole or in part) as an asset or liability for accounting purposes but the potential common shares are included in the denominator of the calculation of diluted EPS. ASC 260-10-55-34 requires that, in such situations, the numerator adjustment be calculated on the basis of the income statement for the year-to-date period. However, the number of shares included in the denominator must be calculated in accordance with ASC 260-10-55-3 (e.g., under the treasury stock, reverse treasury stock, and contingently issuable share methods, the incremental common shares are included on a year-to-date basis by using an average of the incremental common shares calculated on a discrete quarterly basis). In other words, a year-to-date approach is used to determine the numerator adjustment and an averaging approach is used to determine the denominator adjustment, if these adjustments are dilutive on the basis of the antidilution sequencing requirements of ASC 260. See Section 4.9.3 for further discussion of the accounting for year-to-date diluted EPS under the if-converted method.

Connecting the Dots

It is possible that an entity would reverse the entire mark-to-market adjustment for the year-to-date period on a contract classified as an asset or liability but only include incremental shares for one quarterly period in a year-to-date calculation of diluted EPS (e.g., a liability-classified option was in-the-money for only one quarterly period). This result arises from the year-to-date approach used for the numerator adjustment and the averaging approach used for the denominator adjustment. However, an entity would never make the numerator adjustment if no incremental shares were added to the denominator for the year-to-date period. Similarly, neither the numerator nor the denominator adjustment would be made if the combined result of those adjustments was antidilutive for the year-to-date period.

4.9.6 Entities That Do Not Present Interim EPS

Some entities that are not subject to the periodic reporting requirements of the Exchange Act only present EPS amounts in annual financial statements. In these situations, an entity is not required to calculate EPS on a quarterly basis so that it can compute EPS amounts on an annual basis. Rather, the annual period may be treated as a discrete period in the same manner in which a quarterly financial reporting period is considered a discrete period for SEC registrants that file quarterly financial statements on Form 10-Q. Treating an annual period as a discrete period could result in significantly different diluted EPS amounts calculated under the treasury stock, reverse treasury stock, and contingently issuable share methods.

SEC Considerations

The above guidance is not intended to apply to entities that present diluted EPS in registration statements filed with the SEC. Such entities must apply the guidance in ASC 260 on year-to-date diluted EPS to any amounts of diluted EPS that are presented or disclosed.