5.5 Two-Class Method of Calculating EPS
5.5.1 General
ASC 260-10
Participating Securities and the Two-Class Method
45-60 The two-class method is
an earnings allocation formula that treats a
participating security as having rights to earnings that
otherwise would have been available to common
shareholders but does not require the presentation of
basic and diluted EPS for securities other than common
stock. The presentation of basic and diluted EPS for a
participating security other than common stock is not
precluded.
45-60A All securities that meet the definition of a participating security, irrespective of whether the securities
are convertible, nonconvertible, or potential common stock securities, shall be included in the computation of
basic EPS using the two-class method.
45-60B Under the two-class method:
- Income from continuing operations (or net income) shall be reduced by the amount of dividends declared in the current period for each class of stock and by the contractual amount of dividends (or interest on participating income bonds) that must be paid for the current period (for example, unpaid cumulative dividends). Dividends declared in the current period do not include dividends declared in respect of prior-year unpaid cumulative dividends. Preferred dividends that are cumulative only if earned are deducted only to the extent that they are earned.
- The remaining earnings shall be allocated to common stock and participating securities to the extent that each security may share in earnings as if all of the earnings for the period had been distributed. The total earnings allocated to each security shall be determined by adding together the amount allocated for dividends and the amount allocated for a participation feature.
- The total earnings allocated to each security shall be divided by the number of outstanding shares of the security to which the earnings are allocated to determine the EPS for the security.
- Basic and diluted EPS data shall be presented for each class of common stock.
For the diluted EPS computation, outstanding common shares shall include all potential common shares
assumed issued. Example 6 (see paragraph 260-10-55-62) illustrates the two-class method.
45-65 Undistributed earnings for a period shall be allocated to a participating security based on the contractual
participation rights of the security to share in those current earnings as if all of the earnings for the period
had been distributed. If the terms of the participating security do not specify objectively determinable,
nondiscretionary participation rights, then undistributed earnings would not be allocated based on arbitrary
assumptions. For example, if an entity could avoid distribution of earnings to a participating security, even if all
of the earnings for the year were distributed, then no allocation of that period’s earnings to the participating
security would be made. Paragraphs 260-10-55-24 through 55-31 provide additional guidance on participating
securities and undistributed earnings.
45-66 Under the two-class method the remaining earnings shall be allocated to common stock and
participating securities to the extent that each security may share in earnings as if all of the earnings for the
period had been distributed. This allocation is required despite its pro forma nature and that it may not reflect
the economic probabilities of actual distributions to the participating security holders.
Participating Securities and Undistributed Earnings
55-25 If a participating security provides the holder with the ability to participate in all dividends declared with
the holders of common stock on a one-to-one per-share basis, then the undistributed earnings should be
allocated between the common stock and the participating security on a one-to-one per-share basis.
ASC 260 requires entities to apply the following two-step approach in allocating earnings under the
two-class method:
- Allocate distributed earnings to participating securities and common stock.
- Allocate undistributed earnings to participating securities and common stock.
The allocation of distributed earnings is based on the actual dividends or dividend equivalents, if
any, that were paid or payable during the period (and that pertain to the reporting period) to each
participating security and class of common stock. The amount of undistributed earnings that must be
allocated is equal to the numerator in the calculation of EPS less distributed earnings. Undistributed
earnings must be allocated to participating securities and classes of common stock on the basis of
their contractual entitlement to participate in distributions, under an assumption that all undistributed
earnings for the period were distributed. This hypothetical allocation is required regardless of whether
the entity intends to declare or pay dividends and even if there are contractual or legal restrictions on
the entity’s ability to pay dividends. The allocation of undistributed earnings to participating securities
and common shares should be based on the weighted-average participating securities and common
shares that were outstanding during a reporting period. It should not be based on the number of
participating securities or common shares outstanding as of the end of the reporting period. If an entity
can avoid a distribution of earnings to a participating security even if all earnings for the period were
distributed, the entity should not allocate undistributed earnings to that participating security.
The implementation guidance in ASC 260 on the two-class method of calculating EPS is written in the
context of basic EPS and does not explicitly address diluted EPS. However, the calculation of diluted
EPS under the two-class method is well established in practice and would be performed by using the
approach described in Section 5.5.4.
The remaining discussion in Section 5.5 provides guidance on using the two-class method to calculate
basic and diluted EPS. Section 5.5.5 provides examples illustrating the calculation of EPS under the
two-class method.
5.5.1.1 Quarterly and Year-to-Date Calculations
SEC Regulation S-X requires SEC registrants to present EPS in their quarterly reports on Form 10-Q.
Other entities that are required, or that elect, to present EPS may also issue financial statements on an
interim basis (e.g., quarterly or semiannually). When issuing interim-period financial statements, entities
include basic and diluted EPS for both the interim period and the year-to-date period.
For year-to-date calculations, an entity should allocate undistributed earnings to participating securities
and classes of common stock on a discrete, or independent, basis as if all undistributed earnings for
the entire year-to-date period were distributed. That is, the allocation is made without regard to how
the undistributed earnings were allocated for the interim financial reporting periods that are part
of the year-to-date financial reporting period. This approach is consistent with the guidance in ASC
260-10-55-3 through 55-3B, as discussed in Section 4.9, which requires that year-to-date diluted EPS be
calculated on the basis of the numerator for the year-to-date period.
The allocation of undistributed earnings in interim-period calculations of EPS (e.g., an EPS calculation for
a quarterly financial reporting period) is generally not controversial when the entitlement of common
shares and participating securities to share in earnings according to their contractual participation terms
is based on discrete interim periods. However, when the contractual participation terms related to
the rights to participate in distributions are based on distributions made over an entire annual period,
additional considerations are necessary regarding the calculations of EPS under the two-class method
for interim periods after the first interim period.
On the basis of informal discussions with the FASB staff during the deliberations of EITF Issue 07-4, there are two views in practice on the
allocation of undistributed earnings to interim periods, since the guidance
in ASC 260 on the two-class method is unclear on this matter. Specifically,
ASC 260-10-45-60B(b) states that undistributed earnings “shall be allocated
to common stock and participating securities to the extent that each
security may share in earnings as if all of the earnings
for the period had been distributed” (emphasis added). The two views
are related to the meaning of the phrase “all of the earnings for the
period” as follows (note that these two views are acceptable only when an
entity pays distributions by using a complex allocation formula on the basis
of an annual distribution):
-
View A: Discrete-period basis — Some interpret “all of the earnings for the period” as indicating that an allocation is required in an interim period on a discrete, or independent, basis as if all undistributed earnings for the interim period were allocated without regard to any allocations made in prior interim periods. In other words, each interim period would be treated in the same manner as an annual period is treated in a year-to-date calculation of EPS. Proponents of View A believe that this approach is required because it is consistent with the period-by-period approach that is generally prescribed by ASC 260. Under this approach, the undistributed earnings allocated to each participating security and class of common stock on a year-to-date basis will often not equal the sum of the interim-period undistributed earnings allocated to each participating security and class of common stock. This same phenomenon exists for calculations of diluted EPS when the two-class method does not apply.
-
View B: Cumulative-period basis — Others interpret “all of the earnings for the period” as not addressing how to allocate undistributed earnings to interim periods. Proponents of View B believe that each interim period is an integral part of a year-to-date period. They further believe that in interim periods after the first interim period, the prior interim-period allocations of undistributed earnings must be considered when distribution formulas are contractually based on earnings during an annual period so that the allocation of undistributed earnings is appropriately reflected in accordance with the “contractual participation rights” of each security under ASC 260-10-45-65. Under this approach, the undistributed earnings allocated to each participating security and class of common stock on a year-to-date basis will often equal the sum of the interim-period undistributed earnings allocated to each participating security and class of common stock; however, the two amounts may not be equal if the distribution formulas are complex or there are undistributed losses during a financial reporting period (i.e., as illustrated in Example 5-15, undistributed losses during a particular financial reporting period should not be allocated to securities that do not absorb losses).
Either of these two approaches is acceptable provided that it is applied
consistently as an accounting policy and disclosed, if material. Regardless
of the method chosen, the denominator in the calculation of diluted EPS will
continue to be subject to the guidance applicable to each method of
computing diluted EPS on an interim and year-to-date basis, as discussed in
Chapter 4.
Example 5-14
illustrates the application of these two alternative views.
5.5.1.1.1 Distribution Formulas That Include a Return of Originally Invested Capital
The allocation of cash distributions by some entities is contractually based on a distribution formula
(i.e., a “waterfall” formula) in which common shares or participating securities must first receive a return
of their initial invested capital before any distributions can be made on other securities. For example,
an entity may have three classes of participating preferred stock outstanding (i.e., Series A, Series B,
Series C) and common shares. The entity’s articles of incorporation, bylaws, or other organization
documents may specify that distributions must first be made to repay the remaining unreturned capital
contribution on Series A before any distributions can be made on Series B, Series C, and common stock.
Once the unreturned capital contributions have been distributed on Series A, distributions must be paid
to return the Series B unreturned capital contribution before distributions can be paid on Series C and common stock. Once Series C has received its unreturned capital contribution, distributions are paid on
Series A, Series B, Series C, and common stock according to a specified formula.
In these types of allocation formulas, regardless of the method applied in
Section
5.5.1.1 for interim-period calculations of EPS under the
two-class method, an entity should allocate undistributed earnings,
taking into consideration the unreturned capital contributions of each
security as of the beginning of the interim period. The two-class method
of calculating EPS is an allocation of earnings and therefore should be
applied on the basis of the return on capital rather than the
return of capital. For further discussion of the allocation of
undistributed earnings by an MLP, see Section 8.9.3.
5.5.2 Application of Two-Class Method to Participating Securities
5.5.2.1 Liability-Classified Participating Securities
An entity may have outstanding participating securities that are classified as liabilities for accounting
purposes. Liability-classified participating securities may be recognized in the statement of financial
position at fair value, with periodic changes in fair value recognized in earnings (or other comprehensive
income for the portion related to the change in the issuing entity’s own credit risk). Alternatively, such
securities may be recognized in the statement of financial position by using another measurement
attribute under other relevant GAAP, such as intrinsic value, current settlement value, or amortized
cost. The classification of securities as liabilities, and their subsequent-measurement attribute, has no
impact on whether they are participating securities to which an entity must apply the two-class method
of calculating EPS.
5.5.2.1.1 Distributed Earnings for Liability-Classified Participating Securities
Dividends declared on liability-classified participating securities that have
been recognized in the income statement as an expense (e.g., interest
expense, compensation expense, other income or expense) should not also
be treated as a reduction of income available to common stockholders to
arrive at undistributed earnings. The recognition of these dividends a
second time through the allocation of distributed earnings would result
in “double counting” the impact of these dividends. An entity should
count dividends declared once, but not twice, in calculating EPS under
the two-class method. See Example 5-19 for an illustration
of this concept.
5.5.2.1.2 Undistributed Earnings for Liability-Classified Participating Securities
The periodic change in the carrying amount of a liability-classified participating security (e.g., change
in fair value, change in intrinsic value, change in current settlement value, interest, dividends
on share-based payment awards not expected to vest) that is recognized in the income statement will
affect net income and therefore the amount of undistributed earnings (losses). Under the two-class
method of calculating EPS, an entity may not reverse such amounts from undistributed earnings or
losses. However, in calculating diluted EPS, an entity may be required to adjust the numerator to reverse
the income statement effect on certain potential common shares that are more dilutive under the
treasury stock, if-converted, or contingently issuable share method than under the two-class method of
calculating diluted EPS. Only in these circumstances is it appropriate to adjust undistributed earnings
for the earnings effect that resulted from classifying the instrument as a liability. See Section 5.5.4 for
further discussion of the two-class method of calculating diluted EPS.
5.5.2.2 Allocation of Undistributed Losses to Participating Securities
ASC 260-10
Participating Securities and the Two-Class Method
45-67 An entity would allocate losses to a nonconvertible participating security in periods of net loss if, based
on the contractual terms of the participating security, the security had not only the right to participate in the
earnings of the issuer, but also a contractual obligation to share in the losses of the issuing entity on a basis
that was objectively determinable. Determination of whether a participating security holder has an obligation to
share in the losses of the issuing entity in a given period shall be made on a period-by-period basis, based on
the contractual rights and obligations of the participating security. The holder of a participating security would
have a contractual obligation to share in the losses of the issuing entity if either of the following conditions is
present:
- The holder is obligated to fund the losses of the issuing entity (that is, the holder is obligated to transfer assets to the issuer in excess of the holder’s initial investment in the participating security without any corresponding increase in the holder’s investment interest).
- The contractual principal or mandatory redemption amount of the participating security is reduced as a result of losses incurred by the issuing entity.
45-68 A convertible participating security should be included in the computation of basic EPS in periods of
net loss if, based on its contractual terms, the convertible participating security has the contractual obligation
to share in the losses of the issuing entity on a basis that is objectively determinable. The guidance in this
paragraph also applies to the inclusion of convertible participating securities in basic EPS, irrespective of the
differences that may exist between convertible and nonconvertible securities. That is, an entity should not
automatically exclude a convertible participating security from the computation of basic EPS if an entity has a
net loss from continuing operations. Determination of whether a participating security holder has an obligation
to share in the losses of the issuing entity in a given period shall be made on a period-by-period basis, based
on the contractual rights and obligations of the participating security.
An entity will have undistributed losses, as opposed to undistributed earnings, during a financial
reporting period in the following situations:
- The entity has a loss attributable to common stockholders.
- The entity has distributed more cash in the form of dividends or dividend equivalents than earnings for the period (i.e., cash distributions exceed income available to common stockholders).
Like undistributed earnings, undistributed losses must be allocated under the
two-class method of calculating EPS. When an entity has undistributed losses
and allocates a portion of those losses to a participating security, net
loss per common share will be reduced. Therefore, it is important to
determine whether participating securities share in undistributed losses
with common shareholders. If a participating security does not share in
losses, undistributed losses should be allocated only to the entity’s common stock.5 If an entity has multiple classes of common stock, undistributed
losses should be allocated to the classes of common stock in accordance with
their terms, which must take into account whether the classes of common
stock share equally in earnings or distributions on liquidation. See further
discussion in Section
5.5.3.3.
Connecting the Dots
It may seem intuitive to think that when undistributed losses are allocated solely to common
shares, there is no need to calculate diluted EPS under the two-class method. However, that
is not necessarily true. The control number for diluted EPS under the two-class method could
be income, notwithstanding cash distributions in excess of the control number for basic EPS, because (1) an entity must recalculate and reallocate undistributed earnings to apply the
two-class method when potential common shares are also participating securities and (2) the
entity may adjust the numerator in the calculation of diluted EPS if it has contracts that may be
settled in cash or common stock. See Section 5.5.4 for further discussion of the calculation of
diluted EPS under the two-class method.
Undistributed losses are allocated to a participating security only if the security contains a
nondiscretionary and objectively determinable contractual obligation to share in net losses.
Just because a security participates in earnings on a nondiscretionary and objectively determinable
basis does not mean it participates in losses. In fact, most participating securities do not share in losses.
A participating security only has a contractual obligation to participate in losses in the following two
circumstances:
- The counterparty is required to fund the losses of the entity (i.e., to “write a check” to the entity).
- The contractual principal or mandatory redemption amount of the participating security is reduced as a result of losses incurred by the entity.
Although the guidance in ASC 260-10-45-67 and 45-68 was written in the context of participating debt
or preferred stock instruments, it should be applied to all types of participating securities. An entity
must consider the contractual rights and obligations of the participating security in assessing whether
a security holder is obligated to share in the entity’s net losses on a period-by-period basis. It is unusual
for participating securities to have a contractual obligation to share in undistributed losses on an
objectively determinable and nondiscretionary basis. If the contractual terms of the participating security
do not specifically require the security holder to participate in losses or do not address the manner of
such loss participation, the entity should not allocate undistributed losses to the participating security.
Connecting the Dots
Because ASC 260-10-45-67 and 45-68 were only written to address participating debt or
preferred stock instruments, questions have arisen regarding whether a nonvested stock
award that is a participating security because the holder is entitled to nonforfeitable dividends
participates in losses. Undistributed losses (whether resulting from a net loss for a period or
distributed earnings that exceed income available to common stockholders) are generally not
allocated to share-based payment awards that meet the definition of a participating security
because the awards do not contain specific language that creates a contractual obligation
for the employee to absorb losses. The forfeiture provisions of the awards do not affect this
evaluation. However, once a nonvested share-based payment award vests and becomes an
outstanding share of common stock, it would participate in losses (see discussion of common
shares in Section 5.5.3.3). Therefore, when an entity has undistributed losses and nonvested
shares vest during a financial reporting period, the entity must allocate the undistributed losses
to the share-based payment arrangement for the portion of the period in which the award
was a vested common share. This allocation is generally performed on the basis of a weighted
average.
5.5.2.2.1 Allocation of Undistributed Losses to Participating Securities When an Entity Reports a Discontinued Operation
ASC 260 does not address how an entity should apply the two-class method when it reports a
discontinued operation. Entities will therefore need to consider how to allocate earnings (losses) under
the two-class method of calculating EPS, which must be done for continuing operations, discontinued
operations, and overall net income (loss) when an entity has participating securities or multiple classes
of common stock.
5.5.2.2.1.1 Distributed Earnings (Losses)
In a manner consistent with the typical application of the two-class method of
calculating EPS, any declared dividends reduce (increase) overall
net income (net loss) to arrive at undistributed earnings (losses).
Typically, distributed earnings will be considered as reducing
income (increasing losses) from continuing operations. However, if
the discontinued operation arises from a spin-off of a subsidiary
that has issued participating securities in the subsidiary, an
allocation of distributed earnings between continuing operations and
discontinued operations would be required.
5.5.2.2.1.2 Undistributed Earnings (Losses)
As discussed in Section 5.5.2.2, ASC 260 specifies that an entity should not allocate undistributed
losses to a participating security if, according to its contractual terms, the participating security does not
have a contractual obligation to absorb such losses on a basis that is nondiscretionary and objectively
determinable. In practice, it is uncommon for a participating security, including an unvested share-based
payment award, to participate in undistributed losses. If an entity reports income from continuing
operations but an overall net loss (because of losses from discontinued operations) or reports a loss
from continuing operations but overall net income (because of income from discontinued operations),
the entity must determine which measure is used to allocate income to participating securities when it
allocates income, but not losses, to participating securities.
If an entity has outstanding securities that participate in income, but not
losses, and those securities participate with common shareholders in
the entity’s overall net income, the entity should use overall net
income (loss) to allocate undistributed earnings (losses). That is,
these participating securities participate in all of the entity’s
undistributed earnings and none of its undistributed losses. The
table below illustrates the allocation of undistributed earnings
(losses) when an entity has participating securities that
participate in its overall net income but do not absorb
undistributed losses.
Table 5-3
Entity Reports6 | Continuing
Operations | Discontinued
Operations | Overall | Allocation to Participating Security |
|---|---|---|---|---|
Scenario 1 | Income | Income | Income | The entity should allocate undistributed earnings
from continuing operations to the participating
security and should allocate undistributed earnings
from discontinued operations to the participating
security. The total amount of undistributed
earnings allocated to the participating security
from continuing and discontinued operations
should equal the overall undistributed earnings
allocated to the participating security. |
Scenario 2 | Income | Loss | Income | The entity should allocate undistributed earnings
from continuing operations to the participating
security and should allocate undistributed losses
from discontinued operations to the participating
security. The net amount of undistributed earnings
allocated to the participating security from
continuing and discontinued operations should
equal the overall undistributed earnings allocated
to the participating security. |
Scenario 3 | Income | Loss | Loss | No allocations are made to the participating
security because the entity reported an overall
loss and the participating security does not absorb
losses. |
Scenario 4 | Loss | Loss | Loss | No allocations are made to the participating
security because the entity reported an overall
loss and the participating security does not absorb
losses. |
Scenario 5 | Loss | Income | Loss | No allocations are made to the participating
security because the entity reported an overall
loss and the participating security does not absorb
losses. |
Scenario 6 | Loss | Income | Income | The entity should allocate undistributed losses
from continuing operations to the participating
security and should allocate undistributed earnings
from discontinued operations to the participating
security. The net amount of undistributed earnings
allocated to the participating security from
continuing and discontinued operations should
equal the overall undistributed earnings allocated
to the participating security. |
Connecting the Dots
As discussed in Section
4.1.2.2, the control number in the
determination of whether potential common shares are
dilutive is income from continuing operations. However, this
control number concept is not relevant to the allocation of
undistributed earnings (losses) to participating securities
in the scenarios above because the participating securities
participate in the overall performance of the entity. Thus,
solely with respect to allocating undistributed earnings
(losses) to participating securities under the two-class
method, the control number is overall net income (loss)
(i.e., total undistributed earnings [losses] for the
period).
In terms of calculating diluted EPS under the two-class method, which is
discussed in Section 5.5.4, the
treasury stock, reverse treasury stock, if-converted, or
contingently issuable share method would not be applied to
calculate diluted EPS in scenarios 4–6, because those
methods would be antidilutive since the control number in
the calculation of diluted EPS is income from continuing
operations, which is a loss in these scenarios. However, for
scenarios 1–3, since the control number is income, those
methods of calculating diluted EPS would be applied in
accordance with the antidilution sequencing requirements, as
discussed in Section 4.1.2.3.
If an entity has securities that participate with common shareholders in earnings, but not losses, and
those securities participate only in the earnings of a specific subsidiary or business operation of the
entity, the entity must consider the facts and circumstances related to the terms of the participating
securities to determine the proper allocation of undistributed earnings (losses) to continuing operations,
discontinued operations, and overall net income (loss) for the period. If securities participate only in
earnings of a specific subsidiary or business operation and that subsidiary or operation is contained
only within continuing operations or only within discontinued operations, the entity should base
its allocation of undistributed earnings only on the undistributed earnings (if any) from continuing
operations or discontinued operations, respectively. In all situations, the entity must ensure that the overall net amount allocated to a participating security (i.e., the aggregate of the allocations from
continuing and discontinued operations) reflects the net amount of undistributed earnings that would
be allocable to the participating security if all undistributed earnings in which the security is entitled to
participate had been distributed for the period.
5.5.2.3 Participating Securities Issued or Redeemed During an Interim Reporting Period
SEC Regulation S-X requires SEC registrants to present EPS in their quarterly reports on Form 10-Q.
Accordingly, if an entity has participating securities outstanding during a quarterly financial reporting
period, it is required to prepare EPS under the two-class method for those interim financial reporting
periods.
An entity may issue or redeem a participating security during a quarterly financial reporting period. A
counterparty may also convert a participating security into common stock during a quarterly financial
reporting period. There are two acceptable methods of incorporating the impact of the issuance,
redemption, or conversion of a participating security during a quarterly financial reporting period in
a quarterly calculation of EPS under the two-class method in accordance with ASC 260: the discrete
method and the weighted-average method. An entity’s choice of either method represents an
accounting policy that must be consistently applied and disclosed, if material.
5.5.2.3.1 Discrete Method
Under the discrete method, the entity prepares, during the single financial reporting period, two EPS
calculations for both basic and diluted EPS, one for the portion of the financial reporting period for
which the participating security was outstanding and the other for the portion of the financial reporting
period for which the participating security was not outstanding. The date of separation for the two
separate calculations is the date of the participating security’s issuance, redemption, or conversion. The
entity aggregates the two separate calculations to determine the reported amounts of basic and diluted
EPS for the entire quarterly financial reporting period.
The appropriateness of the discrete method depends on the entity’s performance of two financial
reporting closings during a single quarterly financial reporting period, with each closing reflecting the
same processes and internal controls normally applied to a quarter-end closing. Given the complexity
of this approach, which requires an entity to (1) allocate net income to the discrete portions of the
quarterly financial reporting period and (2) calculate accruals and estimates twice during a single
quarterly financial reporting period, entities will most likely choose to apply the weighted-average
method.
5.5.2.3.2 Weighted-Average Method
The weighted-average method is predicated on the general requirement in ASC 260 to determine
outstanding common shares and potential dilutive common shares on a weighted-average basis. The
two-class method is applied under this approach, as discussed below.
5.5.2.3.2.1 Numerator
Net income attributable to common stockholders is first reduced by dividends declared during the
quarterly reporting period, with the remaining amount representing undistributed earnings. The
amount of dividends, if any, paid on the participating securities issued, redeemed, or converted during
the period will represent the actual amount of dividends declared or paid on such securities during
the quarterly financial reporting period (i.e., the distributed earnings). Undistributed earnings will be allocated to common shares and the participating securities issued, redeemed, or converted during the
quarterly financial reporting period on the basis of the weighted-average number of common shares
and participating securities outstanding during the quarterly financial reporting period. An allocation
based on the weighted-average number of common shares and participating securities outstanding
during the quarterly financial reporting period (in lieu of an allocation based on the period-end number
of outstanding shares of common stock and participating securities) of undistributed earnings under
the two-class method is consistent with other guidance in ASC 260 (see ASC 260-10-45-26 and ASC
260-10-45-42, which address the treatment of options or convertible debt issued, canceled, exercised,
or converted during a reporting period). In addition, such allocation reflects the notion that income
is earned and distributed evenly throughout the financial reporting period and is not a one-time
distribution of earnings as of the end of the financial reporting period.
5.5.2.3.2.2 Denominator
In a manner similar to the treatment of the numerator, the number of outstanding common shares used
in an entity’s calculation of basic and diluted EPS should be based on the weighted-average number of
shares of common stock outstanding during the quarterly financial reporting period, as required by ASC
260-10-45-10.
ASC 260 does not require presentation or disclosure of basic or diluted EPS for a participating security
that is not a class of common stock. However, if an entity presents or discloses such EPS amounts, the
denominator in the EPS calculation should be the weighted-average number of securities outstanding
only for the period during the quarterly financial reporting period in which the class of participating
securities was outstanding. For example, if a class of participating securities was entirely redeemed or
settled on the 46th day of the quarterly financial reporting period, the weighted-average calculation of
the number of securities outstanding should be based on a 45-day period.
5.5.2.4 Participation Is Contingent on a Specified Event
ASC 260-10
Participating Securities and Undistributed Earnings
55-26 If a participating security provides the holder with the ability to participate with the holders of common
stock in dividends declared contingent upon the occurrence of a specified event, the occurrence of which is
subject to management discretion or is not objectively determinable (for example, liquidation of the entity or
management determination of an extraordinary dividend), then the terms of the participating security do not
specify objectively determinable, nondiscretionary participation rights; therefore, undistributed earnings would
not be allocated to the participating security.
55-27 If a participating security provides the holder with the ability to participate with the holders of common
stock in earnings for a period in which a specified event occurs, regardless of whether a dividend is paid during
the period (for example, achievement of a target market price of a security or achievement of a certain earnings
level), then undistributed earnings would be allocated to common stock and the participating security based
on the assumption that all of the earnings for the period are distributed. Undistributed earnings would be
allocated to the participating security if the contingent condition would have been satisfied at the reporting
date, irrespective of whether an actual distribution was made for the period.
55-28 If a participating security provides the holder with the ability to participate in extraordinary dividends
and the classification of dividends as extraordinary is predetermined by a formula, for example, any dividend
per common share in excess of 5 percent of the current market price of the stock is defined as extraordinary,
then undistributed earnings would be allocated to common stock and the participating security based on the
assumption that all of the earnings for the period are distributed. If earnings for a given period exceed the
specified threshold above which the participating security would participate (that is, earnings for the period are
in excess of 5 percent of the current market price of the stock), undistributed earnings would be allocated to
the participating security according to its terms.
55-29 If a participating security provides the holder with the ability to participate in extraordinary dividends
and the classification of dividends as extraordinary is within the sole discretion of the board of directors,
then undistributed earnings would be allocated only to common stock. Since the classification of dividends
as extraordinary is within the sole discretion of the board of directors, undistributed earnings would not be
allocated to the participating security as the participation in the undistributed earnings would not be objectively
determinable.
55-30 If a participating security provides the holder with the ability to participate in all dividends up to a
specified threshold (for example, the security participates in dividends per common share up to 5 percent of
the current market price of the stock), then undistributed earnings would be allocated to common stock and
the participating security based on the assumption that all of the earnings for the period are distributed. In this
example, undistributed earnings would be allocated to common stock and to the participating security up to
5 percent of the current market price of the common stock, as the amount of the threshold for participation
by the participating security is objectively determinable. The remaining undistributed earnings for the period
would be allocated to common stock.
55-31 See Example 9 (paragraph 260-10-55-71) for an illustration of this guidance.
As noted in ASC 260-10-55-27, the two-class method applies when a security participates in
earnings only upon the occurrence of a specified contingent event, provided that such participation
is objectively determinable and nondiscretionary. While various types of contingencies may affect
participation, examples include securities that participate (1) on the basis of the entity’s earnings or
other performance measures or the entity’s common stock price or (2) upon discrete events such as
the occurrence of an IPO or business combination. If participation is based on conditions that are not
objectively determinable or that are at the entity’s discretion if the contingency occurs, allocation of
undistributed earnings to the security under the two-class method is precluded. Participation may be
considered not objectively determinable if it depends on a condition that is subject to interpretation (i.e.,
it is subjective rather than objective).
Undistributed earnings should be allocated to a participating security that
participates contingently only if the condition on which participation is
based is satisfied as of the reporting date.7 Thus, for each financial reporting period, an entity must evaluate
whether the relevant condition has been met as of the reporting date under
an assumption that all undistributed earnings for the period are
distributed.8 If the relevant condition is met, the entity should allocate earnings
to the participating security on the basis of an assumption that all
earnings for the period were distributed (regardless of whether an actual
distribution was made for the period). This reporting-date approach is
consistent with the approach to diluted EPS approach for contingently
issuable shares, which is discussed in Section 4.5. Because the condition may
be met as of some reporting-period dates and not others, such securities may
participate in undistributed earnings in some quarterly financial reporting
periods but not in others. Example
5-18 illustrates this concept.
5.5.2.5 Application to Specific Types of Participating Securities
5.5.2.5.1 Participating Preferred Stock
An entity should apply the two-class method to preferred stock only if the preferred stock meets the
definition of a participating security. See Section 5.3.3.2 and Examples 5-2, 5-3, and 5-4 for discussion of
whether preferred stock meets the definition of a participating security.
As discussed in ASC 260-10-45-60, the two-class method is “an earnings allocation formula that treats a
participating security as having rights to earnings that otherwise would have been available to common
shareholders.” In accordance with ASC 260, an entity that has participating preferred stock should
allocate distributed and undistributed earnings in calculating basic EPS under the two-class method as
follows:
- Distributed earnings — Distributed earnings allocable to participating preferred stock include (1) the amount of dividends declared in the current period on the preferred stock; (2) the amount of any unpaid cumulative dividends on the preferred stock for the current period; and (3) the amount of any other current-period “deemed dividends” or “deemed contributions” on the preferred stock.9 In summary, distributed earnings equal the dividends on the preferred stock that reduce net income in arriving at income available to common stockholders during the financial reporting period. Distributed earnings on cumulative preferred stock would not include the payment of dividends that have accumulated in a prior financial reporting period, since those accumulated dividends would have been considered distributed earnings in that prior financial reporting period.Distributed earnings on common stock and other participating securities are based on the amount of dividends declared during the current period. If an entity is required to reduce income available to common stockholders to reflect a down-round feature, as discussed in Section 3.2.5.3, that amount would also be treated as distributed earnings.
- Undistributed earnings — To arrive at undistributed earnings, an entity adjusts both income (loss) from continuing operations and net income (loss) (or income [loss] from continuing operations attributable to common stockholders of the parent and net income [loss] attributable to common stockholders of the parent if the entity had an NCI) by the amount of distributed earnings to arrive at undistributed earnings or losses. Undistributed earnings or undistributed losses are allocated to common stock and participating securities, including participating preferred stock, to the extent that each security may share in such earnings or absorb such losses (as determined on the basis of the contractual participation rights of each participating security) under an assumption that all of the undistributed earnings or losses for the period were distributed.
The total earnings or losses allocated to each security (i.e., the sum of distributed earnings and
undistributed earnings or losses) are divided by the number of the security’s outstanding units to
calculate basic EPS for the security. Diluted EPS is calculated under the two-class method, as discussed
in Section 5.5.4. ASC 260-10-45-60 indicates that entities are permitted, but not required, to present
basic and diluted EPS for a participating preferred security. See further discussion in Section 9.1.4.
For illustrations of how the two-class method is applied by an entity whose
capital structure includes preferred stock that meets the definition of
a participating security, see Examples 5-16, 5-20, 5-21, and
5-22.
Table 5-4 summarizes various scenarios
related to preferred stock. The table also summarizes scenarios
illustrating whether and, if so, how an entity with a capital structure
that includes preferred stock should apply the two-class method of
calculating EPS, depending on whether (1) dividends on the preferred
stock are cumulative or noncumulative and (2) the preferred stock is a
participating security. In the scenarios, it is assumed that:
-
The entity’s capital structure includes only a single class of common stock and a single class of preferred stock that were not issued in a share-based payment arrangement.
-
The entity did not declare or pay any dividends on common stock during the period. (If the entity had declared dividends on common stock, those dividends would be included in the distributed earnings under the two-class method.)
-
The preferred stock does not represent a redeemable equity security for which periodic measurement adjustments are required under ASC 480-10-S99-3A. (If the entity’s preferred stock had been remeasured to its redemption amount under ASC 480-10-S99-3A, those measurement adjustments would be reflected as dividends or distributed earnings on the preferred stock.)
-
The preferred stock does not contain a contractual obligation to share in losses. (If the preferred stock had a contractual obligation to absorb losses, which would be unusual, any undistributed losses would be allocated to the preferred stock.)
Table 5-4
Dividends on
Preferred Stock | Preferred Stock Meets the Definition of
Participating Security | Preferred Stock Does Not Meet the
Definition of Participating Security |
|---|---|---|
Cumulative (Regardless of Whether Declared or Paid) | ||
The entity
reports net
income for the
period that is
greater than
the cumulative
dividends on
preferred stock. | The two-class method applies.
Distributed earnings for the period equal
the cumulative dividends on preferred stock
for the period. The remaining undistributed
earnings for the period should be allocated
to the common stock and preferred stock
on the basis of the contractual participation
rights of each security as if all earnings for
the period were distributed. | The two-class method does not apply.
The entity should compute income available
to common stockholders (the numerator in
the calculation of basic EPS) by deducting
from net income the dividends on the
preferred stock that accumulated during the
period. |
The entity
reports net
income for the
period that is
less than the
cumulative
dividends on
preferred stock. | The two-class method applies.
Distributed earnings for the period equal
the cumulative dividends on preferred stock
for the period. The resulting undistributed
losses for the period should be allocated
entirely to the common stock. No
undistributed losses should be allocated to
the preferred stock because the preferred
stock does not contain a contractual
obligation to absorb losses. | The two-class method does not apply.
The entity should compute loss available to
common stockholders (the numerator in the
calculation of basic EPS) by deducting from
net income the dividends on the preferred
stock that accumulated during the period. |
The entity
reports net loss
for the period. | The two-class method applies.
Distributed earnings for the period equal
the cumulative dividends on preferred stock
for the period. The resulting undistributed
losses for the period should be allocated
entirely to the common stock. No
undistributed losses should be allocated to
the preferred stock because the preferred
stock does not contain a contractual
obligation to absorb losses. | The two-class method does not apply.
The entity should compute loss available to
common stockholders (the numerator in the
calculation of basic EPS) by adding to net
loss the dividends on the preferred stock
that accumulated during the period. |
Noncumulative (and Declared for the Period) | ||
The entity
reports net
income for the
period that is
greater than the
noncumulative
dividends on
preferred stock. | The two-class method applies.
Distributed earnings for the period equal
the noncumulative dividends declared
on preferred stock for the period. The
remaining undistributed earnings for the
period should be allocated to the common
stock and preferred stock on the basis of
the contractual participation rights of each
security as if all earnings for the period were
distributed. | The two-class method does not apply.
The entity should compute income available
to common stockholders (the numerator in
the calculation of basic EPS) by deducting
from net income the dividends on the
preferred stock that were declared during
the period. |
The entity
reports net
income for the
period that is
less than the
noncumulative
dividends on
preferred stock. | The two-class method applies.
Distributed earnings for the period equal
the noncumulative dividends declared on
preferred stock for the period. The resulting
undistributed losses for the period would be
allocated entirely to the common stock. No
undistributed losses should be allocated to
the preferred stock because the preferred
stock does not contain a contractual
obligation to absorb losses. | The two-class method does not apply.
The entity should compute loss available to
common stockholders (the numerator in the
calculation of basic EPS) by deducting from
net income the dividends on the preferred
stock that were declared during the period. |
The entity
reports net loss
for the period. | The two-class method applies.
Distributed earnings for the period equal
the noncumulative dividends declared on
preferred stock for the period. The resulting
undistributed losses for the period should
be allocated entirely to the common stock.
No undistributed losses should be allocated
to the preferred stock because the preferred
stock does not contain a contractual
obligation to absorb losses. | The two-class method does not apply.
The entity should compute loss available to
common stockholders (the numerator in the
calculation of basic EPS) by adding to net
loss the dividends on the preferred stock
that were declared during the period. |
Noncumulative (and Not Declared or Paid for the Period) | ||
The entity
reports net
income for the
period that is
greater than the
noncumulative
dividends on
preferred stock. | The two-class method applies.
There are no distributed earnings for the
period. Undistributed earnings for the
period should first be allocated to the
preferred stock in an amount equal to the
noncumulative dividends on preferred stock
for the period. The remaining undistributed
earnings for the period should be allocated
to the common stock and preferred stock
on the basis of the contractual participation
rights of each security as if all earnings for
the period were distributed. | The two-class method does not apply.
There should be no adjustments to net
income. Net income for the period should
represent the numerator in the calculation
of basic EPS. |
The entity
reports net
income for the
period that is
less than the
noncumulative
dividends on
preferred stock. | The two-class method applies.
There are no distributed earnings for the
period. Undistributed earnings for the
period (equal to net income for the period)
should be allocated entirely to the preferred
stock. No income or loss should be allocated
to the common stock. | The two-class method does not apply.
There should be no adjustments to net
income. Net income for the period should
represent the numerator in the calculation
of basic EPS. |
The entity
reports net loss
for the period. | The two-class method applies.
There are no distributed earnings for the
period. Undistributed losses (equal to net
loss for the period) should be allocated
entirely to the common stock. No income or
losses should be allocated to the preferred
stock because the preferred stock does not
contain a contractual obligation to absorb
losses. | The two-class method does not apply.
There should be no adjustments to net loss.
Net loss for the period should represent the
numerator in the calculation of basic EPS. |
See Section 5.5.2.5.3A for discussion of
application of the two-class method of calculating EPS to mandatorily
convertible preferred stock arrangements that contain a variable number
of common shares issuable upon settlement.
5.5.2.5.2 Participating Share-Based Payment Awards
ASC 260-10
Participating Securities and the Two-Class Method
45-68B Paragraph 718-10-55-45 requires that nonrefundable dividends or dividend equivalents paid on
awards for which the requisite service is not (or is not expected to be) rendered be recognized as additional
compensation cost and that dividends or dividend equivalents paid on awards for which the requisite service
is (or is expected to be) rendered be charged to retained earnings. As a result, an entity shall not include
dividends or dividend equivalents that are accounted for as compensation cost in the earnings allocation
in computing EPS. To do so would include the dividend as a reduction of earnings available to common
shareholders from both compensation cost and distributed earnings. Undistributed earnings shall be allocated
to all share-based payment awards outstanding during the period, including those for which the requisite
service is not expected to be rendered (or is not rendered because of forfeiture during the period, if an entity
elects to account for forfeitures when they occur in accordance with paragraph 718-10-35-3). An entity’s
estimate of the number of awards for which the requisite service is not expected to be rendered (or no
estimate, if the entity has elected to account for forfeitures when they occur in accordance with paragraph
718-10-35-3) for the purpose of determining EPS under this Topic shall be consistent with the estimate used
for the purposes of recognizing compensation cost under Topic 718. Paragraph 718-10-35-3 requires that an
entity apply a change in the estimate of the number of awards for which the requisite service is not expected
to be rendered in the period that the change in estimate occurs. This change in estimate will affect net income
in the current period; however, a current-period change in an entity’s expected forfeiture rate would not affect
prior-period EPS calculations. See Example 9 for an illustration of this guidance.
In addressing share-based payment awards granted to employees, ASC 718-10-35-3
states, in part, that “[t]he total amount of compensation cost
recognized at the end of the requisite service period for an award of
share-based compensation shall be based on the number of instruments for
which the requisite service has been rendered (that is, for which the
requisite service period has been completed).” Regarding the
determination of the amount of compensation cost to recognize in each
reporting period, ASC 718-10-35-3 allows entities to elect, as an
entity-wide accounting policy, to either (1) estimate forfeitures before
they occur (i.e., recognize compensation cost on the basis of the number
of share-based payment awards that are expected to vest) or (2)
recognize the effect on compensation cost of awards for which the
requisite service period is not rendered only when the award is
forfeited. The guidance in ASC 718-10-35-3 applies to all share-based
payment awards, regardless of their classification as an equity or
liability instrument.10
The accounting policy elected regarding the treatment of forfeitures will affect
how the entity treats dividends in applying the two-class method when it
has granted share-based payment awards that are participating securities
because they contain nonforfeitable rights to dividends before vesting.
The discussion below pertains to participating share-based payment
awards granted to employees that are classified as equity
instruments.11
-
Entity estimates forfeitures — Distributed earnings during a period will equal the current-period dividends on unvested participating share-based payment awards that are expected to vest (i.e., the amount of dividends on unvested participating share-based payment awards that have been charged to retained earnings during the period). Dividends on awards that are not expected to vest and that have been recognized as compensation expense are not considered distributed earnings under the two-class method since doing so would result in the “double counting” of such dividends. An entity should allocate undistributed earnings to all unvested participating share-based payment awards outstanding during the period on the basis of the weighted-average number of awards outstanding during the period. Undistributed losses are generally not allocated to share-based payment awards, as discussed in Section 5.5.2.2.
-
Change in estimated forfeitures — In accordance with ASC 718-10-35-3, in the period of a change in estimated forfeitures, an entity is required to adjust compensation cost to reflect the cumulative effect on current and prior periods of the change in the estimated number of instruments for which the requisite service period is expected to be or has been rendered. For equity-classified share-based payment awards, this adjustment will include two components: (1) a change in the amount of compensation cost recognized to date on the basis of the grant-date fair-value-based measure (i.e., an adjustment to compensation cost to cumulatively reflect the grant-date fair-value-based measure that should be recognized to date on the basis of the revised estimate of forfeitures) and (2) a change in the amount of compensation cost recognized to date for dividends declared on unvested awards (i.e., an adjustment to compensation cost [and retained earnings] to cumulatively reflect in compensation cost the dividends declared to date on awards that are not expected to vest, on the basis of the revised estimate of forfeitures). This adjustment should not affect previously reported EPS amounts. In the period in which the forfeiture adjustment is made, net income (the numerator) will be affected by the adjustment to compensation cost described above; however, there will be no effect on the application of the two-class method. The two-class method should reflect an allocation of current-period earnings, including the adjustment to compensation cost to reflect the change in estimated forfeitures. ASC 260 does not permit a cumulative adjustment to distributed earnings for a change in estimated forfeitures. Rather, in the period in which an adjustment is made to compensation expense for a change in estimated forfeitures, an entity should continue to allocate distributed earnings to unvested participating share-based payment awards on the basis of the amount of current-period dividends that are recognized in retained earnings for awards that have vested or that are expected to vest.12 The change in estimated forfeitures will also not affect the allocation of undistributed earnings in the period in which the change is made because the allocation of undistributed earnings to participating share-based payment awards does not depend on whether the outstanding awards are expected to vest. In summary, the adjustment that an entity must make to reflect the change in estimated forfeitures affects the entity’s net income during the period but not how the entity applies the two-class method of calculating EPS.
-
-
Entity accounts for forfeitures as they occur — Distributed earnings during a period will equal the current-period dividends on all unvested participating share-based payment awards (i.e., when an entity does not estimate forfeitures, it initially recognizes all dividends on unvested participating share-based payment awards within retained earnings). An entity should also allocate undistributed earnings to all unvested participating share-based payment awards outstanding during the period on the basis of the weighted-average number of awards during the period. Undistributed losses are generally not allocated to share-based payment awards, as discussed in Section 5.5.2.2.
-
Recognition of actual forfeitures — In accordance with ASC 718-10-35-3, an entity is required to recognize the effect of forfeitures as they occur. For equity-classified share-based payment awards, the adjustment recognized to reflect actual forfeitures will include two components: (1) a reduction in compensation cost equal to the amount of the grant-date fair-value-based measure recognized to date on the awards that are forfeited and (2) an increase in compensation cost equal to the amount of dividends declared to date on the awards that are forfeited (i.e., to cumulatively reflect the amount of dividends previously recognized in retained earnings that must be charged to expense because the awards did not vest). This adjustment should not affect previously reported EPS amounts. In the period in which the forfeitures occur and are recognized, net income (the numerator) will be affected by the adjustment to compensation cost described above; however, there will be no effect on application of the two-class method. The two-class method should reflect an allocation of current-period earnings, including the adjustment to compensation cost to reflect actual forfeitures. ASC 260 does not permit cumulative adjustments to distributed earnings to reflect actual forfeitures. Rather, in the period in which an adjustment is made to compensation expense to reflect actual forfeitures, an entity should continue to allocate distributed earnings to all unvested participating share-based payment awards in an amount equal to the current-period dividends declared on such awards. The recognition of forfeitures will also not affect the allocation of undistributed earnings in the period in which forfeitures occur because the allocation of undistributed earnings to participating share-based payment awards does not depend on whether the outstanding awards are expected to vest.
-
Connecting the Dots
The accounting policy an entity elects to account for forfeitures will affect the timing of the
recognition of compensation expense but will have no impact on the cumulative amount
of compensation expense recognized for a grant of equity-classified share-based payment
awards to employees once the requisite service period is completed. Regardless of the policy
an entity elects to account for forfeitures, the cumulative amount of compensation expense
recognized will be based on the awards that vest. While it may be intuitive to think that the
cumulative EPS impact under the two-class method would also be the same regardless of
the policy elected, this is not necessarily true because ASC 260 does not permit a cumulative
adjustment to distributed earnings in a reporting period to reflect the occurrence, or a change
in the estimate, of forfeitures that would have affected the amount of prior-period distributed
earnings. Cumulatively, basic EPS under the two-class method may be lower for an entity that
elects to account for forfeitures as they occur because dividends on awards that are forfeited
will ultimately be reflected in both distributed earnings and compensation cost (i.e., before
forfeiture, the dividends represent distributed earnings, and in the period in which the forfeiture
occurs, those same dividends must be reflected as compensation cost). The same phenomenon
may not occur when an entity estimates forfeitures because dividends on the awards not
expected to vest are initially treated as compensation cost (and therefore did not factor into
distributed earnings). The cumulative differences that could arise between the two approaches (i.e., recognizing forfeitures as they occur vs. estimating forfeitures) will ultimately depend on
the facts and circumstances, including the level of forfeitures and the significance of changes in
estimates when forfeitures are estimated for the purpose of recognizing compensation cost.
The policy election regarding the accounting for forfeitures should not, however, affect the
calculation of diluted EPS under the treasury stock method, which is based on the actual
number of nonforfeited awards regardless of an entity’s accounting policy election related to the
accounting for forfeitures. See ASC 718-10-45-1 for further discussion.
5.5.2.5.3 Mandatorily Redeemable Common Shares and Forward Contracts to Repurchase Common Shares
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.
Under ASC 480-10-45-4, when an entity has mandatorily redeemable common shares
or a forward purchase contract that must be physically settled by
repurchase of a fixed number of common shares in exchange for cash, the
common shares to be redeemed or repurchased are excluded from the
denominator in the calculation of basic and diluted EPS.13 While the outstanding common shares are excluded from the
denominator in the calculations of EPS, if the counterparty that owns
the common shares has a contractual right to participate in dividends
declared by the entity before the common shares are retired, the entity
must treat the excluded common shares as participating securities under
ASC 260. Under the two-class method, an entity adjusts the numerator for
any dividends declared or paid and undistributed earnings, but only to
the extent that these amounts have not been accounted for as interest
cost. Generally, no distributed earnings will be allocated to these
participating securities because the dividends will have been recognized
in earnings as interest cost; therefore, reflecting the distributed
earnings under the two-class method would result in “double-counting”
the impact on EPS. However, undistributed earnings must be allocated to
these participating securities in accordance with ASC 260-10-45-59A
through 45-70. As discussed in Section 3.2.4.3.1, the impact on
EPS of treating the common shares as participating securities will often
be the same as including the common shares in the denominator in the EPS
calculations when an entity has undistributed earnings. If, however, a
forward purchase contract on a fixed number of common shares contains
fixed adjustments to the forward price that are based on anticipated
dividends, the guidance in Section 5.3.3.5.2 applies and the
forward purchase contract is not a participating security.
ASC 480-10-45-4 only specifically applies to forward purchase contracts that involve the repurchase of
a fixed number of common shares in exchange for cash. The accounting for prepaid forward purchase
contracts that involve the repurchase of a fixed number of common shares and forward purchase
contracts on a variable number of common shares is discussed below.
5.5.2.5.3.1 Prepaid Forward Contracts to Repurchase Common Shares
An entity may enter into a forward contract to purchase a fixed number of common shares in exchange
for cash and prepay the forward price (i.e., a prepaid forward share purchase contract). A prepaid
forward share purchase contract does not meet the criteria to be accounted for as an asset or liability
under ASC 480-10-25-8 because it does not represent an obligation of the issuing entity to transfer
assets. More specifically, because the issuing entity prepays the forward price to the seller of the
common shares, it does not have an obligation to transfer assets in the future. This is the case even if
the entity is required to pay dividends to the counterparty when it declares dividends on its common
stock since an obligation to pay dividends does not exist before declaration.
While ASC 480-10-45-4 does not explicitly apply to prepaid forward share purchase contracts, it is
still generally appropriate to apply that guidance. That is, the common shares to be repurchased are
removed from the denominator in the calculations of basic and diluted EPS and the contract is treated
as a participating security if the counterparty that owns the common shares has a contractual right to
participate in dividends declared by the entity before the common shares are repurchased.
5.5.2.5.3.2 Forward Contracts to Repurchase a Variable Number of Common Shares
The EPS accounting for forward contracts to purchase a variable number of common shares in
exchange for cash depends on the facts and circumstances. If there is a minimum number of common
shares that will be repurchased and those shares have been removed from the denominator in the
calculation of basic and diluted EPS, the entity should apply the two-class method to the number of
common shares removed in a manner consistent with the guidance above if the counterparty has
a contractual right to participate in dividends declared by the entity before the common shares are
repurchased. When common shares are not removed from the denominator, since the common shares
are considered outstanding for EPS purposes, there is no need to treat them as participating securities
and the two-class method should not be applied. See further discussion in Section 3.2.4.3.1.
5.5.2.5.3A Forward Contracts to Sell a Variable Number of Common Shares
Section 5.3.3.5.3 addresses when a VSF contract represents a participating security. As noted in that discussion, if the following two conditions are met, a VSF contract constitutes a participating security and the two-class method of calculating EPS must be applied:
- The VSF contract does not entitle the counterparty to participate in dividends if it is settled within the final range.
- At the inception of the VSF contract, it is not at least reasonably possible that the contract ultimately will be settled within the final range.
When the two-class method of calculating EPS is required for a VSF contract
because it is not at least reasonably possible that the contract
ultimately will be settled within the final range, ASC 260 is not clear
on how earnings should be allocated to the participating security.
Therefore, either of the following two approaches would be acceptable as
an accounting policy election that is consistently applied:
-
Full impact approach — The full amount of distributed and undistributed earnings would be allocated to the VSF contract (i.e., the participating security). As a result, dividends may be allocated to the participating security that are in excess of the economic benefit that the holder receives from the actual and assumed distribution of earnings.
-
Incremental impact approach — The amount for which the VSF contract is considered to participate in earnings should equal the value of the additional common shares that results from distributed and undistributed earnings, under the assumption that all earnings for the period were distributed as dividends. In other words, the amount of participation by the VSF contract would be limited to the economic benefit, if any, to which holders of the VSF contract would be entitled if all earnings were distributed. This approach may involve a calculation of the difference between settlement amounts under the assumption that settlement occurs (1) outside the final range and (2) within the final range.
These same two approaches would also be acceptable if an entity has issued a
mandatorily convertible preferred stock instrument whose range
settlement provisions are similar to those of the VSF contracts
discussed in Section
5.3.3.5.3.
5.5.2.5.4 Participating NCIs and Equity Method Investments
An entity may report an NCI in a consolidated subsidiary (or own an equity
method investee) that has issued participating securities or that has
multiple classes of common stock. In these circumstances, basic and
diluted EPS must be calculated at the subsidiary (investee) level by
using the two-class method to determine the amount of the subsidiary’s
(investee’s) income available to common stockholders that is
attributable to the parent (investor). The parent’s (investor’s) portion
of the EPS amount of the subsidiary (investee) is included in the
numerator in the parent’s (investor’s) calculation of EPS. The parent’s
portion is determined by multiplying the number of shares of the
subsidiary’s (investee’s) common stock owned by the parent by the
subsidiary’s (investee’s) basic and diluted EPS amounts. The product of
these two amounts is included in the numerator in the parent’s
(investor’s) calculation of the consolidated group’s basic and diluted
EPS. In these circumstances, it is necessary to use the two-class method
to calculate the subsidiary’s (investee’s) basic and diluted EPS,
regardless of whether the subsidiary (investee) separately reports EPS.
See further discussion in Section 8.8.1.1.
Special considerations are necessary when an entity has an NCI in a consolidated
subsidiary in the form of common stock and that interest is redeemable
at an amount other than fair value, regardless of whether the redemption
obligation is an obligation of the subsidiary or its parent. In these
situations, the two-class method of EPS must be applied. See further
discussion in Sections
3.2.3.3 and 8.8.4.
An NCI in a consolidated subsidiary in the form of common stock or potential
common stock may participate in the earnings of the parent. An NCI in a
consolidated subsidiary in the form of preferred stock may also
participate in earnings of the parent. In these situations, the parent
should reflect the impact of such participation by applying the
two-class method after it has included 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 taken into
account in the determination of the amount of the parent’s undistributed
earnings that is allocated between the NCI and the parent’s common
stockholders. If the NCI that participates in the parent’s earnings is
also redeemable, the impact of the redemption provisions on the
calculation of the parent’s basic EPS must be considered. The impact of
such a redeemable NCI will depend on whether the NCI is in the form of
common stock or preferred stock. See Section 8.8.4 for additional
discussion of the accounting for redeemable NCIs.
5.5.2.5.5 Master Limited Partnerships
See Section 8.9.3.1
for discussion of the application of the two-class method to MLPs
containing incentive distribution rights that are treated as
participating securities.
5.5.3 Application of Two-Class Method to Multiple Classes of Common Stock
5.5.3.1 Redeemable Common Shares
An entity may have common shares that are redeemable securities. As discussed in Section 3.2.4.2, the
impact of the redemption feature on the calculation of EPS depends on the nature of the redemption
feature (i.e., fair value vs. non–fair value).
If an entity has common shares that are redeemable at fair value, in accordance with ASC 480-10-S99-3A(21), the two-class method of calculating EPS is not required solely because of the redemption
feature in the common stock. Similarly, the two-class method is not required when share-based
payment awards granted to employees are redeemable at fair value (provided that those awards are
in the form of common shares or options on common shares). However, an entity may be required to
apply the two-class method if it has determined that, for reasons other than the fair value redemption
feature, it has multiple classes of common stock or if it has determined that a share-based payment
award is a participating security. If the two-class method is applied for reasons other than the fair value
redemption feature, any change in the carrying amount to reflect the fair value redemption under the
subsequent-measurement guidance in ASC 480-10-S99-3A should not be treated as a dividend or
distributed earnings.
If an entity has common shares that are redeemable at any amount other than fair
value, in accordance with ASC 480-10-S99-3A(21), the entity must apply the
two-class method and any increase in the carrying amount of the redeemable
common stock under the subsequent-measurement guidance in ASC 480-10-S99-3A
should be treated as a dividend. Changes in the carrying amount of the
redeemable common stock should not affect income available to common
stockholders but should be treated as distributed earnings under the
two-class method. 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 qualifies for the exception in ASC
480-10-S99-3A(3)(f)), an amount that is other than the fair value of the
common shares, that common shareholder has, in substance, received a
distribution different from that of other common shareholders. Under ASC
260-10-45-59A, entities with capital structures that include a class of
common stock with dividend rates that differ from those of another class of
common stock, but without prior or senior rights, should apply the two-class
method of calculating EPS. As discussed in Section 3.2.4.2, there are two methods
an entity may apply to determine the amount of any increase in the carrying
amount of common stock redeemable at an amount other than fair value that is
treated as a dividend or distributed earnings under the two-class
method.
In addition to the impact of distributed earnings, when the two-class method is applied, the entity must
allocate undistributed earnings (losses) to the redeemable common shares. See Section 3.2.4.2 for
further discussion of redeemable common securities.
5.5.3.2 Multiple Classes of Common Stock With the Same Rights to Distributions
As discussed in Section
5.4.1, in the calculation and presentation of EPS, an entity
may have multiple classes of common stock even if each class has the same
dividend rate. Since basic and diluted EPS must be presented for each class,
the entity should use the two-class method to calculate EPS. Since the
allocation of undistributed earnings is based on a hypothetical assumption
of the distribution of earnings on the basis of the weighted-average shares
of each class of common stock outstanding, in the calculation of basic EPS,
in the absence of participating securities that affect only one class, the
undistributed EPS of each class would generally be expected to be the same.
However, the distributed earnings allocated to each class must be based on
the actual dividends declared (or other distributions made) during the
financial reporting period. Thus, the distributed earnings component per
share will be the same for each class only when the actual and
weighted-average shares of each class are the same during the financial
period. When the actual and weighted-average shares of each class are not
the same, the basic EPS for each class of common stock would not be expected
to be the same, even though each of these classes of common stock has the
same contractual right to dividends (i.e., the same dividend rate per
share).
In addition, diluted EPS under the two-class method could also differ for each class depending on the
facts and circumstances, including the nature of securities and potential common shares in an entity’s
capital structure. See Section 5.5.4 for further discussion of the calculation of diluted EPS under the
two-class method.
5.5.3.3 Allocating Undistributed Losses When an Entity Has Multiple Classes of Common Stock
When an entity’s capital structure includes multiple classes of common stock to
which it must apply the two-class method, and the entity reports
undistributed losses, questions have arisen regarding whether each class of
common stock should participate in the allocation of the undistributed
losses. The guidance in ASC 260-10-45-67 and 45-68 on whether participating
securities absorb undistributed losses is not relevant to the allocation of
undistributed losses to a class of common stock but should be applied only
to participating securities (i.e., securities in a form other than an
outstanding common share). When an entity has multiple classes of common
stock, undistributed losses should be allocated to each class on the basis
of on their contractual terms, regardless of whether the classes have
specifically stated contractual obligations to absorb losses. However, the
allocation of undistributed losses may differ from the allocation of
undistributed earnings. For example, if an entity has two classes of common
stock that share equally in the entity’s residual net assets on liquidation
but have different participation rights to dividends, the entity should
allocate undistributed losses equally to each class. If, however, the rights
to share in the distribution of the residual net assets of the entity are
unequal between the classes, the entity should generally allocate
undistributed losses in accordance with the contractual distribution rights
upon liquidation.14 The entity should also carefully consider whether any liquidation
preference causes one of the classes to be more representative of a
preferred security for EPS purposes (see Section 3.1.1).
5.5.3.4 One Class of Common Stock Is Convertible Into Another Class
An entity may have two classes of common stock in which one class is convertible into the other class.
For this purpose, we refer to the class that is convertible into the other class as the “convertible class”
and the class of common stock into which the convertible class is convertible as the “main class.”
At the 2006 AICPA Conference on Current SEC and PCAOB Developments, Cathy Cole,
then associate chief accountant in the SEC’s Office of the Chief Accountant,
gave a speech addressing how an entity should apply ASC 260
when it has one class of common stock that is convertible into another
class. Ms. Cole stated that the SEC staff believes that an entity must use
the two-class method to present basic EPS for each class of common stock.
ASC 260 prohibits an entity from applying the if-converted method to the
convertible class or the main class in the calculation of basic EPS.
In these situations, an entity must also present diluted EPS for each class. Ms. Cole explained that an
entity should use the if-converted method when calculating diluted EPS of the main class, provided that
the conversion of the convertible class into the main class is dilutive (and that the if-converted method
is more dilutive than the two-class method of calculating diluted EPS). An entity should not apply the
if-converted method in calculating diluted EPS of the convertible class. Rather, diluted EPS for the
convertible class should be calculated by using the two-class method, as if all earnings were distributed
to each class of common stock on the basis of their contractual rights. For this purpose, an entity must
consider potential common shares of the convertible class by using the treasury stock method, the
if-converted method, or the contingently issuable share method, as applicable (see Section 5.5.4 for
further discussion of the application of the two-class method to the calculation of diluted EPS).
Ms. Cole referred to an example in which Class B common shares are convertible into Class A common
shares and stated, in part:
The first situation relates to diluted [EPS] when one class of common is
convertible into another class of common. [ASC 260] requires the use
of the two-class method of computing EPS in certain circumstances,
namely, when there is more than one class of common stock and the
classes have different dividend rates or when there are other
securities that have a right to participate in dividends with common
stock. . . .
As an example, a company may have two classes of common stock, say Class A and
Class B. Class A may be entitled to dividends at a rate that is 1.2
times that of Class B, but Class B may have twice the voting rights
of Class A. Class B may also be convertible at any time into Class A
on a 1 to 1 basis. . . .
[T]he staff believes that for diluted EPS, a company with two classes of common stock must actually present
both a basic and diluted earnings per share number for each class of common stock regardless of conversion
rights. One might ask, “If for diluted EPS, I have assumed the conversion of one class into the other, how can
I then present two diluted earnings per share numbers, one for each class? Doesn’t assuming the conversion
of one class into the other essentially eliminate the second class for diluted EPS purposes?” Well, for the
class being converted into (Class A in the example), we believe diluted EPS should be computed using the
if-converted method for the convertible class (Class B), if doing so would be dilutive. Diluted EPS for the
convertible class (Class B in the example) should be computed using the two-class method. Diluted EPS must
be presented for both classes.
You may ask, “What is the point of this second computation?” Why can’t the company just present diluted EPS
for Class A and be done with it? Well, there are several reasons for the presentation of diluted EPS for Class B.
The first reason is that while presenting diluted EPS for Class A assuming conversion of Class B may be more
dilutive for Class A, the assumed conversion might in fact be antidilutive for Class B. In our simple example, if
Class A is entitled to $1.20 of dividends for every $1.00 of dividends for Class B, then if Class B is allowed to share equally in earnings with Class A, then Class B would be entitled to a higher share of earnings on a diluted
basis assuming conversion, than it would be entitled to absent the conversion. Further, Class B shareholders
might be interested in knowing what diluted EPS would be for Class B shares, if the shares were not converted
into Class A. This might be especially true in circumstances where potential common shares would also affect
the computation.
The second reason for presenting EPS for Class B is that presenting diluted EPS only for Class A is inconsistent
with the guidance of [ASC 260-10-45-60B], which that says that basic and diluted EPS data should be presented
for each class of common stock. Thus, if there are two classes of common stock that means two sets of EPS
data. I just think of it as double the numbers . . . double the fun. Obviously though, the company should also
provide the appropriate footnote disclosures explaining its computation of basic and diluted EPS.
The SEC staff’s view is an appropriate interpretation of ASC 260 and should be
applied by all entities that present EPS under ASC 260.
In her remarks at the 2006 AICPA Conference, Ms. Cole also addressed the SEC
staff’s views on a particular scenario involving the application of the
two-class method by an entity that has two classes of common stock. She
stated:
There were two classes of common stock, let’s call
these A and B. Class A was entitled to one vote per share; Class B
was entitled to ten votes per share. The company’s articles of
incorporation stated that dividends could be paid on Class A without
an equal or any dividend being paid on Class B. However, dividends
could not be paid on Class B without an equal amount being paid on
Class A. Further, Class B was convertible into Class A on a 1-to-1
basis at any time. And, Class B common stock controlled
approximately 75% of the shareholder votes of the company. Classes A
and B shared equally in the net assets of the company on
liquidation. The company had historically paid dividends equally to
both classes. In applying the two-class method, the company had
allocated the undistributed earnings equally on a per share basis to
both classes.
In this case, there was no contractually
predetermined ratio of dividends between the classes of common
stock. [ASC 260], if applied literally in this situation, would have
resulted in no allocation of undistributed earnings to the Class B
common stock. Since the articles of incorporation provided that all
the earnings could be entirely distributed to Class A without any
distribution to Class B, no allocation would be made to Class B.
[ASC 260-10-45-65] states that “ . . . if an entity could avoid
distribution of earnings to a participating security, even if all of
the earnings for the year were distributed, then no allocation of
that period’s earnings to the participating security would be
made.”
However, company management believed it was
appropriate to allocate undistributed earnings between the two
classes on a 1-to-1 basis. Management believed that the allocation
of undistributed earnings must be done considering all of the rights
and privileges of the different shareholder groups. They thought
that it was unreasonable to think that the Class B common
stockholders that control the Board would systematically allow the
Board to pay dividends on Class A shares without paying them on
Class B as well. Also, since the Class B was convertible at any time
into Class A, the Class B stockholders could convert and capture any
differential dividend, after it was declared. But, although Class B
controlled the Board, the Board could not pay dividends on Class B
without paying an equal amount on Class A.
After additional consideration and consultation, we
came to believe that the particular facts in this case justified a
different answer from a strict application of [ASC 260]. The SEC
staff believes that the [guidance on the two-class method] was
generally written in the context of classes of participating
securities that do not control the company and that applying [such
guidance] by analogy in this case did not produce the most
transparent reporting. Thus, the staff did not object to the
company’s judgment on how to apply the two-class method in this
case. We did suggest that the company provide disclosures of the
factors it considered in determining that its methodology was
appropriate.
This view is also an appropriate interpretation of ASC 260 that should be
applied by all entities that present EPS under ASC 260.
5.5.3.5 Master Limited Partnerships
See Section 8.9.3.1
for discussion of the application of the two-class method to MLPs that
contain incentive distribution rights that are treated as part of the
general partner’s interest.
5.5.4 Calculation of Diluted EPS Under the Two-Class Method
ASC 260 does not specifically address how to apply the two-class method to the calculation of diluted EPS. In practice, however, entities have applied the approach outlined in proposed FASB FSP FAS 128-a. Under that approach, an entity applies the following three-step process to calculate diluted EPS under the two-class method:
- Step 1 — Use the two-class method to calculate basic EPS.
- Step 2 — Use the total earnings allocated to common stock in step 1 to determine diluted EPS. If a participating security is also a potential common share, separately perform steps 2a and 2b to determine the dilutive effect.
- Step 2a — Assume that the participating security has been exercised, converted, or issued; that is, apply the treasury stock method, the if-converted method, or the contingently issuable share method.
- Step 2b — Add back the undistributed earnings allocated to the participating security (or securities) in arriving at basic EPS, and assume that all other dilutive potential common shares have been exercised, converted, or issued in order of antidilution. Next, reallocate the undistributed earnings — including any additional income that would result from the exercise, conversion, or issuance of potential common shares — to the (1) common shares and potential common shares and (2) participating security (or securities).
- Step 3 — Determine which step — 2a or 2b — results in the more dilutive effect.
The following should be noted regarding this three-step process:
- While step 2b requires a reallocation of undistributed earnings to common shares, potential common shares, and participating securities that are not assumed exercised, converted, or issued under step 2a, it is never appropriate to reverse or reallocate distributed earnings.
- As discussed in Section 4.7.3, for certain contracts that are assumed to be share-settled for diluted EPS purposes, an adjustment must be made to the numerator. The amount of this numerator adjustment would affect the amount of undistributed earnings to be reallocated under step 2b.
Further, an entity that has multiple classes of common stock must calculate diluted EPS for the second
class of common stock by using the two-class method, under an assumption that additional common
shares of the first class of common stock are outstanding as a result of the conversion of all potential
common shares outstanding. In such circumstances, the entity is required to reallocate undistributed
earnings to the second class of common stock. If there are potential common shares related to the
second class of common stock, diluted EPS reflects the more dilutive of the two-class method or the
applicable dilutive method (e.g., the treasury stock, if-converted, or contingently issuable share method)
for the second class of common stock.
While diluted EPS for the first class of common stock may reflect the conversion of the second class of
common stock into the first class of common stock, such conversion may not be assumed for diluted
EPS for the second class of common stock.
5.5.5 Examples
ASC 260 contains two examples illustrating the calculation of basic EPS under the two-class method
when there are participating securities outstanding. Those examples are reproduced below.
ASC 260-10
Example 6: Two-Class Method
55-62 This Example illustrates the two-class method of computing basic EPS (see paragraph 260-10-45-60B)
for an entity that has more than one class of nonconvertible securities. This method is described in paragraphs
260-10-45-59A through 45-70. Diluted EPS would be computed in a similar manner. This Example has the
following assumptions for the year 20X0:
- Net income was $65,000.
- 10,000 shares of $50 par value common stock were outstanding.
- 5,000 shares of $100 par value nonconvertible preferred stock were outstanding.
- The preferred stock was entitled to a noncumulative annual dividend of $5 per share before any dividend is paid on common stock.
- After common stock has been paid a dividend of $2 per share, the preferred stock then participates in any additional dividends on a 40:60 per-share ratio with common stock. (That is, after preferred and common stock have been paid dividends of $5 and $2 per share, respectively, preferred stock participates in any additional dividends at a rate of two-thirds of the additional amount paid to common stock on a per-share basis.)
- Preferred stockholders have been paid $27,000 ($5.40 per share).
- Common stockholders have been paid $26,000 ($2.60 per share).
55-63 Basic EPS for 20X0 would be computed as follows.
Example 9: Participating Securities and the Two-Class Method
55-71 Participating
securities should be included in the computation of
basic earnings per share using the two-class method. The
following Cases illustrate the guidance in paragraphs
260-10-45-59A through 45-70 for the application of the
two-class method of computing basic earnings per share
when:
-
An entity has participating convertible preferred stock (Case A).
-
An entity has participating convertible bonds (Case B).
-
An entity has participating warrants (Case C).
-
An entity has participating share-based payment awards (Case D).
55-72 The application of the two-class method in each of Cases A, B, and C presents an EPS calculation for
both the common stock and the participating security. This presentation is for illustrative purposes only. The
presentation of EPS is only required for each class of common stock (as clarified by this Example). However, the
presentation of basic and diluted EPS for a participating security other than common stock is not precluded.
Cases A, B, and C share both of the following assumptions:
- 10,000 shares of Class A common stock
- Reported net income of $65,000 for 20X1.
Case A: Participating Convertible Preferred Stock
55-73 Assume that Entity A had 5,000 shares of preferred stock outstanding during 20X1. Each share of
preferred stock is convertible into two shares of Class A common stock. The preferred stock is entitled to a
noncumulative annual dividend of $5 per share. After Class A has been paid a dividend of $2 per share, the
preferred stock then participates in any additional dividends on a 40:60 per share ratio with Class A. For 20X1,
the Class A shareholders have been paid $26,000 (or $2.60 per share), and the preferred shareholders have
been paid $27,000 (or $5.40 per share). Basic EPS under the two-class method for 20X1 would be computed as
follows.
Case B: Participating Convertible Debt Instrument
55-74 Assume that on January 1, 20X1, Entity A issues 1,000 30-year convertible bonds with an aggregate par
value of $1,000,000. Each bond is convertible into 8 shares of Class A common stock and carries a coupon
rate of 3 percent. After Class A has been paid a dividend of $2 per share, the bondholders then participate
in any additional dividends on a 40:60 per share ratio with Class A shareholders. The bondholders receive
common stock dividends based on the number of shares of common stock that the bonds are convertible
into. The bondholders do not have any voting rights prior to conversion into common stock. For 20X1, the Class
A shareholders have been paid $20,000 (or $2.00 per share). Basic EPS under the two-class method for 20X1
would be computed as follows.
Case C: Participating Warrants
55-75 Assume that Entity A had warrants to purchase 5,000 shares of common stock outstanding during 20X1.
Each warrant entitles the holder to purchase 1 share of common stock at $10 (fair value at date of grant) per
share. In addition, the warrant holders receive dividends on the underlying common stock to the extent they
are declared. For 20X1, common shareholders have been paid $26,000 (or $2.60 per share), and the warrant
holders have been paid $13,000 (or, also, $2.60 per share). Basic EPS under the two-class method for 20X1
would be computed as follows:
Case D: Participating Share-Based Payment Awards
55-76A Assume that Entity A had 25,000 shares of common stock and 5,000 unvested share-based payment
awards outstanding during 20X8 and reported net income of $100,000. The share-based payment awards
participate in any dividends on a 1:1 per-share ratio with common stock, and the dividends are nonforfeitable
by the holder of the share-based payment awards. Entity A’s accounting policy is to estimate the number of
forfeitures expected to occur in accordance with paragraph 718-10-35-3.
55-76B As of the beginning of 20X8, Entity A estimated that the requisite service will not be provided for 200 of
the 5,000 share-based payment awards outstanding. At the end of 20X8, Entity A adjusts its estimate to reflect
an increased expected forfeiture rate and now expects that the requisite service will not be provided for 300
awards. It recognizes the cumulative effect of this change in compensation cost in the current period.
55-76C Entity A paid a $1.50 per-share dividend at the end of 20X8. Net income includes an expense of $450
related to dividends paid to the awards for which the requisite service is not expected to be rendered in
accordance with paragraph 718-10-55-45. Basic EPS under the two-class method for 20X8 would be computed
as follows:
55-76D Note that in this illustrative example, application of the two-class method presents an EPS calculation
for both the common stock and the participating security, that is, the unvested share-based payment awards.
This presentation is for illustrative purposes only. The presentation of EPS is only required for each class of
common stock. However, the presentation of basic and diluted EPS for a participating security other than
common stock is not precluded. The disclosure in the notes to financial statements of actual distributions
to unvested share-based payment awards, rather than the amount presented as distributed earnings,
also is not precluded to reconcile earnings per common share and per unvested share-based payment
awards. For example, Entity A in the example above may disclose that actual distributions to unvested share-based
payment awards were $7,500 and that $450 of those distributions was included in net income as
compensation cost related to awards for which the requisite service is not expected to be rendered. Disclosure
on a per-share basis also is not precluded.
Below are additional examples illustrating the application of the two-class method.
Example 5-14
Allocation of Undistributed Earnings to Entity With “Waterfall” Formula
Entity C’s capital structure consists entirely of 1 million shares of Class A common stock and 1 million shares
of Class B common stock. Each Class A and Class B share is entitled to one vote on any matter submitted to a
vote of shareholders. Entity C’s certificate of incorporation specifies that C will make annual distributions on the
basis of the following waterfall allocation:
- First, Class A receives $0.25 per share.
- Next, Class B receives $0.25 per share.
- Last, earnings are distributed 40:60 to Class A and Class B on a per-share basis.
During the year ended December 31, 20X1, C reports the following amounts of net income:
Entity C makes distributions annually in March from the prior year’s earnings. The total amount distributed
must be approved by a majority vote of the Class A and Class B shareholders. According to C’s shareholder
agreement, the total distribution will equal the prior year’s distributable cash less any reserves approved
for future expenditures. Such distributions are not approved until after the audited financial statements for
the prior year are issued. This example is not intended to address whether C should calculate an amount of
distributed earnings during the current year or how C should treat any current-year distributions of prior-year
earnings. To determine these matters, an entity would need to use judgment and consider the relevant facts
and circumstances related to distributions. In this example, it is first assumed that there are no distributed
earnings for the year. The example then addresses how the EPS amounts would change if the current-year
earnings were considered distributed earnings during the fourth quarter.
No Distributed Earnings
For the annual period, C would allocate earnings under the two-class method of calculating basic and diluted
EPS as follows (note that the results would be the same if the earnings for the year were distributed earnings
for the fourth quarter):
For the annual period, basic and diluted EPS for each class of common stock would be calculated as follows:
The calculation of basic and diluted EPS for each interim period during the year
depends on which method in Section 5.5.1.1 is
applied (i.e., because the distributions are determined
on the basis of a waterfall that depends on the annual
period, the two views discussed in Section 5.5.1.1 are
acceptable). The allocation of undistributed earnings
according to the two views is as follows:
View A — Discrete-Period Basis
Under the discrete-period approach, it is assumed that earnings for each interim period are distributed in
accordance with the contractual distribution rights of each class of common stock as if the waterfall distribution
applied to the earnings for the interim period. As a result, Class B only receives a distribution in an interim
period in which undistributed earnings exceed $250,000.
View B — Cumulative-Period Basis
Under the cumulative-period approach, it is assumed that earnings on an interim basis are distributed in
accordance with the contractual distribution rights of each class of common stock in a manner consistent with
the application of the waterfall distribution to annual earnings. As a result, the allocation of earnings in quarters
after the first quarter is based on the cumulative amounts that would be allocated on the basis of the year-to-date
earnings. The distributions are as follows:
- First quarter — All of the first-quarter earnings are allocated to the Class A common stock because it is entitled to the first $250,000 of distributions.
- Second quarter — All of the second-quarter earnings are allocated to the Class B common stock because it is entitled to the next $250,000 of distributions. Since there was only $200,000 of earnings during the second quarter, the next $50,000 of earnings is carried over for allocation to Class B.
- Third quarter — Class B is entitled to the first $50,000 of the earnings for the third quarter. The remaining $250,000 is allocated on a 40:60 basis to Class A and Class B, resulting in the allocation of $100,000 and $150,000 of the remaining earnings to Class A and Class B, respectively.
- Fourth quarter — The $250,000 is allocated on a 40:60 basis to Class A and Class B, resulting in the allocation of $100,000 and $150,000 of the earnings to Class A and Class B, respectively.
According to the two views, basic and diluted EPS for the interim periods is as follows:
Under View B, the aggregate interim-period EPS amounts equal the annual amounts. This may not always be
the case. Under View A, the aggregate interim-period EPS amounts would not be expected to equal the annual
amounts.
Distributed Earnings
If the current-year earnings were distributed earnings in the fourth quarter (i.e., C declared a distribution, or it
was concluded that $1 million was equal to distributable cash for the year for which distribution was required),
the interim-period EPS for the first three quarters would not change according to each view. The fourth-quarter
EPS amounts would be as follows:
View A — Discrete-Period Basis
The EPS amounts for each class depend on how the Class A and Class B shares absorb undistributed losses.
Assume that the proceeds on liquidation are allocated pari passu (50:50) to each class. The EPS amounts would
be as follows:
Assume that the proceeds on liquidation are allocated in accordance with the 40:60 allocation of residual
earnings under the waterfall distribution. The EPS amounts would be as follows:
View B — Cumulative-Period Basis
The EPS amounts for each class would be unchanged from the fourth-quarter amounts under View B when
there were no distributed earnings because the earnings allocation is based on an annual distribution
approach. The distributed and undistributed earnings components for the fourth quarter would be as follows:
Example 5-15
Application of Two-Class Method — Interim and
Year-to-Date Basis
Entity R, a real estate investment trust, is required to
distribute at least 90 percent of its taxable income.
Entity R has the following classes of equity securities outstanding:
- One million shares of common stock.
- One million shares of participating cumulative preferred stock.
The preferred stock ranks senior to the
common stock with respect to the rights to receive
dividends and to participate in distributions upon
liquidation. Dividends on the preferred stock are paid
monthly. Holders of preferred stock are entitled to
receive, in preference and before any payment of
dividends on common stock, a monthly dividend of $1.50
per share ($18.00 per share, per annum). After payment
of this amount, holders of preferred stock are entitled
to participate in dividends paid on common stock on an
as-converted basis. The preferred stock does not absorb
any undistributed losses. The preferred stock is
convertible into 500,000 shares of common stock.
Assume the following for the six months ended June 30,
20X9:
- First quarter ended March 31, 20X9:
- Entity R’s net income was $20 million.
- Entity R declared $18 million
of dividends, consisting of the following:
- $4.5 million on the preferred stock at the stated monthly rate (1,000,000 × $1.50 × 3).
- $4.5 million on the preferred stock (based on participation in dividends declared on common stock).
- $9 million on common stock.
- Second quarter ended June 30, 20X9:
- Entity R’s net income was $3 million.
- Entity R declared $4.5 million of dividends, consisting only of the dividends on the preferred stock at the stated monthly rate (1,000,000 × $1.50 × 3).
On the basis of the above facts, R
would report the following amounts of basic EPS for the
quarterly and year-to-date periods:
Example 5-16
Application of Two-Class Method When Distributions Exceed
Earnings
Entity A has 1 million weighted-average common shares outstanding for the fiscal year ended December
31, 20X1, and current-period net income of $2 million. On January 1, 20X1, A issues 100,000 convertible
preferred securities. Each preferred share is convertible into two shares of A’s common stock. The preferred
shareholders are entitled to a noncumulative annual dividend of $5 per share before any dividend is paid
to the common shareholders. After the common shareholders are paid a dividend of $2 per share, the
preferred shareholders participate in any remaining undistributed earnings on a 40:60 per-share basis with
the common shareholders. Accordingly, the preferred securities are participating securities for which A must
use the two-class method to calculate basic and diluted EPS. However, the contractual terms of the preferred
securities do not address whether they would participate in the entity’s losses. In fiscal year 20X1, A declared
and paid $2.5 million in dividends (or a $5 dividend for preferred shareholders and a $2 dividend for common
shareholders).
Undistributed losses should be calculated under the two-class method as follows:
Undistributed losses should be allocated as follows:
- To participating convertible preferred shares — Because the contractual terms of the preferred securities do not address whether the preferred shareholders would participate in the entity’s losses, the undistributed losses should be allocated only to the common shareholders.
- To common shares — ($500,000) ÷ 1,000,000 weighted-average common shares outstanding = ($0.50) per share.
Amounts of basic EPS would be as follows:
Example 5-17
Application of Two-Class Method When Distributions Exceed Earnings for Share-Based Payment
Awards
Entity B has 1 million weighted-average common shares outstanding for the fiscal year ended December 31,
20X1, and current-period net income of $1 million. On January 1, 20X1, A issues 250,000 nonvested share-based
payment awards to its employees. Holders of nonvested shares have a nonforfeitable right to receive
cash dividends on a 1:1 per-share basis with the common shareholders. Accordingly, the nonvested shares
are participating securities for which A must use the two-class method to calculate basic and diluted EPS.
The contractual terms of the nonvested shares do not address whether they would participate in the entity’s
losses. In fiscal year 20X1, A declares and pays $2.5 million in dividends for both the common shares and the
nonvested shares (or a $2 dividend for both the common shareholders and holders of the nonvested share-based
payment awards).
Undistributed losses should be calculated under the two-class method as follows:
Undistributed losses should be allocated as follows:
- To nonvested shares — Because the contractual terms of the nonvested shares do not address whether the holders of nonvested share-based payment awards would participate in the entity’s losses, the undistributed losses should be allocated only to the common shareholders.
- To common shares — ($1,500,000) ÷ 1,000,000 weighted-average common shares outstanding = ($1.50) per share.
Example 5-18
Participation Contingent on Stock Price
Entity B, which has a calendar year-end, has outstanding convertible preferred stock that entitles the holders to
participate in dividends on common stock on a one-for-one share-equivalent basis with common shareholders
at any time dividends are declared, provided that the fair value of B’s common stock exceeds $25 per share for
any three consecutive days during the period within the current fiscal year since dividends were last declared.
If the market price contingency is met (i.e., the fair value of B’s common stock exceeds $25 per share for any
three consecutive days in the reporting period), the two-class method should be applied to the convertible
preferred stock for the financial reporting period on the basis of an assumption that all earnings for the period
have been distributed (regardless of whether any dividends actually have been declared). This treatment is
consistent with how earnings would be allocated between the common stock and convertible preferred stock if
all earnings for the period were actually distributed.
Assume that during the first quarter ended March 31, 20X1, the fair value of B’s common stock did not exceed
$25 for any three-consecutive-day period, but that for the second quarter ended June 30, 20X1, the fair value
of B’s common stock did exceed $25 for a three-consecutive-day period. Further assume that B did not declare
or pay any dividends on common stock during the year. For B’s calculation of EPS for the first quarter ended
March 31, 20X1, no undistributed earnings should be allocated to the convertible preferred stock because
the market price contingency has not been met. For B’s calculation of EPS for the second quarter ended June
30, 20X1, undistributed earnings should be allocated to the convertible preferred stock because the market
price contingency has been met. Since the allocation of undistributed earnings on a year-to-date basis is
determined on an independent, or discrete, basis, as discussed in Section 5.5.1.1, B should also allocate all
the undistributed earnings for the year-to-date period to the convertible preferred stock in calculating EPS
for the six-month period ended June 30, 20X1. This allocation of undistributed earnings is consistent with the
contractual participation terms of the convertible preferred stock.
Note that while market price contingencies are generally assessed at the end of the reporting period in the
calculation of EPS, in this example, the market price contingency must be assessed over the reporting period
on the basis of the contractual participation terms of the convertible preferred stock.
Example 5-19
Allocation of Earnings to Participating Debt
Entity D has the following outstanding securities in its capital structure:
- 1 million common shares.
- $10 million principal amount of senior notes (the “notes”).
The notes pay interest quarterly, in arrears, at a rate of 2.5 percent per annum. The holders of the notes are
also entitled to participate in dividends declared on D’s common stock on a 40:60 basis.
During the quarter ended December 31, 201X, D earns $15 million of pretax income before recognition of
interest expense on the notes. Entity D accrues $62,500 of interest on the notes in accordance with the stated
interest rate on the notes and declares dividends of $1,000,000, which, in accordance with the participation
rights of the notes, is payable in an amount of $400,000 on the notes and $600,000 on the common shares.
Assume that D’s tax rate is 25 percent.
On the basis of the above facts, D would report net income for the period of $10,903,125.(a) Entity D would
calculate distributed and undistributed earnings as follows:
In accordance with the contractual participation rights of the notes, $4,121,250(b) of the undistributed earnings
should be allocated to the notes and $6,181,875(c) to the common shares. Total earnings attributable to the
common shares are $6,781,875,(d) resulting in earnings per common share of $6.78.(e)
Note that in D’s application of the two-class method of calculating EPS, the $400,000 of distributed earnings to
the holders of the notes, based on the contractual right of the noteholders to participate in dividends declared
during the period, should not be reduced from the numerator (i.e., net income) because this amount has been
treated as interest cost and has reduced net income. Income available to common stockholders (net income in
this example) should be reduced only for undistributed earnings attributable to the noteholders because any
reflection of $400,000 as distributed earnings would result in “double-counting” the impact of this participation
in the calculation of EPS.
____________________
(a) $15,000,000 – $62,500 – $400,000 = $14,537,500 × 75% = $10,903,125. (Note
that the $400,000 in dividend equivalents paid on the
notes must be accounted for as interest expense since
the notes are classified as a liability.)
(b) $10,303,125 × 0.4 = $4,121,250.
(c) $10,303,125 × 0.6 = $6,181,875.
(d) $600,000 + $6,181,875 = $6,781,875.
(e) $6,781,875 ÷ 1,000,000 = $6.78.
Example 5-20
Allocation of Earnings to Participating Noncumulative Preferred Stock
Entity E has the following outstanding securities in its capital structure:
- One million common shares.
- 500,000 shares of Series A convertible preferred stock (the “preferred stock”).
The preferred stock is convertible into common stock on a 1:1 basis. Each holder of preferred stock is entitled
to receive noncumulative preferred dividends of $0.08 per share. After payment of the $0.08 noncumulative
dividend, any additional dividends are distributed between the common shareholders and preferred
stockholders (on an as-converted basis) on a 1:1 basis. Entity E has not declared any dividends, and does not
intend to pay or declare any dividends in the future, on any class of stock. For the year ended December 31,
20X1, E had net income of $5 million.
On the basis of the above facts, the preferred stock is a participating security. Accordingly, E is required to
calculate basic and diluted EPS under the two-class method. In applying the two-class method, E would first
determine the amount of noncumulative dividends that would be allocated to the preferred stock (i.e., $0.08
per share or $40,000). Any remaining earnings would be allocated to the common stock and preferred stock
(on an as-converted basis) on a 1:1 basis. On an as-converted basis, 500,000 shares of common stock would
be issued for the preferred stock. Compared with the 1 million outstanding common shares, the holders of the
preferred stock would be entitled to one-third of the undistributed earnings, or $1,653,333.(a) Total distributed
and undistributed earnings allocated to the preferred stock are $1,693,333,(b) as a result of which the common
shareholders would receive total earnings of $3,306,667(c) and basic EPS would be $3.31.(d)
____________________
(a) $5,000,000 – $40,000 = $4,960,000 × 1/3 = $1,653,333.
(b) $40,000 + $1,653,333 = $1,693,333.
(c) $5,000,000 – $40,000 = $4,960,000 × 2/3 = $3,306,667.
(d) $3,306,667 ÷ 1,000,000 = $3.31.
Example 5-21
Use of the Two-Class Method to Calculate Basic and Diluted EPS — Participating Convertible
Preferred Stock
Assume that Entity A has 1 million weighted-average common shares outstanding for the fiscal year ended
December 31, 20X1; a current-period net income of $5 million; and an effective tax rate of 40 percent.
On January 1, 20X1, A issues 100,000 convertible preferred securities. Each preferred share is convertible into
two shares of A’s common stock. The preferred shareholders are entitled to a noncumulative annual dividend
of $5 per share before any dividend is paid to the common shareholders. After the common shareholders
are paid a dividend of $2 per share, the preferred shareholders participate in any remaining undistributed
earnings on a 40:60 per-share basis with the common shareholders. Accordingly, the preferred securities are
participating securities for which A must use the two-class method to calculate basic and diluted EPS. In fiscal
year 20X1, A declares and pays $2.5 million in dividends (or a $5 dividend for preferred shareholders and a $2
dividend for common shareholders).
The calculations under the two-class method are as follows:
Step 1 — Use the two-class method to calculate basic EPS.
Amounts of basic EPS:
Step 2 — Calculate diluted EPS.
Step 2a — Use the treasury stock method, the if-converted method, or the contingently issuable share
method to determine diluted EPS.
Determine the antidilution sequencing:
Since there are no potential common shares other than the participating convertible preferred shares,
antidilution sequencing is not required.
Calculation of diluted EPS for the common shares in which the use of the if-converted method for the participating
convertible preferred shares is assumed:
Step 2b — Use the two-class method to determine diluted EPS.
Because A’s capital structure only includes common shares and participating convertible preferred shares (i.e.,
there are no other potential common shares), basic and diluted EPS under the two-class method would be the
same ($4.34).
Step 3 — Determine which step — 2a or 2b — results in the more dilutive effect.
In this example, A would disclose an amount of diluted EPS per common share that would result from applying
the if-converted method ($4.17) because that amount is more dilutive than the amount that would result from
applying the two-class method ($4.34). In accordance with ASC 260-10-45-60, A would be permitted, but not
required, to present basic and diluted EPS for the participating convertible preferred shares on the face of the
income statement. For more information, see Section 9.1.4.
Example 5-22
Use of the Two-Class Method to Calculate Basic and Diluted EPS — Participating Convertible
Preferred Stock With Convertible Debt and Warrants
Assume that Entity B has 1 million weighted-average common shares stock outstanding for the fiscal year
ended December 31, 20X1; a current-period net income of $5 million; and an effective tax rate of 40 percent.
On January 1, 20X1, B issues 100,000 convertible preferred securities. Each preferred share is convertible into
two shares of B’s common stock. The preferred shareholders are entitled to a noncumulative annual dividend
of $5 per share before any dividend is paid to the common shareholders. After the common shareholders
are paid a dividend of $2 per share, the preferred shareholders participate in any remaining undistributed
earnings on a 40:60 per-share basis with the common shareholders. Accordingly, the preferred securities are
participating securities for which B must use the two-class method to calculate basic and diluted EPS. In fiscal
year 20X1, B declares and pays $2.5 million in dividends (or a $5 dividend for preferred shareholders and a $2
dividend for common shareholders).
In addition, assume the following:
- On January 1, 20X1, B issues warrants to purchase 100,000 shares of its common stock at $50 per share for a period of five years. The average market price of B’s stock price for 20X1 is $60 per share. The warrants do not meet the definition of a participating security.
- On January 1, 20X1, B issues 10,000 units of convertible bonds with an aggregate par value of $1 million. Each bond is convertible into 10 shares of B’s common stock and bears an interest rate of 3 percent. The convertible bonds do not meet the definition of a participating security.
The calculations under the two-class method are as follows:
Step 1 — Use the two-class method to calculate basic EPS.
Amounts of basic EPS:
This calculation is the same as the calculation of basic EPS in Example
5-21, because basic EPS is not affected
by the warrants and convertible debt since neither
security is a participating security.
Step 2 — Calculate diluted EPS.
Step 2a — Use the treasury stock method, the if-converted method, or the contingently issuable share
method to determine diluted EPS.
Determine the antidilution sequencing:
Calculation of diluted EPS for the common shares in which the use of the if-converted method for the participating
convertible preferred shares is assumed:
Step 2b — Use the two-class method to determine diluted EPS.
Step 3 — Determine which step — 2a or 2b — results in the more dilutive effect.
In this example, B would disclose an amount of diluted EPS per common share that would result from applying
the if-converted method ($3.81) because that amount is more dilutive than the amount that would result from
applying the two-class method ($3.92). In accordance with ASC 260-10-45-60, B would be permitted, but not
required, to present basic and diluted EPS for the participating convertible preferred shares on the face of the
income statement. See further discussion in Section 9.1.4.
Example 5-23
Use of the Two-Class Method to Calculate Basic and Diluted EPS — Participating Nonvested Share-Based Payment Awards
Assume that Entity C has 1 million weighted-average shares of common stock outstanding for the fiscal year
ended December 31, 20X1; a current-period net income of $5 million; and an effective tax rate of 40 percent.
On January 1, 20X1, C issues 250,000 nonvested share-based payment awards to its employees. The nonvested
shares have a grant-date fair-value-based measure of $50 per share and vest at the end of the fourth year
of service (i.e., cliff vesting). The average market price of C’s stock price for 20X1 is $60 per share. Holders
of nonvested shares have a nonforfeitable right to receive cash dividends on a 1:1 per-share basis with the
common shareholders. Accordingly, the nonvested shares are participating securities for which C must use the
two-class method in calculating basic and diluted EPS. In fiscal year 20X1, C declares and pays $2.5 million in
dividends for both the common shares and the nonvested shares.
Step 1 — Use the two-class method to calculate basic EPS.
Amounts of basic EPS:
Step 2 — Calculate diluted EPS.
Step 2a — Use the treasury stock method, the if-converted method, or the contingently issuable share
method to determine diluted EPS.
Determine the antidilution sequencing:
Because there are no potential common shares other than the participating nonvested shares, antidilution
sequencing is not required.
Calculation of diluted EPS for the common shares in which the use of the treasury stock method for the
participating nonvested shares is assumed:
Step 2b — Use the two-class method to determine diluted EPS.
Because C’s capital structure only includes common shares and the participating nonvested shares (i.e., there
are no other potential common shares), basic and diluted EPS under the two-class method would be the same
($4.00).
Step 3 — Determine which step — 2a or 2b — results in the more dilutive effect.
In this example, C would disclose an amount of diluted EPS per common share that would result from applying
the two-class method ($4.00) because that amount is more dilutive than the amount that would result from
applying the treasury stock method ($4.68). In accordance with ASC 260-10-45-60, C would be permitted, but
not required, to present basic and diluted EPS for the participating nonvested shares on the face of the income
statement. See further discussion in Section 9.1.4.
Example 5-24
Use of the Two-Class Method to Calculate Basic and Diluted EPS — Participating Nonvested Share-Based Payment Awards With Convertible Debt and Warrants
Assume that Entity D has 1 million weighted-average shares of common stock outstanding for the fiscal year
ended December 31, 20X1; a current-period net income of $5 million; and an effective tax rate of 40 percent.
On January 1, 20X1, D issues 250,000 nonvested share-based payment awards to its employees. The nonvested
shares have a grant-date fair-value-based measure of $50 per share and vest at the end of the fourth year
of service (i.e., cliff vesting). The average market price of D’s stock price for 20X1 is $60 per share. Holders
of nonvested shares have a nonforfeitable right to receive cash dividends on a 1:1 per-share basis with the
common shareholders. Accordingly, the nonvested shares are participating securities for which D must use the
two-class method in calculating basic and diluted EPS. In fiscal year 20X1, D declares and pays $2.5 million in
dividends for both the common shares and the nonvested shares.
In addition, assume the following:
- On January 1, 20X1, D issues warrants to purchase 100,000 shares of its common stock at $40 per share for a period of five years. The warrants do not meet the definition of a participating security.
- On January 1, 20X1, D issues 10,000 units of convertible bonds with an aggregate par value of $1 million. Each bond is convertible into 10 shares of D’s common stock and bears an interest rate of 3 percent. The convertible bonds do not meet the definition of a participating security.
Step 1 — Use the two-class method to calculate basic EPS.
Amounts of basic EPS:
Note that this calculation is the same as the calculation of basic EPS in
Example 5-23, because basic EPS is not
affected by the warrants and convertible debt since
neither security is a participating security.
Step 2 — Calculate diluted EPS.
Step 2a — Use the treasury stock method, the if-converted method, or the contingently issuable share
method to determine diluted EPS.
Determine the antidilution sequencing:
Calculation of diluted EPS for the common shares in which the use of the treasury stock method for the participating
nonvested shares is assumed:
Step 2b — Use the two-class method to determine diluted EPS.
Step 3 — Determine which step — 2a or 2b — results in the more dilutive effect.
In this example, D would use the two-class method to disclose diluted EPS per common share ($3.58) because
that amount is more dilutive than the amount that would result from applying the if-converted method ($4.18).
In accordance with ASC 260-10-45-60, D would be permitted, but not required, to present basic and diluted
EPS for the participating nonvested shares on the face of the income statement. See further discussion in
Section 9.1.4.
Footnotes
5
The allocation of undistributed losses is consistent
with the guidance in the MLP subsections of ASC 260 that addresses
the application of the two-class method to MLPs when distributions
exceed earnings. See further discussion in Section
8.9.3.
6
In this table, it is assumed
that the income or loss amounts are after the
allocation of any distributed earnings.
7
It would be highly unusual for securities that
participate only upon the occurrence of contingent events to
participate in losses.
8
If a security participates only in objectively
determinable and nondiscretionary dividends that meet the definition
of an extraordinary dividend, the amount of undistributed earnings
that would be assumed to be distributed will affect whether the
distribution of those earnings would qualify as an extraordinary
dividend.
9
Section 3.2.2
contains detailed discussion of what constitutes
dividends on preferred stock in the calculation of
income available to common stockholders. As
discussed in that section, dividends on preferred
stock include the accretion of dividends on
increasing-rate preferred stock, measurement
adjustments to reflect redeemable preferred stock at
its redemption amount under ASC 480-10-S99-3A, the
recognition of a down-round feature, and other
“deemed dividends” or “deemed contributions.”
Dividends on preferred stock that are treated as an
adjustment to net income to arrive at income
available to common stockholders represent
distributed earnings under the two-class method of
calculating EPS.
10
The entity-wide policy election related to the
treatment of forfeitures for employee awards can be made
separately from that for nonemployee awards.
11
All nonforfeitable dividends on share-based
payment awards that are classified as liabilities are recognized
in compensation expense.
12
The portion expected to vest
will be based on the revised estimated forfeitures
applicable to the current-period dividends. Thus,
distributed earnings for the period will equal the
amount of current-period dividends on unvested
participating share-based payment awards that are
recognized in retained earnings.
13
As discussed in Section 3.2.4.3.1, the
accounting for the common shares as being effectively retired is
an exception to the general requirement that outstanding common
shares must be included in the denominator for both basic and
diluted EPS.
14
If one class of common stock is redeemable at the
option of the holder, the entity should consider the terms of the
redemption and the application of the guidance in ASC 480-10-S99-3A
in the determination of how to allocate undistributed losses.