8.3 Certain Issuances of Common Stock

8.3.1 Common Stock Subscriptions

ASC 260-10

Partially Paid Shares and Partially Paid Stock Subscriptions

55-23 If an entity has common shares issued in a partially paid form (permitted in some countries) and those shares are entitled to dividends in proportion to the amount paid, the common-share equivalent of those partially paid shares shall be included in the computation of basic EPS to the extent that they were entitled to participate in dividends. Partially paid stock subscriptions that do not share in dividends until fully paid are considered the equivalent of warrants and shall be included in diluted EPS by use of the treasury stock method. That is, the unpaid balance shall be assumed to be proceeds used to purchase stock under the treasury stock method. The number of shares included in diluted EPS shall be the difference between the number of shares subscribed and the number of shares assumed to be purchased.

Stock subscriptions are a mechanism that allows an entity to offer employees and other investors the ability to purchase shares of the entity’s common stock, typically over a period of time and without a broker’s commission. The impact of a stock subscription agreement on basic and diluted EPS will depend on the extent to which the investor is entitled to participate in dividends before the subscription agreement is fully paid and the shares of common stock are outstanding. The table below summarizes the EPS implications of stock subscription agreements that must be settled in common stock.

Table 8-1

	Impact on:
Terms and Payment Status	Basic EPS(a),(b)	Diluted EPS(a),(b)
Fully Unpaid Stock Subscription Agreement
Investor is entitled to participate in dividends on the basis of the number of common shares to be acquired.	The subscription agreement is treated as an option that is a participating security. The two-class method is applied.	The subscription agreement is treated as an option that is a participating security. The more dilutive of the two-class method or the treasury stock method is applied.
Investor is not entitled to participate in any dividends before making payments on the subscription agreement.	No impact.	The subscription agreement is treated as an option that is not a participating security. The treasury stock method is applied.
Partially Paid Stock Subscription Agreement
Investor is entitled to participate in dividends on the basis of the number of common shares to be acquired.	Paid portion — The common share equivalent of the partially paid shares is treated as outstanding common stock. Unpaid portion — The unpaid portion of the subscription agreement is treated as an option that is a participating security; therefore, the two-class method is applied.	Paid portion — The common share equivalent of the partially paid shares is treated as outstanding common stock. Unpaid portion — The unpaid portion of the subscription agreement is treated as an option that is a participating security. The more dilutive of the two-class method or the treasury stock method is applied.
Investor is entitled to participate in dividends only in proportion to the amount of the stock subscription paid.	Paid portion — The common share equivalent of the partially paid shares is treated as outstanding common stock. Unpaid portion — No impact.	Paid portion — The common share equivalent of the partially paid shares is treated as outstanding common stock. Unpaid portion — The unpaid amount of the subscription agreement is treated as an option that is not a participating security. The treasury stock method is applied.
Investor is not entitled to participate in any dividends until the stock subscription is fully paid.	No impact.(c)	The subscription agreement is treated as an option that is not a participating security. The treasury stock method is applied.(c)
Notes to Table: (a) In this table, it is assumed that an entity has entered into the stock subscription agreement with an investor. If the entity has entered into the stock subscription agreement with an employee, a nonemployee in return for goods and services, or a customer, the entity should consider the guidance on share-based payment arrangements. See Section 7.1 for further discussion. (b) The table does not apply to situations in which an entity receives a note receivable in exchange for shares of common stock that are legally issued and outstanding. See Section 8.3.2 for more information. (c) It may seem that the two-class method should be applied to the paid portion of the stock subscription agreement because the investor has paid for shares of common stock that are not entitled to dividends. However, since the shares of common stock will be entitled to dividends only when the stock subscription agreement is fully paid, the two-class method is not applied because the investor will presumably have paid less for the shares of common stock because of their inability to participate in dividends before full payment. Furthermore, applying the two-class method should result in a similar impact on basic and diluted EPS because the shares of common stock underlying the stock subscription agreement (i.e., the participating security) will not be entitled to either distributed or undistributed earnings.

The two examples below illustrate the accounting for basic and diluted EPS for a common stock subscription.

Example 8-2

Common Stock Subscription Agreement — Counterparty Is Entitled to Dividends on Paid Portion

Company Q enters into a stock subscription agreement with Company R. The agreement has the following key terms:

On January 1, 20X1, R agrees to purchase 20,000 common shares of Q over a four-year period. Under this agreement, R will purchase 5,000 common shares per year.
The purchase price of the common shares is $40 per share.
The subscription agreement requires R to pay $10 per share acquired per year, and the shares acquired for each year must be paid for on the first day of each year.
Company R is not entitled to receive dividends on the unpaid portion of the common shares to be purchased under the subscription agreement but is entitled to participate in dividends on the number of common share equivalents paid for (i.e., the paid portion).

Because R is only entitled to dividends on the paid portion of the subscription agreement, in accordance with the guidance in Table 8-1, the paid portion of the subscription agreement is treated as outstanding common shares and the unpaid portion is treated as an option that is not a participating security. The treasury stock method applies to calculating the impact of the subscription agreement on diluted EPS. The calculation under the treasury stock method for Q’s year ended December 31, 20X1, on the basis of a $45 weighted-average price of Q’s common stock, is as follows:

Note that the calculation of the weighted-average options outstanding would be more complex if the counterparty made payments on the stock subscription agreement during a reporting period. In addition, if the counterparty was entitled to receive dividends on the unpaid portion, the options equivalent outstanding would represent a participating security to which an entity must apply the more dilutive of the treasury stock method or the two-class method of calculating diluted EPS.

Example 8-3

Stock Subscription Agreement — Counterparty Is Not Entitled to Dividends on Paid Portion

Assume the same facts as in the example above, except that Company R is not entitled to participate in any dividends until the subscription agreement is paid in full. Further, note that the investor in this scenario would presumably pay less per share than the one in the example above.

Since R is not entitled to dividends on the paid portion of the subscription agreement, in accordance with the guidance in Table 8-1, no shares are treated as outstanding in the calculation of basic EPS and the subscription agreement is treated as an option that is not a participating security. The treasury stock method applies to calculating the impact of the subscription agreement on diluted EPS. The weighted-average options equivalent outstanding would be the entire amount of 20,000 common shares to be issued under the subscription agreement. The calculation under the treasury stock method for Q’s year ended December 31, 20X1, on the basis of a $45 weighted-average price of Q’s common stock, is as follows:

Note that the impact of the subscription agreement on the denominator of diluted EPS is the same as in the example above, in which 5,000 common shares are included in the denominator of basic EPS and 1,667 incremental common shares are included in the denominator of diluted EPS.

8.3.2 Common Stock Issued for Note Receivable

In a transaction that is not subject to ASC 718, an entity may issue shares of common stock that are legally outstanding, not subject to any stated vesting conditions, and entitled to dividends in the same manner as all other outstanding shares of common stock in return for a note receivable from the investor. The note receivable may be recourse or nonrecourse. ASC 260 does not provide specific guidance on situations in which an entity has issued, in return for a note receivable, shares of common stock to an investor that are legally outstanding and not subject to any vesting conditions.

Under U.S. GAAP, an entity that issues common stock in return for a note receivable (in a transaction not subject to ASC 718) is generally required to present the note receivable within contra-equity in accordance with ASC 505-10-45-2. It is acceptable, for EPS purposes, for an entity to treat the shares of common stock that are issued and legally outstanding in the same manner as an option if the entity concludes, on the basis of the terms of the contract and the relevant laws, that it (1) can cancel the shares of common stock if the investor defaults on the note receivable and (2) intends to exercise this cancellation right. Since the shares of common stock are entitled to dividend rights while outstanding, that option would be considered a participating security and therefore may have the same impact as if it were treated as an outstanding share. However, the arrangement should not be treated as an option for EPS purposes if the entity is unable to conclude that it either (1) has the legal right to cancel the shares of common stock if the investor defaults on the note receivable or (2) does not intend to exercise this legally available cancellation right. Rather, in such circumstances, the note receivable should be considered separate from the shares of common stock, which should be considered outstanding shares in the calculation of basic and diluted EPS. In either situation, the EPS accounting would not affect the requirement to classify the note receivable as contra-equity under GAAP.

When shares of common stock are issued to a grantee in return for a note receivable in a share-based payment arrangement subject to ASC 718, the accounting depends, in part, on whether the note is recourse or nonrecourse. If the note is nonrecourse, the award is accounted for as an option until the note is repaid. As a result, until the note is repaid, the shares would be (1) excluded from the denominator in the calculation of basic EPS and (2) included in the denominator in the calculation of diluted EPS in accordance with the treasury stock method. The arrangement could still affect basic EPS if the award is considered a participating security. See Section 3.11 of Deloitte’s Roadmap Share-Based Payment Awards for further discussion of the treatment of common shares issued for notes under ASC 718.

Connecting the Dots

When a note received from an investor in exchange for the issuance of shares of common stock is considered the equivalent of an option for EPS purposes and the transaction is not within the scope of ASC 718, the exercise price should typically consist of the principal amount and interest on the note receivable (therefore, no interest income is recognized in income). It would not be acceptable to consider the arrangement as representing an option for EPS purposes if interest income has been recognized in income.

8.3.3 Distributions That Are Considered Issuances of Common Stock

Certain entities that are required to periodically distribute a certain portion of their taxable income give their common shareholders the ability to elect to receive their entire distribution in cash or common shares of an equivalent value, with a potential limitation on the total amount of cash that shareholders may receive in the aggregate. ASC 505-20-15-3(d) and 15-3A address the accounting for situations in which an entity declares dividends to common shareholders that may be paid in cash or shares at the election of the shareholders. ASC 505-20-15-3(d) and 15-3A indicate that a stock dividend does not include a distribution for which each shareholder is given an election to receive either cash or shares of common stock of an equivalent value, even if there is a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate. In these situations, the common stock portion of the distribution should be accounted for as a share issuance. Thus, the common stock portion will be reflected in the calculation of basic EPS prospectively (i.e., from the date of issuance) rather than being reflected retrospectively in accordance with the treatment of stock dividends.

Although basic EPS is not affected before the issuance of the common shares that are delivered in satisfaction of the dividend, there is an impact on diluted EPS. ASC 260-10-45-45 through 45-47 apply to the calculation of diluted EPS for a contract that may be settled in stock or cash. This guidance must be applied during the period between the declaration date and the dividend payment date. The example below illustrates the application of this guidance.

Example 8-4

Diluted EPS for Distribution That May Be Received in Cash or Common Shares at the Option of Investors

Company A, a real estate investment trust, is a calendar-year entity with quarterly periods ending on March 31, June 30, September 30, and December 31 of each calendar year. On March 1, 20X1, A’s board of directors declares a regular quarterly dividend of $1.00 per share, payable on April 30, 20X1, to shareholders of record on March 15, 20X1. As of the record date, A has 100 million common shares outstanding. In declaring the dividend, the board of directors determines that it will be paid in a combination of cash and common stock. The significant terms of the declared dividend are as follows:

Each investor can elect to receive payment of the dividend in cash or common stock subject to a maximum amount of cash paid on distribution of 25 percent of the aggregate distribution (or $25 million).
For the common stock distribution to qualify as a taxable dividend, each common shareholder must have the option to elect to receive its distribution in either cash or common shares and shareholder elections must be received by April 15, 20X1.
For the portion of the distribution paid in common shares, A will deliver a number of common shares that have the same monetary value as the cash dividend amount; the number of common shares calculated is based on A’s closing share prices for the five-day trading period ending five days before the payment date of the dividend (i.e., the five-day trading period ending on April 25, 20X1).

The accounting guidance on diluted EPS that applies to the payment of this dividend is as follows:

Since 75 percent of the distribution is payable in common stock (because of the limitation on the cash portion) these shares must be reflected in the denominator in the calculation of diluted EPS.
The remaining 25 percent of the distribution is subject to the guidance in ASC 260-10-45-45 through 45-47. In accordance with this guidance, A cannot overcome the presumption of share settlement. Therefore, A must assume that the remaining 25 percent is paid in shares.

Because these shares are issuable for little or no consideration, it is appropriate to apply the contingently issuable share method to calculate diluted EPS. In accordance with ASC 260-10-45-52, A must assume that the end of the reporting period is the end of the contingency period (i.e., the averaging period used to determine the number of common shares issuable). Therefore, A must use the average of the closing stock prices over the five-day trading period ending five days before the end of the reporting period.

Assume that the closing share prices of A’s stock for the five-day trading period ending five days before March 31, 20X1, were as follows:

March 20 — $35.25.
March 21 — $34.88.
March 22 — $35.00.
March 23 — $35.18.
March 26 — $35.32.

These closing prices result in an average price of $35.13 ($35.25 + $34.88 + $35.00 + $35.18 + $35.32 = $175.63 ÷ 5 = $35.13). On the basis of this average price, as of March 31, 20X1, A would issue 2,846,570 shares of common stock ($100,000,000 ÷ $35.13 = 2,846,570). This number of common shares should be included in the denominator of diluted EPS on a weighted-average basis as follows:

If, however, the terms of the dividend indicate that 75 percent will be settled in shares and 25 percent in cash, with the only variability involving which shareholders receive cash and which receive shares (and the number of shares issuable to make the $75 million payment), the dilutive impact would be limited to the requirement to pay $75 million of the dividend through the issuance of common shares.

8.3.4 Nominal Issuances

8.3.4.1 EPS Accounting

SEC Staff Accounting Bulletins

SAB Topic 4.D, Earning per Share Computations in an Initial Public Offering [Reproduced in ASC 260-10-S99-1]

Facts: A registration statement is filed in connection with an initial public offering (IPO) of common stock. During the periods covered by income statements that are included in the registration statement or in the subsequent period prior to the effective date of the IPO, the registrant issued for nominal consideration1 common stock, options or warrants to purchase common stock or other potentially dilutive instruments (collectively, referred to hereafter as “nominal issuances”).

Prior to the effective date of FASB ASC Topic 260, Earnings Per Share, the staff believed that certain stock and warrants2 should be treated as outstanding for all reporting periods in the same manner as shares issued in a stock split or a recapitalization effected contemporaneously with the IPO. The dilutive effect of such stock and warrants could be measured using the treasury stock method.

Question 1: Does the staff continue to believe that such treatment for stock and warrants would be appropriate upon adoption of FASB ASC Topic 260?

Interpretive Response: Generally, no. Historical EPS should be prepared and presented in conformity with FASB ASC Topic 260.

In applying the requirements of FASB ASC Topic 260, the staff believes that nominal issuances are recapitalizations in substance. In computing basic EPS for the periods covered by income statements included in the registration statement and in subsequent filings with the SEC, nominal issuances of common stock should be reflected in a manner similar to a stock split or stock dividend for which retroactive treatment is required by FASB ASC paragraph 260-10-55-12. In computing diluted EPS for such periods, nominal issuances of common stock and potential common stock3 should be reflected in a manner similar to a stock split or stock dividend.

Registrants are reminded that disclosure about materially dilutive issuances is required outside the financial statements. Item 506 of Regulation S-K requires presentation of the dilutive effects of those issuances on net tangible book value. The effects of dilutive issuances on the registrant’s liquidity, capital resources and results of operations should be addressed in Management’s Discussion and Analysis.

Question 2: Does reflecting nominal issuances as outstanding for all historical periods in the computation of earnings per share alter the registrant’s responsibility to determine whether compensation expense must be recognized for such issuances to employees?

Interpretive Response: No. Registrants must follow GAAP in determining whether the recognition of compensation expense for any issuances of equity instruments to employees is necessary.4 Reflecting nominal issuances as outstanding for all historical periods in the computation of earnings per share does not alter that existing responsibility under GAAP.

____________________

1 Whether a security was issued for nominal consideration should be determined based on facts and circumstances. The consideration the entity receives for the issuance should be compared to the security’s fair value to determine whether the consideration is nominal.

2 The stock and warrants encompasse[d] by the prior guidance were those issuances of common stock at prices below the IPO price and options or warrants with exercise prices below the IPO price that were issued within a one-year period prior to the initial filing of the registration statement relating to the IPO through the registration statement’s effective date.

3 The FASB ASC Master Glossary defines potential common stock as “a security or other contract that may entitle its holder to obtain common stock during the reporting period or after the end of the reporting period.”

4 As prescribed by FASB ASC Topic 718, Compensation — Stock Compensation.

FRM Topic 7

7520.2 Nominal Issuances [SAB Topic 4D]

Nominal issuances of shares are considered in-substance recapitalization transactions. Issuances of shares for which compensation or other expense has been appropriately recorded under ASC 718 ordinarily would not be considered nominal issuances since consideration received for issuance of shares may include goods or services. However, even if goods or services are received, it may still be necessary to compare the consideration received, as accounted for in the financial statements, to the fair value of the shares issued to determine whether the consideration is nominal. Also, issuances of shares in exchange for assets (for example, SAB 48 transactions) would not be considered nominal issuances, unless the fair value of the assets is nominal.
In an IPO, and in subsequent filings, nominal issuances of common stock and potential common stock (for example, options and warrants) should be reflected in the calculation of earnings per share for periods prior to their issuance in a manner similar to a stock split or stock dividend for which retroactive treatment is required. [ASC 260-10-55-12]
Nominal issuances should be limited to certain issuances to investors or promoters.

SAB Topic 4.D and paragraph 7520.2 of the FRM address the SEC staff’s views on an SEC registrant’s accounting for nominal issuances. Although this guidance is for SEC registrants, it would apply to all entities that present EPS.

According to such guidance, as well as that in ASC 260, nominal issuances of common stock should be included in basic EPS in a manner similar to how a stock dividend or stock split is included; accordingly, in such circumstances, all prior periods presented (including any selected financial data) must be treated retrospectively for EPS purposes (see Section 8.2). A nominal issuance may also occur in connection with an issuance of potential common stock, such as a warrant or an option to purchase common stock. When a nominal issuance is in the form of potential common stock, generally only diluted EPS would be affected.

8.3.4.2 Determining Whether a Nominal Issuance Has Occurred

To determine whether a nominal issuance of common stock has occurred, an entity should compare (1) the total consideration payable by the party that receives the shares with (2) the fair value of the shares of common stock issued. To determine whether a nominal issuance of potential common stock has occurred, an entity should compare (1) the total consideration payable by the party that receives the instrument with (2) the fair value of the instrument issued.

The total consideration payable by the party that receives the shares or potential common shares should include the cash amount payable and any other assets or future services that the holder must render in return for the shares or potential common shares. That is, the determination of whether an issuance represents a nominal issuance is based on consideration of a ratio that consists of a (1) numerator, which comprises any cash received for the issuance plus the fair value of any other noncash consideration received, such as goods and services received (whether provided by an employee or nonemployee service provider), and (2) denominator, which equals the fair value of the common stock or potential common stock issued. As noted in paragraph 7520.2 of the FRM, nominal issuances are limited to issuances to investors or promoters, because when shares of common stock or potential common stock are issued to employees, compensation cost is recognized under ASC 718 on the basis of the fair value of the award. Since the consideration payable equals the fair value of the award, a nominal issuance cannot occur. If, however, the party that received the award is not a customer and has never provided (and will not be required to provide in the future) any substantive goods or services as an employee or nonemployee, and it is determined that the issuance is not within the scope of ASC 718, a nominal issuance may have been deemed to have occurred. An entity must use significant judgment to determine the substance of certain transactions involving the issuance of common stock or potential common stock.

The determination of whether a nominal issuance has occurred must be based on the specific facts and circumstances of each issuance; an entity cannot apply a standard ratio in determining whether an issuance is considered nominal. While the SEC staff has not specified any numerical thresholds or rebuttable presumptions related to when a nominal issuance has occurred, the staff has indicated that it expects the ratio to be very low and that it would expect a nominal issuance, such as founders’ shares, to be rare. Nominal issuances are expected to exist when the substance of the transaction reflects a recapitalization (i.e., a stock split or reverse stock split). Nominal issuances, as discussed by the SEC staff, have only occurred before an IPO. However, the substance of any issuance must be evaluated to determine whether it is appropriate to treat the issuance as a stock split, reverse stock split, or stock dividend.

The examples below illustrate the determination of whether issuances are nominal.

Example 8-5

Nominal Issuance — Shares and Options

Entity A, which has a calendar year-end, expects to complete an IPO of its common stock on June 1, 20X9. In the three-year period leading up to the IPO, A issued the following shares of common stock and options to purchase common stock:

In January 20X7, as an inducement to join the entity, A granted its new CEO options to purchase common stock with an exercise price of $1 for each share of common stock purchased. The options cliff vest at the end of the third year of service. As of the grant date, the market price of A’s common stock was $100 per share.
In April 20X8, A issued an existing investor 3,000 shares of common stock for $1 per share. As of the issuance date, the market price of A’s common stock was $110. This issuance was not consideration in exchange for any goods or services provided (or to be provided) by the investor.

The issuance of stock options to the CEO is not considered a nominal issuance because the ratio of consideration that would be received upon exercise of the stock options (including compensation cost recognized in accordance with ASC 718) to the fair value of the shares of common stock that would be issued upon exercise is at or close to 100 percent. Accordingly, the stock options would not be accounted for retrospectively. Furthermore, the common stock underlying the stock options would not be included in the calculation of basic EPS; however, if the stock options are dilutive, they would be included in the calculation of diluted EPS under the treasury stock method in periods after the grant date.

The April 20X8 share issuance is a nominal issuance because the ratio of consideration received to the fair value of the shares of common stock issued is less than 1 percent, or $3,000 ($1 cash paid for the shares × 3,000 shares) ÷ $330,000 ($110 fair value per share × 3,000 shares). Therefore, these shares of common stock should be included in the weighted-average shares outstanding for basic and diluted EPS for all prior periods in the same manner as a stock split.

Example 8-6

Nominal Issuance — Shares

Entity T, a bank, completes its IPO of common stock on April 20, 20X7. Before the IPO, T was a wholly owned subsidiary of M, a federally chartered mutual holding company. Immediately before the IPO, T entered into the following transactions:

Entity T declared to M a stock dividend consisting of 227 million shares of T’s common stock; M previously owned 1,000 shares of T’s common stock.
Entity T issued 5 million shares of common stock to a nonconsolidated charitable foundation for $0.01 per share (the “foundation shares”).

In the IPO, T issued 100 million shares of common stock to public subscribers in the offering. Thus, after the IPO, T had 333 million shares of common stock outstanding, which was owned by M (68.5 percent of total), third-party investors in the IPO (30 percent of total), and the charitable foundation (1.5 percent of total).

The issuance of the foundation shares is not a nominal issuance because the total consideration received includes the cash paid by the foundation and a charitable contribution, which equals 100 percent of the fair value of the shares of common stock issued. Entity T should reflect a contribution expense in the period in which the shares were issued (equal to the fair value of the common shares issued less the cash received) and should reflect the shares as outstanding for basic and diluted EPS only from the issuance date.

Retrospective treatment of the stock dividend paid to M, which did not dilute M’s interest in T, is appropriate. However, the issuance of the foundation shares, as well as the issuance of shares of common stock to the public in the IPO, both of which dilute M’s ownership interest in T, should be treated prospectively from the issuance date.

Confidential and Proprietary — for Use Solely by Authorized Personnel

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