Earnings per Share

Dividends on preferred stock reduce net income (or increase net loss) to arrive at income (or loss) available to common stockholders, which is the numerator in the calculation of basic EPS. Such dividends include (1) dividends that accumulate on cumulative preferred stock; (2) dividends that are declared on noncumulative preferred stock; (3) the accretion of dividends on convertible preferred stock with an increasing rate; (4) undistributed earnings attributable to participating preferred stock; and (5) “deemed” dividends such as exercise price adjustments triggered by down-round features and measurement adjustments on redeemable preferred stock.

The numerator in the calculation of basic EPS reflects only net income or loss of the parent; therefore, income or loss attributable to noncontrolling interests (NCIs) must be excluded. Accordingly, an entity must calculate basic EPS at the subsidiary level and use that amount in calculating the parent’s EPS.

SEC registrants are required to present redeemable securities, such as redeemable preferred stock, common stock, share-based payment arrangements, and NCIs, within temporary equity. In addition, an entity may be required to remeasure the carrying amount of such securities to their redemption amount. Such measurement adjustments are treated as “deemed dividends” that may result in an adjustment to the numerator in the calculation of basic EPS.

The ASC master glossary defines a participating security as a “security that may participate in undistributed earnings with common stock, whether that participation is conditioned upon the occurrence of a specified event or not.” Participating securities may include debt instruments, preferred stock instruments, contracts on an entity’s own equity, share-based payment arrangements, and NCIs. An entity with participating securities must allocate a portion of undistributed net income to such securities in accordance with the two-class method of calculating EPS. Such allocation will result in a reduction of basic EPS because the common stockholders are not entitled to share in all of the entity’s earnings.

Entities that have multiple classes of common stock and master limited partnerships (MLPs) must apply the two-class method of calculating basic EPS to present EPS for each class. An entity has more than one class of common stock if some, but not all, of its common shares are redeemable.

When an entity modifies preferred stock or a contract on its own equity and the fair value of the instrument increases as a result of the modification, a charge to the numerator in the calculation of EPS may be required if the modification includes a “deemed dividend.” A modification of common stock could also affect the numerator in the calculation of basic EPS.

ASC 260-10-S99-2 requires entities to adjust the numerator in the calculation of basic EPS for the difference between the fair value of the consideration transferred and the carrying amount of preferred stock that is redeemed or otherwise considered extinguished. The numerator may also need to be adjusted when common stock is repurchased for more than fair value.

Certain conversions of preferred stock into common stock affect the numerator in the calculation of basic EPS. ASC 260-10-S99-2 requires an entity to adjust the numerator for the excess value conveyed in an induced conversion of preferred stock. In addition, when preferred stock that contains a separately recognized equity component or embedded conversion option liability is converted into common stock, an entity may be required to recognize an adjustment to the numerator for a “deemed dividend” that occurs upon such conversion.

When stock dividends, stock splits, and certain rights issues exist, entities must retrospectively adjust previously reported basic EPS to reflect the change in outstanding common shares. Other changes in capital structure may be treated similarly or may be reflected only prospectively. Significant judgment is often required when there is a change in an entity’s capital structure.

Other situations that affect the calculation of basic EPS include prior-period adjustments, certain issuances of common stock, accelerated share repurchase agreements, own-share lending arrangements, business combinations, discontinued operations, and equity method investees.

The treasury stock method is an approach to calculating diluted EPS in which an entity assumes that the proceeds that would be obtained upon the exercise of options, warrants, and similar instruments are used to purchase common stock at the average market price during the period. The excess of the shares issuable over the shares repurchased is added to the denominator. An adjustment to the numerator is also necessary for contracts classified as assets or liabilities since they are considered to be equity-classified for diluted EPS purposes.

The reverse treasury stock method is an approach to calculating diluted EPS in which an entity assumes that the proceeds needed to satisfy an obligation to repurchase common stock (i.e., a put option or forward contract) will be raised by issuing shares at the average market price during the period. The excess of the shares issuable over the shares repurchased is added to the denominator. An adjustment to the numerator is also necessary because contracts subject to the reverse treasury stock method are classified as assets or liabilities for accounting purposes.

The if-converted method is an approach to calculating diluted EPS in which conversion of convertible securities at the beginning of the reporting period (or at the time of issuance, if later) is assumed. To apply the if-converted method, an entity generally must also adjust the numerator.

The contingently issuable share method is an approach to calculating diluted EPS in which an entity assumes that the number of common shares that would be issued, if any, if the reporting period was the end of the contingency period, are issued and outstanding. An adjustment to the numerator is also necessary for contingently issuable share arrangements that are classified as assets or liabilities.