Proposed Amendment to FAS 128 – Earnings per Share
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By: Linda Cavanaugh, CPA, This proposed Statement is being issued as part of a joint project with the IASB to eliminate differences between FAS 128 – Earnings per Share and IAS 33 – Earnings per Share. If adopted the denominator for the earnings per share (EPS) calculation would be the same under both US GAAP and IFRS. The numerator would still be different as the components of net income are different under US GAAP and IFRS.
This project was started in 2002 and previous exposure drafts were issued in 2003 and 2005. A final statement is expected in the second half of 2009. If adopted this standard would be applied retrospectively.
1. Basic Earnings per Share
Instruments included in basic EPS
Paragraph 9(a) has been added to FAS 128 and paragraph 10 has been re-written. These paragraphs have been amended to include “instruments for which the holder has (or is deemed to have) the present right as of the end of period to share in current-period earnings with common shareholders.
Examples of those instruments include the following:
1.An instrument that is currently exercisable for little or no cost to the holder
2.Shares that are currently issuable for little or no cost to the holder
3.A participating security that is not measured at fair value each period with changes in fair value recognized in current-period earnings
4.A class of common stock with different dividend rates from those of another class of common stock but without prior or senior rights.”
The phrase “exercisable or issuable for little or no cost” refers to the amount required to be paid by the holder, whether in cash, assets or services rendered. The amount required to be paid (exercise price) should be compared to the end-of-period market price to determine if the instrument is “exercisable or issuable for little or no cost”. For example an option with a $1 exercise price while the end-of-period market price is $100 would be considered exercisable for little or not cost. For share-based awards all service has to be rendered before the instrument would be considered issuable for little or no cost.
FSP EITF 03-6-1 (see previous blog) clarified that a share-based compensation award that has non-forfeitable dividends is considered a participating security and should be included in the calculation of basic EPS using the two-class method.
Paragraph 60(a) is added to require participating securities to be added to basic EPS using the two-class method. The participating security must be either not measured at fair value with changes in fair value being recognized in earnings or a share-based award that is recognized as equity. The two-class method is to be used regardless whether the participating security can be converted in a class of common stock or not; the if-converted method is no longer allowed.
2. Diluted Earnings per Share
Instrument measured at fair value
Paragraph 11(a) has been added to clarify that an instrument that is measured at fair value with the changes in fair value being recognized in current earnings should not be included in the calculation for diluted EPS. These instruments should not be included in the diluted EPS calculation because their effect on shareholders is already recognized in the numerator through net income.
Treasury stock method
Paragraph 17 has been amended to change the treasury stock method. Under the proposed amendment, options and warrants will be assumed to be outstanding at the beginning of the period and exercised at the end of the period instead of being outstanding and exercised at the beginning of the period.
To determine the proceeds from the assumed exercise and to evaluate if the instruments are dilutive, the end-of-period market price is to be used instead of the average-market-price during the period.
Paragraph 46 has been amended to change calculation of the number of incremental shares to be included in diluted EPS. The number of incremental shares will be calculated using the end-of-period market price for both the quarter and year-to-date calculation. Under current guidance, the average-market-price is used for the quarter-to-date calculation and a weighted average of the quarterly calculations is used for the year-to-date calculation.
If an instrument classified as a liability is settled in common shares, the end-of-period carrying value of the liability is included in diluted EPS as assumed proceeds. Settling a liability with shares has the same effect on an entity’s net assets as issuing shares for cash, therefore, the incremental shares from settling the liability are included in diluted EPS.
Paragraphs 61(a) – 61(e) have been added to clarify the use of the two-class method for diluted EPS. Current guidance requires all potential commons shares assumed to be issued to be included in the computation of diluted EPS.
Under the two-class method, an entity allocates undistributed earnings (what is left after dividends are declared) to all potential common share or participating securities that are assumed to be outstanding. The numerator is adjusted for the undistributed earnings associated with the potential common shares or participating securities that are assumed to be outstanding, but the numerator is not adjusted for any dividends that would have been issued to those shares or participating securities.
Paragraph 61(c) states in part “1) For a participating security that is not measured at fair value each period with changes in fair value recognized in earnings that also is a potential common share, 2) for a second class of common stock that also is a potential common share, or 3) for a participating share-based-payment award that is recognized as equity, diluted EPS shall reflect the more dilutive effect of applying either:
a. The two-class method assuming that the participating security or second class of common stock is not exercised or converted; or
b. The treasury stock method, reverse treasury stock method, if-converted method, or contingently issuable share method for the participating security or second class of common stock.”
The Appendix updates the examples in FAS 128 to incorporate the new rules. Since this is the third exposure draft, we will just have to wait and see if this one actually gets adopted. Stay tuned!
Linda is a CPA living in Southwestern Ohio, working as a research accountant for an investor-owned publicly traded utility company. She specializes in implementing new FASB and SEC requirements and FAS 133 derivative issues. In her role at the utility she has encountered many issues and written many memos, so send in your implementation and derivative issues and Linda will help figure out an answer.