Title: Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities

Transcription

1 FASB STAFF POSITION No. EITF Title: Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities Date posted: June 16, 2008 Objective 1. This FASB Staff Position (FSP) addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (EPS) under the two-class method described in paragraphs 60 and 61 of FASB Statement No. 128, Earnings per Share. All paragraphs in this FSP have equal authority. Paragraphs in bold set out the main principles. Background 2. Statement 128 defines EPS as the amount of earnings attributable to each share of common stock, and indicates that the objective of EPS is to measure the performance of an entity over the reporting period. In its deliberations of Statement 128, the Board decided to require the use of the two-class method of computing EPS for those enterprises with participating securities or multiple classes of common stock (each with a different dividend rate from those of the other classes of common stock). Paragraph 60(a) of Statement 128 describes participating securities as follows: Securities that may participate in dividends with common stocks according to a predetermined formula (for example, two for one) with, at times, an upper limit on the extent of participation (for example, up to, but not beyond, a specified amount per share). 3. The Emerging Issues Task Force (EITF) considered participating securities in Issue No. 03-6, Participating Securities and the Two-Class Method under FASB Statement No In Issue 2 of Issue 03-6, the Task Force reached a consensus that a participating security is a security that may participate in undistributed earnings with common stock in its current form, whether that participation is conditioned upon the occurrence of a specified event or not. Issue FSP on EITF Issue 03-6 (FSP EITF ) p. 1

2 03-6 provides guidance on share-based payment awards that contain a right to receive dividends declared on the common stock of the issuer that are fully vested. However, in Issue 2(a) the Task Force declined to provide guidance on share-based payment awards that were not fully vested (that is, awards for which the requisite service had not yet been rendered). 4. At the September 29 and 30, 2004 EITF meetings, the Task Force confirmed that Issue 03-6 does not provide guidance about whether unvested instruments that are granted as share-based compensation are participating securities. As a result, Issue No , Determining Whether Equity-Based Compensation Awards Are Participating Securities, was added to the EITF s agenda. At the November 17 and 18, 2004 EITF meeting, the Task Force discussed Issue At that meeting, the Task Force was unable to reach a consensus; accordingly, the Task Force agreed to discontinue discussion of Issue and to remove it from the EITF s agenda. The Board added this FSP to its agenda to clarify that instruments granted in share-based payment transactions can be participating securities prior to the requisite service having been rendered. FASB Staff Position Scope 5. The guidance in this FSP applies to the calculation of EPS under Statement 128 for share-based payment awards with rights to dividends or dividend equivalents. Presentation 6. Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. 7. The holder of a share-based payment award that includes nonforfeitable rights to dividends or dividend equivalents receives a noncontingent transfer of value each time an entity declares a dividend or dividend equivalent during the contractual period of the share-based payment award. As a result, the award meets the definition of a participating security in its current form, that is, prior to the requisite service having been rendered for the award. In contrast, the right to receive FSP on EITF Issue 03-6 (FSP EITF ) p. 2

3 dividends or dividend equivalents that the holder will forfeit if the award does not vest does not constitute a participation right. Such an award does not meet the definition of a participating security in its current form (that is, prior to the requisite service having been rendered for the award), consistent with the Task Force s consensus in Issue 2(a) of Issue Dividends or dividend equivalents also may be transferred to the holder of a share-based payment award in the form of a reduction in the exercise price of the award (for example, reduction in the exercise price of an equity share option). Such a feature would not be considered a participation right because the award does not represent a nonforfeitable right to participate in undistributed earnings absent the exercise of the award. That is, a right to dividends or dividend equivalents in the form of a reduction in the exercise price of a sharebased payment award is a contingent transfer of value to the holder of a share-based payment award. This conclusion is consistent with the Task Force s consensus in Issue 2(b)(i) of Issue 03-6 that dividends or dividend equivalents transferred to the holder of a convertible security in the form of a reduction to the conversion price or an increase in the conversion ratio of the security do not represent participation rights. 9. Paragraph A37 of FASB Statement No. 123 (revised 2004), Share-Based Payment, 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 outstanding share-based payment awards, including those for which the requisite service is not expected to be rendered. An entity s estimate of the number of awards for which the requisite service is not expected to be rendered for the purpose of determining EPS under this FSP shall be consistent with the estimate used for the purposes of recognizing compensation cost under Statement 123(R). An entity shall 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 FSP on EITF Issue 03-6 (FSP EITF ) p. 3

4 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. 10. An example illustrating the application of this FSP is included in the appendix. Effective Date and Transition 11. This FSP shall be effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior-period EPS data presented shall be adjusted retrospectively (including interim financial statements, summaries of earnings, and selected financial data) to conform with the provisions of this FSP. Early application is not permitted. The provisions of this FSP need not be applied to immaterial items. This FSP was adopted by the affirmative vote of six members of the Financial Accounting Standards Board. Mr. Linsmeier dissented. Mr. Linsmeier dissents from the issuance of this FSP for several reasons. First, earnings per share calculations often are based on hypothetical assumptions (for example, about future distributions of earnings or future uses of proceeds from the issuance of additional securities) that are highly unlikely, if ever, to occur and, therefore, from his point of view, provide an arbitrary and potentially meaningless portrayal of the per-share amounts that will be available to current and future shareholders. Second, current earnings per share guidance requires the application of multiple methods with differing objectives that in combination further limit the usefulness of reported per-share information. Third, the FASB receives a seemingly neverending series of requests for guidance on how to calculate per-share amounts and by continuing to meet them only will introduce uniformity in the calculation of hypothetical earnings per share amounts that likely will increase the complexity and fail to improve the relevance or comparability of reported per-share information. Fourth, the IASB has not found the need to issue earnings per share guidance similar to that provided in EITF Issue 03-6 and this FSP, perhaps suggesting the issues addressed within them are not significant and potentially represent FSP on EITF Issue 03-6 (FSP EITF ) p. 4

5 a level of detailed guidance not material to capital markets. Fifth, investors have indicated that they pay almost exclusive attention to diluted earnings per share numbers, generally ignoring basic earnings per share information. For all these reasons, Mr. Linsmeier believes that issuing additional detailed guidance that requires making somewhat arbitrary hypothetical assumptions about potential earnings distributions primarily to facilitate calculation of a uniform basic earnings per share amount only will add more pages to the already detailed and complex earnings per share literature without significantly enhancing the relevance or comparability of reported information. As a consequence, issuing this guidance does not pass his cost-benefit test for improving the reporting literature. Members of the Financial Accounting Standards Board: Robert H. Herz, Chairman George J. Batavick G. Michael Crooch Thomas J. Linsmeier Leslie F. Seidman Lawrence W. Smith Donald M. Young FSP on EITF Issue 03-6 (FSP EITF ) p. 5

6 Appendix ILLUSTRATIVE EXAMPLE Background A1. Assume that Entity A had 25,000 shares of common stock and 5,000 unvested sharebased 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. A2. 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. A3. 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 A37 of Statement 123(R). FSP on EITF Issue 03-6 (FSP EITF ) p. 6

7 Calculation of Basic EPS under the Two-Class Method Net income $100,000 Less dividends paid: Common stock 37,500 Unvested share-based payment awards 7,050 (a) 44,550 Undistributed earnings $ 55,450 Allocation of undistributed earnings: To unvested share-based payment awards: 5,000 (5, ,000) $55,450 = $9,242 $9,242 5,000 total unvested share-based payment awards = $1.85 per share To common: 25,000 (5, ,000) $55,450 = $46,208 $46,208 25,000 shares of common stock = $1.85 per share Or, to simplify, because the common shareholders and the share-based payment award holders share in dividends on a 1:1 basis, undistributed earnings could also be calculated as follows: $55,450 30,000 shares (b) = $1.85 per common share and share-based payment award Basic EPS amounts: Unvested Share-Based Payment Awards Common Stock Distributed earnings $1.41 (c) $1.50 Undistributed earnings $3.26 $3.35 (a) Reflects the dividends paid to unvested share-based payment awards ($7,500 = 5,000 unvested share-based payment awards $1.50 dividend per share) less the dividends paid to awards for which the requisite service is not expected to be rendered ($450 = 300 sharebased payment awards for which the requisite service is not expected to be rendered $1.50 dividend per share). Dividends paid on awards for which the requisite service is not expected to be rendered are already recognized in net income as additional compensation cost. (b) 25,000 shares of common stock + 5,000 total unvested share-based payment awards (c) $7,050 of distributed earnings allocated to the unvested share-based payment awards divided by 5,000 total unvested share-based payment awards. Although all unvested share-based payment awards received a payment of $1.50 per share, totaling $7,500, only dividends to awards for which the requisite service is expected to be rendered are considered distributed earnings as that term is used in paragraph 61(a) of Statement 128. Dividends paid on awards for which the requisite service is not expected to be rendered are recognized in net income as additional compensation cost. FSP on EITF Issue 03-6 (FSP EITF ) p. 7

8 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 sharebased 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 sharebased 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. FSP on EITF Issue 03-6 (FSP EITF ) p. 8