PROPOSED FASB STATEMENT (REVISED), EARNINGS PER SHARE, COMMENT LETTER ANALYSIS

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1 PROPOSED FASB STATEMENT (REVISED), EARNINGS PER SHARE, COMMENT LETTER ANALYSIS OVERVIEW OF COMMENT LETTERS 1. The comment period on the proposed FASB Statement (Revised), Earnings per Share, ended on December 5, As of April 22, 2009, comment letters were received from 21 respondents, as summarized below. Respondent Profile Generally support the proposed standard Support the proposed standard with significant comments Do not support the proposed standard Did not indicate an overall position Type of Respondent Number Accounting Firm Accounting Society Consulting Firm Individual Preparer TOTAL The analysis is divided into the following sections to highlight the significant issues raised by respondents: a. Overall Objective of Project b. Basic Earnings per Share c. Instruments Measured at Fair Value with Changes Recognized in Earnings d. Two-Class Method e. Treasury Stock Method f. Assumed Share Settlement g. Disclosures h. Other Comments. 1

2 GENERAL COMMENTS 3. Many respondents suggested deferring this project until other joint projects are completed and the underlying differences between U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) are resolved. Some of those respondents suggested that the Board focus on more urgent accounting issues and not utilize resources on converging earnings per share (EPS) guidance at this time. Many respondents generally agreed with the proposed Statement, but had significant comments on how to improve it. Significant issues raised by respondents are discussed below. SIGNIFICANT ISSUES Overall Objective of Project 4. All of the respondents who recommended deferring the project stated that an amendment to FASB Statement No. 128, Earnings per Share, should not be made until the remaining differences in computing EPS (including major differences in the accounting for financial instruments classified as liabilities and equity) also could be resolved. A few specific comments received include the following: Ohio Society of Certified Public Accountants (CL# 3) stated: several differences will continue to exist in the EPS calculations between US and international standards if the revisions in the ED are approved. Many such differences will continue as a result of underlying differences between the two sets of standards in income recognition and determination, as well as differences in accounting treatment for certain related and impacting instruments. Thus, comparability may not be significantly improved between the two until those underlying differences are resolved. The Board should consider deferring this short-term convergence project until underlying differences between US GAAP and IAS are resolved. Once those underlying accounting differences have been eliminated, a project broader in scope could be undertaken to reconsider earnings per share determination and reporting. Emerson (CL# 5) stated: Now that a timeline has been established for convergence, it seems counterintuitive to continually issue and adopt new standards that do no perfectly mirror IFRS. While efforts have been made to make the EPS calculation under FAS 128 similar to the EPS calculation under IAS 33, there still are exceptions and the amounts still are not comparable. We believe the proposed changes are not significant enough to warrant issuance and a revised FAS 128 should not be issued until true convergence with international standards can be achieved. Otherwise, 2

3 companies will be forced to recalculate and retroactively restate EPS for the adoption of this proposed statement and then again in the near future for the adoption of IFRS. This leads to wasted time and effort for prepares and causes confusion for investors as EPS, one of the most important financial measures, would continually change. PricewaterhouseCoopers (CL# 8) stated: We agree with the Board's objective to eliminate the differences in the methods used to determine the denominator in earnings per share (EPS) computations under United States Generally Accepted Accounting Principles (US GAAP) and International Financial Reporting Standards (IFRS) in a manner that would also simplify and clarify the EPS computation. However, we do not support completing the project at this time. As noted by the dissenting board members, this project will not result in the full convergence of the EPS computation under US GAAP and IFRS. Differences in how earnings are determined and how financial instruments are accounted for will persist and continue to prevent the computation of EPS from being completely comparable. Furthermore, potential changes to the accounting for financial instruments resulting from the liabilities and equity project could have significant EPS implications and require additional changes to the computation. In light of these concerns and the number of high-priority projects targeted for completion by 2011, we recommend that the Board delay this project. On balance, we do not believe that the benefits of the proposed simplifications and clarifications, and limited convergence of methodologies, are currently worth the effort required to complete the project at this time particularly when those benefits may be short-lived because of the impact that the liabilities and equity project could have on the EPS computation in the near future. Additionally, delaying the project would free up Board resources for higher priority projects. Ernst & Young (CL# 17) stated: we question whether the EPS standards should be amended at this time when there are other projects currently being undertaken by both the IASB and the FASB, the outcome of which may affect the calculation of EPS in particular the joint projects on Financial Instruments with Characteristics of Equity and Financial Statement Presentation. In view of this, the changes proposed in the EDs may be short-term in nature and thus the incremental benefits of revised standards to financial statement prepares and users may not justify the costs and efforts of issuing and adopting revised standards given the likelihood of further amendments subsequent to finalisation of these other standards that could affect the determination of EPS. 5. Many respondents supported the project and commented that the proposed convergent guidance would improve current EPS reporting. For example: Grant Thornton (CL# 18) stated: We support the Board's efforts to reduce the differences between international financial reporting standards and U.S. generally accepted accounting principles in the area of the determination of earnings per share (EPS). We believe that the proposed Statement would increase the comparability of EPS on an international basis. 3

4 Goldman Sachs (CL# 20) stated: We support the convergence project and the efforts by both the FASB and the IASB to develop a single set of high quality standards that will be accepted globally. The proposed amendments to FASB Statement 128 and IAS 33 eliminate many of the differences in the denominator used in computing EPS under the two frameworks and represent yet another step towards convergence. 6. Some respondents, who were otherwise supportive of the project, expressed concerns about wording and layout differences between the IASB Exposure Draft, Simplifying Earnings per Share, and the proposed FASB Statement. For example: KPMG (CL# 9) stated: The Exposure Drafts contain no explanation regarding why the Boards decided to seek convergence in application of the guidance in IAS 33 and Statement 128 without converging the actual wording of those standards. The pervasive differences in wording throughout the two Exposure Drafts raise questions as to whether the Boards' objective of converging the EPS denominator will be achieved in practice as differences in wording raise questions as to whether the Boards reached the same conclusions. We believe that the Boards should use identical wording in both final standards, except when the use of identical wording is precluded because of specific differences in other IASB or FASB standards or when identifying areas where the Boards' decisions are not converged. This approach was applied recently in connection with IFRS 3 Business Combinations (as revised in 2008) and FASB Statement No 141R, Business Combinations (revised 2007), and we encourage the Boards to use the same approach in connection with the final amendments to IAS 33 and Statement 128 as well. Using the same language would reduce the likelihood of interpretation differences that can arise in practice. Deloitte (CL# 14) stated: we encourage the FASB and the IASB to work together to develop converged accounting standards that (1) use the same words when describing the same accounting principles or guidance and (2) organize those principles or guidance in the same or similar manner. By doing so, we believe the risk that the accounting standards will be interpreted differently will be reduced, if not eliminated. Basic Earnings per Share 7. In addition to common shares outstanding, the proposed Statement requires that the computation of EPS include instruments for which the holder has (or is deemed to have) the present right as of the end of the period to share in current-period earnings with common shareholders. Paragraph 9A of the proposed amendments to Statement 128 provides the following examples of instruments that would be included in the computation of basic EPS: a. An instrument that is currently exercisable for little or no cost to the holder 4

5 b. Shares that are currently issuable for little or no cost to the holder c. A participating security that is not measured at fair value each period with changes in fair value recognized in current-period earnings d. A class of common stock with different dividend rates from those of another class of common stock but without prior or senior rights. 8. Some respondents supported the proposed guidance to include certain instruments in the computation of basic EPS. For example: North Carolina State Board of CPA Examiners (CL# 4) stated: The Board agrees with the FASB's conclusion that the holder of (a) an instrument that is currently exercisable for little or no cost to the holder or (b) a share that is currently issuable for little or no cost to the holder has the present ability to become a common shareholder and the present right to share in current-period earnings and therefore should be included in the basic EPS calculation. Nortel Networks (CL# 11) stated: We support the Board's decision to include in basic EPS common shares outstanding and instruments which have a right (or are deemed to have a right) to participate currently in profit or loss of the period while at the same time allowing for more types of instruments to be included. This definition better reflects the actual shareholder position by capturing all shares with an immediate potential to participate in earnings 9. Some respondents did not agree with the proposed change to the basic EPS computation. Those respondents noted that the guidance would increase complexity, contrary to the intent of the proposed Statement. United Technologies Corporation (CL# 12) stated that the FASB should not change the basic EPS calculation. Changing this calculation to make it more complex appears to be counter-intuitive to the objective of the standard. We recommend that the FASB continue to utilize the basic EPS calculation provided under the original standard. 10. Some respondents highlighted important differences between being able to participate in earnings and actually participating in earnings, a key component to determining which instruments should be included in the proposed computation of basic EPS. For example: PricewaterhouseCoopers (CL# 8) stated: The Board should (1) provide a definition of a mandatorily convertible instrument and (2) clarify the circumstances under which such an instrument is deemed to have the present right to share in current-period earnings with common shareholders and the extent to which (if any) the no anti-dilution guidance applies. The proposed guidance infers that all mandatorily convertible instruments are participating securities, which is not necessarily true. 5

6 Deloitte (CL# 14) stated: We are concerned about the inclusion of instruments that are deemed to have the present right at the end of the period to share in current-period earnings with common shareholders. That is, we question whether instruments that are currently exercisable and shares that are currently issuable for little or no cost to the holder should be included in basic EPS. We also question whether if these instruments and shares (1) do not share in current-period earnings with common shareholders, (2) truly have no further restrictions on their exercise or issuance, and (3) have not been exercised or received by the holder the holder did not exercise or receive the instruments or shares because there was some benefit (e.g., a tax benefit) that it did not want to forgo (i.e., an additional cost). 11. One respondent, The Ohio Society of Certified Public Accountants (CL# 3), noted that if instruments that are exercisable or issuable for little or no cost to the holder and mandatorily convertible participating securities are included in the computation of basic EPS, it may be appropriate to apply consideration of historical experience, as it relates to forfeited and expiring rights to participate in earnings, for inclusion in the computation of shares outstanding. 12. Some respondents expressed concerns that certain types of instruments should not be included in basic EPS, including vested share-based payments with a nominal strike price and retirement stock awards. For example: Nortel Networks (CL# 11) stated: We would point out the definition of instruments currently exercisable for little or no cost to the holder (paragraph 9A, subparagraph a) suggests that vested stock options issued with an exercise price equal to fair market value at the time of grant but significantly lower than the market price at the end of a reporting period may need to be included in the computation of basic earnings per share. We would suggest the Board either clarify or provide a specific exclusion for stock compensation granted with an exercise price equal to fair market value at the time of grant. BB&T (CL# 13) stated: For some companies, restricted stock awarded to employees that are retirement eligible have no future service requirement and therefore no cost. However, the award is not currently issuable as the employee must actually retire to be issued shares prior to the stated vesting. We do not believe these awards should be included in basic EPS and believe that the Standard should clarify the Board's intention. If the Board would include these in basic EPS, would this determination change if the award does not receive dividends until vested as is the case with restricted stock units? Deloitte (CL# 14), stated: we are concerned that an entity could structure an instrument depending on whether its intent is to include the instrument in basic EPS. For example, consider an 6

7 entity that issues a certain number of instruments (e.g., penny warrants) that are exercisable into common shares for little or no cost to the holder of the instruments. Alternatively, the entity could issue a greater number of instruments with a higher exercise price (one that is not considered to be little or no cost to the holder) that has the same economic value at the inception of the instrument to the holder. In the latter situation, the shares that would be issued upon exercise of the instruments would be excluded from the computation of basic EPS; however, the instruments have the same economic value at inception of the instrument to the holder as in the original situation. Therefore, to further simplify the computation of EPS and alleviate any potential implementation issues that may arise, we would suggest excluding these instruments and shares from the computation of basic EPS and include them in the computation of diluted EPS. 13. Deloitte also commented that it is unclear whether the proposed amended paragraph 10 of Statement 128 is intended to include common shares that could be returned to the issuing entity because of a clawback provision. [They] believe that if the Board intends to include common shares subject to a clawback provision in basic EPS until the shares are clawed back, it needs to clarify that intent. Little-or-No-Cost Criteria 14. Many respondents stated that the proposed little-or-no-cost criteria for the proposed basic EPS computation should be further clarified by the inclusion of additional guidance and examples. For example: PricewaterhouseCoopers (CL# 8) stated The Board should clarify that the amount of interest/dividends that a holder would forgo by converting an instrument early should be considered in determining if an instrument is exercisable/issuable for little or no cost. We do not believe this point is sufficiently clear in the Exposure Draft. BB&T (CL# 13) stated: We believe the term "little cost" may be subject to confusion and warrants further clarification. We believe that the SEC and audit firms will develop their own criteria and establish bright lines for this evaluation. This is one instance that the accounting community would benefit from a threshold being established by the Board. Deloitte (CL# 14) stated: Regarding the little-or-no-cost criterion in the amended paragraph 10 of Statement 128, we believe the Board should expand the discussion of what is considered little or no cost beyond the amount that the holder must pay. That is, we believe the little-orno-cost analysis should include the benefits that a holder would forgo to exercise the instrument or receive the shares. For example, in the little-or-no-cost analysis of a 7

8 convertible debt instrument, an entity should include the fact that the holder must forgo the repayment of principal and the payment of interest to convert the instrument and receive the underlying shares. We believe this expanded discussion would help minimize diversity in practice regarding the little-or-no-cost criterion. McGladrey & Pullen LLP (CL# 19) stated: the current example included in the amendment to paragraph 10 within paragraph A2 of the proposed Statement is not helpful, given that the exercise price is.01% of the end-of-period market price. Perhaps an example that is a bit more realistic might be helpful. 15. One respondent, KPMG (CL# 9), believes that additional guidance about the little-or-no-cost criterion is not necessary. For example: When a warrant or similar instrument can be net-share-settled, application of that guidance would result in the net shares issuable upon exercise of the instrument being included in the denominator of basic EPS whenever the warrant is "in-the-money" at the balance sheet date. We do not believe that this was the FASB's intent and recommend deleting the discussion that the exercise price should be compared to the end-of-period market price for purposes of applying the little-or-no-cost criterion. Given the FASB's objective of providing more principles-based guidance, we do not believe it is necessary to provide interpretive guidance on what is meant by "little or no cost" and we observe that such guidance is not contained in the IASB Exposure Draft. 16. Some respondents requested clarification of the little-or-no-service criteria when assessing the impact of share-based payments on the computation of basic EPS. For example: KPMG (CL# 9) commented: this statement should be modified to require a nominal strike price (i.e., little or no consideration) in addition to the no further service requirement when assessing whether the little-or-no-service criterion is met. Deloitte (CL# 14) commented: Vis-à-vis share-based payment awards, the proposed amended paragraph 10 of Statement 128 states, In the case of share-based payment awards, the little-or-noservice criterion is met only if no further service is required to exercise the award. We believe that an entity could interpret this statement as suggesting that the little-orno-cost criterion of a share-based payment award would only include an analysis of the services rendered. That is, even though the awards may require the holder to pay a substantive cash amount to exercise an award (i.e., a substantive exercise price), this amount would be included in basic EPS upon the completion of the requisite service period. We suggest that the Board revise the proposed language on share-based payment awards to recommend that an entity analyze all costs associated with an award, whether in cash, other assets, or service rendered, in determining whether an award meets the little-or-no-cost criterion. 8

9 Instruments Measured at Fair Value with Changes Recognized in Earnings 17. The FASB Exposure Draft proposed that an entity would no longer include in the denominator of EPS the number of additional common shares that would arise from the assumed exercise or conversion of certain freestanding instruments (or a component of certain compound instruments that are accounted for as if it were freestanding) that are measured at fair value each period with changes in fair value recognized in earnings. Many respondents agreed with this proposed change and the Board s reasoning that the economic impact of these instruments is already reflected in the numerator. Credit Suisse (CL# 7) added that, specifically, excluding derivatives carried at market value from the determination of EPS eliminates an inconsistency as currently only the denominator is adjusted and no consideration was given to the numerator (i.e., the impact of the mark to market recorded in net income). 18. Some respondents who disagreed with the proposed change to the EPS computation for certain instruments measured at fair value with changes recognized in earnings cited that the proposed change conflicts with the objective of diluted EPS. Goldman Sachs (CL# 20) requested the Board re-examine more thoroughly with the input of analysts and user groups, what the appropriate objective of diluted earnings per share should be, as a basis for determining the appropriate approach to calculating diluted EPS for such instruments. The proposed change in method also means that the basic EPS and diluted EPS impact of instruments measured at fair value is identical and thus by implication the diluted EPS information gives no new information. 19. One respondent who disagreed with the proposed change to the EPS computation for certain instruments measured at fair value with changes in fair value recognized in earnings (McGladrey & Pullen LLP [CL# 19]) commented that not only does the proposed change conflict with the objective of diluted EPS, but that it also conflicts with the project s objective of simplifying the EPS computation. McGladrey & Pullen LLP stated As a result of the proposed Statement, a company would need to bifurcate the portion of the warrants that have not yet vested (and are remeasured at fair value) from those that have vested (and are no longer remeasured at fair value) to determine those that may impact the computation of the denominator (post-vesting) and those that do not impact the denominator (pre-vesting) in the computation of diluted EPS. We believe there are other conditions where the reclassifications to and from fair value accounting will complicate the accounting for earnings per share as well. 9

10 In addition, we believe that the proposed Statement may result in a lack of simplification from a user perspective. We believe many users would now begin to try to compute their own adjusted denominator for diluted EPS, to include those instruments measured at fair value each period that are no longer included in the denominator in order to determine the full potential for future dilution. 20. Some of the respondents who disagreed with the proposed change to the EPS computation for certain instruments measured at fair value with changes in fair value recognized in earnings agreed with the alternative view in paragraph B34 of the proposed Statement. That view states that the exclusion of instruments at fair value from the denominator of diluted EPS produces results that are not consistent with the needs of users trying to assess potential dilution possibilities. KPMG (CL# 9) stated: We observe that basic and diluted EPS represent period-to-period calculations of per share amounts, not cumulative calculations of per share amounts. For any given reporting period, a share-settleable financial instrument that is measured at fair value with changes in fair value reported in profit or loss could result in either a gain or a loss being reported in the financial statements. In some periods, the fair value of such an instrument may not change significantly such that there is little, if any, effect on reported profit or loss. In periods in which the change in fair value of a share-settleable financial instrument results in the recognition of a gain, it is unclear how that gain would capture appropriately the potential dilution to holders of outstanding ordinary shares. Such an instrument could be significantly in-themoney at the balance sheet date while its fair value may have changed during the period in a manner that resulted in gain recognition for the period. In many cases, the impact of the proposed guidance would increase diluted EPS, as compared to the current requirements of IAS 33 and Statement 128, because the incremental shares from such instruments no longer would be included in the denominator and any gain from changes in fair value no longer would be reversed through an adjustment to the numerator. 21. Some respondents highlighted inconsistencies between the proposed change for instruments measured at fair value with changes in fair value recognized through earnings and other EPS computation guidance within the proposed Statement and other current accounting literature. Ernst & Young (CL# 17) noted: excluding such instruments from the calculation of diluted earnings per share appears to be inconsistent with the treatment of equity settled share-based payments in the calculation of earnings per share. The Basis for Conclusions to Statement 123(R), Share-Based Payment, states that "[a] transaction that results in an expense and that also increases the number of common shares outstanding properly affects both the numerator and the denominator of earnings per share" (Statement 123(R), paragraph B28. Similarly, for instruments measured at fair value through profit or 10

11 loss, there are two economic events: fair value gains or losses due to changes in market conditions and the potential dilution from the exercise or conversion of instruments by the holder. Consequently to be consistent, both economic events should be reflected in the calculation of diluted earnings per share. McGladrey & Pullen LLP (CL# 19) noted: the proposed Statement s guidance to exclude from the denominator of diluted EPS the number of additional common shares that would arise from the assumed exercise or conversion of certain freestanding instruments that are measured at fair value each period with changes in fair value recognized in earnings seems to be contrary to both the proposed guidance regarding settlement in cash or shares and the objective of computing diluted EPS. Furthermore, we don t believe it is clear in the proposed Statement which of the above rules or principles trumps the other. In other words, if there is a cash settled instrument that contains a provision that requires or permits share settlement and this instrument is also measured at fair value each period with changes in fair value recognized in earnings, we don t believe it s clear whether for purposes of computing diluted EPS this instrument should be included (because one is required to assume share settlement) or excluded (because it is measure at fair value each period with changes in fair value recognized in earnings). Two-Class Method 22. Generally, most respondents agreed with the proposed change to the two-class method for computing diluted EPS in which an entity would no longer reduce income from continuing operations (or net income) by the amount of additional dividends that would be assumed to be declared for potential common shares or potential participating securities that are assumed to be outstanding. One respondent who agreed with the proposed change to the two-class method, PG&E Corporation (CL# 6), provided the following reasons: We believe that the allocation of undistributed earnings between common shareholders (which includes additional potential common shares) and participating securities is sufficient. To support our position, we note that in cases where dividends can be settled in shares of common stock, the assumption of additional dividends and share settlement would result in a circular calculation that is not meaningful. 23. Some respondents requested an exception to the two-class method when an entity has multiple classes of common stock with the same dividend rate. Deloitte (CL# 14) stated: an entity that does [use the two-class method] could arrive at different diluted EPS amounts for each class of common stock on the basis of the Board s conclusion regarding the computation of diluted EPS under the two-class method. To reduce the likelihood of different diluted EPS amounts for each class of common stock, the 11

12 Board should therefore consider explicitly stating that the two-class method is not required for multiple classes of common stock with the same dividend rate. Similarly, Texas Instruments (CL# 16) commented: the Exposure Draft be modified to exclude participating securities that are exchangeable or convertible into common shares where there is only one class of common stock from applying the two-class method. Regarding partially paid shares, Deloitte (CL# 14) commented: We believe that if the common shares issued in partially paid form participate in dividends with common shareholders in a rate different from that of common shareholders, the two-class method should be used. 24. Some respondents believed that the Board should review the two-class method as a whole. One such respondent, PricewaterhouseCoopers (CL# 8), commented that the pro forma nature of the allocation of earnings under the two-class method may not necessarily reflect the economic probabilities of actual distributions to the participating security holders. For this reason, we recommend that the Board undertake a future project to reconsider the two-class method for computing diluted EPS so that the economics of the participating security holders are better reflected. Treasury Stock and Reverse Treasury Stock Methods Liability Included As Proceeds 25. Most respondents agreed with the treasury stock method proposal to include as assumed proceeds the end-of-period carrying value of an instrument that is classified as a liability, that is not measured at fair value each period through earnings, and that would be extinguished upon exercise. 26. Some respondents commented that there should be no different EPS treatment for instruments classified as equities as compared to those classified as liabilities. McGladrey & Pullen LLP (CL# 19) believes there should be no different earnings per share treatment for an instrument that is classified as a liability as compared to an instrument classified as equity, since a company will receive the same proceeds from a liability-classified instrument as from an equity-classified instrument. 12

13 27. Some respondents requested that Statement 128 clearly state that assumed proceeds include liabilities that are expected to be share settled. Those respondents pointed out that the basis of conclusions discusses this issue. Deloitte (CL# 14) stated: We agree with the Board s conclusion in paragraph B10 of the proposed Statement, which indicates that because of the Board s decision to include, as an assumed proceed, the end-of-period carrying amount of a liability (one that is not measured at fair value each reporting period) in the calculation of the treasury stock method, there would be no effect on diluted EPS for an arrangement settled with equity instruments whose value is equal to the end-of-period carrying value of the liability (e.g., a fixed monetary obligation that may be settled in a variable number of shares.) However, we believe that the Board should include such guidance in the amendments to Statement 128 as well as in the Basis for Conclusions. End-of-Period Market Price 28. Some respondents agreed with the proposed change to use the end-of-period market price of common shares to determine the incremental number of shares to be included in the EPS denominator under the treasury stock and reverse treasure stock methods. The North Carolina State Board of Certified Public Accountant Examiners (CL# 4) believes that this change will simplify the computation of diluted EPS and provide more consistency in the standard. 29. PricewaterhouseCoopers (CL# 8) agreed with the proposed change to use the end-of-period market price, but requested one clarification to be included in final guidance. PricewaterhouseCoopers recommends to avoid any confusion for entities listed on multiple exchanges around the world that the Board clarify that the end-of-period market price should be based on the closing price on the principal exchange on which the shares trade. 30. Some respondents commented that this proposed change to the EPS computation only simplifies the computation but does not eliminate an inconsistency within the standard and between U.S. GAAP and IFRS. KPMG (CL# 9) stated: Both Exposure Drafts indicate that use of the end-of-period market price eliminates an inconsistency in calculating the incremental number of shares included in the diluted EPS denominator under the treasury stock method. That method requires the entity to assume that exercise of the instruments (i.e., options, warrants, or their equivalents) occurs at the beginning of the reporting period (or at the time issued, if later), and the assumed repurchase of treasury shares using the proceeds from the exercise occurs at the same time. The use of the entity s end-of-period market price to determine the number of treasury shares assumed to have been repurchased at the beginning of the period does not, in fact, remove the inconsistency cited by the Boards regarding the use of the entity s average stock price for the reporting period. Rather, it simply replaces it 13

14 with a different inconsistency. It is confusing to suggest that the proposed change is somehow eliminating an inconsistency, when it is just changing the nature of the inconsistency. Therefore, we believe that the final standards should clarify that this change was made for purposes of simplifying the diluted EPS calculation, rather than asserting that the change eliminates an inconsistency. 31. The majority of respondents did not agree with the proposed use the of end-of-period market price of common shares in computing the number of incremental shares that would be issued upon an assumed exercise or conversion. These respondents provided various reasons for their disagreement with the proposed change to the EPS computation. 32. Some respondents commented that the use of end-of-period market price introduces volatility to the EPS computation. BB&T (CL# 13) commented: using end-of-period market prices introduces potentially significant volatility in the number of incremental shares and this could significantly reduce the usefulness of diluted EPS in evaluating a company s results as well as the analysts predictive ability. It is also somewhat nonsensical that if a company s stock price drops on the last day of the period, their reported diluted EPS would be higher and that tends to increase the stock price. The use of an average market price is the only alternative that makes any sense. Alternatively, Nortel Networks Corporation (CL# 11) stated: We support the proposed use of end-of-period market price compared to average market price under the treasury stock method as [they] believe it provides a more current view of shareholder participation in earnings. [They] also support the reduction in complexity while acknowledging it could result in significantly different outcomes for companies experiencing significant fluctuations in stock price. 33. Some respondents commented that EPS is an earnings measurement over a period of time and, therefore, an average price should be utilized when computing the number of incremental shares. PG&E Corporation (CL# 6) believes that the end-of-period share price over the reporting period would not be appropriate under the treasury stock method, as diluted EPS is a measure of a company s performance over a reporting period, rather than at the end of the reporting period. Reverse Treasury Stock Method 34. Some respondents stated that the reverse treasury stock method guidance is no longer required. Those respondents added that there would no longer be situations in which the reverse treasury 14

15 stock method would be applicable due to the EPS computation changes proposed in the FASB Exposure Draft. In addition, one respondent, Deloitte (CL# 14), highlighted that the IASB proposed eliminating similar guidance in its exposure draft. Deloitte commented: We believe that the rationale for including the carrying amount of an option or warrant contract that is classified as a liability in the treasury stock method should also apply to the reverse treasury stock method. That is, if a written put option or forward purchase contract is in a liability position (and not measured at fair value in each reporting period), the amount of proceeds that would be needed to satisfy the contract (i.e., to buy back shares) should be reduced. We note that if this rationale is carried forward into the computation of the reverse treasury stock method, coupled with the change to use end-of-period market prices, all written put options and forward purchase contracts (not measured at fair value each reporting period) will most likely be antidilutive. That conclusion seems consistent with the notion that a contract to repurchase an entity s own outstanding shares should not result in dilution. As a result of either (1) measuring written put options and forward purchase contracts at fair value (or applying the guidance in paragraph 25 of Statement 150) or (2) changing the reverse treasury stock method to be consistent with the amendments to the treasury stock method, we believe that the use of the reverse treasury stock method is no longer needed. 35. KPMG (CL# 9) stated that if the reverse treasury stock method is retained, it would be helpful for the final standard to provide examples of instruments that would be subject to the reverse treasury stock method. Assumed Share Settlement 36. The majority of respondents agreed with the proposal that entities should assume share settlement when computing diluted EPS for an instrument that permits or requires either cash settlement or share settlement, unless the only circumstance that would permit or require the share settlement is the legal bankruptcy of the issuer. 37. The FASB Exposure Draft proposes adding the following sentence to paragraph 29 of Statement 128: An otherwise cash-settled instrument that contains a provision that requires or permits share settlement upon the occurrence of a specified event or circumstance is not a contingently issuable share agreement; therefore, share settlement of such an instrument must be assumed for purposes of computing diluted EPS if the effect is dilutive. Deloitte (CL# 14) commented that the proposed guidance creates an inconsistency between (1) an instrument with cash settlement provisions and contingent share settlement provisions (which 15

16 would have to be included in diluted EPS regardless of the contingency) and (2) an instrument that is only settled in shares for which settlement occurs only upon the occurrence of a contingent event. Deloitte also questioned why an instrument that contingently provides for issuance of shares, with cash settlement required in the absence of occurrence of the contingent event, should always be included in diluted EPS (if the instruments are dilutive). Deloitte believes that such an instrument should be considered a potential share-settled instrument and should apply the guidance on contingently issuable shares included in the Exposure Draft. Disclosures 38. Most respondents agreed that additional disclosures beyond those already required by U.S. GAAP (for example, Statement 128, FASB Statement No. 129, Disclosure of Information about Capital Structure, and EITF Issue No , Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company s Own Stock ) are not warranted. 39. Many respondents commented that if the Board finalizes the proposal to no longer include in the denominator of diluted EPS the number of additional common shares that would arise from the assumed exercise or conversion of certain instruments that are measured at fair value each period with changes in fair value recognized in earnings, additional disclosures would be helpful for users to fully understand the dilutive effects of the excluded instruments. Respondents had the following suggestions for additional disclosures: McGladrey & Pullen LLP (CL# 19): In particular, we believe for a financial statement user to truly understand all of the potential dilution, disclosures of both the amount and value of those dilutive instruments measured at fair value and excluded from the denominator of diluted EPS should be required. Furthermore, we believe disclosure of the incremental shares that would have been included in the denominator of the diluted EPS computation if these securities were included in the diluted EPS computation should also be required. KPMG (CL# 9): disclose (a) the number of incremental shares that would have been included in diluted EPS for those instruments under the treasury stock method and (b) the change in the fair value of those instruments for the period. 40. The Ohio Society of Certified Public Accountants (CL# 3) suggested that the use of an end-ofperiod market valuation in EPS calculations may strengthen the need for sensitivity type 16

17 information on market change impacts to those measures disclosed. Such becomes increasingly important to users in volatile markets like those being seen currently. Other Comments 41. In addition to raising the significant issues discussed in the sections above, some respondents provided other comments, as discussed below. Other respondents provided the Board with editorial changes (such as typographical errors, organization of standard, headings, and updates to the table of contents). Editorial changes will be considered during the final standard drafting process. 42. One particular editorial change to highlight is KPMG s (CL# 9) recommendation that the document should contain a single overall statement that instruments measured at fair value through profit or loss should be excluded from both basic and diluted EPS, instead of repeating that statement in various places throughout the document. KPMG then pointed out instances in which the phrase should have been included but was not. Scope 43. Some respondents suggested that the Board expand the scope of the EPS project beyond convergence with IAS 33, Earnings per Share. These respondents had various suggestions to improve the EPS standard and computation. 44. Respondents suggested that the final EPS standard incorporate EPS computation guidance currently addressed in the following literature: a. EITF Issue No. 03-6, Participating Securities and the Two-Class Method under FASB Statement No. 128 b. EITF Issue No. 04-8, The Effect of Contingently Convertible Instruments on Diluted Earnings per Share c. FASB Staff Position (FSP) EITF , Determining Whether Instruments Granted in Share- Based Payment Transactions Are Participating Securities d. SEC Staff Accounting Bulletin (SAB) Topic 5Q, Increasing Rate Preferred Stock. 45. JPMorgan Chase & Co (CL# 15) highlighted that the example on common stock with participating nonvested shares in proposed FSP FAS 128-a, Computational Guidance for Computing Diluted 17

18 EPS under the Two-Class Method, was the only example from the proposed FSP that was not included in the proposed FASB Statement. JPMorgan Chase & Co believes that it would be useful to include such an example because share-based payment transactions would typically have unique considerations in the EPS calculation. JPMorgan Chase & Co adds that in the situation where the nonvested shares participate in dividends at the same rate as the entity s common shares, a company would report a different EPS amount under the Exposure Draft for the nonvested awards, even though those awards participate in earnings pari passu with the common shares. In order to avoid this distortion, the compensation expense related to forfeitable awards should be added back to the EPS numerator. 46. PricewaterhouseCoopers (CL# 8) noted that the Board did not propose changes to the if-converted method and suggested the Board review the if-converted method prior to finalizing the EPS standard. PricewaterhouseCoopers stated that the scope of the EPS project excludes a reconsideration of the application of the if-converted method because that method is already sufficiently converged. Rather than changing the EPS computation for only a subset of convertible instruments (i.e., those for which the conversion option has been separated from the instrument and marked-to-market through earnings), we prefer to see the Board address the if-converted method on a comprehensive basis to ensure that all economically similar instruments are treated consistently in the EPS computation. KPMG (CL# 9) added that the if-converted method should be applied only to convertible instruments in circumstances in which the conversion option is not accounted for separately from the host contract. 47. Deloitte (CL# 14) recommends that the final standard also discuss the effect on the computation of EPS of securities issued by the parent company that are exercisable into common stock of a subsidiary or investee company that would use the treasury stock method. Transition 48. The FASB Exposure Draft proposed that retrospective application be prohibited for instruments that on or before the last day of the period of adoption (including interim periods in the year of adoption) have been settled for cash or modified such that the instruments can no longer be settled in shares. Some respondents commented that this exception to retrospective application should be removed. 18

19 KPMG (CL# 9) stated: We expect that the final standards would be effective on January 1, 2010 for calendar year-end entities and would be applied retrospectively to an entity s 2009 and 2008 financial statements. Given that entities have had nearly five years to amend or settle their share-settleable contracts between the FASB s original proposal in 2003 and 2008, the FASB should consider whether that exception to retrospective application is still necessary. We believe that both standards should be consistent in their retrospective transition requirements, and should be applied to all periods presented. KPMG added: As the paragraph is currently written, it implies that retrospective application of the remaining amendments to Statement 128 (for example, the requirement to use the end-ofperiod price in treasury stock method calculations) would also be prohibited for those instruments. Additionally, if the Board proceeds as proposed, we believe that the prohibition should be for those instruments modified or settled for cash on or before the effective date of the standard, and not for those instruments modified or settled for cash on or before the last day of the period of adoption. Quarterly and Year-to-Date Computations 49. The FASB Exposure Draft proposed that entities should compute quarterly and year-to-date diluted EPS independently from any prior-period computation. Some respondents disagreed with this proposed change to the EPS computation. Emerson (CL# 5) commented: Year-to-date dilutive shares should continue to be based on the current method of averaging the quarterly computations. We question the theoretical support and usefulness of reflecting subsequent events in EPS by effectively re-computing previous quarters EPS in the year-to-date computation. This does not simplify the EPS computation as indicated in the proposed statement. Although possible under the current standard, the proposed standard will lead to more frequent situations when earnings per share for the quarters will not add to the year. This is difficult to communicate and confusing to non-technical users. In fact, if any changes are to be considered, we support a notion that earnings per share for a year-to-date period should merely equal the sum of the periods (monthly, quarterly, six months, or annual) regularly reported by a company. Presentation 50. Deloitte (CL# 14) recommended that the Board consider requiring the presentation of basic and diluted EPS for each class of common stock, even if the second class of common stock is included 19

20 in the computation of diluted EPS for the primary class of common stock. For example if the second class of common stock is convertible into the primary class of common stock, the Board s intent was to present basic and diluted EPS for both classes of common stock if it is assumed that the second class of common stock (1) was converted into the primary class of common stock and (2) was not converted into the primary class of common stock and remains an outstanding common share. 51. KPMG (CL# 9) questioned whether basic and diluted EPS should be disclosed within the basic financial statements or included in Management s Discussion & Analysis (MD&A). KPMG stated: We note that EPS is an analytical tool that is a widely-used metric by external users of the financial statements and by management. However, EPS is a key performance indicator rather than an accounting measurement. There are a number of other financial ratios and metrics that are used widely by analysts and other financial statement users that are not presented within an entity s general purpose financial statements. Therefore, we suggest that as part of the IASB project on Management Commentary (MD&A) and the joint FASB/IASB Financial Statement Presentation project, the Boards should consider whether EPS should continue to be included as part of the basic financial statements or the notes thereto or whether it represents supplemental information that would be reported more appropriately in MD&A or elsewhere outside the financial statements. 20