EITF ABSTRACTS Issue No. 89-12 Title: Earnings-per-Share Issues Related to Convertible Preferred Stock Held by an Employee Stock Ownership Plan Dates Discussed: June 29, 1989; August 10, 1989; September 21, 1989; October 26, 1989; December 14, 1989 References: FASB Statement No. 85, Yield Test for Determining whether a Convertible Security Is a Common Stock Equivalent FASB Interpretation No. 31, Treatment of Stock Compensation Plans in EPS Computations FASB Interpretation No. 45, Guarantor s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others APB Opinion No. 15, Earnings per Share AICPA Accounting Interpretation 26, Classification and Assumed Conversion, of APB Opinion No. 15 AICPA Accounting Interpretation 90, Market Price Conditions, of APB Opinion No. 15 AICPA Statement of Position 76-3, Accounting Practices for Certain Employee Stock Ownership Plans AICPA Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership Plans ISSUE A company (sponsor) issues high-yield convertible preferred stock to an employee stock ownership plan (ESOP). The purchase of stock by the ESOP is financed with debt. The debt is serviced by a combination of dividends on the convertible preferred stock and sponsor contributions. In accordance with SOP 76-3, the dividends paid on the convertible preferred stock are charged to retained earnings. The preferred stock may be redeemed by the sponsor at a redemption price that is equal to the initial value of the preferred stock. Redemption may be satisfied in common stock, cash, or a combination of common stock and cash. Each share of the preferred stock is convertible into a fixed number of shares of common stock. In addition, the sponsor may guarantee that Page 1
participants will receive at least the redemption price of the preferred stock upon termination or retirement. The participant may receive cash, common stock, or a combination of both. In calculating earnings per share under the if-converted method, the issues are: 1. Whether convertible preferred shares issued to an ESOP should be considered common stock equivalents 2. Whether net income should be reduced by the additional ESOP contribution that would be necessary to meet the debt service requirement because the preferred stock dividends would no longer be available when the preferred stock is assumed to be converted 3. If there is a guarantee to the employees of the value of the preferred stock equal to the redemption price, whether and to what extent the number of shares assumed to be outstanding should be increased if the market price of the underlying common stock is less than the redemption price for the preferred stock 4. How the answer in Issue 3 would be affected if the redemption price guarantee can be satisfied by paying cash. EITF DISCUSSION The Task Force reached a consensus on Issue 1 that convertible preferred shares issued to an ESOP are not considered common stock equivalents unless the yield at the date of issuance is less than 66 2 /3 percent of the Corporate Aa bond rate (the yield test in Statement 85). [Note: This consensus has been nullified by SOP 93-6. See STATUS section.] The Task Force reached a consensus on Issue 2 that the difference between the current preferred dividend and the common dividend is a nondiscretionary adjustment as described in paragraph 51 of Opinion 15 because under an assumed conversion only the common dividends would be available to service the debt. Thus, an additional ESOP contribution would be necessary to meet the debt service requirement. Net income should be adjusted by the difference between the amount of the current preferred dividend and the amount of the dividends on the common shares considered outstanding under the if-converted method (see Issues 3 and 4). [Note: This consensus has been nullified by SOP 93-6. See STATUS section.] Page 2
Some Task Force members noted that the provisions of some employee benefit plans may result in other nondiscretionary adjustments related to the conversion of the preferred stock and the additional ESOP contribution that would be required. Those adjustments also should be made when applying the if-converted method. The Task Force reached a consensus on Issue 3 that paragraph 63 of Opinion 15 is applicable if the market price of the underlying common stock is less than the guaranteed value of the convertible preferred stock. Earnings per share calculated under the if-converted method should include the number of shares that are assumed to be issued based on the stated conversion rate for unallocated shares plus the number of shares that would be equivalent to the redemption value, but not less than the stated conversion rate, for shares of convertible preferred stock that have been allocated to participants as of the reporting date. [Note: This consensus has been nullified by SOP 93-6. See STATUS section.] Prior earnings-per-share amounts should be restated if the number of shares issued or contingently issuable subsequently changes because the market price changes. The Task Force reached a consensus on Issue 4 that if the sponsor is either (a) required to or (b) has the ability and expressed intent to satisfy the guarantee feature in cash, the stated conversion rate should be used for all shares and no additional issuance of shares related to the guarantee feature is assumed. Otherwise, additional shares must be provided in accordance with Issue 3 above. [Note: This consensus has been nullified by SOP 93-6. See STATUS section.] Task Force members noted that the consensuses on these issues apply regardless of how the sponsor classifies the convertible preferred stock in the statement of financial position. Further, in accordance with Opinion 15, the if-converted method should not be applied if the effects are antidilutive. Page 3
The FASB staff noted that the consensuses on Issues 2, 3, and 4 would apply to both primary and fully diluted earnings-per-share calculations if the convertible preferred stock is a common stock equivalent. The SEC Observer stated that registrants are required to apply retroactively the consensuses reached on these issues to earnings-per-share calculations, if necessary, for all periods presented in financial statements filed subsequent to the consensuses. The SEC Observer also stated that although the SEC staff will accept the earnings-per-share computations required by this consensus, there may be some unusual ESOP-related circumstances that the SEC staff may address on a case-by-case basis. Further, the consensuses reached on these ESOP issues should not be used as analogies to other earnings-per-share situations. STATUS The AICPA issued SOP 93-6 in December 1993 which supersedes SOP 76-3 and nullifies the consensuses in this Issue. However, under the transition provisions in SOP 93-6, employers may continue their current accounting for shares acquired before January 1, 1993. These consensuses will still apply to employers making that election. Interpretation 45, which was issued in November 2002, requires a guarantor to recognize, at inception of the guarantee, a liability for the obligation undertaken in issuing the guarantee. The Interpretation also elaborates on the disclosures to be made by a guarantor. The Interpretation s disclosure requirements, but not its initial recognition and initial measurement provisions, apply to guarantees of the value of the preferred stock by employers that continued their accounting for shares acquired before January 1, 1993. The initial recognition and initial measurement provisions are applicable only to guarantees issued or modified after December 31, 2002. Interpretation 45 does not impact any of the consensuses reached in this Issue. Page 4
No further EITF discussion is planned. Page 5