Chronology
Timetable
Background
The FASB is considering a change to the treasury stock method for calculating dilution of EPS. The IASB is considering the same issue.
Discussion at the November 2005 IASB Meeting
The Board agreed a staff recommendation that, assuming that the change to the treasury stock method is finalised in a FASB Statement:
- A similar proposed amendment is made in IAS 33 to the treasury stock method that is applied to the inclusion of options, warrants and their equivalents in the calculation of diluted EPS.
- The if converted method is eliminated and that the amended treasury stock method is applied to the inclusion of convertible instruments in the calculation of diluted EPS, that is, the amended treasury stock method is also applied to the inclusion of convertible instrument in the calculation of EPS.
A Board member raised a concern that the treasury stock method does not work if the affected shares are held in a partly-owned subsidiary and suggested that a modest change to IAS 33 paragraphs 19 and 20 could be made to address this issue. Other Board members agreed that there was no reason not to address this. FASB staff present by video link suggested that, if the IASB were to propose such a change in its ED, the FASB might consider it in their redeliberations.
The FASB staff queried whether the elimination of the 'if converted' method is appropriate for convertible equity instruments. Board members saw no conceptual difference, for this purpose, between debt and senior equity securities: both have a prior claim on the residual net assets of the entity. The standard would be cleaner if the 'if converted' method was eliminated for all convertible instruments.
The Board agreed that the proposals would be issued for a 90-day comment period.
Discussion at the June 2006 IASB Meeting
Treasury Stock Method
At the January 2006 meeting, the Board decided that the (amended) treasury stock method should also be used to calculate the dilutive effect of convertible instruments on EPS calculations. This would replace the 'if converted' method that is used for these instruments at present. The staff noted that the difference in treatment of convertible instruments between IFRSs (treasury stock method) and US GAAP (if converted method) would have significant effects on the calculation of diluted EPS. Using the treasury stock method proposed in the amendments to IAS 33, most convertible instruments would not be dilutive. Using the 'if converted' method, an instrument is dilutive when the dividend or interest on the instrument is lower than basic EPS. The staff were concerned about this effect, particularly in the context of the Convergence Agenda.
Board members noted that EPS was not part of the Convergence Agenda and, more importantly, that the Convergence Agenda accommodates differences in treatments in circumstances in which there are legacy differences in standards. In this case, IFRS bifurcates compound financial instruments; US GAAP does not. The majority of Board members thought that it was more important to fix the IASB's EPS standard for the vast majority of IFRS users rather than to accommodate the relatively few US Foreign Private Issuers that might report different EPS numbers under IFRS and US GAAP.
The IASB directed the staff to prepare amendments to IAS 33 utilising the treasury stock method. The Board agreed not to address the matter of the treatment of 'senior securities' in the EPS calculation at this time. The Board thought that it was more important to amend IAS 33 such that it was internally consistent than to attempt, in a 'quick fix' manner, to achieve convergence with US GAAP.
Discussion at the March 2007 IASB Meeting
The FASB staff joined the meeting by video link for this session.
The purpose of this session was to discuss various amendments to IAS 33 Earnings per Share in order to finalise the short-term convergence project. The Board unanimously agreed to all proposed amendments without detailed discussion. The main decisions are summarised in the paragraphs below. Further details are outlined in Agenda Paper 11 and 11A available in the Observer Notes section of the IASB's website.
Fair value method
The Board decided to apply the fair value method to the following instruments and therefore to scope-out these instruments from the computation of diluted earnings per share (EPS):
- all instruments subject to the treasury stock method that can be settled in cash or shares, are classified as a liability on an entity's balance sheet, and are marked-to-market each reporting period through profit or loss
- all instruments subject to the if-converted method that can be settled in cash or shares, are classified as a liability on an entity's balance sheet, and are marked-to-market each reporting period through profit or loss
In addition, the modified treasury stock method would be applied to instruments that are subject to the treasury stock method, can be settled in cash or shares and are not marked to fair value in each reporting period. The modification is to include the end-of-period carrying value of the liability as an assumed proceed and to use the end-of-period market price in the computation of the treasury stock method.
Scoping issues
Among others the following decisions were made:
- To amend paragraph A14 of IAS 33 to clarify that the two-class method is the only acceptable method for computing basic EPS for instruments that participate in earnings with the common shareholders irrespective of whether these instruments are convertible into common shares or not.
- To incorporate into IAS 33 the guidance included in the proposed FSP FAS 128-a regarding the computation of diluted EPS using the two-class method.
- Explicitly to require the use of the two-class method in computing basic EPS for mandatorily convertible instruments that have a stated participation right and to exclude those instruments from the computation of basic EPS that do not have a stated participation right.
Discussion at the July 2007 IASB Meeting
(The FASB staff joined the meeting by video link.)
The Board continued with its discussions with a view to finalising the short-term convergence project with the FASB on the amendment to IAS 33.
The Board had previously made decisions to follow the FASB proposal of not adjusting earnings or the number of shares when a derivative over own equity is fair valued through income. This would apply to stand-alone derivatives over own equity, as well as embedded derivatives that fail the definition of equity.
At this meeting the Board agreed to extend that principle to instruments that are potentially convertible into shares where the whole instrument does not meet the definition of equity and is a financial liability that is fair valued through income. An example would be where the entity has applied the fair value option to the whole instrument and therefore does not recognise a separate embedded derivative.
The Board also agreed that, in computing diluted EPS under the two-class method, actual distributions paid to outstanding common stockholders should be used.
The Board discussed potential differences that may exist between US GAAP and IFRSs in the accounting for forward purchase contracts and to a lesser extent, written puts over own equity.
The Board proposed that gross physically settled forward contract were not dilutive as the entity is considered to have acquired the equity upon entering into the arrangement. The Board also believed that any dividends payable on equity shares that are subject to the forward contract would be recognised as an expense. A comparison was made of the IASB's and FASB's approaches for various instruments. In some circumstances the EPS result was the same even though the method of computation differed. In other instances the EPS result was different because the underlying accounting for the potential ordinary share differed.
There was further discussion on an issue not included in the Board paper on forward purchase arrangement where the dividends on the shares were returned to the issuer (the example in the Board paper assumed dividends were retained by the counterparty to the forward contract) and whether a different EPS would result under IFRSs and US GAAP. The Board did not wish to have a difference in this respect and therefore agreed to bring back this issue in September for further.
With regard to convergence, the Board noted that convergence is achieved if EPS is calculated in the same way. However, different EPS amounts under US GAAP and IFRSs could still result from differences in the underlying accounting for instruments.
The amendments to IAS 33 are intended to be effective for annual periods beginning 1 January 2009 to coincide with the FASB's proposed effective date for annual periods beginning after 15 December 2008.
Discussion at the January 2008 IASB Meeting
(The FASB staff joined the meeting by video link for this session.)
The Board discussed the way forward in this project and some sweep issues that arose during the drafting of the exposure draft (the ED).
Fair Value Method
The IASB and FASB tentatively decided that instruments that can be settled in cash or shares and are measured at fair value through profit or loss should not be adjusted for calculating basic and diluted EPS calculation (referred to as the 'fair value method'). The main reason for this decision was that the changes in fair value recognised in profit or loss reflect the economic effect of these instruments on current shareholders. It was noted that this rationale applies even though the inclusion of a financial liability measured at fair value through profit or loss in computing the incremental shares under the modified treasury stock method would result in EPS being anti-dilutive. In addition, the Board noted that excluding these instruments from the calculation satisfies the objective of simplifying the EPS calculation.
There was support from the Board for finalising the fair value method though one Board member noted that this approach was removing information about the number of shares that would be issued upon conversion of these instruments. Therefore, this Board member suggested requiring additional disclosure in order to enable users to calculate diluted EPS differently from the method required in the ED. The disclosure requirements discussed in this context were
- to disclose the number of incremental shares that would have been added to the denominator of diluted EPS (that is, as if the instrument was classified as equity and the treasury stock method was applied) and
- to disclose the fair value of the instruments excluded from diluted EPS under the fair value method to demonstrate how much value was assigned to the potential equity shares.
The Board decided not to include additional disclosure requirements but to include a question in the ED to seek input from constituents whether:
- They agree with the basis for excluding instruments that are measured at fair value through profit or loss from the EPS calculation, that is, no further adjustment to earnings or the potential number of shares is required.
- Additional information should be provided in a disclosure for these instruments and why.
Basic EPS: Two-class method
The Board also agreed that the two-class method should be applied to all participating securities regardless of whether they are classified as liabilities or equity and that the calculation of basic EPS should only include those shares that are either currently exercisable or convertible for little or no cost or can currently participate in earnings with ordinary shareholders.
Share-based payment awards under IFRS 2 Share-based Payment
The Board decided to clarify that a financial instrument or contract subject to IFRS 2 that is recognised (or would be recognised upon satisfaction of a performance or service condition) as a liability and measured in accordance the fair-value-based measurement approach in IFRS 2 would be considered to be recognised at fair value for purposes of applying the ED.
Way forward
The Board reaffirmed the other tentative decisions made in this project and asked the staff to draft the ED taking into account the decisions made at this meeting.
One Board member indicated an intention to dissent to the ED because of concerns about determining dilution for written puts and forward purchase arrangements as well concerns regarding the lack of disclosure. Another Board member may dissent because of a fundamental concern in issuing a standard on EPS.
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