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.
Discussion at the May 2008 IASB Meeting
(The FASB staff joined the meeting by video link for this session.)
The Board discussed sweep issues identified by the Board and external reviewers in the review process of the pre-ballot draft of proposed amendments to IAS 33 Earnings per Share. The pre-ballot draft was not included in the observer notes for this meeting.
Scope of IAS 33
Puttable financial instruments
In February 2008 the Board amended IAS 32 Financial Instruments: Presentation to include an exception that instruments that meet the definition of a financial liability should be classified as equity instruments if they have all the features and meet the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D of that standard.
Some external reviewers noted that paragraph 96C of IAS 32 Financial Instruments: Presentation treats puttable instruments classified as equity under the amendment as equity only in IAS 1, IAS 32, IAS 39 and IFRS 7. Consequently, the exception does not apply to IAS 33 and those instruments would not be treated as ordinary shares in the EPS calculation.
The Board agreed to amend paragraph 96C of IAS 32 to include IAS 33 in the exception. The Board noted that this amendment will align the EPS calculation with the accounting treatment for those instruments.
In addition the Board deliberated how IAS 33 would apply to an instrument that meets the definition of a financial liability but is required to be classified to equity in accordance with the exception in IAS 32 at some point after initial recognition.
The Board agreed to the staff analysis that by extending the scope of IAS 32 to IAS 33, the standard would provide principles for instruments that (1) meet the definition of a participating instrument or are (2) measured at fair value through profit or loss. Consequently, the Board decided that no amendment to the pre-ballot draft is necessary in this respect.
EPS calculation for options, warrants and their equivalents
Forward contracts to sell an entity's own shares
Some external reviewers asked for clarification of the EPS treatment of forward contracts to sell an entity's own shares.
The Board decided to include guidance in the amendment on the dilutive impact of forward sales of shares classified as equity stating that the treasury stock method should be applied to these contracts.
Proceeds - Carrying amount of liability
Some external reviewers questioned whether guidance is needed on what is deemed proceeds in the instance when the instrument is a financial liability that is an option, warrant, or equivalent. If options, warrants, and their equivalents are classified as liabilities, they would always be measured at fair value through profit or loss, and no denominator adjustment of the diluted EPS calculation is necessary. Therefore, reviewers questioned whether the proposal to define the proceeds from the assumed exercise of options, warrant, and their equivalents is necessary.
The Board agreed with those review comments and decided to delete the paragraph on items to be included in proceeds from the exercise of options, warrants, and their equivalents in paragraph 46 of the pre-ballot draft, as those paragraphs were unnecessary.
Proceeds - Deferred taxes
Some reviewers stated that the wording in the pre-ballot draft (paragraph 47A of current IAS 33) could be interpreted in a way that IAS 33 prohibits the inclusion in the assumed proceeds of tax benefits that would be credited to equity upon exercise of share options to which IFRS 2 Share-based Payment applies.
The Board was of the view that the wording in IAS 33 was never intended to prohibit an entity from including those tax benefits in the proceeds from the assumed exercise of employee options. Consequently, the Board decided to amend the pre-ballot draft to state that the proceeds from the assumed exercise of employee options include tax benefits that are credited to equity upon exercise of the option.
EPS calculation for gross physically settled forward contracts to buy an entity's own shares
Forward purchase contracts with and without remittance of dividends
Paragraph 23 of IAS 32 states that a 'contract that contains an obligation for an entity to purchase its own equity instruments for cash or another financial asset gives rise to a financial liability for the present value of the redemption amount'.
Some external reviewers questioned whether the pre-ballot draft would achieve convergence with US GAAP regarding forward purchase contracts without remittance of dividends because:
- the wording in paragraph A33 is not clear on whether the Board believes that the gross physically settled forward purchase contract or the ordinary shares subject to the contract meet the definition of a participating instrument;
- not all gross physically settled forward contracts to buy an entity's own shares are participating instruments.
In this context the staff noted that the pre-ballot draft also requires forward purchase contracts with remittance of dividends to be accounted for in the same way as those without remittance of dividends. The staff pointed out that when dividends are remitted back, the liability that has been reclassified from equity no longer meets the definition of a participating instrument. Consequently, the staff suggested that for such contracts the denominator should be reduced but that the Application Guidance of the pre-ballot draft should not be applied.
Debate continued about what the accounting should be when a forward contract/written put to buy equity is in the money, that is, when the strike price recognised as a financial liability is in excess of the fair value of the share to be acquired. The staff agreed to look into this issue and will revert back to the Board offline.
Mandatorily redeemable shares
The staff noted that the accounting treatment of mandatorily redeemable ordinary shares in accordance with paragraph 18a of IAS 32 is similar to the accounting treatment of gross physically settled forward contracts to buy an entity's own shares and that therefore the same EPS treatment should apply.
The Board agreed and asked the staff to amend the pre-ballot draft accordingly.
Contracts that may be settled in ordinary shares or cash
Some external reviewers questioned whether the requirements for the diluted EPS calculation of contracts that may be settled in ordinary shares or cash are necessary since they could not think of an instrument to which those requirements would apply. These reviewers were of the view that either an entity would measure a financial instrument with settlement options either at fair value through profit or loss, and therefore no denominator adjustment would be required, or the instrument would meet the definition of a participating instrument, and the application guidance in paragraphs A25 to A30 of the pre-ballot draft would apply.
The Board agreed and asked the staff to delete the respective guidance from the pre-ballot draft.
Effective date and transition guidance
The Board decided that early adoption of the proposed amendments to IAS 33 should not be permitted since early adoption may impair performance comparisons between entities in the same reporting period that prepare financial statements in accordance with IFRSs. Also, not permitting early adoption would be consistent with the equivalent FASB amendment. The Board also decided that no additional transitional provisions are necessary.
Introduction of a comprehensive earnings per share measure
The Board discussed whether, following the 2007 amendments to IAS 1 Presentation of Financial Statements, the ED should encourage the disclosure off 'Comprehensive Earnings per Share' in addition to EPS.
One Board member noted that such a statement is unnecessary since an entity is not precluded from providing this additional information on a voluntary basis. The Board decided not to include the statement in the ED.
August 2008: IASB proposes to amend IAS 33 Earnings per Share
On 7 August 2008, the IASB proposed to amend IAS 33 Earnings per Share (EPS) to simplify the calculation of EPS and to converge the international standard and US GAAP. The proposal is set out in an exposure draft (ED) titled Simplifying Earnings per Share. Comments are requested by 5 December 2008. Concurrently, the US Financial Accounting Standards Board has proposed to amend its EPS standard, SFAS 128 Earnings per Share. The IASB's proposal, if adopted, would supersede the version of IAS 33 issued in 2003 and amended in 2007 by IAS 1.
Among other things, the revisions to IAS 33 would:
- Provide a clear principle to determine which shares and other instruments should be included in the EPS calculation. Under that principle, the weighted average number of ordinary shares includes only those instruments that give their holder the right to share currently in profit or loss of the period.
- Clarify the EPS calculation for particular instruments, such as contracts to sell or repurchase an entity's own shares and participating instruments. The ED treats those contracts as if the entity had already repurchased the shares. Therefore, the entity would exclude those shares from the denominator of the EPS calculation.
- Amend the calculation of diluted EPS for participating instruments and two-class ordinary shares. If a convertible financial instrument would have a more dilutive effect if conversion is assumed, then the entity would assume the more dilutive treatment for diluted EPS.
- Simplify the EPS calculation for instruments that are accounted for at fair value through profit or loss. For such instruments (including the derivative component of a compound financial instrument), an entity would not adjust the numerator or denominator of the diluted EPS calculation.
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Click for IASB Press Release (PDF 48k).
The 13 August 2008 issue of Heads Up titled A Common Denominator:
FASB and IASB Issue Exposure Documents on EPS (PDF 155k) discusses the exposure documents issued by the two boards.
Deloitte's IFRS Global Office has published a Special Edition IAS Plus Newsletter – IASB and FASB issue proposed amendments to Earnings per Share (PDF 146k) explaining the IASB's proposal.
Discussion at the April 2009 IASB Meeting
The staff presented a summary of the comments received on the ED Simplifying Earnings per Share. There was no substantive discussion of this presentation.
Plan for redeliberation
The majority of the discussion concerned whether to continue, delay, or discontinue the project. The staff noted that many respondents recommended either stopping the project or, at least, delaying it until the Board finalises the projects on financial instruments with characteristics of equity and financial statements presentation.
The Board was divided. Some thought that the ED's proposals were a significant improvement over existing guidance and that the work on convergence should not be lost. Others were concerned that any work on EPS at all was wasted effort. Other Board members noted real constraints on staff resources.
Ultimately, the Board did not favour discontinuing the project. It did agree, however, to suspend work on the project until the Consolidation project was complete (the staff resources are the same), at which time work would continue to finalise the proposals in the ED.
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