The Financial Accounting Standards Board has issued another exposure draft on accounting for earnings per share, adding what may be the final tweaks to an amendment of Statement 128.The revised edition has few changes from the original ED that was issued in December 2003, but the board considered at least one change - it involves amending the computational guidance for calculating the number of incremental shares included in diluted shares when applying the treasury stock method - to be substantive enough to require another exposure draft for public comment.
"In the comment letter process, we learned of an unintended consequence of the originally proposed changes," said FASB project manager Jeff Johnson. "We reacted to that and made the document better."
The amended version specifies that in applying the treasury stock method to an instrument classified as a liability that could be settled in shares or cash, the carrying amount of an extinguished liability upon issuance of the shares should be included as assumed proceeds in the computation of incremental shares.
Johnson said that the proposed rule is a "fairly significant change for someone who has an instrument that qualifies for that exception," though he noted that such instruments are relatively rare.
The change came about as a result of comments that the board received from accounting firms, large investment banks and financial companies that structure instruments to achieve multiple objectives.
"We learned in the comment letter process that we had essentially expanded the population of instruments that had to be accounted for as if they were shares settled and to include instruments that are accounted for as liabilities," Johnson said. "That opened up a can of worms we hadn't intended to open."
The consequent change to include the extinguishment of liabilities as part of proceeds, Johnson said, solved the problem that comment letters had pointed out, while still being true to the theory behind Statement 123R (on share-based compensation) and Statement 128.
And it converges, too!
FASB member G. Michael Crooch said that the proposed statement would not only simplify existing guidance and produce similar EPS results for economically similar situations, but also "enhance the comparability of financial reporting internationally by eliminating differences between Statement 128 and comparable international financial reporting standards."
The harmonization with international standards has been an integral part of the EPS project from its start.
Just as the U.S. board issued the first proposed amendment to Statement 128, Earnings Per Share, the International Accounting Standards Board issued improvements to its International Accounting Standard 33, making that standard very similar to the original FASB proposal. The current proposal reflects IAS 33, but offers more guidance on the treasury stock method.
"This proposal goes beyond what is in IAS 33," Johnson said. "It is not explicitly inconsistent with what is in IAS 33, because IAS 33 simply doesn't answer the question that we've answered."
Johnson said that the IASB recently discussed FASB's proposal and decided not to react to it until the proposal was issued as a statement. At that time, they would consider whether the international standard would need clarification.
The proposal retains a stipulation from the earlier draft that shares that can be issued upon conversion of a mandatorily convertible instrument be included in the computation of basic EPS from the date that future conversion becomes mandatory - regardless of whether the effect of including the additional shares is dilutive or anti-dilutive.
The amount of the extinguished liability to be included in assumed proceeds is to be measured at the carrying amount as of the end of the period for which EPS is being measured. This measurement would lead to some dilution when the share price used to compute the end-of-period liability is lower than the average share price used in the treasury stock method.
The notice accompanying the proposal suggests an alternative approach - to measure the liability used in the assumed proceeds computation at the value at which the liability would have been recorded at the end of the period, had the end-of-the-period share price been equal to the average share price during the period. Under that alternative, an instrument subject to the treasury stock method that is classified as a liability and carried at fair value would never be dilutive.
This proposal eliminates the provision of Statement 128 that allows an entity to rebut the presumption that contracts that may be settled in cash or shares will necessarily be settled in shares. Consequently, share settlement must be assumed (if dilutive) for any instrument that permits or requires share settlement under any circumstance, unless the only circumstance that would permit or require share settlement is the legal bankruptcy of the issuer of the instrument.
This proposed statement would be effective for interim and annual periods ending after June 15, 2006. Retrospective application would be required for all changes to Statement 128, except that retrospective application would be prohibited for contracts that were either settled in cash prior to adoption or modified prior to adoption to require cash settlement.
FASB requests comments by Nov. 30, 2005. Depending on how critical incoming comment letters are, a final statement may be issued in the first quarter of 2006.
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