notes that the EPS numerator should be adjusted for a redemption of preferred stock when the fair value of consideration paid upon redemption exceeds the carrying amount, net of its issuance costs, because the excess represents a return to preferred stockholders. Reporting entities should first deduct the commitment date beneficial conversion feature (BCF) related to the preferred stock from the fair value of consideration paid. See FG 7.9.2A
and FG 7.10.1A
for a more detailed discussion of beneficial conversion features in conjunction with the redemption or induced conversion of preferred stock.
The calculation is as follows:
Fair value of consideration transferred
Carrying value, net of issuance costs
When the consideration is less than the carrying amount, net of issuance costs, the reporting entity should add the difference between the carrying amount, net of issuance costs, and the consideration to the EPS numerator. For example, this would apply when a redemption is effected at a discount to the carrying amount of the preferred security.
This guidance applies to redemptions of convertible preferred stock regardless of whether the embedded conversion feature is “in-the-money” or “out-of-the-money” at the time of redemption. Example FSP 7-2A illustrates the impact of a redemption of preferred stock on the computation of basic EPS.
EXAMPLE FSP 7-2A
Impact of redemption of preferred stock on the calculation of basic EPS
On January 1, 20X6, FSP Corp issued perpetual preferred stock that is convertible in four years. The par value (and issuance price) of the convertible preferred stock is $1 million.
The convertible preferred stock also contains a beneficial conversion feature with an intrinsic value of $200,000 on the commitment date. The BCF is recorded as a discount on the preferred stock, with a related credit to APIC, and is being amortized to the first date at which the preferred stock is convertible.
On December 31, 20X7, FSP Corp paid shareholders $1.2 million in cash to redeem the preferred stock.
What is the impact of the redemption of the convertible preferred stock on the calculation of basic EPS?
The difference between the fair value of the consideration transferred to preferred stockholders less the original BCF, and the carrying value of the preferred stock, including any unamortized discount related to the BCF, is treated as a “deemed dividend” to preferred shareholders and results in a reduction to the numerator in the computation of basic EPS.
In this example, the reduction to the numerator in the computation of basic EPS is determined as follows:
Fair value of consideration transferred
Less: BCF (at original intrinsic value)
Less: Carrying value of preferred stock
Reduction in numerator related to “deemed dividend”
1 $1,000,000 par value less $100,000 remaining discount associated with the BCF.
Note that the accounting model for reacquisition of debt securities that contain a BCF and its impact on the gain/loss on extinguishment in ASC 470-20-40-3
differs from that of preferred stock, which is addressed in ASC 260-10-S99-2
(see FG 7.10.1A
If conditionally redeemable preferred shares, initially classified in mezzanine equity, are subsequently determined to be ASC 480
liabilities due to a change in facts (such as the exercise of a holder put feature), such shares would require reclassification from mezzanine equity to a liability. ASC 480-10-30-2
requires the issuer to measure the liability initially at fair value, and reduce equity by the amount of the initial measurement, recognizing no gain or loss in the income statement. This reclassification of shares to a liability is akin to the redemption of such shares by the issuance of debt.
Similar to the accounting for the redemption of preferred shares in ASC 260-10-S99-2
, if the fair value of the liability (less any initial BCF on the preferred stock) differs from the carrying amount of the preferred shares upon reclassification, the reporting entity should deduct the difference from, or add to, the numerator (i.e., as a deemed dividend or as a return from preferred stockholders).
provides guidance on the accounting for a redemption of a subsidiary's preferred stock, either directly by the subsidiary or by its parent, that is not classified as a liability in the parent's consolidated balance sheet. This type of transaction is treated in the parent's consolidated financial statements as an equity transaction and not recorded in the income statement. The related retained earnings charge or credit is reflected in EPS in the same manner described above.
While ASC 260-10-S99-2
states that the excess consideration requires an adjustment to the numerator, it does not address the treatment of the redemption of preferred stock of a subsidiary when that subsidiary's operations will be classified as a discontinued operation. We believe that, because the adjustment is directly associated with the subsidiary being discontinued, it should be attributed to discontinued operations in computing EPS. The impact of attributing the adjustment to discontinued operations could be meaningful because attributing it to discontinued operations would result in excluding this amount from the control number for purposes of determining whether potential common shares are dilutive or anti-dilutive in the computation of diluted EPS (see FSP 7.5.1
Additionally, ASC 260-10-S99-2
indicates that in an induced conversion of preferred shares, the excess of the fair value of securities issued over the fair value of securities issuable pursuant to the original contractual conversion terms also represents a return to preferred stockholders and should reduce the numerator of EPS.
Lastly, as noted in FG 7.8.2
, certain modifications of preferred stock can also result in an adjustment to the EPS numerator as a deemed dividend, based on the incremental fair value arising from the modification.