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ASC 260 describes the two-class method as an earnings allocation formula.

Excerpt from ASC 260-10-45-60

The two-class method is an earnings allocation formula that treats a participating security as having rights to earnings that otherwise would have been available to common shareholders…

The key to applying the two-class method in the computation of basic EPS is identifying any participating securities that are entitled to receive dividends if and when declared on common stock. These participating securities must be entitled to these rights in their current form (e.g., prior to exercise, settlement, conversion, or vesting).
The reporting entity is required to allocate any undistributed earnings between the common stockholders and the participating security holders based on their respective rights to receive dividends, as if all undistributed earnings for the period were distributed.
A participating security will reduce EPS regardless of whether dividends are actually paid, because the two-class method allocates earnings away from common stockholders to the participating security holders. This process is explained in FSP
The reporting entity is not required to present basic and diluted EPS for participating securities, other than a second class of common stock, under the two-class method, but it is not precluded from doing so.
In some cases, a reporting entity may have two classes of common stock that have identical rights and privileges, except for voting rights. Generally, we believe the two classes can be combined and presented as one class for EPS purposes when the only difference is related to voting rights, but the classes otherwise share equally in dividends and residual net assets on a per share basis. In this situation, a reporting entity should clearly indicate that the earnings per share amounts reflect both classes of common stock, and should appropriately disclose the facts and circumstances in the footnotes.
Figure FSP 7-4 illustrates when and how to use the two-class method in computing basic EPS.
Figure FSP 7-4
EPS decision tree

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