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The calculation of assumed proceeds under the treasury stock method for stock-based compensation awards requires additional considerations because the reporting entity receives the benefit of future service, which is considered additional proceeds.
The assumed proceeds under the treasury stock method include:
  • The exercise price of the stock options, if any
  • Average unrecognized compensation cost for future service
Although compensation cost may only be recognized for awards that are expected to vest (determined by applying the pre-vesting forfeiture rate assumption), for those reporting entities that elect to estimate forfeitures, all options and shares outstanding that have not been forfeited are included in diluted EPS. In other words, the amount of stock-based compensation cost in the numerator may include a forfeiture rate assumption, while the number of shares in the denominator does not.
See Example FSP 7-8 for an illustration of the difference between the compensation cost recorded for share-based payment awards in the income statement and the amounts included in the assumed proceeds calculation.
Applying the treasury stock method to in-the-money options could be anti-dilutive if the sum of the proceeds, including the unrecognized compensation, exceeds the average stock price. In that case, those options would be excluded from the computation of diluted EPS. For example, if the average market price of the underlying stock was $12, an option with an exercise price of $10 (i.e., $2 in-the-money) and average unrecognized compensation for the period of $4 would be anti-dilutive because the assumed proceeds of $14 ($10 +$4) is greater than the average market price of the underlying share of $12. As a result, these awards are excluded from the diluted EPS denominator.
Stock options
Stock options with service conditions are included in the computation of the denominator of diluted EPS using the treasury stock method if the option is dilutive. In computing diluted EPS, reporting entities should include all outstanding options that are dilutive, without considering the impact of a forfeiture-rate assumption applied for purposes of recognizing compensation cost under ASC 718.
Reporting entities should include stock options with performance or market conditions in the computation of diluted EPS if the options are dilutive and if their conditions (1) have been satisfied at the reporting date (the events have occurred), or (2) would have been satisfied if the reporting date was the end of the contingency period (for example, the number of shares that would be issuable based on current period earnings or period-end market price). When making the determination, a reporting entity should not use projections that look beyond the current reporting period. In essence, it should follow the contingently issuable share guidance described in FSP 7.5.3.
For example, assume that a stock option has a performance condition under which the option vests when earnings before interest, taxes, depreciation, and amortization (EBITDA) reaches $15 million. At the end of the third quarter, EBITDA is $13 million and the company believes that EBITDA will be $17 million at the end of the year. The option would be excluded from the third quarter diluted EPS computation because the performance condition had not been achieved as of the end of that period, as required by ASC 260-10-45-51.
If the performance or market condition was satisfied, or would have been satisfied if the performance or market metric was measured as of the reporting date, the stock options would be included in diluted EPS from the beginning of the period (or date of grant, if later) using the treasury stock method, if the option is dilutive.
Stock options often contain both performance and market conditions. If the award vests if either the performance or market condition is met, then assuming the options are dilutive, the award would be included in the computation of diluted EPS if either condition has been satisfied at the reporting date or would have been satisfied if the reporting date was the end of the contingency period. If both conditions must be met in order to vest, the award would be included in the computation of diluted EPS if the options are dilutive and both conditions have been satisfied at the reporting date or would have been satisfied if the reporting date was the end of the contingency period.
The accounting treatment for options with performance conditions under ASC 718 requires a probability assessment as to whether the option will vest; the accounting treatment under ASC 260 does not call for an assessment of the probability of vesting. Therefore, the numerator in the EPS computations may include compensation cost related to the performance awards, but the performance awards themselves may be excluded from the denominator. There are no adjustments made to the EPS numerator for such situations.
Example FSP 7-8 illustrates the impact of stock options granted to employees on the computation of diluted EPS.
EXAMPLE FSP 7-8

Stock option with a service condition
On January 1, 20X7, FSP Corp grants employees 10,000 nonqualified stock options with an exercise price of $10. Each stock option has a $4 fair value at the grant date. 25% of the shares vest each year over a four-year period. The employee must be employed by the reporting entity on each vesting date to become vested in each tranche.
FSP Corp has elected a policy of straight-line attribution of compensation cost, and a policy of estimating forfeitures. The assumed forfeiture rate is 5% each year. No options were forfeited during 20X7.
The market price of the common stock is: $10 on January 1, 20X7; $26 on December 31, 20X7; $18 average for 20X7.
Treasury stock computation:
The treasury stock calculations use actual forfeitures rather than the forfeiture assumption used for compensation cost recognition purposes. The results of the calculations are hypothetical for EPS purposes and would not agree to the financial statement amounts. The calculations are only used to determine the number of options to include in the diluted EPS computation.
  • Hypothetical total book compensation cost = $40,000

    $4 (fair value per option on grant date) multiplied by 10,000 (options outstanding)
  • Hypothetical cost will be recognized ratably over four years ($10,000 per year)
  • Hypothetical unrecognized compensation cost at December 31, 20X7 = $30,000

    $40,000 (hypothetical total book compensation cost) minus $10,000 (hypothetical book compensation cost recognized in 20X7)
How many potential common shares should be included in diluted EPS for the year ended December 31, 20X7 for these stock options, assuming the shares are dilutive at the end of 20X7?
Analysis
The options are included in the diluted EPS computation by applying the treasury stock method and assuming that the proceeds will be used to buy back shares. Proceeds equal the hypothetical average unrecognized compensation cost plus the exercise price.
  • Hypothetical average unrecognized compensation cost for 20X7 = $35,000

    Average of $40,000 (hypothetical unrecognized compensation cost at January 1, 20X7) and $30,000 (hypothetical unrecognized compensation cost at December 31, 20X7)
  • Assumed proceeds = $135,000

    $100,000 (10,000 options x $10 exercise price per option) plus $35,000 (hypothetical average unrecognized compensation cost)
  • Shares assumed repurchased = 7,500 shares

    $135,000 (assumed proceeds) divided by $18 (20X7 average stock price)
  • Incremental shares to be included in the December 31, 20X7 diluted EPS computation = 2,500 shares

    10,000 (shares issuable upon exercise) minus 7,500 (shares assumed repurchased)

Restricted stock
A reporting entity should include both of the following in its computation of diluted EPS using the treasury stock method:
  • Unvested restricted stock with service conditions
  • Unvested restricted stock with a performance or market condition that is considered contingently issuable shares pursuant to ASC 260-10-45-48
Assumed proceeds under the treasury stock method consist of unamortized compensation cost. If dilutive, the unvested restricted stock would be considered outstanding as of the later of the beginning of the period or the grant date for diluted EPS computation purposes. If anti-dilutive, it should be excluded from the diluted EPS computation.
Example FSP 7-9, Example FSP 7-10, and Example FSP 7-11 illustrate the impact of restricted stock granted to employees on the computation of diluted EPS.
EXAMPLE FSP 7-9

Restricted stock with a service condition
On January 1, 20X6, FSP Corp grants employees 10,000 shares of restricted stock with a fair value of $10 per share. The shares are legally issued and outstanding, and the employee is not required to pay for the restricted stock. All shares are expected to vest. The average stock price for the year ended December 31, 20X6 is $15 per share.
25% percent of the shares vest each year over a four-year period. The employee must be employed by the reporting entity on each vesting date to become vested in each tranche. The company has elected a policy of straight-line attribution and estimating forfeitures.
Expense computation:
  • Total book compensation cost = $100,000

    $10 (fair value per share on January 1, 20X6) multiplied by 10,000 shares
  • Compensation cost will be expensed ratably over four years ($25,000 per year)
  • Unrecognized compensation cost at December 31, 20X6, is $75,000

    ($100,000 minus $25,000)
How many shares are included in diluted EPS for the year ended December 31, 20X6, assuming the shares are dilutive at the end of 20X6?
Analysis
The unvested shares are included in the diluted EPS computation by applying the treasury stock method and assuming that the proceeds will be used to buy back shares. Proceeds equal the average unrecognized compensation cost plus any purchase price.
  • Average unrecognized compensation cost for 20X6 = $87,500

    Average of $100,000 (unrecognized compensation cost at January 1, 20X6) and $75,000 (unrecognized compensation cost at December 31, 20X6)
  • There are no assumed proceeds from exercise (because the employee is not required to pay for the restricted stock)
  • Assumed repurchase = 5,833 shares

    $87,500 (assumed proceeds) divided by $15 (20X6 average stock price)
  • Incremental shares to be included in the December 31, 20X6 diluted EPS computation = 4,167 shares

    10,000 (unvested shares outstanding) minus 5,833 shares (assumed repurchased)
EXAMPLE FSP 7-10

Restricted stock with a performance condition
On January 1, 20X6, FSP Corp grants 10,000 shares of restricted stock with a fair value of $10 per share. The shares are legally issued and outstanding, and the employee is not required to pay for the restricted stock. All shares are expected to vest. The average stock price for the year ended December 31, 20X6 is $15 per share.
25% of the shares vest each year over a four-year period if certain performance conditions are met. The vesting provision includes a performance condition that requires the reporting entity's revenues to exceed $100 million in 20X6; $115 million in 20X7; $130 million in 20X8; and $145 million in 20X9 for the respective year's award to vest.
The requirements for a grant date are met on January 1, 20X6, for all tranches.
Each tranche is based on performance within that year; therefore, each tranche is treated as a separate award with a service inception date of January 1 of each year and a one-year requisite service period.
The reporting entity recognizes compensation cost for each tranche over the respective one-year requisite service period if it is probable that the target established for that year will be met.
Revenues for the year ended December 31, 20X6 were $120 million.
Compensation cost computation:
  • Total book compensation cost = $100,000

    $10 (fair value per share on January 1, 20X6) multiplied by 10,000 shares
  • Compensation cost will be expensed ratably over four years ($25,000 per year)
  • Unrecognized compensation cost at December 31, 20X6, is $75,000

    ($100,000 minus $25,000)
How many shares are included in diluted EPS for the year ended December 31, 20X6, assuming the shares are dilutive at the end of 20X6?
Analysis
Using the treasury stock method, the diluted EPS computation would reflect the number of shares that would be issued based on the assumption that the current amount of revenue achieved will remain unchanged through the end of the performance period.
One way of viewing the contingent share guidance in ASC 260-10-45-48(b) in this case is to treat the amount of revenue generated in the current reporting period ($120 million) as if it were the amount earned in each respective contingent period, since each tranche is treated as a separate award. Under this approach, the 20X6 performance condition for revenue exceeding $100 million has been satisfied at the reporting date, and the 20X7 performance condition for revenue exceeding $115 million would have been satisfied if the reporting date was the end of that contingency period.
The performance conditions for 20X8 and 20X9 would not have been satisfied by revenue of $120 million. Therefore, under this approach, 5,000 shares (the 20X6 and 20X7 tranches) would be included in the diluted EPS computation process. The 20X8 and 20X9 tranches would not be included.
  • Average unrecognized compensation cost for 20X6 = $37,500

    Average of $50,000 (unrecognized compensation cost at January 1, 20X6 related to shares for which the performance condition has been or would have been satisfied based upon the current period results) and $25,000 (unrecognized compensation cost at December 31, 20X6 related to those same shares)

    The unrecognized compensation cost only reflects shares related to the 20X6 and 20X7 performance goals ($25,000 in compensation cost per tranche multiplied by two tranches). The unrecognized compensation cost related to the 20X8 and 20X9 performance goals is excluded because those performance goals are not being satisfied based upon the current period results and therefore the shares in those two tranches are not included in the EPS computations.
  • Assumed repurchase = 2,500 shares

    $37,500 (assumed proceeds) divided by $15 (20X6 average stock price)
  • Incremental shares to be included in the December 31, 20X6, diluted EPS computation = 2,500 shares

    5,000 (unvested shares outstanding for which the performance condition has been or would have been satisfied based upon the current period results) minus 2,500 shares (assumed repurchased)
We believe an alternative approach would also be acceptable in this particular fact pattern in which the award includes multiple independent periods with discrete performance targets associated with service in that period. Under the alternative approach, the entity would not project any further earnings in future periods (as described in ASC 260-10-45-51 and footnote (f) of the example in ASC 260-10-55-56). Under this approach, only the 20X6 tranche of 2,500 shares would be included in the above calculations because as of the reporting date, no earnings would be assumed for the future independent periods. This approach may not be appropriate in fact patterns that vary from this illustration.
EXAMPLE FSP 7-11

Restricted stock with a market condition
On January 1, 20X6, FSP Corp grants employees 10,000 shares of restricted stock. The shares are legally issued and outstanding, and the employee is not required to pay for the restricted stock.
The vesting provisions are market conditions that state that 50% of the restricted stock will vest if the stock price is higher than $18 on December 31, 20X9, and the remaining 50% of the restricted stock will vest if the stock price is higher than $22 on December 31, 20X9. The recipient is also required to still be employed at the vesting date; FSP Corp expects all of the employees to remain employed through that date. Any shares that do not vest will be forfeited. The fair value of the restricted stock on the grant date is $80,000; the effect of the market conditions is reflected (i.e., discounted) in the award’s fair value.
The market price of the underlying stock is $20 on December 31, 20X6, and the average stock price for the year ended December 31, 20X6 is $15 per share.
Expense computations:
  • Total book compensation cost = $80,000
  • Compensation cost will be recognized ratably over four years ($20,000 per year)
  • Unearned compensation cost at December 31, 20X6, is $60,000

    ($80,000 minus $20,000)
How many shares are included in diluted EPS for the year ended December 31, 20X6, assuming the shares are dilutive at the end of 20X6?
Analysis
Following the contingently issuable share guidance in ASC 260-10-45-48 and ASC 260-10-45-52, the diluted EPS computation should reflect the number of shares that would be issued based on comparing the stock price at the end of the period to the market condition metric. Because the stock price at the end of 20X6 is higher than the $18 threshold price but lower than the $22 threshold price, 50% of the restricted shares would be assumed to be issued.
Then, the treasury stock method would be applied as follows:
  • There are no cash proceeds for the restricted shares
  • Average unrecognized compensation cost for 20X6 = $70,000

    Average of $80,000 (unrecognized compensation cost at January 1, 20X6) and $60,000 (unrecognized compensation cost at December 31, 20X6)
Although the stock price at the end of the period is only higher than the $18 threshold price and 50% of the shares would vest based upon that price, the entire award’s average unrecognized compensation cost is included in the treasury stock method proceeds calculation (not 50%). Under the stock compensation guidance, the effect of a market condition is reflected in the award’s fair value on the grant date and all compensation cost for an award that has a market condition should be recognized if the requisite service period is fulfilled, regardless of the level at which the market condition is satisfied (including even if the award never vests). This is because the likelihood of achieving the market condition is incorporated into the fair value of the award. Therefore, there is no direct correlation between the number of shares that ultimately vest in a market condition award and the amount of compensation cost recognized. As a result, changes in the number of shares assumed to be issued under the award for EPS purposes would not change the amount of compensation cost associated with the award that should be used in the treasury stock method calculations.
This differs from Example FSP 7-10 because, as noted above, an award with a market condition is accounted for and measured differently from an award that has a performance or service condition. For awards with performance or service conditions, there is a direct correlation between the number of shares that ultimately vest and the amount of compensation cost recognized; therefore, changes in the number of shares assumed to be issued under the award for EPS purposes would change the amount of compensation cost associated with the award that should be used in the treasury stock method calculations.
  • Assumed repurchase = 4,666 shares

    $70,000 (assumed proceeds) divided by $15 (20X6 average stock price)
  • Incremental shares to be included in December 31, 20X6, diluted EPS computation = 334 shares

    5,000 (unvested shares outstanding) minus 4,666 shares (assumed repurchased)
If the stock price were below $18 at the end of 20X6, which is less than the lowest threshold price, then none of the restricted shares would be included in the diluted EPS computation.

Stock award modifications
In computing diluted EPS, a reporting entity should treat the modification of a share-based award as if there was a cancellation and new issuance of an award. This includes modifications that are made in conjunction with an equity restructuring, such as a spin-off or large cash dividend.
Consistent with the approach described in ASC 260-10-45-26, the reporting entity should treat the “before” and “after” awards (i.e., the original and the modified awards) separately and include each for the weighted average period that each was outstanding.
Therefore, the reporting entity will perform two treasury stock method calculations.
  • Based on the terms of the award and the average stock price for the period prior to the modification (weighted for the appropriate period)
  • Based on the terms of the award and the average stock price for the period after the modification (weighted for the appropriate period)
The sum of the two calculations will equal the number of incremental shares to be included in the diluted EPS computation. The reporting entity does the “as if” cancellation and reissuance for any share-based payment award whose terms have changed.
Reporting entities that conclude that they should not account for the effects of a modification pursuant to ASC 718-20-35-2A through ASC 718-20-35-9 should still consider the changes it made to the award when applying ASC 260. For example, a reporting entity may modify an award by reducing both the strike price and the number of share options. If the value, the vesting conditions, and the classification of the award are the same immediately before and after the change to the award, then the reporting entity would not account for the effects of the modification. Although the reporting entity would not account for the effects of the modification, it should not ignore the changes it made to the award when it applies the guidance in ASC 260.
Employee stock purchase plans (ESPPs) – after adoption of ASU 2020-06
Under ASC 718, ESPPs are treated as options granted at the start of the offering period. Similarly, ESPPs are considered options to be included in diluted EPS using the treasury stock method because granting an employee the ability to purchase stock at a defined price through an ESPP is very similar to a conventional employee stock option with a vesting period. Both awards give the employee the ability to purchase reporting entity stock in the future at a potentially discounted price. Accordingly, an ESPP represents potential common shares that reporting entities should include in the denominator for the computation of diluted EPS. The same is true for non-compensatory ESPPs, except there would be no unrecognized compensation cost included in assumed proceeds under the treasury stock method.
Because the vesting of an ESPP is typically based on service, not performance, reporting entities should consider the plan in the denominator for diluted EPS purposes from the start date of the offering period. The fact that employees have amounts withheld from their paychecks to pay for the shares over time is a funding mechanism for the ultimate payment of the exercise price; it does not change the nature of the potentially dilutive option arrangement.
At the beginning of the ESPP offering period, management can begin to estimate how many shares of stock will eventually be purchased based on the employees’ withholding elections, the current stock price, and the terms of the ESPP (e.g., the purchase price discount), assuming that the employees continue their employment through the offering period. This is considered the grant date of the share-based compensation award under ASC 718-50-35-1. Changes to employee withholding elections are considered modifications for diluted EPS purposes and are reflected in diluted EPS on a prospective basis.
When including ESPPs in the computation of diluted EPS, a reporting entity must calculate the number of shares to be issued under the ESPP and the hypothetical number of shares that can be repurchased under the treasury stock method. The difference between these two amounts represents the incremental number of potential common shares to be included in the computation of diluted EPS, weighted for the appropriate period of time that the awards were outstanding during the reporting period.
After adoption of ASU 2020-06, we believe there are two acceptable methods to compute the number of shares issuable under the ESPP - either using the average market price during the period or following the contingently issuable shares guidance (which reflects historical practice prior to ASU 2020-06). The method elected should be consistently applied.
Average market price approach
This view uses the average market price for the period to compute the number of shares to be issued under the ESPP. This view is based on the guidance in ASC 260-10-45-21A, which requires use of the average market price to calculate the denominator for diluted EPS when changes in an entity’s share price may affect the number of shares needed to settle the instrument. Since the calculation of the number of shares issuable upon completion of the offering period in most ESPPs is affected by the entity’s share price at that date, this guidance would apply and the average share price for the period would be used.
Under this approach, at each reporting date during the offering period, reporting entities would divide the total expected withholdings during the entire offering period (based on current employee elections) by the average market price during the reporting period applied to the purchase price formula (e.g., if the ESPP provides for a 15% discount from the stock price, then the average market price during the period should be multiplied by 85%) to calculate the number of shares issuable under the ESPP.
Contingently issuable shares approach
This view recognizes that prior to implementing ASU 2020-06, the number of shares issuable under an ESPP was determined by application of the contingently issuable shares guidance in ASC 260-10-45-48 through ASC 260-10-45-52. Under this view, the number of common shares issuable is calculated based on the number of shares that would be issuable if the reporting date were the end of the contingency period (applying the purchase price formula in the ESPP) because it is based on a future market price. Therefore, a reporting entity would utilize the entity’s share price as of the beginning of the offering period, the share price at the reporting date, and the purchase price formula defined in the ESPP to determine the number of shares issuable. This view reflects the language in the Basis for Conclusions of ASU 2020-06, which states “the Board decided to retain the current guidance for calculating diluted EPS for stock-based compensation because those arrangements are not within the scope of this project.”
Under this approach, the total expected withholdings during the entire offering period (based on current employee elections), the stock price at the beginning of the offering period and at the reporting date, and the purchase price formula for the ESPP determine the number of shares considered issuable under the plan, consistent with ASC 260-10-45-52 for market price contingencies. Therefore, if the plan requires the purchase price to be 85% of the lesser of the beginning or ending stock price in the offering period, the reporting entity would compare the stock price at the beginning of the offering period to the stock price at the reporting date and use the lower of those two stock prices (multiplied by 85%) in the calculation of the number of shares issuable under the ESPP. If the formula uses an average stock price over a period of time (such as the last 10 business days before the purchase date), the average for that same period of time as of the end of the reporting period should be used, consistent with ASC 260-10-45-52.
Application of the treasury stock method
Under either approach, the hypothetical number of shares that could be repurchased (using the average market price for the period) is netted against the number of shares issuable under the ESPP in order to determine the incremental shares to be included in the calculation of diluted EPS under the treasury stock method. The reporting entity should determine the assumed proceeds to be used in this calculation as the sum of (1) the cash assumed to be received over the course of the offering period (based on current employee elections), and (2) the average unrecognized compensation cost related to the ESPP during the period.
The reporting entity would then divide the total assumed proceeds by the average stock price for the reporting period to determine the hypothetical number of shares that can be repurchased. In calculating the dilutive effect of an ESPP on EPS, reporting entities should incorporate the aggregate expected amount of withholdings during the entire offering period, rather than only the withholding amount received up to the reporting date. Reporting entities should consider the entire offering period because the ESPP is treated as an option for both accounting and EPS purposes. Accordingly, reporting entities should consider all amounts to be withheld from employees to purchase shares under the plan, both current withholdings and expected withholdings, as part of the assumed proceeds under the treasury stock method for EPS. Furthermore, because the amount withheld from employees is recorded by the reporting entity as a liability (as it belongs to the employees until the offering period has ended), it is not considered a prepayment of the purchase price of the shares for diluted EPS purposes and, therefore, continues to be included in the assumed proceeds for the treasury stock method calculation.
In summary, in order to determine the ESPP’s impact on diluted EPS, the reporting entity should:
  • assess employment status and employee participation as of the reporting date to ensure that employees’ elections are appropriately considered in the computation,
  • determine the exercise (i.e., purchase) price by utilizing either (a) the average stock price during the reporting period and the purchase price discount defined in the ESPP (if applying the approach in ASC 260-10-45-21A) or (b) the stock price as of the beginning of the offering period, the stock price at the reporting date, and the purchase price formula defined in the ESPP (if applying the contingently issuable shares guidance consistent with historical practice),
  • project total withholdings over the course of the offering period, and
  • calculate the number of shares issuable under the ESPP and hypothetical repurchases under the treasury stock method (considering total expected withholdings and average unrecognized compensation cost as assumed proceeds). The difference between these two amounts represents the net incremental number of potential common shares to be included in the diluted EPS calculation, weighted for the portion of the reporting period that the ESPP offering period was outstanding
Example FSP 7-12 illustrates the computation of diluted EPS for an ESPP after adoption of ASU 2020-06. This example depicts the calculation of the number of shares issuable under the ESPP using both the average market price during the period and the contingently issuable shares guidance.
EXAMPLE FSP 7-12

Impact on diluted EPS of an ESPP after adoption of ASU 2020-06
FSP Corp has an ESPP that begins a six-month offering period on October 1, 20X6 (ending on March31, 20X7).
The ESPP allows employees to elect to withhold a certain amount of their salary (up to 15%) to purchase the reporting entity’s stock at a discounted price.
The ESPP provides for shares to be purchased at 85% of the lesser of the stock price at the beginning or end of the offering period (i.e., a look-back option) and is considered compensatory. Since the plan is compensatory, the reporting entity recognizes compensation cost for the ESPP.
Employees are allowed to withdraw from the ESPP at any time during the offering period, are required to withdraw if terminated, and upon withdrawal will be reimbursed any amount withheld.
The stock price on October 1, 20X6, the beginning of the six-month offering period, is $25. After applying the ESPP’s discount, the formula price would be $21.25 ($25 × 85%).
The stock price on December 31, 20X6, the reporting date, is $20. After applying the ESPP’s discount, the formula price (if determined at this date) would be $17 ($20 × 85%).
Employee withholdings at December 31, 20X6 total $3,380,000. Expected withholdings for the remaining offering period, based on current employee elections, is $3,420,000. Therefore, the expected total withholdings are $6,800,000.
Average stock price during the period from October 1 to December 31, 20X6 is $22.
Average unrecognized compensation cost during the period from October 1 to December 31, 20X6 is $1,000,000.
How many shares should FSP Corp include in diluted EPS for the year ended December 31, 20X6, assuming the shares are dilutive at the end of 20X6?
Analysis
Application of the average market price approach:
In applying the average market price guidance in ASC 260-10-45-21A, FSP Corp would calculate the number of shares projected to be issued under the ESPP as of December 31, 20X6 as 363,636, determined as follows:
$6,800,000 (expected total withholding amount) divided by $18.70 (average stock price for the period of $22 multiplied by ESPP formula of 85% of stock price)
Total assumed proceeds = $7,800,000, calculated as follows:
$6,800,000 (expected total withholding amount) plus $1,000,000 (average unrecognized compensation cost during the reporting period)
Shares assumed repurchased = 354,545 shares, calculated as follows:
$7,800,000 (assumed proceeds) divided by $22 (average stock price)
Incremental shares to be included in the December 31, 20X6 diluted EPS computation = 2,273 shares, calculated as follows:
[363,636 (gross number of shares to be issued under the ESPP) minus 354,545 (shares assumed repurchased)] x 3 / 12 (ESPP is outstanding for 3 of 12 months in 20X6)
Application of the contingently issuable share approach:
Alternatively, if FSP Corp applied the contingently issuable share guidance (consistent with historical practice prior to adoption of ASU 2020-06) in calculating diluted EPS for its ESPP, the number of shares projected to be issued would be 400,000, and the resulting incremental shares to be included in the December 31, 20X6 diluted EPS computation would be 11,364. The shares assumed to be repurchased under the treasury stock method is unchanged as assumed proceeds are divided by the average stock price under both methods. See below for detailed calculations.
Number of shares projected to be issued at December 31, 20X6 = 400,000, determined as follows:
$6,800,000 (expected total withholding amount) divided by $17 (purchase price per share determined by the ESPP purchase price formula based on the December 31, 20X6 stock price)
The formula price of $17 per share on the reporting date is used because the ESPP contains a look-back option and this price is lower than the formula price at the beginning of the offering period. If the stock price on the reporting date was greater than the stock price at the beginning of the offering period, the reporting entity would use the formula price at the beginning of the offering period to calculate the shares projected to be issued due to the look-back option.
Incremental shares to be included in the December 31, 20X6 diluted EPS computation = 11,364, determined as follows:
[400,000 (gross number of shares to issue under the ESPP as calculated above) minus 354,545 (shares assumed repurchased)] x 3 / 12 (ESPP is outstanding for 3 of 12 months in 20X6)

Employee stock purchase plans (ESPPs) – before adoption of ASU 2020-06
Under ASC 718, ESPPs are treated as options which are granted at the start of the offering period. Similarly, ESPPs are considered options to be included in diluted EPS using the treasury stock method because granting an employee the ability to purchase stock at a defined price through an ESPP is very similar to a conventional employee stock option with a vesting period. Both awards give the employee the ability to purchase reporting entity stock in the future at a potentially discounted price. Accordingly, an ESPP represents potential common shares that reporting entities should include in the denominator for the computation of diluted EPS. The same is true for non-compensatory ESPPs, except there would be no unrecognized compensation cost included in assumed proceeds under the treasury stock method.
Because the vesting of an ESPP is typically based on service, not performance, reporting entities should consider the plan in the denominator for diluted EPS purposes from the start date of the offering period. The fact that employees have amounts withheld from their paychecks to pay for the shares over time is a funding mechanism for the ultimate payment of the exercise price; it does not change the nature of the potentially dilutive option arrangement.
At each reporting date during the offering period, reporting entities should apply the guidance in ASC 260-10-45-48 through ASC 260-10-45-52 for contingently issuable shares, and ASC 260-10-45-22 through ASC 260-10-45-26 for the treasury stock method. Under this guidance, the number of incremental potential common shares included in diluted EPS is based on the number of shares that would be issuable if the reporting date were the end of the contingency period, net of the hypothetical shares that could be repurchased under the treasury stock method.
The employees’ withholding elections at period-end, the stock price at the beginning of the offering period and at the reporting date, and the purchase price formula for the ESPP will determine the number of shares issuable under the plan, consistent with ASC 260-10-45-52, for market price contingencies. Therefore, if the plan requires the purchase price to be the lesser of the beginning or ending stock price in the offering period, the reporting entity would compare the stock price at the beginning of the offering period to the stock price at the reporting date and use the lower of those two stock prices in the calculation of purchase price.
The reporting entity should calculate the assumed proceeds under the treasury stock method based on the sum of (1) the cash assumed to be received over the course of the offering period, and (2) the average unrecognized compensation cost related to the ESPP during the period.
The reporting entity would divide the total assumed proceeds by the average stock price for the reporting period to determine the hypothetical number of shares that can be repurchased under the treasury stock method.
In calculating the dilutive effect of an ESPP on EPS, reporting entities should base the number of shares issued on the aggregate expected amount of withholdings during the entire offering period, rather than only the withholding amount received up to the reporting date. Reporting entities should consider the entire offering period because the ESPP is treated as an option for both accounting and EPS purposes. Accordingly, reporting entities should consider all amounts to be withheld from employees to purchase shares under the plan, both current withholdings and expected withholdings, as part of the assumed proceeds under the treasury stock method for EPS.
Because the amount withheld from employees is recorded by the reporting entity as a liability (as it belongs to the employees until the offering period has ended), it is not considered a prepayment of the purchase price of the shares for diluted EPS purposes and therefore, continues to be included in the assumed proceeds for the treasury stock method calculation.
At the beginning of the ESPP offering period, management can determine, based on the employees’ withholding elections and the current stock price, how many shares of stock will eventually be purchased, assuming that the employees continue their employment through the offering period. This is considered the grant date of the share-based compensation award under ASC 718-50-35-1. Changes to employee withholding elections are considered modifications for diluted EPS purposes, and are reflected in diluted EPS on a prospective basis.
Accordingly, in order to determine the ESPP’s impact on diluted EPS, the reporting entity should:
  • assess employment status and employee participation as of the reporting date to ensure that employees’ elections are appropriately considered in the computation,
  • determine the exercise price by utilizing the stock price as of the beginning of the offering period, the stock price at the reporting date, and the purchase price formula defined in the ESPP,
  • project total withholdings over the course of the offering period, and
  • calculate the number of shares to be issued under the ESPP and hypothetical repurchases under the treasury stock method (considering total expected withholdings and average unrecognized compensation cost as assumed proceeds). The difference between these two amounts represents the net incremental number of potential common shares to be included in the diluted EPS calculation.
Example FSP 7-13A illustrates the computation of diluted EPS for an ESPP before adoption of ASU 2020-06.
EXAMPLE FSP 7-13A
Impact on diluted EPS of an employee stock purchase plan before adoption of ASU 2020-06
FSP Corp has an ESPP that begins a six-month offering period on September 1, 20X6 (ending on February 28, 20X7).
The ESPP allows employees to elect to withhold a certain amount of their salary (up to 15%) to purchase the reporting entity’s stock at a discounted price.
The ESPP provides for shares to be purchased at 85% of the lesser of the stock price at the beginning or end of the offering period (i.e., a look-back option) and is considered compensatory. Since the plan is compensatory, the reporting entity recognizes compensation cost for the ESPP.
Employees are allowed to withdraw from the ESPP at any time during the offering period, are required to withdraw if terminated, and upon withdrawal will be reimbursed any amount withheld.
The stock price on September 1, 20X6, the beginning of the six-month offering period, is $25. After applying the ESPP’s discount, the formula price would be $21.25 ($25 × 85% = $21.25).
The stock price on December 31, 20X6, the reporting date, is $20. After applying the ESPP’s discount, the formula price would be $17 ($20 × 85% = $17).
Employee withholdings at December 31, 20X6, total $4,500,000. Expected withholdings for the remaining offering period, based on current employee elections, is $2,300,000. Therefore, the expected total withholdings are $6,800,000.
Average stock price during the period from September 1 to December 31, 20X6, is $22.
Average unrecognized compensation cost during the period from September 1 to December 31, 20X6 = $1,650,000.
How many shares should FSP Corp include in diluted EPS for the year ended December 31, 20X6, assuming the shares are dilutive at the end of 20X6?
Analysis
FSP Corp would calculate the number of shares projected to be issued at December 31, 20X6 under the ESPP as 400,000, determined as follows:
$6,800,000 (expected total withholding amount) divided by $17 (purchase price per share determined by the ESPP purchase price formula)
The formula price of $17 per share on the reporting date is used because the ESPP contains a look-back option and this price is lower than the formula price at the beginning of the offering period. If the stock price on the reporting date was greater than the stock price at the beginning of the offering period, the reporting entity would have used the formula price at the beginning of the offering period to calculate the shares projected to be issued due to the look-back option.
Total assumed proceeds = $8,450,000, calculated as follows:
$6,800,000 (expected total withholding amount) plus $1,650,000 (average unrecognized compensation cost during the reporting period)
Shares assumed repurchased = 384,091 shares, calculated as follows:
$8,450,000 (assumed proceeds) divided by $22 (average stock price)
Incremental shares to be included in the December 31, 20X6 diluted EPS computation = 5,303 shares, calculated as follows:
[400,000 (gross number of shares to issue under the ESPP) minus 384,091 shares (assumed repurchased)] x 4 / 12 (ESPP is outstanding for 4 of 12 months in 20X6)
Because most ESPPs provide for the purchase of shares at a discount to the market price, there is typically a dilutive effect on EPS. However, the inclusion of unrecognized compensation cost in the calculation of assumed proceeds tends to mitigate the impact, particularly in the earlier portions of the offering period. Once there is an obligation to issue shares (on March 1 in the above example), the shares would be included in basic EPS on a prospective basis. During the quarter ending March 31, along with being included in basic EPS for the one month from March 1 to March 31, the ESPP would also affect diluted EPS on a weighted average basis for the period from January 1 to February 28.

Stock-appreciation rights
A stock-appreciation right (SAR) is a contract that gives the employee the right to receive an amount of stock that equals the appreciation in a company’s stock from an award’s grant date to the exercise date. SARs generally do not involve payment of an exercise price and may be settled in cash or in stock.
If a SAR is required to be settled in cash, the only effect the cash-settled SAR would have on the numerator is through the recognition of compensation cost in net income.
If a SAR is required to be settled in stock, it will be included in the computation of diluted EPS (if the award is dilutive) based on the net number of shares issuable using the average stock price for the period. Because an employee typically does not pay to exercise a stock-settled SAR, only unrecognized compensation cost is considered proceeds when calculating the dilutive effect under the treasury stock method.
If the reporting entity or the employee can decide whether a SAR will be settled in cash or in stock, see FSP 7.5.7.1 (after adoption of ASU 2020-06) or FSP 7.5.7.1A (before adoption of ASU 2020-06) for the appropriate EPS treatment.
Some cash and stock-settled SARs may be treated differently for determining the classification of an award and related compensation cost to be recorded, and for EPS purposes. For example, a SAR that provides the employee with the choice of settlement method is a liability-classified award; however, EPS will be computed on the assumption that the award will be settled in shares because it is more dilutive. In accordance with ASC 260-10-55-33, the reporting entity should not adjust the numerator for recorded compensation expense in that situation.
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