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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 can receive the benefit of future service upon exercise, which are 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 includes a forfeiture rate assumption, while the number of shares in the denominator does not.
See FSP Example 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.
In accordance with ASC 260-10-45-29, as amended by ASU 2016-09, tax windfalls and shortfalls are no longer recognized in additional paid-in capital (APIC). Therefore, when applying the treasury stock method for computing diluted EPS, the assumed proceeds no longer include any windfall tax benefits or tax shortfalls.
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.
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 expense = $40,000
    $4 (fair value per option on grant date) multiplied by 10,000 (options outstanding)
  • Hypothetical expense will be recognized ratably over four years ($10,000 per year)
  • Hypothetical unrecognized compensation expense 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 expense for 20X7 = $35,000
    Average of $40,000 (hypothetical unrecognized compensation expense at January 1, 20X7) and $30,000 (hypothetical unrecognized compensation 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)
  • 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 expense 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 plus any purchase price.
  • Average unrecognized compensation for 20X6 = $87,500
    Average of $100,000 (unrecognized compensation at January 1, 20X6) and $75,000 (unrecognized compensation 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.
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 expense 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 for 20X6 = $37,500
    Average of $50,000 (unrecognized compensation 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 at December 31, 20X6 related to those same shares)
    The unrecognized compensation 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 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 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.
The vesting provision is a market condition that all of the restricted stock will cliff vest if the stock price is higher than $18 on December 31, 20X9, and the recipient is still employed at that date. Each share of restricted stock has an $8 fair value on the grant date; the effect of the market condition is reflected (i.e., discounted) in the award's fair value.
The market price of the underlying stock is $20 on December 31, 20X6.
Expense computations:
  • Total book compensation cost = $80,000
    $8 (fair value per share on January 1, 20X6) multiplied by 10,000 shares
  • Expense will be recognized ratably over four years ($20,000 per year)
  • Unearned compensation 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
Using the treasury stock method, the diluted EPS computation should reflect the number of shares that would be issued based on comparing the market 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 threshold price, all of the restricted shares are included in the calculation.
  • Average unrecognized compensation for 20X6 = $70,000
    Average of $80,000 (unrecognized compensation at January 1, 20X6) and $60,000 (unrecognized compensation at December 31, 20X6)
  • 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 = 5,334 shares
    10,000 (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 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 (as amended by ASU 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting) 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)
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 expense 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 expense 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. 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
  • 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 expense as assumed proceeds)
Example FSP 7-12 illustrates the computation of diluted EPS for an ESPP.
EXAMPLE FSP 7-12

Impact on diluted EPS of an employee stock purchase plan
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 expense 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 expense 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, 20X7 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 20X7)
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 expense 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 will 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 will 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 expense 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 for the appropriate EPS treatment.
Some cash and share-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 in that situation.
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