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Options or warrants may permit or require the holder of the option to tender debt or other securities of the issuer (or its subsidiary or parent) in payment of all or a portion of the exercise price.
In computing diluted EPS, the reporting entity assumes (1) those options or warrants are exercised, and (2) the debt or other securities is tendered (this is, effectively, the if-converted method which is discussed in FSP 7.5.6). The reporting entity adds back interest (net of tax) on any debt assumed to be tendered to the numerator and also adjusts the numerator for any nondiscretionary adjustments based on income (net of tax), such as profit-sharing and royalty agreements.
If tendering cash, however, would be more advantageous to the option or warrant holder, and the contract permits tendering cash, the reporting entity should apply the treasury stock method.
The terms of certain options or warrants may require that proceeds received from their exercise be applied to retire debt or other securities of the issuer (or its parent or subsidiary). In computing diluted EPS, the reporting entity assumes those options or warrants are exercised and the proceeds applied to purchase the debt at its average market price rather than to purchase common stock under the treasury stock method. In doing so, it should add back interest (net of tax) on any debt assumed to be repurchased to income available to common stockholders. It also adjusts the numerator for any nondiscretionary adjustments based on income (net of tax). However, the reporting entity should apply the treasury stock method for excess proceeds received from the assumed exercise (i.e., the proceeds received on exercise exceed the amount of debt retired).
Convertible securities that permit or require the payment of cash by their holder at conversion are deemed to be warrants. In computing diluted EPS, the reporting entity should apply the proceeds assumed to be received to purchase common stock using the treasury stock method, and should assume the convertible security is converted under the if-converted method.
Written put options and use of reverse treasury stock method
Contracts that require the reporting entity to repurchase its own stock (such as written put options and forward purchase contracts, other than physically-settled forward purchase contracts for a fixed number of shares accounted for pursuant to ASC 480-10-45-4; see FSP 7.4.3.6) are reflected in the computation of diluted EPS if their effect is dilutive.
If, during the reporting period, the exercise price of these contracts is above the average market price for that period (i.e., they are “in-the-money”), reporting entities should compute their dilutive effect using the “reverse treasury stock” method. Under that method:
  • Assume issuance of sufficient common shares at the beginning of the reporting period (at the average market price during the period) to raise enough proceeds to satisfy the contract.
  • Assume the proceeds from issuance are used to satisfy the contract (i.e., “buy back” the shares).
  • Include the incremental shares (the difference between the number of shares assumed to have been issued and the number of shares assumed to have been repurchased) in the denominator.
If the contract is required to be carried at fair value with changes recorded in net income under other US GAAP (as is frequently the case for written put options), then reporting entities should also consider the guidance in FSP 7.5.7.1 regarding numerator adjustments when determining the EPS impact.
Example FSP 7-13 illustrates the application of the reverse treasury stock method to written put options.
EXAMPLE FSP 7-13

Reverse treasury stock method
FSP Corp sells a put option that allows the investor to sell 100 shares to FSP Corp at an exercise price of $25; the average market price for the period is $20.
How should FSP Corp compute diluted EPS?
Analysis
The incremental number of shares to be included in diluted EPS is 25. This is computed as follows:
  • Assume 125 shares are issued at the beginning of the period to raise enough proceeds to satisfy the put option exercise price of $2,500 (100 shares at $25). Number of shares assumed to have been issued is calculated by dividing the required proceeds of $2,500 by the average market price of $20 per share for the period.
  • The $2,500 in proceeds from issuance of new shares is then used to satisfy the put on 100 shares.
  • The EPS computation should include 25 incremental shares—125 shares assumed to be issued less the 100 shares assumed to have been repurchased.
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