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In determining whether potential common shares are dilutive or anti-dilutive, the reporting entity should consider each issue or series of issues of potential common shares separately, rather than in the aggregate.
ASC 260 does not provide an example of how to compute diluted EPS under the two-class method. In August 2008, the FASB included guidance on computing diluted EPS under the two-class method in an exposure draft for FAS 128R. FAS 128R was never finalized, but while the computation methodology it discussed is not required, we believe it represents useful guidance that should be considered. The exposure draft included three examples:
  • Common stock with a participating preferred security
  • Two classes of common stock with different dividend rights when one is convertible into the other
  • Two classes of common stock with different dividend rights when one class is convertible into the other and there are convertible bonds outstanding
In computing diluted EPS under the two-class method described in the exposure draft to FAS 128R, undistributed earnings allocated away from common stockholders in the basic EPS computation are reversed, and then re-allocated to each class of common or potential common shares and participating securities that are assumed to be outstanding for the period at each stage of the sequencing process. FSP Example 7-19 illustrates the impact on diluted EPS when the allocation of undistributed earnings is re-computed at each step in the sequencing process.
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