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This section addresses how EPS can be affected by various changes in capital structure. Changing from an LLC or partnership to a C-corp is addressed in FSP 32.

7.6.1 Stock splits/reverse stock splits/stock dividends

If the number of common shares outstanding increases as a result of a stock dividend or stock split, or decreases as a result of a reverse stock split, the reporting entity should adjust the computations of basic and diluted EPS retroactively for all periods presented to reflect that change in capital structure. If changes in common stock resulting from stock dividends, stock splits, or reverse stock splits occur after the close of the period but either (1) before issuance of the financial statements, or (2) before the effective date of the registration statement, whichever is later, as applicable, the per-share computations for those and any prior period financial statements presented should be based on the new number of shares. If per-share computations reflect such changes in the number of shares, ASC 260-10-55-12 requires disclosure of those changes, including
the
retroactive treatment, explanation of the change made, and the date the change became effective.
The effective date of a stock split (i.e., the distribution date, which is the date that the shares begin trading at their new split-adjusted price) may affect the form of disclosure in the financial statements.
Figure FSP 7-9 illustrates the appropriate financial statement presentation for stock splits in various situations for a registrant that is already a public entity.
Figure FSP 7-9
Presentation of EPS upon stock splits
The following assumptions are applicable in each case:
  • The latest balance sheet date is December 31, 20X7.
  • The accountant’s report date and financial statement issuance date through filing of the Annual Report on Form 10-K is January 31, 20X8.
  • The variable assumptions are the declaration dates and effective dates of the stock split.
Split Date
Case
Declared
Effective
Financial statement presentation
I
11/15/X7
12/16/X7 or 1/16/X8
Split would be reflected in 12/31/X7 balance sheet, 20X7 statement of changes in stockholders’ equity, and in per share data for all periods presented.
II
1/16/X8
1/31/X8
Same as I.
III
12/16/X7 or 1/20/X8
2/20/X8
Split would be disclosed in a footnote along with the pro forma effect (labeled unaudited) on the 12/31/X7 balance sheet. Historical per share data would remain on a pre-split basis, and pro forma per share data (labeled “unaudited”) on a post-split basis would be disclosed in the notes to the financial statements.
Case III illustrates the appropriate presentation when, at the time financial statements are issued, a split has been declared, but is not effective. In this situation, historical EPS must be disclosed on a pre-split basis since the subsequent event “triggering” the split (i.e., its effectiveness) has not occurred as of the time the financial statements are issued. However, once the split is effective, the reported historical EPS becomes irrelevant in relation to post-split shares outstanding, as well as to post-split market price.
Consequently, if a split has been declared, but is not effective at the date the financial statements are issued, pro forma EPS (labeled “unaudited”) on a post-split basis should be presented in the footnotes in addition to historical EPS, which is presented on a pre-split basis. If the financial statements are reissued after the effective date, the aforementioned pro forma amounts would become historical EPS and the previously-disclosed historical amounts would be deleted.

7.6.2 Stock rights plans

A rights issue whose exercise price at issuance is less than the fair value of the stock contains a bonus element that is similar to a stock dividend. If a rights issue contains such a bonus element and it is offered to all existing stockholders, the reporting entity should adjust basic and diluted EPS retroactively for the bonus element for all periods presented. If this occurs after the close of the period but before issuance of the financial statements, the per-share computations for those and any prior period financial statements presented are based on the new number of shares, reflecting the bonus element.
If the ability to exercise the rights issue is contingent on an event other than the passage of time (e.g., a change in control), the reporting entity need not consider the bonus element in the denominator of either basic or diluted EPS until such time as the contingency is resolved.
See further discussion in ASC 260-10-55-13 and ASC 260-10-55-14.

7.6.3 Distributions with components of stock and cash

ASC 505-20-15-3 through 3A provides guidance for real estate investment trusts (REITs) that declare a distribution that stockholders can elect to receive in cash or shares of equivalent value, with a potential limitation on the total amount of cash that stockholders can elect to receive in the aggregate.
The stock portion of a distribution to stockholders that allows them to elect to receive cash or shares with a potential limitation on the total amount of cash that all stockholders can elect to receive in the aggregate is considered a share issuance, not a stock dividend. Therefore, for EPS computation purposes, the stock portion of the distribution is reflected in EPS prospectively, consistent with the treatment of other new share issuances. It is not reflected retroactively as would be the case for a stock dividend.

7.6.4 IPO or spin-off of a subsidiary and recapitalizations

When a reporting entity completes an IPO or a spin-off of either an existing subsidiary or a “carve-out” business, questions often arise as to how to compute EPS in the historical financial statements of the subsidiary or carve-out business.
In computing basic EPS for a carve-out business, the number of shares issued to the owner upon the legal formation of the entity that holds the business and contribution of that business to the entity is used as the denominator for all periods presented, akin to the treatment of a stock split. In this case, the number of shares issued simply reflects a recharacterization of the capital account previously held by the owner. No historical EPS is presented in SEC filings of the carve-out business before the legal formation of the entity, the contribution of the businesses, and the capitalization of the entity.
With respect to an existing subsidiary (i.e., an entity with a separate legal identity), the historical weighted average number of shares actually outstanding during each period is reflected in the denominator for all periods presented. However, issuance of shares to new investors in connection with the IPO/spin-off is treated prospectively from the issuance date. In connection with a stock split, EPS is restated for all periods presented. See FSP 7.6.1 for details.
In computing diluted EPS for a carve-out business or an existing subsidiary whereby parent options issued to employees are exchanged for options in the affiliate at the date of the IPO/spin-off, the dilutive effect of the affiliate options exchanged for the parent options is included in the affiliate’s denominator on a prospective basis. Previous periods are not affected, as the exchange of parent options for affiliate options is considered a modification of the terms of the original award. However, if the affiliate issues options and warrants to the parent company itself as part of the initial capitalization of the carved-out business, then the options are treated as if they were outstanding for all periods presented. It is also common for reporting entities to recapitalize or reorganize their legal entity structure in preparation for an IPO. There is limited guidance on such transactions. However, ASC 260-10-55-17 provides guidance on computing EPS in reorganizations.

ASC 260-10-55-17

When common shares are issued to acquire a business in a business combination, the computations of EPS shall recognize the existence of the new shares only from the acquisition date. In reorganizations, EPS computations shall be based on analysis of the particular transaction and the provisions of this Subtopic.

The reporting entity should evaluate the facts and circumstances of each situation when concluding on the appropriate EPS treatment. For example, some transactions may result in an exchange of equity interests, but no change in relative shareholder rights, rank, or value before and after the transaction. Such reorganizations may be equivalent to a stock split (simply changing the form of legal ownership to a new structure) and require retrospective treatment for EPS purposes, even if effected after the latest balance sheet date. Any financial statements issued, or SEC filings made, after the effective date of such an event should reflect the transaction retrospectively for EPS purposes (i.e., it should be pushed back to prior periods).
In other transactions, often involving more complex capital structures, the reorganization transaction may reflect a value-for-value exchange of equity interests at the point of the recapitalization, which results in a change in relative shareholder rights or rank before and after the transaction. This transaction may be more akin to the repurchase of equity interests through the issuance of new equity interests, and be afforded prospective treatment in the EPS computation.
Oftentimes in an IPO, changes in capitalization will occur upon the effective date of the registration statement or completion (i.e., closing) of the IPO. Such changes could include conversion of preferred stock into common stock. In these cases, EPS should be presented for all periods based on the historical capital structure, and the conversion should be reflected in EPS prospectively from the date of conversion.
See FSP 7.7 for various pro forma EPS considerations related to a change in capital structure in conjunction with an IPO.
Question FSP 7-5
Under ASC 805, Business Combinations, a common control merger is recorded at carryover basis, and the receiving entity reflects the acquired business for all prior periods (or since the date common control was obtained, if later), as if the entities had always been combined. How should the entity reflect the impact of the merger on EPS?
PwC response
If the receiving entity issued shares to the stockholders of the contributing entity, this should be reflected in EPS in a similar fashion as a stock split (i.e., recharacterization of the historical common ownership) and reflected retrospectively for all periods presented under common control. The ratio of exchange of receiving entity shares issued for each share of the transferred entity should be multiplied by the weighted average number of shares and potential shares of the transferred entity for each reporting period, and added to the number of shares and potential shares of the receiving entity.
If the receiving entity paid cash to the stockholders of the contributing entity, there should generally be no impact to EPS. However, if the receiving entity issued shares to new investors to raise that cash, the receiving entity generally would present those newly-issued shares in pro forma EPS computations, consistent with the discussions in FSP 7.7.2 and FSP 7.7.3.

7.6.4.1 Computation of earnings per share in a reverse acquisition

In a reverse acquisition, the financial statements of the combined entity reflect the capital structure (i.e., share capital, share premium and treasury capital) of the legal acquirer (i.e., accounting acquiree), including the equity interests issued in connection with the reverse acquisition. However, consistent with the nature of a reverse acquisition, the number of common shares reflected as outstanding for the reporting periods prior to the acquisition date is computed as the weighted-average number of common shares of the legal acquiree (i.e., accounting acquirer) outstanding during the period, multiplied by the exchange ratio established in the merger agreement. In other words, it is as if the legal acquiree underwent a stock-split/reverse stock split, and then issued additional shares on the acquisition date. See BC 2.10.5 for further details.

7.6.5 Partially paid shares and partially paid stock subscriptions

If a reporting entity has common shares issued in a partially paid form, and those shares are entitled to dividends in proportion to the amount paid, the common-share equivalent of those partially paid shares is included in the basic EPS computation if they were entitled to participate in dividends.
Partially paid stock subscriptions that do not share in dividends until fully paid are considered the equivalent of warrants, and are included in the diluted EPS computation using the treasury stock method. The unpaid balance is assumed to represent proceeds used to purchase stock, and the incremental number of shares to be included is the difference between the number of shares subscribed and the number of shares assumed to be purchased.

7.6.6 Bankruptcy

Under ASC 852-10-45-16, EPS is computed during the bankruptcy period following all of the provisions of ASC 260. This standard specifically notes that any potential changes in the capital structure as a result of the plan of bankruptcy are disclosed but not reflected in the computation of EPS.

7.6.7 Computing EPS when changing legal form

EPS should be presented for all periods based on historical net income unadjusted for income taxes or other pro forma adjustments. See FSP 32.4.2.1 for further discussion of presentation requirements upon a change in tax status.
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