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9.2 Share repurchases
Publication date: 01 Mar 2022
us Financing guide
A reporting entity may repurchase its common shares for a number of reasons, including to:
- Return cash to shareholders
- Increase earnings per share or other financial metrics (e.g., return on equity) that may be of interest to shareholders
- Send a signal to the market that management believes its common stock price is undervalued
- Offset the issuance of shares (e.g., from employee stock option exercise)
- Preclude potentially hostile acquirers from gaining control of, or significant influence over, the reporting entity
- Buyout a partner or major stockholder’s ownership position
Figure FG 9-1 summarizes some of the more common methods reporting entities use to repurchase its common shares.
Figure FG 9-1
Types of share repurchase arrangements
Types of share repurchase arrangements
Repurchase type |
Overview |
Forward repurchase contract
(FG 9.2.2)
|
Reporting entity agrees to purchase shares for a specified price on a specified date in the future
|
Spot repurchase
(FG 9.2.3)
|
Reporting entity agrees to purchase shares at the prevailing market price
|
Accelerated share repurchase (ASR)
(FG 9.2.4)
|
A transaction executed between a reporting entity and an investment bank in which the reporting entity repurchases a large number of shares at a purchase price determined by an average market price over a period of time
|
Written put option
(FG 9.2.5)
|
Reporting entity must buy its shares at a specified price if the option holder elects to exercise its option
|
9.2.1 Recognition date of share repurchase transactions
A share repurchase arrangement accounted for as a liability within the scope of ASC 480, Distinguishing Liabilities from Equity should be recognized on its trade date. A share repurchase arrangement accounted for as a derivative within the scope of ASC 815, Derivatives and Hedging should also be recognized on its trade date. All other share repurchase arrangements should be accounted for on the settlement date of the transaction.
9.2.2 Forward repurchase contracts
A forward repurchase contract obligates the reporting entity to buy its own shares at a future date; therefore, it may be a liability within the scope of ASC 480. The accounting treatment for a forward repurchase contract depends on the settlement alternatives built into the contract and the nature of the reporting entity’s obligation to repurchase its shares. See FG 5.5 for information on ASC 480.
9.2.2.1 Physically settled forward repurchase contracts
A forward repurchase contract that, by its terms, must be physically settled by delivering cash in exchange for a fixed number of the reporting entity’s shares should be recorded as a liability under the guidance in ASC 480. ASC 480-10-30-3 through ASC 480-10-30-5 provide guidance regarding the initial measurement and recognition for such a physically settled forward repurchase contract. It is essentially accounted for as a financed purchase of treasury stock.
Forward contracts that require physical settlement by repurchase of a fixed number of the issuer’s equity shares in exchange for cash shall be measured initially at the fair value of the shares at inception, adjusted for any consideration or unstated rights or privileges.
Two ways to obtain the adjusted fair value include:
- Determining the amount of cash that would be paid under the conditions specified in the contract if the shares were repurchased immediately
- Discounting the settlement amount, at the rate implicit at inception after taking into account any consideration or unstated rights or privileges that may have affected the terms of the transaction.
Equity shall be reduced by an amount equal to the fair value of the shares at inception.
To recognize a physically settled forward repurchase contract to buy a fixed number of shares for a fixed amount of cash, a reporting entity should debit treasury stock and credit a share repurchase (forward contract) liability at trade date based on the guidance in ASC 480-10-25-8 and ASC 480-10-30-5.
The subsequent measurement of a physically settled forward repurchase contract depends on whether the amount to be paid and the settlement date are fixed or can vary. ASC 480-10-35-3 provides guidance regarding the subsequent measurement and recognition of a physically settled forward repurchase contract.
Forward contracts that require physical settlement by repurchase of a fixed number of the issuer’s equity shares in exchange for cash and mandatorily redeemable financial instruments shall be measured subsequently in either of the following ways:
- If both the amount to be paid and the settlement date are fixed, those instruments shall be measured subsequently at the present value of the amount to be paid at settlement, accruing interest cost using the rate implicit at inception.
- If either the amount to be paid or the settlement date varies based on specified conditions, those instruments shall be measured subsequently at the amount of cash that would be paid under the conditions specified in the contract if settlement occurred at the reporting date, recognizing the resulting change in that amount from the previous reporting date as interest cost.
To subsequently account for a physically settled forward contract with a fixed maturity date and a fixed price (common among forward repurchase contracts), a reporting entity should recognize the financing cost embedded in the forward repurchase contract by amortizing the discount to the forward price recorded at inception. To do this, a reporting entity should debit interest cost and credit the share repurchase (forward contract) liability.
See FSP 7.4.3.6 for information related to earnings per share considerations.
Application example
Example FG 9-1 illustrates the accounting for a fixed rate, physically settled forward repurchase contract that settles on a specific date.
EXAMPLE FG 9-1
Accounting for a physically settled fixed rate forward repurchase contract that settles on a specific date
Accounting for a physically settled fixed rate forward repurchase contract that settles on a specific date
FG Corp enters into a forward repurchase contract with a bank. FG Corp is required to physically settle the contract. It must pay cash to the bank in exchange for the shares.
Under the terms of the forward contract, FG Corp is obligated to purchase 1,000 shares of its own stock at a price of $125 per share in one year (total settlement price is 1,000 shares × $125 = $125,000). FG Corp’s stock price on the date the contract is entered into is $122.50; therefore, there is a financing cost of $2,500 embedded in the forward contract as discussed in FG 9.2.2.1. The effective interest rate is 2.04%, which represents the discount rate that equates the settlement price in one year with the current stock price on the contract’s trade date (the fair value of the underlying shares at inception). FG Corp calculates the amount of interest expense for the first quarter based on the effective interest rate as $620.
At the inception of the contract, FG Corp accounts for the trade as a financed purchase of treasury shares.
How does FG Corp measure and record the physically settled forward repurchase contract (a) at commencement of the forward repurchase contract, (b) in its quarterly financial statements three months after entering into the forward contract, and (c) at settlement?
Analysis
To record the physically settled forward repurchase contract at inception, FG Corp records a reduction in equity equal to the current fair value of the shares underlying the contract ($122.50 × 1,000 shares = $122,500) and a corresponding share repurchase liability.
Dr. Treasury stock |
$122,500 |
|
Cr. Share repurchase liability |
$122,500 |
To prepare its quarterly financial statements three months after entering into the forward contract, FG Corp calculates the quarterly amortization of the $2,500 discount created at inception using the effective yield approach.
FG Corp records the amortization to the share repurchase liability with an offsetting entry to interest expense.
Dr. Interest expense |
$620 |
|
Cr. Share repurchase liability |
$620 |
Upon settlement of the forward repurchase contract, FG Corp records the payment of cash to the bank to settle the share repurchase liability.
Dr. Share repurchase liability |
$125,000 |
|
Cr. Cash |
$125,000 |
FG Corp should also consider whether the forward repurchase contract has an effect on its earnings per share. Since the forward contract is accounted for as a financed purchase of treasury stock within the scope of ASC 480, the shares underlying the forward contract should be deducted from weighted average common shares outstanding when calculating basic and diluted earnings per share from inception of the forward repurchase contract.
ASC 480-10-55-14 through ASC 480-10-55-17 provide another example of how a physically settled fixed rate and date forward repurchase contract should be measured and accounted for at inception and in subsequent periods.
9.2.2.2 Net cash or net share settled forward repurchase contracts
ASC 480-10-55-17 provides guidance regarding the initial recognition and subsequent measurement of a forward repurchase contract that (1) either permits or requires net cash or net share settlement, or (2) requires physical settlement for specified quantities of assets other than cash.
In contrast to forward purchase contracts that require physical settlement in exchange for cash, forward purchase contracts that require or permit net cash settlement, require or permit net share settlement, or require physical settlement in exchange for specified quantities of assets other than cash are measured initially and subsequently at fair value, as provided in paragraphs 480-10-30-2, 480-10-30-7, 480-10-35-1, and 480-10-35-5 (as applicable), and classified as assets or liabilities depending on the fair value of the contracts on the reporting date.
A forward repurchase contract that permits or requires net cash or net share settlement, or requires physical settlement in exchange for specified quantities of assets other than cash, should be measured at fair value (both initially and subsequently). Changes in the fair value of these forward repurchase contracts should be recorded in net income. A forward repurchase contract that can be net cash or net share settled may be classified as an asset or liability depending on the fair value of the contracts on the reporting date, which will likely depend on the relationship between the contract price, credit risk and the current forward price of the shares.
See FSP 7.5.5.9 (after adoption of ASU 2020-06) or FSP 7.5.5.9A (before adoption of ASU 2020-06) for earnings per share considerations related to net cash or net share settled forward repurchase contracts, including application of the reverse treasury stock method.
9.2.2.3 Prepaid forward repurchase contracts
A prepaid forward purchase contract requires the reporting entity to pay the total amount it owes at the time the parties enter into the contract in exchange for the future delivery of a fixed or variable number of common shares. A prepaid forward purchase contract is not a liability pursuant to ASC 480 if the reporting entity has no further obligation to either transfer assets or issue shares to the seller.
Prepaid forward purchase contracts are hybrid instruments consisting of a loan to the counterparty and an embedded forward purchase contract on the reporting entity’s own common stock. The embedded derivative should be assessed to determine whether it should be bifurcated under ASC 815. See FG 5.4 for guidance on assessing embedded equity linked components.
Provided the embedded forward purchase contract on a fixed number of common shares does not need to be bifurcated and accounted for separately, we believe it should be reported as a reduction of equity, consistent with the guidance on loans to shareholders in ASC 505-10-45-2 and the treatment of gross physically settled forward purchase contacts (see FG 9.2.2.1). We also believe that the EPS guidance for gross settling forward repurchase contracts should be applied to prepaid forward purchase contracts on an entity’s own stock (see FG 9.2.2.1).
9.2.3 Spot repurchases
A reporting entity may choose to execute a share repurchase by acquiring its common shares in the open market (a spot repurchase). A spot repurchase transaction may be executed by the reporting entity or through a broker for regular-way settlement (typically 2-3 days).
A spot repurchase agreement that (1) unconditionally obligates a reporting entity to repurchase a fixed number of its own shares in exchange for cash and (2) requires physical settlement should be accounted for as a liability under ASC 480 on the trade date (see FG 9.2.2.1). In other words, a spot repurchase transaction should be recorded as of the trade date with a corresponding liability.
It is common for a reporting entity to instruct a third-party broker to purchase its shares in the open market at the prevailing market price up to a fixed-dollar amount. This type of broker-assisted trade should not be recorded until such time as the broker has executed a purchase transaction. If at any point the reporting entity is unconditionally obligated to purchase a fixed number of its shares for a fixed amount of cash (e.g., upon the broker executing a purchase of some or all of the shares pursuant to the order), recognition of a liability with a corresponding reduction of equity may be appropriate based on the guidance in ASC 480. In practice, such transactions are generally limited to a relatively small number of shares, and settlement occurs within a short period of time (e.g., two days).
9.2.4 Accelerated share repurchase (ASR) programs
An accelerated share repurchase (ASR) program is a transaction executed by a reporting entity with an investment bank counterparty. An ASR allows the reporting entity to immediately purchase a large number of common shares at a purchase price determined by an average market price over a fixed period of time. The average market price is generally the volume weighted average price (VWAP), which is an objectively determinable price. One of the primary advantages of an ASR is that it enables the reporting entity to execute a large treasury stock purchase immediately, while paying a purchase price that mirrors the price achieved by a longer-term repurchase program in the open market.
In its most basic form, an ASR program comprises the following two transactions:
- A treasury stock purchase in which the reporting entity buys a fixed number of common shares and pays the investment bank counterparty the spot share price at the repurchase date
- A forward contract under which the reporting entity either receives or delivers cash or shares (generally at the reporting entity’s option) at the contract’s maturity date. The value received or delivered by the reporting entity equals the difference between the VWAP over the term of the contract and the spot share price at inception, multiplied by the number of shares repurchased.
- The reporting entity receives value from the bank if the VWAP is less than the spot share price paid at inception;
- The reporting entity delivers value to the bank if the VWAP is greater than the spot share price paid at inception
Many ASR programs have terms that vary from this basic transaction and commonly include additional features that may complicate the accounting analysis. Figure FG 9-2 describes some of the more common terms and features.
Figure FG 9-2
Common ASR terms and features
Common ASR terms and features
Feature |
Description |
Fixed dollar vs. fixed share
|
|
Fixed vs. variable maturity
|
|
Uncollared, capped, or collared pricing
|
|
Share holdback
|
|
Despite these alternatives, all ASR transactions follow the same basic framework, depicted in Figure FG 9-3.
Figure FG 9-3
Illustration of ASR mechanics
Illustration of ASR mechanics
9.2.4.1 Initial recognition and measurement
As discussed in ASC 505-30-25-6, an ASR is generally accounted for as two separate transactions (1) a treasury stock transaction and (2) an equity-linked contract on the reporting entity’s own stock (ASR contract). See FG 9.3 for information on accounting for treasury stock transactions.
The ASR contract should first be analyzed to determine whether it should be classified as a liability per ASC 480-10-25-14. An instrument requiring delivery of a variable number of shares is classified as a liability if, at inception, the monetary value of the obligation is based solely or predominantly on (1) a fixed monetary amount known at inception or (2) variations inversely related to changes in the fair value of the reporting entity’s equity shares.
In the basic ASR transaction described in FG 9.2.4, a reporting entity could be required to deliver a variable number of shares at maturity of the ASR contract. In this case, the monetary value received or delivered would be equal to (a) the difference between the VWAP over the term of the contract and the spot share price, multiplied by (b) the number of shares purchased at inception. Since the monetary value changes as the VWAP changes, it is not predominantly based on a fixed monetary amount. In addition, the reporting entity could be required to deliver value as the price of its shares (i.e., the VWAP) increases and could receive value as the price of its shares decreases. Therefore, the monetary value is not based on variations inversely related to changes in the fair value of the reporting entity’s equity shares.
The monetary value of an ASR contract that incorporates alternatives to the basic structure may be more complicated to determine. Frequently, a quantitative analysis (or predominance test) of the possible settlement outcomes is needed to determine how the monetary value is affected by the terms of the transaction. For example, a variable maturity option reduces the value of the contract from the perspective of the reporting entity. In other words, this feature behaves like a written put option. In the case of an ASR with a variable maturity option, the quantitative analysis may be designed to determine whether the written put component resulting from the variable maturity option is a predominant feature of the population of settlement alternatives. If it is, then the ASR contract may be within the scope of ASC 480.
A quantitative analysis may take into account factors such as:
- The terms of the contract, including the number of shares delivered at inception of the transaction
- The reporting entity’s stock price at the trade date
- The volatility of the reporting entity’s stock price
- The probability of any cap or floor on the ASR contract being reached
If a reporting entity concludes that an ASR contract is not within the scope of ASC 480, the next step is to determine whether it should be classified as a liability or equity under the guidance in ASC 815-40, Contracts in Entity’s Own Equity. See FG 5.6 (after adoption of ASU 2020-06) or FG 5.6A (before adoption of ASU 2020-06) for further information on the analysis of a freestanding equity-linked instrument.
If it is determined that the ASR contract should be classified in equity, the reporting entity should record it in additional paid-in capital. See Example FG 9-2 for an illustration of this guidance. If the ASR contract should be classified as a liability, the reporting entity should record the contract at fair value with changes in fair value recorded in net income.
9.2.4.2 Settlement of an ASR contract classified in equity
When an ASR contract classified in equity is settled in cash, the cash payment should be recorded in additional paid-in capital because it is a payment to settle an equity classified contract. Similarly, when an ASR contract is settled in shares, the shares should be recorded at fair value in additional paid-in capital because they are issued (or received) to settle an equity classified contract.
Figure FG 9-4 summarizes the accounting treatment for the various settlement alternatives of an ASR contract.
Figure FG 9-4
Summary of ASR settlement alternatives
Summary of ASR settlement alternatives
Settlement form |
Party owing value |
Treatment |
Cash
|
Bank
|
Cash payment should be recorded as an increase to additional paid-in capital
|
Cash
|
Reporting entity
|
Cash payment should be recorded as a reduction of additional paid-in capital
|
Shares
|
Bank
|
Shares should be recorded in treasury stock with an offsetting entry to additional paid-in capital; generally, issuers record the shares at fair value
|
Shares
|
Reporting entity
|
If the reporting entity issues new shares, the shares should be recorded at fair value with an offsetting entry to additional paid-in capital (since the offsetting entry is to additional paid-in capital, on a net basis, it is the equivalent of simply capitalizing the par value)
If the reporting entity reissues treasury shares, the guidance for the reissuance of treasury shares should be applied; see FG 9.3.2 for information on the reissuance of treasury stock
|
If neither the reporting entity nor the investment bank owes value, there should be no accounting entry. The amount originally recorded related to an equity classified ASR contract should remain in additional paid-in capital.
9.2.4.3 ASR contract earnings per share—after adoption of ASU 2020-06
An ASR is reflected in earnings per share as two separate transactions: (1) a treasury stock transaction and (2) the ASR contract.
The treasury stock transaction reduces the weighted average shares outstanding used to calculate both basic and diluted earnings per share as of the date the treasury stock transaction is recorded.
Most ASR contracts give the reporting entity the option to elect to receive, or pay, any value owed under the ASR contract at maturity in cash or shares. The effect of the potential share settlement should be included in the diluted earnings per share calculation using the treasury stock method regardless of whether the settlement election is at the option of the reporting entity or the holder, or whether the reporting entity has a history or policy of cash settlement. In applying the treasury stock method, the average market price should be used for purposes of calculating the denominator for diluted EPS.
The reporting entity should also consider whether the terms of an ASR contract require it to be accounted for as a participating security. In many ASR contracts, the dividends expected to be paid during the term of the ASR contract are included in the forward price. If the reporting entity pays dividends in excess of the expected dividends, this will adversely impact the economics of the ASR transaction for the bank counterparty. To protect against this, the bank counterparty will typically have an option to terminate the ASR contract upon the declaration of the “excess” dividend. If instead, the ASR contract protects the bank counterparty by requiring the reporting entity to pay the difference between the expected and actual dividends paid during the term of the ASR contract to the bank counterparty, the ASR contract is a participating security, and application of the two-class method of calculating earnings per share should be applied. See FSP 7.4.2 for information on participating securities and the two-class method of calculating earnings per share.
9.2.4.3A ASR contract earnings per share—before adoption of ASU 2020-06
An ASR is reflected in earnings per share as two separate transactions: (1) a treasury stock transaction and (2) the ASR contract.
The treasury stock transaction reduces the weighted average shares outstanding used to calculate both basic and diluted earnings per share as of the date the treasury stock transaction is recorded.
The ASR contract is generally included in diluted earnings per share using the treasury stock method; however, the reporting entity should consider (1) the terms of the specific ASR program and (2) the reporting entity’s specific facts and circumstances to determine the appropriate earnings per share treatment. Most ASR contracts give the reporting entity the option to elect to receive, or pay, any value owed under the ASR contract at maturity in cash or shares. If a reporting entity has established a pattern of settling such ASR contracts in cash, the treasury stock method may not be appropriate based on the guidance in ASC 260-10-55-32 through ASC 260-10-55-36A for instruments settleable in cash or shares. See FSP 7.5.7.1A for further information.
The reporting entity should also consider whether the terms of an ASR contract require it to be accounted for as a participating security. In many ASR contracts, the dividends expected to be paid during the term of the ASR contract are included in the forward price. If the reporting entity pays dividends in excess of the expected dividends, this will adversely impact the economics of the ASR transaction for the bank counterparty. To protect against this, the bank counterparty will typically have an option to terminate the ASR contract upon the declaration of the “excess” dividend. If instead, the ASR contract protects the bank counterparty by requiring the reporting entity to pay the difference between the expected and actual dividends paid during the term of the ASR contract to the bank counterparty, the ASR contract is a participating security, and application of the two-class method of calculating earnings per share should be applied. See FSP 7.4.2 for information on participating securities and the two-class method of calculating earnings per share.
9.2.4.4 Application example
Example FG 9-2 illustrates the accounting for an ASR contract.
EXAMPLE FG 9-2
Accounting for an ASR contract
Accounting for an ASR contract
On September 30, 20X1, when its common stock price is $125 per share, FG Corp enters into an ASR program with the following terms:
- The ASR is a fixed dollar program in which FG Corp will deliver $10 million to the bank on September 30, 20X1 to repurchase a variable number of common shares. The variable number of shares will be determined by dividing the $10 million contract amount by the VWAP observed during the term of the ASR contract.
- The bank delivers 76,000 shares to FG Corp on September 30, 20X1.
- FG Corp is not obligated to deliver any cash to the bank after the initial cash delivery of $10 million. FG Corp analyzes the ASR contract and determines that it is not a liability within the scope of ASC 480. In addition, FG Corp concludes that the ASR contract meets the requirements for equity classification. The amount recorded related to the ASR contract after the cash payment and initial share delivery is $500,000 [$10 million – (76,000 shares x $125)].
The contract matures on March 31, 20X2, and the VWAP over the ASR term is $117. At maturity, FG Corp receives an additional 9,470 shares ([$10 million ÷ $117 = 85,470] less 76,000 initial share delivery), at which time FG Corp’s stock price is $110 per share.
What journal entries should FG Corp record at the inception and settlement of the ASR transaction?
Analysis
When FG Corp enters into the ASR contract, it should record (1) treasury stock equal to the shares repurchased multiplied by the then current stock price (76,000 × $125 = $9,500,000), (2) the ASR contract in additional paid-in capital, and (3) the cash payment made.
Dr. Treasury stock |
$9,500,000 |
|
Dr. Equity – additional paid-in capital |
$500,000 |
|
Cr. Cash |
$10,000,000 |
When FG Corp settles the ASR contract, it should record (1) treasury stock equal to the shares received multiplied by the current stock price (9,470 × $110 = $1,041,700) and (2) an offsetting entry to additional paid-in capital.
Dr. Treasury stock |
$1,041,700 |
|
Cr. Equity – additional paid-in capital |
$1,041,700 |
9.2.5 Written put option
When a reporting entity writes a put option on its own shares, it agrees to buy the shares from a counterparty, generally in exchange for cash, when its share price falls below a specified price. In return, the counterparty pays the reporting entity a premium for entering into the written put option. Generally, a put option has a strike price below the share price at inception (i.e., it is out-of-the-money).
Regardless of the form of settlement, a written put option on a reporting entity’s own shares is a liability within the scope of ASC 480. See FG 5.5 for further information on the scope of ASC 480.
A written put option on a reporting entity’s own shares should be recorded at fair value with changes in fair value recorded in net income.
See FSP 7.5.5.9 (after adoption of ASU 2020-06) or FSP 7.5.5.9A (before adoption of ASU 2020-06) for earnings per share considerations related to written put options, including application of the reverse treasury stock method.
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