important information re: Accounting - FSP EITF 03-6-1 - Determining Whether Instruments Granted in Share-Based Payment Transaction are Participating Securities

FSP
EITF 03-6-1 (FSP) is effective for fiscal years beginning after
December 15, 2008 and is to be applied retrospectively.  This means
that all comparative data has to be shown as if this FSP was in
effective from the beginning.

This FSP requires share based compensation awards that qualify as
participating securities to be included in basic EPS using the
two-class method.  A share based compensation award is considered a
participating security if it receives non-forfeitable dividends.   A
non-forfeitable dividend would be a dividend that the participant
receives before the award is vested and if the participant forfeits the
actual shares awarded the dividends he/she has received do  not have to
be paid back to the company.  In other words, once they get the money
they don’t have to return it regardless of what happens to the actual
shares under the award.

Paragraph 6 of the FSP states that “unvested share based payment
awards that contain non-forfeitable rights to dividends or dividend
equivalents (whether paid or unpaid) are participating securities and
shall be included in the computation of EPS pursuant to the two-class
method.”  I think the unpaid part is important.  Sometimes the
dividends are used to buy more shares instead of giving them in cash to
the participant.  These dividends are still included in this
calculation if the company would have to give them that cash if the
shares are forfeited.

Another interested catch is the dividends on shares that are not
expected to vest.  FAS 123R requires a company to estimate the
forfeiture rate of an award at the beginning and on an ongoing basis. 
For the shares that are not expected to vest, the dividends are
considered additional compensation expense and are recorded in earnings
instead of an equity account.  These dividends are not included in the
calculation of EPS, but the shares are still included in the
denominator.

If the dividends are transferred to the participant as a reduction
to the exercise price of the award, the dividends are not considered
non-forfeitable and the shares would not be considered participating
securities.

Paragraph 1 of the FSP states that the participating securities
should be “included in the earnings allocation in computing EPS under
the two-class method described in paragraphs 60 and 61 of FAS 128.” 

Paragraph 61 of FAS 128 states “the two-class method is an earnings
allocation formula that determines earnings per share for each class of
common stock and participating security according to dividends declared
(or accumulated) and participation rights in undistributed earnings.”

 Step 1.  Starting with income from continuing
operations, reduce income from continuing operations by the amount of
dividends declared in the current period for each class of stock.  The
remaining income from continuing operations is considered
“Undistributed Earnings”.

 Net Income                                                                                   $100,000

Less:

           Dividends on Common Stock (10,000 shares)                             (10,000)                  

           Dividends on Participating Securities (5,000 shares)                     (5,000)

Undistributed Earnings                                                                      $ 85,000

 Step 2.   The undistributed earnings are allocated
to common stock and participating securities on a percentage basis.  
This amount is then divided by the number of shares in each category. 
(i.e. common stock outstanding and participating securities.)

 Common Stock

(10,000/15,000) * $85,000 = $56,667/10,000 = $5.67 EPS on common stock

 Participating Securities

(5,000/15,000) * $85,000 = $28,333/5,000 = $5.67 EPS on participating securities

 Step 3.  The dividends paid to the participating
securities is divided by the number of participating securities and the
dividends paid to the rest of the common stockholders is divided by the
number of common stock outstanding.

 Common Stock

$10,000/10,000 = $1 EPS on common stock

 Participating Security

$5,000/5,000 = $1 EPS on Participating Security

 Step 4.  The amount allocated to each category is then added together to obtain the EPS for that category.

 Common Stock

$5.67 + $1.00 = $6.67 EPS on common stock

 Participating Security

$5.67 + $1.00 = $6.67 EPS on Participating Security

 In comparison EPS before the FSP would have been:

 $100,000/10,000 = $10 EPS on common stock

 Basic and diluted EPS data is to be presented for each class of
common stock but the EPS for the restricted shares does not have to be
presented.  However, neither FAS 128 nor the FSP disallows the
presentation of the EPS for participating securities.  This means while
you have to go through the calculation process, you do not have to
present the EPS for the participating securites on the income statement
with the other EPS data.