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Earnings per share (EPS) is the most common and complex performance measurement that a publicly held company presents in its quarterly and annual reports (Josef Rashty and John O'Shaughnessy, "Restricted Stock Units and the Calculation of Basic and Diluted Earnings per Share," The CPA Journal, June 201 1, pp. 40-45). Guidance for calculating and reporting EPS can be found in two parts of the Accounting Standards Codification (ASC): Topic 260, 'Turnings per Share," which provides for the calculation and presentation of me basic and diluted EPS, and Topic 718, "Compensation - Stock Compensation," which provides for certain unique characteristics of stock compensation mat impact the EPS calculation.
ASC 260 defines EPS as the amount of income attributable to each share of common stock. Basic EPS is calculated by dividing net income by the weighted average of the number of common stock shares outstanding during the period, whereas diluted EPS includes all dilutive potential common shares mat are outstanding during the period. Generally, unvested equity awards that companies have granted to their employees are not included in the calculation of basic EPS, even though such contingent awards are legally considered outstanding. These awards are usually included in calculation of diluted EPS, however.
ASC 718 impacts both the EPS numerator (net income) and the denominator (the average number of shares outstanding). Stock compensation not only reduces the net income and income tax expense, but also impacts the amount of proceeds in the treasury stock method (TSM) calculation that determines the average number of shares outstanding.
No specific guidance exists regarding the impact of employee stock purchase plans (ESPP) on the calculation of diluted EPS, and there is diversity in actual practice. Some companies have allocated the number of ESPP shares ratably over the purchase period in order to provide for the dilutive effect of ESPP shares, while others have treated this calculation in a fashion similar to other forms of equity awards. Although ESPP awards are a form of incentive stock option (ISO), they possess some unique characteristics that impact the calculation of diluted EPS.
ASC 718 treats ESPP awards as ISOs because these awards, like options, are granted at the beginning of the period at a defined price and their vesting is subject to continuation of...