Download Two-class method of computing EPS

No. 2008-10
19 November 2008
Technical Line
Technical guidance on standards
and practice issues
Two-class method of
computing EPS
Applying FSP EITF 03-6-1 and EITF 07-4
Contents
Summary ........................................... 1
Summary
FSP EITF 03-6-1................................. 2
In practice, questions frequently arise regarding the application of the two-class method of
computing earnings per share (EPS), primarily because of the complexity of this calculation
and the limited application guidance in FASB Statement No. 128, Earnings per Share
(Statement 128). To address some of these questions, the Financial Accounting Standards
Board (FASB) and the Emerging Issues Task Force (EITF or the Task Force) issued guidance in
2008 on applying the two-class method of computing EPS in certain instances.
Determining whether an unvested sharebased payment award is a
participating security ...............................2
Allocation of earnings and losses...................2
Changes in forfeiture rates ...........................3
Presentation ................................................3
Effective date and transition .........................3
Implementation considerations .....................3
Use of forfeiture estimates in
retrospective application .....................3
Earnings per unvested share-based
payment award...................................4
Diluted EPS..............................................4
Example.......................................................5
EITF 07-4........................................... 9
Determining whether an IDR is a
participating security ...............................9
Allocation of earnings and losses...................9
IDR is separately transferable...................9
IDR is not separately transferable...........10
Effective date and transition .......................11
Implementation considerations ...................11
Determination of Available Cash.............11
Year-to-date calculation.........................11
Transition — retrospective application.....11
Example.....................................................12
International Convergence................ 16
Specifically, the FASB issued FASB Staff Position (FSP) No. EITF 03-6-1, “Determining
Whether Instruments Granted in Share-Based Payment Transactions Are Participating
Securities” (FSP EITF 03-6-1). This FSP was issued to clarify that unvested share-based
payment awards with a right to receive nonforfeitable dividends are participating securities.
This FSP also provides guidance on how to allocate earnings to participating securities and
compute basic EPS using the two-class method. This FSP is effective for fiscal years
beginning after 15 December 2008, and interim periods within those fiscal years. Early
application is not permitted.
In addition, the Task Force issued EITF Issue No. 07-4, “Application of the Two-Class Method
under FASB Statement No. 128, Earnings per Share, to Master Limited Partnerships”
(EITF 07-4) to clarify that incentive distribution rights (IDRs) are participating securities. This
Issue also provides guidance on how to allocate undistributed earnings to the participating
securities of a Master Limited Partnership (MLP) and compute basic EPS using the two-class
method. Similar to FSP EITF 03-6-1, this Issue is effective for fiscal years beginning after
15 December 2008, and interim periods within those fiscal years. Early application is also
not permitted.
The application of FSP EITF 03-6-1 and EITF 07-4 could have a significant effect on earnings
per share of certain companies that had adopted accounting policies that are inconsistent
with the conclusions in FSP EITF 03-6-1 and EITF 07-4. The following discussion includes our
observations on the application of FSP EITF 03-6-1 and EITF 07-4.
Two-class method of computing EPS
FSP EITF 03-6-1
Many companies issue share-based payment awards that contain rights to receive nonforfeitable dividends or
dividend equivalents (collectively referred to as “dividends” herein) prior to the award’s vesting. Since the issuance
of Statement 128, questions had arisen regarding whether these awards are participating securities, as discussed
in paragraphs 60 and 61 of that standard. While EITF 03-6 addressed many implementation issues related to
participating securities, it did not clearly address whether share-based payments subject to FASB Statement
No. 123 (revised 2004), Share-Based Payment (Statement 123(R)), are participating securities. The Task Force
only concluded that share-based payments, including options and nonvested shares that give the option holder the
right to receive nonforfeitable dividends declared on common stock, are not within the scope of EITF 03-6 until
they are fully vested. Because of the lack of guidance in EITF 03-6, diversity in practice developed regarding how
these awards were treated when computing EPS. In June 2008, the FASB issued FSP EITF 03-6-1 to address this
diversity in practice.
Determining whether an unvested share-based payment award is a participating security
In FSP EITF 03-6-1, the FASB concluded that unvested share-based payment awards that contain rights to receive
nonforfeitable dividends are participating securities, and thus, should be included in the two-class method of
computing EPS. These awards are considered participating securities because the award holders participate in
distributions of earnings with common shareholders from the date the awards are granted because no service has
to be rendered to earn the dividends. By comparison, unvested share-based payment awards that contain rights to
receive dividends only if the award fully vests do not represent a participation right. These awards are not
considered participating securities because the award holder does not have the right to retain the dividend unless
the requisite service has been rendered.
The FASB staff also concluded that unvested share-based payment awards would not be considered participating
securities if the dividends transferred could only be applied as a reduction in the exercise price of the award. These
types of awards are not considered participating securities because the holder does not have the nonforfeitable
right to participate in the distribution of earnings with the common shareholders unless the award is exercised.
This conclusion is consistent with the guidance in EITF 03-6, which concluded that that dividends or dividend
equivalents transferred to the holder of a convertible security in the form of a reduction to the conversion price or
an increase in the conversion ratio of the security do not represent participation rights.
Allocation of earnings and losses
The allocation of earnings is consistent with the framework discussed in Statement 128 and EITF 03-6. However,
because of certain issues that result from the accounting for nonforfeitable dividends paid to the holders of sharebased payment awards pursuant to Statement 123(R), FSP EITF 03-6-1 also includes allocation guidance to address
these issues. Statement 123(R) states that nonrefundable dividends paid on awards that are not expected to (or do
not) vest are recognized as additional compensation expense. Accordingly, the FSP concludes that dividends that are
recognized in earnings as compensation expense should not be included in the allocation of earnings when
computing EPS, because to do so would result in these dividends being subtracted from earnings available to
common shareholders twice. As such, the amount of distributed earnings allocated to the unvested share-based
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Technical Line No. 2008-10, 19 November 2008
Two-class method of computing EPS
payment awards should be the total dividends distributed to all share-based payment awards less dividends
transferred to awards that are expected to be forfeited. However, the FSP requires that undistributed earnings be
allocated to all outstanding share-based payment awards, including those that are expected to be forfeited. This
approach is necessary because, under the two-class method, an entity assumes that it distributes all of its earnings
for the period. If an entity distributed all of its earnings, it would be required to distribute earnings to the holders of
all outstanding participating awards (not just those awards that are expected to vest), which would reduce the
earnings available to distribute to common shareholders. The example below illustrates these concepts.
Changes in forfeiture rates
The FASB concluded that the estimated number of awards expected to be forfeited used in the two-class
calculation should be consistent with the estimate made under Statement 123(R) for the purpose of determining
compensation expense. In addition, consistent with the guidance in Statement 123(R), the FSP requires that any
changes in the estimated number of forfeitures be reflected in the EPS calculation in the period that a change in
estimate occurs. As such, the change in estimated forfeitures will only affect net income and EPS in the period a
change in estimate occurs and will not affect EPS reported for prior periods (i.e., EPS in prior periods is not
restated for changes in estimates of expected forfeitures). The FSP includes an example that illustrates the
concepts included in the FSP, including how a change in the forfeiture rates affects the computation of basic EPS
using the two-class method.
Presentation
Consistent with the guidance in EITF 03-6, FSP EITF 03-6-1 concludes that the presentation of EPS is only required
for each class of common stock. However, the presentation of basic and diluted EPS for a participating security
other than common stock (e.g., participating share-based payment awards) is not precluded.
Effective date and transition
This FSP is effective for fiscal years beginning after 15 December 2008, and interim periods within those years.
Early application is not permitted. The guidance in this FSP must be applied retrospectively to all prior-period EPS
data presented in financial statements (including selected financial data).
Implementation considerations
Use of forfeiture estimates in retrospective application
The requirement to reduce distributed earnings to unvested participating awards by the amount of dividends
transferred that were recognized as compensation expense also must be applied retrospectively when applying
FPS EITF 03-6-1 for the first time. This retrospective transition will require companies to determine the amount of
dividends transferred to unvested participating award holders that were recognized as compensation expense in
historical periods so that those dividends are not deducted from earnings available to common shareholders twice.
However, even though nonforfeitable dividends transferred to unvested participating award holders may have
been accounted for differently in the historical periods presented in the financial statements, this FSP does not
require companies to modify how these dividends were accounted for when restating prior period EPS. For
example, if a company’s financial statements include reporting periods whereby share-based payment awards
were accounted for pursuant to APB Opinion No. 25, Accounting for Stock Issued to Employees, dividends
transferred to unvested participating award holders may have been recognized as a reduction to retained earnings
and not as additional compensation expense. Since these dividends were not recognized as additional
Technical Line No. 2008-10, 19 November 2008
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Two-class method of computing EPS
compensation expense in the historical period presented, no adjustment to distributed earnings would be
necessary when restating EPS for this period.
Earnings per unvested share-based payment award
The requirement in the FSP to reduce distributed earnings to unvested participating award holders by the amount
of dividends transferred that were also recognized as additional compensation expense will result in a distributed
earnings per share amount for unvested participating awards that does not equal the declared dividend per share
amount (unless no forfeitures are expected or actually occur). In addition, when unvested participating awards
participate equally with common shares, the calculated basic EPS amount for the unvested participating awards
will be different than the calculated basic EPS amount for common shares (unless no forfeitures are expected or
actually occur). These differences will occur because of the computational guidance included in this FSP regarding
awards not expected to vest and are illustrated in the example below.
Pursuant to the provisions of Statement 128 (and reiterated in FSP EITF Issue 03-6-1), basic and diluted EPS are
required to be disclosed only for common stock. As unvested participating awards are not considered a class of
common stock prior to the vesting or exercise of the awards, companies are not required to disclose EPS for these
awards. However, presentation of EPS for participating securities is not precluded. If a company decides to
disclose the EPS amounts for its unvested participating awards, we encourage them to include additional
disclosures in their financial statements to mitigate the potential for any confusion on the part of the unvested
participating share-based award holders that may result from the fact that EPS for their awards will differ from
EPS for common stock. For example, entities may consider reconciling earnings per unvested participating sharebased payment award and earnings per common share by reference to the dividends recognized as compensation
cost. However, we believe it would be least confusing to simply exclude a separate disclosure of EPS for unvested
participating share-based payments as the holders of such awards do in fact participate on the same basis as
common shareholders, and can look to reported EPS for common stock.
Diluted EPS
There is limited guidance in Statement 128 or EITF 03-6 regarding the calculation of diluted EPS under the twoclass method. However, we believe the dilutive effect of each participating security or second class of common
stock on the common stock should be calculated using the more dilutive of the following approaches:
• The treasury stock method, reverse treasury stock method, if-converted method or contingently issuable share
method, as applicable, provided a participating security or second class of common stock is a potential common
share. The dilutive effect of other potential common shares (e.g., stock options) should also be considered in
conjunction with the antidilution sequencing provisions in Statement 128.
• The two-class method assuming a participating security or second class of common stock is not exercised or
converted. Under this method, the dilutive effect of other potential common shares is determined in conjunction
with the antidilution sequencing provisions in Statement 128, and undistributed earnings are reallocated
between common shares and participating securities.
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Technical Line No. 2008-10, 19 November 2008
Two-class method of computing EPS
The calculation that results in the most dilutive EPS amount for the common stock is reported in the financial
statements. Diluted EPS for a second class of common stock and each participating security would be calculated
using the two-class method discussed above. However, disclosure in the financial statements is only required for
classes of common stock. Disclosure of the diluted EPS amount for a participating security is permitted, but not
required. The example below illustrates the concepts discussed above.
This approach is consistent with the guidance in the FASB’s Exposure Draft on EPS issued in August 2008 and the
interpretative guidance on the two-class method of computing EPS in our Accounting Manual, which is available to
paid subscribers of E&Y GAAIT – Client Edition. See further discussion under “International Convergence” below.
Example
The following example illustrates the concepts and computational guidance in FSP EITF 03-6-1:
Company ABC had 50,000 shares of common stock outstanding during 20X9 and net income of $150,000. On
1 January 20X9, the company issued 5,000 shares of unvested stock to employees, each with a grant-date fair
value of $40. These shares will vest at the end of five years (i.e., cliff vest). As of 1 January 20X9, the Company
estimated that 250 shares would not vest. During 20X9, no shares were actually forfeited and the estimated
forfeiture rate was not revised. The unvested shareholders have a nonforfeitable right to participate in dividends
with common shareholders on a dollar-for-dollar basis.
On 1 January 20X9, the Company also issued options to employees to purchase 8,000 shares of common stock at
the then-current market price of $40. The options have a grant-date fair value of $5 and vest at the end of 5 years
(cliff vest). The option holders do not have rights to participate in dividends with the common shareholders. For
ease of illustration, assume the Company expects all of the options to vest.
On 31 December 20X9, the Company declares and pays a $1.00 per share dividend (or dividends of $50,000 and
$5,000 paid to the common shareholders and holders of unvested shares, respectively). The average market price of
Company ABC’s common stock for the year was $50 per share. Company ABC’s tax rate for 20X9 was 40 percent.
Basic EPS under the two-class method for the year ended 31 December 20X9 would be computed as follows:
Net income
$
150,000
Less dividends to:
Common shares
Unvested shares
$
50,000
4,750 a
54,750
Undistributed 20X9 net income
a
$
95,250
Amount represents the dividends paid to the holders of unvested share-based payment awards (5,000 unvested shares x $1.00 dividend
per share = $5,000) less the dividends paid to the holders of awards that are not expected to vest (250 shares expected to be forfeited x
$1.00 dividend per share = $250). As dividends paid on awards that are not expected to vest already are recognized in net income as
compensation expense, these dividends are excluded from the allocation of distributed earnings.
Technical Line No. 2008-10, 19 November 2008
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Two-class method of computing EPS
Allocation of undistributed net income b :
To common shares:
50,000 shares ÷ (5,000 shares + 50,000 shares) × $95,250 = $86,591
$86,591 ÷ 50,000 shares = $1.73 per share
To unvested shares:
5,000 shares ÷ (5,000 shares + 50,000 shares) × $95,250 = $8,659
$8,659 ÷ 5,000 shares = $1.73 per share
Basic EPS amounts:
Common shares
$ 1.00 c
1.73
$ 2.73
Distributed earnings
Undistributed earnings
Totals
Unvested shares
$ 0.95 d
1.73
$ 2.68
Diluted EPS under the two-class method for the year ended 31 December 20X9 would be computed as follows:
Step 1 — Antidilution sequencing
Options
Unvested shares
b
c
d
e
f
g
6
Increase in earnings available
to common shareholders
—
13,409 f
Increase in number
of common shares
560 e
1,000 g
Earnings per
incremental share
$
—
$ 13.41
The shares used to determine the allocation of undistributed net income and per share amounts are the weighted average common and
unvested shares outstanding for the reporting period.
$50,000 of earnings distributed to common shareholders ÷ 50,000 weighted average common shares outstanding
$4,750 of earnings distributed to unvested shareholders ÷ 5,000 weighted average unvested shares outstanding
Incremental shares outstanding from assumed exercise of the outstanding options:
Calculation of assumed proceeds:
Assumed proceeds received from the exercise of options
$40 x 8,000 = $320,000
Average unrecognized compensation cost
($40,000 + $32,000) ÷ 2 = $36,000
Excess tax benefit
{[($50 − $40) − $5] × 8,000} × 40% = $16,000
Total assumed proceeds
$320,000+36,000+16,000 = $372,000
Shares repurchased:
$372,000 ÷ $50 = 7,440 shares
Incremental shares:
8,000 − 7,440 = 560 shares
$4,750 of earnings distributed to unvested shareholders + $8,659 of undistributed earnings allocated to unvested shareholders
Incremental shares outstanding from assumed conversion of the outstanding unvested shares:
Calculation of assumed proceeds:
Average unrecognized compensation cost
($200,000 + $160,000) ÷ 2 = $180,000
Excess tax benefit
{[($50 − $0) − $40] × 5,000} × 40% = $20,000
Total assumed proceeds
$180,000 + $20,000 = $200,000
Shares repurchased:
$200,000 ÷ $50 = 4,000 shares
Incremental shares:
5,000 − 4,000 = 1,000 shares
Technical Line No. 2008-10, 19 November 2008
Two-class method of computing EPS
Step 2 — Calculation of diluted EPS using the treasury stock method for the unvested shares and options
Undistributed &
distributed earnings to
common shareholders
$ 136,591
—
136,591
13,409
$ 150,000
As reported — basic
Options
Subtotal
Unvested shares
Diluted EPS — common shares
Common shares
50,000
560
50,560
1,000
51,560
Earnings per share
$ 2.73
2.70
$ 2.91 h
Step 3 — Calculation of diluted EPS using the two-class method
Common shares
As reported — basic
Add-back:
Undistributed earnings allocated
to unvested shareholders
Options
Less:
Undistributed earnings
reallocated to unvested
shareholders
Diluted EPS — common shares
h
i
Undistributed &
distributed earnings to
common shareholders
$ 136,591
Common shares
50,000
8,659
—
(8,572) i
$ 136,678
Earnings per share
$ 2.73
—
560
—
50,560
$ 2.70
The purpose of the calculation in Step 2 is calculate the dilutive effect on the common shares of an assumed exercise of the unvested
participating awards using the treasury stock method (inclusive of the dilutive effects of other potential common shares). As such, the EPS
calculation must include the assumed exercise of the unvested participating awards even if it results in an EPS amount that is antidilutive.
(5,000 ÷ (5,000 + 50,000 + 560)) × $95,250 undistributed earnings = $8,572
Technical Line No. 2008-10, 19 November 2008
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Two-class method of computing EPS
Unvested shares
As reported — basic
Less:
Undistributed earnings allocated
to unvested shareholders
Add-back:
Undistributed earnings
reallocated to unvested
shareholders
Diluted EPS — unvested shares
Undistributed &
distributed earnings to
unvested shareholders
$
13,409
Unvested shares
5,000
(8,659)
$
Earnings per share
$ 2.68
—
8,572
13,322
—
5,000
$ 2.66
In this example, Company ABC is required to disclose diluted EPS per common share of $2.70 using the two-class
method because using the treasury stock method results in a less dilutive EPS amount of $2.91. Although not
required to be disclosed pursuant to the disclosure requirement in Statement 128, Company ABC is not precluded
from disclosing the EPS amounts for its unvested shares. If Company ABC decided to disclose EPS amounts for its
unvested share, they would disclose $2.66 as the diluted EPS amount for the unvested shares (see the section
above on implementation considerations for a discussion on disclosing EPS for unvested participating awards). The
following table summarizes the basic and diluted EPS amounts for the common and unvested shares:
Basic
Diluted
8
Common shares
$ 2.73
2.70
Technical Line No. 2008-10, 19 November 2008
Unvested shares
$ 2.68
2.66
Two-class method of computing EPS
EITF 07-4
Publicly traded master limited partnerships (MLPs) typically issue multiple classes of securities that participate in
partnership distributions according to a formula specified in the partnership agreement. A typical MLP consists of
publicly-traded common units (and in some cases, subordinated common units) held by limited partners (LPs), a
general partner (GP) interest, and incentive distribution rights (IDRs). IDRs may be a separate class of non-voting
limited partner interest that the GP initially holds, but may be transferable apart from its GP interest. IDRs may
also be embedded in the GP interest such that they cannot be transferred separately from the GP’s overall interest
in the MLP.
In many cases, the partnership agreement obligates the GP to distribute 100 percent of the partnership's
“Available Cash” (as that term is defined in the partnership agreement) to the LPs, GP, and, when certain
thresholds are met, the holder(s) of IDRs, based on a distribution waterfall schedule included in the partnership
agreement. Partnership agreements generally state that the holder(s) of IDRs are not entitled to distributions
other than those provided in the distribution waterfall of Available Cash. The net income (or loss) of the
partnership is allocated to the capital accounts of the GP and LPs based on their ownership percentages after
taking into account any priority income allocations (or distributions) to the holder(s) of IDRs.
Because the GP and LPs both participate in the distribution of earnings, MLPs are required to calculate earnings
per unit (EPU) using the two-class method. However, questions were raised because of disparities in practice that
developed regarding the treatment of IDRs as participating securities, and, if treated as a participating security,
how earnings and losses were allocated when computing EPU using the two-class method. In March 2008, the Task
Force issued EITF 07-4 to resolve this diversity in practice and to improve the comparability of the EPU
calculations for MLPs.
Determining whether an IDR is a participating security
The scope of EITF 07-4 includes all MLPs that are both required to make incentive distributions when certain
contractually specified thresholds are met and that account for the incentive distributions as equity distributions.
Incentive distributions accounted for as compensation cost are excluded from the scope of this Issue. In Issue
07-4, the Task Force concluded that IDRs in a MLP that are a separate class of LP interest (that is, the IDRs are
transferable and not embedded in the GP interest) are participating securities. If the IDRs are not transferable
separate from the GP interest, the IDRs themselves are not participating securities. However, the GP interest and
the embedded IDRs are a participating security.
Allocation of earnings and losses
IDR is separately transferable
If IDRs are separately transferable, earnings or losses for a reporting period should be allocated to the GP, LPs and
the holder(s) of IDRs (collectively referred to hereafter as “the participating security holders”) using the two-class
method to compute EPU. When computing EPU under the two-class method, EITF 07-4 requires net income or loss
for a reporting period to be reduced (or increased) by the amount of Available Cash that has been or will be
Technical Line No. 2008-10, 19 November 2008
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Two-class method of computing EPS
distributed to the participating security holders for that reporting period. As partnership agreements generally
obligate the GP to distribute Available Cash for each reporting period within a certain number of days after the end
of a reporting period (for example, 60 days), the GP will need to determine Available Cash to be distributed to the
participating security holders prior to issuing financial statements for each reporting period. The distributions of
Available Cash to the participating security holders are generally based on a waterfall schedule (or some other
distribution methodology) that is stipulated in the partnership agreement.
After adjusting net income for the reporting period by the amounts distributed to the participating security
holders, any undistributed earnings should be allocated to the participating security holders, including the
holder(s) of IDRs, pursuant to the terms of the partnership arrangement. Thus, if the partnership arrangement
contractually limits the amount of distributions to the holder(s) of IDRs, undistributed earnings should not be
allocated to the holder(s) of IDRs in excess of the specified amount.
To determine whether distributions to the holder(s) of IDRs are contractually limited, a MLP will need to evaluate
whether distributions for a reporting period would be limited to Available Cash even if all earnings for the period
were distributed (e.g., in the event of a liquidating dividend). Typically, partnership agreements specify that
distributions to the holder(s) of IDRs for a reporting period are contractually limited to the holder’s share of
Available Cash distributed for the current reporting period. In this case, all undistributed earnings or losses would
be allocated to the GP and LPs and no undistributed earnings or losses would be allocated to the holder(s) of IDRs.
However, if the partnership agreement is silent or does not explicitly limit distributions to the holder(s) of IDRs, the
Task Force concluded that the MLP should allocate undistributed earnings or losses to the participating security
holders using the distribution waterfall schedule (or other distribution methodology) specified in the partnership
agreement.
When distributions to the participating security holders exceed earnings for the reporting period, net income (or
loss) would be reduced (or increased) by actual distributions. The resulting net undistributed loss should be
allocated to the GP and LPs based on the method of allocating losses specified in the partnership agreement.
Losses should only be allocated to the holder(s) of IDRs to the extent they are contractually obligated to
participate in losses. The example below illustrates the concepts discussed above.
IDR is not separately transferable
The Task Force concluded that IDRs that are embedded and not separately transferable from the GP interest are
not separate participating securities. While this type of IDR is not considered a separate participating security,
MLPs are still required to compute EPU under the two-class method because the GP and LP interests are separate
classes of equity. When the IDRs are embedded in the GP interest, the guidance in EITF 07-4 is virtually the same
as when the IDRs are a separate LP interest, except that all distributions and allocations of undistributed earnings
(or losses) related to the IDRs are aggregated with the distributions and allocations of earnings (or losses) to the
GP interest. As a result, the effect on the calculated EPU for the LP interests would be the same regardless of
whether the IDRs are a separate LP interest or are embedded in the GP interest. However, the calculated EPU for
the GP in many cases will be higher than if the IDRs were considered separate participating securities.
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Two-class method of computing EPS
Effective date and transition
This Issue is effective for fiscal years beginning after 15 December 2008, and interim periods within those fiscal
years. Early application is not permitted. The guidance in this Issue must be applied retrospectively for all financial
statements presented (including selected financial data).
Implementation considerations
Determination of Available Cash
The requirement in this Issue to determine the contractual obligation to the holder(s) of IDRs at the end of a
reporting period will require MLPs to determine Available Cash at the end of a reporting period before the financial
statements for that period are issued. As such, this requirement may cause some MLPs to accelerate the timing of
this determination in order to comply with the requirements of this Issue. While this Issue requires companies to
determine Available Cash prior to issuing their financial statements for purposes of calculating EPU, this Issue does
not require MLPs to record a distribution payable prior to distributions being declared. For example, if a MLP
determines Available Cash for their first quarter of calendar-year 2009 reporting period in April 2009, the MLP
would not record a distribution payable until April 2009, when the distribution is actually declared, even though
the distributions will be used to compute EPU for the first quarter of 2009 reporting period.
Year-to-date calculation
We believe, based on discussions with the FASB staff, that the computation of EPU for a year-to-date or an annual
period should be made without regard to the quarterly computations. That is, earnings for the annual period
should be allocated to the unit classes independent of the quarterly EPU calculations.
Transition — retrospective application
In addition, the requirement to apply the provisions in this issue retrospectively will require MLPs to recalculate
historically reported earnings per unit. As MLPs were not historically required to determine the amount of
Available Cash that would be distributed for a reporting period prior to issuing their financial statements,
distributions were likely declared after their financial statements were issued and were reflected in the subsequent
reporting period when the distributions were actually declared. However, based on our discussions with the FASB
staff, when restating prior-period EPU amounts, MLPs will need to evaluate all distributions made in historical
reporting periods and reflect those distributions in the reporting period to which the distributions related, even if
the Available Cash amount was determined and the distributions were declared in a subsequent reporting period
and those distributions were declared after the financial statements were issued. For example, assume an MLP
determined Available Cash and declared distributions for their third quarter of calendar-year 2007 reporting
period in December 2007. When the MLP restates their EPU for the third quarter of 2007, they will include
distributions calculated and declared in the fourth quarter (December 2007) in their EPU calculation for the third
quarter of 2007, instead of the EPU calculation for the fourth quarter of 2007.
Technical Line No. 2008-10, 19 November 2008
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Two-class method of computing EPS
Example
The following example illustrates the concepts and computational guidance in EITF 07-4. This example does not
include a calculation of diluted EPU, because many MLPs do not have additional dilutive securities outstanding. If
additional dilutive securities were outstanding, the concepts illustrated in the diluted EPS calculation included in
the discussion of FSP 03-6-1, above, would be followed.
During the first and second quarters of 20X9, Partnership XYZ has 9,800 Common Units outstanding held by the
LPs, 200 GP units outstanding held by the GP and 1,000 IDRs outstanding also held by the GP. According to the
partnership agreement, net income (loss) is allocated to the GP and LPs based on their ownership percentages (98
percent and 2 percent, respectively) after giving effect to any priority income allocations to the IDR holder.
The IDRs are held by the GP and represent a separate class of non-voting limited partnership interests that are
transferable by the GP separate from its ownership interest. The GP is obligated to distribute 100 percent of the
partnership's Available Cash every quarter based on a distribution waterfall specified in the partnership
agreement. The GP must distribute the Available Cash within 60 days after the end of the quarter. The MLP must
determine the Available Cash to be distributed prior to issuing its quarterly financial statements. The distributions
to the IDRs are contractually limited to the eligible amounts as stipulated in the waterfall schedule and the IDRs are
not contractually obligated to participate in losses. During the first and second quarter of 20X9, the partnership
had Available Cash of $25,000 each quarter (fully distributed to the GP, LPs, and IDR holder) and net income of
$50,000 and $15,000, respectively. The following table illustrates the cumulative amount of Available Cash that
would be distributed to the Common Units, GP interest, and IDRs at each of the thresholds based on the
distribution waterfall in the partnership agreement:
Waterfall percentage
Distribution per
common units
(LPs)
st
1 threshold
$0.40
2nd threshold
0.50
rd
3 threshold
0.60
Thereafter
N/A
LPs
98%
85%
75%
50%
GP
2%
2%
2%
2%
IDRs
—%
13%
23%
48%
Cumulative distribution by interest
LPs
$3,920
4,900
5,880
GP
$80
103
129
IDRs
$
—
150
451
Total
$4,000
5,153
6,460
The following represents the basic EPU calculations for first quarter, second quarter and year-to-date period as of
the end of the second quarter using the two-class method. In the context of a partnership, we believe that to the
extent ownership units or IDRs do not have a preference on liquidation, these securities would be equivalent to
common stock. As a result, EPU for these securities is required to be reported in the financial statements of a
partnership. Disclosure of EPU for other participating securities is not precluded.
12
Technical Line No. 2008-10, 19 November 2008
Two-class method of computing EPS
Basic EPU under the two-class method for the first quarter ended 31March 20X9 would be computed as follows:
Net income
Less distributions to:
Incentive distribution rights
General partner
Limited partners
$
$
50,000
9,350 j
500 k
15,150 l
25,000
Undistributed net income
$
25,000
Allocation of undistributed net income to the GP and LPs m :
To general partner:
2% ownership interest × $25,000 = $500
$500 ÷ 200 units = $2.50 per unit
To limited partners:
98% ownership interest × $25,000 = $24,500
$24,500 ÷ 9,800 units = $2.50 per unit
Basic EPU amounts:
Distributed earnings
Undistributed earnings
Total
j
k
l
m
n
o
p
q
Incentive
distribution rights
$ 9.35 n
—q
General partner
$ 2.50 o
2.50
$ 9.35
$ 5.00
Limited partners
$ 1.55 p
2.50
$ 4.05
$451 cumulative distribution to IDR holders for 3rd threshold + $8,899 [($25,000 (Available Cash) − $6,460 (total cumulative distribution
for 3rd threshold)) x 48% waterfall percentage]
$129 cumulative distribution to GP for 3rd threshold + $371 [($25,000 (Available Cash) − $6,460 (total cumulative distribution for 3rd
threshold)) x 2% waterfall percentage]
$5,880 cumulative distribution to LPs for 3rd threshold + $9,270 [($25,000 (Available Cash) − $6,460 (total cumulative distribution for
3rd threshold)) x 50% waterfall percentage]
The units used to determine the undistributed net income per unit are the weighted average GP and LP units outstanding for the reporting
period.
$9,350 (earnings distributed to the IDRs) ÷ 1,000 weighted average IDRs outstanding
$500 (earnings distributed to the GP) ÷ 200 weighted average GP units outstanding
$15,150 (earnings distributed to the LPs) ÷ 9,800 weighted average LP units outstanding
No undistributed earnings were allocated to the IDRs because their participation in earnings is contractually limited to amounts actually
distributed in accordance with the waterfall schedule in the MLP agreement.
Technical Line No. 2008-10, 19 November 2008
13
Two-class method of computing EPS
Basic EPU under the two-class method for the second quarter ended 30 June 20X9 would be computed as follows:
Net income
Less distributions to:
Incentive distribution rights
General partner
Limited partners
$
$
15,000
9,350 r
500 s
15,150 t
25,000
Undistributed net loss
$
(10,000)
Allocation of undistributed net loss to the GP and LPs u :
To general partner:
2% ownership interest × $(10,000) = $(200)
$(200) ÷ 200 units = $(1.00) per unit
To limited partners:
98% ownership interest × $(10,000) = $(9,800)
$(9,800) ÷ 9,800 units = $(1.00) per unit
Basic EPU amounts:
Distributed earnings
Undistributed earnings
Total
r
s
t
u
v
w
x
y
14
Incentive
distribution rights
$ 9.35 v
—y
General partner
$ 2.50 w
(1.00)
$ 9.35
See note j.
See note k.
See note l.
See note m.
See note n.
See note o.
See note p.
See note q.
Technical Line No. 2008-10, 19 November 2008
$ 1.50
Limited partners
$ 1.55 x
(1.00)
$ 0.55
Two-class method of computing EPS
Basic EPU under the two-class method for the year-to-date period ended 30 June 20X9 would be computed as follows:
Net income
Less distributions to:
Incentive distribution rights
General partner
Limited partners
$
$
65,000
18,700 z
1,000 aa
30,300 bb
50,000
Undistributed net loss
$
15,000
Allocation of undistributed net loss to the GP and LPs cc :
To general partner:
2% ownership interest × $15,000 = $300
$300 ÷ 200 units = $1.50 per unit
To limited partners:
98% ownership interest × $15,000 = $14,700
$14,700 ÷ 9,800 units = $1.50 per unit
Basic EPU amounts:
Distributed earnings
Undistributed earnings
Total
z
aa
bb
cc
dd
ee
ff
gg
Incentive
distribution rights
$ 18.70 dd
— gg
General partner
$ 5.00 ee
1.50
Limited partners
$ 3.09 ff
1.50
$ 18.70
$ 6.50
$ 4.59
$9,350 (Q1 distribution) + $9,350 (Q2 distribution)
$500 (Q1 distribution) + $500 (Q2 distribution)
$15,150 (Q1 distribution) + $15,150 (Q2 distribution)
See note m.
$18,700 ( year-to-date distributions) ÷ 1,000 weighted average IDRs outstanding
$1,000 (year-to-date distributions) ÷ 200 weighted average GP units outstanding
$30,300 (year-to-date distributions) ÷ 9,800 weighted average LP units outstanding
See note q.
Technical Line No. 2008-10, 19 November 2008
15
Two-class method of computing EPS
International Convergence
In August 2008, the FASB, as part of a joint convergence project with the International Accounting Standards
Board (IASB), released a Proposed Statement of Financial Accounting Standards, Earnings per Share – an
amendment of FASB Statement No. 128 (Proposed Statement). The primary objective of this Proposed Statement
is to eliminate certain differences between Statement 128 and International Accounting Standard (IAS) 33,
Earnings Per Share. The Proposed Statement also includes clarification on certain aspects of applying the twoclass method of computing EPS – in particular, computing diluted EPS using the two-class method. These
clarifications and additional examples were added to the Proposed Statement in an attempt to address requests
from constituents for clarification on the application of the two-class method that arose after the issuance of
Statement 128 and EITF Issue No. 03-6, “Participating Securities and the Two-Class Method under FASB
Statement No. 128” (EITF 03-6). A summary of the key provisions of the Proposed Statement can be found in our
Hot Topic, “FASB releases proposed statement to amend Statement 128, Earnings per Share” issued in the
Accounting and Auditing News on 5 September 2008.
The current guidance on participating securities and the two-class method of computing EPS in Statement 128 and
IAS 33 are consistent, and we believe that the guidance in EITF 03-6, FSP EITF 03-6-1 and EITF 07-4 is consistent
with Statement 128 and IAS 33. Accordingly, we would not expect a difference between US GAAP and IFRS with
respect to the EPS calculation for unvested share-based payment awards with a right to receive nonforfeitable
dividends and interests in MLPs.
16
Technical Line No. 2008-10, 19 November 2008
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