Accounting considerations for accelerated share repurchases

Video , PwC US Aug 01, 2018

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Watch our video on accounting considerations for accelerated share repurchases

US public companies have been buying back their shares at a record pace. This video will revisit the basic terms and accounting for accelerated share repurchase programs. While the accounting for accelerated share repurchase programs is not new, it can often be complex. To help navigate these complexities, this video discusses:

  1. What an accelerated share repurchase program is,
  2. The general accounting framework for accelerated share repurchases, and
  3. Specific complexities to consider when working through the accounting analysis.
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Duration: 6:47

Transcript

Hello, I'm John Horan, a managing director in PwC's national office.

US public companies have been buying back their shares at a record pace. It is estimated that S&P 500 companies will repurchase as much as $800 billion in stock this year -- a significant increase from the $530 billion in repurchases that occurred in 2017. As companies continue to ramp up share repurchases, I would like to revisit the accounting for share repurchase programs. While the accounting for share repurchase programs is not new, it can often be complex.

To help navigate these complexities, I'll cover the following in this video:

  1. What an accelerated share repurchase program is;
  2. The general accounting framework for accelerated share repurchases; and
  3. Some specific complexities to consider when working through the accounting analysis.

To start, there are many ways companies can repurchase their shares; for example, on the open market or in privately negotiated purchases, tender offers and accelerated share repurchase programs -- or "ASR's". While each one has unique complexities and regulatory issues to consider, our view is that the accounting for accelerated share repurchase programs can be the most challenging.

In a typical ASR, a company will make an upfront payment to an investment bank as consideration for entering into the contract.

As part of the contract, the investment bank borrows shares from existing shareholders, typically institutional investors, and delivers the shares to the company in exchange for the upfront payment. Over a predefined period of time, the investment bank satisfies its obligation to the institutional investors to return the shares on loan by making open market purchases.

At the end of the predefined period, the company and the investment bank settle the contract. The contract is typically structured to settle for the difference between the number of shares delivered at the inception of the ASR and the number of shares equal to the upfront payment divided by the volume-weighted average price of the stock during the repurchase period (essentially a forward contract).

In effect, the forward contract allows the company to not have to pay more than the volume-weighted average price of the stock over the repurchase period. With that basic framework in mind, let's cover some of the accounting issues that arise in these transactions. 

First, the upfront receipt of shares to a company would generally be accounted for as a treasury stock transaction which allows the company to immediately receive the benefit of excluding those shares from the denominator of its earnings per share computation resulting in an increase in earnings per share prospectively.

The more difficult analysis relates to the accounting for the forward contract. Generally, the forward contract is considered a derivative, which would require the forward contract to be marked to market, with changes in fair value flowing through earnings each period. 

However, the forward contract may qualify for a scope exception that allows the company to avoid mark-to-market treatment.

To qualify for this scope exception, the forward contract must:

  1. Have settlement provisions that are indexed solely to the company's own stock -- said differently, if the payoff for the contract is tied in part to variables that are not directly linked with the company's stock, it would not meet this criterion, and 
  2. The company must always have the ability to settle the forward contract in the company's stock and not have a requirement to deliver cash under any circumstances.

First, in assessing whether the settlement of the forward contract is indexed solely to the company’s own stock, companies should consider adjustments that change the number of shares to be delivered at settlement. If there are adjustments that are contingent upon variables that are not directly linked to the company’s stock, it may not qualify for the scope exception.

For example, one area of complexity we've seen relates to pricing adjustments that allow for the exclusion of partial trading days when computing the volume-weighted average price for settling the forward. These adjustments may be conditioned upon certain events that are specific to the operations of the investment bank. These provisions should be reviewed carefully to ensure that they wouldn’t preclude a company from asserting that the settlement is indexed solely to the company's own stock.

Secondly, in assessing whether the company has the unconditional ability to settle the forward in shares, we find that forward contracts typically provide the company with the option to choose whether it will settle the forward contract in either cash or shares. However, often times, there may be provisions that only allow for share settlement under certain circumstances; for example, only if the company is not aware of any material nonpublic information.

If the Company was unable to make this representation, then the accounting presumption would be that it would be unable to share settle the transaction and the contract would not be eligible for the derivative scope exception. In these cases, many companies have concluded that it would be within their control to disclose material nonpublic information, for example by filing a Form 8-k, prior to the time the representation is required. In such a case, the company would be able to share settle the forward contract, and therefore, meet the derivative scope exception.

Additionally, the accounting guidance presumes that cash settlement would occur in certain circumstances, for example, when settlement is not permitted in unregistered shares, or if the number of shares has no theoretical maximum or cap. Companies should keep these facts in mind when evaluating the accounting for the forward contract.

ASRs continue to be a popular mechanism for companies to buy back shares, however, the accounting, as we said, can be complex. For more information on ASRs, refer to our guide to accounting for Financing transactions on CFOdirect.com.

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Heather Horn
US Strategic Thought Leader, National Professional Services Group, PwC US
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David Schmid
IFRS & US Standard Setting Leader, National Professional Services Group, PwC US
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