United States

Accounting for equity-linked instruments in financing transactions

FINANCIAL REPORTING INSIGHTS  | 

We have updated our white paper, What management should know before issuing equity-linked instruments in financing transactions, which provides an overview of the relevant accounting guidance applicable to instruments that will result in the issuance of shares or cash payments related to the fair value of such shares (i.e., equity-linked instruments). Examples of equity-linked instruments include warrants, conversion rights and forward contracts to sell or purchase shares. The updates to our white paper reflect:

  • Changes resulting from Accounting Standards Update 2014-16, Derivatives and Hedging: Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or Equity
  • Changes that may result from the Financial Accounting Standards Board’s project, Liabilities and Equity – Targeted Improvements, which include: (a) replacing the indefinite deferral of specific guidance applicable to certain mandatorily redeemable financial instruments issued by nonpublic entities with a scope exception and (b) excluding a down round feature from the assessment of whether an equity-linked instrument is indexed to an entity’s own stock and instead recognizing the effects of the down round feature when it is triggered
  • Additional discussion related to put features in a debt or equity instrument that enable the holder to accelerate repayment or call features in such an instrument that give the issuer the ability to repurchase the instrument

The accounting for equity-linked instruments can be quite complicated because there is a myriad of guidance that needs to be considered in arriving at the right conclusion. Completing the necessary accounting analysis for equity-linked instruments may, depending on the facts and circumstances, result in unanticipated accounting consequences, such as liability treatment for warrants, conversion features and certain preferred stock, with ongoing income statement volatility as the liability is continuously adjusted to fair or redemption value. Our white paper is intended to make management aware of potential issues when designing equity-linked instruments to ensure they are not surprised by the resulting accounting treatment. In addition to an overview of the relevant accounting guidance applicable to equity-linked instruments, our white paper also provides numerous examples and detailed flowcharts illustrating how to navigate the guidance applicable to: (a) convertible instruments and preferred stock and (b) warrants.