United States

FASB Liabilities and Equity: Targeted Improvement project developments


On September 16, 2015, the Financial Accounting Standards Board (FASB) made some significant tentative decisions related to its Liabilities and Equity – Targeted Improvements project. Specifically, the Board addressed the accounting for equity-linked financial instruments containing “down round” features.

A down round is a provision in an equity-linked instrument, such as a warrant or a convertible instrument, which provides for a downward adjustment of the exercise price specified in the contract in certain circumstances (usually the subsequent issuance of the underlying stock at a price that is below the specified exercise price). FASB Accounting Standards Codification (ASC) 815-40, Derivatives and Hedging — Contracts in Entity’s Own Equity, provides guidance to determine whether an equity-linked financial instrument (or an embedded feature) is considered indexed to an entity’s own stock and accordingly qualifies for equity classification. Per FASB ASC 815-40-15-7C, an instrument (or embedded feature) is considered indexed to an entity’s own stock if its settlement amount will equal the difference between (a) the fair value of a fixed number of the entity’s equity shares and (b) a fixed monetary amount or a fixed amount of a debt instrument issued by the entity. An instrument’s strike price or the number of shares used to calculate the settlement are not fixed if its terms provide for any potential adjustments, regardless of the probability of such adjustments or whether such adjustments are in the entity’s control, unless the only variables that could affect the settlement amount are inputs to the fair value of a fixed-for-fixed forward or option on equity shares. Under current guidance in ASC 815-40, a down round feature generally results in liability classification of the financial instrument, requiring fair value measurement with subsequent changes in fair value reflected in the income statement.

At its September 16 meeting, the Board tentatively decided that in classifying financial instruments with down round features, an entity would exclude the down round feature from the assessment of whether the instrument is indexed to an entity’s own stock, but would be required to recognize the effect of the down round feature when it is triggered. For example, if a down round adjustment included in an equity classified award is triggered, recognition would be similar to the payment of a dividend. All down round provisions would be subject to this model, regardless of whether they meet the definition of a derivative. The tentative decision to exclude the down round feature from the assessment of whether an equity-linked financial instrument is considered indexed to an entity’s own stock likely will result in fewer equity-linked instruments requiring liability classification, particularly for private companies where inclusion of down round provisions in equity-linked instruments is more common.

The Board tentatively decided to require additional disclosures, including disclosure at the time a down round is triggered and disclosure of where the related effect of the down round adjustment is recorded in the financial statements. Also, the Board tentatively decided the proposed transition method of adoption would be the cumulative effect approach. The Board instructed its staff to draft the exposure document, which is expected to be released for comment sometime in the fourth quarter of 2015. Refer to Liabilities & Equity — Targeted Improvements for additional information on this project.