What management should know before issuing equity-linked instruments in financing transactions
October 2012 [Updated January 2016]
Both debt and equity financing arrangements commonly include various sweeteners such as warrants, forward contracts to sell or purchase shares and conversion options. These and other instruments that will result in the issuance of shares or cash payments related to the fair value of such shares often are referred to as equity-linked instruments. The accounting for these instruments can be quite complicated because there is a myriad of guidance that needs to be considered in arriving at the right conclusion. The analysis is further complicated by the sophistication of instruments that continue to evolve and by the careful consideration that needs to be given to the agreements for each instrument as well as shareholder rights and related agreements for the underlying shares.
It is common for an entity to issue some of these instruments and be unpleasantly surprised by unanticipated and undesirable 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. To preempt such unpleasant consequences, consult our white paper, What management should know before issuing equity-linked instruments in financing transactions. This white paper provides an overview of the relevant accounting guidance and 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.