Convertible instruments and contracts in an entity’s own equity

Aug 09, 2020
Aug 09, 2020
0 min. read
Audit Debt & equity Financial reporting

The Financial Accounting Standards Board (FASB) recently issued Accounting Standards Update (ASU) 2020-06 to address the complexity of its guidance for certain financial instruments with characteristics of liabilities and equity. Changes in this ASU include the following, among others:

  • Removing the accounting models that require beneficial conversion features or cash conversion features associated with convertible instruments to be recognized as a separate component of equity. Convertible instruments that continue to be subject to separation models are (a) those with embedded conversion features that are not clearly and closely related to the host contract, meet the definition of a derivative and do not qualify for a scope exception from derivative accounting and (b) convertible debt instruments issued with substantial premiums for which the premiums are recorded as paid-in capital. 
  • Adding certain disclosure requirements for convertible instruments.
  • Amending the guidance for the derivatives scope exception for contracts in an entity’s own equity. Contracts primarily affected by this amendment are freestanding instruments, such as warrants, and embedded features that are accounted for as derivatives under the extant guidance because of failure to meet the settlement conditions of the derivatives scope exception related to certain requirements of the settlement assessment. The FASB simplified the settlement assessment by removing the requirements to (a) consider whether the contract would be settled in registered shares, (b) consider whether collateral is required to be posted, and (c) assess shareholder rights.
  • Simplifying the diluted earnings per share calculation for certain situations.

The ASU, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, is effective for public business entities that meet the definition of an SEC filer, excluding entities eligible to be smaller reporting companies as defined by the SEC, for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. For all other entities, the ASU will be effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. An entity should adopt the guidance as of the beginning of its annual fiscal year.