In 2020, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2020-06, 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, to address the complexity in accounting for certain financial instruments with characteristics of liabilities and equity. Amongst other provisions, the amendments in this ASU significantly change the guidance on the issuer’s accounting for convertible instruments and the guidance on the derivative scope exception for contracts in an entity’s own equity such that fewer conversion features will require separate recognition, and fewer freestanding instruments, like warrants, will require liability treatment.Refer to our white paper, Accounting simplifications for convertible instruments and warrants, for additional information.
While the ASU does not start coming into effect for any entities until fiscal years beginning after December 15, 2021 (including interim periods), early adoption is permitted, as early as fiscal years (including interim periods) beginning after December 15, 2020. (In other words, the guidance should be adopted as of the beginning of an entity’s fiscal year such that calendar-year-end SEC filers seeking to early adopt would need to do so with their first-quarter Form 10-Q). Certain entities can early adopt the amendments for convertible instruments that include a down round feature for fiscal years beginning after December 15, 2019. Given the intent of the ASU to simplify the accounting for convertible instruments and warrants, we expect entities may be interested in early adopting, but before doing so should carefully consider all of the ASU’s provisions. We recently updated our white paper to discuss uncertainty associated with the interaction of the revised guidance in Subtopic 815-40 with the SEC’s guidance on redeemable securities.