United States

Accounting for modifications of call options, including warrants

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The Financial Accounting Standards Board (FASB) recently issued Accounting Standards Update (ASU) 2021-04, which provides guidance, including the following, to clarify an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (e.g., warrants) that remain equity classified after modification or exchange and are not within the scope of another Topic of the FASB’s Accounting Standards Codification (ASC):

  • An entity should treat such a transaction as an exchange of the original instrument for a new instrument.
  • An entity should measure the effect of such a transaction as follows:
    • For a modification or an exchange that is a part of or directly related to a modification or an exchange of an existing debt instrument or line-of-credit or revolving-debt arrangement, as the difference between the fair value of the modified or exchanged written call option and the fair value of that written call option immediately before it is modified or exchanged.
    • For all other modifications or exchanges, as the excess, if any, of the fair value of the modified or exchanged written call option over the fair value of that written call option immediately before it is modified or exchanged.
  • An entity should recognize the effect of such a transaction on the basis of the substance of the transaction, in the same manner as if cash had been paid as consideration, as follows:
    • For a financing transaction to raise equity, the effect should be recognized as an equity-issuance cost in accordance with ASC 340, “Other Assets and Deferred Costs.”
    • For a financing transaction to raise or modify debt, the effect should be recognized as a cost in accordance with ASC 470, “Debt,” and ASC 835, “Interest.”
    • For other modifications or exchanges that are not related to financings or compensation for goods or services or other exchange transactions within the scope of another ASC Topic, the effect should be recognized as a dividend. That dividend should be an adjustment to net income (or net loss) in the basic earnings-per-share calculation for entities that present earnings per share in accordance with ASC 260, “Earnings Per Share.”
  • An entity should recognize the effect of a modification or an exchange of a freestanding equity-classified written call option to compensate for goods or services in accordance with the guidance in ASC 718, “Compensation – Stock Compensation.”
  • In a multiple-element transaction (e.g., one that includes both debt financing and equity financing), the total effect of the modification should be allocated to the respective elements in the transaction.

The ASU is effective for all entities for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. An entity should apply the amendments prospectively to modifications or exchanges occurring on or after the effective date of the amendments. Early adoption is permitted.

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