Accounting simplifications for convertible instruments and warrants
September 2020 (Updated February 2021)
The current guidance on financial instruments with conversion features is complex and difficult to apply, leading to confusion and errors in its application. In 2020, the Financial Accounting Standards Board (FASB) 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.
Our white paper, Accounting simplifications for convertible instruments and warrants, discusses the changes made by the FASB in ASU 2020-06, including those to simplify the guidance on the issuer’s accounting for convertible instruments and the guidance on the derivatives scope exception for contracts in an entity’s own equity. The changes to this guidance are explained in the context of the current U.S. generally accepted accounting principles, which makes clear why fewer conversion features will require separate recognition, and fewer freestanding instruments, like warrants, will require liability treatment. Our white paper also discusses changes made to the disclosure requirements for convertible instruments, improvements made to the earnings per share guidance applicable to the instruments affected by the simplifications and the effective date and transition guidance provided in ASU 2020-06.
While the ASU is not first effective for certain entities until fiscal years beginning after December 15, 2021 (including interim periods therein) and other entities until fiscal years beginning after December 15, 2023 (including interim periods therein), early adoption of the ASU as of the beginning of the year is permitted, but no earlier than fiscal years beginning after December 15, 2020 (including interim periods therein). Given the intent of the ASU to simplify the accounting for convertible instruments and warrants, entities should carefully consider early adoption of its provisions.