United States

Convertible instruments and contracts in an entity’s own equity

FINANCIAL REPORTING INSIGHTS  | 

The Financial Accounting Standards Board recently issued a proposed Accounting Standards Update (ASU) to address the complexity of its guidance for convertible instruments and the derivatives scope exception for contracts in a company’s own equity. If finalized, the proposed ASU would:

  • Reduce the number of accounting models for convertible debt instruments and convertible preferred stock. Specifically, the accounting models in ASC 470-20 that require substantial premiums, beneficial conversion features or cash conversion features associated with convertible instruments to be recognized as a separate component of equity would be removed. Only 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 would continue to be separately recognized (as a derivative).
  • Revise the guidance for the derivatives scope exception for conversion features and contracts in an entity’s own equity (e.g., warrants) to reduce form-over-substance-based accounting conclusions driven by remote contingent events. If the likelihood of occurrence is remote, potential adjustments to the settlement terms and contingent events that could require net cash settlement would no longer be considered in the accounting evaluation.   
  • Amend the related disclosure and earnings-per-share guidance.

The proposed 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 available for comment until October 14, 2019.