Accounting for debt and equity instruments in financing transactions
May 2017 (Updated July 2019)
We are in the process of updating this guide for 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. 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. For additional information about these and other amendments in ASU 2020-06, refer to our white paper, Accounting simplifications for convertible instruments and warrants.
The accounting for debt and equity instruments issued in financing transactions can be quite complicated due in part to the complexity inherent in certain instruments, the sheer volume of transaction documents that may need to be considered in performing the accounting analysis, and the myriad of accounting guidance that may be relevant. In many cases, an accounting outcome can be significantly affected by the existence or absence of one sentence in the relevant documents. Consideration needs to be given to not only the appropriate balance sheet classification of instruments, such as preferred stock and warrants, which may have both debt and equity characteristics, but also the subsequent measurement. Additionally, instruments such as debt and preferred stock oftentimes have embedded features that may need to be given separate accounting recognition. The accounting analysis is further complicated if multiple instruments are issued as part of the same transaction as that typically necessitates an allocation of proceeds to the various instruments or features.
Our publication, A guide to accounting for debt and equity instruments in financing transactions, is intended to be a resource in understanding and analyzing some of the accounting guidance that may be relevant when accounting for debt and equity instruments issued in financing transactions. While oftentimes the accounting for these instruments is not considered until after the transactions are finalized, the appropriate upfront consideration of the accounting ramifications can help to minimize the risk of unanticipated and undesirable accounting consequences. To assist in understanding the accounting guidance and ramifications, the guide includes the following four chapters:
- Accounting for the issuance of multiple instruments or embedded features
- Accounting for debt with conversion and other embedded features
- Accounting for preferred and similar stock
- Accounting for warrants and other equity-linked instruments
Each chapter discusses the accounting guidance and provides examples illustrating how this guidance should be applied to debt and equity instruments with various terms.