Temporary Equity Rules - Accounting Standard Update 2009-04
(I think this first paragraph is unreadable with all of the new acronyms we have to learn with the new codification. When are the new acronyms going to look familiar?)
ASU 2009-04- Accounting for Redeemable Equity Instruments (ASU 2009-04) is an amendment to Section 480-10-S99 – Distinguishing Liabilities from Equity (FASC 480) and codifies recent SEC guidance. This interpretation was issued to provide guidance in the application of SEC Accounting Series Release No. 268 – Presentation in Financial Statements of “Redeemable Preferred Stocks” (ASR268) and clarifies that ASR 268 pertains to preferred stocks and other redeemable securities including common stock, derivative instruments, non-controlling interest, securities held by an employee stock ownership plan (ESOP) and share-based payment arrangements with employees.
1. When must a redeemable equity instrument be classified in temporary equity?
A redeemable equity security that is redeemable for cash or other asset is to be classified in temporary equity if they are redeemable 1) at a fixed or determinable price on a fixed or determinable date, 2) at the option of the holder or 3) upon the occurrence of an event that is not solely within the control of the issuer.
Freestanding financial instruments that are classified as assets or liabilities per FASC 480-10, freestanding derivative instruments that are classified in stockholders’ equity pursuant to FASC 815-40, and the equity portion of convertible debt instruments that are not currently redeemable are not subject to ASR 268 or ASU 2009-04.
Certain clauses within equity instruments do not presume the classification of the equity instrument as temporary equity. Other factors need to be considered. These clauses would include:
1.Registration payment arrangements
2.Equity-classified share-based payment arrangements with employees that
1)net cash settlement is assumed under the guidance of FASC 815-40-25-11 due to an obligation to deliver registered shares or
2)have a provision to use the shares to satisfy payroll tax requirements
3.Ordinary liquidation clauses
4.“Death or disability of holder” clause that is funded by an insurance policy.
Certain provisions need to be carefully evaluated to determine whether or not the provisions are solely within the control of the issuer. These provisions include 1) the failure to have a registration statement declared effective by the SEC; 2) the failure to maintain compliance with debt covenants; 3) the failure to achieve specified earnings targets; 4) a reduction in the issuer’s credit rating; or 5) any provision that requires the approval of the board of directors.
The SEC staff states in this updated guidance, that all facts and circumstances need to be considered when determining if an equity instrument should be classified as temporary equity.
2. How are the redeemable equity instruments in temporary equity to be measured; initially and subsequently?Initial Measurement
Redeemable equity instruments that are required to be presented in temporary equity should initially be measured at its issuance date fair value. The fair value of the instrument will normally be its transaction price.
The following transactions are not initially recorded at fair value:
1. Share –based payment arrangements with employees:
The initial amount presented in temporary equity should be based on the conditions that the employee can put the security back to the company and the proportion of consideration received in the form of employees’ services at initial recognition.
2. Employee stock ownership plans:
An accounting policy election may be made to present in temporary equity either the guaranteed market value of the securities or the maximum cash obligation based on the fair value of the underlying securities.
3. Noncontrolling interests:
The portion of the equity-classified component that is presented in temporary equity (if any) is measured as the excess of the amount of cash or other assets that would be required to be paid to the holder over the carrying amount of the liability-classified component of the convertible debt instrument.
4. Host equity contracts:
The initial amount presented in temporary equity should be the initial carrying amount of the host contract pursuant to FASC 815-15-30.
5. Preferred Stock with a beneficial conversion feature:
The initial amount presented in temporary equity should be the amount allocated to the instrument in its entirety pursuant to FASC 470-20 less any beneficial conversion feature recorded at the issuance date.
Equity instruments that are currently redeemable should be adjusted each reporting period to the maximum redemption amount. If the maximum redemption amount is based on a future amount (such as EBITDA) then the value of that factor at the current balance sheet date should be used to determine the maximum redemption amount. The amount presented in temporary equity should never be less than the initial value at issuance.
If an equity instrument is not currently redeemable and is not probable of the instrument will become redeemable, then the amount in temporary equity should not be adjusted.
If a currently non-redeemable equity instrument is probable of becoming redeemable, then either of the following two methods can be used to subsequently measure the value of the equity instrument.
1. Accrete changes in the redemption value over the period from the date of issuance to the earliest redemption date using an appropriate methodology, usually the interest method.
2. Recognize changes in the redemption value immediately as they occur and adjust the carrying amount of the instrument to equal the redemption value at the end of each reporting period.
3. What adjustments to earnings per share (EPS) are to be made due to the subsequent measurement of the redeemable equity instrument?
1. Preferred stock instruments issued by a parent (or single reporting entity)
Increases or decreases in the carrying amount of the redeemable equity instrument should reduce or increase income available to common stockholders in the calculation of EPS.
2. Common stock instruments issued by a parent (or single reporting entity)
Increases or decreases in the carrying amount of the redeemable equity instrument should not reduce or increase income available to commons stockholders in the calculation of EPS.
3. Noncontrolling interest in the form of preferred stock instruments
If the parent has guaranteed the redemption feature, the all of the increase or decrease in the carrying amount should reduce or increase not income available to common stockholders. If the parent has not guaranteed the redemption feature, then the changes are attributed to the parent and the Noncontrolling interest.
4. Noncontrolling interest in the form of common stock instruments
Adjustments to the carrying amount caused by a fair value redemption feature do not impact EPS, while adjustments cause by an other than fair value redemption feature depends on the terms of the equity instrument.
5. Convertible debt instruments that contain a separately classified equity component
Increases or decreases in the carrying amount of the separately classified equity instrument should not reduce or increase income available to commons stockholders in the calculation of EPS.
Reclassification to permanent equity
If an equity instrument is not longer required to be presented in temporary equity, then the current carrying amount is moved to permanent equity. Prior financial statements are not to be adjusted.
1. A description of the accounting method used to adjust the redemption amount should be disclosed.
2. When accreting the redemption amount, the redemption amount of the equity instrument as if it were currently redeemable should be disclosed.
3. If an equity instrument is not probable of redemption, the reason why it is not probable should be disclosed.
4. If charges or credits to income available to common stockholders are material, a reconciliation between net income and income available to common stockholders should be disclosed.
5. The amount credited to equity of the parent upon the deconsolidation of a subsidiary should be disclosed.
Linda is a CPA living in Southwestern Ohio, working as a research accountant for an investor-owned publicly traded utility company. She specializes in implementing new FASB and SEC requirements and FAS 133 derivative issues. In her role at the utility she has encountered many issues and written many memos, so send in your implementation and derivative issues and Linda will help figure out an answer.