New FASB Standard Impacts Certain Financial Instrumentsby
The Financial Accounting Standards Board (FASB) issued new guidance on July 13 that simplifies the accounting for certain financial instruments with down round features.
The new standard is based on recommendations from the Private Company Council.
Accounting Standards Update (ASU) 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), and Derivatives and Hedging (Topic 815), includes two sections – Part I: Accounting for Certain Financial Instruments with Down Round Features, and Part II: Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception.
Down round features are a provision in an equity-linked financial statement or embedded feature that provides a downward adjustment of the current exercise price based on the price of future equity offerings.
Down round features are common in warrants, convertible preferred shares, and convertible debt instruments issued by private companies and development-stage public companies.
The FASB heard concerns expressed by stakeholders that current accounting guidance created unnecessary cost and complexity for organizations that issue financial instruments with down round features by requiring, on an ongoing basis, fair value measurement of the entire instrument or conversion option. That created unnecessary income statement volatility connected to changes in the value of a company’s share price, they said.
Stakeholders also contend that the current guidance doesn’t reflect the economics of the down round feature that exists to protect certain investors from declines in the issuer’s share price in some situations.
Part I of the ASU addresses those concerns by requiring companies to disregard the down round feature when assessing whether the instrument is indexed to its own stock, for purposes of determining liability or equity classification.
Companies that provide earnings-per-share data will adjust their basic calculation for the effect of the feature when triggered (when the exercise price of the related equity-linked financial instrument is adjusted downward because of the down round feature) and also will recognize the effect of the trigger within equity.
Part II of the ASU addresses navigational concerns within the FASB Accounting Standards Codification (ASC) related to an indefinite deferral available to private companies with mandatorily redeemable financial instruments and certain noncontrolling interest, which created significant “pending content” in the ASC. As a result, the FASB reclassified the indefinite deferral as a scope exception, which does not have an accounting effect.
The provisions in the new standard related to down rounds take effect for public business entities for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2018. For all other organizations, the amendments take effect for fiscal years beginning after Dec. 15, 2019, and interim periods within fiscal years beginning after Dec. 15, 2020. Early adoption is allowed for all organizations.
Terry Sheridan is an award-winning journalist who has covered real estate, mortgage finance, health care, insurance, personal finance, and accounting and taxation issues for newspapers, magazines, and websites. A Chicago native and former South Florida resident, she now lives in New England.