FASB Embedded Derivatives Exercised or Expired Prior to Initial Application

FASB: Embedded Derivatives Exercised or Expired Prior to Initial Application

Derivatives Implementation Group

Statement 133 Implementation Issue No. J1

Title: Transition Provisions: Embedded Derivatives Exercised or Expired Prior to Initial Application
Paragraph references: 50, 518-522
Date cleared by Board: February 17, 1999
(Revised August 2, 1999 for the issuance of Statement 137)

QUESTION

An entity issued, acquired, or substantively modified a hybrid instrument on or after the entity's selected transition date for embedded derivatives (that is, January 1, 1998 or January 1, 1999) that contained an embedded derivative that warranted separate accounting (such as the conversion option in convertible debt). However, that embedded derivative expired or was exercised prior to the date that the entity initially applied Statement 133 (for example, prior to January 1, 2001). Must that entity include in its transition adjustment the results of separate accounting for both the host contract and the embedded derivative from the date of the hybrid instrument's issuance, acquisition, or modification?

RESPONSE

The application of Statement 133 to a hybrid instrument issued, acquired, or substantively modified on or after the entity's selected transition date for embedded derivatives (that is, January 1, 1998 or January 1, 1999) that contains an embedded derivative depends on whether, at the date of initial application, the entity continues to hold or report any component of the hybrid instrument (either the host contract or both the host contract and the embedded derivative).

If the entity no longer holds or reports any component of the hybrid instrument at the date of initial application (such as when the conversion option in convertible debt has been exercised and the debt security has been surrendered in conjunction with that exercise), the entity should not include in its transition adjustment the results of separate accounting for either the host contract or the embedded derivative from the date of the hybrid instrument's issuance, acquisition, or modification.

In contrast, if the entity continues to hold or report any component of the hybrid instrument at the date of initial application (such as when an embedded conversion option has expired unexercised but the host debt security is still held as an investment), the entity should include in its transition adjustment the results of separate accounting for both the host contract and the embedded derivative from the date of the hybrid instrument's issuance, acquisition, or modification.

The above response also applies to a hybrid instrument issued, acquired, or substantively modified prior to the entity's selected transition date for embedded derivatives (that is, January 1, 1998 or January 1, 1999) if the entity has not elected the optional scope exclusion described in paragraph 50. (A hybrid instrument issued, acquired, or substantively modified on or after the entity's selected transition date for embedded derivatives (that is, January 1, 1998 or January 1, 1999) is not eligible for the optional scope exclusion described in paragraph 50.)

The above response has been authored by the FASB staff and represents the staff's views, although the Board has discussed the above response at a public meeting and chosen not to object to dissemination of that response. Official positions of the FASB are determined only after extensive due process and deliberation.