Project Updates

Financial Instruments with Characteristics of Equity (formerly Liabilities and Equity)—Joint Project of the FASB and IASB

Last Updated: June 26, 2009 (Updated sections are indicated with an asterisk *)

This project update summarizes the project activities and decisions of the FASB and IASB (the Boards). It was prepared by the staff and is for the information and convenience of the Boards’ constituents. All decisions of the Boards are tentative, may change at future Board meetings, and do not change current accounting and reporting requirements. Decisions of the Boards become final only after extensive due process.

Project Objective
Due Process Documents
Decisions Reached at the Last Meeting
Summary of Decisions Reached to Date
Next Steps
*Board/Other Public Meeting Dates
Related FASB Articles
Background Information
Contact Information

PROJECT OBJECTIVE

The objective of this joint FASB/IASB project is to improve and simplify the financial reporting requirements for financial instruments with characteristics of equity. Specifically, this project is intended to:

  1. Converge U.S. and international standards
     
  2. Eliminate more than 60 pieces of current U.S. accounting literature that are inconsistent, subject to structuring, or difficult to understand and apply
     
  3. Provide investors with more decision useful information.

DUE PROCESS DOCUMENTS

On November 30, 2007, the FASB issued its Preliminary Views, Financial Instruments with Characteristics of Equity. The comment period ended on May 30, 2008.

Preliminary Views

Comment Letters

Comment Letter Summary

DECISIONS REACHED AT THE LAST MEETING (June 10, 2009)

The Board discussed measurement requirements for freestanding equity, liability, and asset instruments and equity hybrids instruments (instruments that are separated into an equity component and a liability or asset component).

The Board made the following decisions:

    Transaction Costs

    1. An entity should expense as incurred all transaction costs or fees arising from the issuance of a financial instrument.

    Initial Measurement of a Freestanding Equity Instrument

    1. An entity should initially measure a freestanding equity instrument at its transaction price.   The term transaction price does not include transaction costs or fees.

    Initial Measurement of the Components of a Separated Equity Hybrid Instrument

    1. An entity should initially measure components of a separated equity hybrid instrument as follows.   The liability or asset component should be measured at fair value as if it were a freestanding liability or asset.   The remainder of the transaction price for the hybrid instrument as a whole should be allocated to the equity component.

    Subsequent Measurement of a Freestanding Equity Instrument and an Equity Hybrid Instrument

    1. An entity should not remeasure a freestanding equity instrument or equity component of a hybrid instrument that it cannot be required to redeem.

    2. At each reporting date, an entity would remeasure at current redemption value an equity instrument or a separated equity component of a hybrid instrument that has a redemption requirement.   The current redemption value is the amount that would have resulted from applying the redemption formula as if redemption were required at the measurement date.   Changes in current redemption value would be recorded as a transfer between retained earnings and the redeemable equity instrument or component.  

    3. An entity should remeasure the liability or asset component of a separated hybrid instrument on the basis of the requirements of U.S. generally accepted accounting principles (GAAP) that would apply if it were a freestanding instrument.

    Measurement of Freestanding Liabilities and Assets

    1. An entity should present a physically settled forward contract on a net basis in the statement of financial position and remeasure that instrument at fair value as of the subsequent reporting date.   Changes in value would be reported in income.

    2. An entity should report convertible debt as a liability in its entirety and subsequently measure that liability at fair value at each reporting date.   Changes in value should be reported in income.

    3. All other freestanding liability and asset instruments should be remeasured as required by existing U.S. GAAP.   For example, all derivatives would be subject to the measurement requirements in FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities.

The Board also discussed and expressed general support for the following broad measurement requirements for liability and asset instruments.   The requirements are intended to be consistent with existing measurement requirements.

  1. A freestanding instrument should be initially measured at fair value, unless another initial measurement basis is specified in other U.S. GAAP.

  2. An instrument with a fixed maturity date and a settlement amount that is fixed or that changes only because of variable interest rates should be reported at an accreted (or amortized) cost amount.

  3. An instrument that has a varying or uncertain settlement amount should be remeasured at fair value at each reporting date.

The Board’s measurement decisions for freestanding liabilities and assets are subject to change as a result of future deliberations in the financial instruments recognition and measurement project.

SUMMARY OF DECISIONS REACHED TO DATE (As of June 10, 2009)

Classification

The Board discussed and expressed support for a set of draft principles that could be used to distinguish between equity and liabilities and a related set of decision rules to operationalize those principles.

The decision rules are as follows:

  1. An entity must classify as equity retained earnings and capital contributed without the contributor receiving a claim against the entity in exchange, even if that entity has issued no equity instruments.

  2. An issuer must classify an instrument as a liability if the instrument has a fixed settlement date or must be settled on the occurrence of an event that is certain to occur, excluding those instruments described in items 3(a) and 3(b) below.

  3. An issuer must classify the following other instruments as equity:

    1. Instruments that the issuer cannot be required to settle before winding up its operations and distributing all of its assets (regardless of the amount of the claim).

    2. Instruments that the holder is required to own to do business with or otherwise actively engage in activities of the issuer and that are redeemable only if the holder dies, retires, resigns, or otherwise ceases to actively engage in the activities of the issuer. (This includes holdings, the amounts of which vary based on the volume of business transacted by the holder.)

  4. An instrument should be separated into liability and equity components if the instrument has two separate or alternative outcomes, one of which would require equity classification if it were the only outcome and one of which would require liability classification if it were the only outcome.

An example of an instrument with separate outcomes is a share with a required dividend. The issuer must pay cash if particular events occur (liability outcome) but the perpetual instrument remains outstanding (equity outcome).

The following are examples of instruments with alternative outcomes that would require separation:

  1. An ownership instrument that is required to be settled upon specified events that are not certain to occur

  2. An ownership instrument that gives the holder the option to require the issuer to settle the instrument.

The instruments described above consist of both a derivative (a written put option or a forward purchase contract) and a perpetual instrument and have two alternative outcomes. The instrument could remain outstanding in perpetuity (equity outcome) or the issuer could be required to settle it (liability outcome). The issuer could be required to settle the instrument if the holder so chooses or an uncertain event triggers the settlement. However, only one of those outcomes will occur. The form of settlement, for example, cash or shares, does not matter for classification purposes.

All derivatives on an issuer's own equity instruments should be classified as liabilities or assets. At a future meeting, the Boards will discuss whether derivative instruments within the scope of FASB Statement No. 123 (revised 2004), Share-Based Payment, and IFRS 2, Share-based Payment, are within the scope of this project.

NEXT STEPS

The Boards will continue to develop a classification model. Specifically, the Boards will consider (1) presentation issues, (2) whether, and, if so, when, an entity is required to reassess an instrument’s classification, and (3) whether instruments that are classified as equity in the financial statements of a subsidiary should maintain that classification in the consolidated financial statements.

*BOARD/OTHER PUBLIC MEETING DATES

RELATED FASB ARTICLES

Article from The FASB Report—"Deferred Effective Date for Certain Provisions of Liabilities and Equity Project"
(February 2004)

Issue Highlights from Status Report—"FASB Addresses Issues Related to the Classification of Compound Financial Instruments That Have Characteristics of Liabilities and Equity"
(March 30, 2001)

BACKGROUND INFORMATION

The FASB added a broad financial instruments project to its agenda in 1986. This project, which was formerly referred to as the liabilities and equity project, was one part of that broader initiative. The dates and titles of key documents issued as part of the liabilities and equity project are as follows:

  1. August 1990—FASB Discussion Memorandum, Distinguishing between Liability and Equity Instruments and Accounting for Instruments with Characteristics of Both (1990 Discussion Memorandum)
     
  2. October 2000—FASB Exposure Draft, Accounting for Financial Instruments with Characteristics of Liabilities, Equity, or Both (2000 Exposure Draft)
    Comment Letters Received
     
  3. October 2000—FASB Exposure Draft, Proposed Amendments to FASB Concepts Statement No. 6 to Revise the Definition of Liabilities (Concepts Exposure Draft)
    Comment Letters Received
     
  4. May 2003—FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity
    FAS 150
     
  5. October 2003—FSP FAS 150-1, Issuer's Accounting for Freestanding Financial Instruments Composed of More Than One Option or Forward Contract Embodying Obligations under FASB Statement No. 150
    FSP FAS 150-1
     
  6. October 2003—FSP FAS 150-2, Accounting for Mandatorily Redeemable Shares Requiring Redemption by Payment of an Amount That Differs from the Book Value of Those Shares, under FASB Statement No. 150
    FSP FAS 150-2
     
  7. November 2003—FSP FAS 150-3, Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement No. 150
    FSP FAS 150-3
     
  8. November 2003—FSP FAS 150-4, Issuers' Accounting for Employee Stock Ownership Plans under FASB Statement No. 150.
    FSP FAS 150-4 
     
  9. June 2005—FSP FAS 150-5, Issuer's Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares That Are Redeemable.
    FSP FAS 150-5

After issuing the 1990 Discussion Memorandum and holding public hearings in 1991, the FASB decided to suspend work on the liabilities and equity project to devote its resources to financial instruments projects that it judged to be more urgent at the time. The project was reactivated in December 1996. That effort led to an Exposure Draft in October 2000.

The 2000 Exposure Draft addressed a broad range of liability and equity classification issues. During 2001 and 2002, the FASB met with various constituents, held a public roundtable meeting, and redeliberated the issues. At the end of 2002, the FASB had affirmed its conclusions in the 2000 Exposure Draft that the following types of instruments should be classified as liabilities: mandatorily redeemable instruments, instruments that obligate the issuer to repurchase its own equity instruments for cash or other assets, and certain instruments that the issuer must or can settle by issuing a variable number of its own equity shares.

Although the FASB had not finished its deliberations on all issues addressed in the 2000 Exposure Draft, it decided to issue a limited-scope Statement to provide necessary and timely guidance for certain troublesome instruments for which the practice problems were clear and resolvable. The FASB issued Statement 150 to require classification as liabilities (or assets in some circumstances) for the specific types of instruments about which it had affirmed its conclusions. In that Statement, the FASB stated that it planned to continue redeliberating the remaining issues and issue another Statement at a future date. Changes proposed in the Concepts Exposure Draft were delayed because the FASB believed that resolution of the remaining issues in the 2000 Exposure Draft could affect any modification to the definition of a liability.

Shortly after the issuance of Statement 150, constituents raised questions about certain types of mandatorily redeemable instruments. To give itself time to resolve those issues, the FASB directed the FASB staff to issue FSP FAS 150-3 to defer the effective date for applying the provisions of Statement 150 for:

  1. Mandatorily redeemable financial instruments of certain nonpublic entities
     
  2. Certain mandatorily redeemable noncontrolling interests.

View a table of revised Statement 150 effective dates as a result of that deferral

Although the FASB had stated in Statement 150 that its next step would be to redeliberate the remaining issues discussed in the 2000 Exposure Draft and not resolved by that Statement, the FASB changed its plan. The new plan was to start over and attempt to develop a convergent set of classification principles that would avoid the issues raised by Statement 150, as well as resolve the remaining issues.

In 2004, the FASB and IASB added a joint project to their agendas to develop an improved, common conceptual framework. The decisions made in this project will be considered in conjunction with the proposed amendments that will be considered within the conceptual framework project.

CONTACT INFORMATION

Jill Switter
Project Manager
jmswitter@fasb.org


Additional Details