Project Updates

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

Last Updated: October 30, 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 (October 26, 2009) 

The Boards decided to consider an approach that would classify as equity particular share-settled instruments. Under that approach, an issuer would classify as equity an instrument it must settle by issuing equity instruments unless the issuer is using the equity instruments as currency. Examples of circumstances in which the issuer is using its equity instruments as a form of currency are the following:
  1. Either party has a cash settlement option.
  2. The contract requires net settlement in shares or either party has a net settlement option.
  3. The contract exposes either party to risks of changes in value other than those resulting from share price changes, time value of money, counterparty performance risk, and possibly foreign currency (if the counterparty is a foreign owner before the transaction).

*SUMMARY OF DECISIONS REACHED TO DATE (As of October 26, 2009)

Classification

Cash-settled Claims

A claim required to be settled by paying cash or other assets is classified as equity if:

  1. Its claim status is lower than all liability claims; and
  2. It has redemption features.

Claim Status

Equity interests as a group are the claims against an entity with the lowest claim status. There may be more than one class of equity instruments, those classes may have different rights and obligations, and one may have a lower claim status than another. However, an equity instrument is never senior to a liability.

Redemption

Redemptions of equity instruments occur for the following reasons: 

  1. The entity issuing the instrument chooses to or is required by an event such as bankruptcy to distribute all its assets
  2. The issuer chooses to pay a dividend (partial redemption) or repurchase shares
  3. The terms of the instrument require, or permit the holder or issuer to require, retirement of that instrument to allow an existing group of shareholders, partners, or other participants to maintain control of the entity when one of them chooses to withdraw.
  4. The terms of the instrument require, or permit the holder or issuer to require, retirement of that instrument when the holder has ceased to engage in transactions with the entity or otherwise participate in the activities of the entity.

In contrast, a claim required to be settled by paying cash or other assets is classified as a liability if it has a settlement feature. Settlements of liabilities have both of the following characteristics:

  1. The payment date is fixed or determined by events or conditions other than those that determine redemption dates; and
  2. The issuer may be able to influence the timing of the event that triggers settlement but cannot prevent the event or condition from occurring.

Share-Settled Claims

A claim required to be settled by issuing equity instruments should be classified as equity unless the issuer is using the equity instruments as currency. Examples of circumstances in which the issuer is using its equity instruments as a form of currency are the following:

  1. Either party has a cash settlement option.
  2. The contract requires net settlement in shares or either party has a net settlement option.
  3. The contract exposes either party to risks of changes in value other than those resulting from share price changes, time value of money, counterparty performance risk, and possibly foreign currency (if the counterparty is a foreign owner before the transaction).

Equity-Liability Hybrid Instruments

Some instruments have both liability features and equity features (equity-liability hybrid instruments). There are two types of equity-liability hybrid instruments.

One type has both a settlement and a redemption (both occur). A perpetual share with a required dividend is an example of a hybrid instrument with two separate outcomes. Another common example is an ordinary share with a registration rights penalty. In both examples, the issuer must pay cash on a specified date or if specified events occur (liability feature) but the perpetual instrument remains outstanding until and unless the entity distributes all its assets (equity feature). In other words, the instrument has equity features and, at particular times, it also requires the issuer to transfer cash (settlement).

The other type has a settlement or a redemption, only one of which will occur:

  1. An otherwise perpetual instrument that gives the holder the option to require the issuer to settle the instrument (an embedded written put option)
  2. An otherwise perpetual instrument that is required to be settled upon a specified event or condition that is not certain to occur (an embedded forward purchase contract that does not apply unless triggered by an event or condition).

The Board’s approach would deal simply and directly with both types of equity-liability hybrid instruments by separating them into equity components and liability components.

Convertible Debt Instruments

A convertible debt instrument would be classified as a liability in its entirety. Under the Board’s approach any instrument with a cash settlement feature would be classified using the principles described for cash-settled claims.

Measurement

Transaction Costs

An entity should expense as incurred all transaction costs or fees arising from the issuance of equity or separated equity hybrid instruments.

Initial Measurement of a Freestanding Equity Instrument

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

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

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

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.

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. Those measurement requirements are subject to change based on future deliberations in the Board’s project on accounting for financial instruments.

Measurement of Freestanding Liabilities and Assets

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.

Freestanding liabilities and assets would be measured using principles developed in the Board’s project on accounting for financial instruments.

NEXT STEPS

The Boards will continue to develop a classification model. Specifically, the Boards will consider (1) balance-sheet presentation issues, (2) whether, and, if so, when, an entity is required to reassess an instrument’s classification, and (3) how the Board’s classification decisions will impact the earnings per share calculations.

*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

U.S. GAAP referenced in this section is currently included in (Topic 480) of the Accounting Standards Codification.

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