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Project Updates
Financial Instruments with Characteristics of Equity (formerly Liabilities and Equity)—Joint Project of the FASB and IASB
Last Updated: March 15, 2010 (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:
- Converge U.S. and international standards
- Eliminate more than 60 pieces of current U.S. accounting literature that are inconsistent, subject to structuring, or difficult to understand and apply
- 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.
*DECISIONS REACHED AT THE LAST MEETING (March 11, 2010)
The Boards decided the following:
Accounting for Conversion or Settlement of Convertible Debt and Exercises of Options
Shares issued upon exercise of written call options should be reported at their fair values on the issuance date (current trading price if available). If the option has been classified as equity, the difference between the fair value of the shares and the carrying value of the option plus the cash received should be reported in the statement of stockholders' equity. If the instrument that is being exercised is classified as a liability, the difference between the fair value of the shares and the carrying value of the instrument should be reported in net income.
Shares issued upon conversion of convertible debt should be reported at their fair values on the issuance date (current trading price if available). If the convertible debt has been separated into liability and equity components, a gain or loss should be recognized equal to the difference between the carrying value of the liability component and the fair value of that component (which is equal to the fair value of a comparable freestanding instrument without an equity component). The remainder of the fair value of the shares issued (the total fair value of the shares less the fair value of the liability component) should be reported in equity.
Reassessment of Classification
An instrument should be reclassified if events occur or circumstances change so that the instrument no longer meets the conditions for its existing classification. The reclassification should take place as of the date of the event that changed the classification.
An entity should immediately remeasure a reclassified instrument according to the requirements for the new classification as if it were a newly issued instrument on the date of reclassification. If an instrument classified as equity is reclassified as a liability, the difference between the carrying value before the reclassification and the measurement after reclassification should be reported as an adjustment to equity. If an instrument classified as a liability is reclassified as equity, the difference between the carrying value before the reclassification and the measurement after reclassification should reported as a gain or loss in income. There is no limit on the amount of times an instrument may be reclassified.
If an instrument is required to be reclassified, the issuer should disclose a description of the instrument, the amount that was reclassified, and the reason for reclassification.
Economic Compulsion
Economic compulsion (as distinguished from expressed or implied contractual obligations) should not be considered in determining an instrument's classification.
Fair Value Option
An issuer may not avoid separation of an instrument with a liability and equity component by electing the fair value option for the instrument in its entirety.
Scope
The proposed requirements would apply to all financial instruments except:
- Interests in subsidiaries, associates, or joint ventures that are accounted for under other standards
- Employers' rights and obligations under employee benefit plans
- Insurance contracts accounted for under other standards
- Share-based payment awards accounted for under IFRS 2, Share-based Payment, and FASB Accounting Standards Codification™ Topic 718, Compensation—Stock Compensation.
The proposed standard would also apply to contracts to buy or sell a nonfinancial item that can be settled in net cash or another financial instrument or by exchanging financial instruments.
Transition
An entity would apply the proposed requirements to all instruments outstanding at the beginning of the first period presented in the financial statements for the period of adoption. Net income would be restated for all periods presented. If the proposed requirements result in an instrument being reclassified from a liability to equity, any measurement change upon reclassification should result in an adjustment to equity. If the proposed requirements result in an instrument being reclassified from equity to a liability, any measurement change upon reclassification should result in an adjustment to beginning retained earnings. The IASB decided the same transition requirements would apply to first-time adopters under IFRS 1, First-time Adoption of International Financial Reporting Standards.
Disclosures
An entity should disclose the nature and terms of instruments with settlement alternatives—liability or asset instruments. That disclosure should include:
- The identity of the entity that controls the settlement alternatives
- The amount that would be paid, or the number of shares that would be issued and their fair value, determined under the conditions specified in the contract if the settlement were to occur at the reporting date
- How changes in the fair value of the issuer's equity shares would affect those settlement amounts (for example, "the issuer is obligated to issue an additional X shares or pay an additional Y dollars in cash for each $1 decrease in the fair value of one share")
- The maximum amount that the issuer could be required to pay to redeem the instrument by physical settlement, if applicable
- The maximum number of shares that could be required to be issued, if applicable
- That a contract does not limit the amount that the issuer could be required to pay or the number of shares that the issuer could be required to issue, if applicable
- For a forward contract or an option indexed to the issuer's equity shares, all of the following:
- The forward price or option strike price
- The number of issuer's shares to which the contract is indexed
- The settlement date or dates of the contract, as applicable.
Comment Period
The comment period will be approximately 120 days.
The Boards directed the staff to begin drafting an Exposure Draft on reporting financial instruments with characteristics of equity for vote by written ballot.
*SUMMARY OF DECISIONS REACHED TO DATE (As of March 11, 2010)
Scope
The proposed requirements would apply to all financial instruments except:
- Interests in subsidiaries, associates, or joint ventures that are accounted for under other standards
- Employers' rights and obligations under employee benefit plans
- Insurance contracts accounted for under other standards
- Share-based payment awards accounted for under IFRS 2 and Topic 718.
The proposed standard would also apply to contracts to buy or sell a nonfinancial item that can be settled in net cash or another financial instrument or by exchanging financial instruments.
Classification
Equity InstrumentsThe following types of instruments should be equity in their entirety:
- Perpetual instruments (instruments not required to be redeemed unless the entity decides to or is forced to liquidate its assets and settle claims against the entity) issued by entities without specified limits to their lives. (That includes both ordinary and preferred shares.)
- A nominally perpetual instrument issued by an entity with a specified limit on its life or that must be liquidated at the option of an instrument holder. (That means an instrument that would otherwise be equity will not become a liability merely because it is issued by an entity that is not or may not be able to continue to exist indefinitely.)
- Mandatorily redeemable and puttable instruments that meet either of the following criteria:
- The instrument’s terms require, or permit the holder or issuer to require, redemption to allow an existing group of shareholders, partners, or other participants to maintain control of the entity when one of them chooses to withdraw.
- The holder must own the instrument in order to engage in transactions with the entity or otherwise participate in the activities of the entity, and the instrument’s terms require, or permit the holder or issuer to require, redemption when the holder ceases to engage in transactions or otherwise participate.
Contracts that require or may require an entity to issue a specified number of its own perpetual equity instruments in exchange for a specified price (for example, call options, forward contracts to issue shares, rights issues, and purchase warrants) should be classified as equity. For this purpose, the specified number must be either fixed or vary only so that the counterparty will receive a specified percentage of total shares that were outstanding on the issuance date for a specified price. The specified price must be fixed in the reporting entity’s currency unless the domestic currency of the shareholder that holds the derivative (or functional currency if the shareholder is a reporting entity or a unit of a reporting entity) is different from the currency in which the issuing entity issues equity instruments to domestic shareholders. In that case, the price may be specified in the currency of the shareholder instead of in the currency of the issuer.
- Instruments that require an entity to issue a specified number of its own perpetual equity instruments for no further compensation should be classified as equity (for example, prepaid forward contracts to issue shares).
- Preferred shares required to be converted into a specified number of common shares on a specified date or on the occurrence of an event that is certain to occur should be classified as equity.
- A contract that requires an entity to issue for a specified price (or for no future consideration) a specified number of puttable or mandatorily redeemable instruments that will be equity in their entirety when issued. Examples are a forward contract to issue mandatorily redeemable equity instruments and an identical forward contract that has been prepaid.
- A contract that requires the entity to issue for a specified price (or for no future consideration) a specified number of derivatives that will require the entity to issue a specified number of instruments that will be equity in their entirety when issued. Examples are a forward contract to issue a written call option on the entity’s own shares and an identical forward contract that has been prepaid.
- Preferred shares that are required to be converted into a specified number of perpetual equity instruments.
- Preferred shares that are required to be converted into a specified number of puttable or mandatorily redeemable instruments that will be equity in their entirety when issued.
Ability to Settle in Shares
The entity's ability to issue its own perpetual equity instruments to settle share-settled instruments classified as equity should be assessed at the date that each instrument is issued and at each reporting date thereafter. If, at any time, the entity does not have enough authorized shares to settle a share-settled instrument classified as equity, that instrument should be reclassified as a liability and left there for the remainder of its life.
Convertible Debt
A bond (or other debt instrument) should be separated into a liability component and an equity component if it is convertible at the option of the holder into a specified number of instruments that will be equity in their entirety when issued. All other convertible debt instruments should be classified as liabilities in their entirety.
Shares That Are Redeemable at the Option of the Holder
Puttable shares that are not classified as equity in their entirety should be separated into liability and equity components. The liability component, which represents a written put option, should be accounted for as a freestanding written put option.
Presentation of Freestanding Written Put Options and Forward Repurchase Contracts
A freestanding written put option should be presented net as a liability in its entirety.
Contracts that require an entity to repurchase its own shares on a specified date or on the occurrence of an event that is certain to occur should be separated into a liability representing the amount to be paid (measured according to standards for similar freestanding instruments) and an offsetting debit to equity (grossed up).
All Other Instruments
All instruments that are not classified as either equity in their entirety or separated into liability and equity components are classified as liabilities or assets.
Classification of Subsidiary Instruments in Consolidated Financial Statements
Equity classification in a subsidiary’s financial statements should carry forward into consolidated financial statements unless the nature of the instrument changes in consolidation because of arrangements between the instrument holder and another member of the consolidated group. If the nature of the instrument changes in consolidation, classification should be reconsidered in the consolidated financial statements.
Reassessment of Classification
An instrument should be reclassified if events occur or circumstances change so that the instrument no longer meets the conditions for its existing classification. The reclassification should take place as of the date of the event that changed the classification.
An entity should immediately remeasure a reclassified instrument according to the requirements for the new classification as if it were a newly issued instrument on the date of reclassification. If an instrument classified as equity is reclassified as a liability, the difference between the carrying value before the reclassification and the measurement after reclassification should be reported as an adjustment to equity. If an instrument classified as a liability is reclassified as equity, the difference between the carrying value before the reclassification and the measurement after reclassification should reported as a gain or loss in income. There is no limit on the amount of times an instrument may be reclassified.
If an instrument is required to be reclassified, the issuer should disclose a description of the instrument, the amount that was reclassified, and the reason for reclassification.
MeasurementTransaction 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
Freestanding liabilities and assets would be measured using principles developed in the Board’s project on accounting for financial instruments.
Accounting for Conversion or Settlement of Convertible Debt and Exercises of Options
Shares issued upon exercise of written call options should be reported at their fair values on the issuance date (current trading price if available). If the option has been classified as equity, the difference between the fair value of the shares and the carrying value of the option plus the cash received should be reported in the statement of stockholders' equity. If the instrument that is being exercised is classified as a liability, the difference between the fair value of the shares and the carrying value of the instrument should be reported in net income.
Shares issued upon conversion of convertible debt should be reported at their fair values on the issuance date (current trading price if available). If the convertible debt has been separated into liability and equity components, a gain or loss should be recognized equal to the difference between the carrying value of the liability component and the fair value of that component (which is equal to the fair value of a comparable freestanding instrument without an equity component). The remainder of the fair value of the shares issued (the total fair value of the shares less the fair value of the liability component) should be reported in equity.
Economic Compulsion
Economic compulsion (as distinguished from expressed or implied contractual obligations) should not be considered in determining an instrument's classification.
Fair Value Option
An issuer may not avoid separation of an instrument with a liability and equity component by electing the fair value option for the instrument in its entirety.
Transition
An entity would apply the proposed requirements to all instruments outstanding at the beginning of the first period presented in the financial statements for the period of adoption. Net income would be restated for all periods presented. If the proposed requirements result in an instrument being reclassified from a liability to equity, any measurement change upon reclassification should result in an adjustment to equity. If the proposed requirements result in an instrument being reclassified from equity to a liability, any measurement change upon reclassification should result in an adjustment to beginning retained earnings. The IASB decided the same transition requirements would apply to first-time adopters under IFRS 1.
Disclosures
An entity should disclose the nature and terms of instruments with settlement alternatives—liability or asset instruments. That disclosure should include:
- The identity of the entity that controls the settlement alternatives
- The amount that would be paid, or the number of shares that would be issued and their fair value, determined under the conditions specified in the contract if the settlement were to occur at the reporting date
- How changes in the fair value of the issuer's equity shares would affect those settlement amounts (for example, "the issuer is obligated to issue an additional X shares or pay an additional Y dollars in cash for each $1 decrease in the fair value of one share")
- The maximum amount that the issuer could be required to pay to redeem the instrument by physical settlement, if applicable
- The maximum number of shares that could be required to be issued, if applicable
- That a contract does not limit the amount that the issuer could be required to pay or the number of shares that the issuer could be required to issue, if applicable
- For a forward contract or an option indexed to the issuer's equity shares, all of the following:
- The forward price or option strike price
- The number of issuer's shares to which the contract is indexed
- The settlement date or dates of the contract, as applicable.
In addition, a public company should present a statement of capitalization at fair value. The statement would show the beginning balance plus issuances less repurchases or expirations plus (or minus) changes in fair values of equity instruments and long-term debt instruments.
Comment Period
The comment period will be approximately 120 days.
*NEXT STEPS
The Boards directed the staff to begin drafting an Exposure Draft on reporting financial instruments with characteristics of equity for vote by written ballot.
*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:
- August 1990—FASB Discussion Memorandum, Distinguishing between Liability and Equity Instruments and Accounting for Instruments with Characteristics of Both (1990 Discussion Memorandum)
- October 2000—FASB Exposure Draft, Accounting for Financial Instruments with Characteristics of Liabilities, Equity, or Both (2000 Exposure Draft)
Comment Letters Received
- 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
- May 2003—FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity
FAS 150
- 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
- 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
- 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
- November 2003—FSP FAS 150-4, Issuers' Accounting for Employee Stock Ownership Plans under FASB Statement No. 150.
FSP FAS 150-4
- 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:
- Mandatorily redeemable financial instruments of certain nonpublic entities
- 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