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Distinguishing Liabilities from Equity (Including Convertible Debt)
Last updated on July 31, 2019. Please refer to the Current Technical Plan for information about the expected release dates of exposure documents and final standards.
(Sections updated on the date above are indicated with an asterisk *)
Project Objective and Background
Objective:
The objective of this project is to improve understandability and reduce complexity (without loss of information for users) of the accounting for instruments with characteristics of liabilities and equity (including convertible debt).
Background:
The FASB’s history of distinguishing liabilities from equity dates back to 1986 when the FASB added to its technical agenda a broad project on financial instruments. Since then, the FASB issued various pieces of guidance to resolve various issues raised by stakeholders. Stakeholders observe that distinguishing liabilities from equity (including convertible debt) continues to be a major financial reporting issue that the Board should consider for improvement because current guidance is overly complex, internally inconsistent, path dependent, form based, and is a cause for frequent financial statement restatements.
On September 20, 2017, the Board decided to add to its agenda a project on distinguishing liabilities from equity (including convertible debt) with the objective of improving understandability and reducing complexity (without loss of information for users). The Board’s major decisions for convertible instruments and derivatives scope exception for contracts in an entity’s own equity are summarized below.
Convertible Instruments
At the June 6, 2018 Board meeting, the Board decided that convertible instruments with embedded conversion features would be accounted for as a single unit of account based on the model for traditional convertible debt or traditional convertible preferred shares. This means that convertible debt would be recognized in the balance sheet as a single liability, measured at amortized cost. There no longer would be bifurcation of the conversion feature and the debt host. Similarly, convertible preferred shares would be recognized in the balance sheet as a single equity element. Convertible instruments with embedded conversion features that meet the definition of a derivative and are ineligible for the derivative scope exception are outside the scope of the project (and the embedded conversion option will continue to be bifurcated and measured initially and subsequently at fair value).
Derivatives Scope Exception for Contracts in an Entity’s Own Equity
At the February 13, 2019 Board meeting, the Board decided to layer a qualitative screen on to the indexation and settlement criteria in Subtopic 815-40, Derivatives and Hedging—Contracts in an Entity’s Own Equity. This means that an entity would exclude potential settlement adjustments and provisions that could require net cash settlement that are remote in occurring in its evaluation of the indexation and settlement criteria. The Board also decided to remove certain of the additional conditions for equity classification.
Exposure Documents*
Exposure Draft:
On July 31, 2019, the Board issued a proposed Accounting Standards Update, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The due date for comment letters is October 14, 2019.
Download the proposed Accounting Standards Update, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.
Media Releases and Educational Materials*
Read the FASB in Focus, which summarizes the amendments in the proposed Update.
Read the news release on the August 2016 Invitation to Comment.
Board Decisions
Decisions Reached at Last Meeting (as of June 19, 2019):
The Board deliberated sweep issues and decided to:
Modify the scope of Section 815-40-50, Derivatives and Hedging—Contracts in Entity’s Own Equity—Disclosure, to apply only to freestanding instruments. Embedded features would not be subject to Section 815-40-50 requirements.
Retain the existing language related to the disclosure frequency for convertible instruments in Section 470-20-50, Debt—Debt with Conversion and Other Options—Disclosure.
Clarify that an entity should use the average share price when calculating the diluted earnings-per-share denominator for contracts if there is variability in the pricing or number of shares that would be issued.
Reverse its prior decision to make a technical correction to paragraph 470-20-25-2 that would have clarified that an entity should consider Topics 480, Distinguishing Liabilities from Equity, and 815, Derivatives and Hedging, for the classification of the detachable stock purchase warrant.
Clarify that the remote threshold in Section 815-40-25, Derivatives and Hedging—Contracts in Entity’s Own Equity—Recognition, applies to the likelihood of the occurrence of contingent events that could cause net cash settlement, not to the likelihood of net cash settlement.
Clarify that penalty payments, if the entity fails to make timely filings with the U.S. Securities and Exchange Commission, would not preclude equity classification under paragraph 815-40-25-10(d) because they would not result in settlement of a contract.
Analysis of Costs and Benefits
The Board concluded that it has received sufficient information and analysis to make an informed decision on the perceived costs of the changes and that the expected benefits would justify the expected costs of the amendments in the proposed Update.
Next Steps
The Board directed the staff to draft a proposed Accounting Standards Update for vote by written ballot, with a comment period of 75 days.
Tentative Board Decisions Reached to Date (as of June 19, 2019):
A summary of the Board’s tentative decisions reached to date can be found here.
Board Meeting Materials and Information
The Board meeting minutes, handouts, and videos are provided for the information and convenience of constituents who want to follow the Board’s deliberations. All of the conclusions reported are tentative and may be changed at future Board meetings. Decisions become final only after a formal written ballot to issue a final standard.
The following are links to the minutes for each meeting. To view Board meetings and handouts from the past 90 days, click here.
June 19, 2019
Board Meeting—The Board deliberated sweep issues and directed the staff to draft a proposed Accounting Standards Update for vote by written ballot.
April 3, 2019
Board Meeting—The Board deliberated consequential amendments, technical corrections, and transition for the project.
February 13, 2019
Board Meeting—The Board deliberated the direction of the project.
January 30, 2019
Board Meeting—The Board discussed the direction of the project.
June 6, 2018
Board Meeting—The Board deliberated the direction of the project.
December 13, 2017
Board Meeting—The Board discussed the project plan for this project.
September 20, 2017
Board Meeting—The Board added to its agenda a project on distinguishing liabilities from equity (including convertible debt).
Next Steps*
After the comment period closes, the Board will consider comment letter feedback on the proposed Update.
The staff has prepared this summary for information purposes only. Any Board decisions are tentative and do not change current accounting. Official positions of the FASB are determined only after extensive due process and deliberations.
