FASB, Financial Accounting Standards Board.

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:

There are no exposure documents at this time.

Media Releases and Educational Materials

Distinguishing Liabilities from Equity (Including Convertible Debt) was added to the Board’s technical agenda as a result of extensive stakeholder outreach and input on its August 2016 Invitation to Comment, for further details, see the news release here.

Board Decisions*

Decisions Reached at Last Meeting (as of April 3, 2019):

The Board deliberated consequential amendments and technical corrections for convertible instruments and decided to:

1. Clarify the difference between a convertible debt and a debt instrument that could be converted to a variable number of shares with an aggregate fair value equal to a fixed monetary amount (such as share-settled debt) to improve application of the guidance.
2. Define or redefine the scope of the guidance on convertible debt instruments in Subtopic 470-20, Debt—Debt with Conversion and Other Options, and on convertible preferred shares in Topic 505, Equity.
3. Remove the word conventional from the term conventional convertible debt instrument used in Subtopic 815-40, Derivatives and Hedging—Contracts in Entity’s Own Equity.
4. Amend paragraph 470-20-25-2 to clarify that an entity should consider the guidance in Topic 480, Distinguishing Liabilities from Equity, and Topic 815 for the classification of the detachable stock purchase warrant.

The Board deliberated consequential amendments and technical corrections for the derivatives scope exception and decided to:

1. Expand the scope of the subsequent fair value measurement guidance in paragraph 815-40-35-4 to include instruments that failed the indexation criterion under the scope and scope exception Section of Subtopic 815-40 and do not meet the definition of a derivative.
2. Modify the disclosure requirement in paragraph 815-40-50-5(d) about the fair value of settlement alternatives to parallel the disclosure requirement in paragraph 480-10-50-2(a) through (b).
3. Retain the disclosure requirement in paragraph 815-40-15-5(e), which requires that an entity provide certain disclosures if an instrument within the scope of Subtopic 815-40 is classified as temporary equity.
4. Remove the embedded written put options and forward purchase contracts table in paragraph 815-40-55-11 (and the related paragraphs 815-40-55-8 through 55-10).
5. Modify the reassessment guidance in the subsequent measurement Section of Subtopic 815-40 as follows:
   1. Clarify that the reassessment guidance in paragraph 815-40-35-8 applies to the same scope as the indexation and settlement criterion. That is, the reassessment requirement of the derivatives scope exception applies to both freestanding instruments and embedded features (similar to the scope as written in paragraph 815-40-15-5).
   2. Add a cross-reference in Section 815-40-35 to the guidance in Subtopic 815-15, Derivatives and Hedging—Embedded Derivatives, on the accounting for embedded features upon a change in assessment of the derivatives scope exception.

The Board deliberated other consequential amendments and decided to:

1. Expand the scope of the down rounds EPS adjustment in Topic 260, Earnings Per Share, to include equity-classified convertible preferred shares.
2. Exclude liability-classified stock-based payment arrangements from the Board’s February 2019 decision about the diluted EPS calculation for contracts that may be settled in cash or shares, resulting in no change in the diluted EPS calculation for those instruments.
3. Align the post-vesting classification of convertible instrument awards with other financial instrument awards under Topic 718, Compensation—Stock Compensation, by requiring that convertible instrument awards continue to be accounted for under Topic 718 after they are fully vested rather than being accounted for under guidance in other Topics.

The Board deliberated transition and decided to:

1. Require the modified retrospective transition approach, and allow an option for full retrospective approach, for the derivatives scope exception and convertible instrument amendments. Under the modified retrospective approach, an entity would apply the proposed guidance to transactions outstanding as of the beginning of the year in which the standard is adopted and record a cumulative effect adjustment to the opening balance of retained earnings at the date of adoption.
2. Provide a transition expedient for an entity to assess at the date of adoption whether the adjustment, or settlement, features are remote rather than requiring an entity to assess likelihood and reassessments from the contract inception to the date of adoption.
3. Require full retrospective transition for the amendments to EPS guidance on cash versus share settlement and require that an entity apply the if-converted method as of the date of adoption for the amendments to the EPS guidance on convertible instruments, unless the entity chooses the full retrospective option for transition for the convertible instrument amendments.
4. Require disclosures in Topic 250, Accounting Changes and Error Corrections (except for the disclosures in paragraph 250-10-50-1(b)(2), which would be required only for an entity that elects full retrospective transition, and paragraph 250-10-50-3).
5. Require an entity to apply any transition expedients consistently to all contracts within all reporting periods presented and to require an entity to disclose the following information:
   1. The expedients that have been used
   2. To the extent reasonably possible, a qualitative assessment of the estimated effect of applying each of those expedients.

The Board also decided to allow entities that have not yet adopted the amendments in Accounting Standards Update No. 2017-11, Earnings per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financing Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception, to early adopt the amendments to the convertible instruments guidance for a convertible instrument that includes a down round feature.

Tentative Board Decisions Reached to Date (as of April 3, 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.
 

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*

The Board directed the staff to draft a proposed Accounting Standards Update and distribute that staff draft for external review. Following external review, the staff will bring back any additional issues and an analysis of costs and benefits.

Contact Information

Mary Mazzella
Senior Project Manager
msmazzella@fasb.org

Aarika Friend
Project Manager
afriend@fasb.org

Lucy Cheng
Project Manager
lcheng@fasb.org

Celine Olcott
Postgraduate Technical Assistant
colcott@fasb.org

Rachel Cole
Postgraduate Technical Assistant
rcole@fasb.org