Distinguishing Liabilities from Equity (including
convertible debt)

Accounting Standards Update 2020-06—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

 

Overview


On August 5, 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2020-06Debt—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 EquityThe Update is expected to reduce complexity and improve comparability of financial reporting associated with accounting for convertible instruments and contracts in an entity’s own equity.

The amendments in the Update result in the following improvements:
  1. Convertible Instruments: Reduces the number of accounting models for convertible debt instruments and convertible preferred stock, resulting in simpler accounting treatment with enhanced transparency of disclosures.
  2. Derivatives Scope Exception: Removes three conditions required to qualify for the settlement guidance for the derivatives scope exception for contracts in an entity’s own equity.
  3. Earnings Per Share: Improves the consistency of the diluted earnings per-share calculation by requiring the if-converted method for convertible instruments and by applying share-settlement assumption for instruments that may be settled in cash or shares.

Effective Dates


The amendments in this Update are effective for public business entities that meet the definition of a Securities and Exchange Commission (SEC) filer, excluding entities eligible to be smaller reporting companies as defined by the SEC, for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. This was done to provide smaller reporting companies and other entities with sufficient time to adopt the amendments.

Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The Board specified that an entity should adopt the guidance as of the beginning of its annual fiscal year.

Additionally, an entity that has not yet adopted the amendments in Accounting Standards Update No. 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities and Equity (Topic 480); Derivatives and Hedging (Topic 815): (PART I) Accounting for Certain Financial Instruments With Down Round Features, can early adopt the amendments in this Update for convertible instruments that include a down round feature. This early adoption is permitted for fiscal years beginning after December 15, 2019.
 

Transition


The Board decided to allow entities to adopt the guidance through either a modified or fully retrospective method of transition. In applying the modified retrospective method, an entity should apply the guidance to transactions outstanding as of the beginning of the year of adoption. Transactions that were settled (or expired) during prior reporting periods are unaffected. The cumulative effect of the change should be recognized as an adjustment to the opening balance of retained earnings at the date of adoption.  

If an entity elects the full retrospective method of transition, the cumulative effect of the change should be recognized as an adjustment to the opening balance of retained earnings in the first comparative period presented.

The Board also decided to allow all entities to irrevocably elect the fair value option in accordance with Subtopic 825-10, Financial Instruments—Overall, for any financial instrument that is a convertible security upon adoption of the amendments in this Update.
 

Additional Information

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