Distinguishing Liabilities from Equity

WHY DID THE FASB ISSUE A NEW STANDARD?

The Board issued this Update to address issues identified as a result of the complexity associated with applying generally accepted accounting principles (GAAP) for certain financial instruments with characteristics of liabilities and equity. Complexity associated with the accounting is a significant contributing factor to numerous financial statement restatements and results in complexity for users attempting to understand the results of applying the current guidance. In addressing the complexity, the Board focused on amending the guidance on convertible instruments and the guidance on the derivatives scope exception for contracts in an entity’s own equity.
 
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HOW WILL THE NEW GUIDANCE IMPROVE FINANCIAL REPORTING?

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.
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WHEN WILL THE NEW STANDARD BE EFFECTIVE?

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. 2017-11Earnings 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.
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