A reporting entity may execute agreements in connection with the issuance of a debt instrument. Registration rights allow the holder to require that the reporting entity file a registration statement for the resale of specified instruments and may be provided to lenders in the form of a separate agreement, such as a registration rights agreement, or included as part of an investment agreement such as an investment purchase agreement, warrant agreement, debt indenture, or preferred stock indenture. These arrangements may require the issuer to pay additional interest in the event that a registration statement is not filed or is no longer effective.
The ASC Master Glossary provides a definition of a registration payment arrangement.
Definition from ASC Master Glossary
Registration Payment Arrangement: An arrangement with both of the following characteristics:
a. It specifies that the issuer will endeavor to do either of the following:
1. File a registration statement for the resale of specified financial instruments and/or for the resale of equity shares that are issuable upon exercise or conversion of specified financial instruments and for that registration statement to be declared effective by the U.S. Securities and Exchange Commission (SEC) (or other applicable securities regulator if the registration statement will be filed in a foreign jurisdiction) within a specified grace period
2. Maintain the effectiveness of the registration statement for a specified period of time (or in perpetuity).
b. It requires the issuer to transfer consideration to the counterparty if the registration statement for the resale of the financial instrument or instruments subject to the arrangement is not declared effective or if effectiveness of the registration statement is not maintained. That consideration may be payable in a lump sum or it may be payable periodically, and the form of the consideration may vary. For example, the consideration may be in the form of cash, equity instruments, or adjustments to the terms of the financial instrument or instruments that are subject to the registration payment arrangement (such as an increased interest rate on a debt instrument).
provides exceptions to the provisions of the registration payment arrangement guidance.
The guidance in this Subtopic does not apply to any of the following:
a. Arrangements that require registration or listing of convertible debt instruments or convertible preferred stock if the form of consideration that would be transferred to the counterparty is an adjustment to the conversion ratio. See Subtopic 470-20
on debt with conversion and other options or Subtopic 505-10
on equity for related guidance.
b. Arrangements in which the amount of consideration transferred is determined by reference to either of the following:
1. An observable market other than the market for the issuer’s stock
2. An observable index.
For example, if the consideration to be transferred if the issuer is unable to obtain an effective registration statement is determined by reference to the price of a commodity. See Subtopic 815-15
for related guidance.
c. Arrangements in which the financial instrument or instruments subject to the arrangement are settled when the consideration is transferred (for example, a warrant that is contingently puttable if an effective registration statement for the resale of the equity shares that are issuable upon exercise of the warrant is not declared effective by the SEC within a specified grace period).
There is no recognition of a registration payment arrangement unless transfer of consideration under the arrangement is probable and the payment amount or a range of payment amounts can be reasonably estimated. In that case, the contingent liability under the registration payment arrangement should be included in the allocation of proceeds from the related financing transaction. The remaining proceeds should then be allocated to the financial instruments issued based on the provisions of other US GAAP. For example, if a registration payment arrangement relates to debt issued with warrants, the registration payment proceeds should be recognized and measured under ASC 450
, first, then the remaining proceeds should be allocated between the debt and warrants.
Any change in the value of the estimated contingent liability should be recognized in the income statement.
Question FG 1-9 addresses the accounting for convertible debt with a contingent interest escalation clause.
Question FG 1-9
A reporting entity issues convertible debt with an initial coupon rate of 6% per annum. If the reporting entity does not complete a qualified IPO within 18 months of the convertible debt being issued, then the coupon will increase in accordance with a specified schedule set forth in the debt agreement.
How should the reporting entity account for the convertible debt with the contingent interest escalation clause?
The contingent escalation clause is a contingent obligation to pay additional interest that meets the definition of a registration payment arrangement within the scope of ASC 825-20
. Accordingly, the reporting entity should recognize the contingent obligation to pay additional interest using the guidance in ASC 450-20-25
. That is, a liability should be recorded once payment is probable and the payment amount, or a range of payment amounts, can be reasonably estimated.
If, at issuance, payment under the contingent escalation clause is not probable (or the range of payment amounts cannot be reasonably estimated), the convertible debt should be measured without regard to the contingent obligation to pay additional interest. See FG 6
(post adoption of ASU 2020-06
) or FG 6A
(pre adoption of ASU 2020-06
) for information on the accounting for convertible debt.
If payment under the escalation clause is probable when the debt is issued, and the payment amount or a range of payment amounts can be reasonably estimated, the proceeds received from the convertible debt should be first allocated to the contingent liability and then allocated to the convertible debt. If payment under the escalation clause becomes probable after the debt is issued, and the payment amount or a range of payment amounts can be reasonably estimated, a contingent liability should be recorded with an offsetting entry to the income statement.