The SEC has provided guidance on the subsequent measurement of mandatorily redeemable instruments classified as mezzanine equity. The guidance is codified in
ASC 480-10-S99-3A
ASC 480-10-S99-3A14
If an equity instrument subject to ASR 268 is currently redeemable (for example, at the option of the holder), it should be adjusted to its maximum redemption amount at the balance sheet date. If the maximum redemption amount is contingent on an index or other similar variable (for example, the fair value of the equity instrument at the redemption date or a measure based on historical EBITDA), the amount presented in temporary equity should be calculated based on the conditions that exist as of the balance sheet date (for example, the current fair value of the equity instrument or the most recent EBITDA measure). The redemption amount at each balance sheet date should also include amounts representing dividends not currently declared or paid but which will be payable under the redemption features or for which ultimate payment is not solely within the control of the registrant (for example, dividends that will be payable out of future earnings).
ASC 480-10-S99-3A15
If an equity instrument subject to ASR 268 is not currently redeemable (for example, a contingency has not been met), subsequent adjustment of the amount presented in temporary equity is unnecessary if it is not probable that the instrument will become redeemable. If it is probable that the equity instrument will become redeemable (for example, when the redemption depends solely on the passage of time), the SEC staff will not object to either of the following measurement methods provided the method is applied consistently:
a. Accrete changes in the redemption value over the period from the date of issuance (or from the date that it becomes probable that the instrument will become redeemable, if later) to the earliest redemption date of the instrument using an appropriate methodology, usually the interest method. Changes in the redemption value are considered to be changes in accounting estimates.
b. Recognize changes in the redemption value (for example, fair value) immediately as they occur and adjust the carrying amount of the instrument to equal the redemption value at the end of each reporting period. This method would view the end of the reporting period as if it were also the redemption date for the instrument.
As stated in
ASC 480-10-S99-3A14, a redemption amount based on a formula (e.g., a multiple of trailing twelve-month EBITDA) should be calculated using the applicable information as of the balance sheet date. In this example, the reporting entity would use the trailing twelve-month EBITDA as of the balance sheet date. A reporting entity should not, for example, project the future value of the relevant metric expected as of the date of the earliest redemption.
An issuer should consider the nature of an instrument’s redemption provisions when choosing the appropriate accretion method. We believe an issuer should use a method that most closely reflects the underlying economics of the instrument. For example, it may be appropriate for a preferred share redeemable at a fixed date for a fixed amount to be accreted using the method described in
ASC 480-10-S99-3A15(a); however, a preferred share redeemable for a variable amount may be more appropriately measured using the method described in
ASC 480-10-S99-3A15(b).
Question FG 7-14
Is preferred stock that is both redeemable on a specified date and automatically convertible in the event of an IPO considered probable of becoming redeemable?
PwC response
Maybe. We believe that the probability of the IPO occurring should be considered when determining whether the preferred stock is probable of becoming redeemable. Given the subjective nature of this determination, all relevant facts and circumstances should be considered.
If the preferred stock is redeemable at the option of the holder on a specified date and convertible at the option of the holder in the event of the IPO, it is inappropriate to consider the probability of the IPO occurring because the exercise of the option is controlled completely by the holder. In this case, the preferred stock should be considered probable of becoming redeemable.
Question FG 7-15FG Corp issued preferred stock with a stated value of $1,000 on June 30, 20X1 that is convertible at the investor’s option into a variable number of FG common shares with a fair value equal to its redemption value at any time after June 30, 20X3. The redemption value is equal to stated value plus accrued but unpaid dividends of 5%. FG Corp has classified the preferred stock as mezzanine equity because there are settlement scenarios where FG Corp may not have sufficient authorized but unissued shares to satisfy this conversion, although those scenarios are remote of occurrence. Must FG Corp accrete the preferred stock to its redemption value pursuant to
ASC 480-10-S99-3A15?
PwC response
We believe there are two acceptable views.
- View A
Once FG Corp has determined that the preferred stock is redeemable pursuant to ASC 480-10-S99-3A6, there are no contingencies to consider because the investor can force FG Corp to redeem merely through the passage of time. Therefore, FG Corp must accrete the preferred stock in accordance with ASC 480-10-S99-3A15.
- View B
Although FG Corp believes there are scenarios where they must assume cash settlement, they believe potential cash settlement is contingent upon their stock price falling to a level that would require FG Corp to obtain shareholder approval to authorize additional shares. Since FG Corp believes that such an event (i.e., the stock price falling to such a level) is not probable, the preferred stock is not probable of becoming redeemable for cash or other assets, and therefore accretion to the redemption amount is not necessary.
Question FG 7-16FG Corp issued preferred stock with a stated value of $1,000 on June 30, 20X1 that is convertible into FG common shares. Upon issuance, FG Corp determined that the conversion option must be bifurcated and accounted for separately as a derivative instrument pursuant to
ASC 815-15-25. The preferred stock is redeemable at the option of the holder any time after June 30, 20x6. The redemption value is equal to stated value plus accrued but unpaid dividends of 5%. FG Corp has classified the preferred stock host as mezzanine equity in accordance with
ASC 480-10-S99-3A. In accreting the preferred stock host to its redemption value, should FG Corp consider the liability-classified conversion option when determining the amount of accretion pursuant to
ASC 480-10-S99-3A15.?
PwC response
Although there is no direct guidance that addresses the question, we believe that the recorded value of the separated conversion option should be considered when determining the amount of accretion pursuant to
ASC 480-10-S99-3A15. This is because, in the event of redemption of the preferred stock, both the preferred stock host and the separated conversion option would be redeemed. In determining the appropriate amount of accretion, FG Corp would first measure the fair value of the separated conversion option, recording the changes in that fair value through earnings. Except as noted below, the period-end recorded value of the preferred stock host would then be determined by subtracting the fair value of the separated conversion from the redemption value of the preferred stock. The accretion amount is then determined by computing the period-end recorded value of the preferred stock host to the beginning-of-period recorded value. The preferred stock host would only be decreased to the extent of previous accretion.
Example FG 7-4 illustrates how to measure a mezzanine equity classified preferred stock instrument that is redeemable based on an index
EXAMPLE FG 7-4
Redeemable preferred stock based on an index
FG Corp issued preferred stock on 1/1/20X1 at a stated value of $1,000 that is redeemable at the option of the investor beginning on 1/1/20X6. Since the instrument is redeemable at the option of the investor, FG Corp has classified the preferred stock as mezzanine equity. The preferred stock is redeemable based on a multiple of five times trailing twelve-month EBITDA as of 1/1/20x6. FG Corp has concluded that the preferred stock is not within the scope of
ASC 480-10-25-14 and that the redemption option does not need to be bifurcated from the preferred stock host.
At 12/31/20X3, five times trailing twelve-month EBITDA (based upon the trailing twelve-month EBITDA as of 12/31/20X3) yields a value of $1,200. However, based on FG Corp’s forecast of trailing twelve-month EBITDA, as of 1/1/20X6, the redemption value of the preferred stock would be $1,500. FG Corp has made a policy election to subsequently measure the preferred stock using the methodology described in
ASC 480-10-S99-3A15b.
At what amount should FG Corp measure the preferred stock instrument at 12/31/20X3?
Analysis
FG Corp would measure the preferred stock instrument at $1,200 at 12/31/20X3 since this would be the redemption value using the conditions that exist as of the balance sheet date.
ASC 480-10-S99-3A15b stipulates that, pursuant to this method, FG Corp should view the end of the reporting period as if it were also the redemption date of the instrument. As such, FG Corp would not use forecasted EBITDA to subsequently measure the instrument.