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Accounting for convertible instruments and own equity contracts
Publication date: 20 Aug 2020
us In depth 2020-07
At a glance
Instruments that have characteristics of both liabilities and equity (such as convertible debt) are commonly issued by companies to raise capital from investors seeking certain return profiles. Preparers and users of financial statements have long noted that the accounting models for these instruments are complex, rules based, and can result in different accounting and reporting for instruments with similar economics.
The FASB recently issued guidance that simplifies the accounting for certain financial instruments with characteristics of liabilities and equity. The Board reduced the number of accounting models for convertible debt and convertible preferred stock instruments and made certain disclosure amendments to improve the information provided to users. In addition, the Board amended the derivative guidance for the “own stock” scope exception and certain aspects of the EPS guidance.
For additional insights on adopting the new guidance, refer to In depth 2021-02, Adopting the new liability and equity guidance early and our Financing transactions guide.
On August 5, 2020, the FASB issued ASU No. 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). The amendments in this update affect entities that issue convertible instruments and/or contracts indexed to and potentially settled in an entity’s own equity.
The new ASU eliminates the beneficial conversion and cash conversion accounting models for convertible instruments. It also amends the accounting for certain contracts in an entity’s own equity that are currently accounted for as derivatives because of specific settlement provisions. In addition, the new guidance modifies how particular convertible instruments and certain contracts that may be settled in cash or shares impact the diluted EPS computation.
The amendments in the ASU are effective for public business entities that meet the definition of an 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. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The Board also specified that an entity should adopt the guidance as of the beginning of its annual fiscal year and is not permitted to adopt the guidance in an interim period.
Note: The discussion in this document of various convertible instruments and freestanding instruments potentially settled in an entity’s own stock assumes that these instruments are not within the scope of ASC 480, Distinguishing Liabilities from Equity. The scope and guidance of ASC 480 was not significantly amended by ASU 2020-06. For information on the application of ASC 480, see Chapter 5 of PwC’s Financing transactions guide.
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