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FASB to Publish Simpler New Rules on Convertible Instruments This Summer

Thomson Reuters Tax & Accounting  

· 5 minute read

Thomson Reuters Tax & Accounting  

· 5 minute read

By Denise Lugo

The FASB on June 10, 2020, voted to issue new rules this summer that simplify the accounting for convertible instruments and contracts in an entity’s own equity, a tricky area in financial reporting accountants said can be confusing.

The decision will finalize an amended version of proposed Accounting Standards Update (ASU) No. 2019-730Debt—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, which was issued in July 2019.

For public companies, the rules will take effect for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. All other entities, including private companies, would apply the changes to fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Companies can adopt the rules earlier.

Board members said any added costs incurred by the changes would be worth it because of the benefits of the rules—fixes to an area of GAAP that caused frequent financial statement restatements.

“This has been a project that’s been very important to me. I think the accounting for liabilities and equity, including convertible debt, is one of the more challenging areas in all of GAAP for well-intended, well-meaning companies to apply and the output is very challenging for investors to understand,” FASB Vice Chairman James Kroeker said during board discussions.

Kroeker said though changes the board made on convertible debt do not necessarily reflect the economics of those instruments, investors were challenged by the models that existed and therefore the resulting information would better fit their needs.

“The approach we have taken gives them a better starting point for how they want to do their analysis for similar instruments,” said Kroeker. “I wish we would have gone farther on some of the free-standing instruments that end up being classified as liabilities when they behave economically like equity.”

Under the forthcoming new rules, more convertible instruments will be reported as a single liability or equity with no separate accounting for embedded conversion features. A convertible instrument is a bond or a preferred stock that can be converted into shares of a company’s common stock. Some companies use convertible debt as an alternative financing solution.

Other changes companies can expect under the rules are that certain types of settlement conditions that are required for equity contracts to qualify for the exception under derivative rules will be removed. As a result, more equity contracts will qualify for the accounting exception.

The new standard will also simplify the diluted earnings-per-share (EPS) calculation in certain areas.

“We expect it to result in improved comparability of information for financial statement users and reduced cost and complexity for preparers and auditors,” outgoing FASB Chairman Russell Golden said.

The final standard will be an amendment to what FASB originally proposed in July 2019 under ASU No. 2019-730. The board had proposed simplifying the accounting for equity contracts by reducing form-over-substance-based accounting conclusions that are driven by remote contingent events in the assessment of the derivatives scope exception. Companies were conflicted about that changes, resulting in board decided not to include those changes in a final standard.

FASB has said that it will, however, continue to research improvements on that aspect of the guidance under Phase II of its work on the topic.


This article originally appeared in the June 11, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.

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