On The Horizon: FASB addresses accounting for certain antidilution provisions

Contents FASB ASU addresses accounting for certain antidilution provisions    
PCC posts highlights of July 11 meeting
GASB issues exposure draft on additional debt disclosures

FASB ASU addresses accounting for certain antidilution provisions The Board recently issued ASU 2017-11, I – Accounting for Certain Financial Instruments with Down Round Features, II – Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception.

Part I of the amended guidance simplifies the accounting for financial instruments that include down round features.

The amendments in Part II, which do not have an accounting effect, address the difficulty of navigating the guidance in ASC 480, Distinguishing Liabilities from Equity, due to the existence of extensive pending content in the Codification. This pending content has resulted from the indefinite deferral of accounting requirements related to mandatorily redeemable financial instruments of certain nonpublic entities and certain mandatorily redeemable noncontrolling interests. As a result, the amendments in Part II recharacterize the pending content related to the indefinite deferral of certain provisions of ASC 480 as a scope exception.

The main provisions of Part I of the ASU are summarized below.

Background A “down round” feature is a provision in an equity-linked financial instrument (or embedded feature) that reduces the current exercise (or strike) price based on the strike price of future equity offerings, such as a sale of the issuer’s stock or the issuance of another equity-linked financial instrument.

When a down round feature is triggered, the strike price reduction is based on how the down round feature operates. Therefore, the strike price of a financial instrument may be reduced to either (1) the current issuance price, (2) an amount between the original strike price and the current issuance price, or (3) an amount below the current issuance price.

Amendments to the classification analysis for instruments with down round features Under the existing guidance, an equity-linked financial instrument (or embedded feature) with a down round provision that is not classified as a liability under ASC 480 is evaluated under ASC 815, Derivatives and Hedging, to determine whether the instrument meets the definition of a derivative. If the instrument meets that definition, it is evaluated further to determine whether it qualifies for a scope exception from derivative accounting because it is both (1) indexed to the entity’s own stock, and (2) classified in equity.

For embedded features in certain financial instruments with a debt host, an instrument is not considered to be indexed to the entity’s own stock if a down round feature exists. As a result, under the existing guidance, the entity is then required to classify the freestanding financial instrument (or the bifurcated conversion option) as a liability that is initially measured at fair value and is remeasured at each reporting date in the future.

Under the ASU, when an entity determines whether it should classify certain financial instruments (or embedded features) as either a liability instrument or as an equity instrument, it should not consider the down round feature when assessing whether the instrument qualifies for the scope exception from derivative accounting that is discussed above.

As a result, the existence of a down round feature no longer precludes equity classification when assessing whether certain equity-linked financial instruments (or embedded features) are indexed to the entity’s own stock. Therefore, a freestanding equity-linked financial instrument (or embedded conversion option) with a down round feature will no longer be accounted for as a derivative liability due solely to the existence of a down round feature.

Accounting for the effect of a down round feature when triggered Under the ASU, when the down round feature of an equity-classified freestanding financial instrument, such as a warrant, is triggered (meaning that the exercise price of the related instrument is adjusted downward), the value of the effect of the feature is the difference between the following amounts determined immediately after the down round feature is triggered:

  • The fair value of the financial instrument (without the down round feature) based on the strike price before the strike price reduction
  • The fair value of the financial instrument (without the down round feature) based on the strike price after the strike price reduction

Also under the ASU, entities that present earnings per share (EPS) under ASC 260, Earnings Per Share, should recognize the value of the effect of this down round feature as a dividend in equity and as a reduction of income available to common stockholders in basic EPS.

Convertible instruments with embedded conversion options that have down round features are now subject to the existing specialized guidance for contingent beneficial conversion features in ASC 470-20, Debt – Debt with Conversion and Other Options, which requires an entity to recognize the intrinsic value of the feature only when the feature becomes beneficial (instead of bifurcating the conversion option on the issuance date and measuring it at fair value each reporting period).

Clarified disclosures The amendments in Part I require an entity to disclose the terms that may change the conversion or exercise prices other than “standard antidilution provisions” (as defined in the ASC Glossary), along with actual changes to conversion or exercise prices that occur during the reporting period other than changes that are due to standard antidilution provisions. An entity is also required to disclose certain information when a down round feature has been triggered during the reporting period.

Effective date and transition For public business entities, the amendments in Part I are effective in fiscal years, and in interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, these amendments are effective in fiscal years beginning after December 15, 2019 and in interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted for all entities as of the beginning of an interim period for which the financial statements (interim or annual) have not been issued or have not been made available for issuance.
All entities should apply the amendments in Part I using either a retrospective approach or a modified retrospective approach. Under the retrospective approach, an entity should apply the amendments to outstanding financial instruments with a down round feature for each prior reporting period presented. Under the modified retrospective approach, an entity should apply the amendments to these outstanding instruments as of the beginning of the fiscal year of adoption, with a cumulative-effect adjustment to the statement of financial position as of the beginning of the first fiscal year and interim period(s) of adoption.

PCC posts highlights of July 11 meeting The Private Company Council (PCC) met on July 11 with FASB members and shared stakeholder input from the June private company Town Hall meeting. The FASB staff delivered project updates, and PCC members provided input, on the following FASB projects:

  • Consolidation targeted improvements to related-party variable-interest entity (VIE) guidance: PCC members expressed support for the proposal that would permit a private company to elect to apply an accounting alternative, exempting it from the requirement to apply the VIE guidance to legal entities under common control when certain requirements are met.
  • Liabilities and equity – targeted improvements: PCC members expressed support for the proposed ASU, which would simplify the accounting for financial instruments with down-round features. Since the meeting, the FASB released this proposal as ASU 2017-11, which is discussed above.
  • Cloud computing (EITF Issue 17-A): PCC members agreed that accounting for implementation costs in a cloud computing arrangement is relevant for private companies. One PCC member recommended that the FASB provide additional guidance for determining the types of implementation costs that may be capitalized.
  • Nonemployee share-based payment accounting improvements: PCC members supported the private company alternatives within the proposed ASU.
  • Invitation to Comment on agenda consultation: PCC members supported the FASB’s continuing implementation and education efforts for recently issued guidance. They also recommended that the FASB remain mindful of the pace of change when it considers possible new projects.
  • Balance-sheet classification of debt: A majority of PCC members recommended that the FASB finalize the proposed guidance, with minor improvements to the proposed amendments related to the balance-sheet presentation. They also expressed interest in assisting the Board with transition provisions and educational efforts.

The next PCC meeting will be held on September 19. The FASB and PCC also will hold the next private company Town Hall meeting on August 31.

GASB issues exposure draft on additional debt disclosures The GASB issued a proposed Statement, Certain Disclosures Related to Debt, including Direct Borrowings and Direct Placements, which is intended to improve information related to debt that is disclosed in notes to government financial statements. It would also clarify which liabilities governments should include when disclosing information related to debt.

The main provisions of the proposal would

  • Define “debt” for purposes of disclosing information in notes to financial statements
  • Require that additional information related to debt, including, among other disclosures, unused lines of credit, as well as terms related to significant events of default and significant subjective acceleration clauses, be disclosed in notes to financial statements.
  • Require that existing and proposed disclosures on debt be provided separately from information about all other debt for direct borrowings and direct placements

The requirements of the proposal, when finalized, would be effective for reporting periods beginning after June 15, 2018. Earlier application of the final statement upon issuance will be encouraged.

These proposed disclosure requirements would be applied to notes to financial statements for all periods presented, unless application for prior periods is not practicable.

Comment period on the proposed statement ends September 15, 2017.

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