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Application of the definition of ‘down round’ feature

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Contents Current reporting issue Application of the definition of ‘down round’ feature

FASB ASU clarifies scope of ASC 842 and provides land easement transition expedient
Board discusses comments received on proposed amendments to ASC 842
Q1 2018 FASB Outlook e-newsletter published

AICPA adds industry guidance to revenue recognition guide IASB issues January 2018 update

Current reporting issue Application of the definition of ‘down round’ feature ASU 2017-11, I – Accounting for Certain Financial Instruments with Down Round Features, amends the guidance in ASC 815-40-15, Derivatives and Hedging: Contracts in Entity’s Own Equity, on determining whether a freestanding instrument or a feature embedded in a hybrid financial instrument is indexed to an entity’s own stock (the “indexation” guidance). Specifically, the amendment requires an entity to disregard “down round” features when applying the indexation guidance to determine whether a freestanding instrument is classified as a liability, or whether an embedded feature is accounted for separately from its host contract.

The guidance in ASU 2017-11 defines a “down round feature” as follows:

"A feature in a financial instrument that reduces the strike price of an issued financial instrument if the issuer sells shares of its stock for an amount less than the currently stated strike price of the issued financial instrument or issues an equity-linked financial instrument with a strike price below the currently stated strike price of the issued financial instrument.

"A down round feature may reduce the strike price of a financial instrument to the current issuance price, or the reduction may be limited by a floor or on the basis of a formula that results in a price that is at a discount to the original exercise price but above the new issuance price of the shares, or may reduce the strike price to below the current issuance price. A standard antidilution provision is not considered a down round feature."

Prior to adopting the guidance in ASU 2017-11,1 entities are required to classify freestanding equity-linked instruments containing down round features as liabilities, and to separately account for a feature (such as a conversion option) embedded in a hybrid financial instrument subject to a down round feature as a derivative, provided that the other applicable separation criteria are satisfied.2

After adopting the guidance in ASU 2017-11, an entity is required to classify a freestanding equity-linked instrument containing a down round feature as equity, provided that all of the other equity classification criteria are met under both ASC 480, Distinguishing Liabilities from Equity, and ASC 815. Likewise, after adopting the guidance in ASU 2017-11, an entity can no longer account for a feature embedded in a hybrid financial instrument separately from its host contract, provided that the feature previously required separate accounting solely because it was subject to a down round feature.

Entities adopting the guidance in ASU 2017-11 should ensure that all relevant contractual provisions have been considered before concluding that an instrument, or an embedded feature subject to a down round feature, ceases to require liability classification or separate accounting from the host contract, respectively. Prior to adopting the guidance in ASU 2017-11, entities might have ended their evaluation of an instrument or embedded feature after identifying a down round feature, since identification of that feature would have been sufficient to conclude that liability classification was appropriate for the instrument or feature. These instruments and embedded features might be subject to other previously unassessed contractual provisions that require liability classification, meaning that the accounting for the instrument or embedded feature subject to a down round feature may be unchanged as a result of adopting the guidance in ASU 2017-11.

For example, sometimes a warrant agreement contains a down round feature as well as a provision that adjusts the warrant’s strike price when certain changes are made to the strike price of other equity-linked instruments issued by the same entity, such as an adjustment to the strike price of a debt conversion option in connection with a debt modification. This latter provision adjusts the warrant’s strike price as though the entity had issued an equity-linked instrument with a strike price equal to the revised strike price of the other equity-linked instrument.

To illustrate, assume that an entity sells Warrant A, which allows the holder to purchase a single share of the entity’s common stock at a strike price of $10. The contract contains the following provisions:

  1. If the entity issues common stock for less than $10 per share or issues another warrant or a convertible instrument with a strike price below $10 per share, then Warrant A’s strike price will automatically adjust so that it equals the newly issued instrument’s strike price.
  2. If the strike price of the entity’s other warrants or convertible instruments changes to any amount below Warrant A’s then-current strike price, then Warrant A’s strike price will automatically adjust so that it equals the other instrument’s new strike price.

If, after issuing Warrant A, the entity issues convertible debt with a strike price of $8 per share, then Warrant A’s strike price would automatically adjust to $8. Provision (a) above meets the definition of a down round feature and, on its own, would not require Warrant A to be classified as a liability based on the guidance in ASU 2017-11.

If, after issuing the convertible debt, the entity negotiates with its creditor to modify the debt agreement, lowering the debt’s conversion price to $7 per share, then Warrant A’s strike price would automatically adjust to $7. Provision (b) above does not meet the definition of a down round feature because it is not triggered by the issuance of stock or an equity-linked instrument, and therefore Warrant A must be classified as a liability based on the indexation guidance in ASC 815-40-15.

Prior to adopting the guidance in ASU 2017-11, Warrant A would be accounted for as a liability because both provisions (a) and (b) cause Warrant A not to be indexed to the entity’s own stock.

After adopting the guidance in ASU 2017-11, Warrant A would be accounted for as a liability because provision (b) causes Warrant A not to be indexed to the entity’s own stock.



FASB ASU clarifies scope of ASC 842 and provides land easement transition expedient The FASB has issued ASU 2018-01, Land Easement Practical Expedient for Transition to Topic 842, to clarify how entities should apply the new guidance in ASC 842, Leases, to land easements. The Board issued the ASU in response to stakeholders’ concerns about the cost, complexity, and limited benefits of the requirement to evaluate all existing or expired land easements upon adopting ASC 842.

A land easement, or right of way, is the right to use, access, or cross another entity’s land for a specified purpose. In accounting for land easements, some entities currently apply the existing guidance in ASC 840, Leases, while others apply the existing guidance in either ASC 350, Intangibles – Goodwill and Other, or ASC 360, Property, Plant and Equipment.

ASU 2018-01 includes a practical expedient that allows entities to elect not to apply ASC 842 to land easements previously accounted for under guidance other than ASC 840. If an entity elects to use the practical expedient, it is required to apply the expedient to all existing or expired land easements as of the effective date of ASC 842 and should continue to account for the land easements existing as of the adoption date in accordance with guidance other than ASC 842. If an entity does not make the election, it should evaluate all existing or expired land easements on the effective date of ASC 842 to determine whether they meet the definition of a lease under ASC 842.

ASU 2018-01 further requires an entity to apply ASC 842 to all new or modified land easements to determine whether the arrangement should be accounted for as a lease.

ASU 2018-01 also amends an example in the implementation and illustration guidance of ASC 350-30, General Intangibles Other Than Goodwill, to clarify that an entity should determine whether land easements are leases under ASC 842 before applying the guidance in the example.

The effective date and transition requirements for ASU 2018-01 are the same as those for ASC 842. If an entity has early adopted ASC 842, it should apply these amendments upon issuance of the ASU.

Board discusses comments received on proposed amendments to ASC 842 All decisions reached at Board meetings are tentative and may be changed at future meetings.

On January 24, the Board met to discuss comments received from stakeholders on Part II of the proposed ASU, Technical Corrections and Improvements to Recently Issued Standards: Accounting Standards Update No. 2016-02, Leases.

As a result of these discussions, the Board tentatively decided that the net adjustment to equity resulting from applying the proposed transition guidance in both ASC 842-10-65-1(h)(3) and in ASC 842-10-65-1(w)(3) would be zero.

In addition, the Board clarified that the guidance in ASC 842-10-15-40 does not override other relevant guidance that a lessor should apply when accounting for the nonlease component(s) of an arrangement that contains a lease. For example, the amount of variable payments allocated to the nonlease component(s) would be recognized in accordance with the guidance in ASC 606, Revenue from Contracts with Customers, if this guidance applies to these payments.

The Board directed the staff to draft a final ASU for vote by written ballot, and to document the summary of its public discussion of the Board meeting on the FASB’s leases implementation webpage.

See the October 5, 2017 On the Horizon for a summary of this proposal.

Q1 2018 FASB Outlook e-newsletter published The FASB issued the Q1 2018 edition of the FASB Outlook e-newsletter, which includes articles that discuss
  • The FASB’s projects page on accounting for the Tax Cuts and Jobs Act
  • How the FASB is reducing cost, complexity, and uncertainty after a standard is issued
  • Investor influence in new accounting standards
  • A summary of the Private Company Council’s advice to the FASB on key projects

The newsletter also includes a link to a video that discusses the Board’s lease simplification efforts.

AICPA adds industry guidance to revenue recognition guide The AICPA has added new industry-related content to the Audit and Accounting Guide, Revenue Recognition (Updated January 1, 2018). The new chapter, Chapter 17, Hospitality Entities, includes guidance for applying ASC 606, Revenue from Contracts with Customers, and related interpretations from the FASB/IASB Joint Transition Resource Group for Revenue Recognition.

The chapter discusses accounting implementation issues, including application of the new five-step model within the context of hospitality entities and other issues, as follows:
  • Identification of the contract with a customer
  • Identifying the performance obligations, including the effect of affinity programs and “tier status”
  • Determination of the transaction prices and consideration to the customer
  • Allocation of the transaction price to the performance obligations
  • Revenue streams, including hotel management and service arrangements, franchise fees, and owned and leased property revenue

IASB issues January 2018 update All decisions reached at IASB meetings are tentative and may be changed or modified at future meetings. Board decisions become final only after completion of a formal ballot to issue a new Standard or Interpretation or to publish an Exposure Draft.

The IASB has issued the January 2018 Update summarizing the tentative decisions reached by the Board during its January public meeting. The Board discussed the following topics:
  • Primary financial statements
  • Financial instruments with characteristics of equity
  • Conceptual framework
  • IFRS implementation issues
  • Goodwill and impairment
  • Post-implementation review of IFRS 13, Fair Value Measurement



1For 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.
2Typically, an embedded feature requires separate accounting as a freestanding derivative if (1) the embedded feature is not clearly and closely related to the host contract, (2) the hybrid instrument is not subsequently measured at fair value, and (3) the embedded feature meets the definition of a derivative, and does not qualify for a scope exception, under ASC 815.




© 2018 Grant Thornton LLP, U.S. member firm of Grant Thornton International Ltd. All rights reserved. This Grant Thornton LLP On the Horizon provides information and comments on current accounting and SEC reporting issues and developments. It is not a comprehensive analysis of the subject matter covered and is not intended to provide accounting or other advice or guidance with respect to the matters addressed in this publication. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this publication. For additional information on topics covered in this publication, contact a Grant Thornton client-service partner.