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On August 5, 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The ASU aims to improve complexities of financial reporting associated with accounting for convertible instruments and contracts in an entity’s own equity.
There are currently five separation accounting models for convertible instruments under Subtopic 470-20. The amendments remove two separation models that require embedded conversion features to be separated from the host contract for convertible instruments issued with beneficial conversion features or cash conversion features. Consequently, a convertible debt instrument will be accounted for as a single liability instrument measured at amortized cost and a convertible preferred stock will be accounted for as a single equity instrument measured at historical cost, as long as no other features require bifurcation and recognition as derivatives. Convertible instruments that will continue to be subjected to separation models include:
Certain enhancements were made to the disclosures for convertible instruments, which impact all entities that issue convertible instruments, including:
Contracts in an Entity’s Own Equity
Under the current guidance, a freestanding contract settled in an entity’s own equity, or a contract with embedded features that have all the characteristics of a derivative instrument, is recorded as an asset or a liability unless it meets below criteria:
If both criteria are met, the contract can be recognized as equity if it qualifies for the derivatives scope exception based on the conditions listed in Subtopic 815-40 (the settlement criterion). This rules-based guidance has resulted in inconsistent accounting conclusions for economically similar contracts. Therefore, the amendments revise the guidance in Subtopic 815-40 on conditions for equity classification under the settlement criterion, as follows:
Freestanding instruments that qualify for the derivatives scope exception under the amendments should be recorded in equity. Embedded features that qualify for the derivatives scope exception under the amendments should no longer be bifurcated and should be accounted for separately.
Earnings per Share (EPS)
Amendments to the EPS guidance were also made to improve the consistency of EPS calculations:
The amendments are effective as follows:
Early adoption is permitted for all entities at the beginning of their annual fiscal year, but no earlier than fiscal years beginning after December 15, 2020, including interim periods therein. An entity that has not yet adopted the amendments to the guidance for accounting for certain instruments with down-round features may adopt the recognition and measurement amendments in this ASU for any convertible security that includes a down-round feature in financial statements that have not yet been issued or made available for issuance for fiscal years (or interim periods) beginning after December 15, 2019. An entity may choose to adopt the guidance through either a modified retrospective method of transition or a fully retrospective method of transition.
To access the full script of ASU No. 2020-06, click here.
For more information on the financial reporting library, contact a local MNP Assurance Professional, or Jody MacKenzie, Director, Assurance Professional Standards.
This communication contains a general overview of the topic and is current as of August 5, 2020. The application of the principles addressed will depend upon the particular facts and circumstances of each individual case. Accordingly, this publication is not a substitute for professional advice and we recommend that any decisions you take about the application or not of any of the information presented be made in consultation with a qualified professional, who can address any variance that may be required to reflect your circumstances. Please contact your local MNP representative for customized assistance with the application of this material. MNP LLP accepts no responsibility or liability for any loss related to any person's use of or reliance upon this material. © MNP LLP 2020. All rights reserved.
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