Scope of Accounting for Complex Instruments
The information in this Blueprint applies to all entities but there are some differences in the requirements for public and private entities. This Blueprint discusses the accounting for financial instruments from the perspective of the issuer (the entity that issued the financial instrument or may be required to issue its equity shares under the terms of the financial instrument). The instrument holder must apply other U.S. GAAP to account for the transaction.
Distinguishing Liabilities From Equity
ASC 480 requires entities to account for as liabilities (or assets in some cases) some financial instruments with characteristics of both liabilities and equity. Common examples of financial instruments that are accounted for under ASC 480 include mandatorily redeemable shares, puttable warrants, warrants for redeemable shares, and some variable share-settled obligations.
Hybrid Instruments and Embedded Derivatives
An entity must evaluate whether embedded derivatives (such as conversion and redemption features) meet the criteria for bifurcation from hybrid instruments (such as convertible debt or preferred stock). An embedded derivative is accounted for separately as a derivative asset or liability if it is not clearly and closely related to the host contract, is embedded in a hybrid instrument that is not remeasured at fair value through earnings and would be a derivative if it were freestanding (and no scope exceptions apply).
Contracts in an Entity’s Own Equity
A freestanding equity-linked financial instrument (such as a warrant) that meets the equity classification requirements in ASC 815-40 — it is indexed to the entity’s own stock and meets the criteria for equity classification — is classified as equity. Similarly, an embedded equity-linked feature (such as a conversion option) that meets the requirements is not bifurcated from the hybrid instrument.
Entities that prepare financial statements in accordance with SEC Regulation S-X and other entities that elect to follow the SEC’s guidance must determine whether to classify a redeemable equity instrument that is not accounted for as a liability under ASC 480 as permanent or temporary equity (mezzanine equity).
This Blueprint provides guidance for other debt and equity related topics, such as issuance costs, treasury stock, stock splits and dividends, PIK interest and dividends, deemed dividends and contributions, conversions, and extinguishments.
Debt Restructurings, Modifications, and Exchanges
Any time a debtor and creditor change the terms of their relationship by amending a loan agreement, exchanging one instrument for another, or entering an incremental debt instrument, the debtor must determine the appropriate accounting model to apply to the restructured debt arrangement. For guidance on these transactions, see BDO’s publication, Troubled Debt Restructuring, Debt Modification, and Extinguishment.
This Blueprint addresses the presentation and disclosure requirements for debt and equity instruments, including current and noncurrent presentation of debt instruments in an entity’s balance sheet.
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