FASB issued a new Accounting Standards Update (2020-06) to improve financial reporting associated with accounting for convertible instruments and contracts in an entity’s own equity. This update concerns topic 470 on debt with respect to conversion and other options and topic 815 on derivatives and hedging with respect to contracts in entity’s own equity. FASB issued this Accounting Standards Update to address issues identified as a result of the complexity associated with applying generally accepted accounting principles (GAAP) for certain financial instruments with characteristics of liabilities and equity. In addressing the complexity, FASB focused on amending the guidance on convertible instruments and the guidance on the derivatives scope exception for contracts in an entity’s own equity.
The Accounting Standards Update simplifies accounting for convertible instruments by removing major separation models required under the current GAAP. Consequently, more convertible debt instruments will be reported as a single liability instrument and more convertible preferred stock will be reported as a single equity instrument with no separate accounting for embedded conversion features. The Accounting Standards Update removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for it. The Accounting Standards Update also simplifies the diluted earnings per share calculation in certain areas.
The Accounting Standards Update is effective for public business entities that meet the definition of a SEC filer, excluding entities eligible to be smaller reporting companies as defined by the SEC, for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. For all other entities, the standard will be effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption will be permitted. FASB specified that an entity should adopt the guidance as of the beginning of its annual fiscal year.
FASB had published an exposure draft on the proposed Accounting Standards Update in July 2019. In the July 2019 exposure draft, FASB had also 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. However, due to the mixed feedback from stakeholders during the public comment period, FASB has decided not to include those proposed changes in the Accounting Standards Update. Consequently, FASB plans to continue to explore improvements on this aspect of the guidance in a separate Phase 2 project.
Keywords: Americas, US, Banking, Securities, Financial Instruments, Liabilities and Equity, GAAP, Convertible Instruments, Derivatives and Hedging, Accounting Standards Update, IFRS 9, Accounting, Reporting, FASB
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