FASB simplifies accounting for certain financial instruments

Following a Private Company Council recommendation, FASB issued a new standard Thursday that simplifies the accounting for certain financial instruments with down round features.

Down round features are a provision in an equity-linked financial instrument or embedded feature that provides a downward adjustment of the current exercise price based on the price of future equity offerings. Down round features are common in warrants, convertible preferred shares, and convertible debt instruments issued by private companies and development-stage public companies.

The new standard is a response to concerns that current accounting rules create unnecessary cost and complexity for organizations that issue financial statements with down round features. The cost and complexity are a result of a requirement on an ongoing basis for a fair value measurement of the entire instrument or conversion option.

Accounting Standards Update No. 2017-11 addresses these concerns by requiring companies to disregard the down round feature when assessing whether the instrument is indexed to its own stock, for purposes of determining liability or equity classification.

Companies that provide earnings-per-share data will adjust their basic EPS calculation for the effect of the feature when triggered and will also recognize the effect of the trigger within equity.

The new standard also addresses navigational concerns within the FASB Accounting Standards Codification (ASC) related to an indefinite deferral available to private companies with mandatorily redeemable financial instruments and certain noncontrolling interests. The deferral created significant “pending content” in the ASC.

FASB addressed this concern by reclassifying the indefinite deferral as a scope exception, which does not have an accounting effect.

The provisions in the new standard related to down rounds take effect for public business entities for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2018. For all other organizations, the amendments take effect for fiscal years beginning after Dec. 15, 2019, and interim periods within fiscal years beginning after Dec. 15, 2020. Early adoption is permitted for all organizations.

—Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is a JofA editorial director.