In August 2020, the FASB issued ASU 2020-06, Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity that is intended to simplify the accounting for certain financial instruments with characteristics of liabilities and equity. The existing guidance can be complex for both preparers to apply and users to understand.

For convertible debt and convertible preferred stock, ASU 2020-06 reduces the number of available accounting models. Under ASU 2020-06, a convertible debt instrument will be accounted for as a single liability measured at its amortized cost and a convertible preferred stock instrument will be accounted for as a single equity instrument measured at its historical cost, as long as no other features require bifurcation and recognition as derivatives. This is expected to result in more convertible instruments being accounted for as a single unit.

For contracts in an entity’s own equity, ASU 2020-06 removes several criteria that preclude a contract from being classified in equity and clarifies the other criteria. This is expected to result in more contracts being classified in equity and more embedded derivatives meeting the scope exception. ASU 2020-06 also simplifies the calculation of earnings per share when these types of instruments are present and updates disclosure requirements.

The amendments are effective for public business entities that are not smaller reporting companies for fiscal years starting after December 15, 2021 and, for all other entities, for fiscal years starting after December 15, 2023. Early adoption is allowed, but no earlier than fiscal years starting after December 15, 2020. Adoption must be as of the beginning of a fiscal year. Entities can elect either the modified retrospective method, with a cumulative-effect adjustment as of the date of adoption or the full retrospective method with a cumulative-effect adjustment to the opening balance of the earliest period presented.

The full text of ASU 2020-06 is available here.

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