The FASB has issued an exposure draft related to Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The exposure draft sets forth the FASB’s proposed changes for certain transactions that have elements of both debt and equity for which there have been inconsistencies in application of existing standards. The proposed ASU is split into three sections of changes to be considered: convertible instruments, derivatives scope exception, and earnings-per-share (EPS). The FASB feels that the proposed changes will reduce complexity by eliminating the number of accounting models for convertible debt instruments and by reducing form-over-substance-based conclusions for the derivatives scope exception for contracts in an entity’s own equity.

Existing GAAP includes five different accounting models for convertible debt instruments. Four of the models currently require embedded conversion features to be measured and classified as equity or liabilities. The proposed ASU seeks to eliminate the requirement to separate the embedded conversion feature. Therefore, a convertible debt instrument would be accounted for as a single liability and the related interest rate would be closer to the stated interest rate than under current GAAP. Additional disclosures would be expected about factors that influence conversion conditions, information on which party controls conversion rights and enhanced disclosures for contingently convertible instruments.

The proposed ASU would also remove the requirement for an entity to evaluate potential adjustments that have a remote likelihood of occurring when considering the indexation of an embedded feature or equity contract to its own stock. Additionally, the proposed ASU would also eliminate the requirement to evaluate contingent events that could require net cash settlement but have a remote likelihood of occurring. Under existing guidance both of the circumstances noted are required to be evaluated and often result in form-over-substance based conclusions for accounting treatment when evaluating embedded derivatives and freestanding financial contracts.

The proposed ASU would also enhance EPS guidance to align with the other proposed changes in particular as it relates to diluted EPS.

The FASB has proposed that these standards be applied as of the beginning of the year in which the amendments are adopted and would not impact accounting for transactions that settled in a prior reporting period. There is no indication of dates in which this proposed ASU would be effective, if approved.

Comments are due on this proposed ASU to the FASB by October 14, 2019. The full text of the Exposure Draft is available here.

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