Defining Issues | December 2016
 

Proposed changes to down-round financial instruments

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KPMG CL about FASB ED Distinguishing Liabilities from Equity-File Re. No. 2016-370

KPMG reports on the FASB’s proposed ASU impacting down-round financial instruments. The proposals on equity-linked instruments with down-round features aim to make the accounting guidance easier to use.

Applicability

Proposed ASU on ASC Topic 480

  • Company that has financial instruments with down-round features

Relevant dates

  • December 7, 2016 – FASB issued proposed ASU
  • February 6, 2017 – Comments due on proposed ASU

Key impacts

  • The proposed ASU would affect classification and accounting for equity-linked instruments with down-round features. These instruments include warrants and convertible debt instruments that have an equity conversion option for which other guidance does not require separation of the equity conversion option from the debt host
  • A company would no longer have to account for freestanding and embedded financial instruments with down-round features as liabilities subject to fair value measurement on an ongoing basis, if they otherwise qualify for equity classification
  • The consequences of down-round features would be reflected only when triggered, rather than including the down-round feature in ongoing fair value measurements of the instrument
  • The indefinite deferral for mandatorily redeemable instruments of certain nonpublic entities and NCI would be converted to a scope exception – i.e. no change in current practice

A down-round feature is a provision in an equity-linked instrument that reduces the strike price of a financial instrument if the entity:

  • sells additional shares of its common stock for an amount less than the current strike price of the equity-linked instrument; or
  • issues an equity-linked instrument with a strike price below the current strike price of the financial instrument.

A down-round feature exists to protect certain investors from a decline in an entity’s share price. Although a down-round feature is not normally a significant driver of the fair value of the instrument, the fair value of that instrument is somewhat greater than a similar equity-linked instrument without a down-round feature.

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Report contents

  • Financial instruments with down-round features
  • Scope exception for mandatorily redeemable financial instruments
  • Effective dates and transition

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