FASB guidance will impact financial instruments with down round features

In brief , PwC US Jul 18, 2017

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FASB guidance will impact financial instruments with down round features. We explain.

What happened?

On July 13, 2017, the FASB issued guidance1 intended to reduce the complexity associated with the issuer’s accounting for certain financial instruments with characteristics of liabilities and equity. Specifically, the Board determined that a down round feature (as defined) would no longer cause a freestanding equity-linked financial instrument (or an embedded conversion option) to be accounted for as a derivative liability at fair value with changes in fair value recognized in current earnings. In addition, the Board re-characterized the indefinite deferral of certain provisions of Topic 480 to a scope exception. The re-characterization has no accounting effect.

At a glance

The FASB determined that a down round feature does not preclude a freestanding equity-linked financial instrumental from being classified as equity.


Why is this important?

The change to the guidance relating to down round features is a significant change from existing practice. Down round features are most often found in warrants and conversion options embedded in debt or preferred equity instruments issued by private entities, but may be found in financial instruments issued by public companies. These features reduce the strike price of the warrant or conversion option when an issuer sells shares of its stock (or issues equity-linked instruments) for amounts less than the current strike price (or with strike prices less than the current strike). Down round features will no longer cause freestanding equity-linked financial instruments and embedded conversion options to be considered “not indexed to an entity’s own stock.”

When a down round feature is triggered on an equity-classified freestanding financial instrument (i.e., when the strike price is reduced), entities that present earnings per share must recognize the value of the effect of the down round feature as a dividend, which should be reflected as a reduction of income available to common stockholders in the computation of basic earnings per share.

The new guidance also provides for additional disclosures, including the existence of the down round feature and the financial statement impact upon its trigger.

What's next?

The changes are effective for public business entities in 2019. All others have an additional year. Early adoption is permitted for all entities, including in an interim period. Entities may use the retrospective or modified retrospective transition method.


1Accounting Standards Update 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815) I. Accounting for Certain Financial Instruments with Down Round Features II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception

To have a deeper discussion, contact:

Chip Currie

Partner, National Professional Services Group, PwC US


John F. Horan

Managing Director, National Professional Services Group, PwC US


Colleen Surace

Senior Manager, National Professional Services Group, PwC US


Contact us

David Schmid
IFRS & US Standard Setting Leader, National Professional Services Group, PwC US

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