The Financial Accounting Standards Board (FASB) recently issued a standards update designed to clarify the accounting for modifications or exchanges of freestanding equity-classified written call options—such as warrants—that remain equity-classified after modification or exchange based on consideration of the economic substance of the modification or exchange.

ASU 2021-04: Modification of Equity Classified Written Call Options, provides measurement and recognition guidance for modification or exchanges of freestanding equity-classified written call options that are not within the scope of other authoritative codification guidance, such as ASC 718.

The new guidance addresses input received from stakeholders regarding the diversity in the accounting for economically similar modifications or exchanges of freestanding equity-classified written call options. This was due to lack of explicit guidance in the FASB’s standards codification. In response, the new guidelines are meant to clarify whether an issuer should account for a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange as:

  • An adjustment to equity and, if so, the related earnings per share effects, or
  • An expense, and if so, the manner and pattern of recognition.

Who Is Affected?

All entities that modify or exchange freestanding written call options that are classified in equity. It does not affect the accounting by holders of such instruments.

The Main Provisions of ASU 2021-04

Entities modify or exchange written call options for a variety of reasons. For example, modifications of warrants commonly occur with the issuance or modification of debt and/or equity instruments.They are also frequently modified in connection with compensation arrangements entered into with various counterparties. The issuer must evaluate the facts and circumstances of a modification or exchange of an equity classified freestanding written call option and account for a change in fair value of the written call option (measured as the difference between the fair value of the modified or exchanged written call option and the fair value of the original written call option immediately prior to modification or exchange), based on the reasons for the modification or exchange:

Modification or Exchange is Due to the:

Accounting Treatment:

Issuance of Equity

Any increase in fair value is accounted for as an equity issuance cost that reduces paid in capital.

Issuance of debt

Any increase in fair value is accounted for as a debt issuance cost or a discount pursuant to the guidance provided by ASC 835.

Result of a modification of an existing debt instrument

Any change in the fair value of a warrant held by a creditor is included in the 10% cash flow test when determining modification or extinguishment pursuant to ASC 470-50.Additionally, the change in fair value is considered a fee between the debtor and the creditor pursuant to the application of ASC 470-50 and when evaluating ASC 470-60 – Troubled Debt Restructuring.

The effect of a freestanding equity-classified written call option to compensate for goods or services

This should be recognized in accordance with the guidance in Topic 718, Compensation—Stock Compensation. In a multiple-element transaction (for example, one that includes both debt and equity financing), the modification’s total effect should be allocated to the respective elements in the transaction.

Any reason other than the rows above

Any increase in fair value is accounted for as a deemed dividend that reduces retained earnings and EPS, provided that the modification is not within the scope of other FASB Codification guidance.

If a modification or exchange is considered to have been the result of more than one of the categories noted above, the issuer is required to allocate any change in fair value among the categories and follow the accounting prescribed accordingly.

When Will the Accounting Changes Go Into Effect?

The guidance is applied prospectively to all modifications or exchanges that occur on or after the date of adoption. It is effective for fiscal years beginning after Dec. 15, 2021, including interim periods within those fiscal years.

Early adoption is permitted for all entities, including adoption in an interim period. If an entity elects to adopt the amendments during an interim period, the guidance should be applied as of the beginning of the fiscal year that includes the interim period.

For More Information

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Published on August 03, 2021