B1. This appendix includes the current guidance that has been referred to in this Issue Summary.
B2. The guidance on subsequent measurement and reclassification of contracts in an entity's own equity under Subtopic 815-40 states:
> > Equity Instruments—Permanent Equity
815-40-35-2 Contracts that are initially classified as equity under Section 815-40-25 shall be accounted for in permanent equity as long as those contracts continue to be classified as equity. Subsequent changes in fair value shall not be recognized as long as the contracts continue to be classified as equity.
> > Assets or Liabilities
815-40-35-4 All other contracts classified as assets or liabilities under Section 815-40-25 shall be measured subsequently at fair value, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as assets or liabilities.
> Reclassification of Contracts
815-40-35-9 If a contract is reclassified from permanent or temporary equity to an asset or a liability, the change in fair value of the contract during the period the contract was classified as equity shall be accounted for as an adjustment to stockholders' equity. The contract subsequently shall be marked to fair value through earnings. [Emphasis added.]
815-40-35-10 If a contract is reclassified from an asset or a liability to equity, gains or losses recorded to account for the contract at fair value during the period that the contract was classified as an asset or a liability shall not be reversed.
B3. The guidance on modifications of equity-classified awards under Topic 718 states:
718-20-35-2A An entity shall account for the effects of a modification as described in paragraphs 718-20-35-3 through 35-9, unless all the following are met:
a. The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification.
b. The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified.
c. The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified…
718-20-35-3 Except as described in paragraph 718-20-35-2A, a modification of the terms or conditions of an equity award shall be treated
as an exchange of the original award for a new award. In substance, the entity repurchases the original instrument by issuing a new instrument of equal or greater value, incurring additional compensation cost for any incremental value. The effects of a modification shall be measured as follows:
a. Incremental compensation cost shall be measured as the excess, if any, of the fair value of the modified award determined in accordance with the provisions of this Topic over the fair value of the original award immediately before its terms are modified, measured based on the share price and other pertinent factors at that date. As indicated in paragraph 718-10-30-20, references to fair value throughout this Topic shall be read also to encompass calculated value. The effect of the modification on the number of instruments expected to vest also shall be reflected in determining incremental compensation cost. The estimate at the modification date of the portion of the award expected to vest shall be subsequently adjusted, if necessary, in accordance with paragraph 718-10-35-3 and other guidance in Examples 14 through 15 (see paragraphs 718-20-55-107 through 55-121).
c. A change in compensation cost for an equity award measured at intrinsic value in accordance with paragraph 718-20-35-1 shall be measured by comparing the intrinsic value of the modified award, if any, with the intrinsic value of the original award, if any, immediately before the modification.
> > Short-Term Inducements
718-20-35-5 Except as described in paragraph 718-20-35-2A, a short-term inducement shall be accounted for as a modification of the short-terms of only the awards of employees who accept the inducement, and other inducements shall be accounted for as modifications of the terms of all awards subject to them.
> > Equity Restructuring or Business Combination
718-20-35-6 Exchanges of share options or other equity instruments or changes to their terms in conjunction with an equity restructuring or a business combination are modifications for purposes of this Subtopic. An entity shall apply the guidance in paragraph 718-20-35-2A to those exchanges or changes to determine whether it shall account for the effects of those modifications. Example 13 (see paragraph 718-20-55-103) provides further guidance on applying the provisions of this paragraph.
See paragraph 718-10-35-10 for an exception.
> > Repurchase or Cancellation
718-20-35-7 The amount of cash or other assets transferred (or liabilities incurred) to repurchase an equity award shall be charged to equity, to the extent that the amount paid does not exceed the fair value of the equity instruments repurchased at the repurchase date. Any excess of the repurchase price over the fair value of the instruments repurchased shall be recognized as additional compensation cost. An entity that repurchases an award for which the requisite service has not been rendered has, in effect, modified the requisite service period to the period for which service already has been rendered, and thus the amount of compensation cost measured at the grant date but not yet recognized shall be recognized at the repurchase date.
> > Cancellation and Replacement
718-20-35-8 Except as described in paragraph 718-20-35-2A, cancellation of an award accompanied by the concurrent grant of (or offer to grant) a replacement award or other valuable consideration shall be accounted for as a modification of the terms of the cancelled award. (The phrase offer to grant is intended to cover situations in which the service inception date precedes the grant date.) Therefore, incremental compensation cost shall be measured as the excess of the fair value of the replacement award or other valuable consideration over the fair value of the cancelled award at the cancellation date in accordance with paragraph 718-20-35-3. Thus, the total compensation cost measured at the date of a cancellation and replacement shall be the portion of the grant-date fair value of the original award for which the requisite service is expected to be rendered (or has already been rendered) at that date plus the incremental cost resulting from the cancellation and replacement.
718-20-35-9 A cancellation of an award that is not accompanied by the concurrent grant of (or offer to grant) a replacement award or other valuable consideration shall be accounted for as a repurchase for no consideration. Accordingly, any previously unrecognized compensation cost shall be recognized at the cancellation date.
B4. The guidance on modifications of liability-classified awards under Topic 718 states:
718-30-35-5 A modification of a liability award is accounted for as the exchange of the original award for a new award. However, because liability awards are remeasured at their fair value (or intrinsic value for a nonpublic entity that elects that method) at each reporting date, no special guidance is necessary in accounting for a modification of a liability award that remains a liability after the modification (see Example 15, Case C [paragraph718-20-55-135] for what happens when the modification causes the award to no longer be a liability).
B5. The guidance on nonemployee share based payments under Topic 718 states:
718-10-25-2B Transactions with nonemployees in which share-based payment awards are granted in exchange for the receipt of goods or services may involve a contemporaneous exchange of the share-based payment awards for goods or services or may involve an exchange that spans several financial reporting periods. Furthermore, by virtue of the terms of the exchange with the grantee, the quantity and terms of the share-based payment awards to be granted may be known or not known when the transaction arrangement is established because of specific conditions dictated by the agreement (for example, performance conditions). Judgment is required in determining the period over which to recognize cost, otherwise known as the nonemployee’s vesting period 718-10-25-2C This guidance does not address the period(s) or the manner (that is, capitalize versus expense) in which an entity granting the share-based payment award (the purchaser or grantor) to a nonemployee shall recognize the cost of the share-based payment award that will be issued, other than to require that an asset or expense be recognized (or previous recognition reversed) in the same period(s) and in the same manner as if the grantor had paid cash for the goods or services instead of paying with or using the share-based payment award. A share-based payment award granted to a customer shall be reflected as a reduction of the transaction price and, therefore, of revenue as described in paragraph 606-10-32-25 unless the payment to the customer is in exchange for a distinct good or service, in which case the guidance in paragraph 606-10-32-26 shall
718-10-35-1F …As the goods or services are disposed of or consumed, the grantor shall recognize the related cost. For example, when inventory is sold, the cost is recognized in the income statement as cost of goods sold, and as services are consumed, the cost usually is recognized in determining net income of that period, for example, as expenses incurred for services. In some circumstances, the cost of services (or goods) may be initially capitalized as part of the cost to acquire or construct another asset, such as inventory, and later recognized in the income statement when that asset is disposed of or consumed.
B6. The guidance on inducement offers under Topic 470 states:
470-20-40-13 The guidance in paragraph 470-20-40-16 applies to conversions of convertible debt to equity securities pursuant to terms that reflect changes made by the debtor to the conversion privileges provided in the terms of the debt at issuance (including changes that involve the payment of consideration) for the purpose of inducing conversion. That guidance applies only to conversions that both:
a. Occur pursuant to changed conversion privileges that are exercisable only for a limited period of time (inducements offered without a restrictive time limit on their exercisability are not, by their structure, changes made to induce prompt conversion)
b. Include the issuance of all of the equity securities issuable pursuant to conversion privileges included in the terms of the debt at issuance for each debt instrument that is converted, regardless of the party that initiates the offer or whether the offer relates to all debt holders.
470-20-40-16 If a convertible debt instrument is converted to equity securities of the debtor pursuant to an inducement offer (see paragraph 470-20-40-13), the debtor shall recognize an expense equal to the fair value of all securities and other consideration transferred in the transaction in excess of the fair value of securities issuable pursuant to the original conversion terms. The fair value of the securities or other consideration shall be measured as of the date the inducement offer is accepted by the convertible debt holder. That date normally will be the date the debt holder converts the convertible debt into equity securities or enters into a binding agreement to do so. Until the debt holder accepts the offer, no exchange has been made between the debtor and the debt holder. Example 1 (see paragraph 470-20-55-1) illustrates the application of this guidance.
B7. The guidance on accounting for equity issuance cost discussed in SAB Topic 5.A, Expenses of Offering, and codified in Topic 340, states:
340-10-S99-1 The following is the text of SAB Topic 5.A, Expenses of Offering.
Facts: Prior to the effective date of an offering of equity securities, Company Y incurs certain expenses related to the offering.
Question: Should such costs be deferred?
Interpretive Response: Specific incremental costs directly attributable to a proposed or actual offering of securities may properly be deferred and charged against the gross proceeds of the offering. However, management salaries or other general and administrative expenses may not be allocated as costs of the offering and deferred costs of an aborted offering may not be deferred and charged against proceeds of a
subsequent offering. A short postponement (up to 90 days) does not represent an aborted offering.
B8. The SEC Staff Announcement: The Effect on the Calculation of Earnings Per Share for a Period That Includes the Redemption or Induced Conversion of Preferred Stock, codified in Topic 260, states:
260-10-S99-2 This SEC staff announcement applies to redemptions and induced conversions of equity-classified preferred stock instruments. For purposes of this announcement:
1. Modifications and exchanges of preferred stock instruments that are accounted for as extinguishments, resulting in a new basis of accounting for the modified or exchanged preferred stock instrument, are considered redemptions.
2. A preferred stock instrument classified within temporary equity pursuant to the guidance in ASR 268 and paragraph 480-10-S99-3A is considered equity-classified, and redemptions and induced conversions of such securities would be subject to this guidance.
3. If an equity-classified security is subsequently required to be reclassified as a liability based on the provisions of other GAAP (for example, because a preferred share becomes mandatorily redeemable pursuant to Subtopic 480-10), the reclassification is considered a redemption of equity by issuance of a debt instrument.
The accounting for conversions of preferred stock instruments into other equity-classified securities pursuant to conversion privileges provided in the terms of the instruments at issuance is not affected by this announcement.
The Effect on Income Available to Common Stockholders of a Redemption or Induced Conversion of Preferred Stock
If a registrant redeems its preferred stock, the SEC staff believes that the difference between (1) the fair value of the consideration transferred to the holders of the preferred stock and (2) the carrying amount of the preferred stock in the registrant's balance sheet (net of issuance costs) should be subtracted from (or added to) net income to arrive at income available to common stockholders in the calculation of earnings per share. The SEC staff believes that the difference between the fair value of the consideration transferred to the holders of the preferred stock and the carrying amount of the preferred stock in the registrant’s balance sheet represents a return to (from) the preferred stockholder that should be treated in a manner similar to the treatment of dividends paid on preferred stock. This calculation guidance applies to redemptions of convertible preferred stock regardless of whether the embedded conversion feature is
"in-the-money" or "out-of-the-money" at the time of redemption. The fair value of the consideration transferred is reduced by the commitment date intrinsic value of the conversion option if the redemption includes the reacquisition of a previously recognized beneficial conversion feature in a convertible preferred stock instrument.
If convertible preferred stock is converted into other securities issued by the registrant pursuant to an inducement offer, the SEC staff believes that the excess of (1) the fair value of all securities and other consideration transferred in the transaction by the registrant to the holders of the convertible preferred stock over (2) the fair value of securities issuable pursuant to the original conversion terms should be subtracted from net income to arrive at income available to common stockholders in the
calculation of earnings per share. Registrants should consider the guidance provided in Subtopic 470-20 to determine whether the conversion of preferred stock is pursuant to an inducement offer.
B9. The speech by T. Kirk Crews, SEC Professional Accounting Fellow, at the 2014 AICPA National Conference on Current SEC and PCAOB Developments, states:
Accounting for amendments to or exchanges of preferred stock
…the Financial Accounting Standard Board’s (FASB) Codification does not explain how to determine whether amendments to preferred stock represent an extinguishment or modification. Before we move forward, I want to be clear my focus today is only on equity-classified preferred stock, as liability-classified preferred stock should follow the existing debt modification and extinguishment guidance.
The staff believes that an amendment to preferred stock can be of such significance that it represents an extinguishment of the existing preferred stock and the issuance of new preferred stock. On the other hand, the staff also believes that an amendment to preferred stock, while important to the parties, can lack the same level of significance and is more appropriately characterized as a modification. We believe current accounting literature supports this view. First, debt literature acknowledges that certain changes are merely modifications while other changes should be captured by extinguishment accounting. The staff believes it is appropriate to apply similar analysis to preferred stock.
Second, in September 2009 when technical corrections were made to the scoping guidance to ASC 260-10-S99, the staff believed exchanges of preferred stock could be either extinguishments or modifications.
Two issues remain:
• How do you determine whether an amendment or exchange is a modification or extinguishment? whether an amendment or exchange is a modification or extinguishment is what I will call a “Qualitative Approach.” Under this approach, one considers the significance of any contractual terms added, contractual terms removed, and changes to existing contractual terms. It is also necessary to evaluate the business purpose for the changes and how the changes may influence the economic decisions of the investor. If these changes are judged to be significant, the amendments or exchange would be treated as an extinguishment; otherwise, the changes are considered a modification to the preferred stock.
We are also aware of other approaches in practice that would seem to yield reasonable conclusions.
We have seen what I will call a “Fair Value Approach” used in practice.
Under this approach, the fair value of the preferred stock after the amendment is compared to the fair value of the preferred stock immediately before the amendment to determine if the preferred stock is substantially different. For purposes of this approach, if there is a 10% or
greater change in the fair value of the preferred stock, the preferred stock is considered substantially different and the amendment or exchange would be accounted for as an extinguishment. If the change is less than 10% the preferred stock was simply modified.
We have also seen what I will call a “Cash Flow Approach.” This approach is similar to the “Fair Value Approach” except that contractual cash flows are evaluated, rather than the fair value. This approach may only be reasonable, however, when the preferred stock has well-defined periodic contractual cash flows.
Finally, we have seen what I will call a “Legal Form Approach.” Under this approach, any legal exchange resulting in the issuance of new preferred stock would be viewed as an extinguishment. Otherwise, any change in terms (regardless of significance) that does not result in the legal exchange of the preferred stock would be captured as a modification.
We understand that debt and equity literature can be form driven, however, the staff cautions that the legal form is merely one data point to consider and should not be viewed as determinative with respect to this
We understand that debt and equity literature can be form driven, however, the staff cautions that the legal form is merely one data point to consider and should not be viewed as determinative with respect to this