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Issuers' accounting for debt and equity capital transactions: Key differences between U.S. GAAP and IFRSs

Under U.S. GAAP, there are numerous sources of guidance on issuers' accounting for debt and equity capital transactions, including ASC 470, ASC 480, ASC 505, ASC 815, ASC 825, and ASC 835.

Under IFRSs, IAS 32, Financial Instruments: Presentation, as interpreted by IFRIC Interpretation 2, Members' Shares in Co-operative Entities and Similar Instruments; IFRIC Interpretation 19, Extinguishing Financial Liabilities With Equity Instruments; IAS 39, Financial Instruments: Recognition and Measurement; and IFRS 9, Financial Instruments, are the primary sources of guidance on issuers' accounting for debt and equity capital transactions.

Note that IFRS 9 was originally issued in November 2009. An entity must adopt IFRS 9 for annual periods beginning on or after January 1, 2018; early adoption is permitted.

The table below summarizes the differences between U.S. GAAP and IFRSs in issuers' accounting for debt and equity capital transactions and is followed by a detailed explanation of each difference.1

SubjectU.S. GAAPIFRSs

Debt — presentation of debt issue costs

For liabilities carried at amortized cost, debt issue costs may be capitalized as an asset.

Debt issue costs are never capitalized as an asset.

Modification or exchange of debt instruments

Principle — An extinguishment gain or loss is recognized if the terms are substantially different. The assessment is based, in part, on a "10 percent cash flow" test. There is detailed guidance on determining the present value of the cash flows.

Third-party costs (e.g., legal fees) — If an extinguishment occurs, the effective interest method is used to amortize such costs. If no extinguishment occurs, then such costs are expensed.

Convertible debt — There is specific guidance on evaluating a modification that affects an embedded conversion option.

Troubled debt restructurings — Gain recognition is precluded for troubled debt restructurings unless the total future cash payments specified by the new terms are less than the carrying amount.

Principle — An extinguishment gain or loss is recognized if the terms are substantially different. The assessment is based on a "10 percent cash flow" test. There is less detailed guidance on determining the present value of the cash flows.

Third-party costs (e.g., legal fees) — If an extinguishment occurs, such costs are expensed. If no extinguishment occurs, the effective interest method is used to amortize such costs.

Convertible debt — Entities apply the 10 percent cash flow test.

Troubled debt restructurings — Entities apply the 10 percent cash flow test.

Convertible debt — Separation of the conversion option

A conversion option is only separated in certain circumstances.

Separation of the conversion option is always required (either as equity or as a derivative liability).

Convertible debt — Conversion into equity pursuant to original terms

Conversion of convertible debt in accordance with the original terms sometimes results in a gain or loss.

Conversion of convertible debt in accordance with the original terms under which the conversion option is recognized in equity does not result in a gain or loss.

Convertible debt — Early redemption (extinguishment)

Entities typically do not allocate between liabilities and equity consideration paid upon redemption or repurchase.

Entities allocate the consideration paid upon redemption or repurchase between the liability and equity components on the basis of the fair value of the liability component.

Convertible debt — Multiple settlement alternatives upon conversion

Separation of the conversion option as an embedded derivative is required unless the issuer cannot be forced to settle for cash.

Separation of the conversion option is always required. An issuer generally is precluded from classifying the conversion option as equity; instead, the issuer must account for the conversion option as an embedded derivative.

Puttable or contingently redeemable equity securities

Typically, such instruments are classified as equity or, by SEC registrants, as mezzanine equity.

Typically, such instruments are classified as liabilities. There is no mezzanine equity classification under IFRSs.

Obligations to issue a variable number of equity shares

Accounted for as equity, unless they meet certain conditions.

Accounted for as liabilities.

Derivatives indexed to, and potentially settled in, the entity's own stock that the issuer has the ability to net-share settle

Except for written put options and forward repurchase contracts, classified as equity unless the issuer could be forced to settle in cash.

Accounted for as assets or liabilities.

Rights, options, or warrants on a fixed number of an entity’s equity instruments whose exercise price is a fixed amount of a foreign currency

Cannot be accounted for as equity instruments.

May qualify as equity instruments.

Written put options on an entity's own equity

Accounted for at fair value.

Accounted for at the present value of the redemption amount (exercise price) unless they can only be net settled.

Forward purchase contracts on an entity's own equity

If net share or net cash settlement is an alternative, subsequent measurement is at fair value (even if gross physical share settlement is an alternative).

If gross physical share settlement is an alternative, subsequent measurement is at the present value of the redemption amount (even if net share or net cash settlement is an alternative).

Debt — Presentation of Debt Issue Costs

Under U.S. GAAP, ASC 835-30-45-3 indicates that issuers of debt defer and amortize debt issue costs unless the fair value option under ASC 825-10 is applied to the debt, in which case, in accordance with ASC 825-10-25-3, the debt issue costs are expensed immediately. Deferred debt issue costs are capitalized as an asset in accordance with ASC 835-30-45-3 or treated as a reduction of the related liability as indicated in paragraph 237 of FASB Concepts Statement No. 6, Elements of Financial Statements.

Under IFRSs, paragraph 43 of IAS 39 (paragraph 5.1.1 of IFRS 9 for entities that have adopted IFRS 9) indicates that issuers of debt initially recognize a liability at its fair value2 less transaction costs that are directly attributable to the issuance of the debt unless the debt will subsequently be accounted for at fair value, in which case debt issue costs are expensed immediately. Thus, under IFRSs, deferred debt issue costs are presented as a reduction of the related liability. Unlike U.S. GAAP, IFRSs prohibit entities from capitalizing debt issue costs as an asset.

Modification or Exchange of Debt Instruments

Principle

U.S. GAAP and IFRSs have similar principles for determining whether a modification or exchange of debt instruments should be accounted for as an extinguishment. This is an important determination because if an extinguishment of issued debt occurs, an entity must derecognize the existing debt and recognize a possible gain or loss in income. Both sets of standards require an entity to determine whether the terms of a debt instrument are substantially different after the modification or exchange.

Under both U.S. GAAP and IFRSs, the terms are considered substantially different if the discounted present value of the cash flows under the new terms (including any fees paid net of any fees received and discounted by using the original effective interest rate) is at least 10 percent different from the discounted present value of the remaining cash flows of the original financial liability. Under U.S. GAAP, there is specific guidance on how an entity should calculate the present value of the cash flows when applying the "10 percent cash flow" test. IFRSs do not have similar detailed guidance. For more information, see ASC 470-50-40 and paragraphs 40 and AG62 of IAS 39 (paragraphs 3.3.2 and B3.3.6 of IFRS 9 for entities that have adopted IFRS 9).

In addition, under IFRSs, if an entity extinguishes all or part of a financial liability by issuing equity instruments to a creditor, it must also consider the requirements of IFRIC 19. Paragraph 5 of IFRIC 19 clarifies that "the issue of an entity’s equity instruments to a creditor to extinguish all or part of a financial liability is consideration paid [in determining a debt extinguishment gain or loss] in accordance with paragraph 41 of IAS 39 [paragraph 3.3.3 of IFRS 9]."

Third-Party Costs (e.g., Legal Fees)

U.S. GAAP and IFRSs differ in their guidance on accounting for third-party costs that are directly related to an exchange or modification (e.g., legal fees). ASC 470-50-40-18 indicates:

a. If the exchange or modification is to be accounted for in the same manner as a debt extinguishment and the new debt instrument is initially recorded at fair value, then the costs shall be associated with the new debt instrument and amortized over the term of the new debt instrument using the interest method in a manner similar to debt issue costs.

b. If the exchange or modification is not to be accounted for in the same manner as a debt extinguishment, then the costs shall be expensed as incurred.

Thus, under U.S. GAAP, third-party costs are amortized over the term of the new debt instrument if extinguishment accounting applies and are expensed as incurred if extinguishment accounting does not apply.

Under IFRSs, paragraph AG62 of IAS 39 (paragraph B3.3.6 of IFRS 9 for entities that have adopted IFRS 9) indicates that if an entity accounts for an exchange of debt instruments or modification of terms as an extinguishment, it recognizes any costs or fees "as part of the gain or loss on the extinguishment." If, however, the entity does not account for the exchange or modification as an extinguishment, any costs or fees incurred will result in an adjustment to the carrying amount of the liability and will be amortized "over the remaining term of the modified liability."

Convertible Debt

Under U.S. GAAP, ASC 470-50-40-12(g) and ASC 470-50-40-15 and 40-16 indicate:

The change in the fair value of an embedded conversion option resulting from an exchange of debt instruments or a modification in the terms of an existing debt instrument shall not be included in the 10 percent cash flow test. Rather, a separate test shall be performed by comparing the change in the fair value of the embedded conversion option to the carrying amount of the original debt instrument immediately before the modification, as specified in paragraph 470-50-40-10(a). . . .

If a convertible debt instrument is modified or exchanged in a transaction that is not accounted for as an extinguishment, an increase in the fair value of the embedded conversion option (calculated as the difference between the fair value of the embedded conversion option immediately before and after the modification or exchange) shall reduce the carrying amount of the debt instrument (increasing a debt discount or reducing a debt premium) with a corresponding increase in additional paid-in capital. However, a decrease in the fair value of an embedded conversion option resulting from a modification or an exchange shall not be recognized.

The issuer shall not recognize a beneficial conversion feature or reassess an existing beneficial conversion feature upon a modification or exchange of convertible debt instruments in a transaction that is not accounted for as an extinguishment.

Similar guidance does not exist under IFRSs. Instead, entities apply the same 10 percent cash flow test to modifications of convertible debt that they apply to other exchanges and modifications of debt instruments.

Troubled Debt Restructurings

Under U.S. GAAP, issuers account for troubled debt restructurings in accordance with ASC 470-60. ASC 470-60-35-5 states, in part:

A debtor in a troubled debt restructuring involving only modification of terms of a payable — that is, not involving a transfer of assets or grant of an equity interest — shall account for the effects of the restructuring prospectively from the time of restructuring, and shall not change the carrying amount of the payable at the time of the restructuring unless the carrying amount exceeds the total future cash payments specified by the new terms.

Thus, debtors subject to the troubled debt restructuring guidance in ASC 470-60 only recognize a gain when, according to ASC 470-60-35-6, "the total future cash payments specified by the new terms of a payable, including both payments designated as interest and those designated as face amount, are less than the carrying amount of the payable." Note that the guidance on troubled debt restructurings differs from the guidance on convertible debt in ASC 470-50 in that, under ASC 470-60, there is no 10 percent cash flow test for use in determining whether a gain should be recognized.

Similar guidance does not exist under IFRSs. Instead, debtors apply the same 10 percent cash flow test to troubled debt restructurings that they apply to other exchanges and modifications of debt instruments.

Convertible Debt

Separation of the Conversion Option

Under U.S. GAAP, separation of convertible debt into a liability and an equity component is precluded unless one of the following conditions is satisfied:

  • The conversion option is a detachable stock purchase warrant that meets the requirements for equity classification in U.S. GAAP, in which case, in accordance with ASC 470-20-25-2, the amount in equity is recognized on the basis of a relative fair value allocation.
  • The convertible debt is issued at a substantial premium, in which case, in accordance with ASC 470-20-25-13, the premium is treated as additional paid-in capital.
  • The conversion option is in the money for the holder as of the commitment date of the convertible debt (generally this is the date on which a firm commitment to issue convertible debt was made). In this case, a portion of the proceeds that is equal to the intrinsic value of the option is allocated to equity in accordance with ASC 470-20-25-5. Under U.S. GAAP, such a conversion option is referred to as a "beneficial conversion feature."
  • The convertible debt instrument is subject to the requirements of the Cash Conversion Subsection of ASC 470-20. In this case, in accordance with ASC 470-20-25-22 through 25-25, the liability and equity components of the convertible debt instrument must be separately accounted for in a manner that reflects the issuer's nonconvertible debt borrowing rate.
  • The conversion option meets the definition of a derivative under ASC 815 and does not qualify for the scope exception in ASC 815-10-15-74(a) for contracts issued by a reporting entity that are both (1) indexed to its own stock and (2) classified as stockholders' equity. In this case, the convertible debt is separated into two liability components (a debt host and an embedded derivative liability). (See also ASC 815-40-15-7 and ASC 815-40-25.)

Under IFRSs, paragraphs 28 and 29 of IAS 32 explain that if a nonderivative financial instrument contains both a liability and an equity component, each component should be recognized and accounted for separately. For example, if the equity conversion option in a convertible debt instrument settles "fixed-for-fixed" (i.e., a fixed number of own equity shares is to be exchanged for a fixed principal amount of debt denominated in the functional currency of the issuer), the convertible debt is separated into a liability and an equity component. In accordance with paragraph 31 of IAS 32, an issuer separates the instrument into its components by determining the fair value of the liability component and then deducting the liability component from the fair value of the instrument as a whole; the resulting residual amount is the equity component. The financial liability component is then measured under IAS 39 (IFRS 9 for entities that have adopted IFRS 9) according to its classification (i.e., a financial liability measured at fair value through profit or loss or a liability measured at amortized cost under the effective interest rate method). The equity component is classified as equity and is not remeasured. This accounting treatment is similar to that under U.S. GAAP for convertible debt instruments within the scope of the Cash Conversion Subsections of ASC 470-20; however, as discussed in the Multiple Settlement Alternatives Upon Conversion section below, financial instruments within the scope of the Cash Conversion Subsection of ASC 470-20 would include a derivative component, not an equity component, under IFRSs, since the conversion option can be cash-settled.

If the equity conversion option does not settle "fixed-for-fixed," it does not meet the conditions for equity classification under IFRSs and the convertible debt would be separated into two liability components: a debt host contract and an embedded derivative liability. (See, for example, paragraph AG30(f) of IAS 39.)

The equity conversion option under U.S. GAAP is separated only in certain circumstances (see above), while this option must always be separated under IFRSs (either as an equity component or as an embedded derivative). In addition, the definition of a derivative and the criteria for classification as equity under U.S. GAAP differ from those under IFRSs; as a result, an entity may sometimes be required to account for the equity conversion option as a separately recognized embedded derivative under IFRSs, but not under U.S. GAAP. To determine the proper accounting for the equity conversion feature, an issuer must perform a detailed analysis of the feature's terms and conditions in the given circumstances.

Conversion Into Equity Pursuant to the Original Terms

Under U.S. GAAP the accounting for the conversion of a convertible debt instrument into an issuer's equity shares depends on the facts and circumstances, which may include the following:

  • If the debt contained a substantive conversion feature as of its issuance date, but no beneficial conversion feature, under ASC 470-20-40-4 and 40-5 the "carrying amount[3] of the debt, including any unamortized premium or discount, shall be credited to the capital accounts upon conversion to reflect the stock issued and no gain or loss is recognized."
  • If the debt instrument was separated into its liability and equity components in accordance with the Cash Conversion Subsection of ASC 470-20, a portion of the fair value of the equity instruments issued upon conversion is allocated to the extinguishment of the liability component of the debt instrument on the basis of the fair value of the liability component as of the conversion date. Any difference between this amount and the net carrying amount of the extinguished debt component should be recognized currently in income.
  • If the debt includes a beneficial conversion option, according to ASC 470-20-40-1, "all of the unamortized discount remaining at the date of conversion shall be recognized immediately at that date as interest expense or as a dividend, as appropriate, including both of the following amounts: (a) The discount originated by the beneficial conversion option accounting under paragraph 470-20-25-5 [and] (b) The discount from an allocation of proceeds under this Subtopic to other separable instruments included in the transaction."
  • If the debt became convertible upon the issuer's exercise of a call option and did not otherwise contain a substantive conversion feature as of its issuance date, debt extinguishment accounting applies. (For more information see ASC 470-20-05-11 and ASC 470-20-40-5 through 40-10.) ASC 470-50-40-2 indicates that under debt extinguishment accounting, any "difference between the reacquisition price of debt and the net carrying amount of the extinguished debt shall be recognized currently in income of the period of extinguishment as losses or gains and identified as a separate item."

Under IFRSs, paragraph AG32 of IAS 32 indicates that upon conversion of convertible debt at maturity in a situation in which an instrument is bifurcated into a financial liability and an equity component, the original equity component remains as equity (although it may be reclassified from one line item of equity to another) and the liability component is derecognized. No gain or loss is recognized upon conversion.

Under U.S. GAAP, conversion of convertible debt pursuant to the original conversion terms sometimes results in a gain or loss (as discussed above), while under IFRSs, conversion in accordance with the original conversion terms does not result in a gain or loss.

Early Redemption (Extinguishment)

Under U.S. GAAP, ASC 470-50-40-4 indicates that upon redemption or repurchase of convertible debt that does not contain a beneficial conversion feature, an entity should recognize an extinguishment gain or loss equal to the difference between the reacquisition price and the net carrying amount of the extinguished debt. For convertible debt within the scope of the Cash Conversion Subsection of ASC 470-20, the reacquisition price of the extinguished debt is the portion of the redemption amount allocated to the extinguishment of the liability component (i.e., the fair value of the liability component as of the extinguishment date). ASC 470-20-40-3 states that if convertible debt that contains a beneficial conversion feature is extinguished before conversion, the amount of the reacquisition price equal to the intrinsic value of the conversion feature as of the extinguishment date is allocated to equity and the remaining amount is allocated to the extinguishment of the debt.

Under IFRSs, paragraph AG33 of IAS 32 indicates that when an entity redeems or repurchases a convertible instrument before its maturity (without altering the conversion feature), the consideration paid (including any transaction costs) is allocated to the liability and equity components as of the date of the early redemption or repurchase on the basis of the fair value of the liability component as of the extinguishment date. To the extent that the amount of the consideration allocated to the liability component differs from the carrying amount of the liability component at that time, a gain or loss is recorded in the income statement. The amount of consideration allocated to the equity component is recorded in equity with no gain or loss recorded.

Under U.S. GAAP, other than for convertible debt accounted for in accordance with the Cash Conversion Subsection of ASC 470-20, entities either do not allocate consideration paid or allocate the consideration paid on the basis of the intrinsic value of the conversion feature as of the extinguishment date for instruments with beneficial conversion features. Under IFRSs, however, entities allocate the consideration paid between the liability and equity components on the basis of the fair value of the liability component.

Multiple Settlement Alternatives Upon Conversion

Under U.S. GAAP, if the embedded conversion option is indexed to the issuer's stock and would be classified in shareholders' equity on a freestanding basis, it would not be bifurcated as an embedded derivative. However, convertible debt with an issuer option upon conversion to settle the conversion value entirely in either stock or cash ("Instrument B"), or the accreted value in cash and the conversion spread in either cash or stock ("Instrument C"), should be separated into an equity and liability component that is accounted for in a manner that reflects the issuer's nonconvertible debt borrowing rate (see ASC 470-20-30-27 through 30-29 for guidance on the initial measurement).

Under IFRSs, paragraph 26 of IAS 32 indicates that an entity must always separate the conversion option as an embedded derivative when any of the settlement alternatives result in a cash settlement upon conversion.

Therefore, under U.S. GAAP, instruments with conversion options that may be settled in cash often do not result in bifurcation of embedded derivatives, while under IFRSs such conversion options are separated and accounted for as embedded derivative liabilities.

Puttable or Contingently Redeemable Equity Securities

Under U.S. GAAP, puttable or contingently redeemable equity securities typically are classified as equity, because redemption is not certain to occur. The definition of mandatorily redeemable financial instruments (which must be classified as financial liabilities) in the Master Glossary is limited to "unconditional obligation requiring the issuer to redeem the instrument by transferring its assets at a specified or determinable date (or dates) or upon an event that is certain to occur." Therefore, outstanding shares that could be redeemed at the option of the holder, or upon some contingent event that is outside the control of the issuer and the holder, generally are not classified as financial liabilities (i.e., they are classified as equity and not subsequently remeasured). Under U.S. GAAP, mandatorily redeemable equity securities that are not certain to be redeemed (e.g., those containing an equity conversion option that permits the securities to be converted into nonredeemable equity securities before the mandatory redemption date) would also be classified as equity. If redemption becomes certain to occur, the securities would be reclassified as, and accounted for, as a liability. ASC 480-10-S99-3A indicates that when a puttable instrument has a redemption feature that is not solely within the control of the issuer, an SEC registrant is required to present the instrument in the balance sheet between permanent equity and liabilities in a section entitled "temporary equity" or "mezzanine equity."

IFRSs indicate that an instrument that gives the holder the right to put the instrument back to the issuer for cash or another financial asset (e.g., redeemable preferred shares) or that is automatically put back to the issuer upon the occurrence of an uncertain future event (e.g., contingently mandatorily redeemable shares) should be accounted for as a liability. Paragraph 18(b) of IAS 32 notes that the conditional redemption obligation creates a contractual obligation for the issuer to deliver cash or another financial asset. Paragraph 19(b) of IAS 32 states that the fact that a contractual obligation is conditional upon the holder's exercising its right to require redemption does not negate the existence of a financial liability, since the issuer does not have the unconditional right to avoid delivering cash or another financial asset. Under IAS 32, the issuer is exempt, in limited circumstances, from the liability classification requirement for puttable financial instruments.

Specifically, IAS 32 requires that puttable instruments be presented as equity if the following four criteria are met:

  1. The holder is entitled "to a pro rata share of the entity's net assets [at] liquidation."
  2. "The instrument is in the class of instruments that is [the most] subordinate" and all instruments in that class are identical.
  3. The instrument has no other characteristics that would meet the definition of a financial liability.
  4. "The total expected cash flows attributable to the instrument over the life of the instrument are based substantially on the profit or loss, the change in the recognised net assets or the change in the fair value of the recognised and unrecognised net assets of the entity."

Instruments, or components of instruments, that obligate the entity to deliver a pro rata share of the net assets of the entity only on liquidation should be presented as equity if they meet the criteria above, except for criteria (3) and (4). See paragraphs 16A–16D of IAS 32 for additional information.

Obligations to Issue a Variable Number of Equity Shares

Under U.S. GAAP, ASC 480-10-25-14 states:

A financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares shall be classified as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominantly on any one of the following:

  1. A fixed monetary amount known at inception (for example, a payable settleable with a variable number of the issuer's equity shares)
  2. Variations in something other than the fair value of the issuer's equity shares (for example, a financial instrument indexed to the Standard and Poor's S&P 500 Index and settleable with a variable number of the issuer's equity shares)
  3. Variations inversely related to changes in the fair value of the issuer's equity shares (for example, a written put option that could be net share settled).

Obligations to issue a variable number of shares that do not meet the above conditions are typically accounted for as equity under U.S. GAAP.

Under IFRSs, paragraph 21 of IAS 32 states that all obligations to issue a variable number of shares are accounted for as financial liabilities.

Derivatives Indexed to, and Potentially Settled in, an Entity's Own Stock

Under U.S. GAAP, entities are required to evaluate derivatives on their own stock under ASC 815. Instruments that have all the characteristics of a derivative, but whose settlements are indexed to an entity's own stock under ASC 815-40-15-7 and that would be classified as equity under ASC 815-40-25, are outside the scope of ASC 815-10. Instruments that do not have all the characteristics of a derivative under ASC 815 typically must be analyzed under ASC 815-40-15-7 and ASC 815-40-25. It is possible for derivatives on an entity's own equity to be classified as equity instruments, provided that the conditions in ASC 815-40-15-7 and ASC 815-40-25 are met.

ASC 815-40-15-7 states that any instrument that is potentially settled in an entity's own stock and includes an exercise contingency (i.e., a provision that entitles the entity (or the counterparty) to exercise the financial instrument on the basis of changes in an underlying, including the occurrence (or nonoccurrence) of a specified event) is potentially considered indexed to the entity's own stock (i.e., it is not precluded from classification as equity) if the exercise contingency is not based on (1) an observable market, other than the market for the issuer's stock (if applicable) or (2) an observable index, other than an index calculated or measured solely by reference to the issuer's own operations (e.g., revenue of the issuer).

In addition to performing the contingency test, the entity must assess whether the settlement features of the instrument meet the ASC 815-40-15-7 criteria for the instrument to be deemed indexed to the entity's own stock. The model in ASC 815-40-15-7 requires an instrument's settlement provisions to be "fixed-for-fixed, plus fair value inputs"4 for the instrument to be considered indexed to the entity's own stock and fall within the scope of ASC 815-40-25. For financial instruments within the scope of ASC 815-40-25, the entity must evaluate the instrument's potential settlement alternatives to determine the appropriate classification between equity and an asset or a liability. Under ASC 815-40-25, a net-share-settled contract could qualify for classification as equity.

If the entity can conclude that the instrument is indexed to the issuer's stock, equity classification is required for (1) contracts that must be physically settled or net-share-settled and (2) contracts that give the issuer the choice of net cash settlement or settlement in its own shares (physical or net share settlement), provided that all the criteria in ASC 815-40-25-7 through 25-35 have been met.

Under IFRSs, an entity must evaluate all derivatives on its own equity (including those embedded in host contracts) under IAS 32 to determine whether they qualify for equity classification or must be classified as liabilities (or assets in some cases). Paragraph 22 of IAS 32 indicates that "[a] contract that will be settled by the entity (receiving or) delivering a fixed number of its own equity instruments in exchange for a fixed amount of cash or another financial asset [in its functional currency (in a "fixed-for-fixed" settlement)] is an equity instrument," provided that it is not otherwise required to be classified as a liability or an asset. Thus, under IFRSs, unless settlement of a contract is "fixed-for-fixed," it is accounted for as a derivative in accordance with IAS 39 (IFRS 9 for entities that have adopted IFRS 9). For instance, in accordance with paragraphs AG27(d) and 26 of IAS 32, the following contracts on an entity's own equity are accounted for as derivatives:

  • Those that are net settled in own equity shares.
  • Any derivative over own equity that gives either party a choice regarding how it is settled unless all the settlement alternatives result in the exchange of a fixed number of own shares for a fixed amount of cash or another financial asset. (The only exceptions are forward purchases and written puts over own shares for which one of the settlement alternatives is gross physical settlement. These derivatives are classified as liabilities and subsequently measured on the basis of the gross redemption amount at amortized cost.)

Unlike IFRSs, U.S. GAAP require that derivatives indexed to, and potentially settled in, an entity's own stock be classified as equity if (1) they are net-share-settled (or give the issuer the choice to net-share-settle), (2) they are not written put options or forward repurchase contracts, and (3) the criteria in ASC 815-40-25-7 through 25-35 are met. IFRSs require derivative accounting for such instruments.

Rights, Options, or Warrants on a Fixed Number of an Entity’s Equity Instruments Whose Exercise Price Is a Fixed Amount of a Foreign Currency

Under U.S. GAAP, rights, options, or warrants that allow the holder to acquire a fixed number of an entity’s equity instruments for a fixed amount of a foreign currency are explicitly prohibited from being classified as equity instruments. Specifically, ASC 815-40-15-7I states that “[a]n equity-linked financial instrument (or embedded feature) shall not be considered indexed to the entity’s own stock if the strike price is denominated in a currency other than the issuer’s functional currency.”

Conversely, under IFRSs, these types of contracts may qualify as equity instruments. In describing the evaluation performed under IAS 32, paragraph 16(b)(ii) clarifies that “rights, options or warrants to acquire a fixed number of the entity’s own equity instruments for a fixed amount of any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its existing owners of the same class of its own non-derivative equity instruments” (emphasis added).

Written Put Options on an Entity's Own Equity

Under U.S. GAAP, a written put option on an entity's own shares is accounted for as a liability at fair value, with changes in fair value recognized in earnings in accordance with ASC 480-10-25-8 through 25-10, ASC 480-10-25-14(c), and ASC 480-10-35-5.

Under IFRSs, paragraph 23 of IAS 32 indicates that a written put option on an entity's own shares is accounted for as a liability at the present value of the redemption amount — often referred to as a "gross liability" — unless it can only be net settled. This treatment applies if the contract may result in a gross exchange of cash for shares even if the issuer or the holder has the right to elect net cash or net share settlement (i.e., it applies when either the issuer or the holder has the choice of settling the contract gross by the exchange of either cash or another financial asset for shares). Also, to be recognized as a gross liability, the arrangement does not need to result in the exchange of a fixed amount of cash or another financial asset, a fixed number of shares, or both. An exchange of a variable amount of cash or another financial asset for a variable number of shares is classified as a gross liability at initial recognition.

Forward Purchase Contracts on an Entity's Own Equity

Under U.S. GAAP, a forward purchase contract on an entity's own shares that is within the scope of ASC 480-10 is classified as a liability. If the forward contract requires physical (share) settlement, the contract is measured in accordance with ASC 480-10-35-3 (i.e., the present value of the amount to be paid at settlement). Such accounting is similar to the gross liability accounting described below. If the contract is net-share-settled or net-cash-settled (or either party has the ability to elect net cash or net share settlement), an entity should apply the guidance on subsequent measurement in ASC 480-10-35-5 (i.e., fair value).

Under IFRSs, a forward purchase contract on an entity's own shares is accounted for as a liability at the present value of the redemption amount — often referred to as a "gross liability" — if one of the settlement alternatives (regardless of party) is settlement in gross physical shares. This guidance differs from that in U.S. GAAP, under which fair value accounting is required when an ASC 480-10 liability can be net-share-settled or net-cash-settled. That is, gross liability accounting is not permitted under U.S. GAAP solely because share settlement is an alternative.

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1 Differences are based on comparison of authoritative literature under U.S. GAAP and IFRSs and do not necessarily include interpretations of such literature.

2 In initially measuring the liability at fair value, an entity would consider paragraph AG76 of IAS 39 (paragraph B5.1 of IFRS 9 for entities that have adopted IFRS 9). That guidance, however, does not affect the treatment of debt issue costs as described herein.

3 ASC 470-20-40-11 indicates that the carrying amount of the debt also includes any interest accrued between the last interest payment date, if applicable, and the date of conversion, net of related income tax effects, if any. In addition, the carrying amount of the debt includes any unamortized debt issue costs.

4 The fixed-for-fixed, plus fair value inputs, model in ASC 815-40-15-7 requires that for an instrument to be considered indexed to the entity's own stock, in situations in which the strike price or the number of shares used to calculate the settlement amount are not fixed, the only variables that could affect the settlement amount would be inputs to the fair value of a "fixed-for-fixed forward" or option on equity shares.

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