FASB changes accounting and EPS for certain instruments with down round features

Key Impacts:

• Equity-linked instruments or embedded equity-linked features will not be accounted for as a liability solely because there is a down round feature
• Fewer free-standing equity-linked instruments with down round features will be accounted for as liabilities than under current accounting
• Fewer embedded equity-linked features with down round features will be bifurcated from the host contract
• A company will still need to evaluate other features in the equity-linked instrument to determine whether the instrument or embedded feature should be accounted for as a liability
• A company that presents EPS information will reflect the effect of a down round feature of free-standing equity-linked financial instruments in EPS only if it is triggered
• The ASU prescribes how the company will measure the effect of the down round feature, which will be accounted for as a deemed dividend when computing income available to common shareholders in basic EPS

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.