FASB proposes to simplify ‘own equity’ guidance

Under ASC 815-40, a contract that is indexed to, and potentially settled in, the entity’s own stock is analyzed under both indexation guidance and equity classification guidance (collectively referred to as the ‘own equity’ guidance). Under the indexation guidance, an entity evaluates whether a contract is indexed to its own stock using a two-step approach: Step 1 evaluates contingent exercise provisions, and Step 2 evaluates settlement provisions. Under Step 2, an instrument meets the indexation guidance if its settlement amount equals the difference between the fair value of a fixed number of the entity’s shares and a fixed amount. If the settlement amount can be adjusted, the contract meets the Step 2 guidance only if all variables that could affect settlement are inputs to the fair value of a fixed-for-fixed forward or option on equity shares (this analysis is referred to as the ‘fixed-for-fixed’ assessment).

However, determining whether variables that could affect settlement are consistent with fair value inputs into a fixed-for-fixed forward or option pricing model can be complex and has led to financial statement errors and diversity in practice. To address this issue, the FASB has proposed amendments to ASC 815-40 to simplify Step 2 of the indexation guidance and improve the usefulness of information provided to investors. The proposal would not revise analyses performed under Step 1 of the indexation guidance or under the equity classification guidance (i.e. the remainder of the ‘own equity’ guidance).