The Financial Accounting Standards Board has finalized its hedge accounting guidance meant to eliminate the use of different accounting methods when companies raise capital by offering shares that include embedded derivative features.
Shares with embedded derivative features are often called hybrid financial instruments because they have features that make them like both debt and equity. The issues arise when companies raise capital by issuing different classes of shares that provide different preferences and rights, like conversion rights, redemption rights, voting rights, liquidation and dividend payment preferences, and so on.
In some cases, companies account for such hybrid instruments considering all the terms and features in the instrument, including the embedded derivative; in other cases, companies consider all the features except the embedded derivative, which is evaluated separately for separate accounting treatment. Different methods can lead to different accounting outcomes for instruments that are otherwise economically similar, FASB says.
That prompted FASB to issue Accounting Standards Update No. 2014-15, which is meant to help preparers sort out with greater consistency whether the host contract of a hybrid instrument issued as a share should be treated like debt or equity. The new guidance doesn’t change how to evaluate the economic characteristics and risks, but clarifies how current GAAP should be interpreted, FASB says. “Specifically, the amendments clarify that an entity should consider all relevant terms and features, including the embedded derivate feature being evaluated for bifurcation, in evaluating the nature of the host contract,” FASB wrote in the update.
The new guidance takes effect for fiscal periods and interim periods that begin after Dec. 15, 2015, giving calendar year companies a full year to implement it.
Separately, FASB also is looking for feedback on a recommendation of its Emerging Issues Task Force to address differences in how companies apply fair value measurement rules to certain investments measured at net asset value. FASB says entities have developed different pathways through a practical expedient permitted in the rules. The proposed update to accounting standards would remove investments measured at net asset value from the fair value hierarchy, assuring a more consistent approach. The proposal is open for comment through Jan. 15.