Today’s capital market continues to be flush with cash. Companies are feverishly developing and executing strategies to support and finance operations, all in hopes of attracting the attention of investors who are eager to put excess funds to work and maximize returns. Both sides of the table come together and, depending on the size as well as stage of business cycle, create financing instruments that are mutually beneficial. This is an ongoing trend of the financing environment, and all signs point to it staying put for the foreseeable future. So, what do you need to understand about financing transactions that arise in this current environment? 

The basics

The most common forms of financing instruments come in the form of debt and equity. Debt financing is often a primary source of funds for entities seeking to finance working capital, to purchase assets, and to complete an acquisition. Debt financing often includes a repayment schedule and requires the borrower to pay interest to the lender. Equity financing sells interests in the company to an investor. While there is a potential for dividends, investors have no contractual right to repayment.

There are various strategic reasons why an entity may elect to issue financing instruments in one of the forms described above. Want to learn more? Well, you are in luck, because we have a 0.2 CPE eligible eLearning course, Issuance of Debt and Equity Securities: Introduction to Debt and Equity Issuances, that provides an overview of these strategies from the perspective of both an issuer and an investor. We also have the following eLearning courses available to help you navigate basic financing instruments:

• Issuance of Debt and Equity Securities: Accounting and Reporting for Debt Instruments (1.5 CPE)
• Issuance of Debt and Equity Securities: Accounting and Reporting for Equity Instruments (0.5 CPE)

Wait, there’s more!

As I mentioned above, financing transactions arise across the capital market. Far too often there seems to be an inverse relationship between the size/stage of a business and the complexity of the issued financial instruments.

Highly complex financing instruments end up in early-stage development companies rather than with well-established, large organizations. Complexity arises from the terms and conditions included in financing instruments and can include various clauses, provisions, or other matters that have a significant accounting impact. In the end, the financing instrument has characteristics of both debt and equity, or equity-linked instruments. And the companies who are left to classify and account for these instruments often do not have personnel in finance that have extensive experience with these instruments.

Below are some hints for you to consider in the event equity-linked instruments find their way into your financial reporting landscape!

Hint #1: Get your highlighters out – there is a lot of guidance to review!

Equity-linked instruments require careful analysis to determine if they qualify for full or partial equity classification. The process to analyze equity-linked instruments involves a patchwork of authoritative guidance in U.S. GAAP:

• ASC 470-10, Debt Overall
• ASC 470-20, Debt with Conversion and Other Options
• ASC 480, Distinguishing Liabilities from Equity
• ASC 505, Equity
• ASC 815-10, Derivatives and Hedging Overall
• ASC 815-15, Embedded Derivatives
• ASC 815-40, Contracts in Entity’s Own Equity
• ASC 825, Financial Instruments

Hint #2: Hold the vision. Trust the process.

So, where should you start? Luckily, there is an assessment process that requires consideration of guidance in a specific order. Here is a sneak peek:

This assessment process comes complete with extensive use of judgment and consideration of individual and collective terms, and features of financing instruments to conclude appropriate classification and accounting. The better an entity understands the impact that certain features have on classification and measurement, the easier it becomes to structure these arrangements. You can learn all about the assessment process by taking our 1.5 CPE eLearning course Issuance of Debt and Equity Securities: Classification and Accounting for Equity-Linked Instruments.

Hint #3: Great timing! You stand to benefit from recent improvements to accounting models.

Before you get too overwhelmed, it is important to note that accounting for these instruments is not as onerous as it once was. I walked through some of the recent simplifications from the FASB in my blogs on the elimination of beneficial conversion features and simplification of analyzing convertible debt instruments.

Are you like me and just want to learn as much as you can about financing instruments? Well, we have you covered! We also have a collection available to purchase all four of the Issuance of Debt and Equity Securities courses cited above at a discounted price!

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Disclaimer  

This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.