New Convertible Debt Standard
Convertible debt is a type of financial instrument that a company can issue to raise capital from investors. It is a hybrid security that combines features of debt and equity. Essentially, convertible debt is a loan that can be converted into shares of common stock in the issuing company or cash of equal value, later based on timing or circumstances within the term of the agreement.
Convertible debt is used by companies in the early stages of development and has yet to establish a valuation or a track record of profitability. It allows investors to participate in the company’s growth potential while still having some protection in the form of a debt instrument.
Under the previous guidance, numerous accounting models needed to be considered, each with different recognition and measurement requirements:
- Embedded derivative model
- Substantial premium model
- Cash conversion model
- Beneficial conversion feature model
- Traditional convertible debt model
The Financial Accounts Standards Board (FASB) announced new guidance on convertible debt through Accounting Standards Update (ASU) 2020-06. The update was focused on helping to reduce the complexity of the subject. The new standard eliminates the cash conversion and beneficial conversion feature models resulting in more streamlined reporting. As convertible debt is a great way to raise capital for your business, understanding the impact on your company’s financial statements is critical.
The new guidance through ASU 2020-06 went into effect for fiscal years beginning after December 15, 2021, for public company filers. All other private companies’ adoption begins with budgetary periods after December 15, 2023, although early adoption is permitted. With the reduction of complexity, we expect this to be an item many companies would have elected to adopt early.
If you have any questions, please contact your WG business advisor.
