Companies raise capital in various forms of debt, equity or both. The issuance of conventional debt or the sale of common stock does not normally present complex accounting issues. However, when debt and equity are mixed in a single transaction, when equity instruments become more complex than simple common stock, when transactions take on characteristics of both debt and equity, or when certain instruments or embedded features within debt and equity instruments have characteristics of derivatives, the accounting can become overwhelming.
This section addresses equity-linked transactions (ELT) that are not employee stock-based compensation arrangements or stock-based compensation paid to non-employees for which the goods and/or services have not been delivered. Those situations have special accounting rules that will be addressed separately on this site. An ELT can come in a variety of forms and is generally designed to enhance the potential return to the investor while lowering the cash costs of the financing to the company. Typical ELT instruments include (this is not an exhaustive list):
- Debt (bonds, debentures, promissory notes, etc.) issued together with detachable warrants for preferred and/or common stock;
- Conventional convertible debt;
- Unconventional convertible debt; and,
- Convertible preferred stock with debt-like features.
There are as many types of instruments and features as there are lawyers and investment bankers to conceive them. As these financings have become more complex, the accounting standards have grown in volume and complexity in an attempt to keep pace. The standards are often written in a way that the FASB hopes will address all possible existing and future issues that could arise. As a result, the standards are often vague and nearly always very difficult to understand. This section will shed some light on the practical application of the standards to ELTs and provide a road map to analyzing an instrument or embedded feature.
The general areas of accounting addressed in this section include: treatment of instruments with characteristics of both debt and equity, freestanding derivatives, embedded derivatives and beneficial conversion features. You are welcome to use this site as a visitor. The site is designed to provide a logical decision process and guidance at each step. However, if you wish to save your analysis as a project for future editing or printing, please register. Registration is free. So why not?
Caveat: This section is not intended to be a comprehensive analysis of derivatives. This section does address derivatives, but only in the context of ELTs. Other sections of this site go into other areas of derivative accounting, including hedge accounting, in detail.