FASB Clarifies the Accounting Treatment for Warrant Modifications

The FASB issued ASU 2021-04[1] (“Update”) to clarify the accounting by issuers for modifications or exchanges of equity-classified warrants. The new ASU is available and effective for all entities in fiscal years starting after December 15, 2021. Early adoption is permitted.

Background

There has been diversity in accounting for modifications of equity-classified warrants due to a lack of explicit guidance in the Codification. For example, one entity may recognize an expense, while another may record a dividend for an economically similar warrant modification. The FASB issued the ASU to reduce this diversity and establish a principles-based recognition framework according to the substance of the modification transaction.

The framework applies to freestanding written call options, such as warrants, that were and remain equity classified by the issuer after the modification and are not in the scope of another Codification Topic. For example, the framework does not apply to warrants that are modified to compensate for goods or services within the scope of ASC 718[2]. The framework applies regardless of whether the modification is through an amendment to the existing terms or issuance of a replacement warrant.

Main Provisions

The effect of the modification of the warrant is measured as the difference in its fair value immediately before and after the modification.

The effect is recognized in the same manner as if cash had been paid as consideration, as follows:

Related EventRecognition
Financing transaction to raise equity Increase in fair value is recognized as an equity issuance cost
Financing transaction to raise debt Increase in fair value is recognized as a debt issue cost
Multiple-element transaction (e.g., both equity and debt financing) Allocate the total effect to the respective elements in the transaction
Modification of debt – warrant held by a creditor The increase or decrease in fair value is accounted for as debt fees between the debtor and the creditor
Modification of debt – warrant held by third-party The increase (but not a decrease) in fair value is accounted for as third-party issue costs
Modification of debt – evaluating a troubled debt restructuring (TDR) or whether the debt is modified or extinguished for accounting purposes The increase or decrease in fair value of creditor warrants is included in determining the effective borrowing rate of the restructured debt for assessing whether a concession has been granted under the TDR guidance and in applying the 10% cash flow test under the debt modification guidance
Other modifications (unrelated to equity or debt financings, or other exchange transactions not within the scope of another Topic) Increase in fair value is recognized as a dividend. If EPS is presented, the dividend would be an adjustment to net income or loss in computing basic EPS

Additionally, other modifications may need to be accounted for as a cost to the issuing entity based on the substance of the transaction, rather than as a dividend, for example, a modification related to an agreement by the warrant holder to abandon certain acquisition plans, forgo other planned transactions, settle litigation, settle employment contracts, or restrict share purchases.[3]

Disclosures

The Update requires incremental disclosures related to information about the nature and effect of the modification and how it is recognized in the financial statements.

Effective Dates and Transition

The Update is effective prospectively for fiscal years beginning after December 15, 2021, including interim periods therein, with early adoption permitted. If an entity early adopts in an interim period, the Update will be effective as of the beginning of the fiscal year of adoption.

The Update requires transition disclosures of the nature of and reasons for the accounting change, the transition method, and a qualitative description of the financial statement line items affected.

[1] Earnings Per Share (ASC 260), Debt— Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (ASC 718), and Derivatives and Hedging— Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options

[2] ASC 718, Compensation—Stock Compensation

[3] See paragraph BC19 of ASU 2021-04

About Centri Business Consulting, LLC

Centri Business Consulting provides the highest quality advisory consulting services to its clients by being reliable and responsive to their needs. Centri provides companies with the expertise they need to meet their reporting demands. Centri specializes in financial reportinginternal controlstechnical accounting researchvaluationmergers & acquisitions, and tax, CFO and HR advisory services for companies of various sizes and industries. From complex technical accounting transactions to monthly financial reporting, our professionals can offer any organization the specialized expertise and multilayered skillsets to ensure the project is completed timely and accurately.

Philadelphia
Eight Penn Center
1628 JFK Boulevard
Suite 500
Philadelphia, PA 19103
New York City
530 Seventh Avenue
Suite 2201
New York, NY 10018
Raleigh
4509 Creedmoor Rd
Suite 206
Raleigh, NC 27612
Tampa
615 Channelside Drive
Suite 207
Tampa, FL 33602
Atlanta
1175 Peachtree Street NE
Suite 1000
Atlanta, GA 30361
Boston
50 Milk Street
18th Floor
Boston, MA 02109
Tysons Corner
1775 Tysons Blvd
Suite 4131
McLean, VA 22102
Denver
8310 South Valley Highway
3rd Floor
Englewood, CO 80112
Centri Everywhere
1-855-CENTRI1
virtual@CentriConsulting.com

03/22/2024

Bridging the GAAP: March 2024

Centri’s Bridging the GAAP newsletter highlights this month’s news, developments, and emerging issues in...

Read More

03/19/2024

Is Your Real Estate Portfolio at Risk for Impairment?

Today’s real estate environment can be challenging with certain sectors feeling the...

Read More

03/19/2024

The Value of a PEO Liaison: Minding the HR Service Gap

Introduction PEOs (Professional Employer Organizations) have been around for decades.  A recent...

Read More