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Issuer’s accounting for debt
On the Radar: Debt and equity securities under ASC 470
Issuers that account for debt instruments under ASC 470 need to analyze the fine print. In our latest On the Radar, we walk through six key considerations for classifying and disclosing information about highly scrutinized debt and equity securities.
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Unpacking an entity’s capital structure
Entities raising capital by issuing debt instruments must account for those instruments by applying ASC 470 as well as other applicable US GAAP. Key questions to consider when determining the appropriate accounting include:
All entities are capitalized with debt or equity. The nature and mix of debt and equity securities that comprise an entity’s capital structure, and its decisions about the types of securities to issue when raising capital, may depend on the stage of the entity’s life cycle, the cost of capital, the need to comply with regulatory capital requirements or debt covenants (e.g., capital or leverage ratios), and the financial reporting implications. The complexity of the terms and characteristics of debt instruments is often influenced by factors such as the entity’s size, age, or creditworthiness. For example, early-stage and smaller growth companies are often financed with capital securities that contain complex and unusual features, whereas larger, more mature entities often have a mix of debt and equity securities with largely plain-vanilla characteristics. The complexity of the accounting for debt generally depends on the intricacy of the instrument’s terms.
Financial instruments that are debt in legal form must always be classified by the issuer as liabilities. In addition, some legal-form equity shares also require liability classification under ASC 480. An entity must reach a conclusion about the classification of an obligation or equity share before it can appropriately apply US GAAP to account for the instrument.
The SEC staff closely scrutinizes the manner in which entities classify and disclose information about debt instruments. For example, the staff frequently comments on (1) an entity’s classification of instruments as equity rather than debt, (2) restrictions in debt agreements that limit an entity’s ability to pay dividends, and (3) a registrant’s compliance with debt covenants, including the impact of any noncompliance on its liquidity and capital resources and the classification of debt as current versus long term.
Financial reporting considerations
Continue your issuer’s accounting debt learning
This Roadmap provides a comprehensive discussion of the classification, initial and subsequent measurement, and presentation and disclosure of debt, including convertible debt.
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