8.4 Embedded Features
8.4.1 Separation of Embedded Derivatives
While both U.S. GAAP and IFRS Accounting Standards contain requirements about
separation of embedded derivatives, they define a
derivative differently. Unlike that under ASC 815,
the definition of a derivative under IFRS
Accounting Standards does not include a
requirement for net settlement. Therefore, the
accounting for an equity-linked feature that is
embedded in a host liability and does not qualify
as equity under IAS 32 and ASC 815-40 may differ
depending on whether the feature has the net
settlement characteristic specified in the
definition of a derivative under ASC 815. If the
liability is not accounted for at fair value, with
changes in fair value recognized in net income, an
embedded feature that neither qualifies as equity
nor possesses the net settlement characteristic
(e.g., because it involves physical settlement in
private company stock) would be separated from its
host contract and accounted for as a derivative at
fair value under IFRS Accounting Standards but not
under U.S. GAAP.
8.4.2 Separation of Equity Components
Under IFRS Accounting Standards, if a liability contains a component that
qualifies as equity in accordance with IAS 32
(e.g., an equity conversion feature embedded in a
debt security), that component must always be
separately recognized in equity by the issuer.
Under U.S. GAAP, the separation of an equity
component from a liability is generally precluded
unless the equity component is contained in
convertible debt that (1) was issued at a
substantial premium to par, (2) was modified or
exchanged if extinguishment accounting did not
apply and the fair value of the conversion feature
increased, or (3) had a bifurcated conversion
option derivative that was reclassified as
equity.