Chapter 14 — Presentation, Disclosure, and Other Considerations

14.3 Presentation

14.3.1 Balance Sheet

14.3.1.1 Balance Sheet Offsetting

ASC 210-20

45-1 A right of setoff exists when all of the following conditions are met:

Each of two parties owes the other determinable amounts.
The reporting party has the right to set off the amount owed with the amount owed by the other party.
The reporting party intends to set off.
The right of setoff is enforceable at law.

45-2 A debtor having a valid right of setoff may offset the related asset and liability and report the net amount.

When certain conditions are met, ASC 210-20 permits but does not require an entity to offset the carrying amounts of assets and liabilities and present only a net amount on the balance sheet (i.e., only a net asset or a net liability is presented related to the amounts that have been offset). Offsetting does not affect the application of the accounting requirements that apply to the recognition, measurement, and derecognition of assets and liabilities (e.g., it does not affect when gain or loss recognition is appropriate or how it should be measured); it only affects the display of assets and liabilities on the balance sheet.

Under ASC 210-20-45-1, four conditions must be met for an entity to offset assets and liabilities:

“Each of two parties owes the other determinable amounts.”
That is, (1) an entity cannot offset receivables and payables with different counterparties, (2) the amounts must be determinable (i.e., contingent or estimated amounts cannot be offset), and (3) an entity is not precluded from offsetting amounts that are denominated in different currencies or have different stated interest rates (see ASC 210-20-45-3).
“The reporting party has the right to set off the amount owed with the amount owed by the other party.”
In the absence of a right to set off, an entity cannot present amounts net even if it expects that such amounts will be net settled. If the maturities of a payable and receivable with the same counterparty differ, only the party with the nearer maturity can offset the related amounts (see ASC 210-20-45-3). Balances without an explicit settlement date cannot be set off. For example, payables cannot be offset against cash on deposit at a financial institution (see ASC 210-20-55-18A).
“The reporting party intends to set off.”
An entity should document its intention to set off, and that intention should be consistent with its past practice of setting off in similar situations, if applicable (see ASC 210-20-45-5). If an entity’s right to set off is contingent on the entity’s or the counterparty’s default, the related amounts cannot be presented net. The right to set off must be exercisable in the normal course of business. If an entity does not expect to set off amounts, those amounts do not qualify for net presentation on the balance sheet.
There are two exceptions to this condition. They apply to amounts recognized under certain (1) repurchase agreements and reverse repurchase agreements accounted for as collateral borrowings under ASC 860 (see ASC 210-20-45-11 through 45-17) and (2) derivatives and cash collateral balances subject to a master netting agreement (see ASC 815-10-45-5). However, these exceptions do not apply to debt that is within the scope of the guidance in this Roadmap (see Section 2.3.2).
“The right of setoff is enforceable at law.”
A legal analysis may be necessary in the determination of whether an enforceable right of setoff exists. In accordance with ASC 210-20-45-9, all available evidence must be considered and must provide “reasonable assurance that the right of setoff would be upheld in bankruptcy.” An entity cannot necessarily assume that it has a right to set off even if a contract states so, since state laws differ and the U.S. bankruptcy code limits the ability to assert a right of set off in certain circumstances (see ASC 210-20-45-8).
An entity should apply a consistent policy for offsetting amounts that qualify for such treatment.

14.3.1.2 Legal-Form Debt Cannot Be Presented in Equity

SEC Staff Accounting Bulletins

SAB Topic 4.A, Subordinated Debt [Reproduced in ASC 470-10-S99-2]

Facts: Company E proposes to include in its registration statement a balance sheet showing its subordinate debt as a portion of stockholders’ equity.

Question: Is this presentation appropriate?

Interpretive Response: Subordinated debt may not be included in the stockholders’ equity section of the balance sheet. Any presentation describing such debt as a component of stockholders’ equity must be eliminated. Furthermore, any caption representing the combination of stockholders’ equity and only subordinated debts must be deleted.

An instrument that represents a legal-form debt obligation should be presented as a liability even if it has certain economic characteristics that are similar to those of an equity instrument. For example, debt that has a stated maturity, a stated coupon right, and creditor rights (e.g., an ability to seek recourse in a bankruptcy court) is presented as a liability on the basis of its legal form even if it is mandatorily convertible into the debtor’s equity shares. As noted in SAB Topic 4.A, a debtor is not permitted to present debt as a component of equity even if it is subordinated to other debt or presented in a balance sheet caption that includes both subordinated debt and equity.

An instrument that represents a legal-form debt obligation in the jurisdiction in which it is issued and carries creditor rights should be presented as a liability even if the issuer only has a de minimis amount of common equity capital and the instrument (1) is described as an “equity certificate,” (2) has a long maturity (e.g., 40 years) or no stated maturity, (3) is subordinated to all other creditors, (4) contains conversion rights into common equity, and (5) provides dividend rights that are similar to those of a holder of common equity (e.g., payable only if declared). If it is not readily apparent whether a claim on the entity legally represents debt or equity, the entity may need to seek an opinion from legal counsel.

A debtor is precluded from presenting debt as equity even if it is converted into the debtors’ equity shares or repaid from the proceeds of the issuance of equity-classified shares shortly after the balance sheet date. Such an event represents a nonrecognized subsequent event under ASC 855. Further, ASC 470-10-45-14(a) states, in part, that if “equity securities have been issued for the purpose of refinancing [a] short-term obligation on a long-term basis . . . , the short-term obligation, although excluded from current liabilities, shall not be included in owners’ equity” (see Section 13.7.3).

14.3.1.3 Structured Trade Payable Arrangements

14.3.1.3.1 Financial Statement Presentation

SEC Rules, Regulations, and Interpretations

Regulation S-X, Rule 5-02, Balance Sheets [Reproduced in ASC 210-10-S99-1]

19. Accounts and notes payable.

(a) State separately amounts payable to

(1) banks for borrowings;

(2) factors or other financial institutions for borrowings;

(3) holders of commercial paper;

(4) trade creditors;

(5) related parties (see § 210.4-08(k));

(6) underwriters, promoters, and employees (other than related parties); and

(7) others.

Amounts applicable to (1), (2) and (3) may be stated separately in the balance sheet or in a note thereto. . . .

When an entity purchases goods or services on credit from a supplier (vendor), a trade payable arises for the invoice amount owed to the supplier. Sometimes entities with trade payables enter into arrangements with a bank or other intermediary under which the intermediary offers to purchase receivables held by the entity’s suppliers. Such arrangements are known by various names, such as “structured payable arrangements,” “vendor payable programs,” “open account structured vendor payable programs,” “reverse factoring,” “supplier finance,” or “supplier-chain finance.”

Examples of structured payable arrangements include (1) open account platforms that permit an entity’s suppliers to elect to sell trade receivables to one or more participating intermediaries, (2) an entity’s use of charge cards issued by a financial institution to settle invoices, and (3) an entity’s issuance of negotiable instruments (e.g., bills of exchange) to settle invoices.

Typically, open account platforms give participating suppliers the option to settle trade receivables by obtaining a payment from an intermediary either (1) before the invoice date at a discounted amount or (2) on the invoice due date for its full amount. Although the supplier may receive payment early, the purchasing entity is not required to settle its trade payable with the intermediary until the original invoice date.

Depending on its terms, a structured trade payable arrangement offers the parties various potential benefits, such as the following:

Suppliers can monetize trade receivables and reduce the associated credit exposure — By selling their trade receivables to an intermediary, suppliers can receive payment before the invoice due date and reduce their credit exposure.
Purchasers can obtain extended payment terms — Suppliers may be more willing to agree to extended payment terms with purchasers if they can obtain early payment from intermediaries. Further, intermediaries may offer purchasers extended payment terms.
Intermediaries can benefit from early payment discounts, rebates, and transaction fees and charges — Intermediaries earn a spread on the basis of the relationship between their funding costs and the amount of early payment discounts, rebates, and other fees and charges received from suppliers.
Operational benefits — Because of an intermediary’s involvement, the arrangement may enhance the processing, administration, and control of the associated payments for purchasers and suppliers.
Extended early-payment discount period — If an intermediary pays a supplier within the period during which the supplier offers an early payment discount (e.g., a 2 percent discount for payment within 30 days or 2/10 net 30), for instance, the intermediary may offer the entity a discount on the amount due for an extended period (e.g., 1/10 net 60).
Reduction in the amount due or other similar rebate — The intermediary may offer the entity a reduction of the amount due or a reimbursement of part of the amount paid on the basis of net amounts paid to suppliers. (A supplier may agree to pay the intermediary a fee or reduce the amount due because of benefits it receives from the arrangement, such as a lowered credit risk exposure on the amount due or earlier payment of such amount.)

If an entity has a trade payable arrangement involving an intermediary, it should consider how to appropriately present and disclose the amount payable. Regulation S-X, Rule 5-02(19)(a), requires SEC registrants to present amounts payable to trade creditors separately from borrowings on the face of the balance sheet. Accordingly, a purchasing entity that participates in a trade payable program involving an intermediary should consider whether the intermediary’s involvement changes the appropriate presentation of the payable from a trade payable to a borrowing from the intermediary (e.g., bank debt). Entities often seek to achieve trade payable classification because trade payables tend to be treated more favorably than short-term indebtedness in the calculation of financial ratios (e.g., balance sheet leverage measures) and in the determination of whether financial covenants are met. Further, the determination of whether the payable should be presented as an amount owed to trade creditors or an amount borrowed from the intermediary may affect the appropriate cash flow statement classification (see below for further discussion).

Generally, a supplier’s decision to factor a trade receivable to a bank or other financial institution does not affect the purchaser’s presentation of the associated trade payable if the factoring terms are negotiated and agreed to independently by the supplier and the institution without any involvement of the purchaser, which may not even be aware of the factoring transaction. Similarly, an entity’s decision to outsource its supplier processing payments to an intermediary does not necessarily cause a reclassification of associated trade payables if the terms of the payables remain unaffected and the entity is not involved in, or does not benefit from, transactions between the suppliers and the intermediary. In other words, if the intermediary’s involvement does not change the nature, amount, and timing of the entity’s payables and does not provide the entity with any direct economic benefit, continued trade payable classification may be appropriate. However, reclassification may be required if such changes or benefits result from the intermediary’s involvement (e.g., because fees or rebate payments were received from the intermediary).

In speeches at the 2003 and 2004 AICPA Conferences on Current SEC and PCAOB Developments, then Professional Accounting Fellow Robert Comerford discussed the SEC staff’s views about the presentation of certain trade payable arrangements involving an intermediary as trade payables or short-term borrowings. At the 2004 event, he stated the following:

As a general rule, the OCA Staff does not believe that it is possible to determine the appropriate accounting for structured transactions simply via reference to checklists and templates. Rather, . . . an entity must perform a thorough analysis of all the facts and circumstances specific to the individual transaction in order to ensure that the entity’s accounting for the transaction serves investors well. . . . [T]his necessitates meeting not just the letter, but the spirit of the accounting literature.

Mr. Comerford identified a number of points (summarized below) that the SEC staff encourages preparers and auditors to consider in determining whether amounts due in trade payable arrangements involving an intermediary should be classified as trade payables or borrowings. He also noted that a registrant may wish to preclear its proposed classification with the OCA if there is a risk that its position could be subject to challenge. Given the subjective nature of the evaluation and the lack of prescriptive guidance, alternative views may be acceptable in some circumstances.

SEC Staff Consideration Point	Related SEC Staff Observations	Deloitte Observations
What are “the roles, responsibilities and relationships of each party” to the arrangement? What is “the totality of the arrangement”?	By analogy to a supplier’s factoring of accounts receivables, the definition of factoring “does not make any mention of the [purchaser] actively or passively participating in the process.”	It can be helpful to consider whether the intermediary’s role in the arrangement is primarily that of (1) a factor of supplier receivables, (2) a finance provider to the entity, or (3) the entity’s paying agent. If the intermediary’s involvement does not change the nature, amount, and timing of the entity’s payments and does not provide the entity with any direct economic benefit, continued trade payable classification may be appropriate. See below for further discussion.
“Does the financial institution make any sort of referral or rebate payments” to the purchaser?	By analogy to a supplier’s factoring of accounts receivables, the definition of factoring “does not make any mention of [the supplier’s] customer receiving . . . any referral fees or rebates.”	If the entity receives no fees, rebates, payments, or other direct economic benefits from transactions between suppliers and the intermediary, continued trade payable classification may be appropriate. An entity’s receipt of referral or rebate payments from the intermediary (e.g., on the basis of fees, early settlement discounts collected by the intermediary, or a dollar-volume-based rebate) suggests that continued classification of a payable as an amount owed to trade creditors may no longer be appropriate. In practice, classifying payables as trade payables has been considered unacceptable when the purchaser shares in early settlement discounts collected by the intermediary from the supplier (e.g., the intermediary provides a rebate to the purchaser that is equivalent to half of a 2 percent early settlement discount received from the supplier).
“Has the financial institution reduced the amount due . . . , such that the amount due is less than the amount the [entity] would have had to pay to the vendor on the original payable due date?”	By analogy to a supplier’s factoring of accounts receivables, the definition of factoring does not “make any mention of the [supplier’s] customer receiving any reductions in the amount of its obligation.”	If the entity’s original invoice terms remain the same, continued trade payable classification may be appropriate. An intermediary’s reduction of the amount due from the entity may suggest that continued classification of a payable as an amount owed to trade creditors is no longer appropriate.
“Has the financial institution extended beyond the payable’s original due date, the date on which payment is due”?	By analogy to a supplier’s factoring of accounts receivables, the definition of factoring does not “make any mention of the [supplier’s] customer receiving . . . any extension of its trade payable maturity dates beyond that which were customary prior to the inception of the arrangement [e.g.,] 2/10 net 30.”	Payment terms and amounts that remain consistent with those of the entity’s other vendor payables and industry practice may suggest that continued classification as a trade payable may be appropriate. However, if the intermediary is not merely facilitating the payment of the entity’s invoice but extending the entity’s due date to a date after the original invoice due date and the date the intermediary pays suppliers, the entity’s arrangement may, in substance, be a borrowing from the intermediary.
The literal definition of the term “trade creditor.”	“The OCA Staff believes that a trade creditor is a supplier that has provided an entity with goods and services in advance of payment.”	Generally, third-party factoring arrangements involving an entity’s payables do not preclude trade payable classification if the entity has no involvement and is not a party to contracts entered into between the supplier and the factor. If the creditor at origination is a supplier, therefore, the supplier’s subsequent sale of its receivable to a factor does not necessarily change the nature of that trade payable so that reclassification is required.

As noted above, one of the consideration points is related to the roles, responsibilities, and relationships among the parties and the totality of the arrangement, such as whether the intermediary’s primary role in the arrangement is that of a factor of supplier receivables, a finance provider to the purchaser, or a paying agent of the purchaser. In some arrangements, the intermediary may serve both as a paying agent and a factor or finance provider (e.g., if the intermediary gives suppliers the option to either receive payment on the original invoice due date or to transfer trade receivables to the intermediary before the due date at a discounted amount).

Primary Role of Intermediary	Description	Implication
Factor of trade receivables	The intermediary purchases trade receivables from the entity’s suppliers, with no active involvement of the entity. The arrangement does not significantly affect the nature, amount, and timing of the entity’s payments to settle trade payables.	Trade payable classification may be appropriate.
Finance provider to purchasing entity	The entity’s purpose is to obtain financing from the intermediary. The arrangement affects the nature, amount, or timing of the entity’s payments to settle trade payables, and there may be a direct economic benefit to the entity.	Trade payable classification is likely to be inappropriate.
Paying agent of purchasing entity	The intermediary acts as the purchasing entity’s paying agent in settling trade payables with suppliers on behalf of the entity.	Although trade payable classification may be appropriate initially, the purchasing entity should assess whether extinguishment accounting is required under ASC 405-20 when the intermediary pays the supplier.

In practice, additional factors that an entity may consider in its evaluation of whether amounts due in trade payable arrangements involving an intermediary should be classified as trade payables or borrowings include:

Consideration Point	Observations
How significant is the entity’s involvement in the contractual relationship between suppliers and the intermediary?	The purchaser’s involvement in the initial set-up of the process (e.g., by requiring vendors to sign up with the intermediary) and submitting invoices for payment to the financial institution (e.g., in an electronic payable processing system) would not necessarily preclude a conclusion that the payable is still an amount due to trade creditors. More direct involvement by the purchasing entity may suggest that trade payable classification is inappropriate, particularly if the entity has a direct economic interest in the terms agreed to between the suppliers and the intermediary (e.g., through the sharing of fees or discounts received by the intermediary from suppliers).
Have any of the terms of the payable changed as a result of the intermediary’s involvement in the arrangement?	If the terms of the payable have not changed as a result of the intermediary’s involvement in the arrangement, continued trade payable classification may be appropriate. If the intermediary has rights that go beyond that of a holder of the original trade receivable (e.g., a priority claim in the entity’s liquidation), reclassification may be required.
Does the supplier maintain recourse against the entity?	The supplier’s maintenance of recourse against the entity for nonpayment, and the intermediary’s recourse against the supplier if the entity does not pay, may help support a conclusion that the payable should be presented as a trade payable.
Does the entity still have the right to negotiate returns of damaged goods and refunds and other adjustments to the invoice terms with the supplier?	If the entity does not retain the right to negotiate returns of damaged goods and refunds and other adjustments to the invoice terms with the supplier (e.g., in case of commercial disputes), reclassification may be required.
Is supplier participation voluntary?	Although a requirement for an entity’s suppliers to participate in a trade payable arrangement with an intermediary is not determinative, it may support a conclusion that trade payable classification is inappropriate.
Is the arrangement offered to a broad range of suppliers?	If the arrangement is offered only to one or a small, limited group of suppliers, a conclusion that trade payable classification is inappropriate may be supported.
Are the payment terms consistent with those of trade payables in the entity’s industry?	If the payment terms are atypical of those of trade payables in the entity’s industry (e.g., due dates) because of the intermediary’s involvement in the arrangement, trade payable classification may be inappropriate.
Is the entity informed of transactions between suppliers and the intermediary?	The entity’s lack of direct knowledge of transactions between suppliers and the intermediary (e.g., early settlements at a discount) may help support a conclusion that the payable should be presented as a trade payable. However, the entity’s right to obtain such information does not necessarily preclude trade payable classification.
Does interest accrue before the due date?	The fact that the payable accrues interest before the due date may suggest that trade payable classification is inappropriate.
What is the legal form of the entity’s obligation?	An instrument whose legal form under the U.S. Uniform Commercial Code is more like a negotiable instrument (such as a promissory note) than an account payable may suggest that trade payable classification is inappropriate. (The intermediary may prefer the legal form to be that of a negotiable instrument to facilitate transfers of the receivable.)
Does the intermediary require the entity to post collateral, maintain credit facilities, or arrange third-party guarantees?	The fact that the entity is required to post collateral, maintain credit facilities, or arrange third-party guarantees for the benefit of the intermediary suggests that trade payable classification may be inappropriate.
Is the priority of the intermediary’s claim on the entity more senior than that of the original trade payable?	If the priority of the intermediary’s claim on the entity is more senior than that of the original trade payable, trade payable classification may be inappropriate.

In his 2003 speech, Mr. Comerford provided two examples of arrangements involving trade payable transactions with an intermediary that an entity should not, according to the SEC staff, present as amounts payable to trade creditors but rather as borrowings from financial institutions:

“[A]n intermediary, typically a financial institution or one of its affiliates, pays trade payables on behalf of the purchaser in order to take advantage of discounts for early payment that the purchaser would not otherwise avail itself of. The purchaser then pays the lender either the full amount of the trade payable at a future date beyond the payable’s normal terms, or an amount less than the full amount of the trade payable but on the trade payable’s normal due date. Thus, the arrangement between the lender and the purchaser often results in the purchaser securing financing at lower cost of funds than is inherent in the vendor’s invoice. In this transaction, the vendor is often not aware of the arrangement between the purchaser and the lender.”
“[T]he vendor [is] a willing participant in a tri-party arrangement between the manufacturer, the vendor and the intermediary. Specifically, the intermediary accepts an IOU from the purchaser and presents a separate IOU to the vendor. The lender provides the purchaser with incentives similar to those provided in the first transaction and provides the vendor with the ability to present its IOU to the lender for accelerated payment at an appropriately discounted amount.”

In both examples, the purchasing entity benefits by either (1) obtaining a repayment date from the financial institution beyond the due date of the original payable or (2) sharing in a portion of the trade discount received by the financial institution via the accelerated payment to the vendor. Further, the payments made by the intermediary to the vendor “were made within the time period necessary to secure a trade discount.” Mr. Comerford noted that the OCA objects to trade payable classification in these circumstances. Instead, the staff believes as follows:

[T]he substance of both of these transactions equates to the purchaser obtaining financing from a lender in order to pay amounts due to its vendors. . . . [T]he manufacturer’s original liability to the vendor is extinguished on the date the lender remits cash or a lender IOU to the vendor. Pursuant to the provisions of Article 5, the purchaser should derecognize its trade account payable and record a new liability classified on its balance sheet as a borrowing from the lender. Consistent with this classification, the purchaser should then accrete the difference between the initial carrying amount of the borrowing (i.e. the discounted amount of the vendor invoice) and the repayment amount (i.e. the amount owed to the lender) through interest expense using the effective yield method.

In his 2004 speech, Mr. Comerford warned registrants and auditors not to mistake the SEC staff’s 2003 discussion of the two trade payable arrangements for a set of rules to use for determining when short-term borrowings should be classified as trade payables. Rather, as noted above, an entity must consider all the facts and circumstances and comply with both the letter and the spirit of the accounting requirements.

We are not aware that the SEC staff has addressed an entity’s use of p-cards (i.e., purchase cards), other types of charge cards, or credit cards to pay invoices. If these arrangements are only used as the original mechanism to incur an expenditure with a vendor, it may be acceptable to consider such amounts owed as trade payables in certain situations. For example, if one of these types of bank-issued cards is used only as a matter of convenience to incur an expenditure (i.e., pay the vendor immediately), the amounts owed are paid during the customary period in which trade payables are due, and interest costs are not incurred, classification of such amounts owed as trade payables is generally acceptable.

P-cards and other charge cards are sometimes used by entities to extend payment terms. When a p-card or other charge card is used to pay an invoice owed to a vendor, the entity has extinguished its liability to the vendor and incurred an obligation with a bank. Therefore, continued classification as a trade payable is not appropriate. For example, an entity might extend the payment terms on a trade payable with an invoice due date of April 1, 20X0, by using a charge card that has a monthly settlement date of April 30, 20X0, for which full payment of all charges incurred in April 20X0 are due on May 31, 20X0. In this scenario, the entity has extended the payment terms by 60 days. Continued classification as a trade payable after the vendor has been paid is inappropriate; therefore, such classification could only be accepted on the basis of a materiality argument in this type of arrangement.

It is difficult to distinguish between (1) an entity’s use of a credit card to make payments to vendors and (2) its use of a traditional revolving line of credit to make such payments (i.e., in both arrangements, interest costs accrue). Therefore, any time a credit card is used to pay trade payables, the entity should reclassify such payables as liabilities owed to a bank. In no situation in which an entity (1) uses any type of bank-issued card to pay invoices and (2) incurs interest on such card can the entity continue to classify as trade payables amounts paid to vendors as a result of having incurred those charges.

Example 14-1

Structured Vendor Payable Program

A structured vendor payable program (SVPP) that is established as follows might not change the characteristics of trade payables (i.e., it might not require reclassification to short-term debt):

The entity enters into an agreement for buyer payment services in which the intermediary is acting as the entity’s paying agent for the entity’s suppliers.
The intermediary offers participating suppliers the opportunity to voluntarily factor their receivables from the entity to the intermediary. That is, a supplier is able to factor its receivable to the intermediary on a discounted basis before the invoice due date. Specifically, the intermediary offers vendors the following two payment options: (1) payment on the due date in 60 days or (2) advance payment in 30 days at a 2.5 percent discount.
The SVPP does not relieve the entity of its obligation to its suppliers under invoices eligible for factoring under the SVPP. The supplier maintains recourse against the entity for nonpayment and for any commercial dispute related to the invoice.
The SVPP does not change the payment terms, timing, or amount with respect to the entity’s obligation to its supplier. The entity’s obligation to the supplier is neither affected nor reduced by any separate contract between the intermediary and the supplier.
The payment terms are consistent with those typically offered in the entity’s industry.
The entity will not participate in any negotiations between suppliers and the intermediary.
Although the entity may request such information from the intermediary, it will not be automatically notified of any advance payment or other transactions between the supplier and intermediary.
The entity is not obligated to pay any fees directly to the intermediary and will not receive any amounts or benefits from the intermediary in the form of a rebate or other incentives. The entity is obligated to pay the full invoice amount even if the intermediary paid the supplier at a discount.
The legal form of the trade payable has not changed.

If a trade payable arrangement involving an intermediary must be classified as a borrowing, an entity should consider the associated cash flow statement implications (see also Section 7.2 of Deloitte’s Roadmap Statement of Cash Flows). At the December 2005 AICPA Conference on Current SEC and PCAOB Developments, SEC Associate Chief Accountant Joel Levine stated, in part:

The situation addressed by the staff dealt with a transaction similar to the purchase of non-[X] products financed through [X]. For example, say a dealer purchases [Y and Z] financed under a floor-plan arrangement with [X]. [X] pays the supplier directly and then is repaid later by the dealer. In this case, the financing arrangement is not with the supplier, as it was when the dealer purchased [X] products; therefore, it does not represent a trade loan. It represents a third-party financing arrangement. Not a big deal, except that the inventory purchase, an operating activity, has taken place without the dealer physically delivering the cash. Based on the view that the financing entity effectively has acted as the dealer’s agent, we concluded that upon purchase of the inventory, the dealer should report the increase in the third-party loan in substance as a financing cash inflow, with a corresponding operating cash outflow for the increase in inventory. Upon repayment, the cash outflow would be reported as a financing activity. Here, the cash flows statement would depict the substance of the transactions — with the end result being similar to the previous example where the net effect on operating cash flows is the amount of gross profit generated.

In accordance with this speech, when the debt owed to a bank for a good or service purchased from a supplier is recognized, the amount must be treated as an operating cash outflow and a financing cash inflow even though the entity actually did not have any cash outflow to the supplier. This is because an entity must apply, in substance, a “constructive cash payment/receipt” approach to the transaction when preparing the statement of cash flows. The subsequent cash paid to satisfy the amount owed to the bank is classified as a financing cash outflow.

14.3.1.3.2 Disclosure

ASC 405-50

05-1 This Subtopic addresses the disclosures applicable for an entity that uses a supplier finance program in connection with the purchase of goods and services (the buyer in a supplier finance program). A supplier finance program also may be referred to as a reverse factoring, payables finance, or structured payables arrangement.

10-1 The objective of this Subtopic is to establish disclosures that enhance the transparency of a supplier finance program used by an entity in connection with the purchase of goods and services (the buyer in a supplier finance program).

10-2 This Subtopic does not address either of the following:

A buyer’s recognition, measurement, or financial statement presentation of an obligation in connection with a supplier finance program
The accounting and disclosure for other parties involved in a supplier finance program.

15-1 The guidance in this Subtopic applies to all entities that use supplier finance programs in connection with the purchase of goods and services (buyers in a supplier finance program).

15-2 The guidance in this Subtopic applies to obligations in connection with supplier finance programs. A supplier finance program is an arrangement that has all the following characteristics:

An entity enters into an agreement with a finance provider or an intermediary.
The entity confirms supplier invoices as valid to the finance provider or intermediary under the agreement described in (a).
The entity’s supplier has the option to request early payment from a party other than the entity for invoices that the entity has confirmed as valid.

15-3 Although not determinative, an indicator that an entity may have a supplier finance program is the commitment to pay a party other than the supplier for a confirmed invoice without offset, deduction, or any other defenses to payment.

15-4 In determining whether an entity has established a supplier finance program and, therefore, is subject to the disclosures required by this Subtopic, all available evidence shall be considered, including arrangements between the entity and its finance provider or intermediary and between the entity and its suppliers whose invoices the entity has confirmed as valid to the finance provider or intermediary.

50-1 The objective of the requirements in this Subtopic is for an entity to disclose sufficient information to enable users of financial statements to understand the nature, activity during the period, changes from period to period, and potential magnitude of the entity’s supplier finance programs. To achieve that objective, an entity shall disclose qualitative and quantitative information about its supplier finance programs.

50-2 An entity shall consider the level of detail necessary to satisfy the disclosure objective. If an entity uses more than one supplier finance program, the entity may aggregate disclosures, but not to the extent that useful information is obscured by the aggregation of programs that have substantially different characteristics.

50-3 In each annual reporting period, an entity shall disclose all the following information about its supplier finance programs:

The key terms of the program, including, but not limited to:
1. A description of the payment terms, including payment timing and the basis for its determination
2. Assets pledged as security or other forms of guarantees provided for the committed payment to the finance provider or intermediary.
See paragraphs 405-50-55-1 through 55-3 for an illustrative example.
The amount of obligations outstanding at the end of the reporting period that the entity has confirmed as valid to the finance provider or intermediary under the program (that is, the amount of obligations confirmed under the program that remains unpaid by the entity) and the following information about those obligations:
1. Where those obligations are presented in the balance sheet. If those obligations are presented in more than one balance sheet line item, then the entity shall disclose the amount outstanding at the end of the reporting period in each line item.
2. A rollforward of those obligations showing, at a minimum, all the following:
  1. The amount of those obligations outstanding at the beginning of the reporting period
  2. The amount of those obligations added to the program during the reporting period
  3. The amount of those obligations settled during the reporting period
  4. The amount of those obligations outstanding at the end of the reporting period.

50-4 In each interim reporting period, an entity shall disclose the amount of obligations outstanding that the entity has confirmed as valid to the finance provider or intermediary under the supplier finance program at the end of the reporting period.

ASC 405-50 requires the buyer in a supplier finance program to disclose qualitative and quantitative information about the program. Under ASC 405-50-15-2, such a program is defined as an “arrangement that has all the following characteristics:”

“An entity enters into an agreement with a finance provider or an intermediary.”
“The entity confirms supplier invoices as valid to the finance provider or intermediary under the agreement.”
“The entity’s supplier has the option to request early payment from a party other than the entity for invoices that the entity has confirmed as valid.”

The disclosure requirements in ASC 405-50 apply regardless of whether the entity classifies its liabilities under a supplier finance program as a trade payable or on another balance sheet line (e.g., debt).

ASC 405-50 does not apply to any of the following:

The intermediary or supplier in a supplier finance program.
Traditional credit card programs for which an intermediary is directed to pay the supplier on behalf of an entity.
Payment processing arrangements that do not give a supplier the option to request early payment.
Arrangements that extend, or give an entity the option to extend, the payment terms associated with the payment due date in the related invoice.
Credit enhancements, such as letters of credit or financial guarantees, provided by an intermediary to a supplier on an entity’s behalf.

ASC 405-50-50-3 and 50-4 specify the disclosures for annual and interim periods, and ASC 405-50-55-4 and 55-5 illustrate how to disclose the rollforward information required under ASC 405-50-50-3(b)(2). (Note that entities do not have to provide these disclosures until fiscal years beginning after December 15, 2023, although early adoption is permitted.)

ASC 405-50

Example 2: Disclosure of a Rollforward of Obligations Confirmed as Valid Under a Supplier Finance Program

55-4 This Example provides an illustration of the guidance in paragraph 405-50-50-3(b)(2) based on the assumptions that Entity A provides one comparative balance sheet and that its supplier finance program is denominated in Entity A’s reporting currency.

55-5 The following illustrates the disclosures in a tabular format.

The rollforwards of Entity A’s outstanding obligations confirmed as valid under its supplier finance program for years ended December 31, 20X2, and 20X1, are as follows (in thousands):

Connecting the Dots

ASC 405-50-50-3(b) requires entities to provide certain disclosures related to “[t]he amount of obligations outstanding at the end of the reporting period that the entity has confirmed as valid to the finance provider or intermediary under the program.” Questions have arisen related to whether these disclosures are limited to the amount that the finance provider or intermediary has funded (i.e., the amount the supplier has been paid by the finance provider or intermediary before the related invoice due date). However, this requirement applies to the amount that remains unpaid by the entity irrespective of whether the supplier has been paid. There is no requirement in ASC 405-50 to disclose the amount funded by the finance provider or intermediary.

14.3.1.4 Separate Presentation of Debt Measured at Fair Value

ASC 825-10

45-1A An entity shall separately present financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) in the statement of financial position or the accompanying notes to the financial statements.

45-1B Entities shall report assets and liabilities that are measured at fair value pursuant to the fair value option in this Subtopic in a manner that separates those reported fair values from the carrying amounts of similar assets and liabilities measured using another measurement attribute.

45-2 To accomplish that, an entity shall either:

Present the aggregate of fair value and non-fair-value amounts in the same line item in the statement of financial position and parenthetically disclose the amount measured at fair value included in the aggregate amount
Present two separate line items to display the fair value and non-fair-value carrying amounts.

ASC 815-15

45-1 In each statement of financial position presented, an entity shall report hybrid financial instruments measured at fair value under the election and under the practicability exception in paragraph 815-15-30-1 in a manner that separates those reported fair values from the carrying amounts of assets and liabilities subsequently measured using another measurement attribute on the face of the statement of financial position. To accomplish that separate reporting, an entity may do either of the following:

Display separate line items for the fair value and non-fair-value carrying amounts
Present the aggregate of the fair value and non-fair-value amounts and parenthetically disclose the amount of fair value included in the aggregate amount.

An entity must disaggregate financial liabilities by measurement category either on the face of the balance sheet or in the notes to the financial statements. A debtor that has measured debt instruments at fair value under ASC 825-10 (see Section 4.4) or ASC 815-15 (including those measured at fair value because the entity is unable to reliably identify and measure an embedded derivative that would otherwise need to be bifurcated; see Sections 8.5.5 and 8.5.6) must present those debt instruments on the balance sheet in a manner that separates them from the carrying amounts of similar debt instruments that are measured by using an attribute other than fair value (e.g., debt that is accounted for by using the interest method in ASC 835-30; see Section 6.2). ASC 825 and ASC 815-15 identify two ways to accomplish such presentation: (1) separate line items or (2) parenthetical disclosure of fair value amounts.

In the absence of regulations that require separate presentation of accrued interest, the fair value amount presented on the balance sheet for an interest-bearing financial asset or financial liability accounted for at fair value through earnings should include any interest earned or incurred but not paid (accrued interest). It would, however, be acceptable for an entity to parenthetically disclose the amount of the fair value measurement that represents accrued interest in the financial statement line item for which the interest-bearing financial asset or financial liability accounted for under the fair value option is presented.

If there are regulations that require presentation of accrued interest separately from the related interest-bearing financial asset or financial liability for which the fair value option has been elected, an entity must do one of the following to comply with the disclosure requirements in ASC 825:

Present the aggregate amount of accrued interest, which represents part of the fair value of the asset or liability, in a separate line item in the statement of financial position.
Parenthetically disclose the amount of the fair value measurement that represents accrued interest in the financial statement line item for which the interest-bearing financial asset or financial liability is presented.

14.3.1.5 SEC Requirements

The FASB has not prescribed which specific line items an entity must present related to debt on its balance sheet, although debtors typically present short-term borrowings separately from long-term debt (see Chapter 13). Entities that file financial statements with the SEC must comply with the balance sheet requirements in Regulation S-X, including those that apply to the following types of entities:

Commercial and industrial companies (see the next section).
Bank holding companies (see Section 14.3.1.5.2).
Insurance companies (see Section 14.3.1.5.3).
Registered investment companies (see Section 14.3.1.5.4).

14.3.1.5.1 Commercial and Industrial Companies

SEC Rules, Regulations, and Interpretations

Regulation S-X, Rule 5-02, Balance Sheets [Reproduced in ASC 210-10-S99-1]

The purpose of this rule is to indicate the various line items and certain additional disclosures which, if applicable, and except as otherwise permitted by the Commission, should appear on the face of the balance sheets or related notes filed for the persons to whom this article pertains (see § 210.4-01(a)). . . .

Liabilities and Stockholders’ Equity

Current Liabilities, When Appropriate

19. Accounts and notes payable.

(a) State separately amounts payable to

(1) banks for borrowings;

(2) factors or other financial institutions for borrowings;

(3) holders of commercial paper;

(4) trade creditors;

(5) related parties (see § 210.4-08(k));

(6) underwriters, promoters, and employees (other than related parties); and

(7) others.

Amounts applicable to (1), (2) and (3) may be stated separately in the balance sheet or in a note thereto.

(b) The amount and terms (including commitment fees and the conditions under which lines may be withdrawn) of unused lines of credit for short-term financing shall be disclosed, if significant, in the notes to the financial statements. The weighted average interest rate on short term borrowings outstanding as of the date of each balance sheet presented shall be furnished in a note. The amount of these lines of credit which support a commercial paper borrowing arrangement or similar arrangements shall be separately identified.

20. Other current liabilities. State separately, in the balance sheet or in a note thereto, any item in excess of 5 percent of total current liabilities. Such items may include, but are not limited to, accrued payrolls, accrued interest, taxes, indicating the current portion of deferred income taxes, and the current portion of long-term debt. Remaining items may be shown in one amount.

21. Total current liabilities, when appropriate.

Long-Term Debt.

22. Bonds, mortgages and other long-term debt, including capitalized leases.

(a) State separately, in the balance sheet or in a note thereto, each issue or type of obligation and such information as will indicate:

(1) The general character of each type of debt including the rate of interest;

(2) the date of maturity, or, if maturing serially, a brief indication of the serial maturities, such as “maturing serially from 1980 to 1990”;

(3) if the payment of principal or interest is contingent, an appropriate indication of such contingency;

(4) a brief indication of priority; and

(5) if convertible, the basis. For amounts owed to related parties, see § 210.4-08(k).

(b) The amount and terms (including commitment fees and the conditions under which commitments may be withdrawn) of unused commitments for long-term financing arrangements that would be disclosed under this rule if used shall be disclosed in the notes to the financial statements if significant.

23. Indebtedness to related parties — noncurrent. Include under this caption indebtedness to related parties as required under § 210.4-08(k). . . .

Regulation S-X requires SEC registrants subject to Rule 5-02 (i.e., commercial and industrial companies) to present current liabilities separately from long-term debt on the face of the balance sheet. When appropriate, a total of current liabilities must also be shown.

Within current liabilities, accounts and notes payable are presented separately from other current liabilities on the face of the balance sheet. Within accounts and notes payable, the amounts of borrowings from (1) banks, (2) factors and other financial institutions, and (3) commercial paper holders are shown separately either on the face of the balance sheet or in the notes. Further, amounts due to (1) trade creditors (e.g., payables for goods or services); (2) related parties; (3) underwriters, promoters, and employees (other than related parties); and (4) others are stated separately on the face of the balance sheet. Other current liabilities include, for example, accrued interest and the current portion of long-term debt. Any item within the other current liabilities category in excess of 5 percent of total current liabilities must be displayed separately on the face of the balance sheet or in the notes.

Within noncurrent liabilities, bonds, mortgages, and other long-term debt, are shown separately from related-party debt. For each issue or type of obligation of bonds, mortgages, and other long-term debt, the entity states separately either on the face of the balance sheet or in a note (1) the general character of each debt type; (2) the interest rate; (3) the maturity date or, for serial-maturity debt (e.g., amortizing debt), the serial maturity period; (4) an indication of any contingency associated with the payment of principal or interest (e.g., additional interest contingent upon an event of default or delayed filings); (5) priority (e.g., senior or subordinated debt); and (6) if applicable, conversion terms.

14.3.1.5.2 Bank Holding Companies

SEC Rules, Regulations, and Interpretations

Regulation S-X, Rule 9-03, Balance Sheets [Reproduced in ASC 942-210-S99-1]

The purpose of this rule is to indicate the various items which, if applicable, should appear on the face of the balance sheets or in the notes thereto. . . .

13. Short-term borrowing. Disclosure separately on the balance sheet or in a note, amounts payable for

(1) Federal funds purchased and securities sold under agreements to repurchase;

(2) commercial paper, and

(3) other short-term borrowings.

(a) Disclose any unused lines of credit for short-term financing: (§ 210.5-02.19(b)). . . .

16. Long-term debt. Disclose in a note the information required by § 210.5-02.22. . . .

Regulation S-X requires SEC registrants subject to Rule 9-03 (i.e., bank holding companies) to present separate balance sheet captions for short-term borrowings and long-term debt. However, such entities are not required to present a classified balance sheet with separate subtotals for short-term and long-term liabilities.

Within the short-term borrowings category, entities separately disclose federal funds purchased and securities sold under repurchase agreements, commercial paper, and other short-term borrowing either on the face of the balance sheet or in the notes. For each issue or type of obligation of bonds, mortgages, and other long-term debt, the entity states in a note (1) the general character of each debt type; (2) the interest rate; (3) the maturity date or, for serial-maturity debt (e.g., amortizing debt), the serial maturity period; (4) an indication of any contingency associated with the payment of principal or interest (e.g., additional interest contingent on an event of default or delayed filings); (5) priority (e.g., senior or subordinated debt); and (6) if applicable, conversion terms.

14.3.1.5.3 Insurance Companies

SEC Rules, Regulations, and Interpretations

Regulation S-X, Rule 7-03, Balance Sheets [Reproduced in ASC 944-210-S99-1]

(a) The purpose of this rule is to indicate the various items which, if applicable, and except as otherwise permitted by the Commission, should appear on the face of the balance sheets and in the notes thereto filed for persons to whom this article pertains. (See § 210.4-01(a).). . .

16. Notes payable, bonds, mortgages and similar obligations, including capitalized leases.

(a) State separately in the balance sheet the amounts of (1) short-term debt and (2) long-term debt including capitalized leases.

(b) The disclosure required by § 210.5-02.19(b) shall be given if the aggregate of short-term borrowings from banks, factors and other financial institutions and commercial paper issued exceeds five percent of total liabilities.

17. Indebtedness to related parties. (See § 210.4-0.8(k).) . . .

Regulation S-X requires SEC registrants subject to Rule 7-03 (i.e., insurance companies) to divide their presentation of amounts for notes payable, bonds, mortgages, and similar obligations between short-term debt and long-term debt (including capitalized leases) on the face of the balance sheet. However, such entities are not required to present a classified balance sheet with separate subtotals for short-term and long-term liabilities.

For each issue or type of obligation of long-term debt, the entity discloses separately either on the face of the balance sheet or in a note (1) the general character of each debt type; (2) the interest rate; (3) the maturity date or, for serial-maturity debt (e.g., amortizing debt), the serial maturity period; (4) an indication of any contingency associated with the payment of principal or interest (e.g., additional interest contingent on an event of default or delayed filings); (5) priority (e.g., senior or subordinated debt); and (6) if applicable, conversion terms.

14.3.1.5.4 Registered Investment Companies

SEC Rules, Regulations, and Interpretations

Regulation S-X, Rule 6-04, Balance Sheets [Reproduced in ASC 946-210-S99-1]

This section is applicable to balance sheets filed by registered investment companies and business development companies except for persons who substitute a statement of net assets in accordance with the requirements specified in § 210.6-05, and issuers of face-amount certificates which are subject to the special provisions of § 210.6-06. Balance sheets filed under this rule shall comply with the following provisions: . . .

13. Notes payable, bonds and similar debt.

(a) State separately amounts payable to:

(1) Banks or other financial institutions for borrowings;

(2) controlled companies;

(3) other affiliates; and

(4) others, showing for each category amounts payable within one year and amounts payable after one year.

(b) Provide in a note the information required under § 210.5-02.19(b) regarding unused lines of credit for short-term financing and § 210.5-02.22(b) regarding unused commitments for long-term financing arrangements. . . .

Regulation S-X requires SEC registrants subject to Rule 6-04 (i.e., registered investment companies) to present the amount of notes payable, bonds, and similar debt on the face of the balance sheet with a breakdown of amounts payable to (1) banks or other financial institutions for borrowings, (2) controlled companies, (3) other affiliates, and (4) others. For each category, amounts payable within one year and amounts payable after one year are shown. However, such entities are not required to present a classified balance sheet with separate subtotals for short-term and long-term liabilities.

14.3.2 Cash Flow Statement

ASC 230-10

45-14 All of the following are cash inflows from financing activities: . . .

b. Proceeds from issuing bonds, mortgages, notes, and from other short- or long-term borrowing . . . .

45-15 All of the following are cash outflows for financing activities: . . .

b. Repayments of amounts borrowed, including the portion of the repayments made to settle zero-coupon debt instruments that is attributable to the principal or the portion of the repayments made to settle other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing that is attributable to the principal.

c. Other principal payments to creditors who have extended long-term credit. See paragraph 230-10-45-13(c), which indicates that most principal payments on seller-financed debt directly related to a purchase of property, plant, and equipment or other productive assets are financing cash outflows. . . .

e. Payments for debt issue costs. . . .

g. Payments for debt prepayment or debt extinguishment costs, including third-party costs, premiums paid, and other fees paid to lenders that are directly related to the debt prepayment or debt extinguishment, excluding accrued interest.

45-17 All of the following are cash outflows for operating activities:

a. Cash payments to acquire materials for manufacture or goods for resale, including principal payments on accounts and both short- and long-term notes payable to suppliers for those materials or goods. The term goods includes certain loans and other debt and equity instruments of other entities that are acquired specifically for resale, as discussed in paragraph 230-10-45-21. . . .

d. Cash payments to lenders and other creditors for interest, including the portion of the payments made to settle zero-coupon debt instruments that is attributable to accreted interest related to the debt discount or the portion of the payments made to settle other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing that is attributable to accreted interest related to the debt discount. For all other debt instruments, an issuer shall not bifurcate cash payments to lenders and other creditors at settlement for amounts attributable to accreted interest related to the debt discount, nor classify such amounts as cash outflows for operating activities. . . .

Under ASC 230, proceeds from borrowings are classified as cash inflows from financing activities, whereas repayment of amounts borrowed, payments for debt issue costs, and payments for debt prepayment or debt extinguishment costs are classified as cash outflow for financing activities. However, principal payments on notes payable to suppliers for materials or goods are classified as cash outflows for operating activities.

Although ASC 230 does not address debt modifications accounted for under ASC 470-50, when debt is restructured and is accounted for as a modification rather than as an extinguishment, an entity should apply the principles in ASC 230 and classify fees paid to the creditor on the modification date as a financing cash outflow (see Section 6.2.1 of Deloitte’s Roadmap Statement of Cash Flows). Further, any fees paid to a third party other than the creditor in connection with a debt modification should generally be classified as operating cash outflows because, in accordance with ASC 470-50-40-18(b), the payment must be expensed.

An entity that issues zero-coupon bonds to an investor records the proceeds from the bonds’ issuance as a financing cash inflow. Unless the debtor elects to account for the bonds at fair value under the fair value option, the bonds are accreted to their redemption value in accordance with the interest method (see Section 6.2); that is, the carrying amount of the bonds increases from issuance until maturity (or earlier if prepayment is allowed) for the accrued interest to arrive at the bonds’ redemption value. On the maturity date (or earlier if prepayment is allowed), the entity repays (1) the original proceeds (the principal amount of the bonds) and (2) the accrued interest from the date of issuance. Before the bonds’ maturity (or the date of prepayment, if earlier), the interest expense is presented in the statement of cash flows as a reconciling item between net income and cash flows from operating activities, since no interim cash payments are made for the periodic accrual of interest. At redemption, the cash paid to settle the interest component is reflected as a cash outflow from operating activities in the statement of cash flows in accordance with ASC 230-10-45-17(d) as the accrued interest is recognized in earnings. The cash paid to settle the principal component (excluding the interest component) is reflected as a cash outflow from financing activities in the statement of cash flows in accordance with ASC 230-10- 45-15(b). For an illustration of this accounting, see Example 6-9 in Deloitte’s Roadmap Statement of Cash Flows.

In addition to zero-coupon bonds, the guidance in ASC 230-10-45-17(d) also applies to other debt instruments “with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing that is attributable to the principal.” The objective of including these other debt instruments (rather than all debt instruments) is to improve comparability related to entities’ presentation of economically similar transactions. ASC 230 does not define the term “insignificant” or otherwise provide guidance on what would constitute insignificant coupon rates. Consequently, entities that issue other debt instruments with coupon rates that are insignificant in relation to the effective interest rate attributable to the principal will most likely need to exercise greater judgment in evaluating the portion of the rates that is insignificant. We generally believe that an entity should determine whether an interest rate is insignificant by looking to the market. For example, a 1 percent coupon rate may not be insignificant if the market rate is 2 percent. However, an entity may conclude that a 1 percent coupon rate is insignificant compared with a market rate of 10 percent.

As discussed in Section 6.4.3 of Deloitte’s Roadmap Statement of Cash Flows, the guidance in ASC 230-10-45-17(d) applies to all debt instruments that are economically similar to zero-coupon instruments, including debt instruments that contain periodic interest coupons that are payable in kind.

For additional discussion about the application of ASC 230, see Deloitte’s Roadmap Statement of Cash Flows.

14.3.3 Earnings per Share

While a detailed discussion of the guidance in ASC 260-10 is beyond the scope of this Roadmap, this section briefly discusses how debt could affect an issuer’s EPS calculations. For a comprehensive discussion of the guidance in ASC 260-10, see Deloitte’s Roadmap Earnings per Share.

14.3.3.1 Participating Securities

Sometimes, debt securities (e.g., certain convertible debt) have a nondiscretionary and objectively determinable participation right in the debtor’s undistributed earnings (e.g., a right to participate on an if-converted basis in any dividends or other distributions to holders of common stock). For such securities, the debtor should consider whether EPS must be calculated by using the two-class method under ASC 260. The two-class method applies to both basic and diluted EPS. Potential common shares (e.g., convertible debt) are subject to the two-class method of calculating diluted EPS if the effect is more dilutive than the application of another dilutive method of calculating diluted EPS (i.e., the treasury stock, if-converted, or contingently issuable share method). For a detailed discussion of these requirements, see Chapter 5 of Deloitte’s Roadmap Earnings per Share.

14.3.3.2 Convertible Debt

When debt is convertible into the debtor’s shares of common stock, the if-converted method should be applied in the computation of diluted EPS. For convertible debt that is a participating security, the two-class method should be applied in the computation of diluted EPS if it is more dilutive than the if-converted method (see the previous section).

If a convertible debt instrument does not represent a participating security, the if-converted method is used to reflect the impact of the embedded conversion option on diluted EPS. Under the if-converted method, an entity may need to adjust both the numerator and denominator. Since an entity using the if-converted method assumes that a convertible debt instrument was converted into common shares at the beginning of the reporting period (or the date of issuance, if later), the numerator is adjusted to reverse any recognized interest expense (including any amortization of discounts), net of tax, unless the principal amount must be settled in cash. The common shares issuable upon conversion are added to the denominator on the basis of the most favorable conversion terms available to the holder. Except for convertible debt for which the principal amount must be settled in cash upon conversion and certain contingently convertible debt instruments, the if-converted method, if dilutive, must be applied even if the embedded conversion option is out-of-the-money. For a detailed discussion of these requirements, see Sections 4.4 and 6.2 of Deloitte’s Roadmap Earnings per Share.

If a convertible debt instrument does not represent a participating security and the debtor can settle all or a portion of it in cash or common stock upon conversion, the debtor must consider the guidance in ASC 260 on contracts that may be settled in stock or cash. Under that guidance, an entity presumes that a contract that may be settled in either cash or stock will be settled in common stock for diluted EPS purposes. That presumption cannot be overcome (e.g., on the basis of past experience or a stated policy). If the principal amount must be settled in cash and the conversion spread in shares, only the net number of shares equivalent to the conversion spread is reflected in the computation of diluted EPS. If the entire obligation can be settled in shares, the full number of shares underlying the conversion feature is reflected in the application of the if-converted method.

Special considerations are necessary if:

An induced conversion occurs (see Section 6.6.1 of Deloitte’s Roadmap Earnings per Share).
The conversion feature is nonsubstantive at inception and becomes exercisable only upon the exercise of a call option (see Section 6.6.2 of Deloitte’s Roadmap Earnings per Share).
The embedded conversion option is separated as a derivative under ASC 815-15 (see Section 6.6.3 of Deloitte’s Roadmap Earnings per Share).
The issuer has elected the fair value option in ASC 815-15 or ASC 825-10 (see Section 6.6.4 of Deloitte’s Roadmap Earnings per Share).
The convertible debt contains an embedded put or call option (see Section 6.6.5 of Deloitte’s Roadmap Earnings per Share).
The conversion feature is contingent (see Section 4.4.3 of Deloitte’s Roadmap Earnings per Share).

In addition, ASC 470-20-45-2A contains EPS guidance for own-share lending arrangements executed in contemplation of a convertible debt offering or other financing. Under this guidance, loaned shares are excluded from EPS unless the counterparty to the arrangement defaults on its obligation to return the loaned shares (or an equivalent amount of consideration). If the counterparty defaults, the shares are included in both basic and diluted EPS. (Note that under ASC 470-20-45-2A, the counterparty would need to default for the loaned shares to be included in EPS, whereas under ASC 470-20-35-11A, the counterparty’s default must be probable for a loss to be recognized.)

In practice, own-share lending arrangements often require the counterparty to reimburse the issuer for any dividends paid on the loaned shares. If the counterparty does not reimburse the issuer for such dividends, however, the issuer must deduct the corresponding amount and any participation right in undistributed earnings from income available to common stockholders.

For more discussion of the EPS accounting for own-share lending arrangements, see Deloitte’s Roadmap Earnings per Share, in particular Sections 3.3.2.8, 4.8.3.5, 5.3.3.9, and 8.5.

14.3.3.3 Contracts That May Be Settled in Stock or Cash

Some debt instruments allow for settlement in stock or cash (e.g., certain convertible debt and variable-share settleable instruments). The specific guidance in ASC 260 on diluted EPS applies to contracts that may be settled in such a manner whether the option to elect the form of settlement is controlled by the entity or the counterparty to the arrangement. ASC 260-10-45-45 states:

The effect of potential share settlement shall be included in the diluted EPS calculation (if the effect is more dilutive) for an otherwise cash-settleable instrument that contains a provision that requires or permits share settlement (regardless of whether the election is at the option of an entity or the holder, or the entity has a history or policy of cash settlement). An example of such a contract accounted for in accordance with this paragraph and paragraph 260-10-45-46 is a written call option that gives the holder a choice of settling in common stock or in cash. An election to share settle an instrument, for purposes of applying the guidance in this paragraph, does not include circumstances in which share settlement is contingent upon the occurrence of a specified event or circumstance (such as contingently issuable shares). In those circumstances (other than if the contingency is an entity’s own share price), the guidance on contingently issuable shares should first be applied, and, if the contingency would be considered met, then the guidance in this paragraph should be applied. Share-based payment arrangements that are payable in common stock or in cash at the election of either the entity or the grantee shall be accounted for pursuant to this paragraph and paragraph 260-10-45-46, unless the share-based payment arrangement is classified as a liability because of the requirements in paragraph 718-10-25-15 (see paragraph 260-10-45-45A for guidance for those instruments). If the payment of cash is required only upon the final liquidation of an entity, then the entity shall include the effect of potential share settlement in the diluted EPS calculation until the liquidation occurs.

Except for certain share-based payment arrangements, an entity must assume in the calculation of diluted EPS that any contract that allows for settlement in shares will be settled in shares. This assumption must be made regardless of (1) the likelihood of share settlement or (2) the intent of the party that has the right to elect settlement in stock or cash. Accordingly, an entity uses the if-converted method to include potential common shares in the denominator of diluted EPS when a debt instrument may be settled in stock or cash at the option of the issuer or investor. The numerator in the calculation of diluted EPS may also need to be adjusted for these instruments. For more information about the accounting for diluted EPS for contracts that may be settled in stock or cash, see Section 4.7 of Deloitte’s Roadmap Earnings per Share.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.