10.2 Issuances of Equity Instruments
10.2.1 Recognition
An entity recognizes the issuance of equity shares (e.g., common or preferred
stock) on the date the shares are legally issued and outstanding, which is
typically the settlement date. Settlement date accounting applies even though an
agreement to issue shares is ordinarily executed on an earlier date. Therefore,
shares issuable upon settlement of a forward contract, or upon the conversion of
a convertible instrument, are recognized on the date such shares are legally
issued and outstanding.
If an entity issues equity shares before it receives the related proceeds, it
should consider the appropriate classification of the receivable. A receivable
that results from the issuance of shares is typically classified as a reduction
of equity as opposed to an asset (see further discussion in Sections
10.2.1.1, 10.2.1.2, and
10.2.1.3). If an entity receives the proceeds before
the equity shares are legally issued and outstanding, it should generally
evaluate the arrangement as an equity-linked instrument in accordance with ASC
815-40 or other applicable literature.
Connecting the Dots
Under ASC 815-40-15-6, any contract on an entity’s own
equity (including one that contingently requires the entity to issue
equity shares) must be recognized when the contract is issued, which is
akin to trade-date accounting. However, if an arrangement is not legally
binding (i.e., a contract does not exist), it would not be recognized.
For example, recognition would not occur as a result of a letter of
intent or a memorandum of understanding that is not contractually
binding on either party (i.e., both parties are free to “walk away”
without having to obtain the other party’s consent or incurring
penalties for nonperformance). However, an arrangement that
contractually obligates one party would be recognized under ASC
815-40-15-6. For example, a warrant on equity shares contractually
obligates only the entity that issued the warrant, but both parties to
the contract must recognize the warrant. See Section 2.8 of Deloitte’s Roadmap
Contracts on an
Entity’s Own Equity for more information.
10.2.1.1 Receivables From the Issuance of Equity
ASC 505-10
Receivables for Issuance of Equity
45-2 An
entity may receive a note, rather than cash, as a
contribution to its equity. The transaction may be a
sale of capital stock or a contribution to paid-in
capital. Reporting the note as an asset is generally
not appropriate, except in very limited
circumstances in which there is substantial evidence
of ability and intent to pay within a reasonably
short period of time, for example, as discussed for
public entities in paragraph 210-10-S99-1
(paragraphs 27 through 29), which requires a
deduction of the receivable from equity. However,
such notes may be recorded as an asset if collected
in cash before the financial statements are issued
or are available to be issued (as discussed in
Section 855-10-25).
SEC Staff Accounting Bulletins
SAB Topic 4.E, Receivables From Sale of Stock
[Reproduced in ASC 310-10-S99-2]
Facts: Capital stock is sometimes issued to
officers or other employees before the cash payment
is received.
Question: How should the receivables from the
officers or other employees be presented in the
balance sheet?
Interpretive Response: The amount recorded as
a receivable should be presented in the balance
sheet as a deduction from stockholders’ equity. This
is generally consistent with Rule 5-02.30 of
Regulation S-X which states that accounts or notes
receivable arising from transactions involving the
registrant’s capital stock should be presented as
deductions from stockholders’ equity and not as
assets.
It should be noted generally that all amounts
receivable from officers and directors resulting
from sales of stock or from other transactions
(other than expense advances or sales on normal
trade terms) should be separately stated in the
balance sheet irrespective of whether such amounts
may be shown as assets or are required to be
reported as deductions from stockholders’
equity.
The staff will not suggest that a receivable from an
officer or director be deducted from stockholders’
equity if the receivable was paid in cash prior to
the publication of the financial statements and the
payment date is stated in a note to the financial
statements. However, the staff would consider the
subsequent return of such cash payment to the
officer or director to be part of a scheme or plan
to evade the registration or reporting requirements
of the securities laws.
SEC Financial Reporting Manual
7320 Receivables
7320.1 Receivables from affiliates which are
the equivalent of unpaid subscriptions receivable or
capital distributions should be reflected as a
deduction from equity. [SAB Topic 4G]
7320.2 Receivables from an officer or director
need not be deducted from equity if the receivable
was paid in cash prior to the publication of the
financial statements and the payment date is stated
in a note to the financial statements. [SAB Topic
4E]
10.2.1.1.1 Accounting by SEC Registrants
If an SEC registrant receives a note or other receivable for legally
issued and outstanding equity shares that are classified in permanent
equity, the receivable must be classified as a reduction of permanent
equity (as opposed to an asset) unless the receivable is paid in cash
before the date the entity’s financial statements are issued.1 If the receivable resulted from the issuance of equity shares that
are classified in temporary equity, the receivable would be classified
as a reduction of temporary equity (see Section 9.8.1.3). Whether classified as a reduction of
equity or as an asset, receivables from the sale of equity shares should
be separately presented on the balance sheet in accordance with SAB
Topic 4.E (see Sections 10.10.1.1
and 10.10.1.2).
Connecting the Dots
The accounting discussed above applies to any situation in which
an entity receives a note or other receivable for equity shares
that are legally issued and outstanding. For example, the
accounting would apply to stock subscription arrangements if the
equity shares have been legally issued and outstanding but the
investor has not yet paid for them (see also Section 8.3.1 of Deloitte’s
Roadmap Earnings per
Share).
In addition, the SEC staff has indicated that
the accounting classification as a reduction of equity for
receivables associated with the sale of equity shares is also
appropriate for certain transactions in which an entity prepays
the amount owed to a counterparty related to an obligation to
repurchase its own equity shares (e.g., a prepaid forward
purchase contract or a prepaid written put option). In these
transactions, the entity does not have a receivable from a third
party but has received a payment akin to a deposit that should
be classified as a reduction of equity, as opposed to an asset,
because the amount is associated with the repurchase of equity
shares. For more information, see Section 5.2.1.4.
If there is significant doubt about whether the shareholder will repay
the receivable, the issuing entity should initially recognize the
transaction as a shareholder distribution (i.e., a dividend) or an
expense as opposed to a contra asset within equity. If no significant
doubt about repayment exists but the receivable does not contain market
terms (e.g., the principal amount of the receivable is less than the
fair value of the equity shares issued, or the interest terms are
“off-market”), the issuing entity may report the receivable as a contra
asset within equity; however, it should also recognize either a
distribution (i.e., a dividend) or an expense as a result of the
issuance of equity shares on terms that do not reflect fair value. See
Section 10.3.2 for further
discussion of whether a dividend or an expense should be recognized in
these situations.
For transactions in which the receivable is initially recognized as a
contra asset within equity, any interest on the receivable should be
accounted for as a contribution to equity because entities are not
allowed to recognize income on capital transactions under U.S. GAAP (see
ASC 505-10-25-2). Although classified as a reduction of equity,
receivables for the sale of equity shares must still be evaluated for
impairment in accordance with ASC 326. Any credit losses recognized must
be accounted for as credit loss expense.
Example 10-1
Receivable Issued for Sale of Common
Stock
Entity A, an SEC registrant, issues 10,000 shares
of common stock that have a par value of $1 per
share to Entity B in exchange for a note
receivable with a principal amount of $25 million.
Assuming that A expects B to repay the note and
the note’s terms are not off-market, A would
record the following journal entry:
The EPS considerations related to receivables for the sale of equity
shares, including stock subscription arrangements, are addressed in
Section 8.3.1 of Deloitte’s
Roadmap Earnings per
Share.
10.2.1.1.2 Accounting by Other Entities
An entity that is not an SEC registrant generally accounts for
receivables from the sale of equity shares in the same manner as an SEC
registrant. While ASC 505-10-45-2 states that asset recognition is
acceptable “in very limited circumstances in which there is substantial
evidence of ability and intent to pay within a reasonably short period
of time,”2 an entity should consider the reason for the transaction as well
as its substance and terms before reporting the receivable as an
asset.
10.2.1.2 Other Receivables From Shareholders and Affiliates
SEC Staff Accounting Bulletins
SAB Topic 4.G, Notes and Other Receivables From
Affiliates [Reproduced in ASC 310-10-S99-3]
Facts: The balance sheet of a corporate
general partner is often presented in a registration
statement. Frequently, the balance sheet of the
general partner discloses that it holds notes or
other receivables from a parent or another
affiliate. Often the notes or other receivables were
created in order to meet the “substantial assets”
test which the Internal Revenue Service utilizes in
applying its “Safe Harbor” doctrine in the
classification of organizations for income tax
purposes.
Question: How should such notes and other
receivables be reported in the balance sheet of the
general partner?
Interpretive Response: While these notes and
other receivables evidencing a promise to contribute
capital are often legally enforceable, they seldom
are actually paid. In substance, these receivables
are equivalent to unpaid subscriptions receivable
for capital shares which Rule 5-02.30 of Regulation
S-X requires to be deducted from the dollar amount
of capital shares subscribed.
The balance sheet display of these or similar items
is not determined by the quality or actual value of
the receivable or other asset “contributed” to the
capital of the affiliated general partner, but
rather by the relationship of the parties and the
control inherent in that relationship. Accordingly,
in these situations, the receivable must be treated
as a deduction from stockholders’ equity in the
balance sheet of the corporate general partner.
SEC Financial Reporting Manual
7320 Receivables
7320.1 Receivables from affiliates which are
the equivalent of unpaid subscriptions receivable or
capital distributions should be reflected as a
deduction from equity. [SAB Topic 4G]
7320.2 Receivables from an officer or director
need not be deducted from equity if the receivable
was paid in cash prior to the publication of the
financial statements and the payment date is stated
in a note to the financial statements. [SAB Topic
4E]
Receivables from shareholders or affiliates other than those associated with
the sale of equity shares should generally be classified as a reduction of
equity as opposed to an asset. However, different considerations apply
depending on whether an entity is an SEC registrant.
10.2.1.2.1 Accounting by SEC Registrants
The SEC staff believes that other receivables from shareholders or
affiliates should be classified as a reduction of equity unless paid in
cash before the financial statements have been issued.3 That is, an SEC registrant classifies other receivables from
shareholders or affiliates in the same manner as receivables from the
issuance of equity shares. With one exception related to the recognition
of interest income, the accounting considerations discussed in Section 10.2.1.1.1 also apply to other
receivables from shareholders or affiliates. If the terms of the
receivable are comparable to the terms that would be expected to be
available from an unrelated third party (e.g., interest rates, payment
terms and maturities, nature and sufficiency of collateral), it is
acceptable for an entity to recognize interest within income, as opposed
to equity, even though the receivable is classified as a reduction of
equity. The determination of whether such interest is recognized in
income on an accrual, cash, or cost recovery basis would depend on the
evaluation of the borrower’s ability to repay the loan.
10.2.1.2.2 Accounting by Other Entities
To determine whether to present a receivable from a shareholder or
affiliate that is not related to the sale of stock as an asset or as a
reduction of equity, entities that are not SEC registrants must evaluate
the reason for and the substance of the transaction. Factors to consider
in this evaluation include the following:
-
Receivable is outstanding when the financial statements are issued or available to be issued — If the terms of the transaction are not comparable to the terms that would be expected to be available from an unrelated third party (e.g., interest rates, payment terms and maturities, nature and sufficiency of collateral) or there is significant doubt about the borrower’s ability or intent to repay the receivable, reporting the amount as an asset is not appropriate. Receivables consummated in accordance with terms that are not equivalent to those that prevail in an arm’s-length transaction should be presented as a reduction of equity. In addition, the entity should evaluate whether there is a distribution or expense that needs to be recognized related to the arrangement.
-
Receivable has been paid before the financial statements are issued or available to be issued — If the receivable is repaid after the balance sheet date but before the entity’s financial statements are issued or available to be issued, it is acceptable to report the amount as an asset. However, the entity would still be required to evaluate whether the transaction involved a distribution to a shareholder or an expense.
Interest should not be recognized in income on such receivables unless
the terms of the arrangement are comparable to terms that would be
expected to be available from an unrelated third party. If the terms are
comparable to those that could be obtained from third parties but the
entity has concerns about the borrower’s ability or intent to repay the
loan, the receivable must be classified as a reduction of equity and any
interest income must be recognized on a cost recovery or cash basis.
Example 10-2
Receivable From Principal Owner
Entity B, a private company, loaned a principal
owner $10 million. The loan requires the borrower
to make quarterly payments of principal and
interest. The interest rate and other terms of the
receivable are similar to the terms B has obtained
on receivables from unrelated third parties.
Furthermore, B has determined that the borrower
has the ability and intent to repay the loan in
accordance with its contractual terms.
Entity B can classify the loan as an asset and
record interest on the loan in earnings given that
B is not an SEC registrant and (1) the terms of
the loan are comparable to the terms that B could
receive on similar loans with unrelated third
parties and (2) the borrower is expected to repay
the loan in accordance with its contractual
terms.
Note that if the terms of the loan were not
comparable with terms that B could receive from
unrelated third parties, B would be required to
classify the loan as a reduction of equity and
classify any interest on the loan as equity rather
than income. If, however, B classified the loan in
equity only because of collectibility concerns
(i.e., the terms were at market), it would be
appropriate for B to recognize interest in
earnings provided that B used the cost recovery or
cash basis for such recognition.
Example 10-3
Receivables for Distribution of Assets
Entity C, a private entity, has two common
shareholders that each own 50 percent of the total
outstanding shares. In July 20X5, C sold one of
its wholly owned subsidiaries equally to each of
its two shareholders in return for notes
receivable of $50 million from each shareholder.
Entity C does not expect to collect any amount on
either of the two notes receivable. Therefore, C
should treat the sale of the subsidiary as an
equity distribution, which is consistent with the
substance of the transaction since the transaction
involved a pro rata distribution to C’s
shareholders.
10.2.1.3 Summary of Accounting for Receivables From Shareholders and Other Affiliates
The table below summarizes the accounting for receivables from shareholders
and other affiliates in accordance with the guidance discussed in
Sections 10.2.1.1 and
10.2.1.2.
Table 10-1
|
Entity
|
Receivable From Sale of Stock
|
Other Receivables
| |||
|---|---|---|---|---|---|
|
Classification
|
Interest Recognition
|
Classification
|
Interest Recognition
| ||
|
SEC registrants
|
Accounted for as a reduction of
equity unless the receivable is repaid before the
financial statements are issued.
Recognition of a dividend or expense
is required if the receivable is not at market terms
or is not expected to be collected.
|
Any interest must be recorded as a
capital transaction. It is never appropriate to
recognize interest in earnings.
|
Accounted for as a reduction of
equity unless the receivable is repaid before the
financial statements are issued.
Recognition of a dividend or expense
is required if the receivable is not at market terms
or is not expected to be collected.
|
Regardless of the classification of
the loan, interest may be recognized in earnings if
the terms of the receivable are comparable to the
terms that would be received on a loan to an
unrelated third party. Application of the interest
method, cost recovery method, or cash basis depends
on an evaluation of collectibility.
| |
|
Other entities
|
Accounted for as a reduction of
equity unless (1) there is substantial evidence that
the receivable will be repaid in accordance with its
contractual terms or (2) the receivable is repaid
before the financial statements are issued or
available to be issued.
Recognition of a dividend or expense
is required if the receivable is not at market terms
or is not expected to be collected.
|
Any interest must be recorded as a
capital transaction. It is never appropriate to
recognize interest in earnings.
|
Accounted for as a reduction of
equity unless either:
Recognition of a dividend or expense
is required if the receivable is not at market terms
or is not expected to be collected.
|
Regardless of the classification of
the loan, interest may be recognized in earnings if
the terms of the receivable are comparable to the
terms that would be received on a loan to an
unrelated third party. Application of the interest
method, cost recovery method, or cash basis depends
on an evaluation of collectibility.
| |
10.2.1.4 Defaults on Stock Subscriptions
Nonauthoritative AICPA Guidance
Technical Q&As Section 4110, “Issuance of
Capital Stock”
.11 Default on Stock Subscribed
Inquiry — A company entered into a stock
subscription agreement to sell its stock. The
agreement called for three monthly payments of
$10,000 after which the stock would be issued.
Although the first payment was received by the
company, the subscriber subsequently defaulted on
the remaining two payments. According to the
agreement, any payments made by the subscriber
towards the stock subscription are not refundable.
How should the company account for the retention of
the first $10,000 payment?
Reply — The payment should be recorded as an
addition to shareholders’ equity (i.e., a credit to
paid-in capital). According to Financial Accounting
Standards Board (FASB) Accounting Standards
Codification (ASC) 505-10-25-2, capital
transactions shall be excluded from the
determination of net income or the results of
operations.
If an entity receives consideration in advance of issuing an equity
instrument and retains such consideration without issuing any equity
instruments in accordance with the default provisions of a contract, it
should recognize the consideration received as a contribution to capital as
opposed to income. In this situation, the entity would initially recognize
the consideration received within equity (i.e., as a contra equity) and then
reclassify it to contributed capital (e.g., APIC) on the date the payment
becomes nonrefundable, without any obligation to issue equity or other
consideration to the counterparty.
10.2.2 Initial Measurement
Except for the transactions discussed in Section 10.2.2.1, an
entity initially measures equity instruments at their issuance-date fair value
less any incremental costs directly attributable to the issuance that are
eligible to be recognized as a reduction of equity (see Section 10.2.2.2). If an
entity issues common stock that has a par or stated value, the portion of the
initial carrying amount equal to the stock’s par or stated value is credited to
the applicable common stock account and any remaining amount is credited to APIC
(see Example
10-16). If common shares are issued without a par or stated value,
the entire initial carrying amount is credited to the applicable capital
account. If an entity issues common shares at a discount to their par or stated
value, the shares are shown at their par or stated value and the discount is
shown separately in equity as a deduction from that account (see Example 10-17).
When common shares or other equity instruments are issued for
cash in an arm’s-length financing transaction with an unrelated party and there
are no other transaction elements, the gross proceeds (i.e., the transaction
price) should represent the fair value of the instruments issued (see ASC
820-10-30-3 and Chapter
9 of Deloitte’s Roadmap Fair Value Measurements and Disclosures (Including
the Fair Value Option)). However, entities should
carefully evaluate transactions in which evidence suggests that the
issuance-date fair value of the equity instruments issued exceeds the value of
the consideration received (i.e., cash or the fair value of noncash
consideration). Any difference may be attributable to other transaction
elements, such as (1) a share-based payment for goods or services received that
should be accounted for under ASC 718 (see Deloitte’s Roadmap Share-Based Payment
Awards), (2) a payment for an asset that requires recognition
under other applicable U.S. GAAP, (3) a dividend to existing shareholders, or
(4) an expense.4 See also Sections
3.3.4.2.1 and 10.3.2.
If the proceeds represent consideration for more than one freestanding financial
instrument (e.g., common shares issued with freestanding warrants) and equal the
fair value of the package of instruments issued (when the type and quantity of
the instruments issued are taken into account), the entity should allocate the
proceeds among the separate units of account by using an appropriate method (see
Section 3.3.4.1).
Example 10-4
Issuance of Common Stock Upon Settlement of
Liability-Classified Warrant
Entity D issues a warrant to Investor C in exchange for
$1 million of cash. The warrant allows C to purchase
100,000 shares of D’s common stock for $5 million in
cash. Entity D determines that the warrant must be
classified as a liability under ASC 815-40 that is
initially and subsequently recorded at fair value, with
changes in fair value reported in earnings. Furthermore,
D determines that the proceeds received from issuing the
warrant represent the initial fair value of the warrant.
Entity D makes the following journal entry on the
issuance date of the warrant:
On the next reporting date, the fair value of the warrant
is $3 million. Therefore, D records the following
journal entry:
Subsequently, C exercises the warrant by
paying D the $5 million exercise price. On the date of
exercise, the aggregate fair value of the shares issued
was $8.5 million. Entity D makes the following journal
entry to record the settlement of the warrant:
Note that the entry to record the common shares issued
was measured on the basis of the fair value of those
shares. This is appropriate given that the contract was
subsequently measured at fair value, with changes in
fair value reported in earnings. When the fair value of
the equity shares on the settlement date differs from
the sum of the (1) carrying amount of the reported
liability (or asset) and (2) cash paid (or received),
that difference must be recognized in earnings if the
equity-linked contract was subsequently recorded at fair
value through earnings.
Equity shares issued upon the settlement of other
contracts on an entity’s own equity (e.g., options,
forwards, standby equity purchase agreements, or tranche
preferred stock commitments) would also be initially
measured at their fair value on the date of issuance if
those equity-linked contracts were (1) classified as a
liability or asset and (2) subsequently measured at fair
value, with changes in fair value reported in earnings.
This accounting is required notwithstanding the guidance
in U.S. GAAP under which such instruments must be
classified as assets or liabilities and subsequently
measured at fair value through earnings (e.g., ASC 480,
ASC 815, or ASC 815-40).
Any costs incurred in conjunction with the settlement of
a contract on an entity’s own equity that is classified
as a liability or asset must be expensed as incurred
because they do not represent direct and incremental
costs of issuance that qualify for capitalization.
10.2.2.1 Exceptions to Initial Measurement at Fair Value
Equity instruments issued in accordance with the following
are not initially measured at their issuance-date fair value:
-
The original conversion privileges in a convertible instrument (see Section 10.7.2).
-
An induced conversion of a convertible instrument (see Section 10.7.3).
-
The settlement of an equity-classified contract on an entity’s own stock under the original settlement provisions (see Example 10-5 as well as Section 6.1.3 of Deloitte’s Roadmap Contracts on an Entity’s Own Equity).
-
The issuance of equity shares upon settlement of certain share-settleable obligations (see Section 6.3).
-
The payment of a nondiscretionary PIK dividend (see Section 10.3.4.3.1).
Example 10-5
Issuance of Common Stock Upon Settlement of
Equity-Classified Warrant
Entity E issues a warrant to Investor D in exchange
for $1 million of cash. The warrant allows D to
purchase 100,000 shares of E’s common stock for $5
million in cash. Entity E determines that the
warrant qualifies for classification within equity
and that the proceeds received from issuing the
warrant represent the warrant’s initial fair value.
Entity E makes the following journal entry on the
issuance date of the warrant:
Subsequently, D exercises the
warrant by paying E the $5 million exercise price.
On the date of exercise, the aggregate fair value of
the shares issued was $8.5 million. Entity E makes
the following journal entry to record the settlement
of the warrant:
The total amount that E recognized within equity for
the common shares issued was $6 million, which is
$2.5 million less than the fair value of the common
shares on the issuance date. This difference was not
recorded because the warrant was an equity
instrument that E was not required to subsequently
remeasure (see Section
10.2.3).
10.2.2.2 Issuance Costs
SEC Staff Accounting Bulletins
SAB Topic 5.A, Expenses of Offering
[Reproduced in ASC 340-10-S99-1]
Facts: Prior to the effective date of an
offering of equity securities, Company Y incurs
certain expenses related to the offering.
Question: Should such costs be deferred?
Interpretive Response: Specific incremental
costs directly attributable to a proposed or actual
offering of securities may properly be deferred and
charged against the gross proceeds of the offering.
However, management salaries or other general and
administrative expenses may not be allocated as
costs of the offering and deferred costs of an
aborted offering may not be deferred and charged
against proceeds of a subsequent offering. A short
postponement (up to 90 days) does not represent an
aborted offering.
Nonauthoritative AICPA Guidance
Technical Q&As Section 4110,
“Issuance of Capital Stock”
.01 Expenses Incurred in Public Sale of Capital
Stock
Inquiry — A closely held corporation is
issuing stock for the first time to the public.
How would costs, such as legal and accounting fees,
incurred as a result of this issue, be handled in
the accounting records?
Reply — Direct costs of obtaining capital by
issuing stock should be deducted from the related
proceeds, and the net amount recorded as contributed
stockholders’ equity. Assuming no legal
prohibitions, issue costs should be deducted from
capital stock or capital in excess of par or stated
value.
Such costs should be limited to the direct cost of
issuing the security. Thus, there should be no
allocation of officers’ salaries, and care should be
taken that legal and accounting fees do not include
any fees that would have been incurred in the
absence of such issuance.
.07 Expenses Incurred in Withdrawn Public
Offering
Inquiry — What is the proper accounting for
the costs of a public offering that was
withdrawn?
Reply — Accounting Research
Study No. 15, Stockholders’ Equity, page 23,
discusses accounting for stock issue costs. The
Study states that such costs are usually deducted
from contributed portions of equity, that is,
capital stock or capital in excess of stated or par
value, as a reduction in the proceeds from the sale
of securities.
Since there were no proceeds from a sale of
securities to offset the costs, the costs should be
charged to current year’s income, but not as an
extraordinary item.
Qualifying costs directly attributable to an actual or proposed issuance of
equity instruments may be deferred rather than expensed as incurred. Before
the equity issuance is completed, the qualifying costs are deferred as an
asset (i.e., prepaid expense). Upon completion of the equity issuance, the
qualifying costs are classified as a reduction of equity. If an offering is
aborted, any deferred costs are immediately expensed.
Deferred issuance costs of equity instruments are generally not accreted.
However, accretion is required in certain situations, such as when the
related equity instrument is (1) an increasing-rate preferred stock (see
Section 10.3.4.3.4) or (2)
classified in temporary equity (see Section
9.5.2). In addition, the deferred issuance costs on preferred
securities are included in the determination of the adjustment to the
numerator that is required in the calculation of basic EPS in the period in
which the preferred securities are extinguished (see Section 3.2.2.6 of Deloitte’s Roadmap
Earnings per Share).
Deferred issuance costs are limited to specific incremental costs and fees
that are (1) paid to third parties and (2) directly attributable to the
equity issuance. A cost is considered directly attributable to an equity
issuance if it results directly from and is essential to the equity issuance
and would not have been incurred had the issuance not occurred. Costs and
fees that would have been incurred regardless of whether there is a proposed
or actual offering do not qualify for deferral (e.g., allocated management
salaries and other general and administrative expenses). Further, costs and
fees qualify for deferral as issuance costs only if they were incurred by
the time the equity instruments were issued. Costs incurred after an equity
issuance has occurred are not eligible for deferral unless the issuer was
obligated to incur such costs as part of the original issuance of the equity
instrument (see Section 10.2.2.4). Any
costs and fees paid to investors in an entity’s equity instruments represent
a reduction of the proceeds and therefore do not qualify as deferred
issuance costs. The table below illustrates examples of costs and fees that
may qualify for deferral in conjunction with a proposed or actual issuance
of equity instruments.
Table 10-2
|
Deferrable Costs if Directly Attributable to Equity
Issuance
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Costs That May Not Be Deferred as Issuance Costs
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Connecting the Dots
At the 2023 AICPA & CIMA Conference on Current
SEC and PCAOB Developments, a member of the SEC staff indicated that
costs related to the initial preparation and auditing of an entity’s
financial statements may not be deferred as equity issuance costs
even if the financial statements were prepared and audited for the
sole purpose of pursuing an IPO. Although the entity might need to
obtain audited financial statements to pursue the IPO, the SEC staff
did not view these costs as being directly attributable to the
planned offering because the entity may obtain audited financial
statements for various other reasons.
10.2.2.2.1 Organization Costs
The initial costs incurred to form or incorporate an entity (e.g., legal
costs and fees) do not represent a cost of issuing equity instruments.
Such costs must be expensed in the period in which they are incurred
unless an entity can clearly demonstrate that they are associated with a
future economic benefit that qualifies for recognition as an asset in
accordance with other authoritative literature.
Example 10-6
Organization Costs
Entity F, a real estate
investment trust, formed an operating partnership
in exchange for a 100 percent general partner
interest in the partnership. A third party
contributed notes receivable for all of the
limited partnership interests. The partnership was
formed to facilitate a securities offering.
However, F and not the partnership, offered the
securities. The costs associated with forming the
partnership represent an organization cost and,
therefore, cannot be treated as a share issuance
cost.
10.2.2.2.2 Postponed or Aborted Offering
If an entity aborts a contemplated equity offering, any deferred costs
must be immediately expensed. If an offering of equity is postponed, an
entity should evaluate whether the delay represents an aborted offering
for which previously deferred offering costs must be expensed. The
determination of whether costs should be deferred or recognized as an
expense is based on whether the costs are associated with a probable,
successful future offering of securities. To the extent that a cost will
be incurred a second time or will not provide a future benefit, it
should be expensed.
Although SAB Topic 5.A states that “[a] short postponement (up to 90
days) does not represent an aborted offering,” an entity will need to
use judgment and consider the facts and circumstances in determining the
actual postponement date. For example, if an entity delays an offering
beyond 90 days because market conditions would not yield an acceptable
return, the delay would be considered an aborted offering and offering
costs would have to be expensed. Conversely, a delay of more than 90
days from the anticipated offering date could be considered a short
postponement, rather than an aborted offering, in certain circumstances.
The following factors (not all-inclusive) may indicate that an offering
has not been aborted:
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The resolution of items causing the delay (i.e., accounting, legal, or operational matters) is necessary for the completion of the offering. Such resolution may include:
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Completing new (or revising existing) contractual arrangements with shareholders or other parties.
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Obtaining audited financial statements for other required entities.
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The entity has a plan for resolving the delay, including a revised timetable, and this plan has been approved by the entity’s board of directors or management.
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The entity continues to undertake substantive activities (i.e., activities to resolve issues causing the delay) in accordance with its plan, demonstrating its intent to proceed with the offering.
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The entity is continuing to prepare financial information or update its registration statement (either to respond to SEC staff review comments or because the entity expects the information to become stale).
An entity should have sufficient and appropriate evidence to support its
assertion that a delay of an equity offering does not constitute an
aborted offering. Because entities need to use significant judgment in
determining whether a delay is a short postponement or an aborted
offering, they are encouraged to consult with their accounting and legal
advisers.
10.2.2.3 Shelf Registration Costs
Nonauthoritative AICPA Guidance
Technical Q&As Section 4110, “Issuance of
Capital Stock”
.10 Costs Incurred in Shelf
Registration
Inquiry — A public company incurs legal and
other fees in connection with an SEC filing for a
stock issue it plans to offer under a shelf
registration. How should the company account for
these costs?
Reply — The costs should be capitalized as a
prepaid expense. When securities are taken off the
shelf and sold, a portion of the costs attributable
to the securities sold should be charged against
paid in capital. Any subsequent costs incurred to
keep the filing “alive” should be charged to expense
as incurred. If the filing is withdrawn, the related
capitalized costs should be charged to expense.
A shelf registration permits a public company to issue securities in one or
more future offerings, with the size and price determined at the time of
sale. Initial shelf registration costs are deferred as a prepaid expense.
When the entity issues equity securities under the shelf, an appropriate
portion of the deferred costs is reclassified as an issuance cost of the
securities issued. For example, deferred costs might be allocated to current
and future share issuances on the basis of estimates of the amount of equity
the entity might issue under the shelf over its expected life. Any
subsequent costs to maintain the shelf registration are charged to expense
as incurred. If an entity defers costs and fees in connection with a shelf
registration and it is no longer probable that the entity will issue
securities under the registration statement, the entity should immediately
expense any remaining deferred costs. On the date the filing is withdrawn or
expires, there should be no remaining deferred costs.
10.2.2.4 Secondary Offering Costs
Contracts governing the sale of equity securities that are sold in a private
placement offering (a “primary offering”) often require the issuer to
register the securities with the SEC within a specified period. It is common
for these contracts to specify a penalty for failure to complete the
registration. Registration of the securities is usually accomplished through
a secondary offering, which does not yield any proceeds.
The appropriate accounting for the specific incremental costs directly
attributable to the secondary offering (e.g., underwriting fees, attorneys’
fees, and accountants’ fees) depends on the facts and circumstances.
Informal discussions with the SEC staff have indicated that the acceptable
method of accounting for the secondary offering costs depends on whether the
terms of the primary offering contractually require the issuer to effect a
secondary offering.
10.2.2.4.1 Contractual Obligation Present in Primary Offering
If, as of the date of the primary offering, the issuer is contractually
obligated to enter into a secondary offering (e.g., in accordance with a
registration rights agreement), the obligation constitutes a liability
for future third-party registration costs that should be recognized as
of the date of the primary offering as an additional cost of the
offering. The specific incremental costs of the secondary offering
should be estimated and deferred as an issuance cost (i.e., reduction of
equity) upon completion of the primary offering (provided that
completion of the registration is deemed to be probable within a
reasonable period). Recognition of the secondary offering costs as an
expense as of the date of the primary offering, or as incurred, would be
inconsistent with analogous guidance in ASC 825-20. In accordance with
ASC 825-20-30-4, “[i]f the transfer of consideration under a
registration payment arrangement is probable and can be reasonably
estimated at inception, the contingent liability under the registration
payment arrangement shall be included in the allocation of proceeds from
the related financing transaction” and not recorded as an expense.
10.2.2.4.2 Contractual Obligation Not Present in Primary Offering
If there is no contractual obligation to enter into a secondary offering
as of the date of the primary offering, the two offerings are
disassociated and the costs of the secondary offering should be expensed
as incurred. This is analogous to the treatment of deferred costs of an
aborted offering described in SAB Topic 5.A, which indicates that such
costs “may not be deferred and charged against proceeds of a subsequent
offering.” In essence, SAB Topic 5.A requires consideration of whether
transaction costs have been incurred as part of a single, combined
offering or as the result of a separate, subsequent offering. If there
is no contractual obligation to have a secondary offering, entities
should treat the secondary offering as a separate, subsequent offering.
Because this offering does not result in additional proceeds (i.e., no
additional capital raising), the costs associated with it should be
expensed as incurred. That is, the secondary offering is the economic
equivalent of an aborted offering.
10.2.2.5 Transfers of Equity Instruments Between Holders
Costs incurred in connection with a transfer of equity instruments between
holders (e.g., legal or accounting fees) do not qualify as equity issuance
costs. For instance, if an entity reacquires outstanding shares from one
party and contemporaneously reissues those shares to another party as part
of a contemplated set of transactions (e.g., in connection with the transfer
of a controlling interest from one party to another or in accordance with a
drag-along provision applicable to the shares), any associated costs
represent, in substance, costs paid on behalf of the selling and buying
shareholders and must be expensed as incurred.
Example 10-7
Offering Costs
in a Dutch Auction
Entity G undertakes a modified Dutch auction to
purchase outstanding common shares. The terms of the
Dutch auction are as follows:
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The offer is not contingent on the purchase of a minimum number of shares.
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Up to 500,000 shares at a price ranging between $13 and $15 per share will be purchased by G for cash.
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All shares acquired in the offer will be acquired at the purchase price even if tendered below the purchase price.
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If oversubscribed, the purchase will be subject to proration.
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All shares acquired will be held as treasury stock.
An existing shareholder provided the financing for
the Dutch auction by agreeing to purchase an
equivalent number of common shares from G at a price
per share equal to the average price per share paid
by G to reacquire shares in the Dutch auction.
Entity G incurred $200,000 in legal, accounting, and
other costs associated with the Dutch auction and
the issuance of new common shares to the existing
shareholder. In total, the number of outstanding
common shares of G was unchanged as a result of the
Dutch auction and issuance of new shares.
The legal, accounting, and other costs associated
with the repurchase of outstanding shares in the
Dutch auction and the issuance of the same number of
new shares to a different party should be expensed
as a period cost. Treating these transactions as a
share repurchase and a separate share issuance would
ignore the fact that both transactions were part of
a set of contemplated transactions. Further, G did
not issue or retire a net number of common shares.
Other than transaction costs, the Dutch auction was
funded entirely by the existing shareholder. In
substance, the transaction represents a transfer of
shares from one group of shareholders to another
shareholder, with G acting as an intermediary.
Therefore, the payment by G of the transaction costs
represents costs paid on behalf of selling and
buying shareholders.
It would be inappropriate to treat the above
transactions as two separate transactions (i.e., a
repurchase of common shares and a new issuance of
common shares) and account for the costs incurred as
a reduction of equity because the two transactions
were executed in contemplation of one another.
Separately accounting for the two components of the
overall transaction would also fail to acknowledge
that both components were part of a planned and
integrated transaction whose effect is no net share
issuance or repurchase by G. The payment by G of the
transaction costs represents a payment that
otherwise would have to be made by the selling and
buying shareholders if G had not acted as an
intermediary. Such costs are not deemed to have any
future benefit to G related to the issuance or
redemption of equity.
Since the reacquisition of shares for the purpose of
reissuing those shares to other shareholders may be
part of planned and integrated transactions whose
effect is no net issuance or repurchase by the
entity, costs incurred in connection with such
transactions are, in substance, costs paid on behalf
of the selling and buying shareholders, which must
be expensed as incurred.
10.2.3 Subsequent Measurement
An entity generally does not remeasure the initial carrying amount recognized for
an equity-classified instrument. However, there are some exceptions to this
general principle, including the following:
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Remeasurement of a redeemable equity instrument is required under the SEC’s guidance on temporary equity (see Section 9.5.2).
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The equity instrument is reclassified to a liability (see Section 4.4.2 as well as Section 6.1.2 of Deloitte’s Roadmap Contracts on an Entity’s Own Equity).
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A preferred stock instrument has an increasing-rate dividend (see Section 10.3.4.3.4).
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The equity instrument is modified or exchanged (see Section 10.3.4.3.5).
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A down-round feature is triggered (see Section 10.3.4.3.6).
Footnotes
1
In these situations, the registrant must include appropriate
disclosures in its financial statements.
2
This exception does not apply to SEC registrants.
3
See footnote
1.
4
If (1) the proceeds received are less than the fair
value of the package of instruments issued, (2) no other transaction
element can be identified, and (3) the amount does not represent a pro
rata distribution to all holders of a class of equity, expense
recognition would be required for the excess of the fair value of the
instruments issued over the proceeds.