10.6 Modifications and Exchanges
10.6.1 Common Stock
10.6.1.1 General
Modifications or exchanges of common stock do not need to be
evaluated for extinguishment accounting. Rather, the focus is on whether
they result in the transfer of additional fair value to the holder(s). If
the modification or exchange results in an increase in the fair value of the
common stock, that increase must be accounted for as either a deemed
dividend on common stock or an expense unless other authoritative literature
specifically addresses the accounting. The appropriate accounting is
determined in a manner similar to a repurchase of common stock for an amount
that exceeds fair value (see Section
10.5). An entity generally does not account for any reduction
in the fair value of the instrument as a result of the modification or
exchange.
If the modification or exchange applies to all outstanding shares of the
class of common stock being modified or exchanged, the entity would account
for any increase in fair value as a dividend to common stockholders. If,
however, the modification or exchange is provided only to certain holders of
a class of common stock, the entity would account for any increase in fair
value as an expense unless other applicable literature specifically
applies.
For a discussion of related EPS considerations, see Section
3.2.6.2 of Deloitte’s Roadmap Earnings per Share.
10.6.1.2 Exchange of Common Stock for Preferred Stock
Nonauthoritative AICPA Guidance
Technical
Q&As Section 4230, “Capital
Transactions”
.02 Exchange
of No Par Common Shares for Par Value Preferred
Shares
Inquiry — The shareholders of
Corporation A exchanged their no par common shares
for preferred shares with a par value to “freeze”
the value of stock ownership for estate tax
purposes. How should the difference between the
carrying basis of the preferred shares and the
carrying basis of the common shares be accounted
for?
Reply — The difference should
be charged or credited to additional paid-in
capital. If there is no additional paid-in capital,
any “debit” balance should first be charged to
retained earnings and any remaining “debit” balance
should be described in the financial statements as a
discount on preferred stock. However, in many states
the law requires that issued stock must be fully
paid and nonassessable and therefore, if the par
value of the preferred shares exceeds the market
value of the common shares this exchange may have
legal implications that should be considered.
The issuance of preferred stock in exchange for outstanding shares of common
stock is accounted for as a repurchase of common stock. Therefore, if the
fair value of the preferred shares issued equals the fair value of the
common shares reacquired, any difference between the initial carrying amount
of the preferred stock issued and the recorded amount of the common stock
reacquired may be recognized in APIC. If there is no APIC, any debit balance
is recorded against retained earnings and, to the extent that retained
earnings have been reduced to zero, as a preferred stock discount.
10.6.2 Preferred Stock
10.6.2.1 General
An entity must evaluate whether a modification or exchange of preferred
stock, including an equity-classified contract on an entity’s preferred
stock, is accounted for as an extinguishment or modification of the
instrument. Although not specifically discussed in U.S. GAAP, in practice,
the following three approaches may be used to determine whether modification
or extinguishment accounting applies:
-
Qualitative approach.
-
Fair value approach.
-
Cash flow approach.
If a modification or exchange of preferred stock is accounted for as an
extinguishment, the difference between the fair value of the new or modified
preferred stock and the net carrying amount of the original preferred stock
instrument is accounted for in accordance with ASC 260-10-S99-2 (see
Section 10.5.1). If the
modification or exchange does not represent an extinguishment, the entity
should recognize any incremental fair value provided to the holder(s) as a
dividend on preferred stock if the modification or exchange is made to all
outstanding shares of the class of preferred stock being modified or
exchanged (i.e., debit retained earnings, credit preferred stock). If the
modification or exchange is provided to only certain holders of the class of
preferred stock being modified or exchanged, the incremental fair value is
recognized as either an expense or in accordance with other applicable
literature (see Section 10.3.2). An entity does not
account for any reduction in the fair value of the instrument as a result of
a modification. For more information about modifications and exchanges of
preferred stock, see Section 3.2.6.1 of Deloitte’s
Roadmap Earnings per Share.
10.6.2.2 Exchange of Preferred Stock for Common Stock
If an entity’s issuance of common stock in return for the settlement of
preferred stock is not subject to conversion or induced conversion
accounting, the transaction should be treated as an extinguishment of
preferred stock. The common stock issued in satisfaction of the preferred
stock should be initially recognized at fair value. Any difference between
the initial carrying amount of the common stock issued and the net carrying
amount of the preferred stock extinguished should be accounted for in
accordance with ASC 260-10-S99-2 (see Section
10.5.1).
10.6.3 Equity-Linked Instruments
10.6.3.1 Freestanding Contracts Indexed to an Entity’s Common Stock
Modifications or exchanges of freestanding contracts on an entity’s common
stock that are classified in equity before and after the modification or
exchange do not need to be evaluated for extinguishment accounting. Rather,
the accounting is similar to modifications of common stock. For more
information about modifications of freestanding contracts on an entity’s
common stock, see Section 6.1.4.1 of Deloitte’s Roadmap
Contracts on an Entity’s Own
Equity and Section 3.2.6.4 of
Deloitte’s Roadmap Earnings per
Share.
10.6.3.2 Freestanding Contracts Indexed to an Entity’s Preferred Stock
The accounting for a modification or exchange of a freestanding contract on
an entity’s preferred stock that is classified in equity before and after
the modification or exchange is the same as the accounting for a
modification of a preferred stock instrument. For more information about
modifications of freestanding contracts on an entity’s preferred stock, see
Section 3.2.6.4 of Deloitte’s Roadmap Earnings per Share.