5.4 Reassessment
Under ASC 480-10-25-8, an issuer assesses at inception whether a financial
instrument, other than an outstanding share, embodies an obligation to repurchase
the issuer’s equity shares (or is indexed to such an obligation) and therefore
requires or may require the issuer to settle the obligation by transferring assets.
If an outstanding instrument ceases to embody such an obligation after inception
(e.g., because the contract specifies that the obligation expires on a specific date
or upon the occurrence of a specified event, such as an IPO), an issuer may elect to
apply either of the following two views as an accounting policy choice under ASC
480-10-25-8:
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View A: No reassessment — An issuer does not subsequently reassess whether an instrument should be classified as an asset or a liability under ASC 480-10-25-8 unless the instrument is treated as a new instrument for accounting purposes (e.g., as a result of a modification or exchange that is accounted for as an extinguishment of the existing instrument; see ASC 470-50). That is, the issuer applies literally the requirement in ASC 480-10-25-8 to perform the evaluation “at inception.”
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View B: Reassessment — An issuer reassesses whether an instrument that was classified as an asset or a liability under ASC 480-10-25-8 should continue to be classified as an asset or a liability under ASC 480, ASC 815-40, and any other applicable GAAP if the obligation that caused the instrument to be classified as an asset or a liability under ASC 480-10-25-8 no longer exists. That is, the classification of an instrument reflects its operative terms as of the assessment date but does not take into account any expired terms. (As discussed in Section 3.2.1, however, the issuer does not reassess whether any feature is nonsubstantive or minimal after inception.) If reclassification is appropriate, it is performed as of the date the obligation ceases to exist. This view is consistent with the reassessment guidance in ASC 480-10-25-4 (see Section 4.4.1) and ASC 815-40 that applies to instruments within the scope of that guidance (see Section 5.4 of Deloitte’s Roadmap Contracts on an Entity’s Own Equity).
Example 5-3
Reassessment of the Classification of Warrants on
Redeemable Shares
Company A issues physically settled warrants on its convertible preferred stock. The convertible preferred stock includes a provision that requires A to redeem the stock for cash upon a deemed liquidation event (e.g., a change of control). Further, the convertible preferred stock includes a mandatory conversion feature that requires the stock to be converted into nonredeemable common stock upon an IPO. If an IPO were to occur, therefore, the warrants would no longer be settleable in convertible preferred stock but in nonredeemable common stock. At inception, A classifies the warrants as liabilities under ASC 480-10-25-8 because the deemed liquidation provision represents an obligation to repurchase shares of A’s convertible preferred stock that may require the issuer to transfer assets under ASC 480-10-25-8 (see Section 5.2.2).
After inception, A undergoes an IPO. On the IPO date, all of A’s outstanding series of convertible preferred stock are converted into shares of nonredeemable common stock in accordance with the mandatory conversion terms of the convertible preferred stock. Further, the warrants are no longer settleable in convertible preferred stock. Therefore, the warrants no longer embody an obligation that requires or may require the issuer to transfer assets under ASC 480-10-25-8.
Depending on its accounting policy for reassessment under ASC 480-10-25-8, A
could elect either to continue to classify the warrants as
liabilities under ASC 480-10-25-8 or to reclassify them to
equity provided that they meet all the conditions for equity
classification in ASC 815-40 and any other applicable
GAAP.