Chapter 9 — The SEC's Guidance on Temporary Equity

9.8 Presentation and Disclosure

9.8.1 Presentation

9.8.1.1 Separate Presentation of Temporary Equity

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)). . . .

Redeemable Preferred Stocks

27. Preferred stocks subject to mandatory redemption requirements or whose redemption is outside the control of the issuer.

(a) Include under this caption amounts applicable to any class of stock which has any of the following characteristics: (1) it is redeemable at a fixed or determinable price on a fixed or determinable date or dates, whether by operation of a sinking fund or otherwise; (2) it is redeemable at the option of the holder; or (3) it has conditions for redemption which are not solely within the control of the issuer, such as stocks which must be redeemed out of future earnings. Amounts attributable to preferred stock which is not redeemable or is redeemable solely at the option of the issuer shall be included under § 210.5–02.28 unless it meets one or more of the above criteria. . . .

(d) Securities reported under this caption are not to be included under a general heading “stockholders’ equity” or combined in a total with items described in captions 29, 30 or 31 which follow.

SEC Rules, Regulations, and Interpretations

CFRP 211, Redeemable Preferred Stocks [Reproduced in ASC 480-10-S99-1]

.01 General: ASR 268:

On July 27, 1979, the Commission amended Regulation S-X to modify the financial statement presentation of preferred stocks subject to mandatory redemption requirements or whose redemption is outside the control of the issuer. The rules adopted do not impact reporting practices of registrants not having such securities outstanding. Registrants having such securities outstanding are required to present separately, in balance sheets, amounts applicable to the following three general classes of securities: (i) preferred stocks subject to mandatory redemption requirements or whose redemption is outside the control of the issuer; (ii) preferred stocks which are not redeemable or are redeemable solely at the option of the issuer; and (iii) common stocks. A general heading, “Stockholders’ Equity,” is not to be used and presentation of a combined total for equity securities, inclusive of redeemable preferred stocks, is prohibited. In addition, the rules require disclosure of redemption terms, five-year maturity data, and changes in redeemable preferred stocks in a separate note to the financial statements captioned “Redeemable Preferred Stocks.”

There is a significant difference between a security with mandatory redemption requirements or whose redemption is outside the control of the issuer and conventional equity capital. The Commission believes that it is necessary to highlight the future cash obligations attached to this type of security so as to distinguish it from permanent capital. It is expected that the rules will provide more meaningful presentation of the financial obligations of those companies which finance operations through the use of such securities.

The Commission noted an increase in the issuance, by registrants, of preferred stocks to finance operations, consummate mergers and acquisitions, or to restructure existing debt arrangements. Many of the preferred stock issues included terms which required the issuer to redeem the stock at a fixed or determinable price on a fixed or determinable date. Other issues required the issuer to redeem the stock at the option of the holder at the time certain prescribed conditions are met which are not necessarily within the control of the issuer, such as attainment of a specified level of earnings.

The Commission believes that redeemable preferred stocks are significantly different from conventional equity capital. Such securities have characteristics similar to debt and should, in the opinion of the Commission, be distinguished from permanent capital. The Commission believes that traditional financial reporting practices do not provide the most meaningful presentation of the financial obligations attached to these types of securities and that improvement in the financial statement presentation of redeemable preferred stocks is necessary.

The rules are intended to highlight the future cash obligations attached to redeemable preferred stock through appropriate balance sheet presentation and footnote disclosure. They do not attempt to deal with the conceptual question of whether such a security is a liability. Further, the rules do not attempt to deal with the income statement treatment of payments to holders of such a security or with any related income statement matters, including accounting for its extinguishment. The Commission is cognizant of these conceptual problems in determining the appropriate accounting for and reporting of redeemable preferred stock and believes that these matters can best be addressed by the FASB. As an interim measure, the rules require that the amounts applicable to redeemable preferred stock be presented in financial statements as a separate item — and not combined with equity investments not having similar redemption requirements. The Commission believes the presentation required by the rules will highlight the redemption obligation and the fact that amounts attributable to these securities are not part of permanent capital.

.02 Definitions

ASR 268:

The following definitions apply to the terms listed below as they are used in this section:

Preferred Stock Subject to Mandatory Redemption Requirements or Whose Redemption is Outside the Control of the Issuer (“Redeemable Preferred Stock”). The term means any stock which (i) the issuer undertakes to redeem at a fixed or determinable price on the fixed or determinable date or dates, whether by operation of a sinking fund or otherwise; (ii) is redeemable at the option of the holders, or (iii) has conditions for redemption which are not solely within the control of the issuer, such as stocks which must be redeemed out of future earnings.FN*

Preferred Stocks Which Are Not Redeemable or Are Redeemable Solely at the Option of the Issuer (“Non-Redeemable Preferred Stock “). The term means any preferred stock which does not meet the criteria for classification as a “redeemable preferred stock.”

.03 Exemption

ASR 268:

The Commission has concluded that the necessary refinements concerning the presentation in financial statements of amounts applicable to redeemable preferred stocks should not impact the present reporting practices of registrants who do not use such securities to finance their operations. Therefore, registrants not having such securities may continue to use the general heading “Stockholders’ Equity” and show a combined total. Where redeemable preferred stocks are outstanding, the Commission will not prohibit the combining of non-redeemable preferred stocks, common stocks and other equity accounts under an appropriate designated caption (e. g., “Non-Redeemable Preferred Stocks, Common Stocks, and Other Stockholders’ Equity”) provided that any combinations be exclusive of redeemable preferred stocks. . . .

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FN* Under this definition, preferred stock which meet one or more of the above criteria would be classified as redeemable preferred stock regardless of their other attributes such as voting rights, dividend rights or conversion features.

Regulation S-X, Rule 5-02.27 (reproduced in ASC 210-10-S99-1), contains the basic balance sheet presentation and footnote disclosure requirements for redeemable preferred stocks classified as temporary equity. It requires an entity to present in a separate caption on the face of the balance sheet the amount of such redeemable equity instruments.

Although temporary equity represents equity under GAAP (e.g., in connection with disclosing information about equity instruments under ASC 505-10-50 or evaluating whether an embedded derivative qualifies for the scope exception to derivative accounting for contracts on own equity under ASC 815-10-15-74(a); see ASC 815-10-15-76), the SEC’s rules preclude an entity from (1) combining the balance sheet line item for redeemable equity with line items for components of permanent equity (including those preferred stocks, common stocks, other stockholders’ equity, and noncontrolling interests that qualify as permanent equity) and (2) including redeemable equity under a general heading for stockholders’ equity (see also CFRP 211.03).

Accordingly, the SEC staff would object to an entity’s inclusion of redeemable equity in any total or subtotal titled “stockholders’ equity” or “total equity” in the entity’s financial statements, including the reconciliation of total equity under Regulation S-X, Rule 3-04 (reproduced in ASC 505-10-S99-1). As noted in the highlights of the June 23, 2009, CAQ SEC Regulations Committee joint meeting with the SEC staff, the staff believes that “the renaming of the caption in the statement of changes in shareholders’ equity “total equity” to “total” does not make the inclusion of redeemable equity acceptable.”

9.8.1.2 Liability Classification Prohibited

ASC 480-10 — SEC Materials — SEC Staff Guidance

SEC Staff Announcement: Classification and Measurement of Redeemable Securities

S99-3A(4) . . . The SEC staff does not believe it is appropriate to classify a financial instrument (or host contract) that meets the conditions for temporary equity classification under ASR 268 as a liability.FN10

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FN10 At the June 14, 2007 EITF meeting, the SEC Observer stated that a financial instrument (or host contract) that otherwise meets the conditions for temporary equity classification may continue to be classified as a liability provided the financial instrument (or host contract) was classified and accounted for as a liability in fiscal quarters beginning before September 15, 2007 and has not subsequently been modified or subject to a remeasurement (new basis) event.

SEC Rules, Regulations, and Interpretations

CFRP 211, Redeemable Preferred Stocks [Reproduced in ASC 480-10-S99-1]

.05 Existing Agreements

ASR 268:

It is not the Commission’s present intention to establish whether redeemable preferred stocks are liabilities or components of equity. Therefore, the rules should not require any change in the calculations of debt-equity ratios under existing loan agreements. Further, the Commission believes that creditors already consider the distinctive characteristics of the types of securities which comprise a company’s capital structure when evaluating a potential loan.

In the past, the SEC staff did not object to liability classification for certain instruments that meet the conditions for temporary equity classification. However, at the EITF’s June 14, 2007, meeting, the SEC observer announced that the SEC staff would “no longer accept liability classification for financial instruments (or host contracts) that meet the conditions for temporary equity classification.“ While CFRP 211.01 and CFRP 211.05 suggest that it was not the SEC’s intention to establish whether redeemable preferred stocks are liabilities or components of equity, it would be inappropriate for an entity to classify as a liability an instrument that qualifies as temporary equity (see Section 9.3.2). When the SEC announced that it would object to liability classification for instruments that meet the criteria for temporary equity classification, it grandfathered instruments that had previously been classified as liabilities. Accordingly, an entity may still have redeemable equity instruments outstanding that it has classified as liabilities, even though they do not meet the criteria for liability classification under ASC 480. However, such classification is not permitted for financial instruments (or host contracts) “that [were] entered into, modified, or otherwise subject to a remeasurement (new basis) event in [fiscal quarters] beginning after September 15, 2007.” Further, a grandfathered instrument that continues to be classified on the balance sheet as a liability “would not be eligible for initial application of the fair value option under [ASC 825-10] or initial adoption of hedge accounting in fiscal quarters beginning after September 15, 2007.” (ASC 825-10-15-5(f) precludes application of the fair value option in ASC 825 for instruments that are classified in whole or in part in equity [including temporary equity].)

9.8.1.3 Presentation of Shareholder Loans

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 2: 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.[29] 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.

If the issuer of a redeemable equity instrument classified as temporary equity receives notes issued by the holders of the redeemable shares instead of cash in exchange for the instrument, Regulation S-X, Rule 5-02(27)(b), requires the issuer to present the shareholder loan as a reduction of temporary equity. The issuer should not present the shareholder loan as an asset or as a reduction of permanent equity.

This is consistent with the consensus in EITF Issue 89-11, in which the Task Force noted, in part:

[W]hen ASR 268 . . . requires some or all of the value of the securities to be classified outside of permanent equity, a proportional amount of the debit in the equity section . . . if any, should be similarly classified.

9.8.2 Disclosure

ASC 505-10

Redeemable Securities

50-11 An entity that issues redeemable stock shall disclose the amount of redemption requirements, separately by issue or combined, for all issues of capital stock that are redeemable at fixed or determinable prices on fixed or determinable dates in each of the five years following the date of the latest statement of financial position presented.

SEC Rules, Regulations, and Interpretations

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

Redeemable Preferred Stocks

27. Preferred stocks subject to mandatory redemption requirements or whose redemption is outside the control of the issuer. . . .

(b) State on the face of the balance sheet the title of each issue, the carrying amount, and redemption amount. (If there is more than one issue, these amounts may be aggregated on the face of the balance sheet and details concerning each issue may be presented in the note required by paragraph (c) below.) Show also the dollar amount of any shares subscribed but unissued, and show the deduction of subscriptions receivable there from.

If the carrying value is different from the redemption amount, describe the accounting treatment for such difference in the note required by paragraph (c) below.

Also state in this note or on the face of the balance sheet, for each issue, the number of shares authorized and the number of shares issued or outstanding, as appropriate (See § 210.4–07).

(c) State in a separate note captioned “Redeemable Preferred Stocks” (1) a general description of each issue, including its redemption features (e.g. sinking fund, at option of holders, out of future earnings) and the rights, if any, of holders in the event of default, including the effect, if any, on junior securities in the event a required dividend, sinking fund, or other redemption payment(s) is not made; (2) the combined aggregate amount of redemption requirements for all issues each year for the five years following the date of the latest balance sheet; and (3) the changes in each issue for each period for which a statement of comprehensive income is required to be filed. (See also § 210.4–08(d).) . . .

CFRR 211: Redeemable Preferred Stocks [Reproduced in ASC 480-10-S99-1]

.04 Footnote Disclosure of Future Cash Obligations

ASR 268:

In the interest of clear and prominent disclosure of the future cash obligations attendant with these types of securities, the rules require disclosure of the term of redemption, five-year maturity data, and changes in these securities in a separate note to the financial statements captioned “Redeemable Preferred Stocks.” It should be noted that although in the past a registrant may have disclosed changes in redeemable preferred stocks in a statement of stockholders’ equity, such changes are now required to be disclosed in a separate note as described above. . . .

.06 Ratios and Materiality Tests

ASR 268: (7/27/79).

Where certain ratios or other data involving amounts attributable to stockholder’s equity are presented as required or are optionally presented in filings with the Commission, such ratios or other data should be accompanied by an explanation as to their basis of calculation. If material amounts of redeemable preferred stock are combined with amounts applicable to non-redeemable preferred and common stocks for purposes of computing a ratio, there should also be represented a similar ratio which excludes amounts applicable to redeemable preferred stock from equity and includes such amounts as debt. This would also apply to any financial information such as tables, charts, graphic illustrations and ratios presented in annual reports to shareholders if such reports are to meet the requirements to Rule 14a-3 of the General Rules and Regulations under the Exchange Act.

In addition, the Commission did not amend its rules, regulations and releases to the extent that they provide for various materiality tests for disclosure purposes using a percentage of total stockholders’ equity. In making these tests, registrants may use amounts applicable to all classes of capital stock.

ASC 480-10 — SEC Materials — SEC Staff Guidance

SEC Staff Announcement: Classification and Measurement of Redeemable Securities

S99-3A(24) ASR 268 and SEC Regulation S-X require certain disclosures about redeemable equity instruments. In addition, the SEC staff expects the following disclosures to be provided in the notes to the financial statements:

A description of the accounting method used to adjust the redemption amount of a redeemable equity instrument (as discussed in paragraphs 14–16).
When a registrant elects to accrete changes in the redemption amount of a redeemable equity instrument in accordance with paragraph 15(a), the redemption amount of the equity instrument as if it were currently redeemable.
For a redeemable equity instrument that is not adjusted to its redemption amount, the reasons why it is not probable that the instrument will become redeemable.
When charges or credits discussed in paragraphs 20 and 22(a) are material, a reconciliation between net income and income available to common stockholders.
The amount credited to equity of the parent upon the deconsolidation of a subsidiary (as discussed in paragraph 19).

SEC Staff Accounting Bulletins

SAB Topic 6.B, Accounting Series Release 280 — General Revision of Regulation S-X: Income or Loss Applicable to Common Stock [Reproduced in ASC 220-10-S99-55]

Facts: A registrant has various classes of preferred stock. Dividends on those preferred stocks and accretions of their carrying amounts cause income applicable to common stock to be less than reported net income.

Question 2: In ASR 280, the Commission stated that although it had determined not to mandate presentation of income or loss applicable to common stock in all cases, it believes that disclosure of that amount is of value in certain situations. In what situations should the amount be reported, where should it be reported, and how should it be computed?

Interpretive Response: Income or loss applicable to common stock should be reported on the face of the income statementFN1 when it is materially different in quantitative terms from reported net income or lossFN2 or when it is indicative of significant trends or other qualitative considerations. The amount to be reported should be computed for each period as net income or loss less: (a) dividends on preferred stock, including undeclared or unpaid dividends if cumulative; and (b) periodic increases in the carrying amounts of instruments reported as redeemable preferred stock (as discussed in Topic 3.C) or increasing rate preferred stock (as discussed in Topic 5.Q).

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FN1 When a registrant reports net income and total comprehensive income in one continuous financial statement, the registrant must continue to follow the guidance set forth in the SAB Topic. One approach may be to provide a separate reconciliation of net income to income available to common stock below comprehensive income reported on a statement of income and comprehensive income.

FN2 The assessment of materiality is the responsibility of each registrant. However, absent concerns about trends or other qualitative considerations, the staff generally will not insist on the reporting of income or loss applicable to common stock if the amount differs from net income or loss by less than ten percent.

Regulation S-X, Rule 5-02.27(b), requires an issuer to provide the following information related to instruments classified as temporary equity on the face of the balance sheet:

The title of the issue.
The carrying amount.
The redemption amount.

If there is more than one issuance, the entity must present the above information for each issuance either on the face of the balance sheet or in the related notes and must provide aggregate amounts on the face of the balance sheet. The issuer should also provide:

The dollar amount of any shares subscribed but unissued.
The deduction of subscriptions receivable therefrom.

Rule 5-02.27(c) and ASC 480-10-S99-3A(24) require an issuer to provide the following information about instruments classified as temporary equity in a separate note:

A “general description of each issue, including its redemption features (e.g. sinking fund, at option of holders, out of future earnings) and the rights, if any, of holders in the event of default, including the effect, if any, on junior securities in the event a required dividend, sinking fund, or other redemption payment(s) is not made.”
Five-year maturity data; that is, “the combined aggregate amount of redemption requirements for all issues each year for the five years following the date of the latest balance sheet.” The purpose of this guidance is to require “clear and prominent disclosure of the future cash obligations attendant with these types of securities” (CFRP 211.04). (Similar five-year data must be disclosed under ASC 505-10-50-11 by both SEC registrants and nonregistrants for redeemable stock that is redeemable at fixed or determinable prices on fixed or determinable dates.)
The “changes in each issue for each period for which a statement of comprehensive income is required to be filed.”
“A description of the accounting method used to adjust the redemption amount,” i.e., the subsequent measurement method (see Section 9.5.2). (Similarly, Rule 5-02.27(b) requires disclosure of the accounting treatment for any difference between the carrying value and the redemption amount.)
“When a registrant elects to accrete changes in the redemption amount of a redeemable equity instrument [that is not currently redeemable; see Sections 9.5.2 and 9.5.3], the redemption amount of the equity instrument as if it were currently redeemable” (i.e., the current redemption value).
“For a redeemable equity instrument that is not adjusted to its redemption amount [because it is not probable that it will become redeemable; see Sections 9.5.2 and 9.5.4], the reasons why it is not probable that the instrument will become redeemable.”
When charges or credits related to preferred stock instruments (including noncontrolling interests in the form of preferred stock) are material, “a reconciliation between net income and income available to common stockholders.”
“The amount credited to equity of the parent upon the deconsolidation of a subsidiary” (see Section 9.7.5).

When changes in the carrying amount of instruments presented as temporary equity cause income or loss applicable to common stock to be materially different from reported net income or loss, SAB Topic 6.B requires separate disclosure of income or loss applicable to common stock on the face of the income statement.

An issuer (including a nonpublic entity that is not required to apply the SEC’s temporary equity guidance) should also consider the general disclosure requirements related to stockholders’ equity and specific outstanding securities issued by an entity under ASC 505-10-50. For instance, ASC 505-10-50-11 requires disclosure of “the amount of redemption requirements, separately by issue or combined, for all issues of capital stock that are redeemable at fixed or determinable prices on fixed or determinable dates in each of the five years following the date of the latest statement of financial position presented.”

An entity is not required to provide fair value measurement disclosures under ASC 825 for items classified in temporary equity, because instruments classified in temporary equity qualify under the scope exception in ASC 825-10-50-8(i) for items classified in stockholders’ equity. (ASC 815-10-15-76 notes that “[t]emporary equity is considered stockholders’ equity . . . even if it is required to be displayed outside of the permanent equity section.”)

If an issuer is required or elects to present financial information (such as ratios, tables, charts, and graphic illustrations) that includes amounts of stockholders’ equity, it should “explain the basis of calculation” (CFRP 211.06). “If material amounts of [temporary equity classified] redeemable preferred stock are combined with amounts applicable to non-redeemable preferred and common stocks,” similar information should be provided that “excludes amounts applicable to redeemable preferred stock from equity.”

Footnotes

The version of SAB Topic 6.B that is reproduced in ASC 220-10-S99-5 differs from the text published on the SEC’s Web site and in the Federal Register. That is, whereas the SEC’s Web site and Federal Register state, “When a registrant reports net income and total comprehensive income in one continuous financial statement,” ASC 220-10-S99-5 states, “If a registrant elects to follow the encouraged disclosure discussed in paragraph 23 of Statement 130 [paragraph 220-10-45-9], and displays the components of other comprehensive income and the total for comprehensive income using a one-statement approach.” Although the wording differs, the guidance is consistent.

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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.