Chapter 9 — The SEC's Guidance on Temporary Equity

9.1 Overview and Sources of Guidance

Issuers of certain equity-classified instruments that are redeemable for cash or other assets in circumstances not under their sole control must, in financial statements filed with the SEC under Regulation S-X, (1) present such instruments in a caption that is separate from both liabilities and stockholders’ equity on the face of the balance sheet and (2) apply specific measurement and disclosure guidance to them. Instruments presented in this manner are described as temporary (or “mezzanine”) equity instruments.

Under the SEC’s temporary equity guidance, equity instruments that contain terms that could force the issuer to redeem the instruments for cash or other assets are presented separately from conventional equity capital, which does not contain such terms. Temporary equity presentation highlights that the proceeds received from equity instruments within the scope of the guidance may have to be repaid and thus may not be available to the issuer as a permanent source of equity financing.

Terms and features that could trigger temporary equity classification are not limited to those that are explicitly described as cash-settled redemption or put features. For example, call, conversion, and liquidation features that could force the issuer to redeem an equity instrument for cash or assets might necessitate such classification. Accordingly, the SEC staff has advised issuers to “carefully consider all contractual provisions of a security before determining how it should be classified in the financial statements.”1

9.1.1 SEC Announcements, Speeches, and Discussions

Although there are many types of SEC guidance on the separate presentation and disclosure of certain redeemable equity instruments (see Appendix B), the SEC staff announcement in ASC 480-10-S99-3A addresses the classification and measurement requirements for redeemable equity securities comprehensively. When applying the SEC’s temporary equity guidance, registrants should consider these requirements as well as remarks made by the SEC staff in public speeches, meetings with members of the accounting profession (including the CAQ’s SEC Regulations Committee and its International Practices Task Force), and informal discussions about how the staff expects registrants to apply the guidance.

For ease of reference, the FASB has included in the Codification certain portions of the SEC’s rules and guidance (e.g., excerpts from Regulation S-X and SABs). If any discrepancies exist (e.g., because of updates to the SEC’s guidance that the FASB has not yet reflected in the Codification), registrants should apply the text issued by the SEC rather than the version in the Codification. However, note that since the SEC does not separately publish staff announcements or observer comments made at EITF meetings, the Codification is the primary repository for that text.

9.1.2 SEC Rules and Policies

9.1.2.1 Regulation S-X

Regulation S-X, Rule 5-02 (reproduced in ASC 210-10-S99-1), contains requirements related to what should appear on the face of the balance sheet and be disclosed in related notes in financial statements filed with the SEC by all entities except those specifically exempted. Rule 5-02.27 specifies the basic balance sheet presentation and footnote disclosure requirements related to redeemable preferred stocks classified as temporary equity. It requires an entity to present redeemable preferred stocks separately from components of permanent equity on the face of the balance sheet (see Section 9.8.1).

In presenting redeemable preferred stock separately under Regulation S-X, registrants should consider the SEC’s additional guidance on this topic, in particular the SEC staff announcement in ASC 480-10- S99-3A, and the GAAP requirements related to what should be presented as liabilities or equity. For instance, while Regulation S-X, ASR 268, CFRP 211, and SAB Topic 3.C focus on redeemable preferred stock, ASC 480-10-S99-3A clarifies that the SEC staff also expects registrants to apply the SEC’s temporary equity guidance to other types of redeemable equity-classified instruments (such as common stock and noncontrolling interests; see Section 9.3.1). Further, while Regulation S-X, ASR 268, and CFRP 211 suggest that the temporary equity guidance applies to stocks subject to mandatory redemption requirements, the FASB has subsequently issued guidance that requires certain financial instruments to be classified as liabilities even if they are in the form of outstanding shares of stock (see Chapters 4 and 6). Accordingly, the SEC’s temporary equity guidance does not apply to outstanding shares that must be classified as liabilities under GAAP.

9.1.2.2 ASR 268

ASR 268 contains the amendments to Regulation S-X that the SEC adopted on July 27, 1979, when it first established separate presentation and disclosure requirements for redeemable preferred stocks. In addition, the supplementary information in ASR 268 discusses the SEC’s decision to require separate presentation and disclosure of redeemable preferred stocks. While the complete, original text of ASR 268 is not reproduced in the Codification, ASC 210-10-S99-1 contains excerpts from Regulation S-X that were amended by ASR 268. Further, ASC 480-10-S99-1 contains selected portions of the supplementary information in ASR 268 that the SEC incorporated into CFRP 211.

9.1.2.3 CFRP 211

The SEC codified selected portions of ASR 268 in CFRP 211 (also known as CFRR 211 or FRR 211). Reproduced in ASC 480-10-S99-1, CFRP 211 provides information about the SEC’s decision to require separate presentation and disclosure of redeemable preferred stocks in accordance with Regulation S-X. CFRP 211 does not contain the actual amendments to Regulation S-X, however, and omits portions of the supplementary information that was originally included in ASR 268, such as a brief discussion of comments the SEC received on the proposed rule that resulted in ASR 268 and the SEC’s observations about the FASB’s standard-setting activity at the time.

9.1.3 SEC Staff Accounting Bulletins

9.1.3.1 SAB Topic 3.C

SAB Topic 3.C (reproduced in ASC 480-10-S99-2) contains the SEC staff’s views on how redeemable preferred stock should be measured and how changes in the carrying amount should be treated in EPS and ratio calculations. The SEC staff announcement in ASC 480-10-S99-3A contains additional detailed guidance on these topics.

9.1.3.2 SAB Topic 14.E

SAB Topic 14.E (reproduced in ASC 718-10-S99-1) contains the SEC’s views on the application of the temporary equity guidance to share-based payment arrangements with employees. This Roadmap touches briefly on these topics (see Sections 9.3.9, 9.4.9, and 9.5.12). For a more detailed discussion, see Deloitte’s Roadmap Share-Based Payment Awards.

9.1.4 SEC Announcements and Observer Comments Made at EITF Meetings

9.1.4.1 SEC Staff Announcement: Classification and Measurement of Redeemable Securities

ASC 480-10 — SEC Materials — SEC Staff Guidance

SEC Staff Announcement: Classification and Measurement of Redeemable Securities

S99-3A(1) This SEC staff announcement provides the SEC staff’s views regarding the application of Accounting Series Release No. 268, Presentation in Financial Statements of “Redeemable Preferred Stocks.” FN1

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FN1 ASR 268 (SEC Financial Reporting Codification, Section No. 211, Redeemable Preferred Stocks) is incorporated into SEC Regulation S-X, Articles 5-02.27, 7-03.21, and 9-03.19. Hereafter, reference is made only to ASR 268.

The SEC staff announcement in ASC 480-10-S99-3A (originally issued as EITF Topic D-98) provides a comprehensive overview of the SEC staff’s views on the application of the redeemable equity requirements in Regulation S-X and related guidance.

9.1.4.2 SEC Observer Comments — Sponsor’s Balance Sheet Classification of Capital Stock With a Put Option Held by an ESOP

The SEC staff observer comments in ASC 480-10-S99-4 discuss the application of the SEC’s temporary equity guidance to equity instruments issued by a sponsor to an ESOP in situations in which the instruments can be put to the sponsor for cash or other assets (see Sections 9.3.8 and 9.5.11).

Footnotes

From remarks by then SEC Professional Accounting Fellow Dominick J. Ragone III before the 2000 AICPA Conference on Current SEC Developments.

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.