FASB clarifies accounting for call options

The Financial Accounting Standards Board released a standards update Monday to improve the accounting for modifications or exchanges of freestanding equity-classified written call options, such as warrants, that stay classified as equity after a modification or exchange.

The accounting standards update is based on a consensus that emerged from FASB’s Emerging Issues Task Force. The document offers guidance on how an issuer would measure and recognize the effect of these transactions. In particular, it offers a principles-based framework to decide whether an issuer should recognize the modification or exchange as an adjustment to equity or an expense.

The standard aims to reduce some of the diversity in practice when it comes to accounting for modifications of freestanding equity-classified written call options that remain equity classified after a modification or exchange. Some of FASB’s constituents complained about differences in how various issuers accounted for economically similar modifications or exchanges of freestanding equity-classified written call options due to a lack of explicit guidance in FASB’s codification of accounting standards. They asked FASB to provide guidance to clarify whether an issuer should account for a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange as either (1) an adjustment to equity and, if so, the related earnings per share effects, if any; or (2) as an expense and, if so, the manner and pattern of recognition.

Courtesy of GASB

“An entity should treat a modification of the terms or conditions or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange as an exchange of the original instrument for a new instrument,” said FASB. “An entity should measure the effect of a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange as follows.”

The document then goes on to provide the details for how to measure the effect. The amendments in the update take effect for all entities for fiscal years starting after Dec. 15, 2021, including interim periods within those years. Issuers should apply the amendments prospectively to any modifications or exchanges that happen on or after the effective date. Early adoption is allowed.