The Financial Accounting Standards Board has released its preliminary views on financial instruments with the characteristics of equity in an effort to simplify a patchwork of 60-plus pieces of guidance.
The proposal limits the instruments that can be classified as equity to the lowest residual interests in an entity. The holders of the instruments are viewed as the owners of the entity. All other instruments represent either liabilities or assets. An instrument that reduces the net assets available to the owners of the entity is a liability; and an instrument that enhances net assets available to the owners is an asset.
Under this approach, forward contracts, options and convertible debt would be classified as liabilities or assets.
"The basic ownership approach would represent a major change to current accounting and reporting," said FASB member Tom Linsmeier in a statement. The change provides investors with more understandable information about the relative priority of claims on an entity's net assets and income, and reduces opportunities to structure arrangements to achieve a desired accounting result, he noted.
FASB believes its proposal is generally consistent with the views of some investor groups, such as the CFA Institute, which have called for a narrow, principles-based view of equity. It also responds to concerns about the complexity of the existing piecemeal guidance.
As part of the effort to develop common international standards, the International Accounting Standards Board plans to publish FASB's preliminary views in early 2008 for comment by its constituents. FASB and the IASB intend to use the feedback they receive to determine the best way to develop a common standard in this area. For more information and to comment on the proposal, go to www.fasb.org.
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