Complex Financial Instruments
Companies raise capital by issuing debt, equity, and instruments with both debt and equity-like features. To meet investor’s demands, these instruments are often complex and commonly issued in combination with other financial instruments or contain various embedded features. The combination of instruments and features increases the complexity of the accounting analysis and often require valuation procedures to be performed.
The accounting for these instruments is complicated and auditors generally consult with their national offices to ensure appropriate accounting is applied. Opportune’s subject matter experts streamline this process with robust and best-in-class documentation that has been tried and tested by all the national accounting firms.
Technical Accounting Memorandum
Determining the appropriate accounting complex financial instruments, such as preferred stock, convertible debt, warrants and other equity linked instruments, can be complex and time-consuming. To properly apply the numerous rules and exceptions in U.S. GAAP, an issuer may need to closely analyze an instrument’s terms and conditions and the related facts and circumstances. The outcome of this analysis can significantly affect the classification, measurement, and earnings impact of these instruments.
Common accounting issues addressed include:
Determining whether liability classification is required
Embedded derivative assessments
Debt modifications
Accounting for transaction costs
Valuation
The accounting for these instruments often involves the need for valuation services. For each valuation, Opportune pairs accounting experts with valuation experts. This ensures that the valuation is performed in line with the accounting needs and provides for a cohesive deliverable.
Common areas requiring valuation services include:
Valuation of embedded derivatives
Allocation of proceeds for the issuance of multiple financial instruments
Financial instruments issued in business combinations
10% cash flow tests for debt modification vs. extinguishments
SEC guidance on Redeemable Equity Instruments
Although certain instruments are issued in the form of equity, the SEC requires certain redeemable equity instruments to be classified outside of permanent equity. We assist our public company clients and our clients that are heading towards an IPO by performing a thorough review of their equity securities to see if the SEC’s redeemable equity guidance is applicable. If so, the SEC requires these instrument to be classified as temporary (or mezzanine) equity between liabilities and stockholders’ equity to highlight the future potential cash obligations attached to these types of securities.
Here is how we help:
Thorough review of legal documents to identify any contingent events not solely within the control off the issuer that could force redemption.
Coordination between legal and accounting to ensure proper interpretation.
Assist with the initial and subsequent measurement for instruments within the scope the SEC’s redeemable equity guidance
Disclosures and EPS
The issuance of complex financial instruments can be new for many companies, resulting in financial reporting complications.
Due to the complexity of these instruments, we often provide the following financial reporting services related to the issuance of these complex financial instruments:
Drafting new significant accounting policy language
Drafting footnote disclosure for the new securities issued
Assistance with setting up templates for calculating basic and diluted earnings per share to include the effect of participating securities, convertible securities, and other equity linked instruments
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