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The FASB recently issued ASU 2021-04 to guide how a registered public accounting firm classifies written call options, such as warrants, that remain equity classified after a modification or exchange. This article helps you understand the changes and how to deal with them during a public company audit


How Can ASU 2021-04 Affect Your Public Company Audit?

ASU 2021-04 will affect the public accounting audit of all entities that modify or exchange freestanding written call options (such as warrants) classified as equity. But, this framework does not apply to warrants modified to compensate for goods or services within the scope of Topic 718.


Main Provisions of ASU 2021-04 

To determine the effect of the modification of the warrant, consider the difference in its fair value before and after the modification. The effect of the modification is recognized in the same approach as if cash had been paid as consideration. ASU 2021-04 provides that recognition will be contingent on the related event. Events that will affect recognition include:

    • Financing transactions to raise equity: Any increase in fair value is recognized as an equity issuance cost in accordance with ASC 340 Other Assets and Deferred Costs.
    • Financing transactions to raise equity: Any decrease in fair value is accounted for as a debt issue cost pursuant to guidance provided by ASC 835.
  • Multiple-element transactions: Distribute the total effect to the respective elements in the transaction. 
  • Modification of debt (warrant held by creditor): Any change (i.e., increase or decrease) in fair value is accounted for as debt fees between the debtor and the creditor. 
  • Modification of debt (warrant held by third-party): Any increase (but not a decrease) in fair value is accounted as third-party issue costs in accordance with ASC Subtopic 470-50 Debt – Modifications and Extinguishments
  • Modification of debt (troubled debt restructuring):  The difference (i.e., increase or decrease) in fair value of creditor warrants is included in determining the effective borrowing rate of the restructured debt in accordance with ASC Subtopic 470-60 Troubled Debt Restructurings.
  • Other modifications: The increase in fair value is accounted as a dividend. This would be adjusted to net income or loss when computing basic earnings per share.


Effective Date

The guidance under ASU 2021-04 is applied prospectively to all modifications or exchanges that occur on or after adoption. It is effective for fiscal years after December 15, 2021, including interim periods, with early adoption permitted. If an entity chooses to early adopt during an interim period, then the guidance is applied at the beginning of the fiscal year that includes the interim period.


The Future Impact of ASU 2021-04 on Registered Public Accounting Firms

This new guidance comes on the heels of ASU 2020-06, as the SEC attempts to simplify guidance for public accounting audits. The SEC has been reviewing how special purpose acquisition companies (SPACs) have been accounting for warrants. In the past, warrants were usually classified as part of equity. However, the guidance of 2021-04 states certain warrants are more correctly classified as a liability. The changes with this guidance will most likely lead to SPACs amending warrants to avoid SEC scrutiny and affect how issuers raise capital. 


How Can You Adopt This Guidance For Your Audit?

You may be able to adopt this guidance during this current fiscal year or an interim period. Prepare your independent analysis and speak with your PCAOB auditor about how this may affect your reporting.

As a registered public accounting firm that specializes in PCAOB audits, Assurance Dimensions understands the complex rules associated with regulatory compliance and PCAOB accounting. Contact us today to prepare for your next public company audit.