New accounting guidance can perpetually affect your SEC audit. Last year, the FASB issued ASU 2020-06 Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, which simplifies the guidance related to PCAOB accounting for specific financial instruments that fall into the categories of debt and equity. Most specifically, ASU 2020-06 affects the complexities of convertible debt instruments.
Convertible Instruments Simplified
Convertible debt instruments are a complex part of a public company audit, also known as an SEC audit. Currently, there are five accounting models in ASC 470-20 for handling convertible debt (excluding fair value). These are:
- Convertible debt with bifurcated derivative
- Traditional convertible debt
- Convertible debt issued at a substantial premium
- Convertible debt with a cash conversion feature
- Convertible debt with a beneficial conversion feature
With the introduction of ASU 2020-06, there are now only three accounting models to allocate convertible debt. ASU 2020-06 removes convertible debt with bifurcated derivative (BCF) and convertible debt with a cash conversion feature (CCF).
How Can ASU 2020-06 Affect Your Public Company Audit?
The elimination of the BCF and CCF accounting models will affect entities that have issued a convertible debt instrument in the scope of those models before the adoption of ASU 2020-06. It is possible that this guidance may reduce reported interest expenses and increase reported net income for such entities. When planning for your public company audit, understand if and how this may affect you and speak to your auditor about ASU 2020-06 analysis that has been performed.
SEC Audit Disclosures Expanded
Under ASU 2020-06, entities are required to provide additional disclosures to better inform financial statement users about “the terms and features of convertible instruments” and “information about events, conditions, and circumstances that can affect how to assess the amount or timing of an entity’s future cash flows related to those instruments.”
Effective Date
This new guidance applies to any SEC audit, excluding smaller reporting companies defined by the SEC, for fiscal years beginning after December 15, 2021. For all other entities, ASU 2020-06 and its amendments are effective for fiscal years beginning after December 15, 2023. Early adoption is permitted, but not before the fiscal years that begin after December 15, 2020.
Future Impact of ASU 2020-06
Given the intent of this guidance to simplify the accounting for convertible debt instruments, it is likely that many entities will be interested in early adoption. Overall, these amendments will provide transparency to financial statement users and valuable information for investors while reducing the complexity of recognition and measurement requirements for convertible debt features.
How Can You Adopt This Guidance?
Adopting this new FASB guidance can be done either by following a modified retrospective method or a fully retrospective method of transition. Speak with your SEC audit team to discuss which adoption method your company has adopted.
At Assurance Dimensions, our team of talented professionals understands the complex rules associated with PCAOB audits and regulatory compliance. Contact us today to prepare for your next public company audit.
