CFM55215 - Derivative contracts: holders of convertible or share-linked securities: convertible securities: accounting treatment
Accounting treatment, a brief history
The accounting treatment for convertible instruments under both UK GAAP and International Financial Reporting Standards (IFRS) has changed over time.
Under UK GAAP, for periods of account beginning before 1 January 2015, an entity would typically have applied “Old UK GAAP” (and some entities may have applied the accounting standards FRS 25 and FRS 26 on financial instruments). For periods beginning before 1 January 2016, smaller entities would have applied the Financial Reporting Standard for Smaller Entities (FRSSE). These standards are no longer applicable.
As a result, a UK company has a choice of the following accounting frameworks going forwards:
(1) EU-endorsed IFRS/IAS: those accounts prepared in accordance with International Accounting Standards within the meaning of s395 of the Companies Act - referred to as ‘IFRS’ in the CFM. Those adopting IFRS apply the IFRS standards - IAS 39, and the newer standard IFRS 9.
(2) New UK GAAP: FRS 100, FRS 101 and FRS 102. Entities applying New UK GAAP will, within the framework of FRS 100, apply one of the following:
- FRS 101 is effectively the recognition and measurement requirements of IFRS subject to some adjustments to ensure alignment with UK Companies Act and also reduced disclosure requirements.
- FRS 102 is a new suite of accounting requirements which are closely aligned to, but are not the same as, IFRS. Under FRS 102 there is an accounting policy choice whereby an entity can apply choose to apply the recognition and measurement requirements of IAS 39 or IFRS 9 instead of sections 11 and 12 of FRS 102.
- Section 1A of FRS 102, available to small companies, is aligned to FRS 102 but with reduced disclosures and presentation requirements.
- FRS 105 is based on the recognition and measurement requirements of FRS102, with some accounting simplifications and reduced disclosures for eligible micro entities.
So, it is fair to say that at present the accounting for financial instruments is complex and the accounting treatment can vary greatly depending upon which accounting standard is applied, and which GAAP is being applied.
A simplified summary of the accounting position and treatment of convertible assets and share-linked securities from the position of the holder is below. Please note that this is not a complete position, but is instead a broad overview, and there are exceptions, exemptions and other complexities which are not included in the simplified table below:
| GAAP | Applicable period. | UK GAAP or IFRS | Accounting Treatments. |
|---|---|---|---|
| Old UK GAAP. (where FRS 26 is not applied) and the FRSSE. | Medium and large companies cannot apply Old UK GAAP for periods from 1 January 2015. Small companies cannot apply Old UK GAAP or the FRSSE for periods from 1 January 2016. | UK GAAP | Amortised cost. |
| Old UK GAAP (where FRS 26 is applied). | Medium and large companies cannot apply Old UK GAAP for periods from 1 January 2015. | UK GAAP | Bifurcate if host debt and embedded derivative element are not “closely related”. Alternatively, the whole instrument could be measured at fair value. |
| FRS 102 (where the option to applu IAS 39 or IFRS 9 are not taken). | For periods starting on or after 1 January 2015 (early adoption permitted). | UK GAAP | These willl typically be a non-basic instrument and so will be measured at fair value under Section 12 of FRS 102. |
| FRS 101 | For periods starting on or after 1 January 2015 (early adoption permitted). | UK GAAP | Follows the IFRS treatement - see references to IAS 39 and IIFRS 9 below. |
| FRS 105 | For periods starting on or after 1 January 2016 (early adoption permitted). | UK GAAP (very small “micro” entities only). | Amortised cost. |
| ISA 39 | For periods commencing before 1 January 2018. IAS 39 can still be applied as a policy option under FRS 102. | IFRS (Where applied throught FRS 101 or FRS 102 this would be UK GAAP). | Bifurcate if host debt and embedded derivative element are not “closely related”. Alternatively the whole instrument could be measured at fair value. |
| IFRS 9 | For accounting periods starting on or after 1 January 2018 (early adoption permitted). IFRS 9 can also be applied as a policy option under FRS 102. | IFRS (Where applied through FRS 101 or FRS 102 this would be UK GAAP). | The entire asset will typically be measured at fair value through profit or loss (FVTPL). (It may be possible in certain cases for the instrument to be measured at cost of at fair value throught Other Comprehensive Income (FVOCI) |
Specialist accountancy advice may often be needed in order to determine the appropriate accounting treatment for the specific fact pattern of each situation.
Once the accounting treatment has been determined, the main outcomes for the accounting treatment that are possible are:
- Amortised cost for the whole instrument.
- Fair value through profit or loss (FVTPL) for the whole instrument.
- Fair value through other comprehensive income (FVOCI) for the whole instrument.
- Bifurcation of the “debt” and the embedded derivate (equity) components of the instrument. The “debt” element would be recognised at amortised cost, and the embedded derivative element would be FVTPL (similar to a stand-alone purchased call option on equities).