New FASB guidance reduces complexity in accounting for financial instruments with down round features

On July 13, 2017, the FASB issued ASU 2017-11, Part 1: Accounting for Certain Financial Instruments with Down Round Features. The new guidance provides relief for issuers of certain free-standing equity-linked financial instruments (such as warrants on the issuer’s shares) and instruments with conversion options (such as convertible debt and preferred stock) that contain down-round features.


Down-round features are provisions in equity-linked instruments (or embedded features) that result in the strike price being reduced on the basis of the pricing of future equity offerings. For example, a warrant may provide for an adjustment to the strike price if the entity sells shares of its common stock for an amount less than strike price of the warrant.


Down-round features broadly impact 1) the balance sheet classification and subsequent treatment for freestanding financial instruments, such as warrants, and 2) the assessment to determine whether conversion options embedded in debt and equity instruments require bifurcation and separate accounting as derivatives.

While there are many factors to consider, these features are problematic, often resulting in warrants and other freestanding equity instruments being classified as a liability. When found in convertible debt or equity, these features may result in bifurcation and separate accounting for the conversion option as a derivative liability. In both cases, the down-round feature leads to fair value adjustments that impact earnings. These conclusions are reached because the down found features prevent the instruments (or embedded features) from being considered indexed to the entity’s own stock.

Responding to the FASB’s request for comment, CFGI argued that down round features should be excluded from the assessment of whether an instrument is indexed to an entity’s own stock for the following reasons:

  • Recognizing a liability (and resulting changes in fair value through income) for a feature which will be settled in a company’s equity and the value of which fluctuates based on a company’s equity value leads to fluctuations in income that do not significantly improve information provided to users of the financial statements;
  • Accounting for the instruments at fair value does not reflect the economics of the down round feature. When applying fair value accounting, the issuer recognizes gains and losses in its earnings upon changes in the issuers’ share price even though these changes in share price do not impact the probability that a down round will be triggered;
  • Measuring the fair value of these instruments is costly and complex.


The new rules broadly allow instruments with down round features to receive the more favorable treatment afforded to instruments without such features by allowing entities to exclude down round features from the assessment of whether an instrument is indexed to an entity’s own stock. Entities may be able to immediately stop accounting for already outstanding instruments and embedded features as derivatives, eliminating the need for fair value adjustments that impact earnings.

Freestanding equity-linked financial instruments with down round features

The new guidance changes the classification analysis of certain equity-linked financial instruments with down round features. Under the new rules, a down round feature alone no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. Provided certain additional criteria are met, warrants and other instruments that were previously classified as a liability and marked-to-market at each reporting period may be reclassified to equity, no longer requiring adjustments that impact earnings.

Convertible instruments with down round features

Under the new rules convertible instruments with embedded conversion options that have down round features that were previously bifurcated and separately accounted for as derivatives may no longer require separate treatment. These instruments are now subject to the specialized guidance for contingent beneficial conversion features.


Although the new rules are not effective for public business entities until 2019 (2020 for all other entities), early adoption is permitted.

Entities may want to consider the many benefits of early adoption:

  • Eliminate need for periodic valuations of outstanding instruments with down round features;
  • Eliminate earnings volatility from mark-to-market adjustments;
  • Reduce complexity in the initial assessment of new instruments and prevent need to unwind treatment upon later adoption.

We are happy to discuss the impact of ASU 2017-11 and the opportunity it may present for your organization. Please reach out to Josh Verni to discuss (585-748-3687,