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Navigating the depths of debt and equity accounting and valuation.

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TLDR:

Companies that use both debt and equity financing must carefully account for these financial instruments in accordance with U.S. GAAP. Properly evaluating the accounting for these instruments requires understanding complex legal agreements and accounting principles. Auditors often engage subject matter experts to help assess the accounting for debt and equity financings, and companies that use third-party service providers with expertise in this area have higher success in evaluating the accounting correctly.

Key considerations when evaluating debt and equity instruments include:

  • Separate accounting for multiple financial instruments
  • Accounting for financial instruments as liabilities or at fair value
  • Allocation of consideration to multiple financial instruments
  • Bifurcation of embedded derivatives and separate accounting
  • Scope exceptions for recording to equity
  • Treatment of equity financing in balance sheet presentation
  • Treatment of equity financings and convertible debt in earnings per share calculations
  • Inclusion of appropriate financial instrument and fair value measurement disclosures
  • Complex valuation methodologies for fair valuing financial instruments

Specific considerations for common debt and equity financing include:

  • Convertible debt: Accounting for embedded derivatives and fair valuing using a bond plus call option model
  • Warrants to purchase common or preferred stock: Accounting for warrants as liabilities or equity and fair valuing using an option pricing model
  • Preferred stock: Determining if the stock is debt or equity and fair valuing using various methodologies

The accounting determinations and valuations for debt and equity financings are complex, and third-party assistance can help ensure accuracy and compliance with accounting standards. Independent assessments of the fair value of these instruments provide greater confidence in financial reporting and decision making.

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