Accounting Standards Codification 480 (ASC 480) was released to address the more specific topic of distinguished liabilities from equity.
Typical ASC 480 Balances
At first blush, an experienced accountant may see that it is quite easy to distinguish a liability from an equity. Liabilities are obligations to pay outside parties, whereas equities are the owners share of the business. However due to the complexities associated with accounting, there are typically never answers that are that straight forward. In this topic, it relates to transactions which are considered to be convertible instruments.
A convertible instrument is one in which starts out as, for example, preferred stock and has the option to be converted into a bond. The ultimate call as to when and at what terms will vary across the board depending on the specific deal that was brokered. There are several other types of transactions that could be considered to be included within this standard as well, listed below:
a. Common stocks
b. Derivative instruments
c. Noncontrolling interests
d. Securities held by an employee stock ownership plan
e. Share-based payment arrangements with employees
So what we are getting at in the end, is that those convertible options which are able to be exercised to switch from an equity to a liability are going to need to be considered on a case-by-case basis in order to determine the proper balance sheet classification. Simply because a financial instrument starts out as an equity does not mean that it can be classified as an equity; if there are convertible options that it exist those must be considered in the classification process when determining the amounts and classification to be recorded.
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