Companies that enter into share-lending arrangements in connection with convertible debt offerings now have some new accounting rules to follow.

The Financial Accounting Standards Board issued Accounting Standards Update No. 2009-15, which spells out new rules for how to account for share-lending arrangements when linked with convertible debt issuance or other financing and how to calculate earnings per share. The guidance was recommended to FASB by its Emerging Issues Task Force.

A share-lending arrangement is an agreement between a corporate entity and an investment bank in which the bank uses shares loaned by the corporate entity to enter into equity derivative contracts, such as options, forwards, and total return swaps. The contracts allow investors to hedge long positions in the corporate stock that they hold via an embedded conversion option in the convertible debt instrument, while the bank gets to hedge its own market risk associated with the long position.

EITF says corporate entities may enter into such arrangements to get a reduction in the interest rate, an increase in the proceeds received from issuing a convertible debt instrument, or just because of a lack of liquidity or an already substantial load of open short positions in their shares.

The new rule says when companies enter into share-lending arrangements, they should be booked at fair value and recognized as an issuance cost with an offset to additional paid-in capital, and the loaned shares should not be included in the EPS calculation. If a company fears default, then the company must begin recognizing expense. The rule, which takes effect for calendar-year companies with the beginning of 2010, also spells out some disclosure requirements.

Separately, FASB also has proposed an accounting standards update that would address some possible confusion related to embedded credit derivatives and a scope exception provided in derivative accounting. The issue cropped up at the peak of the credit crisis, with confusion surfacing about how existing rules applied to some collateralized debt obligations and synthetic CDOs. The board is proposing some new language and some examples to help clarify.

Topics