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A rise in creative financings used by dealmakers has so blurred the lines between what’s debt and what’s equity that U.S. accounting rulemakers Oct. 27 proposed a new rule to make the distinction clearer. The Financial Accounting Standards Board, the country’s main accounting rulemaking body, said it proposed the rule to clarify the difference between accounting for debt and equity and would require separate reporting of the two. “The innovation in the capital markets over the past decade has resulted in more complex financial instruments, and we can’t tell what’s debt or equity,” said Diana Willis, a FASB senior project manager. “People introduce new [variations] everyday.” The proposed rule would establish standards for accounting for financial instruments with characteristics of liabilities, equity or both. It also would establish standards for certain issues related to accounting for the noncontrolling interest in a consolidated subsidiary. In addition, the proposed rule would provide guidance on the accounting for costs incurred to issue a financial instrument that has either debt or equity characteristics. Other esoterica, such as accounting for repayments and the conversions of convertible debt into stock, are covered by the proposal, too. What gives the rule broad applicability is the fact that few companies are financed solely by common stock these days, Willis said. The rule would apply to financial instruments such as bonds, derivatives, options and puts that have both debt and equity components. The rule-making process is at the earliest stage, with the FASB only releasing an exposure draftfor comments, which are due in March. Currently, if Company A owes Company B $1,000 and the two draft a contract that allows Company A to repay the sum in cash or in its own stock, the sum would qualify as equity. But under the proposal, such a contract would be considered debt because Company B has a claim to a fixed amount of value, Willis said. Willis said the proposed rule is part of the FASB’s financial instruments projects, which has already yielded the controversial Statement 133. That recently promulgated rule, which goes into effect in January, requires corporations to report on their balance sheets the fair market value of their derivatives as either assets or liabilities and that they may be marked to market. FASB said it will wait until it receives comment letters on the new debt-and-equity definition rule proposal to determine if public hearings are needed. “I imagine the [proposed rule] would get a lot of attention, but it’s too early to tell if it’ll be positive or negative,” Willis said. Copyright (c)2000 TDD, LLC. All rights reserved.

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