As more fully discussed in Section 3.2.1 of our publication, A guide to accounting for debt and equity instruments in financing transactions, Topic 480, “Distinguishing Liabilities from Equity,” of the Accounting Standards Codification (ASC) requires liability classification for certain instruments, such as preferred stock, when those instruments are mandatorily redeemable and within its scope. ASC 480-10-35 addresses the subsequent measurement of liability-classified mandatorily redeemable financial instruments and indicates that changes necessary to adjust the carrying amount to the settlement amount (or the present value of the settlement amount) are recognized as interest cost. Questions have been raised in practice as to whether interest costs for these instruments are within the scope of ASC 835-20, “Interest – Capitalization of Interest.”

Interest costs are defined in ASC 835-20 to include interest recognized on obligations with explicit interest rates, including amounts arising from the periodic amortization of discount or premium and issue costs. Given the depiction of dividends and other adjustments to the carrying amount of a mandatorily redeemable financial instrument classified as a liability in ASC 480-10-35 as interest cost, we believe consideration should be given to applying ASC 835-20 to such instruments and capitalizing interest if and as appropriate. Conversely, dividends and adjustments to the carrying amount of instruments that are in the legal form of equity that are not liability classified are recognized as dividends rather than interest costs and would not be within the scope of ASC 835-20.