Accounting for Temporary Equity in Private Company Capital Structures
- Graziano Stefanelli
- May 12
- 2 min read
✦ Temporary equity (mezzanine equity) includes instruments such as redeemable preferred stock or shares subject to mandatory redemption features.
✦ Under ASC 480-10-S99 (SEC guidance) and common practice, these instruments are reported separately between liabilities and permanent equity due to their conditional redemption terms.
✦ Instruments classified as temporary equity must be measured at their redemption amounts, often adjusted each reporting period.
✦ Accurate accounting ensures clear presentation of capital structure and correct reflection of redemption obligations.
1. Definition of Temporary Equity (Mezzanine Equity)
✦ Temporary equity refers to equity instruments that contain mandatory or conditional redemption features, meaning the issuer may be required to repurchase shares or settle obligations in cash.
✦ Common examples include: • Redeemable preferred stock • Shares subject to put rights by holders • Equity with mandatory redemption clauses
2. Criteria for Classification as Temporary Equity
✦ According to ASC 480-10-S99 (SEC), instruments must be classified as temporary equity if redemption is:
• Outside the control of the issuer (e.g., at holder’s option), or • Conditional upon certain events or milestones (e.g., IPO, merger).
✦ If redemption is unconditional and mandatory, instruments may be classified as liabilities rather than temporary equity.
3. Measurement at Redemption Amount
✦ Temporary equity instruments are measured at the current redemption value, not historical issuance price.
✦ If redemption value exceeds carrying value, incremental amounts are recorded as reductions to retained earnings or additional paid-in capital.
Example entry if redemption value increases from $100,000 to $110,000:
debit Retained Earnings – $10,000credit Temporary Equity (Redeemable Preferred Stock) – $10,000
4. Balance Sheet Presentation
✦ Temporary equity is presented in a distinct section on the balance sheet between liabilities and shareholders’ equity.
✦ Clear labeling is required (e.g., "Redeemable Preferred Stock" or "Temporary Equity").
Example Balance Sheet:
Liabilities:…
Temporary Equity: Redeemable Preferred Stock – $110,000
Shareholders' Equity:…
5. Adjustments to Redemption Value
✦ Adjustments to temporary equity are recorded each reporting period to reflect changes in redemption value.
✦ Changes directly impact equity (retained earnings or APIC), not income.
Example of subsequent adjustment (decrease):
debit Temporary Equity – $5,000
credit Additional Paid-in Capital (or Retained Earnings) – $5,000
6. Disclosure Requirements
✦ Clearly disclose:
• Nature, terms, and redemption conditions of temporary equity instruments. • Redemption value and adjustments during the period. • Potential impact on financial condition and liquidity.
7. IFRS Comparison (IAS 32)
8. Common Errors
✦ Misclassifying temporary equity as permanent equity or as a liability.
✦ Failing to measure temporary equity at redemption amount.
✦ Omitting adjustments for changes in redemption values each period.
✦ Insufficient or unclear disclosures regarding redemption terms and financial impacts.
✦ Confusing redemption rights controlled by issuer versus holder rights.
