The accounting treatment for a convertible debt instrument depends on the terms of the instrument, including the manner in which the instrument is settled upon conversion. Some convertible debt instruments are settled upon conversion entirely in shares, some in a combination of cash and shares, and, less commonly, entirely in cash. The terms of the convertible debt instrument may mandate a settlement method or the reporting entity (or less commonly the investor) may have a choice.

In addition, many convertible debt instruments contain a number of provisions–such as put and call options or contingent interest features–that should be assessed to determine whether the features should be accounted for separately.

Figure FG 6-1 provides a framework for determining the appropriate accounting for the issuance of convertible debt (ignoring any embedded derivatives other than the conversion option).

Figure FG 6-1
Analysis of convertible debt

This framework will help a reporting entity determine which of the three accounting models it should follow when accounting for its convertible debt, assuming the reporting entity is not eligible, or has not elected the fair value option. Each of the three remaining models is summarized in Figure FG 6-2.

Figure FG 6-2
Methods for accounting for convertible debt

Convertible debt instruments issued at a substantial premium that are separated into a debt and an equity component based on the guidance in ASC 470-20, Debt with Conversion and Other Options, are not eligible for the fair value option under ASC 825, Financial Instruments, based on the guidance in ASC 825-10-15-5(f). ASC 825-10-15-5(f) precludes application of the fair value option to financial instruments that are classified in whole or in part in equity. All other convertible debt instruments may be carried at fair value under the fair value option by the issuer, although this is typically not the case.