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6.3A Analysis of convertible debt—before adoption of ASU 2020-06
Publication date: 31 Oct 2020
us Financing guide
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 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 6-1A provides a framework for determining the appropriate accounting for the issuance of convertible debt.
Figure FG 6-1A
Analysis of convertible debt
Analysis of convertible debt
This framework will help a reporting entity determine which of the four accounting models it should follow when accounting for its convertible debt. Each is summarized in Figure FG 6-2A.
Figure FG 6-2A
Methods for accounting for convertible debt
Methods for accounting for convertible debt
Method
| Description of methodology
|
Single instrument
(FG 1) | |
Derivative separation
(FG 6.5A) | • Determine the fair value of the embedded conversion option
• Record the conversion option at fair value and reduce the convertible debt liability by an equivalent amount
• Carry the conversion option as a liability at fair value with changes in fair value recorded in the income statement
• Amortize any discount or premium in the same manner as nonconvertible debt (see FG 1.2.3)
• Account for derecognition as discussed in FG 6.5.1A
|
Cash conversion option separation
(FG 6.6A) | • Determine the fair value of the debt liability by determining the fair value of an equivalent debt instrument without a conversion option
• The difference between the proceeds received and the debt liability is recorded in additional paid-in capital
• No subsequent remeasurement of the amount recorded in equity
• Amortize the discount on the debt liability to interest expense over the expected life of the debt instrument
• Account for derecognition as discussed in FG 6.6.5A
|
Beneficial conversion feature (BCF) separation
(FG 6.7A) | • Determine the BCF amount based on the in-the-money amount of the conversion option
• Record the BCF in additional paid-in capital and record a corresponding discount on the debt liability
• No subsequent remeasurement of the amount recorded in equity
• Amortize any discount or premium in the same manner as nonconvertible debt (see FG 1.2.3)
• Account for derecognition as discussed in FG 6.7.5A
|
Convertible debt instruments that are separated into a debt and an equity component based on the guidance in ASC 470-20, Debt with Conversion and Other Options, such as debt with a cash conversion feature, beneficial conversion feature, or substantial premium, 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 by the issuer, although this is typically not the case.
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