A BCF is measured as the intrinsic value of the conversion option at the commitment date, representing the difference between the conversion price and the reporting entity’s stock price on the commitment date.

A BCF should be separated from a convertible instrument and recorded in additional paid-in capital. SEC registrants should present the BCF as mezzanine equity in periods in which it is redeemable, as described in ASC 480-10-S99-3A. The amount recorded in temporary equity is equal to the amount of cash an investor would receive upon redemption less the amount of liability recorded for the debt component.

Although technically not required for nonpublic entities, mezzanine equity presentation is strongly encouraged, especially in those circumstances where there is not a high likelihood that the capital is in fact permanent, for example when the instrument is redeemable at the option of the holder at any time. On the other hand, use of a mezzanine presentation may be considered less relevant in other circumstances, such as when an instrument is redeemable by the holder only upon a remote event. If mezzanine presentation is not elected, separate presentation from other items within equity should be considered.

Separating a BCF will create a discount in the convertible debt that will result in additional interest expense.

The discount on the convertible debt instrument created by separating a BCF, or contingent BCF, should be amortized over the period from the issuance date to the stated maturity date using the effective interest method; the amortization should be recognized as interest cost.

If the convertible debt is puttable by the investor prior to the first conversion date, we believe amortization of a discount created by separation of a BCF may be amortized over the period (1) from the issuance date to that first conversion date, or (2) from the issuance date to the first put date. A reporting entity should elect one of these options as an accounting policy and apply it consistently.

If a BCF is recorded on a convertible instrument with a multi-step discount, the amount of amortization recorded may require periodic adjustment to ensure that the BCF amount is at least equal to the intrinsic value the investor could realize if the instrument were converted at that point in time. See FG 7.3.2.2A for information on convertible instruments with multiple-step discounts.

ASC 470-20-40-1 requires a reporting entity to recognize any unamortized discount resulting from the separation of a BCF upon conversion of the instrument as interest expense. Any other unamortized discounts (e.g., created by allocating proceeds to warrants issued with the convertible instrument) should also be recognized as interest expense upon conversion. In accordance with ASC 470-20-40-2, if the amount of BCF discount amortized exceeds the amount the holder realized because conversion occurred at an earlier date, no adjustment should be made to amounts previously amortized. This guidance is unique to convertible instruments containing a BCF and should not be applied to other convertible instruments.

If a convertible instrument with a multiple-step discount is converted at a point in time when the conversion price on that date is less beneficial than the conversion price used to initially record the BCF, any previously recognized amortization of the discount created by separating the BCF should not be reversed. See FG 7.3.2.2A for information on BCFs with a multiple-step discount.

ASC 470-50-40-2 provides guidance on how to calculate a gain or loss on debt extinguishment.

The net carrying amount of debt includes any unamortized discount created by separating a BCF.

In addition to derecognizing the debt instrument, the reporting entity should derecognize the BCF as well. To do this, the reporting entity should perform the following steps.

See FG 3.7 for further information on debt extinguishment accounting.