In a conversion of convertible preferred stock pursuant to original conversion terms, the preferred stock is exchanged for common shares with no effect on retained earnings. However, the exchange of a number of common shares for preferred stock that differs from the number of common shares exchangeable under the original conversion terms (other than an induced conversion as discussed in FG 7.9.1) is considered an extinguishment.
When a conversion right is exercised, a period of time may elapse between the irrevocable election to convert and the legal exchange of shares. An issuer should reflect the conversion in its financial statements only once the conversion has settled and the rights under the preferred stock have been extinguished. In certain circumstances, there may be additional accounting required between exercise and settlement of the conversion option. For example, if the preferred stock was classified in mezzanine equity prior to the irrevocable election to convert, it may need to be reclassified to permanent equity if the shares in which the preferred stock would convert are not redeemable.

7.9.1 Induced conversions

An induced conversion is a transaction in which an issuer offers additional shares or other consideration (“sweeteners”) to investors to incentivize them to convert their convertible instrument. For example, an issuer may reduce the original conversion price or issue additional consideration (e.g., cash or warrants) not provided for in the original conversion terms to holders that agree to convert during a limited offer period. See FG 6.8.2 after adoption of ASU 2020-06 or FG 6.9.2A before adoption of ASU 2020-06 for additional information on induced conversions.
ASC 260-10-S99-2 addresses the accounting for induced conversions of preferred stock.

Excerpt from ASC 260-10-S99-2

If convertible preferred stock is converted into other securities issued by the registrant pursuant to an inducement offer, the SEC staff believes that the excess of (1) the fair value of all securities and other consideration transferred in the transaction by the registrant to the holders of the convertible preferred stock over (2) the fair value of securities issuable pursuant to the original conversion terms should be subtracted from net income to arrive at income available to common stockholders in the calculation of earnings per share. Registrants should consider the guidance provided in Subtopic 470-20 to determine whether the conversion of preferred stock is pursuant to an inducement offer.

In an induced conversion of preferred stock, the fair value of the inducement is charged to retained earnings with an offsetting credit to the inducement consideration as appropriate (e.g., cash, common stock). The fair value of the inducement is also reflected in earnings per share.
The conversion of an instrument into common or preferred stock is not an extinguishment if it only represents the exercise of a conversion right that was included in the original terms of the instrument.

7.9.2A Conversion of an instrument with a BCF—before adoption of ASU 2020-06

ASC 470-20-40-1 requires an issuer to recognize any unamortized discount resulting from the separation of a BCF upon conversion of the instrument. For convertible preferred stock, the charge should be recognized as a dividend in retained earnings and earnings per share. Any other unamortized discounts (e.g., created by allocating proceeds to warrants issued with the convertible instrument) should also be recognized as interest expense or as a dividend to retained earnings 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 for information on BCFs with a multiple-step discount.
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