12.3 Convertible Debt With No Equity Component
12.3.1 Background
If convertible debt that does not contain a bifurcated embedded conversion
feature under ASC 815-15 or a separately recognized equity component is
converted into the issuer’s equity shares under the instrument’s original
conversion terms, (1) the net carrying amount of the debt is derecognized and
cash, equity, or both are credited to reflect the consideration issued and (2)
no gain or loss is recognized (see Section 12.3.2). In practice, this is
often referred to “conversion accounting.”1 If the conversion qualifies as an “induced conversion” under ASC
470-20-40-16, the issuer first recognizes “an expense equal to the fair value of
all securities and other consideration transferred in the transaction in excess
of the fair value of securities issuable [under] the original conversion terms”
and then applies conversion accounting (see Section 12.3.4).
12.3.2 Conversion in Accordance With the Original Conversion Terms
ASC 470-20
35-11 If the terms of
conversion of a convertible debt instrument provide that
any accrued but unpaid interest at the date of
conversion is forfeited by the former debt holder, that
interest should be accrued or imputed to the date of
conversion of the debt instrument.
Contractual Conversion
40-4 If a convertible debt
instrument accounted for in its entirety as a liability
under paragraph 470-20-25-12 is converted into shares,
cash (or other assets), or any combination of shares and
cash (or other assets), in accordance with the
conversion privileges provided in the terms of the
instrument, upon conversion the carrying amount of the
convertible debt instrument, including any unamortized
premium, discount, or issuance costs, shall be reduced
by, if any, the cash (or other assets) transferred and
then shall be recognized in the capital accounts to
reflect the shares issued and no gain or loss is
recognized.
Interest
Forfeiture
40-11 If the terms of
conversion of a convertible debt instrument provide that
any accrued but unpaid interest at the date of
conversion is forfeited by the former debt holder,
accrued interest from the last interest payment date, if
applicable, to the date of conversion, net of related
income tax effects, if any, shall be charged to interest
expense and credited to capital as part of the cost of
securities issued. Thus, the accrued interest is
accounted for in the same way as the principal amount of
the debt converted and any unamortized premium,
discount, or issuance costs; the net carrying amount of
the debt, including any unamortized premium, discount,
or issuance costs and the related accrual for interest
to the date of conversion, net of any related income tax
effects, is a credit to the entity’s capital.
ASC 470-20-40-4 specifies the accounting for a conversion of a
convertible debt instrument that (1) does not contain a bifurcated embedded
conversion feature under ASC 815-15 and (2) is not addressed by other guidance
(i.e., conversions of convertible debt that contain a separately recorded equity
component as well as induced conversions). Under this guidance, no gain or loss
is recognized upon the conversion of debt into shares, cash, or other assets in
accordance with the debt’s original conversion terms. Conversion accounting does
not apply if the minimum number of shares that were required to be issued under
the original conversion terms have not been issued.
If the conversion feature is settled entirely in shares, the debt’s net carrying
amount is credited to equity upon conversion to reflect the equity shares
issued. For example, the issuer may make the following accounting entry:
Convertible debt
Equity — common stock/APIC
If the conversion feature is settled (1) entirely in cash upon
conversion or (2) in a combination of cash and shares, the journal entry would
differ because it would reflect the payment of cash in lieu of equity shares,
but the issuer still would recognize no gain or loss on the conversion date.
The net carrying amount of the debt reflects any remaining
unamortized discount or premium as of the date of conversion as well as any
remaining unamortized debt issuance costs as of that date, in accordance with
the definition of “net carrying amount of debt” in ASC 470-50 (see Section 9.3.1.3). The
issuer should amortize any premium or discount and debt issuance costs up to the
date on which the instrument is converted. As indicated in ASC 470-20-40-11, the
carrying amount also includes any “accrued interest from the last interest
payment date, if applicable, to the date of conversion, net of related income
tax effects, if any,” irrespective of whether accrued unpaid interest is
forfeited upon conversion. If convertible debt does not contain a bifurcated
embedded conversion feature under ASC 815-15 (see Section 12.4) or a separately recognized
equity component (see Section
12.5), the accrued interest cost, net of any related income tax
effects, is credited to equity as part of the cost of any equity shares
issued.
See Section
12.3.4 for a discussion of the accounting for induced
conversions. See Section
12.4 for a discussion of the accounting for a conversion of a
convertible debt instrument for which the embedded conversion option has been
separated as an embedded derivative liability. Such accounting applies if the
embedded conversion option has been separated from the host debt instrument upon
or after issuance but before conversion. See Section 12.5 for a discussion of the
application of conversion accounting to a convertible debt instrument with a
separated equity component.
Connecting the Dots
For certain convertible debt instruments, the issuer may
elect to settle a conversion partially or fully in cash. In such cases,
the issuer must elect to settle the conversion value in cash on a date
before the settlement occurs. Consequently, if the election is
irrevocable and the issuer elects to settle all or a portion of the
conversion value in cash, the embedded conversion feature will no longer
meet the own-equity exception in ASC 815-10-15-74(a). Therefore, the
issuer will have to bifurcate the embedded conversion feature as a
derivative instrument under ASC 815-15. The nature of the embedded
derivative that must be bifurcated will depend on the facts and
circumstances.
For example, assume the following:
- A convertible debt instrument requires the issuer to settle the principal amount in cash and permits the issuer to settle the excess conversion value in either cash or shares (i.e., Instrument C).
- The holders of the instrument give irrevocable notice that they will convert the instrument.
- On the date the issuer receives the conversion notice, it must choose to settle the excess conversion value in either cash or shares. If the issuer elects cash settlement, the amount of cash that must be paid to settle the excess conversion value is calculated over a 30-day period after the date of conversion on the basis of the volume-weighted average price (VWAP) of the issuer’s stock.
- The issuer elects to settle the excess conversion value in cash.
In this situation, the conversion feature no longer qualifies for the
own-equity exception in ASC 815-10-15-74(a); therefore, the issuer must
bifurcate this feature. Such bifurcated derivative will represent a
nonoption embedded derivative that the issuer must initially recognize
at zero in accordance with ASC 815-15-55-160 through 55-164. However,
the issuer must recognize in earnings the bifurcated embedded
derivative’s change in fair value from the date of the irrevocable
notice to settle the excess conversion value in cash until the
settlement date (i.e., a derivative balance will exist after initial
bifurcation). Depending on variations in the issuer’s share price, the
change in fair value could represent an asset or a liability.
Conversion accounting is still appropriate in this
example because the separation of the conversion feature is incidental
to the settlement of the debt instrument in accordance with its original
conversion terms. In the application of conversion accounting, the net
carrying amount of the convertible debt will include the fair value of
the bifurcated embedded derivative. Therefore, no gain or loss will be
recognized on the conversion date (i.e., the settlement date).
Nevertheless, the gain or loss on the bifurcated embedded derivative
should not be reversed (i.e., it will remain recognized in earnings).
Thus, while the conversion of the instrument does give rise to a gain or
loss that is reported in earnings (i.e., for the period between the date
on which the issuer elects cash settlement and the settlement date), it
does not invalidate the application of conversion accounting as of the
settlement date. That is, extinguishment accounting is not required. The
alternative views discussed in Section 12.4 are not relevant to
these types of settlements.
As another example, assume the same facts as described
above except that six months before the convertible debt instrument’s
maturity, the issuer must give irrevocable notice either that it will
settle any excess conversion value in cash or that it will settle such
value in shares. If the issuer irrevocably elects cash settlement, the
conversion feature no longer qualifies for the own-equity exception in
ASC 815-10-15-74(a); therefore, the issuer must bifurcate this feature.
However, in this situation, the issuer must bifurcate an option-based
embedded derivative because the holders have not yet elected whether
they will convert the instrument. In accordance with ASC 815-15-30-6,
when an option-based embedded derivative is separated, the exercise
price of the feature must be based on the stated terms in the
convertible debt agreement. As a result, such embedded derivative will
not have a fair value of zero on the date of initial bifurcation.
Consequently, the fair value of the conversion feature on the date of
separation will create a discount on the host debt instrument that must
be amortized to interest expense over the instrument’s remaining life.
In addition, the bifurcated option-based embedded derivative must be
subsequently remeasured at fair value through earnings. These changes in
fair value cannot be reversed on the settlement date of the instrument.
For more information, see Example 5-8 in Deloitte’s
Roadmap Contracts
on an Entity’s Own Equity.
12.3.3 Conversion Upon the Issuer’s Exercise of a Call Option
12.3.3.1 General
ASC 470-20
05-11 An entity may issue
equity securities to settle a debt instrument that
was not otherwise currently convertible but became
convertible upon the issuer’s exercise of a call
option when the issuance of equity securities is
pursuant to the instrument’s original conversion
terms. This Subtopic provides related guidance.
40-5 The following
guidance addresses accounting for the issuance of
equity securities to settle a debt instrument
(pursuant to the instrument’s original conversion
terms) that became convertible upon the issuer’s
exercise of a call option:
- Substantive conversion feature. If the debt instrument contained a substantive conversion feature as of time of issuance, the issuance of equity securities shall be accounted for as a contractual conversion. That is, no gain or loss shall be recognized related to the equity securities issued to settle the instrument.
- No substantive conversion feature. If the debt instrument did not contain a substantive conversion feature as of time of issuance, the issuance of equity securities shall be accounted for as a debt extinguishment. That is, the fair value of the equity securities issued should be considered a component of the reacquisition price of the debt.
Sometimes, the terms of a convertible debt instrument include both (1) an
option for the issuer to call the instrument and (2) a right for the holder
to exercise the conversion feature if the issuer calls the instrument. In
this circumstance, the accounting for the conversion of the instrument into
the issuer’s equity shares in accordance with the original terms of the debt
depends on whether the conversion feature was (1) otherwise currently
convertible and (2) substantive as of the instrument’s issuance date (see
Section 12.3.3.2).
If the conversion option is nonsubstantive at issuance and the instrument
becomes convertible upon the issuer’s exercise of the call option, the
conversion of the instrument into equity shares is accounted for as a debt
extinguishment (see Section 9.3). As long as the conversion feature is
nonsubstantive at issuance, and provided that the holder does not currently
have the ability to convert the instrument unless the issuer exercises its
call option, extinguishment accounting applies even if the instrument would
have become convertible upon the passage of time (e.g., a conversion option
that becomes exercisable on the instrument’s maturity date or on specified
prior dates).
The conversion of an instrument into the issuer’s equity shares is accounted
for as a conversion (see Section 12.3.2) as long as it otherwise qualifies for such
accounting if either (1) the conversion feature is substantive at issuance
or (2) the holder has the ability to exercise the conversion feature
irrespective of the issuer’s exercise of its call option.
Convertibility of Debt Instrument
|
Conversion Feature Substantive at Inception
|
Conversion Feature Not Substantive at Inception
|
---|---|---|
Convertible only upon the issuer’s exercise of a call
option
|
N/A. (By definition, such a conversion option is not
substantive as of the issuance date.)
|
Accounted for as an extinguishment.
|
Convertible upon the issuer’s exercise of a call
option and could otherwise become convertible in the
future
|
Accounted for as a conversion.
|
Accounted for as an extinguishment.
|
Currently convertible even if the issuer has not
exercised its call option
|
Accounted for as a conversion. Because the instrument
is convertible without the issuer’s exercise of a
call option, the accounting does not depend on
whether the conversion option was substantive on the
issuance date.
|
This guidance does not apply to transactions that would not
otherwise qualify for conversion accounting (see Section 12.2) or to induced conversions. See Section 12.4 for a
discussion of the accounting for a conversion of a convertible debt
instrument for which the embedded conversion option has been separated as an
embedded derivative liability. Such accounting applies if the embedded
conversion option has been separated from the host debt instrument upon or
after issuance but before conversion.
12.3.3.2 Determining Whether a Conversion Feature Is Substantive
ASC Master Glossary
Substantive Conversion Feature
A conversion feature that is at least reasonably
possible of being exercisable in the future absent
the issuer’s exercise of a call option.
ASC 470-20
40-6 The assessment of
whether the conversion feature is substantive may be
performed after time of issuance but shall be based
only on assumptions, considerations, and marketplace
information available as of time of issuance.
40-7 By definition, a
substantive conversion feature is at least
reasonably possible of being exercised in the
future. If the conversion price of an instrument at
issuance is extremely high so that conversion of the
instrument is not deemed at least reasonably
possible as of time of issuance, then the conversion
feature would not be considered substantive.
40-8 For purposes of
determining whether a conversion feature is
reasonably possible of being exercised, the
assessment of the holder’s intent is not necessary.
Therefore, even if such an instrument included a
conversion feature that provided for conversion due
solely to the passage of time (for example, the
instrument will become convertible at a date before
its maturity date), it would be inappropriate to
conclude that the conversion feature is substantive.
Also, an instrument that became convertible only
upon the issuer’s exercise of its call option does
not possess a substantive conversion feature.
40-9 Methods that may be
helpful in assessing whether a conversion feature is
substantive include the following:
- The fair value of the conversion feature relative to the fair value of the debt instrument. Comparing the fair value of a conversion feature to the fair value of the debt instrument (that is, the complete instrument as issued) may provide evidence that the conversion feature is substantive.
- The effective annual interest rate per the terms of the debt instrument relative to the estimated effective annual rate of a nonconvertible debt instrument with an equivalent expected term and credit risk. Comparing the effective annual interest rate of the debt instrument to the effective annual rate the issuer estimates it could obtain on a similar nonconvertible instrument may provide evidence that a conversion feature is substantive.
- The fair value of the debt instrument relative to an instrument that is identical except for which the conversion option is not contingent. Comparing the fair value of the debt instrument to the fair value of an identical instrument for which conversion is not contingent isolates the effect of the contingencies and may provide evidence about the substance of a conversion feature. If the fair value of the debt instrument is similar to the fair value of an identical convertible debt instrument for which conversion is not contingent, then it may indicate that the conversion feature is substantive. However, this approach may not be appropriate unless it is clear that the conversion feature, not considering the contingencies, is substantive.
- Qualitative evaluation of the conversion provisions. The nature of the conditions under which the instrument may become convertible may provide evidence that the conversion feature is substantive. For example, if an instrument may become convertible upon the occurrence of a specified contingent event, the likelihood that the contingent event will occur before the instrument’s maturity date may indicate that the conversion feature is substantive. However, this approach may not be appropriate unless it is clear that the conversion feature, not considering the contingencies, is substantive.
40-10 The guidance in paragraphs
470-20-40-7 through 40-9 does not address the
treatment of an instrument for purposes of applying
Subtopic 260-10.
In evaluating whether a conversion option is substantive as of the debt’s
issuance date, an issuer considers the assumptions that were made and the
marketplace information that was available as of that date even if the
assessment is performed subsequently. A conversion option may be deemed
substantive if — as of the instrument’s issuance date — there is at least a
reasonable possibility that it will become exercisable by the holder upon
(1) the passage of time or (2) the occurrence or nonoccurrence of a
specified event (other than the issuer’s exercise of the call option) that
is likely to occur. However, in accordance with ASC 470-20-40-7, a
conversion option that currently has a reasonable possibility of becoming
exercisable would not be considered substantive if, as of the instrument’s
issuance date, its exercise was not reasonably possible (e.g., because the
conversion option is deeply out-of-the-money).
Under ASC 470-20, a conversion feature would not be considered substantive as
of the instrument’s issuance date in any of the following circumstances:
-
The holder has no ability to exercise the conversion feature (i.e., it is not exercisable) unless the issuer exercises its call option.
-
It is not reasonably possible for the holder to obtain the ability to exercise the conversion feature (i.e., it is not reasonably possible that the feature will become exercisable) unless the issuer exercises its call option. For example, this would be the case if the only circumstance in which the holder can obtain a right to convert the instrument (other than the issuer’s exercise of the call option) is a specified event that does not have a reasonable possibility of occurring.
-
It is not reasonably possible that the holder will exercise the conversion feature (e.g., the conversion price is extremely high relative to the current share price as of the issuance date).
In evaluating whether a conversion option is substantive as of the issuance
date in accordance with ASC 470-20-40-9 (e.g., when determining whether it
is reasonably possible that the holder will exercise the conversion
feature), an issuer should consider the following:
-
The smaller the fair value of the conversion feature relative to the fair value of the debt instrument, the more likely it is that the conversion option is not substantive.
-
The smaller the difference between the convertible debt’s effective interest rate and the effective interest rate on a hypothetical nonconvertible debt instrument with the same terms except for the conversion feature, the more likely it is that the conversion option is not substantive.
-
The greater the difference between the fair value of the convertible debt and the fair value of a hypothetical convertible debt instrument with the same terms (except that the conversion feature is not contingent), the more likely it is that the conversion option is not substantive.
-
The smaller the likelihood of a contingent event that would make the conversion feature exercisable, the more likely it is that the conversion option is not substantive.
12.3.3.3 Illustration
ASC 470-20
Example 9: Illustration of a Conversion of an
Instrument That Becomes Convertible Upon the
Issuer’s Exercise of a Call Option
55-67 This Example
illustrates an instrument subject to the guidance in
paragraphs 470-20-40-5 through 40-9.
55-68 An entity issues a
contingently convertible instrument on January 1,
2006, with a market price trigger, a $1,000 par
amount, and a maturity date of December 31, 2020.
The debt instrument is convertible at the option of
the holder if the share price of the issuer exceeds
a specified amount. The issuer can call the debt at
any time between 2009 and the maturity date of the
debt. If the issuer calls the debt, the holder has
the option to receive cash for the call amount or a
fixed number of shares as specified in the terms of
the instrument upon issuance, regardless of whether
the market price trigger has been met. In 2010, the
issuer calls the debt before the market price
trigger being met and the holder elects to receive a
fixed number of shares (as specified in the terms of
the instrument).
Example 9 in ASC 470-20-55 describes a contingently
convertible debt instrument (the “CoCo”). Since the holder does not have the
ability to convert the CoCo debt before the issuer calls it (because the
market price trigger is not met), the transaction is evaluated on the basis
of the guidance in ASC 470-20-40-5 on conversions that occur upon the
issuer’s exercise of a call option. If the feature had been substantive at
issuance, the conversion would have been accounted for as a conversion (see
Section
12.3.2). If the feature had been nonsubstantive at issuance,
the conversion would have been accounted for as an extinguishment (see
Section
9.3).
If the facts were altered so that the market-price trigger had been met when
the issuer exercised its call option, the guidance in ASC 470-20-40-5 on
conversions that occur upon the issuer’s exercise of a call option would not
have applied because the holder already had an unconditional right to elect
to convert the debt when the issuer chose to call it. In those
circumstances, the conversion would have been accounted for as a conversion
irrespective of whether the conversion feature was substantive at
issuance.
12.3.4 Induced Conversions
12.3.4.1 Scope
ASC 470-20
05-10 Some convertible
debt instruments include provisions allowing the
debtor to alter terms of the debt to the benefit of
debt holders. In some circumstances, conversion
privileges for a convertible debt instrument are
changed or additional consideration is paid to debt
holders for the purpose of inducing prompt
conversion of the debt to equity securities
(sometimes referred to as a convertible debt
sweetener). Such provisions may be general in
nature, permitting the debtor or trustee to take
actions to protect the interests of the debt
holders, or they may be specific, for example,
specifically authorizing the debtor to temporarily
reduce the conversion price for the purpose of
inducing conversion.
Pending Content (Transition Guidance: ASC
470-20-65-4)
05-10 Some convertible debt instruments
include provisions allowing the debtor to alter
the terms of the debt to the benefit of debt
holders. In some circumstances, conversion
privileges for a convertible debt instrument are
changed or additional consideration is paid to
debt holders for the purpose of inducing prompt
conversion of the debt instrument (sometimes
referred to as a convertible debt sweetener). Such
provisions may be general in nature, permitting
the debtor or trustee to take actions to protect
the interests of the debt holders, or they may be
specific, for example, specifically authorizing
the debtor to temporarily reduce the conversion
price for the purpose of inducing conversion.
40-13 The guidance in
paragraph 470-20-40-16 applies to conversions of
convertible debt to equity securities pursuant to
terms that reflect changes made by the debtor to the
conversion privileges provided in the terms of the
debt at issuance (including changes that involve the
payment of consideration) for the purpose of
inducing conversion. That guidance applies only to
conversions that both:
- Occur pursuant to changed conversion privileges that are exercisable only for a limited period of time (inducements offered without a restrictive time limit on their exercisability are not, by their structure, changes made to induce prompt conversion)
- Include the issuance of all of the equity securities issuable pursuant to conversion privileges included in the terms of the debt at issuance for each debt instrument that is converted, regardless of the party that initiates the offer or whether the offer relates to all debt holders.
Pending Content (Transition Guidance: ASC
470-20-65-4)
40-13 The guidance in paragraph
470-20-40-16 applies to conversions of convertible
debt instruments pursuant to terms that reflect
changes made by the issuer to the conversion
privileges provided in the terms of the existing
debt instrument (including changes that involve
the payment of consideration) for the purpose of
inducing conversion. That guidance applies only to
conversions for which all of the following
criteria are satisfied:
-
The conversion occurs pursuant to changed conversion privileges that are exercisable only for a limited period of time (inducements offered without a restrictive time limit on their exercisability are not, by their structure, changes made to induce prompt conversion).
-
The conversion includes the issuance of all of the consideration (in form and amount) issuable pursuant to conversion privileges provided in the terms of the existing debt instrument for each debt instrument that is converted, regardless of the party that initiates the offer or whether the offer relates to all debt holders. See paragraph 470-20-40-13A for additional guidance applicable to debt instruments whose conversion privileges permit the entity to issue cash (or other assets) or a combination of shares and cash (or other assets) upon conversion. The examples in paragraphs 470-20-55-9A through 55-9J illustrate the application of this guidance.
-
The existing debt instrument, regardless of whether it is currently convertible, contained a substantive conversion feature as of both the time of issuance and the date the inducement offer is accepted by the convertible debt holder. See paragraphs 470-20-40-6 through 40-10 for additional guidance on determining whether a conversion feature is substantive.
40-13A In applying the guidance in
paragraph 470-20-40-13(b), an entity shall compare
the amount of cash (or other assets) and number of
shares issuable under the conversion privileges
provided in the terms of the existing instrument
with the amount of cash (or other assets) and
number of shares issuable under the inducement
offer. An entity shall consider the following:
-
For purposes of comparing the amount of cash (or other assets) and number of shares issuable, if the settlement terms under either the existing conversion privileges or the inducement offer are based on a future share price or average of future share prices (such as a volume-weighted average price), then an entity shall use the fair value of the shares as of the date the inducement offer is accepted. For example, the incorporation, elimination, or modification of a volume-weighted average price formula that is based on future share prices does not affect the determination of the amount of cash or number of shares issuable for the induced conversion assessment because the fair value of the shares as of the date the inducement offer is accepted would be used instead of the future volume-weighted average price. A future share price refers to a share price measured after the inducement offer is accepted.
-
Changes that result in the amount of cash (or other assets) and number of shares being indexed to something other than the future price of the issuer’s shares (for example, the fair value of a commodity) shall be considered a change in the form of settlement.
-
If within the one-year period preceding the date the inducement offer is accepted by the convertible debt holder the existing debt has been exchanged or modified (without being deemed to be substantially different in accordance with the guidance in Subtopic 470-50), then the conversion privileges provided in the debt terms that existed one year before the date the offer is accepted by the convertible debt holder shall be used in place of the conversion privileges provided in the terms of the existing debt instrument.
40-14 A conversion
includes an exchange of a convertible debt
instrument for equity securities or a combination of
equity securities and other consideration, whether
or not the exchange involves legal exercise of the
contractual conversion privileges included in terms
of the debt. The preceding paragraph also includes
conversions pursuant to amended or altered
conversion privileges on such instruments, even
though they are literally provided in the terms of
the debt at issuance.
Pending Content (Transition Guidance: ASC
470-20-65-4)
40-14 A conversion includes an exchange
of a convertible debt instrument for equity
securities or other consideration, whether or not
the exchange involves legal exercise of the
contractual conversion privileges included in
terms of the debt. The guidance in paragraphs
470-20-40-13 through 40-13A also applies to
conversions pursuant to amended or altered
conversion privileges on such instruments, even
though the right to amend the terms is provided in
the terms of the existing debt instrument.
40-15 The changed terms
may involve any of the following:
- A reduction of the original conversion price thereby resulting in the issuance of additional shares of stock
- An issuance of warrants or other securities not provided for in the original conversion terms
- A payment of cash or other consideration to those debt holders that convert during the specified time period.
The guidance in the following paragraph does not
apply to conversions pursuant to other changes in
conversion privileges or to changes in terms of
convertible debt instruments that are different from
those described in this paragraph.
Pending Content (Transition
Guidance: ASC 470-20-65-4)
40-15
The changed terms may involve any of the
following:
-
A reduction of the conversion price thereby resulting in the issuance of additional shares of stock
-
An issuance of warrants or other securities not provided for in the conversion privileges in the terms of the existing instrument
-
A payment of cash or other consideration to those debt holders that convert during the specified time period.
The guidance in paragraph
470-20-40-16 does not apply to conversions
pursuant to other changes in conversion privileges
or to changes in terms of convertible debt
instruments that are different from those
described in this paragraph.
For various reasons, such as to reduce interest costs or
improve debt-equity ratios, an issuer may seek to induce debt holders to
promptly convert convertible debt into equity shares under changed
conversion terms that are effective for a limited period and involve
additional consideration. That is, the issuer may make an “inducement
offer.” The additional consideration offered can take any form (e.g.,
reduced conversion price, issuance of warrants or other securities, issuance
of other noncash assets, payment of cash).
If convertible debt is converted in accordance with an
inducement offer that meets the conditions described above, neither
conversion only accounting (as described in Section 12.3.2) nor extinguishment
accounting (as described in Section 9.3) applies; instead, the
issuer must recognize an inducement expense upon the conversion (as
described in Section 12.3.4.2).
Changing Lanes
In November 2024, the FASB issued ASU
2024-04 to clarify the induced conversion
guidance in ASC 470-20. The ASU addresses questions from
stakeholders related to applying such guidance to convertible debt
instruments with cash conversion features (i.e., those that
permitted some or all of the consideration issuable upon conversion
to be paid in cash). The ASU’s amendments are effective for annual
reporting periods beginning after December 15, 2025 (and interim
reporting periods within those annual reporting periods). Early
adoption is permitted.
The application of induced conversion accounting
could change upon an entity’s adoption of ASU 2024-04. Induced
conversion accounting applies to conversions that have all of the
characteristics in the following table:
Characteristic
|
ASC References
|
Applicable Before ASU
2024-04?
|
Applicable After ASU
2024-04?
|
---|---|---|---|
The debt’s terms contained a
substantive conversion feature as of the time of
issuance of the instrument. (The evaluation of
whether the conversion feature is substantive is
performed by applying the guidance in ASC
470-20-40-5 through 40-9; see Section
12.3.3.)
|
470-20-40-13(b)
470-20-40-13(c)
|
Yes
|
Yes
|
The debt’s terms contained a
substantive conversion feature as of the date the
inducement offer was accepted by the holder. (The
evaluation of whether the conversion feature is
substantive is performed by applying the guidance
in ASC 470-20-40-5 through 40-9.)
|
470-20-40-13(c)
|
No(a)
|
Yes
|
Either the debtor or the
holder offered revised conversion terms that gave
the holder an economic incentive (a “sweetener”)
to convert the instrument early (e.g., a reduced
conversion price or additional consideration such
as cash or warrants). If the terms were adjusted
for some purpose other than to induce conversion
(e.g., to settle a legal dispute about the correct
interpretation of the conversion terms), induced
conversion accounting does not apply.
|
470-20-40-13(b)
|
Yes
|
Yes
|
The inducement offer contained
an exercisability period that was limited (e.g.,
30 to 60 days).
|
470-20-40-13(a)
|
Yes
|
Yes
|
The convertible debt was
converted under the revised conversion terms.
|
470-20-40-13
|
Yes
|
Yes
|
The conversion includes the
issuance of all the consideration (in both form
and amount) issuable in accordance with the
original conversion terms. The form of the
consideration issuable under the revised terms
must be identical to that issuable under the
original terms.
The application of this
provision depends on the contractual terms of the
debt instrument before the conversion occurs in
accordance with the amended terms, as follows:
|
470-20-40-13(b)
|
Yes(b)
|
Yes
|
Notes to
Table:
(a) ASU 2024-04 adds condition (c) to ASC
470-20-40-13, which, upon the ASU’s adoption,
clarifies that for induced conversion accounting
to apply, the terms of the existing debt must
contain a substantive conversion feature as of the
date the inducement offer is accepted. While the
FASB established this guidance in response to
questions raised by constituents about whether
induced conversion accounting may be applied to a
debt instrument that was not otherwise convertible
on the date the inducement offer was made, it
applies to all convertible debt instruments.
Before the adoption of ASU 2024-04, there is no
requirement to evaluate whether the conversion
feature in the existing debt instrument is
substantive on the date of the inducement
offer.
(b) ASU 2024-04 clarifies the application of
induced conversion accounting to convertible debt
instruments with cash conversion features. Before
the ASU’s adoption, induced conversion accounting
is applied in practice only when (1) the fair
value of the consideration transferred exceeds the
fair value of the consideration issuable under the
original conversion terms and (2) the form of the
consideration issuable under the original
conversion terms is preserved by the offer.
Therefore, before adopting ASU 2024-04, entities
apply the principle that the conversion must
preserve the form and amount of consideration
payable in accordance with the existing conversion
terms. However, this practice has resulted in
diversity related to how entities evaluate whether
the fair value of the consideration issuable under
the revised conversion terms at least equaled the
fair value of the consideration issuable in
accordance with the original conversion terms when
the revised conversion terms incorporated,
eliminated, or modified a VWAP formula used to
calculate the amount of cash or number of shares
issuable. ASU 2024-04 addresses this diversity by
specifying that, in these situations, an entity
should use the fair value of the shares as of the
date of the inducement offer to compare the amount
of cash or number of shares issuable under the
inducement offer with the existing conversion
terms. Accordingly, upon the ASU’s adoption, the
incorporation, elimination, or modification of a
VWAP formula should not preclude the application
of induced conversion accounting.
|
In the evaluation of whether inducement accounting applies, it does not
matter whether:
-
The inducement offer is initiated by the debtor or the holder.
-
The inducement offer is provided to all holders, some holders, or only one holder of the debt.
-
Some holders accept the offer and others do not (i.e., inducement accounting applies only to a holder or holders that accept the offer).
-
The inducement transaction involves the legal exercise of contractual conversion privileges (i.e., the legal form of the inducement transaction does not matter). For example, a repurchase of convertible bonds in the open market may be accounted for as an induced conversion if it involves the issuance of all of the equity securities that were required to be issued under the original conversion terms and the other requirements for inducement accounting are met (e.g., the convertible instrument allowed the issuer to elect to settle a conversion entirely in cash).
-
The ability to modify the conversion terms to induce conversion was contemplated in the original terms of the debt instrument (i.e., the original terms of the instrument explicitly permit contractual revisions for the purpose of inducing conversion).
-
The inducement offer involves the issuance of equity securities only or a combination of equity securities and cash or other consideration (as long as the inducement offer preserves the form and amount of consideration issuable under the original conversion terms).
-
The conversion option is out-of-the-money, at-the-money, or in-the-money (as long as the debt instrument contains a substantive conversion feature).
-
The holder’s carrying amount of the convertible debt differs from the principal amount.
An entity applies extinguishment accounting (see Section 9.3) to any
settlement of convertible debt whose terms are different from the original
conversion terms and that does not meet the accounting requirements for
induced conversions. Induced conversion accounting can never be applied if
the settlement would not have been treated as a conversion, aside from the
incremental consideration the issuer provides to the holders. Accordingly,
induced conversion accounting would not apply to a convertible debt
instrument for which the principal amount must be settled in cash and the
excess conversion spread must be settled in equity shares if (1) the
principal amount is settled partially or fully in equity shares or (2) the
excess conversion spread is settled partially or fully in cash.
Example 12-1
Modification of Conversion Terms That Are Not for
a Limited Period
On January 1, 20X1, Entity A issued
convertible debt securities that mature in 10 years
and allow the holder to convert the securities into
A’s common stock at any time before maturity. Entity
A accounts for these securities as convertible debt
under ASC 470-20-25-12 (i.e., entirely as a
liability).
At issuance, the conversion price for each $1,000
principal amount of securities was $10 per share. On
March 1, 20X4, A reduces the conversion price to $8
per share, and this revised conversion price remains
in effect through maturity. The modification to the
conversion price cannot be accounted for as an
induced conversion because the changed conversion
privileges have no stated expiration date and are
available for the remaining term of the convertible
debt securities. When conversion terms are altered
for the remaining term of a convertible debt
instrument, a modification of the convertible debt
instrument has occurred that must be accounted for
in accordance with the guidance in Chapter 10.
Example 12-2
Change in Nature of Equity Securities Issued Upon
Conversion
Entity B has outstanding convertible debt securities
that it accounts for as convertible debt under ASC
470-20-25-12 (i.e., entirely as a liability). Upon
conversion of the securities, the holder is entitled
to 10 shares of common stock for each $1,000
principal amount of securities converted. To induce
prompt conversion, B offers all the holders a right,
exercisable for the next 30 days, to receive 10
shares of its Series A convertible preferred stock
in lieu of receiving 10 shares of common stock.
Because the offer involves the issuance of equity
securities that are different from those that were
issuable under the original conversion terms (i.e.,
preferred stock instead of common stock), induced
conversion accounting cannot be applied for any
holders that accept the offer. ASC 470-20-40-13(b)
requires that for induced conversion accounting to
be applied, the form of consideration issuable under
the original conversion terms must be the same as
the form of consideration issued under the revised
conversion terms. In this example, conversion
accounting also does not apply; instead, B should
account for any settlements under the offer as
extinguishments of debt (see Section 9.3).
12.3.4.2 Recognition and Measurement
ASC 470-20
40-16 If a convertible debt
instrument is converted to equity securities of the
debtor pursuant to an inducement offer (see
paragraph 470-20-40-13), the debtor shall recognize
an expense equal to the fair value of all securities
and other consideration transferred in the
transaction in excess of the fair value of
securities issuable pursuant to the original
conversion terms. The fair value of the securities
or other consideration shall be measured as of the
date the inducement offer is accepted by the
convertible debt holder. That date normally will be
the date the debt holder converts the convertible
debt into equity securities or enters into a binding
agreement to do so. Until the debt holder accepts
the offer, no exchange has been made between the
debtor and the debt holder. Example 1 (see paragraph
470-20-55-1B) illustrates the application of this
guidance.
Pending Content (Transition Guidance: ASC
470-20-65-4)
40-16 If a convertible debt instrument
is converted pursuant to an inducement offer (see
paragraph 470-20-40-13), the issuer shall
recognize an expense equal to the fair value of
all securities and other consideration transferred
in the transaction in excess of the fair value of
securities and other consideration issuable
pursuant to the conversion privileges provided in
the terms of the existing instrument. The fair
value of the securities or other consideration
shall be measured as of the date the inducement
offer is accepted by the convertible debt holder.
That date normally will be the date the debt
holder converts the convertible debt or enters
into a binding agreement to do so. Until the debt
holder accepts the offer, no exchange has been
made between the issuer and the debt holder.
Example 1 (see paragraph 470-20-55-1B) illustrates
the application of this guidance.
40-17 The guidance in the
preceding paragraph does not require recognition of
gain or loss with respect to the shares issuable
pursuant to the original conversion privileges of
the convertible debt when additional securities or
assets are transferred to a debt holder to induce
prompt conversion of the debt to equity securities.
In a conversion pursuant to original conversion
terms, debt is extinguished in exchange for equity
pursuant to a preexisting contract that is already
recognized in the financial statements, and no gain
or loss is recognized upon conversion.
Pending Content (Transition
Guidance: ASC 470-20-65-4)
40-17
The guidance in paragraph 470-20-40-16 does not
require recognition of gain or loss with respect
to the shares (or other consideration) issuable
pursuant to the conversion privileges provided in
the terms of the existing convertible debt
instrument when additional securities,
instruments, or assets are transferred to a debt
holder to induce prompt conversion of the existing
debt instrument. In a conversion pursuant to the
conversion privileges provided in the terms of the
existing instrument, debt is settled in exchange
for shares, cash (or other assets), or any
combination of shares and cash (or other assets)
pursuant to a preexisting contract that is already
recognized in the financial statements, and no
gain or loss is recognized upon conversion.
Under ASC 470-20, when a conversion must be accounted for as
an induced conversion, the issuer should recognize an inducement expense
equal to the fair value of the consideration transferred (including the fair
value of the additional securities issued and that of any other sweetener,
such as cash, warrants, or other securities issued) in excess of the fair
value of the securities issuable under the original conversion terms. No
gain or loss is recognized for the securities that were issuable under the
original conversion terms (i.e., conversion accounting applies). Thus, in an
induced conversion that involves only the issuance of additional shares, for
example, the issuer may make the following accounting entry:
Convertible debt
Debt conversion expense (inducement loss)
Equity — common stock
Although conversions in accordance with changed conversion
terms are otherwise accounted for as debt extinguishments, it would be
inappropriate to record a debt extinguishment gain or loss related to the
shares issuable under the original conversion terms in an induced conversion
subject to ASC 470-20-40-13.
The inducement expense is recognized as of the date the
inducement offer is accepted by the convertible debt holder (i.e., generally
the earlier of (1) the conversion date and (2) the date the holder enters
into a binding agreement to convert), not as of the date the inducement
offer is made.
Similarly, in the calculation of the inducement cost, the
fair value of the securities or other consideration transferred as part of
the inducement transaction is measured as of the date the inducement offer
is accepted by the holder, not as of the date the inducement offer is made.
If different holders accept the same offer on different dates, there may be
multiple measurement dates.
Because the inducement expense recognized must equal the
fair value of the additional securities issued upon conversion regardless of
the convertible debt’s net carrying amount and the total fair value of the
consideration paid on conversion, some accounting outcomes may be
economically counterintuitive. For example, an offer that is settled
entirely in cash might result in the recognition of a debt extinguishment
gain, whereas an offer of equal economical value that is settled in shares
might result in the recognition of an inducement loss. Further, the amount
credited to equity to reflect the shares issued may exceed their fair
value.
Example 12-3
Recognition of
Inducement Loss
Entity C has outstanding convertible
bonds that it accounts for as convertible debt under
ASC 470-20-25-12 (i.e., entirely as a liability).
Their net carrying amount is $1 million. The
original conversion price was $20 (i.e., the issuer
would deliver 50,000 shares upon conversion). To
induce prompt conversion, C reduces the conversion
price to $16 for a limited period (i.e., 62,500
shares), and the holders accept the offer. The
current stock price is $15. Accordingly, the fair
value of the securities issuable under the original
conversion terms was $750,000 (50,000 × $15) and the
fair value of the securities issuable under the
revised conversion terms is $937,500 (62,500 × $15).
Because the consideration issuable under the changed
conversion privileges exceeds the consideration
under the original terms, C recognizes an inducement
loss under ASC 470-20 equal to the fair value of the
additional shares, $187,500 (12,500 × $15). However,
if C had repurchased the shares for a cash payment
of $937,500 instead of issuing shares worth
$937,500, it would have recognized a debt
extinguishment gain of $62,500 ($1,000,000 –
$937,500).
12.3.4.3 Additional Illustrations
ASC 470-20
Example 1: Induced Conversions of Convertible
Securities
55-1B The
following Cases illustrate application of the
guidance in paragraph 470-20-40-16 to induced
conversions of convertible securities:
- Reduced conversion price for conversion before determination date, increase in bond fair value (Case A)
- Reduced conversion price for conversion before determination date, decrease in bond fair value (Case B).
Pending Content (Transition Guidance: ASC
470-20-65-4)
55-1B The Cases in paragraphs
470-20-55-3 through 55-9 illustrate application of
the guidance in paragraph 470-20-40-16 for
measuring an expense when a convertible debt
instrument is converted pursuant to an inducement
offer:
-
Reduced conversion price for conversion, increase in bond fair value (Case A)
-
Reduced conversion price for conversion, decrease in bond fair value (Case B).
55-1C The Cases in paragraphs
470-20-55-9A through 55-9J illustrate application
of the guidance in paragraphs 470-20-40-13(b) and
470-20-40-13A for determining whether an
inducement offer includes the issuance of all of
the consideration (in form and amount) issuable
pursuant to conversion privileges provided in the
terms of the existing debt instrument:
-
Offer to settle convertible debt instrument in cash and warrants (Case C)
-
Offer to settle convertible debt instrument in cash and shares (Case D)
-
Offer to settle convertible debt instrument in shares and warrants (Case E).
55-2 For simplicity, the
face amount of each security is assumed to be equal
to its carrying amount in the financial statements
(that is, no original issue premium or discount
exists).
Case A: Reduced Conversion Price for Conversion
Before Determination Date — Bond Fair Value
Increased
55-3 On January 1, 19X4,
Entity A issues a $1,000 face amount 10 percent
convertible bond maturing December 31, 20X3. The
carrying amount of the bond in the financial
statements of Entity A is $1,000, and it is
convertible into common shares of Entity A at a
conversion price of $25 per share. On January 1,
19X6, the convertible bond has a fair value of
$1,700. To induce convertible bondholders to convert
their bonds promptly, Entity A reduces the
conversion price to $20 for bondholders that convert
before February 29, 19X6 (within 60 days).
Pending Content (Transition Guidance: ASC
470-20-65-4)
Editor’s Note: The heading that
precedes paragraph 470-20-55-3 will be amended
upon transition as shown below. The content of the
paragraph will not change.
Case A: Reduced Conversion
Price, Increase in Bond Fair Value
55-3 On January 1, 19X4, Entity A issues
a $1,000 face amount 10 percent convertible bond
maturing December 31, 20X3. The carrying amount of
the bond in the financial statements of Entity A
is $1,000, and it is convertible into common
shares of Entity A at a conversion price of $25
per share. On January 1, 19X6, the convertible
bond has a fair value of $1,700. To induce
convertible bondholders to convert their bonds
promptly, Entity A reduces the conversion price to
$20 for bondholders that convert before February
29, 19X6 (within 60 days).
55-4 Assuming the market
price of Entity A’s common stock on the date of
conversion is $40 per share, the fair value of the
incremental consideration paid by Entity A upon
conversion is calculated as follows for each $1,000
bond that is converted before February 29, 19X6.
Pending Content (Transition Guidance: ASC
470-20-65-4)
55-4 Assuming the market price of Entity
A’s common stock on the date the inducement offer
was accepted is $40 per share, the fair value of
the incremental consideration that will be paid by
Entity A is calculated as follows for each $1,000
bond that is converted before February 29,
19X6.
55-5 Therefore, Entity A
records debt conversion expense equal to the fair
value of the incremental consideration paid as
follows.
Pending Content (Transition Guidance: ASC
470-20-65-4)
55-5 Entity A concludes that it meets
all of the criteria in paragraph 470-20-40-13.
Therefore, upon conversion, Entity A records debt
conversion expense equal to the fair value of the
incremental consideration paid as follows.
Case B: Reduced Conversion Price for Conversion
Before Determination Date — Bond Fair Value
Decreased
55-6 On January 1, 19X1,
Entity B issues a $1,000 face amount 4 percent
convertible bond maturing December 31, 20X0. The
carrying amount of the bond in the financial
statements of Entity B is $1,000, and it is
convertible into common shares of Entity B at a
conversion price of $25. On June 1, 19X4, the
convertible bond has a fair value of $500. To induce
convertible bondholders to convert their bonds
promptly, Entity B reduces the conversion price to
$20 for bondholders that convert before July 1, 19X4
(within 30 days).
Pending Content (Transition Guidance: ASC
470-20-65-4)
Case B: Reduced Conversion Price, Decrease in
Bond Fair Value
55-6 On January 1, 19X1, Entity B issues
a $1,000 face amount 4 percent convertible bond
maturing December 31, 20X0. The carrying amount of
the bond in the financial statements of Entity B
is $1,000, and it is convertible into common
shares of Entity B at a conversion price of $25.
On June 1, 19X4, the convertible bond has a fair
value of $500. To induce convertible bondholders
to convert their bonds promptly, Entity B reduces
the conversion price to $20 for bondholders that
convert before July 1, 19X4 (within 30 days).
55-7 Assuming the market
price of Entity B’s common stock on the date of
conversion is $12 per share, the fair value of the
incremental consideration paid by Entity B upon
conversion is calculated as follows for each $1,000
bond that is converted before July 1, 19X4.
Pending Content (Transition Guidance: ASC
470-20-65-4)
55-7 Assuming the market price of Entity
B’s common stock on the date the inducement offer
was accepted is $12 per share, the fair value of
the incremental consideration that will be paid by
Entity B is calculated as follows for each $1,000
bond that is converted before July 1, 19X4.
55-7A
Entity B is required to assess whether the
criteria in paragraph 470-20-40-13 are met,
including whether the conversion feature is
substantive (in accordance with the guidance in
paragraphs 470-20-40-6 through 40-10) as of both
the time of issuance and the date the inducement
offer is accepted by the convertible debt holder.
If Entity B concludes that, on the basis of its
facts and circumstances, all of the criteria in
paragraph 470-20-40-13 are met, then it would
account for the transaction as illustrated in
paragraph 470-20-55-8. If Entity B determines that
the criteria in paragraph 470-20-40-13 are not
met, it should not account for the settlement
transaction as an induced conversion.
55-8 Therefore, Entity B
records debt conversion expense equal to the fair
value of the incremental consideration paid as
follows.
Pending Content (Transition Guidance: ASC
470-20-65-4)
55-8 If Entity B determines that the
criteria in paragraph 470-20-40-13 are met, upon
conversion, Entity B would record debt conversion
expense equal to the fair value of the incremental
consideration paid as follows.
55-9
The same accounting would apply if, instead of
reducing the conversion price, Entity B issued
shares pursuant to a tender offer of 50 shares of
its common stock for each $1,000 bond surrendered to
the entity before July 1, 19X4. See paragraph
470-20-40-14.
Pending Content (Transition Guidance: ASC
470-20-65-4)
Case C: Offer to Settle
Convertible Debt Instrument in Cash and
Warrants
55-9A On January 1, 2X24, Entity A
issues a $1,000 face amount 10 percent convertible
bond maturing December 31, 2X33. The bond has a
conversion price of $25 per share. The terms of
the existing instrument require that, upon
conversion, the issuer settle the principal in
cash and the conversion premium in any combination
of cash and shares. Under the existing conversion
privileges, the total amount of cash (or the total
value of the cash and shares) required to be
issued upon conversion equals the product of 40
shares per $1,000 bond and a volume-weighted
average price of Entity A’s common stock. The
volume-weighted average price is calculated over a
period of 40 days beginning the day after the
holder notifies the issuer that it will convert
the debt instrument. On May 15, 2X27, to induce
convertible bondholders to convert their bonds
promptly, Entity A offers the following
consideration in exchange for each $1,000 bond
that is converted within 60 days (for purposes of
this Example, assume the offer meets the other
criteria in paragraph 470-20-40-13 and that the
offer is accepted by bondholders on June 1,
2X27):
-
A cash payment equal to 40 shares multiplied by the volume-weighted average price of Entity A’s common stock calculated over a period of 15 days (beginning the day after the holder accepts the inducement offer)
-
Five warrants (offered as a sweetener). Each warrant enables the holder to acquire a share of Entity A’s common stock at a fixed exercise price of $40. The warrants are exercisable upon issuance and expire five years after issuance.
55-9B Assume that the fair value of
Entity A’s common stock on the date the inducement
offer was accepted (June 1, 2X27) is $40 per
share. To evaluate whether the inducement offer
meets the criterion in paragraph 470-20-40-13(b),
Entity A would compare the form and amount of
consideration offered with the form and amount of
consideration that would be issued upon conversion
pursuant to the terms of the existing instrument.
The conversion privileges in the existing
instrument require Entity A to settle the
principal in cash and permit Entity A to settle
the conversion premium in any combination of cash
and shares.
55-9C In this Case, the inducement offer
includes the form (entirely cash) and amount
($1,600) of consideration required to settle both
the principal ($1,000) and the conversion premium
($600) pursuant to the conversion privileges
provided in the terms of the existing debt
instrument. The amount of $1,600 is the product of
40 shares and the fair value of Entity A’s shares
at the offer acceptance date ($40).
55-9D The offer of warrants to induce
conversion does not affect the assessment of
whether the inducement offer includes the form and
amount of consideration issuable under the
existing conversion privileges because the
existing conversion privileges did not provide for
the issuance of warrants (however, the offer of
warrants as a sweetener affects the measurement of
the debt conversion expense recognized in
accordance with paragraph 470-20-40-16).
Similarly, the fact that the inducement offer
changes the number of days over which the
volume-weighted average price of Entity A’s shares
is measured does not affect whether the inducement
offer includes the amount of consideration
issuable under the existing conversion privileges
because Entity A would use the fair value of its
common stock as of the offer acceptance date to
calculate the amount of cash payable under both
the conversion privileges in the existing
instrument and the inducement offer in accordance
with paragraph 470-20-40-13A(a). Therefore, the
inducement offer satisfies the criterion in
paragraph 470-20-40-13(b).
Case D: Offer to Settle Convertible Debt
Instrument in Cash and Shares
55-9E Assume the same facts as Case C,
except that Entity A offers the following
consideration (instead of the consideration listed
in paragraph 470-20-55-9A):
-
A cash payment of $1,400
-
Ten shares of Entity A’s common stock.
55-9F To evaluate whether the inducement
offer meets the criterion in paragraph
470-20-40-13(b), Entity A would compare the form
and amount of consideration offered with the form
and amount of consideration that would be issued
upon conversion pursuant to the terms of the
existing instrument. The conversion privileges in
the terms of the existing instrument require
Entity A to settle the principal in cash and
permit Entity A to settle the conversion premium
in any combination of cash and shares.
55-9G In this Case, the inducement offer
includes the form (cash) and amount ($1,000) of
consideration required to settle the principal
pursuant to the conversion privileges provided in
the terms of the existing debt instrument. Under
the existing conversion privileges, the remaining
settlement value of $600 can be settled in any
combination of cash and shares. If $400 ($1,400
total cash payment − $1,000 principal) of the
conversion premium is settled in cash, then the
inducement offer must provide for at least 5
shares ($200 remaining conversion premium ÷ $40
share price) of Entity A’s common stock to provide
the same form (cash and shares) and at least the
same amount of cash and shares that would have
been provided under the conversion privileges of
the existing instrument. Because the inducement
offer illustrated in Case D includes 10 shares, it
would satisfy the criterion in paragraph
470-20-40-13(b). The fact that the inducement
offer eliminates the volume-weighted average price
formula contained in the existing conversion
privileges and instead offers a specified amount
of cash and shares does not affect whether the
inducement offer includes the amount of
consideration issuable under the existing
conversion privileges because Entity A would use
the fair value of its common stock as of the offer
acceptance date to calculate the amount of cash
payable and shares issuable under the conversion
privileges in the existing instrument in
accordance with paragraph 470-20-40-13A(a).
Case E: Offer to Settle Convertible Debt
Instrument in Shares and Warrants
55-9H Assume the same facts as in Case
C, except that Entity A offers the following
consideration (instead of the consideration listed
in paragraph 470-20-55-9A):
-
Forty shares of Entity A’s common stock
-
Five warrants (offered as a sweetener). Each warrant enables the holder to acquire a share of Entity A’s common stock at a fixed exercise price of $40. The warrants are exercisable upon issuance and expire five years after issuance.
55-9I To evaluate whether the inducement
offer meets the criterion in paragraph
470-20-40-13(b), Entity A would compare the form
and amount of consideration offered with the form
and amount of consideration that would be issued
upon conversion pursuant to the terms of the
existing instrument. The conversion privileges in
the terms of the existing instrument require
Entity A to settle the principal in cash and
permit Entity A to settle the conversion premium
in any combination of cash and shares.
55-9J In contrast to Case C and Case D,
the inducement offer does not include the issuance
of all the consideration (in form and amount)
issuable pursuant to the conversion privileges
included in the terms of the existing instrument.
The terms of the existing instrument require
settlement of the principal amount in cash, but
Entity A did not offer cash consideration in the
inducement offer. Therefore, Entity A would
conclude that the criterion in paragraph
470-20-40-13(b) is not satisfied.
Footnotes
1
As noted in Section 12.2, conversion
accounting does not apply in certain circumstances in which a debt
instrument is settled for the issuer’s equity shares in accordance with
the original conversion privileges.