Appendix A — Embedded Derivative Analysis

In determining the appropriate accounting for a convertible debt instrument, an issuer is required to evaluate whether the instrument contains any embedded features that must be accounted for as a derivative instrument separately from the host instrument. Examples of such features include equity conversion features, put and call options, indexed interest rate payments, inverse floating interest rate payments, leveraged interest rate payments, interest rate caps and floors, interest rate make-whole features, term-extension options, and foreign currency features.

Section 2.3 provides an overview of the accounting requirements that apply to the bifurcation of embedded derivatives in accordance with ASC 815-15. Because this Roadmap focuses on the issuer’s accounting for convertible debt under ASC 470-20, however, it does not comprehensively address the accounting requirements for derivative instruments. This appendix discusses some of the common questions an issuer may encounter in performing an embedded derivative analysis for a convertible instrument in accordance with ASC 815.

While an entity may be required to bifurcate embedded derivatives for recognition and measurement purposes, such features are usually combined with the host contract in an entity’s balance sheet. In the SEC’s Current Accounting and Disclosure Issues in the Division of Corporation Finance (as updated November 30, 2006), the SEC staff indicated that “embedded derivatives should be presented on a combined basis with the host contract, except in circumstances where the embedded derivative is a liability and the host contract is equity.”