1.1 Background

ASC 470-20 provides guidance on an issuer’s accounting for instruments with embedded equity conversion features as well as certain transactions related to such instruments. Examples of contracts and transactions that may require evaluation under ASC 470-20 (see Chapter 2) include:

Debt that is convertible into the issuer’s equity shares (i.e., convertible debt).
Shares that are convertible into a different class of the issuer’s shares (i.e., convertible stock).
Instruments that are convertible into the issuer’s equity shares (including induced conversions and conversions upon the issuer’s exercise of a call option).
Debt issued with detachable warrants.
Own-share lending arrangements issued in contemplation of a convertible debt issuance.

Navigating the guidance in U.S. GAAP on convertible debt instruments can be challenging since there are multiple disparate sets of classification, measurement, and derecognition requirements whose interactions are complex. Seemingly unimportant differences in the terms of otherwise identical convertible debt instruments can result in significantly different accounting. Consequently, accounting restatements are not uncommon. At the 2005 AICPA Conference on Current SEC and PCAOB Developments, then Acting Chief Accountant Scott Taub commented on the complexity of financial reporting related to these instruments:

An example: try walking through all of the literature that applies (or might apply) to the issuance of convertible debt. Amongst the pieces of accounting literature that might apply are [ASC 470-20-25-12, ASC 815-40-25, the beneficial conversion option requirements in ASC 470-20, ASC 815, ASC 480, ASC 825-20, and ASC 480-10-S99-3A]. And it isn’t exactly obvious how these pieces of literature interact with one another in all circumstances.

To save time, an issuer may seek to organize its accounting analysis in a manner broadly consistent with the order of precedence among the various classification, measurement, and separation requirements that might apply to a transaction involving convertible instruments (see Section 3.2). Before applying a specific accounting approach, the issuer should (1) carefully evaluate the contractual terms (see Section 3.3), (2) determine whether the transaction involves multiple freestanding financial instruments or should be combined with other items (see Section 3.4), and (3) if necessary, allocate the initial transaction amount among multiple freestanding financial instruments (see Section 3.5).

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.