2.4 Share-Settled Redemption or Indexation Features
A financial instrument may contain a term that is described as a “conversion” feature but economically
represents a share-settled redemption provision. That is, the number of equity shares to be delivered is
variable and is calculated to be equal in value to a fixed or specified monetary amount (e.g., the principal
amount plus accrued and unpaid interest) or a monetary amount that is indexed to an unrelated
underlying (e.g., the price of gold).
Even if the terms of the instrument refer to the share-settled feature as a
conversion feature, the issuer should not analyze it as such under ASC 470-20 since
a share-settled feature does not have the economic payoff profile of an equity
conversion feature. Instead, the issuer should (1) evaluate the feature as a put,
call, redemption, or other indexed feature, as applicable, and (2) determine whether
the feature must be separated as a derivative instrument under ASC 815-15 (see
Section 2.3 and
Appendix A). (If
the instrument is issued in the form of an equity share such as preferred stock, the
issuer should also evaluate whether it must be classified as a liability under ASC
480-10.) This view is consistent with the guidance in ASC 470-20-25-8 as well as
with ASC 470-20-55-19, which exempts “a convertible instrument [that] has a
conversion option that continuously resets as the underlying stock price increases
or decreases so as to provide a fixed value of common stock to the holder at any
conversion date” from the application of the accounting guidance on contingent BCFs
in ASC 470-20 when those resets subsequently occur (see Section 7.2.3).
Example 2-1
Share-Settled Redemption Feature in Preferred Stock
A liability-classified instrument issued in the form of preferred stock with a liquidation preference amount of $1 million contains a contingent conversion feature that requires the issuer to settle the instrument in a variable number of common shares when a qualified financing occurs. The conversion price is defined as $1.2 million divided by the market price of the common stock on the conversion date. The issuer would not analyze the instrument as a convertible instrument under ASC 470-20. Instead, it should analyze the feature as a contingent redemption provision and evaluate whether the feature must be separated as a derivative instrument under ASC 815-15.
Example 2-2
Share-Settled Indexation Feature in Debt Instrument
A debt instrument with a principal amount of $1 million contains a conversion feature that gives the holder the option to require the issuer to settle the instrument in a variable number of common shares worth $1 million, adjusted for changes in the S&P 500 Index, as of the conversion date. The issuer should not analyze the debt instrument as a convertible debt instrument under ASC 470-20. Instead, it should analyze the feature as indexed to the S&P 500 Index and evaluate whether it must be separated as a derivative instrument under ASC 815-15.