3.2 Framework for the Issuer’s Accounting Analysis

This section illustrates how an issuer may organize its accounting analysis into a sequential framework that is broadly consistent with the order of precedence among the different sets of accounting requirements that might apply to a convertible debt instrument. For example, an issuer can save time by evaluating whether the equity conversion feature is required to be bifurcated as a derivative under ASC 815-15 before considering whether the CCF or BCF guidance in ASC 470-20 applies, since the CCF or BCF guidance does not apply if the equity conversion feature must be bifurcated as an embedded derivative. Regardless of the order in which the different sets of requirements are considered, the ultimate accounting conclusions should not differ.

For debt that is convertible into the issuer’s equity shares (or equity that is convertible into an issuer’s equity shares and is required to be classified as a liability), an issuer may perform the following sequence of steps to determine the appropriate accounting for the instrument at inception:

Step	Accounting Issues	Deloitte Guidance
1. Identify each freestanding financial instrument	Does the transaction represent (1) a freestanding financial instrument (e.g., convertible debt), (2) a bundle of freestanding financial instruments (e.g., debt with detachable warrants), or (3) a component of a larger freestanding financial instrument (e.g., a debt contract that is analyzed on a combined basis with a warrant)?	Section 3.4 of this Roadmap as well as Section 3.3 of Roadmap Distinguishing Liabilities From Equity and Section 3.2 of Roadmap Contracts on an Entity’s Own Equity
2. Allocate the transaction amount among freestanding financial instruments and any other transaction elements	If the transaction represents a bundle of freestanding financial instruments or other elements (see step 1 above), how should the proceeds and issuance costs be allocated among the convertible debt and the other items included in the transaction?	Section 3.5
3. Determine whether the embedded equity conversion feature is required to be bifurcated as an embedded derivative	Does the embedded equity conversion feature require bifurcation as an embedded derivative under ASC 815-15? (If so, steps 5, 6, 7, 8, and 9 below are not applicable to the feature, but the issuer should consider steps 4, 10, and 13.)	Sections 2.3 and 2.4 and Appendix A of this Roadmap and Chapters 2, 4, and 5 of Roadmap Contracts on an Entity’s Own Equity
4. Determine whether the convertible debt contains any other features that require bifurcation as embedded derivatives	Other than the equity conversion feature, does any feature embedded in the convertible debt (e.g., a put, call, redemption, or indexation provision) require bifurcation as an embedded derivative under ASC 815-15?	Sections 2.3 and 2.4 and Appendix A
5. Determine whether the instrument contains a CCF that requires the instrument to be separated into liability and equity components	Is the instrument required to be separated into liability and equity components under the CCF guidance in ASC 470-20? (If so, steps 6, 7, 8, 9, and 10 below do not apply to the instrument.)	Chapter 6
6. For convertible debt instruments without a CCF, determine whether a BCF should be presented in equity	Does the convertible debt contain a noncontingent BCF that is required to be separately recognized in equity at inception under the BCF guidance in ASC 470-20? (If so, steps 8, 9, and 10 below do not apply to the instrument.)	Chapter 7
7. For convertible debt instruments without a CCF, determine whether the instrument contains a contingent BCF	Does the convertible debt contain a contingent BCF that will need to be monitored for potential recognition in equity under the BCF guidance in ASC 470-20 if the contingency is triggered?	Section 7.5
8. For convertible debt instruments without a CCF or BCF, determine whether an in-substance premium should be presented in equity	Was the convertible debt issued at a substantial premium that should be presented in equity under ASC 470-20? (If so, steps 9 and 10 below do not apply.)	Chapter 5
9. For convertible debt instruments without a CCF or BCF or in-substance premium presented in equity, apply the accounting guidance for traditional convertible debt	Should the convertible debt be accounted for as traditional convertible debt (i.e., as a liability in its entirety) under ASC 470-20?	Chapter 4
10. Consider whether to elect the fair value option	If the convertible debt contains no separated equity component at inception (see steps 5, 6, and 8 above), does the issuer wish to elect the fair value option in ASC 825-10?	Section 2.5
11. Allocate the transaction amount attributable to the convertible debt between any liability and equity components	If the convertible debt contains a separated equity component at inception (see steps 5, 6, and 8), how should the proceeds be allocated between the liability and equity components?	Section 3.5.4 and Chapters 5, 6, and 7
12. Determine whether the SEC’s requirements related to temporary equity apply	If the convertible debt contains a separated equity component (see steps 5, 6, 7, and 8), must some or all of this amount be presented in temporary equity?	Section 2.6 of this Roadmap and Chapter 9 of Roadmap Distinguishing Liabilities From Equity
13. Allocate the transaction amount attributable to the convertible debt between the host contract and any embedded derivatives	If the convertible debt contains a bifurcated embedded derivative (see steps 3 and 4), how should the issuer allocate proceeds attributable to the convertible debt (or the liability component) between the host debt contract and the embedded derivative?	Section 3.5.4

Some of the steps above are interdependent. For example:

An issuer cannot determine whether it can elect the fair value option (step 10) before it has determined whether the BCF guidance (applicable only if the convertible debt instrument is not required to be accounted for as a CCF under step 5) requires it to separately recognize an amount in equity at inception (step 6). Further, an issuer cannot determine whether a BCF exists (step 6) until it has allocated proceeds among any freestanding financial instruments (step 2). However, the appropriate method for such an allocation depends in part on whether the issuer has elected the fair value option (step 10). Accordingly, an entity may need to reperform the allocation of proceeds (step 2) if it elects the fair value option (step 10).
The determination of whether the equity conversion feature (step 3) must be bifurcated may depend in part on whether the issuer elects to apply the fair value option (step 10), since one of the bifurcation criteria is that the hybrid contract not be accounted for at fair value, with changes in fair value recognized in earnings. Further, an issuer must determine whether the instrument contains an equity component at inception under the CCF or BCF guidance (steps 5 and 6) before it can determine whether the fair value option is available (step 10). However, an issuer cannot determine whether the CCF or BCF guidance applies (steps 5 and 6) until it has determined whether the equity conversion feature is required to be bifurcated as an embedded derivative (step 3). Accordingly, an entity may not be able to assume that it can elect the fair value option before it performs its embedded derivative analysis (step 3) unless it has already determined that it cannot apply the CCF or BCF guidance (steps 5 and 6).

Confidential and Proprietary — for Use Solely by Authorized Personnel

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.