Chapter 4 — Traditional Convertible Debt

4.6 Presentation and Disclosure

4.6.1 Presentation on a Classified Balance Sheet

ASC 210-10-45 contains the general requirements related to an entity’s classification of assets and liabilities as either current or noncurrent in a classified balance sheet, and ASC 470-10-45 contains specific requirements related to the issuer’s classification of debt obligations, including convertible debt, as either current or noncurrent. Under those requirements, current liabilities generally include convertible debt obligations for which a payment of cash or other current assets or the creation of current liabilities could be required within 12 months (or the entity’s operating cycle, if longer) of the balance sheet date. Examples of such liabilities would include:

Convertible debt that is scheduled to mature within one year (or operating cycle, if longer) after the balance sheet date.
Any portion of long-term convertible debt that is scheduled to mature within one year (or operating cycle, if longer) after the balance sheet date (e.g., the current portion of an amortizing long-term debt obligation for which the principal amount is paid down over the obligation’s life).
Convertible debt that is repayable on demand or puttable by the holder within one year (or operating cycle, if longer) after the balance sheet date (see ASC 470-10-45-9 and 45-10), including convertible debt that is only contingently puttable if the contingency has been met.
Long-term convertible debt that became repayable on demand or within one year (or operating cycle, if longer) after the balance sheet date because of a covenant violation that occurred as of the balance sheet date or before or as of the issuance of the financial statements (see ASC 470-10-45-11).

Generally, the holder’s conversion option does not affect the classification of traditional convertible debt as current or noncurrent if it must be settled by the delivery of the issuer’s equity shares.

Short-term obligations that are expected to be refinanced on a long-term basis are classified as noncurrent if the debtor has both the intent and ability to refinance the obligation on a long-term basis and certain qualifying criteria are met (see ASC 470-10-45-14).

4.6.2 Presentation of Issuance Costs

ASC 835-30

45-1A . . . [D]ebt issuance costs related to a note shall be reported in the balance sheet as a direct deduction from the face amount of that note. [Debt] issuance costs shall not be classified as a deferred charge . . . .

ASC 835-30 requires issuance costs (see Section 3.5.3) that are attributable to the initial sale of a convertible debt instrument, including traditional convertible debt subject to ASC 470-20, to be presented as a direct deduction from the instrument’s face amount. Thus, in a manner similar to a debt discount, such costs are offset against the associated proceeds in the determination of the instrument’s initial net carrying amount. Subsequently, debt issuance costs are amortized as additional interest expense over the life of the debt.

4.6.3 EPS Calculation

This section provides an overview of the issuer’s calculation of EPS for traditional convertible debt. For additional discussion, see Deloitte’s Roadmap Earnings per Share.

4.6.3.1 Basic EPS

Provided that a traditional convertible debt instrument does not meet the definition of a participating security, the impact on basic EPS is attributable to (1) a reduction of the numerator (i.e., net income) resulting from the recognition of interest expense or an adjustment to the numerator resulting from the recognition of a gain or loss upon extinguishment and (2) an increase in the denominator once the convertible debt instrument has been settled in exchange for common stock (i.e., an increase in the weighted-average common shares outstanding calculated from the date the security is exchanged for common stock). If a traditional convertible debt instrument meets the definition of a participating security, the entity must apply the two-class method to calculate basic EPS (see Chapter 5 of Deloitte’s Roadmap Earnings per Share).

4.6.3.2 Diluted EPS

Provided that a traditional convertible debt instrument does not represent a participating security, the if-converted method is used to reflect the impact of the embedded conversion option on diluted EPS. If a traditional convertible debt instrument meets the definition of a participating security, the issuer must apply the more dilutive of the if-converted method or the two-class method to calculate diluted EPS (see Chapter 5 of Deloitte’s Roadmap Earnings per Share).

Under the if-converted method, an entity must adjust both the numerator and denominator. Since an entity using the if-converted method assumes that a convertible debt instrument was converted into common shares at the beginning of the reporting period (or the date of issuance, if later), the numerator is adjusted to reverse any recognized interest expense (including any amortization of discounts), net of tax. The common shares issuable upon conversion are added to the denominator on the basis of the most favorable conversion terms available to the holder. Except in the case of certain contingently convertible debt instruments, the if-converted method, if dilutive, must be applied even if the embedded conversion option is out-of-the-money. The guidance on contracts that may be settled in cash or stock is not relevant to traditional convertible debt instruments since the issuer must satisfy any conversion by issuing common shares. See Section 4.4 of Deloitte’s Roadmap Earnings per Share for further discussion of the if-converted method. Section 4.9.3 of Deloitte’s Roadmap Earnings per Share discusses the application of the if-converted method to year-to-date calculations of diluted EPS.

Special considerations apply if:

An induced conversion occurs (see Section 4.6.3.3).
The conversion feature is nonsubstantive at inception and becomes exercisable only upon the exercise of a call option (see Section 4.6.3.4).
The convertible debt represents a participating security to which the two-class method applies (see Chapter 5 of Deloitte’s Roadmap Earnings per Share).
The conversion feature is contingent (see Section 4.4.3 of Deloitte’s Roadmap Earnings per Share).
The embedded conversion option is separated as a derivative under ASC 815-15 (see Section 6.6.3 of Deloitte’s Roadmap Earnings per Share).
The issuer has elected the fair value option in ASC 825-10 (see Section 6.6.4 of Deloitte’s Roadmap Earnings per Share).
The convertible debt contains an embedded put or call option (see Section 6.6.5 of Deloitte’s Roadmap Earnings per Share).

4.6.3.3 Induced Conversions

Upon an induced conversion of a convertible debt instrument (see Section 4.5.4), the issuer will not be required to adjust the calculation of basic EPS because the loss on inducement will already be reflected in the numerator. In the calculation of diluted EPS under the if-converted method, a recognized inducement loss should be added back to the numerator. By analogy to the guidance in ASC 260-10-S99-2, when an SEC registrant effects an induced conversion of only a portion of a class of outstanding convertible debt instruments, the entity should, in determining whether the if-converted method is dilutive for a financial reporting period, consider the convertible debt instruments converted in accordance with an inducement offer separately from other convertible debt instruments of the same class that are not converted under such an offer.

Connecting the Dots

When convertible debt instruments are converted during a financial reporting period in accordance with an inducement offer, an entity that is using the if-converted method assumes that the instruments were converted at the beginning of the reporting period, or on the date of issuance if later, on the basis of the stated conversion terms. Because the numerator adjustment will reflect a reversal of the additional consideration provided under the inducement offer, the application of the if-converted method during a period in which an induced conversion has occurred will typically be antidilutive for the convertible debt instruments that were converted under such an offer.

In the calculation of diluted EPS under the treasury stock method for Instruments C and X (see Chapter 6), any recognized inducement loss should not be added back to (reversed from) the numerator.

4.6.3.4 Nonsubstantive Conversion Options

As discussed in Section 4.5.3, ASC 470-20-40-5 addresses the accounting for an issuance of common shares “to settle a debt instrument (pursuant to the instrument’s original conversion terms) that became convertible [only] upon the issuer’s exercise of a call option.” According to this guidance, the issuer must evaluate whether the debt instrument contained a substantive conversion feature as of its issuance date. If the debt instrument did not contain a substantive conversion feature as of its issuance date, any settlement through the issuance of common stock should not be treated as a conversion for accounting purposes but should be accounted for as a debt extinguishment, with a gain or loss recognized in earnings (i.e., the fair value of the common shares issued would equal the reacquisition price that is compared with the carrying amount to determine the gain or loss upon extinguishment).

Although it is not common for debt instruments to contain nonsubstantive embedded conversion features, if such a feature exists and it can be exercised by the holder only if the issuer exercises an option to call the debt before its maturity, the issuer is not required to apply the if-converted method to calculate diluted EPS in all financial reporting periods. Rather, since the entity controls the ability to avoid issuing common shares by virtue of its right not to exercise the call option, the diluted EPS implications, if any, should take into account the fact that the entity controls exercise of the call option. If, however, the holder of a debt instrument has the right to exercise a conversion feature that is considered nonsubstantive as of the issuance date, the issuer should evaluate the conversion feature as an embedded put option. The same accounting would apply if the conversion feature only became substantive after the issuance date. In both circumstances, the put option is treated in the same manner as stock-settled debt and the if-converted method applies (as discussed in Section 6.5 of Deloitte’s Roadmap Earnings per Share).

4.6.4 Disclosure

ASC 470-20

50-1 For disclosures about securities as part of equity disclosures, see Section 505-10-50.

50-2 For disclosures about securities in relationship to earnings per share (EPS) disclosures, see paragraph 260-10-50-1(c).

ASC 505-10

50-3 An entity shall explain, in summary form within its financial statements, the pertinent rights and privileges of the various securities outstanding. Examples of information that shall be disclosed are dividend and liquidation preferences, participation rights, call prices and dates, conversion or exercise prices or rates and pertinent dates, sinking-fund requirements, unusual voting rights, and significant terms of contracts to issue additional shares or terms that may change conversion or exercise prices (excluding standard antidilution provisions). An entity shall disclose within its financial statements the number of shares issued upon conversion, exercise, or satisfaction of required conditions during at least the most recent annual fiscal period and any subsequent interim period presented. An entity also shall disclose within the financial statements actual changes to conversion or exercise prices that occur during the reporting period (excluding changes due to standard antidilution provisions).

50-6 To comply with the general disclosure requirements of paragraph 505-10-50-3, the significant terms of the conversion features of the contingently convertible security shall be disclosed to enable users of financial statements to understand the circumstances of the contingency and the potential impact of conversion. Quantitative and qualitative terms of the contingently convertible security, disclosure of which would be helpful in understanding both the nature of the contingency and the potential impact of conversion, include all of the following:

Events or changes in circumstances that would cause the contingency to be met and any significant features necessary to understand the conversion rights and the timing of those rights (for example, the periods in which the contingency might be met and the securities may be converted if the contingency is met)
The conversion price and the number of shares into which a security is potentially convertible
Events or changes in circumstances, if any, that could adjust or change the contingency, conversion price, or number of shares, including significant terms of those changes
The manner of settlement upon conversion and any alternative settlement methods (for example, cash, shares, or a combination).

50-7 In order to meet the disclosure requirements of the preceding paragraph, the possible conversion prices and dates as well as other significant terms for each convertible instrument shall be disclosed. For example:

The Company is obligated to issue X shares and as the market price of the common stock decreases, the Company is obligated to issue an additional X shares for each $1 decrease in the stock price.

50-8 Additionally, the issuer shall disclose in the notes to financial statements the terms of the transaction, including the excess of the aggregate fair value of the instruments that the holder would receive at conversion over the proceeds received and the period over which the discount is amortized.

50-9 Disclosures shall indicate whether the shares that would be issued if the contingently convertible securities were converted are included in the calculation of diluted earnings per share (EPS) and the reasons why or why not.

50-10 Disclosures of information about derivative instruments entered into in connection with the issuance of the contingently convertible securities may be useful in terms of fully explaining the potential impact of the contingently convertible securities. That information might include the terms of those derivative instruments (including the terms of settlement), how those instruments relate to the contingently convertible securities, and the number of shares underlying the derivative instruments. One example of a transaction entered into in connection with the issuance of a contingently convertible security is the purchase of a call option such that the terms of the purchased call option would be expected to substantially offset changes in value of the written call option embedded in the convertible security. Derivative instruments are also subject to disclosure information, as required by Topic 815.

50-10A For incremental disclosure requirements of debt with conversion and other options, see paragraphs 470-20-10-2 and 470-20-50-3 through 50-6.

ASC 260-10

50-1 For each period for which an income statement is presented, an entity shall disclose all of the following: . . .

c. Securities (including those issuable pursuant to contingent stock agreements) that could potentially dilute basic EPS in the future that were not included in the computation of diluted EPS because to do so would have been antidilutive for the period(s) presented. Full disclosure of the terms and conditions of these securities is required even if a security is not included in diluted EPS in the current period.

Since ASC 470-20 does not contain any specific disclosure requirements related to traditional convertible debt, an issuer considers other disclosure requirements in GAAP. In particular, ASC 505-10 contains disclosure requirements that apply to convertible instruments.

Even though ASC 505-10 is in the equity area of the Codification and its scope provisions do not refer to debt, it is evident from other references in the Codification that some of the disclosure requirements in ASC 505-10-50, particularly those in ASC 505-10-50-3 and ASC 505-10-50-6 through 50-10A, apply to outstanding securities irrespective of whether they are in the form of debt or equity (see, e.g., ASC 470-10-50-5 and ASC 470-20-50-1). Further, before the FASB’s codification of U.S. GAAP, those requirements were included in accounting pronouncements that applied to the issuer’s disclosure of both debt and equity instruments:

Current Guidance	Source	Description
ASC 505-10-50-3	FASB Statement 129	Requirements related to disclosing information about capital structure, such as an issuer’s disclosure of information about securities (including both debt and stock as well as warrants and options).
ASC 505-10-50-7 and 50-8	EITF Issues 98-5 and 00-27 (legacy BCF literature)	How to apply the requirements for the issuer’s disclosure of information about securities under FASB Statement 129 to convertible instruments (both convertible debt and convertible preferred stock) that contain a BCF. For example, ASC 505-10-50-7 contains the EITF’s view of how to apply the disclosure requirement in ASC 505-10-50-3 related to “conversion or exercise prices or rates and pertinent dates” to convertible instruments with a BCF. Accordingly, the cross-reference in ASC 505-10-50-7 to “the preceding paragraph” does not limit the scope of application of ASC 505-10- 50-7 to contingently convertible securities addressed in ASC 505-10-50-6. Instead, it is relevant for convertible securities more broadly.
ASC 505-10-50-6, 50-9, and 50-10	FSP FAS 129-1	Disclosures related to contingently convertible securities.

Among the disclosures required by ASC 505-10, the following information is particularly relevant for outstanding convertible securities:

The pertinent rights and privileges (i.e., the significant terms) of each convertible instrument outstanding, including but not limited to conversion prices or rates and pertinent dates. For example, “[t]he Company is obligated to issue X shares and as the market price of the common stock decreases, the Company is obligated to issue an additional X shares for each $1 decrease in the stock price.”
The number of shares issued upon conversion, exercise, or satisfaction of required conditions during the most recent annual period and any subsequent interim period presented.
The period over which any discount is amortized.
The excess of the aggregate fair value of the instruments that the holder would receive at conversion over the proceeds received.

For contingently convertible securities, an issuer should provide additional disclosures, such as:

The nature of the contingency and the potential effect of conversion, including:
- Events or changes in circumstances that would cause the contingency to be met.
- Any significant features necessary for understanding the conversion rights and the timing of those rights (e.g., the periods in which the contingency might be met and the securities may be converted).
- The conversion price.
- The number of shares into which a security is potentially convertible.
- Events or changes in circumstances that could trigger a change in the contingency, conversion price, or number of shares, including significant terms of those changes.
- The manner of settlement upon conversion (e.g., cash, shares, or a combination).
- Alternative settlement methods.
Whether the shares that would be issued upon a contingent conversion are included in the calculation of diluted EPS and the reasons why or why not.

An issuer should provide special disclosures about derivative instruments that it has executed in connection with the issuance of the contingently convertible securities, such as:

The terms of those derivative instruments (including the terms of settlement).
How those instruments are related to the contingently convertible securities.
The number of shares underlying the derivative instruments.

An issuer should also consider other disclosure requirements that may apply to convertible instruments, such as those related to:

EPS (in ASC 260-10-50).
The fair value of financial instruments (in ASC 825-10-50).
Embedded conversion options that are no longer bifurcated (in ASC 815-15-50-3).

SEC registrants should consider any applicable disclosure requirements issued by the SEC. For example:

SEC Regulation S-X, Rule 5-02 (reproduced in ASC 210-10-S99-1), requires a registrant to “[s]tate separately, in the balance sheet or in a note thereto, each issue or type of [long-term] obligation and such information as will indicate . . . (1) The general character of each type of debt including the rate of interest; (2) the date of maturity, or, if maturing serially, a brief indication of the serial maturities, such as ‘maturing serially from 1980 to 1990’; (3) if the payment of principal or interest is contingent, an appropriate indication of such contingency; (4) a brief indication of priority; and (5) if convertible, the basis.”
SEC Regulation S-K, Item 303, requires disclosure in MD&A of information about off-balance-sheet arrangements, including convertible debt arrangements for which the conversion option is not bifurcated as an embedded derivative under ASC 815-15.

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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.