6.2 Scope
6.2.1 Convertible Debt
ASC 470-20
15-3 The Cash Conversion Subsections follow the same Scope and Scope Exceptions as outlined in the General
Subsection of this Section, with specific instrument qualifications and exceptions and other considerations
noted below.
15-4 . . . The guidance in the Cash Conversion Subsections applies only to convertible debt instruments that, by
their stated terms, may be settled in cash (or other assets) upon conversion, including partial cash settlement,
unless the embedded conversion option is required to be separately accounted for as a derivative instrument
under Subtopic 815-15. . . .
The CCF guidance in ASC 470-20 applies to an issuer’s accounting for a convertible debt instrument
that meets the following two conditions: (1) upon conversion, it may be settled either fully or partially in
cash or other assets in accordance with its stated terms and (2) the CCF is not required to be separately
accounted for as a derivative instrument under ASC 815-15 (see Sections 2.3 and 6.2.4.1). Thus, if
convertible debt in the form of Instrument B, C, or X (as described in Section 6.1.3) contains a CCF that
is not bifurcated under ASC 815, such instrument is within the scope of the CCF guidance. Similarly, if, upon conversion, a convertible debt instrument permits (1) the counterparty to elect either cash or net share settlement of all or part of the accreted value and (2) the issuer to satisfy the conversion spread in either cash or net shares, such instrument is within the scope of the CCF guidance in ASC 470-20 unless the CCF is bifurcated under ASC 815-15.
6.2.2 Liability-Classified Convertible Preferred Stock
ASC 470-20
15-6 For purposes of determining whether an instrument is within the scope of the Cash Conversion Subsections, a convertible preferred share shall be considered a convertible debt instrument if it has both of the following characteristics:
- It is a mandatorily redeemable financial instrument.
- It is classified as a liability under Subtopic 480-10.
For related implementation guidance, see paragraph 470-20-55-70.
55-70 An example of a convertible preferred share that paragraph 470-20-15-6 requires an entity [to] consider as a convertible debt instrument for purposes of the scope application of the Cash Conversion Subsections is a convertible preferred share that has a stated redemption date and also would require the issuer to settle the face amount of the instrument in cash upon exercise of the conversion option. Such a convertible preferred share is a mandatorily redeemable financial instrument and is classified as a liability under Subtopic 480-10 because it embodies an unconditional obligation to redeem the instrument by transferring assets at a specified or determinable date (or dates).
ASC 480-10 — Glossary
Mandatorily Redeemable Financial Instrument
Any of various financial instruments issued in the form of shares that embody an unconditional obligation requiring the issuer to redeem the instrument by transferring its assets at a specified or determinable date (or dates) or upon an event that is certain to occur.
The CCF guidance in ASC 470-20 applies to the issuer’s accounting for convertible preferred stock that meets all of the following four conditions:
- Upon conversion, it may be settled either fully or partially in cash or other assets in accordance with its stated terms.
- It meets the definition of a mandatorily redeemable financial instrument in ASC 480-10 (see Section 4.1.1 of Deloitte’s Roadmap Distinguishing Liabilities From Equity).
- It is classified as a liability under ASC 480-10 (i.e., it is a mandatorily redeemable financial instrument that is not exempt from the scope of ASC 480-10; see Section 4.1.5 of Deloitte’s Roadmap Distinguishing Liabilities From Equity).
- The CCF is not required to be separately accounted for as a derivative instrument under ASC 815-15 (see Section 2.3).
In the application of the CCF guidance in ASC 470-20, such convertible preferred stock is treated as convertible debt.
For a convertible preferred share to meet the definition of a mandatorily redeemable financial instrument and be classified as a liability under ASC 480-10, it must embody an unconditional obligation to transfer assets. A convertible preferred share that the issuer must settle at least partially in cash irrespective of whether it is converted embodies such an obligation, since a transfer of cash or other
assets is certain to occur unless there is a violation of the contractual terms. A fixed-term convertible
preferred share with conversion terms that are similar to those of Instrument C (as described in Section
6.1.3) typically would meet the definition of a mandatorily redeemable financial instrument and be
classified as a liability under ASC 480-10. Accordingly, such an instrument would be within the scope of
the CCF guidance in ASC 470-20 unless the CCF must be bifurcated as a derivative instrument under
ASC 815-15.
Example 6-2
Convertible Preferred Stock Subject to CCF Guidance
A convertible preferred share has (1) a fixed redemption date on which the issuer will settle its stated par
amount in cash and (2) a substantive conversion option that, if exercised by the counterparty, requires the
issuer to settle the par amount in cash but permits it to settle the excess of the conversion value over the par
amount (the conversion spread) in either cash or shares. The convertible preferred share meets the definition
of a mandatorily redeemable financial instrument and is classified as a liability under ASC 480-10 since the
issuer has an unconditional obligation to transfer cash or other assets in exchange for the par amount.
Because the issuer has the option to settle the conversion spread in either cash or shares upon conversion,
the instrument is within the scope of the CCF guidance in ASC 470-20 unless the issuer concludes that the
conversion feature must be bifurcated as an embedded derivative under ASC 815-15 (see Section 2.3).
A convertible preferred share that has a stated redemption date and permits the
issuer to elect settlement of the entire
instrument in either cash or shares (in a manner
similar to Instrument B as described in Section
6.1.3) or any combination of cash or
shares (in a manner similar to Instrument X as
described in Section
6.1.3) does not contain an
unconditional obligation to transfer assets
because the issuer has the right to settle the
entire conversion value in shares. Accordingly,
preferred stock with terms similar to those of
Instrument B or X is not within the scope of the
CCF guidance in ASC 470-20.
A requirement to transfer assets that is contingent on the counterparty’s election of a cash settlement
or the occurrence (or nonoccurrence) of an uncertain future event represents a conditional, rather
than an unconditional, obligation to transfer assets. Thus, convertible preferred stock that has such
a requirement is not within the scope of the CCF guidance in ASC 470-20. For example, a perpetual
convertible preferred share that must be settled in cash or other assets upon the counterparty’s
election to convert does not meet the definition of a mandatorily redeemable financial instrument in
ASC 480-10 because the obligation to transfer cash or other assets is contingent on such election.
Connecting the Dots
For further discussion of determining whether a share meets the definition of a
mandatorily redeemable financial instrument and would be classified as a
liability under ASC 480-10, see Chapter 4 of Deloitte’s Roadmap
Distinguishing
Liabilities From Equity.
6.2.3 Exceptions
6.2.3.1 Equity-Classified Convertible Stock
ASC 470-20
15-5 The Cash Conversion Subsections do not apply to any of the following instruments:
a. A convertible preferred share that is classified in equity or temporary equity. . . .
The CCF guidance in ASC 470-20 does not apply to convertible instruments that
are classified in equity or temporary equity. For instance, such guidance
does not apply to an equity-classified preferred share that contains an
option for the holder to convert it into a different class of equity shares
even if the conversion terms require or permit the issuer to pay cash to
settle the conversion value. See Chapter 9 of Deloitte’s Roadmap
Distinguishing
Liabilities From Equity for additional guidance on
preferred stock that is classified in temporary equity.
6.2.3.2 Holders of Underlying Shares Receive Same Form of Consideration
ASC 470-20
15-5 The Cash Conversion Subsections do not apply to any of the following instruments: . . .
b. A convertible debt instrument that requires or permits settlement in cash (or other assets) upon conversion only in specific circumstances in which the holders of the underlying shares also would receive the same form of consideration in exchange for their shares. . . .
The CCF guidance in ASC 470-20 does not apply if the convertible debt instrument only requires or permits settlement in cash or other assets upon conversion if the holders of the shares underlying the convertible instrument receive, or have a right to receive, the same form of consideration for their shares. However, this scope exception is not available if, upon conversion, the form of consideration (e.g., cash, shares, property, or other assets) would be different from the form of consideration paid to holders of the underlying shares.
6.2.3.3 Cash Settlement of Fractional Shares
ASC 470-20
15-5 The Cash Conversion Subsections do not apply to any of the following instruments: . . .
c. A convertible debt instrument that requires an issuer’s obligation to provide consideration for a fractional share upon conversion to be settled in cash but that does not otherwise require or permit settlement in cash (or other assets) upon conversion.
A fractional share of stock is a quantity of shares that is less than one full share. The CCF guidance in ASC 470-20 does not apply to a convertible debt instrument merely because it requires or permits the issuer to cash settle any obligation to deliver fractional shares.
Example 6-3
Convertible Debt Instrument With Fractional Shares Settled in Cash
Issuer A has an obligation to deliver 15.333 shares upon conversion of a convertible debt instrument. The terms of the instrument require A to settle the obligation in shares except for any fractional shares, which are settled in a cash amount that equals their current market value. Upon conversion, therefore, A delivers 15 shares and a cash amount that equals the current market value of 0.333 shares. Even though A has an obligation to deliver cash upon conversion, the CCF guidance in ASC 470-20 does not apply because the obligation to deliver cash applies only to fractional shares.
6.2.4 Other Considerations
6.2.4.1 Embedded Derivatives
ASC 470-20
15-4 The guidance in this Section shall be considered after consideration of the guidance in Subtopic 815-15
on bifurcation of embedded derivatives, as applicable (see paragraph 815-15-55-76A). . . . The guidance in the
Cash Conversion Subsections does not affect an issuer’s determination under Subtopic 815-15 of whether an
embedded feature shall be separately accounted for as a derivative instrument.
25-25 If a convertible debt instrument within the scope of the Cash Conversion Subsections contains
embedded features other than the embedded conversion option (for example, an embedded prepayment
option), the guidance in Subtopic 815-15 shall be applied to determine if any of those features must be
separately accounted for as a derivative instrument. As discussed in paragraph 470-20-15-4, the guidance
in the Cash Conversion Subsections does not apply if there is no equity component because the embedded
conversion option is being separately accounted for as a derivative under Subtopic 815-15.
The requirements in ASC 470-20 (e.g., the CCF guidance) do not apply if the conversion feature must
be bifurcated and accounted for as a derivative instrument under ASC 815. Therefore, an issuer needs
to determine whether ASC 815-15 requires bifurcation of the CCF before it can conclude whether the
CCF guidance in ASC 470-20 applies to the instrument. However, if a feature other than the conversion
feature (e.g., a call or put option) must be bifurcated from the convertible debt instrument, the
instrument is not exempt from the CCF guidance in ASC 470-20 (see Section 6.3.6).
Because of this scope exception, the CCF guidance in ASC 470-20 does not apply to convertible debt
instruments in the form of Instrument A (as described in Section 6.1.3). Since the issuer must settle
the conversion feature of such instruments in cash, they meet the net settlement characteristic in the
definition of derivative instruments in ASC 815-10-15-83 and do not qualify for the scope exception
in ASC 815-10-15-74(a) for certain contracts on the entity’s own equity. Further, an equity feature
is not clearly and closely related to a debt host. Therefore, unless the issuer elects to account for
convertible debt in the form of Instrument A at fair value, with changes in fair value recognized in
earnings under the fair value option in ASC 825-10 (see Section 2.5), the conversion feature in such
an instrument is separated as an embedded derivative under ASC 815-15. Irrespective of whether the
issuer bifurcates the conversion feature under ASC 815-15 or elects to apply the fair value option to the
entire instrument under ASC 825-10, convertible debt in the form of Instrument A is exempt from the
scope of ASC 470-20. For similar reasons, the CCF guidance in ASC 470-20 generally does not apply to
a convertible debt instrument if the holder has an option to require the issuer to settle either the full
conversion value or the conversion spread in cash.
A convertible debt instrument within the scope of the CCF guidance in ASC 470-20 could qualify as
conventional convertible debt under ASC 815-40-25-39 if, in a manner similar to Instrument B, the
holder is able to realize the value of the conversion option only by exercising it and receiving the entire
proceeds in a fixed number of shares or an equivalent amount of cash at the issuer’s discretion. In such
a case, some of the equity classification conditions in ASC 815-40-25 would not apply.
Connecting the Dots
For a discussion of the evaluation of whether an equity conversion feature
qualifies as equity under ASC 815-40, see Deloitte’s Roadmap
Contracts
on an Entity’s Own Equity. Section 5.5
of that Roadmap addresses the requirements related to conventional
convertible debt.
6.2.4.2 Share-Settled Redemption or Indexation Features
As discussed in Section 2.4, a contractual term that economically represents a share-settled put, call, redemption, or indexation provision should not be analyzed as a conversion feature under ASC 470-20 even if the instrument’s terms describe it as a “conversion feature.”
Example 6-4
Share-Settled Debt
The terms of a debt instrument include an option that permits the holder to “convert” the instrument on a specified date. Upon conversion, the issuer is required to settle the principal amount and any accrued and unpaid interest either in cash or a variable number of equity shares of equal value. The conversion price is defined as (1) the sum of $1 million plus unpaid and accrued interest divided by (2) the market price of the common stock on the conversion date. Although the contract refers to the option as a conversion feature and the issuer has the right to settle the feature either in cash or equity shares, the instrument should not be analyzed as a debt instrument with a CCF under ASC 470-20 because the monetary amount of the obligation is unrelated to the fair value of the issuer’s equity shares.
6.2.4.3 Fair Value Option
ASC 470-20
25-21 Paragraph 825-10-15-5(f) states that no entity may elect the fair value option for financial instruments that are, in whole or in part, classified by the issuer as a component of shareholder’s equity (including temporary equity) (for example, a convertible debt instrument within the scope of the Cash Conversion Subsections or a convertible debt security with a noncontingent beneficial conversion feature).
Because ASC 470-20 requires the issuer of a convertible debt instrument that is within the scope of the CCF guidance to separate it into liability and equity components at issuance, the issuer is not permitted to elect the fair value option in ASC 825-10 for such an instrument. By analogy, the instrument is also not eligible for the fair value option in ASC 815-15 (see Section 2.5 for further discussion).
6.2.4.4 The SEC’s Requirements Related to Temporary Equity
As discussed in Section 2.6, an issuer that is an SEC registrant should consider whether the SEC’s guidance on redeemable securities in ASC 480-10-S99-3A applies to convertible debt instruments that are separated into liability and equity components under the CCF guidance in ASC 470-20. While the SEC’s guidance on temporary equity applies to equity-classified redeemable stock even if it is not currently redeemable, such guidance does not apply to convertible debt with a CCF that is not currently redeemable even if it may become redeemable in the future. As indicated in ASC 480-10-S99-3A(12), for convertible debt with a CCF, the amount of temporary equity is limited to the excess (if any) of “(1) the amount of cash or other assets that would be required to be paid to the holder upon a redemption or conversion . . . over (2) the carrying amount of the liability-classified component of the convertible debt instrument” both at initial measurement and on subsequent balance sheet dates.
Connecting the Dots
For further discussion of the application of the SEC’s guidance on temporary
equity, see Sections 9.3.5, 9.4.8, 9.5.7, and
9.6.4 of Deloitte’s Roadmap Distinguishing
Liabilities From Equity.
Example 6-5
Application of ASC 480-10-S99-3A to Puttable Convertible Debt With a CCF
A convertible debt instrument subject to the CCF guidance in ASC 470-20 was issued for net proceeds of $100
and includes a cash-settled put option that permits the investor to put the instrument back to the issuer at any
time for $97. As of the issuance date, the issuer concluded that the put option was (1) nonsubstantive (i.e., its
exercise was not probable; see Section 6.3.2.2) and (2) not required to be bifurcated and accounted for as a
derivative under ASC 815-15. As of the reporting date, the current carrying amount of the liability component is
$90 and the current carrying amount of the equity component is $10. In this case, the issuer would present $3
of the equity component in permanent equity and $7 in temporary equity because $7 of the equity component
is currently redeemable (i.e., the excess of the current redemption amount over the carrying amount of the
debt’s liability component).
If, instead, the put option was contingent and the contingency was not met as of the reporting date, no amount
would be presented in temporary equity (irrespective of whether it was probable that the contingency would
be met in the future) because the SEC’s guidance on redeemable securities in ASC 480-10-S99-3A only applies
to convertible debt instruments with a separately classified equity component if the instrument is currently
redeemable or convertible as of the reporting date.
6.2.4.5 Beneficial Conversion Features
The General subsections of ASC 470-20 include requirements for the separate presentation in equity
of BCFs in certain convertible debt instruments (see Chapter 7). As noted in ASC 470-20-15-2, that
guidance does not apply to an equity conversion feature that causes the convertible debt instrument in
which it is embedded to be separated into liability and equity components under the CCF guidance in
ASC 470-20. Accordingly, an issuer should evaluate whether the CCF guidance applies before potentially
considering the BCF guidance. If the CCF guidance in ASC 470-20 applies, the issuer should not analyze
the conversion feature under the BCF guidance.