Chapter 6 — Cash Conversion Features

6.1 Overview

6.1.1 General Considerations

ASC 470-20

05-13 The Cash Conversion Subsections address certain convertible debt instruments that may be settled in cash upon conversion as specified in paragraph 470-20-15-3.

This chapter discusses the guidance in the Cash Conversion subsections of ASC 470-20 on an issuer’s accounting for certain instruments that contain a CCF. The guidance applies not only to debt instruments but also to liability-classified convertible preferred stock (see Section 6.2.2). However, the CCF guidance does not apply if the conversion feature must be bifurcated and accounted for as a derivative instrument under ASC 815-15 (see Sections 2.3 and 6.2.4.1).

6.1.2 Objective of the CCF Guidance

ASC 470-20

10-1 The objective of the guidance in the Cash Conversion Subsections is that the accounting for a convertible debt instrument within the scope of those Subsections reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods.

Economically, a convertible debt instrument can be analyzed as a combination of (1) a debt obligation with a below-market interest coupon and (2) an equity conversion option. Investors are willing to accept a below-market interest rate on their investment because they also receive an equity conversion option. If, for accounting purposes, all the issuance proceeds are attributed to the debt feature, it may appear that the issuer is able to borrow at a below-market rate; however, this ignores the fact that the issuer has given investors a valuable equity conversion option in exchange for the low interest rate. In the absence of a conversion feature, the issuer would have to pay a higher rate that is commensurate with its nonconvertible debt borrowing rate.

Consequently, the objective of the CCF guidance in ASC 470-20 is to ensure that the interest cost of instruments within its scope reflects the issuer’s nonconvertible borrowing rate. That is, as indicated in paragraph B7 of the Background and Basis for Conclusions of FSP APB 14-1, the cost recognized should reflect “the same interest cost [the issuer] would have incurred had it issued a comparable debt instrument without the embedded conversion option.” The issuer accomplishes this by allocating the amounts received as follows:

To the liability component — An amount of proceeds that equals the fair value of a similar liability that does not have an associated equity component.
To the equity component — The remainder of the proceeds.

The resulting debt discount (or reduction in debt premium) increases the reported interest cost in future periods as a result of the application of the effective interest method. Since any debt discounts or premiums are amortized to earnings under this method, the reported interest cost includes the implicit interest cost that was “paid” through the inclusion of a conversion option in the instrument.

The FASB concluded that it would be inappropriate to account for convertible debt instruments that may be settled in cash (including partial settlement) upon conversion wholly as debt in accordance with ASC 470-20-25-12 (see Chapter 4). In paragraph B3 of FSP APB 14-1, the Board observed that such accounting guidance “was based, in part, on [an assumption of] the mutual exclusivity of the debt and the conversion option such that the holder cannot exercise the option to convert into equity shares unless the holder forgoes the right to repayment of the debt component”; however, that assumption is not valid for convertible debt instruments that may be settled in cash upon conversion. Further, such accounting “can provide misleading information to investors,” since “the diluted earnings-per-share treatment of convertible debt instruments with the characteristics of Instrument C [as described in Section 6.1.3] is a treasury-stock-type method that is consistent with the diluted earnings-per-share treatment of debt issued with detachable warrants.”

As indicated in paragraph B5 of FSP APB 14-1, the Board considered but decided against expanding the scope of the CCF guidance “broadly to all convertible debt instruments, including those instruments that must be settled entirely in shares upon conversion,” pending “a broad reconsideration of the accounting for all convertible instruments . . . in connection with the Board’s liabilities and equity project.”

The separation and allocation approach required under the CCF guidance differs from approaches that apply to other types of debt instruments with conversion features. In developing the guidance, the FASB concluded that the liability-first separation approach would be less difficult to apply than an equity-first separation approach or a relative-fair value separation approach that potentially would have required an entity to determine the fair value of the conversion feature by using complex option-pricing models. Further, the Board noted that the CCF guidance has a different objective (i.e., to measure the interest cost that is “paid” with the conversion feature) than other separation or allocation approaches under GAAP (e.g., to measure bifurcated embedded derivatives at fair value; see Section 3.5.4).

6.1.3 Common Variants

While more traditional forms of convertible debt instruments must be physically settled in the issuer’s equity shares upon conversion, an instrument with a CCF requires or permits settlement of all or part of the instrument’s conversion value by the transfer of cash or other assets. In Issue 90-19, the EITF identified three variants of convertible bonds with CCFs (Instruments A, B, and C); and in his remarks at the 2003 AICPA Conference on Current SEC Developments, then SEC Professional Accounting Fellow Robert Comerford identified a fourth variant (Instrument X):

	Settlement Provision	Description
Instrument A	Cash settlement	“Upon conversion, the issuer must satisfy the obligation entirely in cash based on the fixed number of shares multiplied by the stock price on the date of conversion (the conversion value).”
Instrument B	Issuer option to elect either cash or physical share settlement	“Upon conversion, the issuer may satisfy the entire obligation in either stock or cash equivalent to the conversion value.”
Instrument C	Cash settlement of accreted value and issuer option to elect either net cash or net share settlement of conversion spread	“Upon conversion, the issuer must satisfy the accreted value of the obligation (the amount accrued to the benefit of the holder exclusive of the conversion spread) in cash and may satisfy the conversion spread (the excess conversion value over the accreted value) in either cash or stock.”
Instrument X	Combination settlement	“Instrument X provides the issuer with the ability to settle investor conversions in any combination of shares or cash.”

Example 6-1

Variants of Convertible Debt With CCF

The following table illustrates how Instruments A, B, C, and X, as described above, would be settled if they each have an accreted value of $1 million and are convertible into 10,000 shares, and the current stock price at the time of conversion is $125:

Type	Settlement Upon Conversion
Instrument A	The issuer must pay cash of $1,250,000 (10,000 × $125).
Instrument B	The issuer can elect to either deliver 10,000 equity shares or pay cash of $1,250,000 (10,000 shares × $125).
Instrument C	The issuer must pay $1,000,000 of cash to settle the accreted value of the debt obligation. To settle the conversion spread, the issuer can elect to either deliver 2,000 equity shares ($250,000 ÷ $125) or pay $250,000 of cash.
Instrument X	The issuer can elect to deliver any combination of cash and shares whose aggregate value equals $1,250,000 (e.g., 1,000 shares and $1,125,000 of cash).

Note that convertible debt in the form of Instrument A would be exempt from the scope of the CCF guidance in ASC 470-20 because of the requirement to cash settle the conversion feature (see Section 6.2.4.1).

6.6 Presentation and Disclosure

6.6.1 Presentation on a Classified Balance Sheet

ASC 470-20

45-3 The guidance in the Cash Conversion Subsections does not affect an issuer’s determination of whether the liability component should be classified as a current liability or a long-term liability. For purposes of applying other applicable U.S. GAAP to make that determination, all terms of the convertible debt instrument (including the equity component) shall be considered. Additionally, the balance sheet classification of the liability component does not affect the measurement of that component under paragraphs 470-20-35-12 through 35-16.

In determining whether the liability component of convertible debt within the scope of the CCF guidance in ASC 470-20 should be classified as current or long-term on a classified balance sheet, the issuer considers all the terms of the debt, including the conversion feature. The separation of an equity component does not affect the issuer’s determination of whether the liability component should be classified as current or noncurrent.

An issuer applies ASC 210-10-45 and ASC 470-10-45 to determine the appropriate balance sheet classification of debt. CCFs may cause debt that otherwise would have been classified as noncurrent to be classified as current. Convertible debt should be treated as debt with a demand provision under ASC 470-10-45-10 if the CCFs (1) permit the holder to convert at any time or within one year (or operating cycle, if longer) of the reporting date and (2) require the issuer to settle the accreted value in cash (i.e., Instrument C as described in Section 6.1.3). Similarly, convertible debt that requires the issuer to settle the accreted value in cash should be treated as having a demand provision if (1) the conversion feature is contingent and (2) the contingency is met as of the balance sheet date. The liability component would be treated as debt that is due on demand even if the conversion option were out-of-the-money.

If convertible debt instruments subject to the CCF guidance allow the issuer to pay the accreted value in cash or stock or any combination thereof (i.e., Instrument X), the diluted EPS treatment depends on whether the issuer overcomes the presumption of share settlement of the accreted value. If that presumption is overcome, the entity calculates the dilutive effect of the convertible debt instrument by using the treasury stock method (i.e., the entity uses the dilutive EPS guidance applicable to Instrument C). An entity should determine the current versus noncurrent classification of the liability component in a manner consistent with its intended settlement for calculating diluted EPS. For example, it would generally be inappropriate to assume share settlement of the accreted value for balance sheet classification purposes and cash settlement of the accreted value for diluted EPS calculation purposes.

6.6.2 EPS Requirements

This section provides an overview of the EPS requirements that apply to convertible debt instruments subject to the CCF guidance in ASC 470-20. For additional discussion, see Deloitte’s Roadmap Earnings per Share.

6.6.2.1 Basic EPS

Provided that a convertible debt instrument within the scope of the CCF guidance in ASC 470-20 does not represent a participating security, basic EPS is affected as a result of (1) a reduction of the numerator (i.e., net income) due to the recognition of interest expense or an adjustment to the numerator due to the recognition of a gain or loss upon extinguishment and (2) an increase in the denominator if 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 the cash 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).

Because the initial carrying amount of the liability component is less than its principal amount, a discount arises on issuance and is amortized under the interest method (see Section 6.4.1). This amortization will increase the reported amount of interest expense, thereby reducing the numerator in the calculation of basic EPS.

As discussed in Section 6.5.3.2, modifications or exchanges involving cash convertible debt instruments that do not result in extinguishment accounting may affect both the carrying amount of the liability component and the effective interest rate used to amortize the discount between the carrying amount and principal amount of the liability component. Thus, a modification or exchange could also affect the numerator in the calculation of basic EPS.

Upon any settlement of a cash convertible debt instrument, ASC 470-20-40-20 requires an issuer to allocate the total consideration between the liability and equity components (see Section 6.5.1). Such an allocation will almost always result in the recognition of an extinguishment gain or loss in earnings in connection with the settlement of the liability component. This gain or loss will affect the numerator in the calculation of basic EPS. See Section 6.5.2 for a discussion of the impact of an induced conversion.

Because interest expense and extinguishment gains and losses on cash convertible debt instruments affect net income, no specific adjustments should be made to the numerator in the calculation of basic EPS.

6.6.2.2 Diluted EPS

6.6.2.2.1 Methods Applicable to Cash Convertible Debt Instruments

A conversion of a cash convertible debt instrument in accordance with its original conversion terms may be settled in cash, common stock, or a combination thereof. An entity that has the option of settling all or a portion of a cash convertible debt instrument in cash or common stock must consider the guidance in ASC 260 on contracts that may be settled in stock or cash. As discussed in the guidance below, an entity that may elect to settle a contract in cash or common stock should assume that the contract will be settled in common stock for diluted EPS purposes. That presumption may be overcome on the basis of past experience or a stated policy.

ASC 260-10

Contracts That May Be Settled in Stock or Cash

45-45 If an entity issues a contract that may be settled in common stock or in cash at the election of either the entity or the holder, the determination of whether that contract shall be reflected in the computation of diluted EPS shall be made based on the facts available each period. It shall be presumed that the contract will be settled in common stock and the resulting potential common shares included in diluted EPS (in accordance with the relevant provisions of this Topic) if the effect is more dilutive. Share-based payment arrangements that are payable in common stock or in cash at the election of either the entity or the grantee shall be accounted for pursuant to this paragraph and paragraph 260-10-45-46. An example of such a contract is a written put option that gives the holder a choice of settling in common stock or in cash.

45-46 . . . The presumption that the contract will be settled in common stock may be overcome if past experience or a stated policy provides a reasonable basis to believe that the contract will be paid partially or wholly in cash.

55-32 Adjustments shall be made to the numerator for contracts that are classified, in accordance with Section 815-40-25, as equity instruments but for which the entity has a stated policy or for which past experience provides a reasonable basis to believe that such contracts will be paid partially or wholly in cash (in which case there will be no potential common shares included in the denominator). That is, a contract that is reported as an equity instrument for accounting purposes may require an adjustment to the numerator for any changes in income or loss that would result if the contract had been reported as an asset or liability for accounting purposes during the period. For purposes of computing diluted EPS, the adjustments to the numerator are only permitted for instruments for which the effect on net income (the numerator) is different depending on whether the instrument is accounted for as an equity instrument or as an asset or liability (for example, those that are within the scope of Subtopics 480-10 and 815-40).

55-36 For contracts in which the counterparty controls the means of settlement, past experience or a stated policy is not determinative. Accordingly, in those situations, the more dilutive of cash or share settlement shall be used.

As noted in ASC 260-10-45-46, “[t]he presumption that the contract will be settled in common stock may be overcome if past experience or a stated policy provides a reasonable basis to believe that the contract will be paid partially or wholly in cash.” Section 4.7.2.3 of Deloitte’s Roadmap Earnings per Share discusses matters to be considered in each financial reporting period in the determination of whether the presumption of share settlement of a cash convertible debt instrument may be overcome.

The table below summarizes the diluted EPS methods that apply to cash convertible debt instruments within the scope of the Cash Conversion subsections of ASC 470-20. In this table, it is assumed that (1) the cash convertible debt instrument is not a participating security and (2) if the instrument is only contingently convertible, it must be included in the calculation of diluted EPS. See Deloitte’s Roadmap Earnings per Share for a discussion of the application of the two-class method of calculating diluted EPS (Section 5.5.2) and of contingently convertible debt instruments (Section 4.4.3).

Instrument	Diluted EPS Method
Instrument B	Entity Does Not Overcome Presumption of Share Settlement of the Entire Obligation If an entity is unable to overcome the presumption of share settlement of the entire obligation, it should apply the if-converted method to calculate diluted EPS. Under ASC 260-10-45-21, such a calculation must be based on the conversion terms that are most advantageous to the holder. See Section 4.9 of Deloitte’s Roadmap Earnings per Share for further discussion of the year-to-date calculations of diluted EPS. Entity Overcomes Presumption of Share Settlement of the Entire Obligation If an entity overcomes the presumption of share settlement of the entire obligation, it would assume, in calculating diluted EPS, that the entire obligation will be settled in cash upon conversion. In such circumstances, no adjustment should be made to the denominator in the calculation of diluted EPS. However, additional consideration is necessary because the accounting classification of the contract differs from the assumed method of settlement for diluted EPS purposes. Specifically, the entity would have been required to bifurcate the embedded conversion option if the contract had required cash settlement upon conversion. As a result, the entity should reduce the numerator for any decrease in net income that would have occurred during the period if the embedded conversion option had been classified as a derivative liability. An entity should only consider the impact of recognizing the embedded conversion option as a derivative under ASC 815-15. It should not consider the impact on net income that would have occurred if the entire convertible debt instrument had been recognized at fair value through earnings, since any change in the convertible debt instrument’s fair value arising from something other than the embedded conversion option should not affect the calculation of diluted EPS. The numerator should not be adjusted for any increase in net income that would have occurred during the period if the embedded conversion option had been classified as an embedded derivative liability. See further discussion in Section 4.7.3.2.3 of Deloitte’s Roadmap Earnings per Share.
Instrument C	ASC 260-10-55-84A states that “[t]he if-converted method should not be used to determine the earnings-per-share implications of convertible debt with the characteristics [of Instrument C].” However, the entity must still consider whether it can overcome the presumption of share settlement of the conversion spread. Entity Does Not Overcome Presumption of Share Settlement of the Conversion Spread If an entity is unable to overcome the presumption of share settlement of the conversion spread, in accordance with ASC 260-10-55-84A, (1) the numerator in the calculation of diluted EPS should not be adjusted for the cash-settled portion of the instrument and (2) the conversion spread should be included in diluted EPS by using the treasury stock method in the same manner as if the embedded conversion option was a freestanding written call option on the entity’s common shares. Under ASC 260-10-45-21, the calculation of diluted EPS must be based on the conversion terms that are most advantageous to the holder. See Section 4.9 of Deloitte’s Roadmap Earnings per Share for further discussion of the year-to-date calculations of diluted EPS. Note that ASC 260-10-55-84A indicates that the number of incremental shares added to the denominator is calculated on the basis of the average market price of the common shares during the financial reporting period. This guidance is consistent with the application of the treasury stock method (i.e., the proceeds received upon exercise of a written option to sell common shares are used to repurchase such shares on the basis of the average market price during the period). The average market price is used in this example because the conversion price in the convertible debt instrument is substantively akin to proceeds. However, the FASB did not intend to require this approach. Rather, for Instrument C, since there are no proceeds that the entity actually receives upon conversion (i.e., the entity can only potentially issue net common shares on the basis of the conversion value), in a manner consistent with the discussion in Section 8.4.2 of Deloitte’s Roadmap Earnings per Share for similar arrangements, it is acceptable for an entity to apply the guidance on contingently issuable shares in ASC 260-10-45-52 and use the market price of the entity’s common shares at the end of the reporting period (or over the averaging period specified in the convertible debt agreement; the last stock price used in the average would be the stock price on the last day of the reporting period). Entities must select an accounting policy related to determining the number of incremental shares and must apply that policy consistently to all similar instruments. Entity Overcomes Presumption of Share Settlement of the Conversion Spread If an entity overcomes the presumption of share settlement of the conversion spread, it would assume, in calculating diluted EPS, that the entire obligation will be settled in cash upon conversion. In such circumstances, no adjustment should be made to the denominator in the calculation of diluted EPS. However, additional consideration is necessary because the accounting classification of the contract differs from the assumed method of settlement for diluted EPS purposes. Specifically, the entity would have been required to bifurcate the embedded conversion option if the contract had required cash settlement upon conversion. As a result, the entity should reduce the numerator for any decrease in net income that would have occurred during the period if the embedded conversion option had been classified as a derivative liability. An entity should only consider the impact of recognizing the embedded conversion option as a derivative under ASC 815-15. It should not consider the impact on net income that would have occurred if the entire convertible debt instrument had been recognized at fair value through earnings, since any change in the convertible debt instrument’s fair value arising from something other than the embedded conversion option should not affect the calculation of diluted EPS. The numerator should not be adjusted for any increase in net income that would have occurred during the period if the embedded conversion option had been classified as an embedded derivative liability. See further discussion in Section 4.7.3.2.3 of Deloitte’s Roadmap Earnings per Share.
Instrument X	Entity Does Not Overcome Presumption of Share Settlement of Entire Obligation If an entity does not overcome the presumption of share settlement of the entire obligation, it should treat the convertible debt instrument in the same manner as Instrument B and apply the if-converted method. Under ASC 260-10-45-21, the calculation of diluted EPS must be based on the conversion terms that are most advantageous to the holder. See Section 4.9 of Deloitte’s Roadmap Earnings per Share for further discussion of the year-to-date calculations of diluted EPS. Entity Overcomes Presumption of Share Settlement of the Accreted Value If an entity has a reasonable basis for concluding that it would settle the accreted value of the debt obligation in cash (i.e., on the basis of a “stated policy” or past practice), it should treat the convertible debt instrument in the same manner as Instrument C. Therefore, no adjustment should be made to the numerator, and the entity should apply the treasury stock method to calculate the diluted effect of the conversion spread. Under ASC 260-10-45-21, the calculation of diluted EPS must be based on the conversion terms that are most advantageous to the holder. See Section 4.9 of Deloitte’s Roadmap Earnings per Share for further discussion of the year-to-date calculations of diluted EPS. Entity Overcomes Presumption of Share Settlement of the Entire Obligation If an entity overcomes the presumption of share settlement of the entire obligation, it would assume, in calculating diluted EPS, that the entire obligation will be settled in cash upon conversion. Therefore, in such circumstances, the entity should treat the convertible debt instrument in the same manner as it would treat Instruments B and C when cash settlement of the entire obligation is assumed for diluted EPS purposes.

Connecting the Dots

Although the table above describes how an entity should account for diluted EPS when it overcomes the presumption of share settlement and therefore assumes cash settlement of the entire obligation, it is generally not appropriate to conclude that the entire instrument will be settled in cash in the calculation of diluted EPS. As discussed in Section 4.7.2.3 of Deloitte’s Roadmap Earnings per Share, it is difficult for an entity to assert that it has the intent and ability to cash-settle an instrument for which there is no limit on the amount of cash that would be due upon settlement.

Entities should disclose their intent and judgment regarding whether cash convertible debt instruments are assumed to be settled in cash or shares when such judgment is material to reported diluted EPS.

6.6.2.3 Out-of-the-Money Conversion Options

A holder of a cash convertible debt instrument could exercise the embedded conversion option when it is out-of-the-money. Depending on the terms of the convertible debt instrument, the monetary value of the consideration paid by the issuing entity to satisfy the conversion may differ depending on the settlement method. The terms of some cash convertible debt instruments specify that if the issuing entity chooses to settle a conversion entirely in cash, it must pay the holder no less than the principal amount that is otherwise due on maturity. However, if the entity chooses to settle the conversion in common shares, it is only obligated to deliver a number of common shares based on the original conversion terms. For example, assume that an entity issues a cash convertible debt instrument with a principal amount of $1,000. The terms specify that if the holder exercises the conversion option and the entity elects to pay the entire obligation in cash, it must pay no less than $1,000. Further, assume that the holder exercises the instrument when the conversion value is $900 on the basis of the fair value of the number of the entity’s common shares that would be delivered on conversion. If the entity chooses to settle the entire obligation in cash, it must pay $1,000. However, if the entity can choose to settle the entire obligation in common shares, which would be the case for Instruments B and X, it must only deliver a number of common shares with a fair value of $900. Thus, the monetary value paid on conversion differs because of the $1,000 “floor” on the cash amount payable on conversion that is included in the settlement terms of the instrument.

Questions have arisen regarding the method an issuing entity should use to calculate diluted EPS when cash convertible debt instruments with the characteristics described above are issued in the form of Instrument X. As discussed in the table above, when an entity does not conclude that it would settle the entire obligation underlying Instrument X in cash, which is typically the case, it must use judgment to determine whether to apply the if-converted method or treasury stock method to calculate diluted EPS. In financial reporting periods in which the conversion option is out-of-the-money, upon any conversion by the holder (which must be assumed for diluted EPS purposes), the entity would be economically motivated to elect to settle the entire obligation in common shares, since the fair value of the common shares issued on conversion would be less than the principal amount otherwise payable in cash. This would suggest that the entity should assume share settlement of the entire obligation and apply the if-converted method to calculate diluted EPS for any financial reporting period for which the conversion option is out-of-the-money. The if-converted method would always be more dilutive than the treasury stock method in such cases, since the treasury stock method never produces a dilutive result when an option is out-of-the-money.

While the if-converted method may be applied in such circumstances, an entity is not required to apply this method solely because the conversion option is out-of-the-money. Rather, the entity may analyze Instrument X for diluted EPS purposes at inception (when the conversion option typically is out-of-the-money), and in each subsequent financial reporting period, on the basis of how it would settle an in-the-money conversion. Under this approach, if an entity has previously used the treasury stock method to calculate diluted EPS for Instrument X, the entity is not required to apply the if-converted method simply because the conversion option becomes out-of-the-money. There are several reasons for this conclusion. First, the conversion option in Instrument X is generally out-of-the-money in the period of issuance. ASC 260 does not require an entity to apply the if-converted method to Instrument X in the financial reporting period in which it was issued. Second, while ASC 260 requires an entity to include any dilutive effect under the if-converted method of calculation if the conversion option is out-of-the-money, this requirement is only relevant when an entity applies the if-converted method. ASC 260 does not require an entity to apply the if-converted method solely because a conversion option is out-of-the-money (and such application is not intuitive since it would be uneconomical for the holder to convert the instrument). Lastly, when the FASB issued FSP APB 14-1 (codified in ASC 470-20), it was well acknowledged that entities would be eligible to apply the treasury stock method to cash convertible instruments issued in the form of Instrument X.

Connecting the Dots

The same issue related to diluted EPS generally does not exist for Instruments B and C. For Instrument B, an entity must always apply the if-converted method if it does not overcome the presumption of share settlement of the entire obligation. As discussed in Section 4.7.2.3 of Deloitte’s Roadmap Earnings per Share, since it is difficult for an entity to assert its intent and ability to cash-settle the entire obligation, an entity that has issued Instrument B will generally always apply the if-converted method. For Instrument C, an entity must only determine whether to apply the treasury stock method or the diluted EPS accounting approach for contracts that are classified as equity instruments but assumed to be cash-settled for diluted EPS purposes. Each approach only reflects the dilutive effect of the conversion value. If the conversion value is out-of-the-money, the conversion will involve only a settlement of the accreted value for cash and the entity will not be required to make any adjustment in the calculation of diluted EPS. There is no incremental impact on the calculation of diluted EPS because there is no conversion value to reflect under the treasury stock method when the conversion option is out-of-the-money.

6.6.2.4 Consideration of Extinguishment Gains and Losses

The derecognition model in ASC 470-20 typically results in the recognition of an extinguishment gain or loss in earnings in the financial reporting period in which a cash convertible debt instrument is converted in accordance with its original conversion terms. In such circumstances, questions have arisen about whether (1) a hypothetical gain or loss should be included as an adjustment to the numerator when the if-converted method or treasury stock method is applied to a cash convertible debt instrument and (2) a recognized extinguishment gain or loss should be reversed from the numerator when the if-converted or treasury stock method is applied to a cash convertible debt instrument that was settled during a financial reporting period.

When applying the if-converted method to Instrument B or X to calculate diluted EPS, an entity (1) should not adjust the numerator for any extinguishment gain or loss that would have been recognized if an outstanding Instrument B or X had been converted at the beginning of the reporting period (or the date of issuance, if later) and (2) should reverse from the numerator any gain or loss that was recognized for an Instrument B or X that was extinguished during the financial reporting period. See further discussion in Section 4.4.2.2.4 of Deloitte’s Roadmap Earnings per Share.

When applying the treasury stock method to Instrument C in calculating diluted EPS, an entity should only adjust the denominator, if the effect is dilutive. Such application is consistent with ASC 260-10- 55-84A, which states that “[t]here would be no adjustment to the numerator in the diluted earnings-per-share computation for the cash-settled portion of the instrument because that portion will always be settled in cash.” In essence, Instrument C is treated as comprising both a debt instrument and a written option to sell common stock for diluted EPS purposes; accordingly, the entity may only adjust the denominator in calculating diluted EPS. Therefore, in such circumstances, the entity (1) should not adjust the numerator for any Instrument C outstanding at the end of the period for any extinguishment gain or loss that would have been recognized if conversion had occurred at the beginning of the reporting period (or the date of issuance, if later) and (2) should not reverse from the numerator any gain or loss that was recognized for any Instrument C that was extinguished during the financial reporting period.

6.6.3 Disclosure

ASC 470-20

Disclosure Objectives

10-2 The disclosure requirements of the Cash Conversion Subsections are intended to provide users of financial statements with both:

Information about the terms of convertible debt instruments within the scope of those Subsections
An understanding of how those instruments have been reflected in the issuer’s statement of financial position and statement of financial performance.

50-3 An entity shall provide the incremental disclosures required by the guidance in this Section in annual financial statements for convertible debt instruments within the scope of the Cash Conversion Subsections that were outstanding during any of the periods presented.

50-4 As of each date for which a statement of financial position is presented, an entity shall disclose all of the following:

The carrying amount of the equity component
For the liability component:
1. The principal amount
2. The unamortized discount
3. The net carrying amount.

50-5 As of the date of the most recent statement of financial position that is presented, an entity shall disclose all of the following:

The remaining period over which any discount on the liability component will be amortized
The conversion price and the number of shares on which the aggregate consideration to be delivered upon conversion is determined
For a public entity only, the amount by which the instrument’s if-converted value exceeds its principal amount, regardless of whether the instrument is currently convertible
All of the following information about derivative transactions entered into in connection with the issuance of instruments within the scope of the Cash Conversion Subsections regardless of whether such derivative transactions are accounted for as assets, liabilities, or equity instruments:
1. The terms of those derivative transactions
2. How those derivative transactions relate to the instruments within the scope of the Cash Conversion Subsections
3. The number of shares underlying the derivative transactions
4. The reasons for entering into those derivative transactions.

An example of a derivative transaction entered into in connection with the issuance of an instrument within the scope of the Cash Conversion Subsections is the purchase of call options that are expected to substantially offset changes in the fair value of the conversion option.

50-6 For each period for which a statement of financial performance is presented, an entity shall disclose both of the following:

The effective interest rate on the liability component for the period
The amount of interest cost recognized for the period relating to both the contractual interest coupon and amortization of the discount on the liability component.

ASC 470-20 includes incremental disclosure requirements for convertible debt instruments that are within the scope of its CCF guidance and were outstanding during any of the periods presented. The objective of these disclosure requirements is to inform financial statement users about (1) the terms of convertible debt instruments within the scope of the CCF guidance and (2) how those instruments have been reflected in the issuer’s statements of financial position and financial performance.

Below is a tabular overview of the incremental disclosure requirements applicable to instruments within the scope of the CCF guidance in ASC 470-20.

	Liability Component	Equity Component	Derivatives Executed at Inception
Each balance sheet	Principal amount Unamortized discount Net carrying amount	Carrying amount
Most recent balance sheet	Remaining amortization period	Conversion price Number of shares on which the conversion value is determined The excess of the if-converted value over the principal amount, if any (public entities only)	Terms How they relate to the CCF instrument Number of underlying shares Reasons for execution
Each income statement period	Effective interest rate Amount of recognized interest cost

For a discussion of disclosure requirements that apply broadly to convertible instruments, including instruments within the scope of the CCF guidance, see Section 4.6.4.

The guidance in GAAP does not address whether the disclosure requirements related to fair value in ASC 825-10-50 apply to convertible debt instruments within the scope of the CCF guidance in ASC 470-20 as a whole or only to the liability component of such instruments. However, there are two acceptable views:

The disclosure requirements in ASC 825-10-50 should be applied to the convertible debt instrument as a whole. Supporters of this view note that the disclosures in ASC 825-10-50 apply to liability-classified financial instruments and there is no specific scope exception in ASC 825-10-50 for the equity-classified component of an instrument.
The disclosure requirements in ASC 825-10-50 should be applied only to the liability component. Proponents of this view note that these requirements are not applicable to equity-classified instruments under ASC 825-10-50-8(i), and they apply this scope exception to the equity component of instruments that have been separated into liability and equity components.