9.3 Separation Into Liability and Equity Components
9.3.1 Traditional Convertible Debt
Under U.S. GAAP, the issuer of convertible debt is precluded from allocating to equity any of the proceeds received upon its issuance (see Chapter 4) if the convertible debt is not within the Cash Conversion subsections of ASC 470-20 and there is no separately recognized equity component that results from (1) the issuance of the convertible debt instrument at a substantial premium to par, (2) the recognition of a BCF, (3) a modification that increased the fair value of the conversion option, or (4) a reclassification of a conversion option that was previously classified as a derivative. If the equity conversion feature fails to satisfy the equity classification conditions in ASC 815-40, it is bifurcated as an embedded derivative only if it meets the bifurcation conditions in ASC 815-15 (including the net settlement characteristic in the definition of a derivative in ASC 815-10).
Under IFRS Accounting Standards, the issuer of a convertible debt instrument
must separate it into liability and equity
components if the feature meets the equity
classification conditions in IAS 32. The issuer
separates the instrument into its components by
determining the fair value of the liability
component and then deducting that amount from the
fair value of the instrument as a whole; the
residual amount is allocated to the equity
component. If the equity conversion feature does
not satisfy the equity classification conditions
in IAS 32, it is bifurcated as an embedded
derivative unless the issuer elects to apply the
fair value option to the convertible debt.
The definition of a derivative and the equity classification conditions under
U.S. GAAP and IFRS Accounting Standards are not
identical. Therefore, depending on the specific
facts and circumstances, the assessment of whether
an equity conversion option must be separated as
an embedded derivative may differ under the two
sets of standards (see Chapter 8 of
Deloitte’s Roadmap Contracts on an Entity’s
Own Equity). Further, the
circumstances in which an issuer may elect the
fair value option are not the same, although the
guidance in both sets precludes application of the
fair value option to equity-classified items.
9.3.2 Convertible Debt Issued at a Substantial Premium
Under U.S. GAAP, there is a rebuttable presumption that the premium associated with convertible debt issued at a substantial premium to par should be presented in equity (see Chapter 5) unless the embedded conversion feature must be separated as an embedded derivative under ASC 815-15 or as an equity component under the CCF or BCF guidance in ASC 470-20.
As noted above, under IFRS Accounting Standards, the issuer of a convertible
debt instrument must separate it into liability
and equity components if the feature meets the
equity classification conditions in IAS 32 (see
Section 9.3.1). There is no special
guidance on convertible debt issued at a
substantial premium.
9.3.3 Cash Conversion Features
Under U.S. GAAP, a convertible debt instrument that contains a CCF must be separated into liability and equity components (see Chapter 6) unless the equity conversion feature has to be separated as an embedded derivative under ASC 815-15. The issuer separates the instrument into its components by determining the fair value of the liability component and then deducting that amount from the fair value of the instrument as a whole; the residual amount is allocated to the equity component.
Under IFRS Accounting Standards, an embedded conversion option that can be
settled in cash upon conversion fails to meet the
conditions for equity classification in IAS 32.
Accordingly, an equity conversion feature that is
separately presented as an equity component under
the CCF guidance in ASC 470-20 would instead be
accounted for as an embedded derivative liability
under IFRS Accounting Standards unless the issuer
elects to apply the fair value option to the
convertible debt.
Paragraph B7 of FSP APB 14-1 states, in part:
[B]ecause the requirements for equity classification under U.S. GAAP [ASC 815-40] differ from the requirements for equity classification under IFRS (IAS 32), the [cash conversion] guidance in [ASC 470-20] does not converge with IFRS. In accordance with IAS 32, the conversion option embedded in a convertible debt instrument that may be settled in cash upon conversion (including partial cash settlement) would be bifurcated and accounted for at fair value as a derivative . . . unless the fair value option is elected for the instrument in its entirety. To accomplish convergence in the accounting for instruments within the scope of [the CCF guidance in ASC 470-20], a broad-based reconsideration of [ASC 815-40] would have been necessary, which the Board decided was beyond the scope of this project.
9.3.4 Beneficial Conversion Features
Under U.S. GAAP, a convertible debt instrument that contains a noncontingent BCF must be separated into liability and equity components (see Chapter 7) unless the equity conversion feature has to be separated as an embedded derivative under ASC 815-15 or as an equity component under the CCF guidance in ASC 470-20. The equity component is measured at the intrinsic value of the equity conversion feature. If a convertible debt instrument contains a contingent BCF, the issuer is required to recognize the intrinsic value of the conversion feature in equity if the contingency is triggered, with a corresponding reduction in the debt’s net carrying amount.
As noted above, under IFRS Accounting Standards, the issuer of a convertible
debt instrument must separate it into liability
and equity components if the feature meets the
equity classification conditions in IAS 32 (see
Section 9.3.1). There is no special
guidance on convertible debt with a BCF. The
equity component is not subsequently remeasured
even if a contingent conversion feature is
triggered or there is a contingent adjustment to
the conversion price.