6.4 Mandatorily Convertible Debt

An entity may issue a debt instrument that is mandatorily convertible into common stock. The conversion may occur on a fixed maturity date or upon the occurrence of an event that is certain to occur. Although the instrument will be converted into common stock, it is still classified as a liability instrument.

Although conversion into common shares will occur upon the mere passage of time, the common shares issuable upon conversion should not be included in the denominator in the calculation of basic EPS. If the convertible debt instrument is a participating security, the two-class method should be applied to calculate basic EPS (see Chapter 5). If the two-class method is not applied, no adjustments should be made to the numerator or denominator (i.e., the impact on basic EPS will result from the reduction in net income for interest expense recognized on the instrument). It is inappropriate to apply the if-converted method to calculate basic EPS.

An entity should apply the if-converted method to determine the dilutive effect of a debt instrument that is mandatorily convertible into common shares (or the more dilutive of the if-converted or the two-class method of calculating diluted EPS if the instrument is a participating security). In applying the if-converted method, an entity should calculate the dilutive impact on the basis of the conversion terms that are most advantageous to the holder, as required by ASC 260-10-45-21. Furthermore, an entity must assume conversion into shares even if the entity or holder could elect to have the instrument partially or fully settled in cash.