6.5 Stock-Settled Debt
A financial instrument issued in the form of debt or equity that embodies an
unconditional obligation that the issuing entity must settle by issuing a variable
number of common shares equal to a fixed monetary amount must be classified as a
liability under ASC 480-10-25-14 and is often referred to as “stock-settled debt.”
Although a stock-settled debt instrument does not provide the holder with any
potential “upside” from increases in the issuing entity’s common stock, it meets the
definition of a convertible security; therefore, the if-converted method of
calculating diluted EPS must be applied to such an instrument. In applying the
if-converted method, an entity should include in the denominator the number of
common shares that would be issuable to settle the instrument on the basis of the
conversion terms that are most advantageous to the holder, as required by ASC
260-10-45-21.
If the issuing entity or the holder has the option of settling such a debt
instrument in either cash or a variable number of
common shares of an equivalent value, the issuing
entity must also apply the if-converted method,
because an entity cannot overcome the presumption
of share settlement. See Example
4-13 for an illustration of
stock-settled debt.