Alert

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2024-04, Debt—Debt with Conversion and Other Options (Subtopic 470-20): Induced Conversions of Convertible Debt Instruments.

The amended guidance is intended to provide clarity on when to apply induced conversion accounting versus extinguishment accounting.

Who Is Affected

The amendments apply to all entities that settle convertible debt instruments for which the conversion terms were changed to induce conversion.

Background

When the terms of a convertible debt instrument are changed to induce conversion of the instrument, an entity needs to determine whether the transaction should be accounted for as an induced conversion or a debt extinguishment.

Stakeholder feedback indicates that there’s confusion around whether conversions of debt instruments with cash conversion features should be accounted for as induced conversions or as extinguishments.

The amendments in ASU 2020-06, Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, removed the cash conversion accounting model, and as a result, convertible debt with cash conversion features became subject to the same conversion guidance as traditional convertible debt instruments. However, ASU 2020-06 didn’t amend the induced conversion guidance, which was written before cash convertible instruments become prevalent in the marketplace and applies to share-settled debt.

In response to stakeholder feedback, ASU 2024-04 amends the guidance for applying induced conversion accounting.

What Changes with the Amended Guidance in ASU 2024-04?

Under ASU 2024-04, the following three criteria must be met to apply the induced conversion guidance to the settlement of a convertible debt instrument:

• The conversion occurs pursuant to changed conversion privileges that are exercisable only for a limited period.
• The conversion includes issuance of all the consideration, in form and amount, issuable pursuant to conversion privileges provided in the terms of the existing debt instrument.
• The debt instrument contains a substantive conversion feature as of both the time of issuance and the date the inducement offer is accepted.

Expanded Criteria for Induced Conversion

Prior to ASU 2024-04, the induced conversion guidance only applies to conversions that include the issuance of all equity securities issuable pursuant to the conversion privileges provided in the terms at issuance and it doesn’t apply to convertible debt instruments that can be settled partly or wholly in cash.

The ASU expands the criteria for induced conversions to include certain debt instruments other than those only convertible to equity securities. The amended guidance clarifies that for a settlement of a convertible debt instrument to be accounted for as an induced conversion, the inducement offer is required to preserve the form and amount of consideration issuable under the conversion privileges provided for in the terms of the existing debt instrument.

An entity should assess whether a settlement of convertible debt is accounted for as an induced conversion as of the date the inducement offer is accepted by the holder.

Preservation of the Form and Amount

It is common for a convertible debt instrument to require the issuer to settle the principal amount of debt in cash upon conversion, with an option to settle any conversion premium in either cash or stock. If the inducement offer provides for settlement in only shares, the criterion to require preservation of the form of the existing debt instrument wouldn’t be met as the inducement offer doesn’t offer cash consideration.

Changes that result in the amount of cash and number shares being indexed to something other than the future price of the issuer’s shares—for example, the fair value of a commodity—should be considered a change in the form of the settlement.

In addition, the criterion to require the preservation of the amount of the terms of the existing debt instrument wouldn’t be met if an inducement offer provides for an amount less than the amount issuable under the existing conversion privileges.

Incorporation, Elimination, or Modification of a VWAP

When determining whether the inducement offers preserves the form and amount of consideration, an entity is required to compare the amount of cash and number of shares issuable under the conversion privileges provided in the terms of the existing debt instrument with the amount of cash and number of shares issuable under the inducement offer.

Current GAAP doesn’t address how the incorporation, elimination, or modification of a volume-weighted average price (VWAP) formula interacts with this criterion.

The amendments clarify that the incorporation, elimination, or modification of a VWAP formula doesn’t automatically cause a settlement to be accounted for as an extinguishment and an entity should instead assess whether the form and amount of conversion consideration are preserved using the fair value of an entity’s shares as of the offer acceptance date.

One-Year Look-Back

When assessing whether a settlement of convertible debt should be accounted for as an induced conversion, the ASU requires entities to look back one year from the date of offer acceptance.

If the convertible debt instrument had been exchanged or modified without being deemed to be substantially different during the one-year look-back period, the entity is required to use the terms that existed one year prior to the offer acceptance to determine whether induced conversion accounting applies.

This amendment is intended to prevent the modification of instruments for the purpose of achieving a specific accounting outcome.

Debt Instruments Not Currently Convertible

The ASU clarifies that the induced conversion guidance applies to a convertible debt instrument that isn’t currently convertible as long as it had a substantive conversion feature as of both the issuance date and the inducement offer acceptance date.

To be considered a substantive conversion feature, the conversion feature must be at least reasonably possible of being exercised in the future absent the issuer’s exercise of a call option.

Effective Dates

The amendments are effective for all entities for annual reporting periods beginning after December 15, 2025, and interim periods within those annual periods.

Early adoption is permitted for all entities that have adopted ASU 2020-06.

Transition Requirements

The amendments permit an entity to apply the guidance on either a prospective or a retrospective basis.

Under the prospective transition approach, an entity should apply the amendments to any settlements of convertible debt instruments that occur after the effective date.

Under the retrospective transition approach, an entity should recast prior periods and recognize a cumulative-effect adjustment to equity as of the later of the beginning of the earliest period presented or the date the entity adopted ASU 2020-06.

We’re Here to Help

For more information on how the amended guidance may affect your business, contact your Moss Adams professional.

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