October 2009
Financial
Executive Summary ...........................1
Instruments in the Scope of
the FSP .........................................2
The Fair Value of the Liability
Component of Convertible
Debt ..............................................3
The Nonconvertible Borrowing
Rate ...............................................4
The Expected Life of the Debt ........4
Allocation of Transaction Costs ........4
Income Taxes ....................................5
Earnings per Share ..........................5
Disclosures.........................................5
Modification and Exchange ..............6
Derecognition ...................................6
EITF Topic D-98 (ASC 480-10)
and the FSP ...................................7
Interplay between Issue 07-5
(ASC 815-40) and the FSP ............7
Retrospective Adoption of the
FSP for SEC Registrants................8
For More Information ........................8
Example I –Accounting at Issuance
and at Subsequent Conversion
under the FSP................................9
Reporting
Accounting for Convertible Debt
Instruments that May Be Settled in Cash
Upon Conversion
Executive Summary
FASB Staff Position APB 14-1 (ASC 470-20), Accounting for
Convertible Debt Instruments That May Be Settled in Cash
Upon Conversion (the FSP), changed the accounting and dis-
closure for convertible debt instruments that permit or
require the issuer to pay cash upon conversion. The FSP
eliminated the perceived accounting benefits these con-
vertible instruments have enjoyed. Before the FSP became
effective, the conversion options on these instruments were
not separated and the treasury stock method of EPS calcu-
lation was allowed for the conversion spread. Consequently,
prior accounting for these instruments resulted in a lower
amount of interest expense and a less dilutive effect on EPS
compared with other similar instruments. Both the number
of instruments affected and the effect of the FSP are sig-
nificant.
Instruments in the scope of the FSP include convertible debt instruments that
may be settled, either partially or entirely in cash or other assets upon con-
version, and in which the conversion option is not required to be bifurcated
from the debt host. For these instruments, the liability component is meas-
ured first at the fair value of the liability without the conversion option, and
the difference between the proceeds from the instrument and the fair value
of the liability without the conversion option represents the residual equity
component. An example of such an instrument follows:
 Financial Reporting

Company A issues convertible debt and the conversion feature does not require bifurcation. When a convertible debt
holder decides to convert, the Company can settle in stock, cash, or a combination of the two, as it chooses. At issuance,
the Company measures the fair value of the liability component first, and the difference between the proceeds from
the instrument and the fair value of the liability without the conversion option represents the residual equity compo-
nent. Company A’s debt was issued with the following features in thousands of dollars:

• The Company issued $1,500 of 2% convertible debt on November 22, 2009 with a due date of November 22, 2014.
• Without the conversion feature, the Company would have paid a coupon rate of 8% on the debt.
• Interest on the $1,500 will be 2%, $30, payable annually. The principal is due November 22, 2014.
• The entire $1,500 note will be convertible at $15/share.

Company A selected the income method to value the liability component. The Company estimated the fair value of the
liability component without the conversion option by calculating the present value of its cash flows using a discount rate
of 8%, the market rate for similar notes with no conversion features, as follows in thousands of dollars:

The present value of the principal and interest payments over the 5 year life at 8% = $1,140
The residual allocated to equity = $360
Total $1,500

During the 5-year life of the note, Company A recognizes $510 in interest expense, consisting of $150 of cash interest
payments ($30*5=$150) and $360 of discount amortization. The present value of the annual interest payments of $30
for 5 years and the principal payment of $1,500 at the end of the 5th year at the company’s nonconvertible borrowing
rate of 8%=$1,140. The residual allocated to equity is $1,500-$1,140=$360; this $360 represents the discount resulting
from the application of the FSP that is amortized over the 5-year life.

The FSP is effective for fiscal years
beginning after December 15, 2008.
The transition guidance requires
retrospective application to all peri-
ods presented. It therefore applies
to instruments that were outstand-
ing during any of the periods pre-
sented in a company’s financial
statements, including instruments
that have been paid off or con-
verted prior to the effective date of
the FSP.
Instruments in the
Scope of the FSP
The FSP is a complex set of guid-
ance that significantly affects debt
instruments (commonly referred to
as Instruments B, C, and X1) that
have the following features:
• Instrument B – Upon conversion,
the issuer may satisfy the entire
obligation in either stock or cash
equivalent to the conversion
value;2
• Instrument C – Upon conversion,
the issuer must satisfy the
accreted value3 of the obligation
in cash and may satisfy the con-
version spread in either cash or
stock; and
• Instrument X – Upon conversion,
the issuer may satisfy the entire
obligation in any combination of
cash and shares at the issuer’s
option.
Also, the FSP significantly affects
accounting for beneficial conver-
sion features. EITF Issues 98-5 (ASC
470-20), Accounting for Convertible
Securities with Beneficial Conversion
Features or Contingently Adjustable
Conversion Ratios, and 00-27 (ASC
470-20), Application of Issue No. 98-5 to
Certain Convertible Instruments, will no
longer apply to instruments within
the scope of the FSP because the
conversion feature will be
accounted for separately from the
liability component .
Convertible preferred shares that
are mandatorily redeemable finan-
cial instruments are classified as
liabilities under FASB Statement
150 (ASC 480-10), Accounting for

1 The references are primarily from EITF Issue 90-19 (ASC 815-15), Convertible Bonds with Issuer Option to Settle for Cash upon Conversion. The FSP superseded Issue 90-19 (ASC
815-15).
2 Conversion value is defined as the market value of the underlying shares into which convertible debt can be exchanged. Conversion value is calculated by multiplying
the number of shares that can be obtained by the market price per share. Debt that can be converted into 50 shares of stock with a market price of $10 each has a con-
version value of $500.
3 Accreted value is defined as the current carrying value of debt with an original-issue discount that takes into account imputed interest that has accumulated since issuance.

COPYRIGHT 2009, BDO SEIDMAN, LLP 2


Certain Financial Instruments with
Characteristics of Both Liabilities and
Equity, because they require a cash
settlement at maturity. If these
instruments may be converted for
cash (in whole or in part), they are
also within the scope of the FSP.
For example, an Instrument C in
the form a mandatorily redeemable
preferred share would be within the
scope of the FSP.
Instruments outside the scope
of the FSP include:
• Convertible debt instruments
with embedded conversion
options that are accounted for
separately as a derivatives under
FASB Statement 133 (ASC 815-
10), Accounting for Derivative
Instruments and Hedging Activities;
• Convertible preferred shares that
are accounted for in equity or in
temporary equity;
• Convertible debt that requires
settlement only in the issuer’s
own stock;
• Convertible debt that requires or
allows settlement of fractional
shares in cash;
• Convertible debt that allows for
settlement in cash or shares in
circumstances in which holders
of the underlying shares also
would receive the same form of
consideration, for example, in a
change-of-control transaction;
and
• Convertible debt that settles in
cash at maturity at its principal
amount.
The Fair Value of the
Liability Component of
Convertible Debt
For instruments within the scope of
the FSP, companies are required to
determine the carrying amount of
4 For financial instruments that were issued before Statement 157 became effective, companies can use preexisting GAAP to
measure fair value that is generally entity-specific and based on entry price.
the liability component of convert-
ible debt at issuance by measuring
the fair value of a similar liability,
without the conversion option, but
including any other embedded fea-
tures that may be present in the
instrument. This represents the
measurement of the nonconvert-
ible liability at fair value using
information available at the
issuance date. Once determined,
this fair value is not subject to
revaluation at a later date. Only
embedded features that are sub-
stantive should be included in the
initial measurement of the liability
component. Embedded features
are considered nonsubstantive if,
at issuance, the company con-
cludes that it is probable that the
embedded feature will not be exer-
cised.
BDO Insight: As a reminder on fair
value measurement, companies
that issued financial instruments
on or after the effective date of
FASB Statement 157 (ASC 820-10),
Fair Value Measurement, should
measure the fair value of the lia-
bility component using Statement
1574. Determining this fair value is
not necessarily straight forward
especially since embedded put and
call options are very common in
these instruments. Companies may
therefore have trouble determin-
ing which options are substantive,
calculating the fair value of a loan
with these features, and determin-
ing the effect of the options on the
expected life of the liability com-
ponent. Information such as the
price of a similar liability, or inputs
to valuation techniques, are not
always readily available and may
be particularly challenging to
obtain if the company’s credit rat-
COPYRIGHT 2009, BDO SEIDMAN, LLP 3
Financial Reporting
ing is below investment grade. A
best practice is to begin the valua-
tion process early and to consider
using a valuation specialist.
The company may use the follow-
ing approaches, available under
both Statement 157 (ASC 820-10)
and preexisting GAAP, to determine
the fair value of a nonconvertible
liability:
Market approach – Identify the
fair value of comparable
liabilities
In practice, companies may find it
difficult to use a market approach
to determine the fair value of a sim-
ilar liability because debt with the
same rights and obligations (e.g.,
call/put rights, other embedded
features, maturity date, specific
covenants, etc.) might not exist at
date of issuance of those instru-
ments. Under this approach, com-
panies should consider the differ-
ences in the nature of the noncon-
vertible debt being fair valued when
compared with the debt being used
to determine the fair value. These
can include features such as sen-
iority, issuance date, put or call
options, and collateral provisions.
The rate differences associated with
the differences in features should
be determined using independent
market data.
Income approach - Discount
cash flows at the nonconvertible
interest rate of comparable
liabilities to determine the fair
value
Companies can use an income
approach and also can derive infor-
mation for inputs to a valuation
technique using a lattice model. As
a result, it is possible for a com-

pany to determine the fair value of
their convertible debt based on the
fair value of a hypothetical instru-
ment with similar features.
If the convertible debt includes
embedded put and or call options
that require bifurcation, after the
company has valued the liability
component with these features, it
must bifurcate the options. The
bifurcated put and or call options
should then be recorded at fair
value as a single compound deriv-
ative. The valuation of the liability
component and the embedded put
and call features may be compli-
cated and may require a valuation
specialist. Bifurcation of an embed-
ded put and or call option from the
liability component does not affect
the accounting for the equity com-
ponent.
The Nonconvertible
Borrowing Rate
One key factor for determining the
fair value of the liability at the date
of issuance is the nonconvertible
debt borrowing rate. The rate may
be estimated by one or a combina-
tion of the following methods:
• Determining the borrowing rate
of the company’s other financing
arrangements on existing non-
convertible debt. These rates
would only be appropriate if the
borrowings and the convertible
debt had comparable attributes
such as issuance date, term, sen-
iority of the debt, and substan-
tive embedded features such as
put or call options;
• Considering the borrowing rate
for nonconvertible debt with
comparable attributes such as
those listed above issued by peer
companies. Peer companies
should be similar in size, nature
and financial profile (e.g., credit-
worthiness). A company could
obtain this information from the
market based on trading prices,
investment bank data, and pos-
sibly from other unrelated par-
ties; and/or
• Generating the rate using a
model such as a lattice model.
Companies that use models to
derive the nonconvertible bor-
rowing market rate should con-
sider factors similar to those
mentioned in the preceding
paragraphs.
The Expected Life of
the Debt
Determining the expected life of
the debt is important for the fol-
lowing reasons:
• The debt discount and debt
issuance costs are amortized
over the expected life. The debt
discount includes the amount
allocated to the equity compo-
nent (the residual of the pro-
ceeds at issuance after fair valu-
ing the debt component) plus
the fair value of any bifurcated
embedded derivatives.
• If the income approach is used to
measure the fair value of the lia-
bility component at initial recog-
nition, the expected life is a nec-
essary input.
The FSP requires companies to
match the amortization period for
the debt discounts and debt
issuance costs to the expected life
of similar debt that does not have a
conversion right. The FSP further
notes that if the income approach
was used, this expected life should
be consistent with the period over
which the discounted cash flow was
measured.
The company should identify all
substantive embedded features in
the debt at issuance, other than the
COPYRIGHT 2009, BDO SEIDMAN, LLP 4
Financial Reporting
conversion option, to determine if
they affect the expected life in addi-
tion to determining whether the
feature requires bifurcation under
Statement 133 (ASC 815-10), Issue
07-5 (ASC 815-40), and Issue 00-19
(ASC 815-40).
The company may determine
that the expected life of the debt is
shorter than the contractual life if
the debt includes a substantive put
option. Generally, companies con-
clude that the expected life is
through the first put date unless
interest rates are expected to drop
significantly such that it would be
beneficial for holders to continue
to hold onto the debt. Companies
generally do not shorten the debt’s
expected life for a call option
because there is a low coupon rate
associated with these instruments.
In accordance with the FSP, com-
panies do not reassess the
expected life of the liability in peri-
ods subsequent to issuance unless
the terms of the instrument are
modified. Therefore, the reported
interest expense for an instrument
should be determined based on the
stated interest rate (i.e., coupon
payments) once the debt discount
is fully amortized (e.g., when the
debt remains outstanding after the
first put date).
Allocation of
Transaction Costs
The FSP requires direct transaction
costs incurred with third parties
other than investors, such as attor-
ney fees, to be allocated between
the liability and equity compo-
nents. The allocation should be
based on the proportion that each
component represents of total pro-
ceeds at issuance.
 Financial Reporting

BDO Insight: In the example above, from the reversal of the deferred numerator and would be higher
the company issued $1,500 of con- tax liability, but also the current tax since the interest expense
vertible debt; $1,140 (76%) was benefit of deducting the contrac- increases under the FSP.
allocated to liability, and $360 tual interest. Incremental shares would be
(24%) was allocated to equity. If If a company settles convertible included in the denominator if
transaction costs were $100, the debt, a book gain or loss is recog- the conversion option is in the
company would capitalize $76 as nized upon extinguishment. At the money. The treasury stock
debt issuance costs and would same time, the company should method would be used for:
treat $24 as equity issuance costs record a deferred tax benefit and – Instrument C – Assumes that
that reduce equity at the time of reverse any residual deferred tax the company claims net share
the transaction.  liability that had been recorded. settlement of the conversion
spread.
Income Taxes Earnings per Share
When companies recognize both a The FSP does not change the basis
Disclosures
debt and an equity component, on which a company assumes Under the FSP, companies should
there is generally a basis difference share settlement or cash settle- disclose the following:
associated with the liability com- ment of the debt for EPS purposes5.
ponent that represents a tempo- Companies should continue to use At each balance sheet date:
rary difference for purposes of the if converted method for instru- • The carrying amount of the
applying FASB Statement 109 (ASC ments that have full share settle- equity component; and
740-10), Accounting for Income Taxes. ment and the treasury stock • The principal amount of the note,
The FSP directs companies to rec- method for instruments with partial its unamortized discount, and its
ognize the initial deferred taxes for share settlement. As such, the EPS net carrying value.
the tax effect of that temporary dif- methods should be applied as
ference as a charge to additional follows: For the most recent balance sheet
paid-in capital and a credit to • If converted method – Interest date:
deferred tax liability. This account- expense added back to the numer- • The remaining amortization
ing only applies if the company ator would be higher since the period for the debt discount on
does not have a full valuation interest expense increases under the liability component;
allowance under Statement 109 the FSP due to amortization of • The conversion price and number
(ASC 740-10). The FSP, like EITF debt discount. This method would of shares used to determine the
Issue 05-8 (ASC 740-10), Income Tax be used for (Instruments are aggregate consideration to be
Consequences of Issuing Convertible Debt defined on page 2): delivered upon conversion;
with a Beneficial Conversion Feature, – Instrument B – Assumes share • The excess of the instrument’s if-
directs companies to recognize a settlement; and converted value over the princi-
deferred tax liability on the differ- – Instrument X – Assumes that pal amount, regardless of
ence between the tax and account- the company claims full share whether the instrument is cur-
ing basis of debt. settlement. rently convertible (NOTE: this
Over the life of convertible debt, • Treasury stock method – disclosure is required only for
the company’s deferred tax liability Companies should continue to public entities);
is reduced, and a deferred tax ben- use the treasury stock method • Information about derivative
efit is recognized as the debt dis- for those instruments that allow transactions entered into in con-
count is amortized. The company’s only the conversion spread to be nection with the issuance of
total income tax benefit includes settled in shares of stock. Interest instruments in the scope of the
not only the deferred tax benefit expense would remain in the FSP, including:

5 Also, the FSP does not affect how EITF Topic D-72 (ASC 260-10), Effect of Contracts That May Be Settled in Stock or Cash on the Computation of Diluted Earnings per Share, is applied.
Topic D-72 notes that for contracts that provide the company with a choice of settlement methods, the company should assume that the contract will be settled in
shares. The company can overcome this presumption if past experience or a stated policy provides a reasonable basis to believe that it is probable that the contract will
be paid partially or wholly in cash. For contracts in which the counterparty controls the means of settlement, past experience or a stated policy is not determinative.
Accordingly, in those situations, companies should use the more dilutive of cash or share settlement.

COPYRIGHT 2009, BDO SEIDMAN, LLP 5


– The terms of those derivative
transactions;
– How those derivative transac-
tions relate to the instruments;
– The number of shares underly-
ing those transactions; and
– The reasons for entering into
those transactions.
For each income statement period
presented, the company should
disclose the following:
• The effective interest rate on the
liability component for the
period; and
• The amount of interest expense
recognized for the period relating
to both the contractual coupon
rate and the amortization of the
discount on the liability compo-
nent disclosed on a disaggre-
gated basis.
If the company is a public com-
pany, it should consider whether
the accounting for the convertible
debt represents a critical account-
ing estimate and, if it does, include
a discussion of the estimate in the
critical accounting policies section
of Management’s Discussion and
Analysis of Financial Condition and
Results of Operations.
Modification and
Exchange
The FSP does not change the guid-
ance on debt restructuring, extin-
guishment, or modification
accounting in FASB Statement 15
(ASC 470-60), Accounting by Debtors
and Creditors for Troubled Debt
Restructurings, and EITF Issue 96-19
(ASC 470-50), Debtor’s Accounting for
a Modification or Exchange of Debt
Instruments as amended by EITF
6 Substantially different is defined by the following three tests. See Issue 96-19 (ASC 470-50) for specifics:
• Ten percent or more difference in cash flows;
• Value of embedded conversion option difference is ten percent or more; or
• There is the addition or elimination of a substantive conversion option.
Issue 06-6 (ASC 470-50), Debtor’s
Accounting for a Modification (or
Exchange) of Convertible Debt Instru-
ments. If a company modifies its
convertible debt, it must analyze
the change, first considering
whether it is a troubled debt, and if
not, concluding whether it is an
extinguishment or modification. If
the company concludes that the
change is to be accounted for as
an extinguishment, then the com-
pany derecognizes the original con-
vertible debt instrument (see the
Derecognition section below).
If a company concludes that a
change to convertible debt is a
modification (i.e., the modified
debt is not substantially different6),
and the modification is an addition
or elimination of a cash settlement
feature, then the company should
perform the following accounting:
• Addition of a cash settlement
feature – A company adds a cash
settlement feature to convertible
debt that was not within the
scope of the FSP. For example, a
company modifies a convertible
debt instrument to change the
stock settleable conversion
option to a conversion option
that can be settled either in stock
or cash at the company’s option.
In this situation, the liability and
equity allocation guidance of the
FSP should be applied prospec-
tively from the date of the modi-
fication.
The company determines the
fair value of the liability compo-
nent as of the modification date.
The amount of the equity com-
ponent is then determined by
deducting the fair value of the
liability component from the
overall carrying amount of the
COPYRIGHT 2009, BDO SEIDMAN, LLP 6
Financial Reporting
convertible debt instrument as
of the date of modification. At
that date, a portion of any
unamortized debt issuance costs
should be reclassified and
accounted for as equity issuance
costs based on the proportion
of the overall carrying amount of
the convertible debt instrument
that is allocated to the equity
component.
• Removal of a cash settlement
feature – A company changes a
convertible debt instrument to
remove a cash settlement fea-
ture, and because the instrument
is no longer settled either par-
tially or entirely in cash upon
conversion, the instrument is no
longer within the scope of the
FSP. In this situation, the com-
pany should continue to account
for the components of the instru-
ment separately and continue to
amortize the recorded debt dis-
count. For example, a company
modifies the conversion option
on convertible debt within the
scope of the FSP to remove the
cash settlement feature and
replace it with share settlement.
The company should continue to
separately account for the debt
and equity components, should
reassess the expected life of the
liability, and continue to amor-
tize the debt discount. If the com-
pany determines that the life of
the liability should change, the
company should modify the
effective interest rate accordingly.
Derecognition
Companies with convertible debt
instruments within the scope of the
FSP should account for conversions

into common stock or extinguish-
ments as settlements in which the
liability component is extinguished
and the equity component is reac-
quired. Consequently, regardless of
the form of the consideration trans-
ferred in the settlement (e.g., con-
version to equity shares, repayment
in cash, etc.), the fair value of that
consideration is attributed to the
liability and equity components in
the same manner as the initial pro-
ceeds were allocated. In other
words, the consideration is meas-
ured at fair value and allocated to
the liability component based on
the liability’s fair value at the set-
tlement date. Any remaining con-
sideration is attributed to the reac-
quisition of the equity component
and recognized as a reduction of
stockholders’ equity. The result is
that a gain or loss is recognized
upon conversion, or upon any other
settlement, equal to the difference
between the fair value and the car-
rying amount of the liability com-
ponent at the conversion/settle-
ment date.
Transaction costs incurred from
third parties other than investors
that relate directly to the settle-
ment of a convertible debt instru-
ment within the scope of the FSP
should be allocated to both the lia-
bility and equity components. The
costs should be allocated in pro-
portion to the settlement amount
allocated to each component. The
costs allocated to the debt compo-
nent should be charged to expense
in the period of derecognition and
those allocated to the equity com-
ponent should reduce equity.
EITF Topic D-98
(ASC 480-10) and
the FSP
After the FSP was issued, the SEC
staff updated EITF Topic D-98 (ASC
480-10), Classification and Measurement
of Redeemable Securities. Topic D-98
(ASC 480-10) addresses the classi-
fication of the equity component
of convertible debt instruments for
registrants, and affects instruments
within the scope of the FSP. If the
issuer can be required to settle
convertible debt that is within the
scope of the FSP (i.e., the instru-
ment is redeemable at the current
balance sheet date for cash), then a
portion of the equity component
may be required to be classified in
temporary equity. This is the case if
the redemption or conversion
amount is greater than the carrying
amount of the liability component
at the balance sheet date. The
amount reported in temporary
equity should generally be the dif-
ference between the redemption or
conversion amount and the carry-
ing amount of the liability.
BDO Insight: If at the balance sheet
date Company D’s convertible debt
is currently redeemable for $117,
and the liability component is cur-
rently $90, the company should
report its temporary equity at
$27.
Interplay between
Issue 07-5 (ASC 815-
40) and the FSP
Both the FSP and Issue 07-5 (ASC
815-40) were effective for fiscal
years beginning after December 15,
2008. The FSP applies to convert-
ible debt in which the conversion
option is not required to be bifur-
cated and for which the issuer can
settle the converted debt com-
pletely or partially in cash. Issue
07-5 (ASC 815-40) provides revised
guidance for determining whether a
conversion option or warrant is
indexed to a company’s own stock.
COPYRIGHT 2009, BDO SEIDMAN, LLP 7
Financial Reporting
Instruments with certain price reset
features are not considered to be
indexed to a company’s own stock,
and consequently these instru-
ments must be accounted for as
derivatives and marked to market
each reporting period. Many com-
panies hold financial instruments
that are within the scope of both the
FSP and Issue 07-5. In this situa-
tion, the FSP should be applied first,
retrospectively to all periods pre-
sented in the financial statements
per the transition provisions of the
FSP. Issue 07-5 (ASC 815-40) should
be applied second, and should be
applied through a cumulative effect
adjustment to the opening balance
of retained earnings on the date of
adoption.
Issue 07-5 (ASC 815-40) also
requires application from the orig-
inal issuance date of the instru-
ments within its scope. However,
this is done by way of a cumulative
effect adjustment to the opening
balance of retained earnings (or
other appropriate components of
equity or net assets in the state-
ment of financial position) on the
date of adoption and, unlike the
FSP, historical periods are not
required to be restated. The cumu-
lative effect adjustment on the date
of Issue 07-5 (ASC 815-40) adop-
tion (January 1, 2009 for calendar
year companies) would therefore
be the difference between:
• Amounts recognized in the
restated statement of financial
position, adjusted for retrospec-
tive adoption of the FSP; and
• Amounts that would have been
recognized at the date of adop-
tion of Issue 07-5 (ASC 815-40) as
if the issue had been applied
from the applicable instruments’
original issuance date.

Retrospective Adoption
of the FSP for SEC
Registrants
The FSP states that it should be
applied retrospectively to all peri-
ods presented. We are aware that
the SEC staff accepts the following
approaches regarding the applica-
tion of the FSP in the selected
financial data tables:
• Financial Statement Approach7 –
Apply the FSP to the convertible
debt instruments that were out-
standing during any of the peri-
ods presented in the audited
financial statements included in
the registrant’s current year Form
10-K (i.e., 3 years for accelerated
filers, 2 years for smaller report-
ing companies). For these instru-
ments, the FSP should be
applied to the convertible debt
from its date of issuance.
Companies would correspond-
ingly restate the selected finan-
cial data table for these instru-
ments for the 3 or 2 year period
(depending on their filing status
and, if they are a smaller report-
ing company, whether they vol-
untarily provide such a table).
They would alert users in a note
to the table that these periods
in the table are not comparable
to the prior periods. The
amounts in the table would
reflect the cumulative effect of
applying the FSP to debt out-
standing during the periods pre-
sented in the financial state-
ments as an adjustment to the
opening retained earnings8 of the
first period presented in the
audited financial statements.
7 The names of the approaches are names we have designated for convenience. They are not generally recognized and should not be used when describing the approach
in a filing.
8 Or other appropriate components of equity or net assets in the statement of financial position.
• Selected Financial Data Table
Approach7 – Apply the FSP to the
convertible debt instruments
that were outstanding during any
of the periods presented in the
selected financial data table in
the registrant’s Form 10-K, i.e.,
the past five years required to be
presented or such longer period
as the registrant elects to pres-
ent. Under this approach, the FSP
would be applied to the convert-
ible debt from the date of
issuance for any instruments out-
standing during any period
included in the table. The
amounts in the table would
reflect a cumulative effect adjust-
ment made to the opening
retained earnings8 of the first
period presented in the periods
covered by the table. It should
be noted that if this approach is
used and the FSP is applied to
convertible debt instruments
that were extinguished or con-
verted prior to the period cov-
ered by the audited financial
statements, the cumulative effect
adjustment reflected in the
audited financial statements will
be different from that under the
Financial Statement Approach.
Under this approach, the
selected financial data table is
comparable for the instruments
that were outstanding during the
period included in the table.
BDO Insight: In the notes to the
financial statements, as part of the
transition disclosure required by
paragraph 39 of the FSP, a regis-
trant should disclose which
approach it selected to implement
COPYRIGHT 2009, BDO SEIDMAN, LLP 8
Financial Reporting
the FSP, how the transition provi-
sions were applied, and the rea-
sons for electing the approach
applied (e.g., if the company had a
number of instruments affected by
the FSP in all of the past five years,
the selected financial data
approach affords greater compa-
rability). In a note to the selected
financial data table, the registrant
should disclose any lack of compa-
rability in the table resulting from
using the Financial Statement
Approach. Registrants are not
required to quantify the effect of
any inconsistency resulting from
the adoption of the FSP.
For More Information
If you would like further informa-
tion or to discuss the implications
of the matters discussed in this
Financial Reporting letter, please
contact the BDO Seidman engage-
ment partner serving you or one of
the following:
Leland Graul
lgraul@bdo.com
(312) 616-4667
Reva Steinberg
rsteinberg@bdo.com
(312) 616-4658
Liza Prossnitz
lprossnitz@bdo.com
(312) 233-1818
Material discussed in this Financial Reporting
letter is meant to provide general informa-
tion and should not be acted upon without
first obtaining professional advice appro-
priately tailored to your individual circum-
stances.
 Financial Reporting

Appendix
Example I –
Accounting at Issuance and at Subsequent Conversion under the FSP
Company B issues 15-year convertible debt at par for proceeds of $2,000 on January 1, 2009. The debt is convertible at any time into
shares of Company B’s common stock at a stated conversion price of $10 per share. The quoted market price of Company B’s com-
mon stock is $7 per share on the date of issuance. The par value of Company B’s common stock is $1. Upon conversion, Company
B can elect to settle the entire if-converted value (the principal amount of the debt plus the conversion spread) in cash, common
stock, or any combination thereof.

The debt is callable and puttable at par after the tenth year. The Company pays interest annually at the end of each year at a rate
of 2 percent on the principal amount or $40 per year. The Company’s nonconvertible borrowing rate is 9 percent which is the rate it
would pay for debt with terms similar to the convertible debt that is callable, puttable, and without a conversion feature. The matu-
rity date is December 31, 2023.

On January 1, 2014, when the quoted market price of Company B’s common stock is $14, all holders of the convertible notes exer-
cise their conversion options. The investors are entitled to aggregate consideration of $2,800. At settlement, the market interest rate
for debt with similar terms and features but without a conversion option is 8 percent.

For purposes of the example, issuance costs and income taxes have been ignored. The only features embedded in the debt are the
put, call, and conversion options.

1. What is the accounting for the liability component and the conversion option component of the
convertible debt at issuance by the issuer?

Step 1 – Company B concludes that the embedded conversion option, the embedded put, and the embedded call do not require
bifurcation, and that the convertible debt is within the scope of the FSP.

Step 2 – Company B applies the FSP and calculates the liability component of the convertible note first, by calculating the expected
present value of 10 years of $40 interest payments and the payment of $2,000 at the end of the tenth year at the Company’s non-
convertible interest rate of 9%. The Company uses the expected life of 10 years rather than the contractual life of 15 years. The
Company’s nonconvertible debt has terms and features that are similar to the convertible debt, including embedded put and embed-
ded call options, and consequently the Company concludes that 9% is the most appropriate rate to use in the computation. The
Company has decided to use an income approach to measure the liability; it could also have chosen to use a market approach. The
fair value of the liability component at January 1, 2009 is $1,102. The $898 difference between the proceeds from the issuance of
the notes and the fair value of the liability is assigned to the equity component.

Reported Interest Expense Carrying Amount of Debt

For the Year Ended At the Balance Sheet Date
Before FSP 14-1 Under FSP 14-1 Before FSP 14-1 Under FSP 14-1
January 1, 2009 $2,000 $1,102
December 31, 2009 $40 $99 $2,000 $1,161
December 31, 2010 $40 $105 $2,000 $1,226
December 31, 2011 $40 $110 $2,000 $1,296
December 31, 2012 $40 $117 $2,000 $1,373
December 31, 2013 $40 $124 $2,000 $1,457
December 31, 2014 $40 $130 $2,000 $1,547
December 31, 2015 $40 $139 $2,000 $1,646
December 31, 2016 $40 $148 $2,000 $1,755
December 31, 2017 $40 $158 $2,000 $1,873
December 31, 2018 $40 $168 $2,000 $2,000
Total Interest Expense
Jan 1, 2009 to
Dec 31, 2018 $400 $1,298

COPYRIGHT 2009, BDO SEIDMAN, LLP 9

 Financial Reporting

Example I –
Accounting at Issuance and at Subsequent Conversion under the FSP (continued)
Step 3 – Company B records the following entry at initial recognition :

Entry at January 1, 2009:

Cash $2,000
Debt discount $ 898
Debt $2,000
APIC $ 898

Company B’s convertible notes contain an embedded call and put that can be exercised at the end of the tenth year. As discussed
above, if a company concludes that features embedded in convertible debt are nonsubstantive because it is probable that they will
not be exercised, then these features should not be included in the determination of the expected life of the convertible debt.
Company B concludes that the put is substantive and consequently that the expected life is the same as the life of the put, ten years.
The Company uses the ten-year period to measure the fair value of the liability, and also uses the ten-year period for calculating
interest using the effective interest method. During the ten years ending December 31, 2018, the Company recognizes $1,298 of inter-
est expense consisting of $400 of cash interest payments and $898 of discount amortization under the effective interest method.

In this example, Step 3 will change if the embedded put and call features require bifurcation. After a company identifies the fact that
the embedded features require bifurcation, the order of the steps is as follows:
a. Apply the FSP to separate the liability component, including the put and call features other than the conversion option, from
the equity component.
b. Separate the put and call from the liability component in accordance with Statement 133 and its related interpretations (ASC
815-10).These put and call option derivatives would be allocated their full fair value and bifurcated from the liability compo-
nent as a single compound derivative. The valuation of the liability component and the embedded put and call features may
be complicated and may require a valuation specialist. Separation of an embedded derivative from the liability component
does not affect the accounting for the equity component.

2. What is the accounting for the liability component and the conversion option component by the
issuer at conversion on January 1, 2014?
Company B settles the note on January 1, 2014, and consequently derecognizes the debt component and reacquires the equity com-
ponent. The Company’s first step is to measure the fair value of the liability component immediately prior to extinguishment by cal-
culating the expected present value of 5 years of $40 interest payments and the payment of $2,000 at the end of the fifth year at the
Company’s nonconvertible interest rate of 8% or $1,520. The Company’s nonconvertible debt has terms and features that are sim-
ilar to the convertible debt, including embedded put and embedded call options, and consequently the Company concludes that
8% is an appropriate rate to use in determining fair value.

As noted above, the fair value of the aggregate consideration due to the investors is $2,800. The amount attributable to the equity
component is $2,800 - $1,520 or $1,280. Whether the consideration is cash, common stock, or a combination of the two, $1,520 will
be attributed to the extinguishment of the liability and $1,280 would be attributed to the reacquisition of the equity. Since Company
B was carrying the debt at $1,457 on December 31, 2013, the Company would incur a loss of $63 ($1,520 - $1,457) upon settlement
of the debt.

At settlement, Company B would record the following assuming it elects to transfer consideration to the convertible debt holder in
the form of $2,000 in cash and 57 shares of common stock with a fair value of $800 (par of $57 and APIC of $743). The $1,280 decrease
to APIC for the reacquisition of the conversion option and the $743 increase to APIC from the issuance of common stock at conver-
sion are presented gross in this journal entry for clear presentation.

Entry at January 1, 2014:

Debt $1,457
APIC – conversion option $1,280
Loss on extinguishment $ 63
Cash $2,000
Common stock at par $57
APIC – share issuance $743

COPYRIGHT 2009, BDO SEIDMAN, LLP 10