An entity issues bonds that are convertible into a fixed number of its own ordinary shares at the holder's option, with no other embedded features that would independently require separation as a derivative. It wants to understand how this instrument would be accounted for at issuance under IAS 32, and separately, how it would be accounted for under current US GAAP following the FASB's 2020 simplification of convertible-instrument accounting (ASU 2020-06).
- Under current US GAAP, the issuer separates the instrument into a liability component and an equity component at issuance, the same approach IAS 32 has always required
- Both frameworks require the conversion option to be bifurcated and remeasured at fair value through profit or loss at every reporting date
- Under IAS 32, the issuer generally separates the instrument into a liability component and an equity component, the conversion option, at issuance; under current US GAAP following ASU 2020-06, the instrument is generally accounted for as a single liability with no separate equity component, unless another feature independently requires bifurcation as a derivative
- Under current US GAAP, the entire instrument is classified as equity; under IAS 32, the entire instrument is classified as a liability, with no split between the two
Why C? And why not the others?
Correct answer: C. Under IAS 32, the issuer generally separates the instrument into a liability component and an equity component, the conversion option, at issuance; under current US GAAP following ASU 2020-06, the instrument is generally accounted for as a single liability with no separate equity component, unless another feature independently requires bifurcation as a derivative
IAS 32 treats a convertible bond like this as a compound financial instrument and requires the issuer to split it at issuance into a liability component, representing the obligation to pay cash, and a residual equity component, representing the conversion option, each initially measured using a specified allocation approach. ASU 2020-06 moved current US GAAP in the opposite direction: it removed the separate accounting models that used to require pulling out a beneficial conversion feature or a cash conversion feature, so an instrument like this one is now generally accounted for as a single liability measured at amortized cost, with no separate equity component recognized, unless some other feature of the instrument independently meets the criteria in the derivatives guidance for bifurcation. The option claiming current US GAAP now mirrors IAS 32's split accounting is wrong because ASU 2020-06 moved US GAAP toward a single-instrument model, away from splitting. The option requiring fair-value-through-profit-or-loss bifurcation under both frameworks is wrong because IAS 32's equity component is not subsequently remeasured at fair value, and current US GAAP's single-liability model does not bifurcate a plain conversion option like this one at all. The option assigning the entire instrument to equity under US GAAP and entirely to a liability under IAS 32 is wrong because it misdescribes both frameworks: current US GAAP still recognizes the instrument as a liability, not equity, and IAS 32 splits the instrument rather than classifying all of it as a liability.
Source: IFRS Foundation, IAS 32 Financial Instruments: Presentation, paragraphs 28-32 (compound financial instruments, split accounting); FASB Accounting Standards Update No. 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity's Own Equity (Subtopic 815-40)