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Accounting for Convertible Equity


How do you account for convertible equity?   I'm familiar with the structure (it honestly doesn't seem as new as the pundits are punting), but haven't done it...until now I am giving it consideration for one of my companies (thus, Anonymously asked).

Descriptions are available below: my question is, if a Preferred round comes in, how do you allocate the investment across Preferred, Common, APIC and other?  I am honestly flummoxed by this one, so appreciate the help.

Cheers, and thanks!



James Quinlan
Title: Partner
Company: Corporate Finance Group, inc.
(Partner, Corporate Finance Group, inc.) |

The accounting for an instrument like this can be really complex and each instrument is a little different. And there really is no one set journal entry.

The first step is to determine if the instrument is a liability or equity under ASC 480. A common feature that causes liability classification is when the instrument converts into a variable number of shares based upon a fixed dollar amount. (ie. the convertible equity is convertible into a number of shares upon IPO by dividiing $1 million by the per share price of IPO).

If the instrument qualifies as equity under ASC 480. You would then have to assess whether or not the instrument has any beneficial conversion features.

Phil Bolles
Title: Chief Financial Officer
Company: Global Commercial Strategies Group
(Chief Financial Officer, Global Commercial Strategies Group) |

I agree with James regarding the complexity and unique nature of each instrument. His advice is a good starting point but, unless you have in-depth experience working with hybrid financial instruments, your chance of success in determining the accounting based on the ASC is extremely limited. I have seen a simple clause within a complex sentence in an obscure paragraph send a hybrid financial instrument into the onerous accounting for derivatives.

The best advice that I can give you is "get a professional" to analyze the instrument in detail and prepare the position paper. If you get a good professional to analyze the current instrument and prepare the position paper, you should be in a better position to handle the accounting for future hybrid financial instruments by learning from his/her work. Again, each instrument is unique, but a professional position on the first one will provide a solid foundation for the future. In addition, you may develop a relationship that will allow you to access the same professional from time to time with specific questions about new transactions.

When clients bring me a transaction for analysis and accounting after it has been executed, they must "live with" the accounting result. Frequently, if they bring me a transaction in the draft stage, I can advise the ways to avoid some accounting and financial reporting pitfalls to minimize the impact on periodic accounting while, at the same time, assuring the the intended financial result is obtained. Fortunately, you are considering the accounting issues before completing the transaction.

Good luck!

(Director of Global Accounting) |

Good stuff (and apologies for the vagueness of the original question).
So, probably drop it into "liabilities" as a pure play until the accounting gets sorted, and make sure I disclose the heck out of it to investors. ;-)

It will likely have some fixed conversion features, but likely no alternative redemption features. Honestly I think the investors will push back for convertible debt (I would)... but we shall see.


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