Convert Case Essay

1109 words - 5 pages

Convertme, Inc Wenjing Chen Convertme Inc. (Convertme) issued convertible debt with several features that call into question whether certain terms (conversion option and make-whole provisions) in the senior subordinated convertible notes (the notes) should be considered embedded derivatives. The holders of the notes can surrender them for cash or shares The principal amount must be settled in cash Convertme is required to pay a premium equal to interest that would have been payable during the lockout period if it decides to call the notes during the lockout period FAS 133, par. 12 “Embedded” derivative instruments—implicit or explicit terms that affect some or all ...view middle of the document...

_ (FAS 133, par.12, par. 61 k) k. Convertible debt. The changes in fair value of an equity interest and the interest rates on a debt instrument are not clearly and closely related. Thus, for a debt security that is convertible into a specified number of shares of the debtor’s common stock or another entity’s common stock, the embedded derivative (that is, the conversion option) must be separated from the debt host contract and accounted for as a derivative instrument provided that the conversion option would, as a freestanding instrument, be a derivative instrument subject to the requirements of this Statement. (For example, if the common stock was not readily convertible to cash, a conversion option that requires purchase of the common stock would not be accounted for as a derivative.) K. That accounting applies only to the holder (investor) if the debt is convertible to the debtor’s common stock because, under paragraph 11(a), a separate option with the same terms would not be considered to be a derivative for the issuer.-Criteria A is met FAS 133, par.11 (a) The reporting entity shall not consider the following contracts to be derivative instruments for purposes of this Statement: a. Contracts issued or held by that reporting entity that are both (1) indexed to its own stock and (2) classified in stockholders’ equity in its statement of financial position. EITF 00-19, par., 12-32 Conversion option is an embedded derivative instrument, and it requires cash payment to the principle settlement and offers choice of cash or share settlement for conversion spread (physical settlement or net-share settlement). According to EITF 00-19, par.8, and 12-32 (above), it should be accounted for as equity. Then according to FAS 133, par.11 (a), the contract meets the criteria of exception of derivative instrument, that is, the contract should not be accounted for as a derivative instrument for issuer. Thus, for issuers, the conversion option doesn’t meet the requirements to be accounted for as a separate embedded derivative. 12 (a) is not met because: FAS 133, par. 61 “d. Call options (or put options) that can accelerate the repayment of principal on a debt instrument are considered to be clearly and closely related to a debt instrument that requires principal repayments unless both (1) the...

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