Convertible Note Classifier (post-ASU 2020-06)
Single liability, bifurcated derivative, or substantial premium? Walk the ASC 815-15 / 815-40 decision tree exactly as your auditor will.
Guide: an equity-conversion feature carries equity-price risk; a debt host carries interest-rate/credit risk — they are NOT clearly and closely related.
See how it works
Informational only — not audit, attest, legal, tax, or investment advice. Embedded-derivative conclusions depend on the actual contract language of the note; confirm with your auditor and a technical accounting advisor before filing. Unfolding Values is not an audit firm.
Convertible note classification after ASU 2020-06
ASU 2020-06 simplified convertible debt accounting — and created a new failure mode. With the beneficial-conversion-feature and cash-conversion models gone, most convertible notes are now a single liability measured at amortized cost, and teams have learned to expect that answer. But the two remaining exceptions carry real consequences, and small-cap financing terms trip them constantly.
The first exception is bifurcation. Under ASC 815-15-25, an embedded conversion feature is separated as a derivative when it is not clearly and closely related to the debt host, the hybrid is not already at fair value through income, the feature would be a derivative on its own, and no scope exception applies. The exception that usually decides the outcome is ASC 815-10-15-74(a): a contract both indexed to the issuer's own stock (the two-step ASC 815-40-15 analysis) and classifiable in stockholders' equity (the ASC 815-40-25 settlement conditions) escapes derivative treatment. Step 1 screens exercise contingencies tied to unrelated markets or indexes; Step 2 is the fixed-for-fixed test. A conversion price set as a discount to a future VWAP or lowest trading price fails Step 2 — the classic "death spiral" note — and the feature becomes a derivative liability remeasured through earnings every quarter, a volatility machine sitting in the P&L.
The second exception is the substantial premium model (ASC 470-20-25): a note issued at a substantial premium over principal records the premium in additional paid-in capital, with roughly 10% serving as the undefined-but-customary threshold.
This classifier walks your note's actual terms through the same decision tree your auditor will apply — host analysis, scope exception, indexation steps, settlement conditions, premium check — and explains each branch with the governing paragraph. It runs entirely in your browser; deal terms are never uploaded unless you save them.
What this tool does not do
Embedded-derivative conclusions turn on the actual contract language of the note - conversion mechanics, adjustment provisions, registration rights, make-whole tables, default clauses. This tool walks the decision tree from your characterization of those terms; auditors read the note itself. Each ancillary feature (puts, calls, contingent interest, default step-ups) needs its own ASC 815-15 analysis, equity-classification and net-settlement conclusions are reassessed every reporting period, and a bifurcated derivative brings a Level 3 valuation your auditor's valuation team will challenge. Confirm before filing.
- Read the actual note agreement - adjustment provisions and settlement mechanics drive the answer
- Fair value the bifurcated derivative (Monte Carlo / lattice for VWAP-based features) or build the debt-discount accretion schedule
- The separate put/call clearly-and-closely-related four-step decision sequence (815-15-25-42) - flagged, not computed
- Contingent-interest bifurcation analysis - flagged, not computed
- Diluted EPS computation under the if-converted method
- Modification vs. extinguishment accounting when the note is amended
Frequently asked questions
How are convertible notes accounted for after ASU 2020-06?
The default is a single liability at amortized cost. ASU 2020-06 eliminated the beneficial-conversion-feature and cash-conversion separation models, so separation now happens only when the embedded conversion feature must be bifurcated under ASC 815-15-25 or the substantial-premium model of ASC 470-20-25 applies.
When must an embedded conversion feature be bifurcated as a derivative?
Under ASC 815-15-25, when all conditions are met: the feature is not clearly and closely related to the debt host, the hybrid isn't measured at fair value through income, the feature would be a derivative standing alone, and no scope exception applies — most importantly the ASC 815-10-15-74(a) own-equity exception.
What is the 'fixed-for-fixed' test?
Step 2 of the ASC 815-40-15 indexation analysis (815-40-15): the settlement amount must equal the difference between the fair value of a fixed number of shares and a fixed monetary amount. Adjustments are permitted only if they are inputs to the fair value of a fixed-for-fixed option.
Why do variable-priced ('death spiral') convertibles become derivative liabilities?
A conversion price tied to a future stock price — for example 80% of the lowest VWAP over some window — fails the fixed-for-fixed test. The conversion feature is bifurcated and carried as a derivative liability at fair value, with changes running through earnings every quarter.
What is the substantial premium model?
Under ASC 470-20-25, when a convertible note is issued at a substantial premium to its principal amount, the premium is presumed attributable to the conversion feature and is recorded in additional paid-in capital. 'Substantial' is not defined; roughly 10% is the common rule of thumb.