A company with convertible notes wants them gone. It offers holders a sweetener to convert now: a few extra shares, or a better conversion price for 30 days. Whether the cost of that sweetener is a modest expense or a large loss depends on a classification test. ASU 2024-04 rewrote that test.
This guide covers what the ASU changed, the criteria, the effective dates, entries for both outcomes and the audit evidence. For convertible debt accounting after ASU 2020-06, see /us/standards/asc-470-20-convertible-debt-asu-2020-06.
What did ASU 2024-04 change?
The FASB issued ASU 2024-04 in November 2024. It clarifies whether a settlement of convertible debt on terms that differ from the original conversion terms is an induced conversion or an extinguishment. The induced conversion guidance in ASC 470-20 was written for share-settled convertible debt. Cash convertible instruments became more common, and ASU 2020-06 changed the accounting for convertible debt with cash conversion features, so stakeholders asked how to classify settlements at terms that differ from the original conversion terms.
The ASU replaces the old requirement that the inducement issue all equity securities issuable under the original terms. The new test asks whether the settlement delivers all of the consideration, in form and amount, that was issuable under the original terms. That change brings certain cash conversion features into induced conversion accounting.
What are the criteria for induced conversion accounting?
All of these must be met:
- Limited period. The settlement occurs under revised conversion terms that are exercisable only for a limited time.
- Consideration preserved. The settlement issues all of the consideration, in form and amount, that was issuable under the original conversion terms, assessed as of the date the holder accepts the offer. Extra consideration does not change the classification. It changes the expense.
- Substantive conversion feature. The debt has a substantive conversion feature at issuance and at the offer acceptance date, whether or not it is convertible at that time.
Three refinements affect real files:
- Prior modifications. If the instrument was exchanged or modified within the year before acceptance and not accounted for as an extinguishment, the terms in effect one year before acceptance are the baseline.
- Share-price formulas. For terms based on a future share price or a volume-weighted average price, the entity uses the fair value of the shares at the acceptance date to compute the amounts. Adding, removing or changing such a formula does not by itself lead to extinguishment accounting.
- Indexation. A change that indexes the cash or shares to something other than the future price of the issuer's shares, for example the fair value of a commodity, is a change in the form of settlement.
How are the two outcomes measured?
- Induced conversion. The issuer recognizes an expense in earnings equal to the fair value of all consideration transferred in excess of the fair value of the consideration issuable under the original terms, measured at the acceptance date.
- Extinguishment. The issuer recognizes a gain or loss equal to the total consideration transferred less the net carrying amount of the debt, measured at the extinguishment date. That loss can be significantly larger than the induced conversion expense.
The distinction decides how much hits earnings. For modification and extinguishment tests on other debt changes, see /us/blog/asc-470-debt-modification-vs-extinguishment-10-percent-test.
When does it take effect?
The ASU is effective for all entities for annual reporting periods beginning after December 15, 2025, including interim periods within those years. A calendar-year client therefore applies it to settlements in fiscal 2026. Early adoption is permitted only for entities that have already adopted ASU 2020-06.
Transition can be prospective or retrospective. Prospective application covers settlements that occur in annual periods beginning after the effective date, with disclosure of the nature of and reason for the change. Retrospective application applies only to settlements after ASU 2020-06 was adopted, recasts prior periods, and records a cumulative-effect adjustment to equity as of the later of the beginning of the earliest period presented or the ASU 2020-06 adoption date.
Worked journal entries
An illustration with round numbers. A client has $1,000,000 of convertible notes with a carrying amount of $1,000,000. The conversion price is $10, so the notes convert into 100,000 shares. The client offers holders a 30-day window in which each holder who converts receives the 100,000 shares plus 10,000 additional shares. The holders accept. The shares have a fair value of $12 at acceptance.
Test. The window is limited. The original consideration, 100,000 shares, is delivered in full, so form and amount are preserved. The conversion feature is substantive at issuance and at acceptance. The settlement is an induced conversion.
Expense. The excess consideration is 10,000 shares at $12, or $120,000. The entry removes the debt at its carrying amount, records the expense, and credits equity for the balancing amount:
| Account | Debit | Credit |
|---|---|---|
| Convertible notes payable | 1,000,000 | |
| Induced conversion expense | 120,000 | |
| Common stock and additional paid-in capital | 1,120,000 |
Contrast. Suppose the offer had failed the test, for example because it had no restrictive time limit. The accounting is then an extinguishment. Consideration transferred is 110,000 shares at $12, or $1,320,000, against a carrying amount of $1,000,000. The loss is $320,000:
| Account | Debit | Credit |
|---|---|---|
| Convertible notes payable | 1,000,000 | |
| Loss on extinguishment of debt | 320,000 | |
| Common stock and additional paid-in capital | 1,320,000 |
The same transaction produces a $120,000 expense in one case and a $320,000 loss in the other. Unamortized issuance costs, if any, would adjust the carrying amount in both cases.
Audit angle
- Read the offer. Obtain the offer letter, board approval and holder acceptances. Establish the acceptance date for each holder, since the tests and the fair value are measured at acceptance.
- Test the limited window. Confirm the revised terms expired and were not extended in practice.
- Test substantive conversion. Document the feature at issuance and at acceptance, including for notes that were not convertible at the time.
- Compare consideration. Recompute the original consideration and the offered consideration at acceptance-date share fair values, and conclude on form and amount.
- Check the prior-year lookback. Search for modifications or exchanges in the preceding year and confirm the baseline terms.
- Recompute the entry. Fair value of shares at the acceptance date, net carrying amount of the debt and the expense or loss. For privately held shares, the share value needs support, see /us/blog/409a-valuation-guide-for-cpas.
- Check adoption. Confirm the effective date, the transition method elected and the disclosures. For startup notes, see /us/blog/convertible-notes-and-safes-audit-for-startups.
Common misstatements: booking a loss on extinguishment when the criteria were met, booking an expense when they were not, measuring shares at the issuance date instead of the acceptance date, and ignoring a modification in the preceding year.
CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.
Sources
- RSM, Summary of Accounting Standards Update (ASU) 2024-04: https://www.rsmus.com/insights/financial-reporting/summary-of-accounting-standards-update-asu-2024-04
- Crowe, FASB issues ASU on convertible debt instruments: https://www.crowe.com/insights/take-into-account/fasb-issues-asu-on-convertible-debt-instrument
- Grant Thornton, Induced conversion of convertible debt: https://www.grantthornton.com/insights/articles/audit/2024/snapshot/december/induced-conversion-of-convertible-debt
- FASB, ASU 2024-04 (PDF): https://storage.fasb.org/ASU%202024-04.pdf
Part of CORAA University · US GAAP for private companies: related guides, calculators and templates.
AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error