Convertible Debt Accounting After ASU 2020-06

Introduction

In March 2021, Airbnb sold $2.0 billion of convertible notes due March 2026 that paid no interest at all. Investors accepted a 0% coupon because each $1,000 note could be converted into 3.4645 Airbnb shares, equivalent to a conversion price of about $288.64, a 60% premium to the share price when the notes were priced. On Airbnb's balance sheet at the end of 2025, the notes were a single $2.0 billion liability with an effective interest rate of 0.2%, reflecting only the amortization of issuance costs. Interest expense was immaterial. Yet the notes still reduced Airbnb's diluted earnings per share (EPS), because the accounting assumes they convert.

That combination, almost no interest expense and a share count that includes the conversion, is the result of Accounting Standards Update (ASU) 2020-06, which simplified US accounting for convertibles from 2022 for public companies other than smaller reporting companies. The cost of a convertible no longer shows up mainly as interest; it shows up in dilution.

A convertible note is debt that the holder can exchange for a fixed number of the issuer's shares. The holder gets a bond's protection on the downside and a share of the equity upside; in return, the issuer pays a much lower coupon than on straight debt. The key terms are the conversion rate, shares per $1,000 of principal, and the conversion price, principal divided by the conversion rate, usually set at a premium of 20% to 60% or more to the share price at issuance.

Convertible note

A debt instrument that the holder may convert into a specified number of the issuer's common shares, or their cash value, under terms set at issuance. Under US generally accepted accounting principles (GAAP) after ASU 2020-06, it is generally accounted for as a single liability at amortized cost, with the conversion feature reflected in diluted earnings per share.

Most modern convertibles let the issuer choose how to settle a conversion: in shares, in cash, or in a combination, often paying the principal in cash and the excess value in shares. Airbnb's notes gave it that choice. How the company intends to settle affects how much dilution investors should expect, though, as discussed below, not the accounting presumption.

Before 2022, US GAAP split many convertibles into a debt component and an equity component, under the cash conversion and beneficial conversion feature models. The debt was recorded at a discount, and the discount was amortized into interest expense at a market-like rate. ASU 2020-06 removed both models, as Deloitte's summary of the update explains. A convertible is now usually recorded as a single liability at the proceeds received, net of issuance costs, and carried at amortized cost under the model described in debt accounting: carrying value and interest expense. Interest expense equals the coupon plus amortization of costs and any discount.

Two exceptions remain. If the conversion feature must be separated as a derivative, for example because it is not considered indexed to the company's own stock, it is carried at fair value with changes in earnings, as covered in derivatives and hedge accounting. And a convertible issued at a substantial premium records the premium in additional paid-in capital.

What Adoption Changed

For companies that had split their convertibles, adopting the update in 2022 reversed the split. The equity component was recombined with the debt, so reported debt rose toward face value and equity fell; the remaining discount disappeared, so interest expense dropped toward the coupon; and convertibles that had used the treasury stock method in diluted EPS moved to the if-converted method, usually increasing the diluted share count. Earnings rose and diluted EPS could fall in the same quarter, with no change in the notes themselves. Comparisons of interest expense or EPS across 2021 and 2022 for heavy convertible issuers need adjusting for the change.

A Convertible Next to Straight Debt

Compare a $1,000 convertible with a 1% coupon and a conversion price of $40 with straight debt that would cost the same issuer 6%:

The convertible saves $50 of interest expense a year, $37.50 after tax. The saving is not free: the issuer has sold investors a call option on 25 shares. Under the current rules, that cost shows up in the share count rather than in interest expense.

ASU 2020-06 requires the if-converted method for convertibles in diluted EPS and requires companies to presume share settlement whenever they may settle in shares, even if they intend to pay cash. The mechanics of diluted EPS generally are covered in earnings per share: basic vs diluted.

If-converted method

The method of including convertible securities in diluted EPS by assuming they converted at the start of the period, or at issuance if later: the after-tax interest or preferred dividends on the securities are added back to earnings, and the shares issuable on conversion are added to the weighted-average share count, if the effect is dilutive.

Because a low-coupon convertible adds back very little interest, it is almost always dilutive for a profitable issuer, even when the share price is far below the conversion price. Airbnb's 2025 annual report shows the effect: it added $3 million of after-tax interest to net income for diluted EPS, and its dilutive securities included the notes, although the notes' if-converted value did not exceed their principal at year-end.

When the terms require the principal to be paid in cash, only the conversion spread, the value above principal, can be settled in shares, so only the shares needed for that spread are added and no interest is added back. Many issuers structure notes this way, or amend them, precisely to limit the reported dilution.

Capped Calls

Many issuers buy a capped call alongside a convertible: an option on their own shares that pays off between the conversion price and a higher cap, offsetting dilution if the shares rise. Airbnb paid about $100 million for capped calls with a cap of $360.80, double the share price at pricing. A capped call is usually classified in equity: its cost reduces additional paid-in capital and it is not remeasured. It is also excluded from diluted EPS, because a purchased option is antidilutive, so the reported share count does not reflect the economic protection it provides.

The low reported interest on a convertible understates its cost to existing shareholders, because part of the cost is the option given away. For valuation, a convertible should be counted once: as debt in the bridge from enterprise value to equity value if it is out of the money and expected to be repaid, or as shares in the diluted share count if it is in the money and expected to convert, as discussed in the equity value to enterprise value bridge. Counting it as both overstates the claims on the business.

Airbnb's notes took that path. None converted, and in March 2026 the company repaid the full $2.0 billion at maturity from a $2.5 billion issue of senior notes with coupons of 4.40% to 5.25%, as its first-quarter 2026 report shows. A financing that had carried almost no interest expense was replaced by debt with a material cash cost.

Induced Conversions and Repurchases

Issuers sometimes pay holders to convert early, offering extra shares or cash to retire the notes and their refinancing risk. Under Accounting Standards Codification (ASC) 470-20, the fair value of the sweetener beyond the original conversion terms is recognized as an inducement expense in earnings. Repurchasing convertibles for cash, often in privately negotiated deals ahead of maturity, is instead an extinguishment, producing a gain or loss against the carrying amount, as described in refinancing and extinguishment gains and losses.

For credit analysis, convertibles are debt until they convert, and they usually rank as senior unsecured obligations. For equity analysis, the questions are how much dilution the notes and any capped calls imply at different share prices, how the company plans to settle, and what refinancing will cost if conversion never happens. The accounting answers the first only partially, so bankers model conversion scenarios directly rather than relying on the reported diluted share count.