Some financial instruments can be considered compound instruments in that they have features of both debt and shareholders equity. The most common example encountered in practice is convertible debtbonds or notes convertible by the investor into common stock. A topic of debate for several years has been whether:

View 1: Issuers should account for an instrument with both liability and equity characteristics entirely as a liability or entirely as an equity instrument depending on which characteristic governs.

View 2: Issuers should account for an instrument as consisting of a liability component and an equity component that should be accounted for separately.

In considering this question, you should disregard what you know about the current position of the FASB on the issue. Instead, focus on conceptual issues regarding the practicable and theoretically appropriate treatment, unconstrained by GAAP. Also, focus your deliberations on convertible bonds as the instrument with both liability and equity characteristics.

Required:

1. Which view do you favor? Develop a list of arguments in support of your view prior to the class session for which the case is assigned.

2. In class, your instructor will pair you (and everyone else) with a classmate (who also has independently developed an argument).

a. You will be given three minutes to argue your view to your partner. Your partner likewise will be given three minutes to argue his or her view to you. During these three-minute presentations, the listening partner is not permitted to speak.

b. After each person has had a turn attempting to convince his or her partner, the two partners will have a three-minute discussion in which they will decide which view is more convincing. Arguments will be merged into a single view for each pair.

3. After the allotted time, a spokesperson for each of the two views will be selected by the instructor. Each spokesperson will field arguments from the class in support of that views position and list the arguments on the board. The class then will discuss the merits of the two lists of arguments and attempt to reach a consensus view, though a consensus is not necessary.