The Financial Accounting Standards Board's Emerging Issues Task Force issued a pronouncement that would close a widely used loophole that lets companies issue contingent convertible bonds - called CoCos - without diluting their earnings per share.

Corporations that have used CoCos to delay EPS dilution have argued that the dilutive effects should continue to be recorded only when conversion is permitted. Typically, conversion is contingent on an increase in the stock price, typically a rise of 20 to 30 percent above the price at which the CoCo was issued.

The EITF took on the project in response to a tendency among investment bankers to use a loophole in FASB's standard on earnings per share. Under that guidance, non-contingent convertible bonds have immediate dilutive effects, but the EPS effects of CoCos can remain in footnotes until the stock hits its target price.

Critics of the task force decision - among them Robert R. Bible, chief accounting officer of General Motors - contended that the two types of bonds are substantively different.

"GM believes there are real economic differences between convertible debt and contingently convertible debt to both the issuer and the investor that would not be recognized by the tentative consensus," Bible wrote in a letter to the task force. He also said that the issue was significant enough for FASB, rather than its task force, to consider the issue in a reconsideration of its EPS standard.

GM has about $8 billion in CoCo bonds outstanding.

A week after the EITF reached its consensus - and before the details of the rule were announced - General Motors said that the change would force the company to drop its per-share net income for fiscal 2004, which ended on May 30, by 15 cents. First-quarter 2004 EPS were seen to drop by three cents, and 2005 EPS were expected to drop two cents.

The CFA Institute disagreed with the corporate perspective.

"What [the EITF] is doing is removing the favored status of these instruments and making them behave, in accounting, like all other such instruments," said Rebecca McEnally, CFA Institute vice president of advocacy. "What we've had until now is a special class of instruments created to take advantage of an accounting peculiarity. We prefer to have similar instruments accounted for similarly. If we had our way, we'd have all such instruments treated as liabilities because they represent obligations to the shareholders."

McEnally said that the issue should be treated under FASB's project on equity and liability, rather than its existing statement on EPS.

Companies generally ceased to issue CoCos while the EITF deliberated a change to the rules. With the new rule due to go into effect on Dec. 15, companies with outstanding CoCos are looking for ways to avoid an instant dilution. One solution would be to convert the bonds to cash in an amount equal to the related stock price.

Conversion to cash before the effective date would eliminate any dilutive effects, unless the contingent price has at any point in the past been reached, in which case past dilutive effects will have to be restated.

FASB practice fellow Gerard O'Callaghan said that the EITF decision covers an area that is not treated under the International Accounting Standards Board's standard on EPS. One reason is that CoCos are rare outside of the United States. FASB expects to converge with the IASB guidance, though the EITF ruling would not be part of it.

"The EITF abstract improves financial reporting, because you now have to show the impact of these CoCos in diluted EPS in the face of the income statement, rather than through disclosure in footnotes," O'Callaghan said.

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