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Some financial instruments can have both debt and equity features. The most common example is convertible debt— bonds or notes convertible by the investor into common stock.

A topic of debate for several years has been whether:

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

Which of the two options do you favor and why? Develop and explain your argument. In considering this question, you should disregard 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.