1.5 Application of the ASC 815 Definition of a Derivative to Specific Contracts
The table below illustrates the
application of the ASC 815 definition of a derivative to different types of
contracts (before any scope exceptions are considered).
|
Contract
|
Does the contract have an underlying?
|
Does the contract have a notional amount or
payment provision?
|
Does the contract involve no or a smaller
initial net investment?
|
Does the contract require or permit net
settlement?
|
Does the contract meet the definition of a
derivative?3
|
|---|---|---|---|---|---|
|
1,000 warrants to purchase 1,000 shares of an entity’s common
stock at a fixed exercise price
|
Yes, the price of the common stock.
|
Yes, the number of shares.
|
Yes, if the price paid for each warrant is at least 10
percent less than the fair value of a share of the entity’s
common stock.
|
Yes, (1) for contracts that provide for cashless exercise
(even if only contingently exercisable4) or whose settlement involves the delivery of shares
that are RCC or (2) if a market mechanism exists to net
settle the contract.
|
Warrants would typically meet the definition of a derivative
if net settlement is present.
|
|
Contract to pay a fixed dollar amount if the company’s common
stock rises above $10
|
Yes, the price of the common stock.
|
Yes, the fixed dollar amount is a payment provision.
|
Yes, if the price paid for the instrument is at least 10
percent less than the fixed dollar amount (i.e., the payoff
from the instrument).
|
Yes, the contract provides for a one-way transfer of cash, so
it is contractually net settled.
|
Typically, yes.
|
|
Short sales of securities (contract under which the short
seller borrows a security with a promise to return it to the
lender)
|
Yes, the price of the security.
|
Yes, the face amount of the security or the number of
shares.
|
No, the short seller received the fair value of the
security.
|
Yes, if the underlying securities are RCC.
|
No.
|
|
Managers’ options or overallotment provisions
|
Yes, the price of the underlying security.
|
It depends on whether the overallotment
option is (1) similar to a requirements contract or (2) an
option for the manager to purchase securities for its own
account.
|
Yes, if the price paid for the option is at least 10 percent
less than the fair value of the instrument underlying the
option.
|
Yes, if the underlying securities are RCC.
No, if the underlying securities are not RCC.
|
It depends, typically on the basis of
whether (1) the holder can exercise the option regardless of
customer demand and (2) the underlying securities are
RCC.5
|
|
Banker’s acceptance agreement6
|
Yes, the fair value of the receivable.
|
Yes, the aggregate dollar value of the receivable.
|
Typically, no, because the initial investment in the
instrument is not lower than 90 percent of the receivable’s
fair value.
|
No, there is typically no market mechanism to net settle the
contract, and the underlying is not RCC.
|
Typically, no, because it does not provide for net
settlement.
|
|
Irrevocable letter of credit
|
Yes, the fair value of the receivable.
|
Yes, the dollar value of the receivable.
|
It depends.
|
No, the receivable generally is not RCC and there is no
market mechanism.
|
Typically, no. A letter of credit would not meet the
definition of a derivative because it does not provide for
de facto net settlement.
|
Footnotes
3
The discussion in the table does not consider the
applicability of any of the scope exceptions from
derivative accounting provided by ASC 815-10. In
practice, more analysis would typically be necessary
before concluding that such instruments must be
accounted for as derivatives.
4
See Section 1.4.3.2.6 for additional
guidance on how to evaluate contingent net
settlement provisions.
5
The issuer of a manager’s option on its own equity
securities often will be able to apply the scope
exception in ASC 815-10-15-74.
6
Banker’s acceptances generally are used when an
entity has credit sales for which payments are not
due for a defined period (e.g., 30 days). The entity
sells the receivables generated by the credit sales
at a discount to a bank. The bank pays the entity
cash and accepts the default risk of the
debtors.