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 need to be accounted for
as 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.
|
Typically, yes.
|
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 the underlying
securities are RCC.
|
|
Banker’s acceptance agreement
|
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.