6.8 Payment Features Indexed to Commodities or Other Nonfinancial Items
6.8.1 Background
This section discusses the analysis of whether payment features that are indexed
to the price or value of a commodity or other nonfinancial item (e.g., a
commodity-indexed principal or interest payment or a participating mortgage
feature) should be separated from their host contract and accounted for as
derivatives under ASC 815-15.
We have generally observed payment features indexed to commodities or other
nonfinancial assets as potential embedded derivatives in debt host instruments,
although it would be possible for such a feature to be incorporated into an
equity or lease host. Regardless of whether the nature of the host contract is
debt, equity, or a lease, the price or value of a commodity or other
nonfinancial item would typically not be clearly and closely related to the host
contract. As illustrated in the table in the section below, the determination of
whether a feature requires bifurcation generally depends on whether the hybrid
instrument is measured at fair value or if the feature meets a derivative scope
exception.
6.8.2 Bifurcation Analysis
The table below presents an overview of the bifurcation analysis of a payment
feature indexed to the price or value of a commodity or other nonfinancial item.
However, an entity should always consider the terms and conditions of a specific
feature in light of all the relevant accounting guidance before reaching a
conclusion.
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Bifurcation Condition
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Condition Met?
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Analysis
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|---|---|---|
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Not clearly and closely related (see
Section 4.3.2)
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Typically, yes
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The price or value of a commodity or
other nonfinancial item is typically not clearly and
closely related to a debt, equity, or lease host.
|
|
Hybrid instrument not measured at fair
value through earnings on a recurring basis (see
Section 4.3.3)
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It depends
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From the perspective of the lessor and
the lessee, a lease host contract is not recorded at
fair value through earnings on a recurring basis.
From the issuer’s perspective, legal
form debt is not measured at fair value on a recurring
basis unless the issuer elects the fair value option in
ASC 815-15 or ASC 825-10. The fair value option cannot
be elected for debt that contains a separately
recognized equity component at inception. In the case of
(1) an outstanding share that qualifies for equity
presentation but was determined to have a debt host
contract or (2) an equity host contract, the issuer
would not measure the instrument at fair value, with
changes in fair value recorded through earnings, on a
recurring basis.
From the perspective of a holder of a
debt or equity host contract, the determination of
whether the hybrid instrument is measured at fair value,
with changes in fair value recorded through earnings,
will depend on whether the instrument is (1) considered
a debt security within the scope of ASC 320 (and the
related classification of the debt security) or (2) an
equity security within the scope of ASC 321.
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Meets the definition of a derivative
(see Section 4.3.4)
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Yes
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Payments indexed to the price or value
of a commodity or other nonfinancial item meet the
definition of a derivative (see Section 6.8.4).
|
|
Meets a scope exception (see Section
4.3.5)
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It depends
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ASC 815 contains a scope exception
related to certain non-exchange-traded contracts with
payments that are based on the price or value of a
unique nonfinancial item of one of the parties to the
contract, provided that the asset is not RCC (see
Section 2.3.5.2).
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As shown in the table above, an entity’s determination of whether a payment
feature indexed to a commodity or other nonfinancial item must be bifurcated as
a derivative tends to focus on whether the feature is exempt from the scope of
derivative accounting (see Section 2.3.5.2) and whether the
host contract is measured at fair value, with changes recorded through earnings.
Such a feature is not clearly and closely related to a debt, equity, or lease
host and typically meets the definition of a derivative (see Section 6.8.4).
6.8.3 Clearly-and-Closely-Related Analysis
ASC 815-15
25-48 The changes in fair
value of a commodity (or other asset) and the interest
yield on a debt instrument are not clearly and closely
related. Thus, a commodity-related derivative instrument
embedded in a commodity-indexed debt instrument shall be
separated from the noncommodity host contract and
accounted for as a derivative instrument.
Case J: Crude Oil Knock-In Note
55-194 An illustrative crude
oil knock-in note has a 1 percent coupon and guarantees
repayment of principal with upside potential based on
the strength of the oil market.
55-195 A crude oil
knock-in note essentially combines an interest-bearing
instrument with a series of option contracts. A
significant portion of the coupon interest rate is, in
effect, used to purchase options that provide the
investor with potential gains resulting from increases
in specified crude oil prices. Because the option
contracts are indexed to the price of crude oil, they
are not clearly and closely related to an investment in
an interest-bearing note. Therefore, the embedded option
contract should be separated from the host contract and
accounted for by both parties pursuant to the provisions
of this Subtopic.
Case K: Gold-Linked Bull Note
55-196 An illustrative
gold-linked bull note has a fixed 3 percent coupon and
guarantees repayment of principal with upside potential
if the price of gold increases.
55-197 A
gold-linked bull note can be viewed as combining an
interest-bearing instrument with a series of option
contracts. A portion of the coupon interest rate is, in
effect, used to purchase call options that provide the
investor with potential gains resulting from increases
in gold prices. Because the option contracts are indexed
to the price of gold, they are not clearly and closely
related to an investment in an interest-bearing note.
Therefore, the embedded option contracts should be
separated from the host contract and accounted for by
both parties pursuant to the provisions of this
Subtopic.
A feature that adjusts the payments of a debt, equity, or lease contract on the
basis of the price or value of a commodity or other nonfinancial item is
typically not clearly and closely related to the respective debt, equity, or
lease host. This determination applies irrespective of whether the entity owns
the commodity or other nonfinancial item.
ASC 815-15-25-48 discusses the concept that changes in the fair value of a
commodity (or other asset) would not be clearly and closely related to the
interest yield in a debt instrument. Similarly, the changes in a commodity’s
fair value would not be clearly and closely related to (1) the value of an
issuer’s equity shares if the hybrid instrument contains an equity host or (2)
the economic risks and characteristics of a lease contract if the contract is a
lease host.
6.8.4 Derivative Analysis
The table below presents an analysis of whether a payment
feature indexed to a commodity or other nonfinancial item meets the definition
of a derivative (see Section
4.3.4). However, an entity should always consider the terms and
conditions of a specific feature in light of the applicable accounting guidance
before reaching a conclusion.
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Characteristics of a Derivative
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Characteristic Present?
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Analysis
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|---|---|---|
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Underlying and notional amount or
payment provision (see Section 1.4.1)
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Yes
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A feature that could adjust the payments
of a contract on the basis of the price or value of a
commodity or other nonfinancial item has both an
underlying (the item’s price or value) and a notional
amount (e.g., the outstanding amount due under a debt or
lease agreement).
|
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Initial net investment (see Section
1.4.2)
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Yes
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The initial net investment in an
embedded feature is its fair value (i.e., the amount
that would need to be paid to acquire the feature on a
stand-alone basis without the host contract). Generally,
a feature indexed to a commodity or other nonfinancial
asset has an initial net investment that is smaller than
would be required for a direct investment that has the
same exposure to changes in the price or value of the
nonfinancial asset (since the investment in the host
contract does not form part of the initial net
investment in the embedded feature).
|
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Net settlement (see Section
1.4.3)
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Yes
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Adjustments to the payments of a host
contract that are indexed to the price or value of a
commodity or other nonfinancial item meet the net
settlement condition since neither party is required to
deliver an asset that is associated with the underlying
and whose principal amount, stated amount, face value,
number of shares, or other denomination is equal to the
feature’s notional amount. (If the feature must be
settled by delivery of the underlying nonfinancial item,
however, the considerations in Section
6.2.4.3 apply.)
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