8.2 Key Differences

Derivative — definition

For an instrument to meet the definition of a derivative, the following characteristics must be present:

• It contains “[o]ne or more underlyings” and “[o]ne or more notional amounts or payment provisions or both” (ASC 815-10).
• It requires no or a small initial net investment.
• It requires or permits net settlement (i.e., via contractual terms or via a means outside the contract), or it provides for delivery of an asset that is RCC.

For an instrument to meet the definition of a derivative, the following characteristics must be present:

• Its value changes in response to an underlying (e.g., specified interest rate, commodity price, foreign currency rate, credit rating, and so forth, provided that in the case of a nonfinancial variable, the variable is not specific to a party to the contract).
• It requires no or a small initial net investment.
• It is settled on a future date.

Though the definition of a derivative under IFRS Accounting Standards does not include a net settlement characteristic, contracts to purchase or sell nonfinancial items are within the scope of IFRS 9 only if they can be settled net.

Derivatives — scope

The NPNS scope exception for qualifying contracts to purchase or sell nonfinancial items is elective and requires the designation to be documented.

While both IFRS Accounting Standards and U.S. GAAP provide scope exceptions for certain contracts to purchase or sell nonfinancial items that will be purchased, sold, or used in the normal course of business, under IFRS Accounting Standards, the own-use scope exception for qualifying contracts is not elective (unless applying the own-use scope exception leads to an accounting mismatch) and does not require an entity to document its designation of a contract as “own-use.”

Embedded derivatives — initial recognition

The bifurcation requirements apply to both assets and liabilities, including financial assets.

In addition, the application guidance under U.S. GAAP is more detailed than that under IFRS Accounting Standards. Accordingly, an entity may not necessarily reach the same conclusion under IFRS Accounting Standards as under U.S. GAAP about whether the conditions for bifurcation are met.

While the overall criteria for bifurcation are similar to those under U.S. GAAP, the bifurcation requirements do not apply to financial assets within the scope of IFRS 9. Therefore, if a hybrid contract contains a host that is a financial asset within the scope of IFRS 9, the bifurcation requirements do not apply.

Embedded derivatives — debt with embedded put or call option

A put, call, or prepayment option embedded in a debt contract is considered not clearly and closely related to a debt host contract if (1) it is indexed to an underlying other than interest rates, credit risk, or inflation; (2) the debt involves a substantial discount or premium and the option is contingent; or (3) the option is not contingent and the negative-yield or double-double test is passed.

A put, call, or prepayment option embedded in a debt contract is not considered closely related to a debt host contract unless (1) the exercise price is approximately equal on each exercise date to the debt host contract’s amortized cost (before the separation of any equity component) or (2) the exercise price results in reimbursement to the lender for an amount up to the approximate present value of lost interest for the remaining term.

Embedded equity components in a debt contract — initial recognition

Embedded equity-linked features that qualify as equity are not separated from liabilities (e.g., convertible debt) except in the specific circumstances listed below:

• The host contract was issued at a substantial premium to par.
• The host contract was modified or exchanged, if extinguishment accounting did not apply and the fair value of the conversion feature increased.
• The host contract has a bifurcated conversion option derivative that was reclassified to equity.

Embedded equity-linked features that qualify as equity are separated from liabilities and accounted for as equity.

Embedded equity components — initial measurement

Different methods apply for initial measurement of equity components depending on the reason an amount is allocated to equity.

The with-and-without method is used for initial measurement of equity components. The liability component is measured first.

Contracts with payments indexed to revenue

ASC 815-10-15-59(d) provides a scope exception for non-exchange-traded contracts in which the underlying is based on specified volumes of sales or service revenues of one of the parties to the contract.

Contracts with an underlying based on sales volumes are subject to IFRS 9 accounting as derivatives or embedded derivatives, as applicable, unless (1) they are subject to a scope exception or (2) the only underlying is a nonfinancial variable that is specific to one party to the contract.

Contracts with payments indexed to operations or activities specific to one of the parties to the contract

ASC 815-10-15-59(e) provides a scope exception for non-exchange-traded contracts in which the underlying is based on “financial operating results,” or “the occurrence or nonoccurrence of an event specific to the operations or activities of one of the parties to the contract.”

Underlyings are not eligible for the scope exception if they are based on market rates, market prices, market indexes, or the “price or performance (including default) of a financial asset or financial liability of one of the parties to the contract.” In addition, contracts involving (1) an entity’s own equity or (2) call or put options on debt instruments also do not qualify for the scope exception.

There may be instances in which a contract or arrangement has multiple underlyings with different eligibilities for the scope exception (e.g., one underlying that is based on a market index and one underlying that is based on an EBITDA target). If a contract or arrangement has multiple underlyings, an entity will need to perform a predominant characteristics assessment in accordance with ASC 815-10-15-60. If the underlyings, in combination, are highly correlated with the behavior of the components that do not qualify for the scope exception, the contract does not qualify for the scope exception.

The phrase “non-financial variable specific to a party to the contract” has been a subject of debate by the IASB and IFRS Interpretations Committee, and the phrase continues to be subject to varying interpretations.

It is acceptable to adopt one of two approaches as an accounting policy choice. In developing its accounting policy, an entity may need to take into consideration specific requirements and views of local regulators.

See B4.2.1 and B4.2.2 of Deloitte’s iGAAP publication for further information on accounting policy elections.