Chapter 1 — Overview
Chapter 1 — Overview
1.1 General Requirements
ASC 815-40
05-1 For a number of business
reasons, an entity may enter into contracts that are indexed
to, and sometimes settled in, its own stock. This Subtopic
provides guidance on accounting for such contracts. Examples
of these contracts include put and call options (both
written and purchased) and forward contracts (for both sales
and purchases). These contracts may be settled using a
variety of settlement methods, or the issuing entity or
counterparty may have a choice of settlement methods. The
contracts may be either freestanding or embedded in another
financial instrument.
ASC 815-40 provides guidance on the accounting for contracts that
are indexed to, and potentially settled in, an entity’s own equity (also known as
contracts on own equity or equity-linked financial instruments). Examples of
contracts and transactions that may require evaluation under ASC 815-40 include:
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Call options on own stock (both written and purchased).
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Warrants on own stock.
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Forward contracts to sell own stock.
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Purchased put options on own stock.
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Accelerated share repurchase programs.
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Contingent consideration arrangements in business combinations.
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Convertible bond hedges.
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Equity line facilities that permit an entity to sell own stock.
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Hybrid equity units.
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Prepaid forward purchases of own stock.
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Prepaid written put options on own stock.
While the accounting requirements in ASC 815-40 focus on
freestanding instruments, some of the guidance also applies to features embedded in
other contracts. In particular, the indexation guidance and other conditions for
equity classification in ASC 815-40 apply to both freestanding and embedded
derivative instruments in the evaluation of whether they are exempt from derivative
accounting (see Section
2.2). Examples of embedded derivative features that would be assessed
under the indexation and equity classification guidance in ASC 815-40 include:
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Equity conversion features embedded in debt or equity securities or lines of credit that are debt hosts.
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Written put options embedded in the entity’s equity securities (i.e., stock redeemable by the holder).
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Redemption requirements in equity securities that are not certain to be redeemed (e.g., mandatorily redeemable convertible preferred stock).
ASC 815-40 also provides guidance on
whether a contract on own equity should be classified as equity or as an asset or a
liability. In making this determination, an entity considers the following
questions:
Question
|
Roadmap Discussion
|
---|---|
Is the instrument within the scope of ASC
815-40?
| |
What are the terms of the instrument?
| |
Does the instrument meet the criteria to be
considered indexed to the entity’s own stock?
| |
Does the instrument meet other conditions
for equity classification?
|
Only an equity-linked instrument that is both indexed to the
entity’s own stock and meets all other conditions for equity classification can be
classified as equity. If an instrument either (1) is not considered indexed to the
entity’s own stock (e.g., because it is indexed to an extraneous variable such as
the price of gold) or (2) does not meet other conditions for equity classification
(e.g., because the entity could be forced to net cash settle the contract), the
instrument is classified as an asset or a liability.
In addition, ASC 815-40 provides guidance (other than for embedded
features) on the following aspects of the accounting for freestanding equity-linked
financial instruments (Chapter 6):
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Initial measurement (i.e., fair value).
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Subsequent measurement (which depends on the instrument’s classification as equity or an asset or a liability).
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Reclassification between (1) equity and (2) liabilities or assets (the classification of an equity-linked instrument is subject to continual reassessment).
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Settlements.
Further, ASC 815-40 includes disclosure requirements for contracts on an
entity’s own equity (Chapter 7).
Some entities are affected by both U.S. GAAP and IFRS®
Accounting Standards. There are significant differences between the guidance in ASC
815-40 and the equivalent guidance under IFRS Accounting Standards (Chapter 8).
The appendixes of this Roadmap include a tabular overview of the FASB’s
examples in ASC 815-40 (Appendix
A), checklists for determining whether a contract or embedded feature
qualifies as equity under ASC 815-40 (Appendix B), and the definitions of selected terms from the ASC master
glossary (Appendix C).
Connecting the Dots
When analyzing equity-linked instruments, entities typically
must also consider the guidance in:
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ASC 260 (see Deloitte’s Roadmap Earnings per Share).
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ASC 470 (see Deloitte’s Roadmaps Issuer’s Accounting for Debt and Convertible Debt (Before Adoption of ASU 2020-06)).
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ASC 480 (see Deloitte’s Roadmap Distinguishing Liabilities From Equity).
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ASC 815 (on derivatives and embedded derivatives).
1.2 Changes Under ASU 2020-06
In August 2020, the FASB issued ASU 2020-06, which simplifies the
accounting for certain financial instruments with characteristics of liabilities and
equity, including convertible instruments and contracts on an entity’s own equity.
While ASU 2020-06 does not change the indexation guidance in ASC 815-40-15, it
removes the following three conditions from the requirements in ASC 815-40-25 that
must be met for a contract to be classified within equity:
- The condition in ASC 815-40-25-10(a) regarding settlement in unregistered shares (see Section 5.3.2).
- The condition in ASC 815-40-25-10(f) that no counterparty rights rank higher than shareholder rights (see Section 5.3.7).
- The condition in ASC 815-40-25-10(g) that no collateral is required (see Section 5.3.8).
In addition, the ASU:
- Removes the guidance on embedded written put options and forward purchase contracts in ASC 815-40-55-8 through 55-12 (see Section 5.2.4.3).
- Specifies that penalty payments for an entity’s failure to file on a timely basis do not preclude equity classification under ASC 815-40-25-10(d) if they do not result in net cash settlement of the contract (see Section 5.3.5).
- Clarifies that the reassessment guidance in ASC 815-40-35-8 applies to both freestanding instruments and embedded features (see Section 5.4).
- Removes the word “conventional” from the term “conventional convertible debt instrument” in ASC 815-40-25-39 and ASC 815-40-25-41 (see Section 5.5).
- Expands the scope of the subsequent measurement guidance in ASC 815-40-35-4 so that instruments that do not qualify as being indexed to the entity’s equity under ASC 815-40-15 must be accounted for at fair value, with changes in fair value recognized in earnings (see Sections 6.2 and 6.3).
- Amends the disclosures required by ASC 815-40 (see Section 7.1.2).
- Makes various amendments to ASC 260, including eliminating the ability of an entity to overcome the presumption of share settlement for contracts that may be settled in stock or cash.
For public business entities that are SEC filers other than entities that qualify as
smaller reporting companies as of August 5, 2020, ASU 2020-06 is effective for
fiscal years beginning after December 15, 2021, including interim periods within
those fiscal years. For all other entities, the ASU is effective for fiscal years
beginning after December 15, 2023, including interim periods within those fiscal
years. Early adoption is permitted for fiscal years beginning after December 15,
2020, including interim periods within those fiscal years.
Entities may adopt ASU 2020-06 by using either a modified retrospective or fully
retrospective method of transition. For entities electing the modified retrospective
method, the guidance is applied to transactions outstanding as of the beginning of
the fiscal year in which the amendments are adopted. Transactions that were settled
(or expired) during prior reporting periods are unaffected. The cumulative effect of
the change is recognized as an adjustment to the opening balance of retained
earnings as of the date of adoption. For entities electing the fully retrospective
method of transition, the cumulative effect of the change is recognized as an
adjustment to the opening balance of retained earnings in the first comparative
period presented.