2.3 Certain Repurchase Obligations and Variable-Share Contracts

ASC 815-40

15-3 The guidance in this Subtopic does not apply to any of the following: . . .

e. Financial instruments that are within the scope of Topic 480 (see paragraph 815-40-15-12).

15-12 Paragraph 480-10-15-5 explains that Topic 480 does not apply to a feature embedded in a financial instrument that is not a derivative instrument in its entirety (for example, a written put option embedded in a nonderivative host contract) in analyzing the embedded feature as though it were a separate instrument as required by paragraph 815-15-25-1(c). Therefore, this Subtopic applies in evaluating those embedded features under Subtopic 815-15.

Financial instruments that must be accounted for as liabilities or assets under ASC 480 are outside the scope of ASC 815-40. Therefore, an entity does not apply ASC 815-40 to an equity-linked instrument unless it has first determined that ASC 480 is not applicable.

ASC 480 applies to three types of freestanding financial instruments that contain obligations of the issuer (see Chapter 4 of Deloitte’s Roadmap Distinguishing Liabilities From Equity as well as Sections 2.3.1 and 2.3.2 below). The scope of ASC 480 is limited to freestanding financial instruments and does not include embedded features (e.g., an embedded written put option in an equity share issued by the entity). The applicability of ASC 815-40 to embedded features is discussed in Section 2.2.2.

2.3.1 Obligations to Repurchase Shares by Transferring Assets

ASC 480-10

25-8 An entity shall classify as a liability (or an asset in some circumstances) any financial instrument, other than an outstanding share, that, at inception, has both of the following characteristics:

It embodies an obligation to repurchase the issuer’s equity shares, or is indexed to such an obligation.
It requires or may require the issuer to settle the obligation by transferring assets.

As discussed in more detail in Chapter 5 of Deloitte’s Roadmap Distinguishing Liabilities From Equity, contracts other than outstanding shares that require — or could require — the issuer to repurchase its equity shares (or are indexed to such an obligation) by transferring assets are accounted for as liabilities (or potentially as assets) under ASC 480. For example, a forward purchase contract on an entity’s own equity shares or a written put option on the entity’s own equity shares is classified as a liability if the issuer could be required to physically settle the contract by delivering cash in exchange for the issuer’s equity shares. Similarly, a forward purchase or written put option contract that permits the counterparty to net cash settle the contract would be classified as an asset or a liability. These requirements apply even if the purchase obligation is contingent on the occurrence or nonoccurrence of an event (unless it is solely within the entity’s control) or upon the counterparty’s exercise of an option.

ASC 480 applies to contracts that require or could require delivery of the entity’s redeemable equity securities (e.g., warrants, written call options, and forward sales) if the entity could ultimately be forced to redeem those securities by transferring assets. This is the case even if the redeemable equity securities would be classified within equity (including temporary equity) when issued. For example, if an entity issues a warrant that permits the holder to purchase the entity’s equity shares, that warrant is classified as a liability if the underlying equity shares contain a redemption requirement that is not solely within the entity’s control (e.g., an investor put option embedded in preferred stock). Although the warrant is required to be classified as a liability, the redeemable equity securities may qualify for classification as equity or temporary equity once issued. Similarly, a written call option or a forward sale contract on redeemable equity securities would be classified as a liability under ASC 480 if the entity could be required to transfer assets even if the obligation to transfer assets is embedded in the shares underlying the option or forward.

If, under the redemption feature, the entity could be required to transfer assets, a contract on redeemable stock is classified as a liability under ASC 480 regardless of the timing of the potential redemption requirement (e.g., immediately after exercise of a warrant or at some date in the future) or the redemption price (e.g., fair value or a fixed price). In addition, such a contract is classified as a liability even if the redemption feature is conditional on a defined contingency (such as a change of control, a reduction in the issuer’s credit rating, a conversion, or a failure to have a registration statement declared effective by the SEC by a designated date), unless the contingency is solely within the control of the issuer.

If an entity could not be required to transfer assets under a freestanding contract on redeemable equity securities, the contract may be within the scope of ASC 815-40. For example, the following types of contracts on redeemable equity securities would potentially be within the scope of ASC 815-40 unless another scope exception applies:

A purchased call option that permits the entity to repurchase redeemable equity securities, at its option (because the entity has no obligation to repurchase the redeemable equity securities).
A purchased put option that permits the entity to issue (sell) redeemable equity securities, at its option (because the entity has no obligation to issue redeemable equity securities).

2.3.1.1 Put Warrants

ASC 815-40

55-16 Put warrants are frequently issued concurrently with debt securities of the entity, are detachable from the debt, and may be exercisable only under specified conditions. The put feature of the instrument may expire under varying circumstances, for example, with the passage of time or if the entity has a public stock offering. Under Subtopic 470-20, a portion of the proceeds from the issuance of debt with detachable warrants must be allocated to those warrants.

55-17 Put warrants are instruments with characteristics of both warrants and put options. The holder of the instrument is entitled to do any of the following:

Exercise the warrant feature to acquire the common stock of the entity at a specified price
Exercise the put option feature to put the instrument back to the entity for a cash payment
Exercise both the warrant feature to acquire the common stock and the put option feature to put that stock back to the entity for a cash payment.

55-18 Because the contract gives the counterparty the choice of cash settlement or settlement in shares, entities should report the proceeds from the issuance of put warrants as liabilities and subsequently measure the put warrants at fair value with changes in fair value reported in earnings as required by Topic 480. That is, a put warrant that embodies an obligation to repurchase the issuer’s equity shares, or is indexed to such an obligation, and that requires or may require a transfer of assets is within the scope of that Topic and therefore is to be recognized as a liability.

A put warrant is an example of an instrument that is required to be classified as a liability under ASC 480. Even though the warrant gives the counterparty an option to purchase the entity’s stock, the warrant is classified as a liability in its entirety under ASC 480 if the entity could be forced to repurchase the warrant for cash or other assets because it represents an obligation that is indexed to an obligation to repurchase the entity’s equity shares, and the entity may be required to transfer cash or other assets (see Section 5.1 of Deloitte’s Roadmap Distinguishing Liabilities From Equity). Alternatively, the counterparty may have the right to put the stock it received upon exercise of the warrant back to the entity for cash. In that case, the warrant embodies an obligation to repurchase equity shares for cash (see Section 5.2.1 of Deloitte’s Roadmap Distinguishing Liabilities From Equity). Because put warrants fall within the scope of ASC 480, they are outside the scope of ASC 815-40.

2.3.2 Contracts to Issue a Variable Number of Shares

ASC 480-10

25-14 A financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares shall be classified as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominantly on any one of the following:

A fixed monetary amount known at inception (for example, a payable settleable with a variable number of the issuer’s equity shares)
Variations in something other than the fair value of the issuer’s equity shares (for example, a financial instrument indexed to the Standard and Poor’s S&P 500 Index and settleable with a variable number of the issuer’s equity shares)
Variations inversely related to changes in the fair value of the issuer’s equity shares (for example, a written put option that could be net share settled).

See paragraph 480-10-55-21 for related implementation guidance.

Sometimes entities use their own shares as “currency” to settle an obligation in which the number of shares delivered depends on the value of the obligation. If a financial instrument embodies an obligation that the entity must or may settle in shares, the entity could be required to classify the contract as a liability (or, potentially, an asset) even if the instrument does not contain an obligation to transfer cash or other assets. As discussed in more detail in Chapter 6 of Deloitte’s Roadmap Distinguishing Liabilities From Equity, ASC 480 identifies three circumstances in which a share-settleable contract would be classified as a liability. A contract that embodies an obligation that the issuer must or may settle in a variable number of equity-classified shares is classified as a liability if, at inception, the obligation’s monetary value is based solely or predominantly on:

A fixed monetary amount known at inception.
Variations in something other than the issuer’s equity shares.
Variations inversely related to changes in the fair value of the entity’s equity shares.

This guidance applies not only to contracts that require share settlement but also to contracts that the issuer may elect to settle in either assets or a variable number of shares. For financial instruments other than outstanding shares, this guidance applies irrespective of whether the obligation is conditional or unconditional.

The following are examples of contracts that would be accounted for as liabilities or assets under this guidance:

A net-share-settled forward repurchase contract whose value is inversely related to the entity’s stock price (e.g., because the forward price is fixed).
A net-share-settled written put option whose value is inversely related to the entity’s stock price (e.g., because the strike price is fixed).
A contract to issue a variable number of equity shares whose value is based solely or predominantly on variations in something other than the entity’s equity shares (e.g., the S&P 500 Index).
A prepaid variable share forward on the entity’s stock that obligates the entity to deliver shares with a monetary value that is predominantly a fixed monetary amount known at inception.
Stock-settled debt.

2.3.3 Application of ASC 480 to Freestanding Written Puts and Forward Purchase Contracts

ASC 480-10

55-63 The following table addresses classification of freestanding written put options and forward purchase contracts within the scope of this Subtopic.

The table in ASC 480-10-55-63 illustrates how an entity would classify, in accordance with ASC 480, freestanding written put options and forward purchase contracts under which the issuer has agreed to buy shares at a specified price on a future date. Irrespective of whether such an instrument requires physical settlement, net cash settlement, or net share settlement, or whether it gives the issuer or the counterparty a choice of settlement methods, the instrument is classified as a liability (or as an asset, in certain circumstances) under ASC 480.

If a forward contract requires physical settlement by repurchase of a fixed number of the issuer’s equity shares for cash, it is classified as a liability under ASC 480-10-25-8 and accounted for in accordance with ASC 480-10-30-3 and ASC 480-10-35-3 in a manner similar to a treasury stock repurchase with borrowed funds (see Section 5.3.1 of Deloitte’s Roadmap Distinguishing Liabilities From Equity). Other forward purchase contracts and written put options that require or may require the issuer to settle its obligation under the contract by transferring assets are classified as assets or liabilities under ASC 480-10-25-8 and accounted for at fair value under ASC 480-10-30-7, ASC 480-10-35-1, ASC 480-10-35-4A, or ASC 480-10-35-5 (see Sections 5.1 and 5.3.2 of Deloitte’s Roadmap Distinguishing Liabilities From Equity). Such contracts include those that require net cash settlement, permit the issuer to choose between net cash or physical settlement (but not net share settlement), and give the counterparty a settlement choice if at least one of the options is physical settlement or net cash settlement. Forward purchase contracts and written put options that require or permit the issuer to settle its obligation under the contract net in shares are classified as assets or liabilities under ASC 480-10-25-14(c) and accounted for at fair value in accordance with ASC 480-10-30-7 as well as ASC 480-10-35-1, ASC 480-10-35-4A, or ASC 480-10-35-5 (see Sections 6.1.4 and 6.3 of Deloitte’s Roadmap Distinguishing Liabilities From Equity).

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.