3.2 Unit of Account

ASC 815-40

15-5B The guidance in paragraphs 815-40-15-5 through 15-8 shall be applied to the appropriate unit of accounting, as determined under other applicable U.S. generally accepted accounting principles. For example, if an entity issues two freestanding financial instruments and concludes that those two instruments are required to be accounted for separately, then the guidance in paragraphs 815-40-15-5 through 15-8 shall be applied separately to each instrument. In contrast, if an entity issues two freestanding financial instruments and concludes that those two instruments are required to be linked and accounted for on a combined basis as a single financial instrument (for example, pursuant to the guidance in paragraph 815-10-15-8), then the guidance in paragraphs 815-40-15-5 through 15-8 shall be applied to the combined financial instrument.

ASC Master Glossary

Unit of Account

The level at which an asset or a liability is aggregated or disaggregated in a Topic for recognition purposes.

In applying ASC 815-40, an entity should consider how to appropriately identify units of account (i.e., the “level at which an asset or a liability is aggregated or disaggregated” for accounting purposes). While a single contract may represent a unit of account, this is not always the case. Sometimes a single legal agreement consists of more than one unit of account that should be accounted for separately. Examples include:

A contract that contains two or more components that individually each meet the definition of a freestanding contract, such as components that are legally detachable and separately exercisable (e.g., debt with a detachable warrant or a contingent consideration arrangement that is included in the terms of an acquisition agreement in a business combination).
A contract that contains a registration payment arrangement (see Section 3.2.4).
An accelerated share repurchase program (see Section 3.2.5).
A hybrid financial instrument with an embedded feature that is required to be bifurcated as a derivative, such as a debt contract with an embedded conversion option that has all the characteristics of a derivative and does not qualify as equity under ASC 815-40 (see Section 2.2).

Conversely, two separate agreements might for accounting purposes have to be combined and treated as a single unit of account (e.g., debt issued with a warrant that is not legally detachable and separately exercisable).

3.2.1 The Concept of a Freestanding Contract

ASC 815-40 — Glossary

Freestanding Contract

A freestanding contract is entered into either:

Separate and apart from any of the entity’s other financial instruments or equity transactions
In conjunction with some other transaction and is legally detachable and separately exercisable.

ASC 815-40-20 defines a freestanding contract as one entered into either “[s]eparate and apart from any of the entity’s other financial instruments or equity transactions” or “[i]n conjunction with some other transaction and is legally detachable and separately exercisable.”1 Therefore, an entity should consider the following questions in identifying freestanding contracts:

Was the transaction entered into contemporaneously with and in contemplation of another transaction, or was it entered into separately and apart from other transactions?

The fact that a transaction was entered into separately and apart from any other transaction suggests that it is a freestanding contract that is separate from any other transaction. If the transaction was entered into contemporaneously and in contemplation of another transaction, the entity should assess whether the transactions represent a single freestanding contract. For example, if warrants are issued in conjunction with a debt issuance of the same issuer, the issuer should consider whether to treat them as being embedded in the debt even if they are subject to a separate contractual agreement.

A transaction’s having been entered into contemporaneously or in conjunction with some other transaction, however, would not necessarily result in a conclusion that the two transactions should be viewed on a combined basis as a single freestanding contract. The entity should also consider whether the transactions are legally detachable and separately exercisable (see below) and whether the combination guidance in ASC 815 applies (see Section 3.2.2).

A one-week period between transactions may be good evidence that the transactions are not contemporaneous if the entity is exposed to market fluctuations during this time. Even when transactions occur at different times, however, entities should consider all available evidence to ensure that no side agreements or other contracts were entered into that suggest that the transactions were entered into in contemplation of one another.

Options written by the acquired entity on its stock as of the date of a business combination are often viewed as effectively modifying previously existing shares. Such options are not considered to have been entered into separately and apart from the shares.
Is the item legally detachable?

Neither ASC 815-40 nor other GAAP provide guidance on the meaning of “legally detachable.” In practice, an item is considered legally detachable from another item if it is (1) separately transferable from that item or (2) otherwise capable of being separated from that item. If an item is separately exercisable but not considered legally detachable, it would not be a separate freestanding contract under item (b) of the definition of a freestanding contract in ASC 815-40-20. However, in some cases, the separate exercisability of an item results in a conclusion that an item is legally detachable.

An item is always considered legally detachable if it can be transferred separately from another item in a single contractual agreement (or from another item in multiple contracts entered into at the same time) at the holder’s discretion (i.e., without limitations imposed by the counterparty). The fact that an item can be transferred independently from another item indicates that it is a separate unit of account even if the two items were entered into contemporaneously and have the same counterparty. This view is supported by the guidance in ASC 815-10-25-9, which states, in part:

Derivative instruments that are transferable are, by their nature, separate and distinct contracts.

Similarly, ASC 815-10-15-5 states, in part:
The notion of an embedded derivative . . . does not contemplate features that may be sold or traded separately from the contract in which those rights and obligations are embedded. Assuming they meet [the] definition of a derivative instrument, such features shall be considered attached freestanding derivative instruments rather than embedded derivatives by both the writer and the current holder.

However, a scenario in which two items cannot be transferred independently of one another suggests that each item is not a freestanding contract under (b) in the definition of a freestanding contract in ASC 815-40-20. For example, if a warrant “travels with” a bond and cannot be transferred separately from the bond, it may be an embedded feature in the bond.

A contract may be entered into in conjunction with some other item. For such a contract to be considered a freestanding contract, an assessment must be performed of both the form and substance of the transaction, including the substance of the independent transferability of the item. In some circumstances, an item is unconditionally separately transferable by the holder but would have no economic value if the related item were not held, which would suggest that the separate transferability has no substance and the item is embedded in the related item (see further discussion in question 3). Similarly, the holder of shares not readily obtainable in the market may have a separately transferable put option that it can exercise only by delivering the same specific shares. In this case, the shares and the put option may represent a single, combined unit of account on the basis of an assessment of the substance of the transaction.

In other circumstances, an item may be separately transferred only with the consent of the counterparty. If an item may be separated from a related contract without any modification to the contractual terms (e.g., the contract specifically permits the item to be transferred if the issuer gives its consent and such consent cannot be unreasonably withheld), the legally detachable condition is, in substance, generally met since the counterparty has agreed to not withhold its consent. If, however, the counterparty can always prevent the separate transfer of the item at its discretion, the legally detachable condition is, in substance, most likely not met and therefore the item is not a freestanding contract.

The SEC staff has indicated in informal discussions that it is possible for two items that have been entered into contemporaneously with the same counterparty to be considered freestanding contracts solely on the basis of the items’ ability to be separately exercised (i.e., even though the contractual terms prevent the items from being transferred separately). This would generally be the case when a reasonable conclusion can be reached that the separate exercisability of one item is sufficient to establish that it is legally detachable from the related item. However, when determining whether an item can be transferred separately, an entity must use significant judgment and consider the transaction’s form and substance. We therefore strongly recommend that an entity consult with its independent accounting advisers when performing this assessment.
Can the item be exercised separately; or does its exercise result in the termination, redemption, or automatic exercise of a specifically identified item?

If an item can be freely exercised without terminating another item (e.g., through redemption, automatic exercise, or expiration), it is considered to be “separately exercisable.” The fact that a warrant remains outstanding if a bond to which it is attached is redeemed, for example, suggests that the warrant is a freestanding contract that is separate from the bond. Similarly, if a bond may remain outstanding after a net-share-settled conversion feature in the bond is exercised, the conversion feature may be a freestanding contract.

Conversely, if the exercise of an item results in the termination of a specifically identified item, the first item would not be considered “separately exercisable” from the other item. For example, if a warrant can be exercised only by tendering a specific bond in a physical settlement, it may be a feature embedded in the bond rather than a freestanding contract. ASC 470-20-25-3 states, in part:
[I]f stock purchase warrants are not detachable from [a] debt instrument and the debt instrument must be surrendered to exercise the warrant, the two instruments taken together are substantially equivalent to a convertible debt instrument.

Similarly, if a specifically identified share is subject to a redemption requirement, the share and the redemption requirement may represent one freestanding contract even if they are documented in separate agreements. ASC 480-10-15-7C states, in part:
Some entities have issued shares that are required to be redeemed under related agreements. If the shares are issued with a redemption agreement and the required redemption relates to those specific underlying shares, the shares are mandatorily redeemable.
Does the transaction involve multiple counterparties?

Contracts with different counterparties are treated as separate freestanding contracts even if they are issued contemporaneously or are transacted as a package. Thus, ASC 815-10-15-6 suggests that an option added or attached to an existing debt instrument by another party is not an embedded derivative because it does not have the same counterparty. Similarly, ASC 815-15-25-2 indicates that the notion of an embedded derivative in a hybrid instrument does not refer to provisions in separate contracts between separate counterparties.

Example 3-1

Issuance of a Bond With a Warrant

An entity delivers a bond and a warrant on own equity to an underwriter for cash. The underwriter is a party to the warrant but holds the bond merely as an agent for a third-party investor. The terms and pricing of the bond sold to the third-party investor are not affected by the sale of the warrant to the underwriter. Because they involve different counterparties, the bond and the warrant are two separate freestanding contracts.

Under ASC 815-10-25-10, transactions that are entered into with a single party are treated as having the same counterparty even if some of them are structured through an intermediary. In consolidated financial statements, the reporting entity is the consolidated group. Therefore, the parent and its subsidiary would not be considered different parties in the consolidated financial statements. For example, if a parent entity writes a put option on subsidiary shares to the holder of those shares, it is acceptable to view the option as being embedded in the shares in the consolidated financial statements even though the subsidiary technically is not a party to the option.

3.2.2 Combination Guidance

ASC 815 contains additional guidance to help an entity determine whether two or more separate transactions should be viewed as separate units of accounting or combined for accounting purposes. ASC 815-10-15-8 states, in part:

In some circumstances, an entity could enter into two or more legally separate transactions that, if combined, would generate a result that is economically similar to entering into a single transaction that would be accounted for as a derivative instrument under this Subtopic.

Nevertheless, ASC 815 ordinarily does not permit an entity to treat two or more freestanding financial instruments as a single combined unit of account because ASC 815 is transaction-based.

ASC 815-10-25-6 states, in part:

This Subtopic generally does not provide for the combination of separate financial instruments to be evaluated as a unit.

However, if two or more freestanding contracts have characteristics suggesting that they were structured to circumvent GAAP, they may need to be combined and treated as a single unit of account. Specifically, ASC 815 requires two or more separate transactions to be combined and viewed in combination as a single unit of account for accounting purposes if they were entered into in an attempt to circumvent that subtopic’s accounting requirements for derivatives (i.e., measured at fair value, with subsequent changes in fair value recognized in earnings except for qualifying hedging instruments in cash flow or net investment hedges). ASC 815-10-15-9 states that such combination is required if the transactions have all of the following characteristics:

They “were entered into contemporaneously and in contemplation of one another.”
They “were executed with the same counterparty (or structured through an intermediary).”
They “relate to the same risk.”
“There is no apparent economic need or substantive business purpose for structuring the transactions separately that could not also have been accomplished in a single transaction.”

ASC 815-10-25-6 identifies characteristics similar to those listed above from ASC 815-10-15-9 and adds the following commentary, in part:

If separate derivative instruments have all of [these] characteristics, judgment shall be applied to determine whether the separate derivative instruments have been entered into in lieu of a structured transaction in an effort to circumvent GAAP: . . . If such a determination is made, the derivative instruments shall be viewed as a unit.

Note that the SEC staff has indicated that it will challenge the accounting for transactions that have been structured to circumvent GAAP.

3.2.3 Application of the Unit of Account Guidance

3.2.3.1 Examples

Example 3-2

Units Consisting of Stock and Warrants

An entity undertakes a placement offering, in which common shares and warrants to acquire common shares are issued simultaneously as one unit. If the warrants are legally detachable and can be exercised separately from the common stock after issuance, they are considered units of account separate from the common shares.

Example 3-3

Issuance of Shares and Call Options

An entity issues equity shares along with call options that permit the counterparty to acquire additional shares. The issuance of the shares and the options is documented in the same legal agreement. The equity shares and options are not publicly traded. The options cannot be readily settled outside the agreement. The shares remain outstanding upon exercise or expiration of the options. Because the rights associated with the shares extend beyond the term of the options, and the exercise of the options does not result in the termination of the existing shares, they are considered legally detachable and separately exercisable. Accordingly, the shares and the options are separate, freestanding contracts that represent separate units of account.

Example 3-4

Issuance of Warrants and Put Options

An entity issues stock purchase warrants on its stock to third-party investors. In conjunction with that transaction, the entity enters into a warrant-holder rights agreement with each warrant holder under which they receive a put right allowing them to require the entity to purchase for cash any or all of the shares issued or issuable to them under the warrants. The put right cannot be sold separately from the shares issued or issuable, and those shares cannot be sold separately from the put rights. In other words, the put rights are directly linked to the shares that are issued or issuable under each warrant and accompany the shares if sold or transferred to another party. The put rights cannot be used to put back shares other than those issued or issuable under the warrants. In this example, the warrants and put rights are combined and viewed as one unit of account, even though they are contained in two separate legal documents. (The accounting for this instrument is addressed in Example 3-2 of Deloitte’s Roadmap Distinguishing Liabilities From Equity.)

Example 3-5

Share Modification

An entity enters into an option agreement that gives the entity a right to call a specific, outstanding equity security from the holder of that security. Although the counterparty maintains its right to transfer the underlying share to another investor, any future investor would continue to be bound by the terms of the option agreement attached to the share. Further, the investor must satisfy its obligation under the call feature by transferring back to the entity the specific underlying share to which the option agreement is attached. In these circumstances, the option agreement is not a separate unit of account and should be analyzed on a combined basis with the underlying share as a single unit of account. The entity would treat the option agreement as a modification of the original share.

Example 3-6

Put Option on Noncontrolling Interest

An entity holds 70 percent of the equity shares of another entity and consolidates that entity (i.e., the entities have a parent-subsidiary relationship). The remaining 30 percent of the shares (the noncontrolling interest) are held by a third party. After the parent acquires its 70 percent of the shares and the third party acquires its 30 percent, the parent entity writes a put option that permits the third party to sell all of its shares to the parent for a fixed price on or before a specified date. Unlike the put option, the shares have no expiration date. Upon exercise, the put option is physically settled. There is no mechanism to net cash or net share settle the option. Given the nature of its terms, the put option cannot be transferred separately from the noncontrolling interest, and the exercise of the put option results in the termination of the noncontrolling interest.

Because it is not legally detachable and separately exercisable, the put option should be considered embedded in the noncontrolling interest rather than a freestanding contract. Because redemption is not certain to occur, the entity would not classify the instrument (the combination of the noncontrolling interest and the put option) as a liability under ASC 480 (see Chapter 4 of Deloitte’s Roadmap Distinguishing Liabilities From Equity). In the parent’s consolidated financial statements, the put option may be considered embedded in the noncontrolling interest irrespective of whether the option issuer is the parent or the subsidiary.

Example 3-7

Issuance of Shares and Put Options

An entity issues equity shares along with put options that give the counterparty the right to require the entity to redeem the same number of shares for cash. The options can be physically settled only through the exchange of shares for cash. The put options do not require delivery of any specifically identified shares, and because shares issued with the put options are publicly traded, they are not the only shares available to settle the put option. Therefore, the put options would not be considered embedded in the shares. (The accounting for the put options is addressed in Example 3-4 of Deloitte’s Roadmap Distinguishing Liabilities From Equity.)

Example 3-8

Tranche Preferred Stock Agreement

Entity X enters into a preferred stock purchase agreement with unrelated investors to sell two tranches of convertible redeemable preferred stock (the “preferred stock”). The purchase agreement stipulates the following:

On the first closing date, which is the date of the purchase agreement, the investors will acquire 50,000 shares of preferred stock for $50 million.
On the second closing date, the investors will acquire 25,000 additional shares of preferred stock for $25 million subject to a specified condition. The second closing will occur only if (1) a specific milestone related to X’s operations is achieved two years from the first closing date or (2) the specific milestone related to X’s operations is not achieved two years from the first closing date but the holders waive the milestone requirement and elect to purchase the additional shares of preferred stock (the “contingent purchase option”).

The purchase agreement stipulates that the holders of preferred stock issued in the first closing cannot transfer their contingent purchase options separately from the preferred shares acquired in the first closing (or vice versa). However, such holders have the right to convert those preferred shares into common stock before the date that is two years from the first closing date. The purchase agreement does not restrict the holders that convert preferred shares into common stock from selling those common shares. The only restrictions on selling common stock stem from restrictions under U.S. securities laws.

In this example, the contingent purchase option would be considered a freestanding contract because it meets the “legally detachable and separately exercisable” condition. The holders can “detach” the two instruments because they can convert the preferred stock into common stock and sell those shares while retaining the contingent purchase option (i.e., the two instruments are capable of being separated). This would be the case even if the contingent purchase option may not be separately transferred after the conversion into common stock of the preferred shares obtained in the first closing. It would not be appropriate to consider the preferred shares and the contingent purchase option a single combined financial instrument, because the contingent purchase option would not become embedded in the common shares received upon conversion of the preferred stock purchased in the first closing.

Note that the conclusion in this example would not change even if:

The holders could not sell the common shares received upon conversion of the preferred stock purchased in the first closing before satisfaction or expiration of the contingent purchase option. At the inception of the arrangement, the two instruments still meet the legally detachable and separately exercisable condition because the contingent purchase option (1) cannot become embedded in the common shares received upon conversion of the preferred stock purchased in the first closing and (2) does not become freestanding only if the preferred stock purchased in the first closing is converted into common stock (instead, the ability to convert the preferred stock purchased in the first closing is evidence that the contingent purchase option is capable of being separated at the inception of the arrangement).
The preferred stock purchased on the first closing date cannot be transferred or converted before the contingent purchase option is satisfied or expires and the holders have the right to acquire the additional shares related to the contingent purchase option at their option at any time before two years from the closing date. The two instruments still meet the legally detachable and separately exercisable condition because the investor can separate the two components by early exercising the contingent purchase option while retaining the preferred shares acquired on the first closing date.

As this example illustrates, and in a manner consistent with practice, an option or commitment to issue additional preferred shares is almost always a freestanding financial instrument because the separate exercisability of the option or commitment is sufficient to demonstrate that the feature is capable of being separated.

Example 3-9

Transfer Restrictions

An entity issues a bond with a warrant. The agreement specifies that the counterparty may not transfer the bond or the warrant without the issuer’s consent. However, the agreement does not preclude the transfer of the warrant separately from the bond if the issuer were to give its consent. Further, the contract specifies that such consent cannot be unreasonably withheld. The exercise of the warrant does not result in the termination of the bond (i.e., the counterparty is not required to tender the bond as payment of the exercise price of the warrant). In these circumstances, the warrant is considered a freestanding contract because it is both independently transferable and separately exercisable. The fact that the warrant contains a restriction that may preclude the counterparty from transferring it does not mean that the warrant is not a freestanding contract since the contract specifies that the issuer’s consent cannot be unreasonably withheld.

3.2.3.2 Contingent Consideration Arrangements With Performance Targets

As discussed in Section 2.5.1, freestanding equity-linked financial instruments accounted for as contingent consideration in a business combination may be within the scope of ASC 815-40. Contingent consideration arrangements often specify that the issuance of shares under the arrangement depends on whether successive or cumulative performance targets (e.g., earnings or revenues) for the acquired entity are met. For example, an arrangement may require the entity to deliver (1) 100,000 of its equity shares if the subsidiary’s revenue exceeds $100 million in the first year after the acquisition and (2) an additional 50,000 of its equity shares if the subsidiary’s revenue exceeds $125 million in the second year after the acquisition. In this case, the entity should evaluate whether the contingent consideration arrangement contains one or multiple units of account.

The entity’s determination of whether the contingent arrangement contains one or multiple units of account may affect whether the arrangement qualifies as equity in whole or in part. As discussed in Section 4.2, a provision that affects whether a contract becomes exercisable or settleable (e.g., a contract that provides for the delivery of shares only if a revenue target is met) is an example of an exercise contingency. An exercise contingency that is based on an index calculated or measured solely by reference to the operations of a consolidated subsidiary that is a substantive entity does not preclude equity classification (see Section 4.2). An adjustment made to the settlement amount on the basis of revenue, however, precludes equity classification (see Section 4.3). This means that the contract potentially would qualify as equity if it is settleable only if a specified earnings target is met; however, it would not qualify as equity if the number of shares that will be delivered upon settlement is not fixed but depends on the level of earnings.

If an entity determines that an arrangement includes multiple payment conditions, triggers, or targets that are independent of one another and if met would result in the issuance of specified consideration regardless of whether the other targets were met, each target-based payment may be treated as a separate freestanding contract (provided that the conditions for the definition of freestanding contract are met). If the payment conditions or targets are cumulative or not independent of one another, the arrangement is considered one contract that requires delivery of a variable number of shares.

The following are examples that illustrate this approach to identifying the appropriate units of account for contingent consideration arrangements:

Contingent Consideration Arrangement	Analysis
The acquirer is required to deliver 10,000 of its equity shares to the seller if the acquired entity has earnings of at least $100 million in the year after the acquisition (otherwise, no shares will be delivered).	One unit of account. There is only one payment condition and target.
The acquirer is required to deliver 10,000 of its equity shares if the acquired entity has earnings of at least $100 million in the first year after the acquisition (otherwise, no shares will be delivered at the end of the first year). In addition, the acquirer is required to deliver 10,000 of its equity shares if the acquired entity has earnings of at least $100 million in the second year after the acquisition (otherwise, no shares will be delivered at the end of the second year).	Two units of account. There are two independent payment conditions and targets. It is assumed that the two payment conditions are capable of being separated.
The acquirer is required to deliver 10,000 of its equity shares to the seller if the acquired entity has earnings of at least $100 million in the year after the acquisition. The acquirer will deliver an additional 5,000 shares if earnings in that year exceed $125 million. Otherwise, no shares will be delivered.	One unit of account. There are two targets, but they cover the same period, and that period has multiple outcomes.
The acquirer is required to deliver 10,000 of its equity shares if the acquired entity has earnings of at least $100 million in the first year after the acquisition (otherwise, no shares will be delivered at the end of the first year). In addition, the acquirer is required to deliver 10,000 of its equity shares if the acquired entity has cumulative earnings of at least $200 million in the first two years following the acquisition (otherwise, no shares will be delivered at the end of the second year).	Two units of account. There are two targets that cover different periods. It is assumed that the two payment conditions are capable of being separated.

3.2.4 Registration Payment Arrangements

ASC 815-40

25-43 Subtopic 825-20 requires that an entity recognize and measure a registration payment arrangement (see paragraph 825-20-15-3) as a separate unit of account from the financial instrument(s) subject to that arrangement. Accordingly, under that Subtopic (see paragraphs 825-20-25-2 and 825-20-30-2), a financial instrument that is both within the scope of this Subtopic and subject to a registration payment arrangement shall be recognized and measured in accordance with this Subtopic without regard to the contingent obligation to transfer consideration pursuant to the registration payment arrangement.

ASC Master Glossary

Registration Payment Arrangement

An arrangement with both of the following characteristics:

It specifies that the issuer will endeavor to do either of the following:
1. File a registration statement for the resale of specified financial instruments and/or for the resale of equity shares that are issuable upon exercise or conversion of specified financial instruments and for that registration statement to be declared effective by the U.S. Securities and Exchange Commission (SEC) (or other applicable securities regulator if the registration statement will be filed in a foreign jurisdiction) within a specified grace period
2. Maintain the effectiveness of the registration statement for a specified period of time (or in perpetuity).
It requires the issuer to transfer consideration to the counterparty if the registration statement for the resale of the financial instrument or instruments subject to the arrangement is not declared effective or if effectiveness of the registration statement is not maintained. That consideration may be payable in a lump sum or it may be payable periodically, and the form of the consideration may vary. For example, the consideration may be in the form of cash, equity instruments, or adjustments to the terms of the financial instrument or instruments that are subject to the registration payment arrangement (such as an increased interest rate on a debt instrument).

ASC 825-20

15-4 The guidance in this Subtopic does not apply to any of the following:

Arrangements that require registration or listing of convertible debt instruments or convertible preferred stock if the form of consideration that would be transferred to the counterparty is an adjustment to the conversion ratio. See Subtopic 470-20 on debt with conversion and other options or Subtopic 505-10 on equity for related guidance.
Arrangements in which the amount of consideration transferred is determined by reference to either of the following:
1. An observable market other than the market for the issuer’s stock
2. An observable index.
For example, if the consideration to be transferred if the issuer is unable to obtain an effective registration statement is determined by reference to the price of a commodity. See Subtopic 815-15 for related guidance.
Arrangements in which the financial instrument or instruments subject to the arrangement are settled when the consideration is transferred (for example, a warrant that is contingently puttable if an effective registration statement for the resale of the equity shares that are issuable upon exercise of the warrant is not declared effective by the SEC within a specified grace period).

25-1 An entity shall recognize a registration payment arrangement as a separate unit of account from the financial instrument(s) subject to that arrangement.

25-2 The financial instrument(s) subject to the registration payment arrangement shall be recognized in accordance with other applicable generally accepted accounting principles (GAAP) (for example, Subtopics 815-10; 815-40; and 835-30) without regard to the contingent obligation to transfer consideration pursuant to the registration payment arrangement.

30-1 An entity shall measure a registration payment arrangement as a separate unit of account from the financial instrument(s) subject to that arrangement.

30-2 The financial instrument(s) subject to the registration payment arrangement shall be measured in accordance with other applicable generally accepted accounting principles (GAAP) (for example, Subtopics 815-10; 815-40; and 835-30) without regard to the contingent obligation to transfer consideration pursuant to the registration payment arrangement.

ASC 825-20 contains special unit-of-account guidance applicable to registration payment arrangements (also known as registration rights agreements). In connection with issuances of equity shares, debt securities, convertible instruments, and equity-linked instruments, an issuer may agree to pay amounts in case it is unable to deliver registered securities or maintain an effective registration. For example, a warrant or other equity-linked financial instrument may require the issuer to:

Use its “best efforts” to file a registration statement for the resale of shares and have the registration statement declared effective by the end of a specified grace period (e.g., within 90 to 180 days).
Maintain the effectiveness of a registration statement for a period.

If the issuer fails to meet these conditions, the contract may require the issuer to make cash payments to the counterparty unless and until a registration statement is declared effective. For example, the contract may require the entity to pay the investor 2 percent of the contract purchase price in each month after the end of a 180-day grace period during which there is no registration statement in effect that covers the shares that will be delivered under the contract.

A registration payment arrangement, as defined in the ASC master glossary, is treated as a unit of account that is separate from any related contract on an entity’s own equity. This is the case even if the registration payment arrangement is included in the contract on own equity itself. This means that a contract could qualify for equity classification under ASC 815-40 even if it includes provisions that require the issuer to pay cash to the holder if the issuer is unable to deliver registered shares or maintain an effective registration statement, unless the contract itself would be net cash settled (see Section 5.2). Those provisions would instead be accounted for separately as a registration payment arrangement in accordance with ASC 825-20, provided that the arrangement meets the definition of a registration payment arrangement.

A registration payment arrangement that is within the scope of ASC 825-20 is treated as a contingent liability (ASC 825-20-30-3). This means that proceeds from the related financing transaction are allocated to the registration payment arrangement upon initial recognition only if there is a probable obligation to make payments under the arrangement that can be reasonably estimated (ASC 825-20-30-4). If the obligation becomes probable and can be reasonably estimated after inception, a contingent liability is recognized at that point with an offset to earnings. Any subsequent change in the amount of the contingent liability is also recognized in earnings (ASC 825-20-35-1). If the entity is required to deliver shares under the arrangement, the number of shares can be reasonably estimated, and the transfer is probable, the entity measures the contingent liability by using the issuer’s stock price as of the reporting date (ASC 825-20-30-5).

An arrangement that contains any of the following provisions would not be accounted for as a separate unit of account under ASC 825-20:

The form of consideration transferred is a contingently adjustable conversion ratio in a convertible instrument.
The payment is adjusted by reference either to an observable market other than the issuer’s stock (e.g., a commodity price) or to an observable index.
The payment is made when the contract subject to the arrangement is settled (e.g., a payment that is made upon the exercise of an option on own stock that is subject to the arrangement).

Accordingly, an entity would consider such provisions in its analysis of the contract under ASC 815-40.

3.2.5 Accelerated Share Repurchase Programs

ASC 505-30

25-5 An accelerated share repurchase program is a combination of transactions that permits an entity to repurchase a targeted number of shares immediately with the final repurchase price of those shares determined by an average market price over a fixed period of time. An accelerated share repurchase program is intended to combine the immediate share retirement benefits of a tender offer with the market impact and pricing benefits of a disciplined daily open market stock repurchase program.

25-6 An entity shall account for such an accelerated share repurchase program as the following two separate transactions:

As shares of common stock acquired in a treasury stock transaction recorded on the acquisition date
As a forward contract indexed to its own common stock. Subtopic 815-40 provides guidance on the accounting for contracts that are indexed to an entity’s own common stock.

Example 1 (see paragraph 505-30-55-1) provides an illustration of an accelerated share repurchase program that is addressed by this guidance.

Example 1: Accelerated Share Repurchase Program

55-1 This Example illustrates the guidance in paragraph 505-30-25-5 by identifying the two separate transactions, namely a treasury stock purchase and a forward contract, that are present in what is sometimes described as an accelerated share repurchase program.

55-2 The treasury stock purchase is as follows.

55-3 Investment Banker, an unrelated third party, borrows 1,000,000 shares of Company A common stock from investors, becomes the owner of record of those shares, and sells the shares short to Company A on July 1, 1999, at the fair value of $50 per share. Company A pays $50,000,000 in cash to Investment Banker on July 1, 1999, to settle the purchase transaction. The shares are held in treasury. Company A has legal title to the shares, and no other party has the right to vote those shares.

55-4 The forward contract is as follows.

55-5 Company A simultaneously enters into a forward contract with Investment Banker on 1,000,000 shares of its own common stock. On the October 1, 1999, settlement date, if the volume-weighted average daily market price of Company A’s common stock during the contract period (July 1, 1999, to October 1, 1999) exceeds the $50 initial purchase price (net of a commission fee to Investment Banker), Company A will deliver to Investment Banker cash or shares of common stock (at Company A’s option) equal to the price difference multiplied by 1,000,000. If the volume-weighted average daily market price of Company A’s common stock during the contract period is less than the $50 initial purchase price (net of a commission fee to Investment Banker), Investment Banker will deliver to Company A cash equal to the price difference multiplied by 1,000,000.

55-6 Under the guidance in paragraph 505-30-25-5, an entity would account for this accelerated share repurchase program as two separate transactions:

As shares of common stock acquired in a treasury stock transaction recorded on the July 1, 1999, acquisition date
As a forward contract indexed to its own common stock.

ASC 505-30-25 contains unit-of-account guidance for ASR programs. Under ASC 505-30-25-6, an entity accounts for an ASR as two separate units of account: a treasury stock repurchase and a separate forward contract on the entity’s shares. An entity should analyze the treasury stock repurchase and forward contract separately to determine how to account for each unit of account. Because ASC 815-40 contains an exception for financial instruments that are within the scope of ASC 480 (see Section 2.3), an entity should determine whether one or both units of account are within the scope of ASC 480 before considering whether ASC 815-40 applies.

The terms of ASRs vary. In a traditional ASR, an entity (1) repurchases a targeted number of its own shares at the current stock price immediately for cash and (2) simultaneously enters into a net-share-settled forward sale of the same number of shares indexed to the average stock market price over the contract period. Economically, the forward serves as a true-up mechanism for adjusting the price ultimately paid for the shares purchased. Its purpose is to reduce the number of outstanding shares immediately at a repurchase price that on a combined basis reflects the average stock market price over an extended period (e.g., the volume-weighted average price on each trading day during the contract period). On a combined basis, the initial share repurchase and the forward sale put the issuer in an economic position similar to that of having conducted a series of open market purchases of its own stock over a specified period.

Example 3-10

ASR Analysis

An entity makes an up-front cash payment and receives a specific number of shares from the counterparty (usually an investment bank). Upon settlement of the forward contract (typically within three to six months), the entity either (1) pays the counterparty an amount equal to any excess of the volume-weighted average daily market price (VWAP) of the entity’s shares over the initial purchase price or (2) receives from the counterparty an amount equal to any excess of the initial purchase price over the VWAP. Often, the entity can choose to settle the forward contract with the counterparty in either cash or a variable number of shares. Under ASC 505-30, this transaction is analyzed as two units of account: a treasury stock repurchase and a net settled forward contract to sell the entity’s stock over the contract period.

In practice, the settlement of the treasury stock repurchase often takes place one or a few days after the execution of the ASR (e.g., the initial share delivery date may be three business days after the transaction date), at which time the issuer pays cash and receives an initial number of shares. In such cases, the obligation to repurchase shares in exchange for cash is classified as a liability under ASC 480-10-25-8 (see Chapter 5 of Deloitte’s Roadmap Distinguishing Liabilities From Equity) during the period between the ASR transaction date and the settlement date of the treasury stock repurchase (sometimes described as the “initial share delivery date” or the “prepayment date”). Note that in some ASR transactions, the payment of cash in the treasury stock repurchase occurs before the receipt of the initial shares, in which case ASC 480 may cease to apply once the obligation to pay cash has been settled.

In evaluating whether the forward component of an ASR is within the scope of ASC 480, the issuer should consider whether it embodies an obligation to transfer assets or a variable number of shares that meet the criteria in ASC 480-10-25-8 or ASC 480-10-25-14 (see Chapters 5 and 6 of Deloitte’s Roadmap Distinguishing Liabilities From Equity). Usually, an issuer is not required to classify as a liability under ASC 480 the forward contract component in a traditional ASR because it does not embody an obligation to repurchase shares for assets and does not involve an obligation to deliver a variable number of shares with a monetary value that moves inversely with — or is based on something other than — the price of the issuer’s stock. However, an issuer cannot assume that the forward contract component of an ASR is outside the scope of ASC 480 without analyzing its specific terms and features.

In some ASR transactions, a portion of the prepayment amount on the initial share delivery date represents a premium paid by the issuer to increase the forward sale price that the issuer will receive in the forward component of the transaction (relative to an at-market forward) rather than a payment for the shares to be received in the initial treasury stock repurchase. For example, the issuer may apply 20 percent of the prepayment amount to the forward component to reduce the likelihood that the forward component will ever dilute EPS. In that case, the issuer may be required to account for the forward component as an asset or a liability under ASC 480-10-25-8 in the period between the transaction date and the initial share delivery date if the forward component permits net share settlement. This is because the forward component embodies an obligation to pay cash (on the initial share delivery date) to repurchase shares (the issuer will receive shares on the forward settlement date if the stock price is less than the forward price).

If the forward component is outside the scope of ASC 480, the issuer considers the guidance in ASC 815-40 when it determines whether the forward should be accounted for as an asset or liability. The terms of an ASR often include rights for the counterparty to end the ASR early upon termination events defined by reference to ISDA’s equity derivatives definitions (e.g., merger events, tender offers, nationalization, insolvency, delisting, change in law, failure to deliver, insolvency filing, loss of stock borrow, increased cost of stock borrow, extraordinary dividends). Further, the contractual provisions often specify or permit the counterparty to make adjustments to the settlement terms upon the occurrence of such events (e.g., calculation agent adjustments, cancellation, and payment) and might require the entity to settle the contract net in cash. In evaluating an ASR’s forward-contract component under ASC 815-40, therefore, the entity should be mindful of the need to assess such terms under the indexation guidance and other equity classification conditions in ASC 815-40 (see Chapters 4 and 5).

Example 3-11

ASR Analysis — Accounting Between Trade Date and Settlement Date

On December 30, an issuer enters into an ASR transaction that requires it to transfer a fixed amount of cash (a prepayment amount of $500 million) in exchange for a fixed number of its common shares (10 million initial shares) on the initial share delivery date (January 2). The issuer will either deliver or receive shares on the transaction’s final settlement date (March 31). If the VWAP of the issuer’s common shares exceeds $50, the issuer will deliver shares; if the VWAP is less than $50, the issuer will receive shares. The number of shares that will be received or delivered is calculated as the prepayment amount ($500 million) divided by the VWAP over the contract period less the initial shares (10 million) already delivered.

In these circumstances, the treasury stock repurchase must be accounted for as a liability under ASC 480-10-25-8. In accordance with ASC 480-10-30-3, the issuer recognizes the liability on the ASR transaction date, which was initially measured “at the fair value of the shares at inception, adjusted for any consideration or unstated rights or privileges.” Simultaneously, in accordance with ASC 480-10-30-5, equity is “reduced by an amount equal to the fair value of the shares at inception.” Because under ASC 480-10-35-3(a) both the amount to be paid — $500 million — and the settlement date — January 2 — are fixed, the liability is measured at the present value of the amount to be paid at settlement — $500 million — with interest cost accruing at the rate implicit at inception during the period from the transaction date to the initial share delivery date. (Further, if any part of the prepayment amount represents a premium payment for the forward component of the accelerated share repurchase transaction, that portion would be accounted for separately as a liability measured at fair value under ASC 480-10-35-1, ASC 480-10-35-4A, or ASC 480-10-35-5 between the transaction date and the initial share delivery date, as discussed above.)

On the initial share delivery date, the liability for the treasury stock repurchase is extinguished by delivery of the prepayment amount. After the initial share delivery date, the transaction is outside the scope of ASC 480 and is therefore evaluated under other GAAP (including ASC 815 and ASC 815-40).

Footnotes

Note that the ASC master glossary definitions of “freestanding contract” and “freestanding financial instrument” are interpreted in practice as being the same.

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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.