5.1 General

ASC 718-10

Determining Whether to Classify a Financial Instrument as a Liability or as Equity

25-6 This paragraph through paragraph 718-10-25-19A provide guidance for determining whether certain financial instruments awarded in share-based payment transactions are liabilities. In determining whether an instrument not specifically discussed in those paragraphs shall be classified as a liability or as equity, an entity shall apply generally accepted accounting principles (GAAP) applicable to financial instruments issued in transactions not involving share-based payment.

An entity’s measurement of compensation cost for awards within the scope of ASC 718 differs depending on whether the entity determines that the awards are classified as equity or liabilities (i.e., a fair-value-based measure as of the grant date for most equity-classified awards versus a fair-value-based measure as of the end of each reporting period until settlement for liability-classified awards). The classification of share-based payment awards can be complex. While classifying a cash-settled award as a liability may seem straightforward, entities must consider the features and conditions of every award. Generally, the following types of awards (with certain exceptions, including those noted below) must be classified as liabilities in accordance with ASC 718-10-25-6 through 25-19A:

Types of Awards	Discussion	Exceptions
Awards that would be classified as liabilities under ASC 480	Although share-based payment awards subject to ASC 718 are outside the scope of ASC 480, ASC 718-10-25-7 requires an entity to apply the classification criteria in ASC 480-10-25 and in ASC 480-10-15-3 and 15-4 unless ASC 718-10-25-8 through 25-19A require otherwise. See ASC 718-10-25-7 and 25-8 and Section 5.2 for a discussion of how to apply the classification criteria in ASC 480 to share-based payment awards.	In determining the classification of share-based payment awards under ASC 480, entities should take into account the scope exceptions related to ASC 480, as discussed in ASC 718-10-25-8 and Section 5.2.1, as well as any specific exceptions in ASC 718-10-25-8 through 25-19A.
Stock awards subject to repurchase features that do not subject the grantee to the risks and rewards of equity share ownership for a reasonable period	ASC 718-10-25-9 and 25-10 distinguish between repurchase features that are within the control of the issuer and those that are not within the control of the issuer. See Section 5.3 for guidance on determining the classification of callable and puttable stock awards.	ASC 718-10-25-9(a) does not require liability classification for contingent repurchase features that are not within the grantee’s control and for which it is not probable that the contingency will occur. In addition, ASC 718-10-25-18 exempts from liability classification, under certain circumstances, repurchases that are used to satisfy the employer’s statutory tax withholding requirements. See Section 5.7.2.
Stock options or similar instruments for which (1) the underlying shares are classified as liabilities or (2) the options or similar instruments can be required to be settled in cash or other assets	ASC 718-10-25-11 and 25-12 require that stock options or similar instruments be classified as a liability if the (1) underlying shares are classified as a liability or (2) the options or similar instruments must be settled in cash or the grantee can require the entity to settle in cash. See Section 5.4 for guidance on determining the classification of stock options for which cash settlement could be required.	ASC 718-10-25-11(b) does not require liability classification for contingent cash settlement features that are not within the grantee’s control and for which it is not probable that the contingency will occur. ASC 718-10-25-16 and 25-17 exempt from liability classification, under certain circumstances, broker-assisted cashless exercises. In addition, ASC 718-10-25-18 exempts from liability classification, under certain circumstances, repurchases of shares upon option exercises that are used to satisfy the employer’s statutory tax withholding requirements. See Section 5.7.2.
Awards with conditions or other features that are indexed to something other than a market, performance, or service condition	Under ASC 718-10-25-13, awards indexed to something other than a market, performance, or service condition must be classified as a liability. See Section 5.5 for a discussion of other conditions.	ASC 718-10-25-14 and 25-14A exempt stock options with a fixed exercise price in a foreign currency awarded to a grantee of a foreign operation from liability classification provided that the exercise price is denominated in (1) the foreign operation’s functional currency, (2) the currency in which the foreign operation’s employees are paid, or (3) the currency of a market in which a substantial portion of the entity’s equity securities trades.
Awards that are substantive liabilities because (1) the grantee has the choice of settlement in cash or shares or (2) the entity can choose the method of settlement but does not have the intent, past practice, or ability to settle with shares	ASC 718-10-25-15 states that to determine an award’s classification, an entity should evaluate the award’s substantive terms as well as the entity’s past practices and its ability to settle in shares. See Section 5.6 for a discussion of factors that an entity with a choice of settlement method may consider in determining an award’s classification.	ASC 718-10-25-15(a) states that a requirement to deliver registered shares does not imply, by itself, that an entity does not have the ability to settle the award in shares.
Certain awards that may become subject to other applicable GAAP	Other applicable GAAP (e.g., ASC 815) may apply to awards that are originally accounted for as share-based payment awards under ASC 718 but are modified after a grantee (1) whose awards are vested is no longer providing goods or services, (2) whose awards are vested is no longer a customer, or (3) is no longer an employee. In addition, once vested, a convertible instrument award granted to a nonemployee becomes subject to other applicable GAAP. See ASC 718-10-35-9 through 35-14 in Section 5.8 as well as Section 9.5 for a discussion of when share-based payment awards subject to ASC 718 become subject to other applicable GAAP.	Under ASC 718-10-35-9 through 35-14, certain freestanding instruments issued to grantees may never become subject to other GAAP. In addition, an award would not be subject to other GAAP if the award is modified (after a grantee whose awards are vested is no longer providing goods or services, after a grantee whose awards are vested is no longer a customer, or the grantee is no longer an employee) solely to reflect an equity restructuring that meets certain conditions under ASC 718-10-35-10A.

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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.