5.2 ASC 480

ASC 718-10

25-7 Topic 480 excludes from its scope instruments that are accounted for under this Topic. Nevertheless, unless paragraphs 718-10-25-8 through 25-19A require otherwise, an entity shall apply the classification criteria in Section 480-10-25 and paragraphs 480-10-15-3 through 15-4 in determining whether to classify as a liability a freestanding financial instrument given to a grantee in a share-based payment transaction. Paragraphs 718-10-35-9 through 35-14 provide criteria for determining when instruments subject to this Topic subsequently become subject to Topic 480 or to other applicable GAAP.

25-8 In determining the classification of an instrument, an entity shall take into account the classification requirements as established by Topic 480. In addition, a call option written on an instrument that is not classified as a liability under those classification requirements (for example, a call option on a mandatorily redeemable share for which liability classification is not required for the specific entity under the requirements) also shall be classified as equity so long as those equity classification requirements for the entity continue to be met, unless liability classification is required under the provisions of paragraphs 718-10-25-11 through 25-12.

ASC 480-10

Mandatorily Redeemable Financial Instruments

25-4 A mandatorily redeemable financial instrument shall be classified as a liability unless the redemption is required to occur only upon the liquidation or termination of the reporting entity.

25-5 A financial instrument that embodies a conditional obligation to redeem the instrument by transferring assets upon an event not certain to occur becomes mandatorily redeemable if that event occurs, the condition is resolved, or the event becomes certain to occur.

25-6 In determining if an instrument is mandatorily redeemable, all terms within a redeemable instrument shall be considered. The following items do not affect the classification of a mandatorily redeemable financial instrument as a liability:

A term extension option
A provision that defers redemption until a specified liquidity level is reached
A similar provision that may delay or accelerate the timing of a mandatory redemption.

25-7 If a financial instrument will be redeemed only upon the occurrence of a conditional event, redemption of that instrument is conditional and, therefore, the instrument does not meet the definition of mandatorily redeemable financial instrument in this Subtopic. However, that financial instrument would be assessed at each reporting period to determine whether circumstances have changed such that the instrument now meets the definition of a mandatorily redeemable instrument (that is, the event is no longer conditional). If the event has occurred, the condition is resolved, or the event has become certain to occur, the financial instrument is reclassified as a liability.

Obligations to Repurchase Issuer’s Equity Shares by Transferring Assets

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.

25-9 In this Subtopic, indexed to is used interchangeably with based on variations in the fair value of. The phrase requires or may require encompasses instruments that either conditionally or unconditionally obligate the issuer to transfer assets. If the obligation is conditional, the number of conditions leading up to the transfer of assets is irrelevant.

25-10 Examples of financial instruments that meet the criteria in paragraph 480-10-25-8 include forward purchase contracts or written put options on the issuer’s equity shares that are to be physically settled or net cash settled.

25-11 All obligations that permit the holder to require the issuer to transfer assets result in liabilities, regardless of whether the settlement alternatives have the potential to differ.

25-12 Certain financial instruments that embody obligations that are liabilities within the scope of this Subtopic also may contain characteristics of assets but be reported as single items. Some examples include the following:

Net-cash-settled or net-share-settled forward purchase contracts
Certain combined options to repurchase the issuer’s shares.

Those instruments are classified as assets or liabilities initially or subsequently depending on the instrument’s fair value on the reporting date.

25-13 An instrument that requires the issuer to settle its obligation by issuing another instrument (for example, a note payable in cash) ultimately requires settlement by a transfer of assets, accordingly:

When applying paragraphs 480-10-25-8 through 25-12, this also would apply for an instrument settled with another instrument that ultimately may require settlement by a transfer of assets (warrants for puttable shares).
It is clear that a warrant for mandatorily redeemable shares would be a liability under this Subtopic.

Certain Obligations to Issue a Variable Number of Shares

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). . . .

Although share-based payment awards subject to ASC 718 are outside the scope of ASC 480, ASC 718-10-25-7 requires entities 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. An entity is not required to classify an award as a liability if equity classification is permitted under ASC 718-10-25-8 through 25-19A; however, if that guidance does not address a share-based payment award’s classification, the entity would consider the guidance in ASC 480.

Under ASC 480-10-25 and ASC 480-10-15-3 and 15-4, liability classification is required if an award meets any of the criteria in the table below unless ASC 718-10-25-8 through 25-19A require otherwise. In addition, ASC 718-10-25-8 clarifies that the scope exceptions in ASC 480 for certain mandatorily redeemable financial instruments also apply to share-based payment awards within the scope of ASC 718. See Section 5.2.1 for more information.

ASC 480 Instruments	Examples of Share-Based Payment Awards	Comments
Mandatorily redeemable financial instruments described in ASC 480-10-25-4 through 25-7, and defined in the ASC master glossary as “financial instruments issued in the form of shares that embody an unconditional obligation requiring the issuer to redeem the instrument by transferring its assets at a specified or determinable date (or dates) or upon an event that is certain to occur.”	An entity issues to a grantee common stock or restricted shares that must be repurchased by the entity as of specified or determinable dates (e.g., upon the employee’s death or any termination event). An entity issues to a grantee redeemable preferred stock that must be repurchased as of specified or determinable dates. If an entity offers a deferred compensation plan to employees under which an employee is forced into a diversified account (i.e., a rabbi trust), such a plan would most likely be considered mandatorily redeemable in accordance with ASC 480 (see Section 2.7).	The repurchase or redemption feature must be unconditional (i.e., the entity and grantee cannot choose the method of settlement). In addition, no other features of the instrument’s terms can exist that would cause the shares not to be redeemed. For example, preferred shares that may be converted into common shares before the specified redemption date(s) would not result in liability classification for the preferred shares if the conversion feature is substantive. ASC 480 includes a scope exception for certain mandatorily redeemable financial instruments of nonpublic entities and certain mandatorily redeemable noncontrolling interests of all entities (public and nonpublic). See Section 5.2.1.
A financial instrument, other than an outstanding share, that embodies (or is indexed to) an obligation to repurchase shares (conditionally or unconditionally) by transferring cash or other assets as described in ASC 480-10-25-8 through 25-13.	An entity issues to a grantee a freestanding written put option for which physical or net-cash settlement is required. An entity enters into a forward contract to repurchase shares of its common stock from a grantee on a specified date in the future at a fixed price.	This element of ASC 480 only applies to freestanding financial instruments (as that term is defined in ASC 480-10) other than outstanding shares and does not apply to repurchase rights embedded in shares. Share-based payment arrangements that are (1) financial instruments other than outstanding shares (e.g., options or similar instruments) and (2) indexed to an obligation to repurchase shares (conditionally or unconditionally) because of a repurchase feature embedded in the equity instrument underlying the award would be accounted for in accordance with the guidance in Section 5.4 in the assessment of whether the share-based payment is equity or liability classified. Further, repurchase rights in share-based payment arrangements, such as restricted stock, are viewed as embedded in the shares and are not legally detachable from the underlying shares or separately exercisable. When assessing whether to classify the share-based payment as equity or liability, an entity would consider the guidance in ASC 718 (on the classification of these types of awards) as well as Section 5.3.
A financial instrument that embodies certain obligations to issue a variable number of shares when the obligation’s monetary value is based, solely or predominantly, on any one of the following items described in ASC 480-10-25-14: “A fixed monetary amount known at inception.” “Variations in something other than the fair value of the issuer’s equity shares.” “Variations inversely related to changes in the fair value of the issuer’s equity shares.”	An entity grants a bonus to its chief executive for services rendered over the next two years. The obligation will be settled by issuing to the grantee a variable number of the entity’s shares valued at $100,000 on the basis of the entity’s share price at the end of the second year (see Example 2-2). ESPPs that require the employee to purchase a specific dollar amount of the employer’s stock on the purchase date; the amount of compensation cost is fixed and known on the service inception date (see Section 8.4).	Awards will generally be classified as share-settled debt arrangements if they are (1) based solely or predominantly on a fixed monetary amount known at inception, or on amounts that vary independently of changes in the fair value of an entity’s equity, and (2) settled in a variable number of shares. Such awards are accounted for as share-based liabilities. An obligation could have multiple outcomes, some of which may have a monetary value that is determined on the basis of one of the three factors in ASC 480-10-25-14. In such a scenario, an outcome is predominant if it is more likely than not to occur (i.e., has a greater than 50 percent likelihood of occurring). Accordingly, if the occurrence of an outcome is reasonably possible but not more likely than not, the outcome is not predominant.

The examples below illustrate situations in which (1) the entity’s obligation related to awards granted to employees meet the criteria in ASC 480-10-25-14 and thus liability classification would be required and (2) the exceptions to the guidance in ASC 718 should be applied and therefore liability classification would not be required.

Example 5-1

Variations in Something Other Than the Fair Value of the Issuer’s Equity Shares

Entity A grants employee stock options with an exercise price established on the grant date equal to a fixed multiple of its trailing 12 months EBITDA. It is assumed that the EBITDA multiple does not represent a reasonable approximation of the fair value of A’s equity shares. The settlement price of the options as of the vesting date is also established according to a fixed multiple of the same trailing 12 months EBITDA of A. Any excess of the options’ settlement price as of the vesting date over the options’ exercise price as of the grant date is paid to the employees in a variable number of A’s shares on the basis of the fair value of A’s shares on the vesting date. Because the monetary value of the options (1) is indexed solely to variations in an operating performance measure of A (i.e., EBITDA) and (2) will be settled in a variable number of A’s shares, the options will be classified as a share-based liability.

Example 5-2

Settlement in a Variable Number of Shares on the Basis of a Fixed Monetary Amount

Entity B is a real estate brokerage firm that has a network of real estate agents who are employees. Upon hiring an agent as an employee, B and the employee enter into a share-based payment arrangement. The terms of the agreement specify that upon the closing of the employee’s first real estate sale, B will issue to the employee shares of common stock equal to $1,000 on the basis of the fair value of B’s common stock as of the date of the closing. The agent will vest in the award at the end of the second year of service following the date of the closing (cliff vesting). Because B has granted an award for a fixed monetary amount to be settled in a variable number of shares, the award is initially classified as a liability. Once the number of shares of common stock to be issued under the award is fixed (upon the closing of the employee’s first real estate sale), and as long as all criteria for equity classification are met, the award would be reclassified as equity.

Example 5-3

Variable Number of Shares Based on Earnings That Exceed a Specified Amount

Entity A grants employees an award of options on A’s common stock. The number of options that vest is based on A’s earnings over a 12-month period. The award cliff-vests at the end of the 12-month period. The number of awards that vest is calculated as follows: for each $500,000 increment of A’s earnings that exceed $2 million, not to exceed $5 million for the 12-month period after the grant date, 25,000 options will vest.

Although awards subject to ASC 718 are outside the scope of ASC 480, ASC 718-10-25-7 requires entities 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. A similar arrangement in which awards are not within the scope of ASC 718 would meet the criteria for classification as a liability under ASC 480-10-25-14(b) because under such an arrangement, the entity would be required to issue a variable number of options on its common shares that derive their value from something other than the fair value of the entity’s equity shares (e.g., value derived from earnings over a 12-month period). However, ASC 718 does not require these awards to be classified as a liability because the issuance of a variable number of shares is indexed to A’s earnings, which represents a performance condition under ASC 718. Accordingly, as long as all other criteria for equity classification are met, the award would be classified as equity.

Example 5-4

Variable Number of Shares Based on a Share Price Target

Entity A grants employees an award on A’s common stock. The monetary value of the award is based on the increases in A’s stock price, as listed below, over a 12-month period. The award will be settled in shares of A on the basis of its stock price at the end of the 12-month period. For example, the dollar amount of the award will be divided by the stock price at the end of the 12-month period to yield the number of shares that will be issued to the grantee.

Increase in Stock Price	Dollar Value of the Award
Less than 5%	$0 million
Between 5% and 10%	$5 million
Between 10% and 15%	$7 million
Greater than 15%	$10 million

Since the award includes multiple settlement outcomes whose value increases on the basis of the increase in A’s stock price, the award generally would not meet the criteria in ASC 480-10-25-14(a). In this case, the award should be accounted for as an equity award with a market condition. This type of award is likely to be viewed as a stock-settled SAR rather than a share-settled debt arrangement.

However, if one of the settlement outcomes is predominant (i.e., it is more likely than not, or there is a greater than 50 percent likelihood, that only one settlement outcome will occur), the award will be classified as a liability under ASC 480-10-25-14(a). The predominance assessment is performed as of the grant date.

Example 5-5

SAR Subject to a Dollar Cap

Entity A grants employees a share-settled SAR. The SAR entitles each grantee to receive an amount in shares equal to the increase in value of one share of A’s stock price over $10 on the vest date. The SAR cliff-vests at the end of three years of service (an explicit and requisite service period of three years) and has a $30 share cap. If A’s share price exceeds the share cap, each grantee will only be entitled to $20 worth of value in shares for the SAR (i.e., $30 less $10).

Two outcomes are possible for the settlement of the SAR with a variable number of shares: (1) settlement at a share price below the share cap of $30 but above $10 or (2) settlement at a share price that exceeds the $30 cap, which would limit the value realized by the grantee. The grantor will deliver a variable number of shares equivalent to a fixed monetary amount known at inception if the share price exceeds the $30 cap on the vest date (the “dead zone”).

The award should be classified as a liability if it is more likely than not (i.e., a likelihood of greater than 50 percent) that the SAR will be settled within the range in which the company will issue a variable number of shares equal to a fixed monetary amount. Thus, A should evaluate whether dead-zone conversion (i.e., the delivery of common shares equal in value to a fixed monetary amount or $20) is the predominant settlement outcome. If so, the grantor must classify the SAR as a liability under ASC 480-10-25-14(a). In evaluating whether an outcome in the dead zone is predominant, A would consider the expected growth rates of, and expected variability in, the price of its common stock. When performing this assessment, A may need to engage a third-party valuation specialist. If the dead-zone version is not the predominant settlement outcome, the SAR would not be classified as a liability under ASC 480.

Example 5-6

Annual Bonus Plan Settled in a Variable Number of Shares

Entity A has a formalized annual bonus plan that is based on various EBITDA targets achieved during the fiscal year. For each grantee, the monetary value of the bonus will be settled in shares of A on the basis of its stock price at the end of the fiscal year. The dollar amount of the bonus will be divided by the stock price to yield the number of shares that will be issued to a grantee.

In accordance with ASC 480-10-25-14, the annual bonus award should be accounted for as a liability award with a performance condition since the plan is based on A’s EBITDA targets (i.e., performance conditions) and represents fixed monetary amounts settled in a variable number of shares rather than a monetary amount that fluctuates on the basis of changes in A’s stock price.

Example 5-7

Options on Puttable Shares

On January 1, 20X5, Entity A grants 1,000 at-the-money employee stock options that vest over four years on the basis of the grantees’ continuous services. The options are not exercisable until the awards vest.

The shares underlying the options are puttable at their then-current fair value once the options have been exercised and the grantees have held the shares for at least six months (i.e., the put right is only exercisable beginning six months and one day after an employee has exercised the options). The options contain no provisions that would require A to settle the options by transferring cash or other assets (i.e., the options can only be settled in shares of A), and there are no other terms that would cause the awards to be classified as a liability.

Although awards subject to ASC 718 are outside the scope of ASC 480, ASC 718-10-25-7 requires entities 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. Entity A determines that the options do not require liability classification under ASC 718-10-25-11 because (1) the shares are not classified as liabilities (a conclusion that takes into account the put right and the applicable guidance in ASC 718-10-25-9 and 25-10) and (2) the options do not contain a cash-settlement feature. While a similar arrangement not within the scope of ASC 718 may be classified as a liability under ASC 480, ASC 718 explicitly addresses the classification of this award.

Note that if A is an SEC registrant, it should also consider the SEC guidance on temporary equity. See Section 5.10.

5.2.1 ASC 480 Scope Exceptions That Apply to Share-Based Payments Within the Scope of ASC 718

In determining the classification of share-based payment awards under ASC 480, nonpublic entities should consider the scope exceptions related to ASC 480 described in ASC 718-10-25-8. The exceptions apply to certain mandatorily redeemable financial instruments that either represent noncontrolling interests or are issued by nonpublic entities that are not SEC registrants. For example, the classification guidance in ASC 480 does not apply to mandatorily redeemable financial instruments of nonpublic entities that are not SEC registrants unless they are mandatorily redeemable on fixed dates for amounts that are either fixed or are determined by reference to an external index (e.g., an interest rate index or currency index).

In addition, if a mandatorily redeemable financial instrument qualifies for one of the exceptions in ASC 480-10, the issuer should consider the applicability of ASC 480-10-S99-3A to that instrument. See Section 5.10 for a discussion and examples of the application of ASR 268 and ASC 480-10-S99-3A to certain redeemable securities. For detailed guidance on the application of ASC 480, see 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.