5.2 Scope

The guidance in ASC 460 is organized into two subsections: (1) general and (2) product warranties. The guidance on product warranties is discussed in Section 5.6; accordingly, the remainder of this section addresses the scope of all guarantees other than product warranties.

It may prove challenging to assess the scope of ASC 460 because there are several exceptions related to applying the recognition, measurement, or disclosure guidance therein. In some instances, the guidance in ASC 460 results in the recognition and disclosure of a liability for a guarantee obligation. However, other types of guarantees are outside the scope of ASC 460’s recognition and measurement guidance (e.g., derivatives accounted for in accordance with ASC 815) but are still subject to its disclosure requirements. The figure below presents a framework for evaluating whether a guarantee is within the scope of ASC 460 and indicates that there are three possible conclusions for guarantees within the scope of ASC 460-10-15-4.

The figure below illustrates the decisions made to determine whether a guarantee is within the scope of any portion of ASC 460.

5.2.1 Transactions Within the Scope of ASC 460-10-15-4

ASC 460-10-15-4 is the starting point for determining whether a transaction is a guarantee that may be within the scope of the recognition, measurement, and disclosure requirements of ASC 460. ASC 460-10-15-4 lists contract types that should be accounted for as guarantees under ASC 460 in the absence of a specific scope exception in ASC 460-10-15-7 (as discussed in Section 5.2.2).

The flowchart below illustrates common types of guarantee contracts that are within the scope of ASC 460-10-15-4.

ASC 460-10

15-4 Except as provided in paragraph 460-10-15-7, the provisions of this Topic apply to the following types of guarantee contracts:

Contracts that contingently require a guarantor to make payments (as described in the following paragraph) to a guaranteed party based on changes in an underlying that is related to an asset, a liability, or an equity security of the guaranteed party. For related implementation guidance, see paragraph 460-10-55-2.
Contracts that contingently require a guarantor to make payments (as described in the following paragraph) to a guaranteed party based on another entity’s failure to perform under an obligating agreement (performance guarantees). For related implementation guidance, see paragraph 460-10-55-12.
Indemnification agreements (contracts) that contingently require an indemnifying party (guarantor) to make payments to an indemnified party (guaranteed party) based on changes in an underlying that is related to an asset, a liability, or an equity security of the indemnified party.
Indirect guarantees of the indebtedness of others, even though the payment to the guaranteed party may not be based on changes in an underlying that is related to an asset, a liability, or an equity security of the guaranteed party.

It is possible that a guarantee could result from a contractual arrangement that represents one or more of the four types of contracts described in ASC 460-10-15-4. In the absence of a scope exception in ASC 460-10-15-7, a contractual arrangement only needs to be one of these four contract types to be a guarantee within the scope of ASC 460. Accordingly, once an entity has concluded that its guarantee is one of these four types of contracts, it does not need to further consider whether it also represents one or more of the remaining three types.

According to the above guidance, contracts or indemnification agreements that could require a guarantor to make payments that are based on an underlying (as defined below) related to an asset, liability, or equity security of the guaranteed party are within the scope of ASC 460-10-15-4.

ASC 460-10 — Glossary

Underlying

A specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, or other variable (including the occurrence or nonoccurrence of a specified event such as a scheduled payment under a contract). An underlying may be a price or rate of an asset or liability but is not the asset or liability itself. An underlying is a variable that, along with either a notional amount or a payment provision, determines the settlement of a derivative instrument.

ASC 460-10-20 describes an underlying as “a variable that . . . determines the settlement of a derivative instrument.” In the context of a guarantee contract, the underlying will govern whether the guarantor is required to make a payment. For example, in a guarantee of the principal balance of a loan, the underlying is the occurrence or nonoccurrence of the debtor’s repayment of the loan. If the debtor repays the loan on its contractual repayment date, the guarantor will not be required to make a payment. If the debtor fails to repay the loan on the specified date, the guarantor is obligated to make the payment.

An important provision of ASC 460-10-15-4(a) is that the underlying must be related to an asset, liability, or equity security of the guaranteed party. Regarding guarantees of debt, ASC 460-10-15-6 states, in part:

[I]t does not matter whether the guaranteed party is the creditor or the debtor, that is, whether the guarantor is required to pay the creditor or the debtor (who would then have the funds to pay its debt to the creditor). The underlying (that is, the debtor’s failure to make scheduled payments or the occurrence of other events of default) could be related to either the creditor’s receivable or the debtor’s liability.

ASC 460-10-15-5 notes that the payment the guarantor must make, as described in ASC 460-10-15-4, is not limited to a payment in cash; rather, payment can take the form of cash, financial assets, nonfinancial assets, shares of the guarantor’s stock, or the provision of services.

Connecting the Dots

While the payment a guarantor may be required to make can take the form of the provision of a service, a contract that requires an entity to perform a service regardless of changes in an underlying would not represent a guarantee and therefore would be subject to other guidance (e.g., ASC 606-10). For example, if an entity is required to perform health care claim services for another party, that contract would not represent a guarantee within the scope of ASC 460-10. Rather, it would constitute a contract to perform services. If, however, an entity agrees to provide a service to a guaranteed party on the basis of another entity’s failure to properly perform this service, such an arrangement may be subject to the recognition, measurement, and disclosure provisions of ASC 460-10.

5.2.1.1 Financial Guarantees

ASC 460-10-15-4(a) describes financial guarantee contracts, and ASC 460-10-55-2 indicates that common examples of such contracts include, but are not limited to, the following:

A financial standby letter of credit
A market value guarantee on either a financial asset (such as a security) or a nonfinancial asset owned by the guaranteed party [e.g., real estate or a commodity]
A guarantee of the market price of the common stock of the guaranteed party
A guarantee of the collection of the scheduled contractual cash flows from individual financial assets held by a special-purpose entity
A guarantee granted to a business or its owner(s) that the revenue of the business (or a specific portion of the business) for a specified period of time will be at least a specified amount.

For each of these contracts, the guarantor could be required to make payments to the guaranteed party for a specified financial obligation. The requirement to make payments is an important consideration in the evaluation of whether an arrangement is within the scope of ASC 460. If the guarantor is able to avoid payment, such as through specific clauses limiting the requirement to make a payment (e.g., a material adverse change clause, as further described in Section 5.2.1.1.1), the arrangement would not be within the scope of ASC 460.

5.2.1.1.1 Financial Guarantees — Financial Standby Letters of Credit

ASC 460-10-20 defines a financial standby letter of credit and a commercial letter of credit as follows:

ASC 460-10 — Glossary

Financial Standby Letter of Credit

An irrevocable undertaking (typically by a financial institution) to guarantee payment of a specified financial obligation.

Commercial Letter of Credit

A document issued typically by a financial institution on behalf of its customer (the account party) authorizing a third party (the beneficiary), or in special cases the account party, to draw drafts on the institution up to a stipulated amount and with specified terms and conditions; it is a conditional commitment (except if prepaid by the account party) on the part of the institution to provide payment on drafts drawn in accordance with the terms of the document.

ASC 460-10-55-16(a) states that “[c]ommercial letters of credit and other loan commitments, which are commonly thought of as guarantees of funding, are not included in the scope of [ASC 460-10] because those instruments do not guarantee payment of a money obligation and do not provide for payment in the event of default by the account party.” Therefore, entities must distinguish between financial standby letters of credit, which are subject to ASC 460-10, and commercial letters of credit, which are not subject to ASC 460-10.

A financial standby letter of credit is an irrevocable undertaking by an entity (e.g., a bank) guaranteeing to the guaranteed party (e.g., a third-party seller of goods) the payment of a specified financial obligation of a third entity (e.g., a customer or account party). For example, if a customer is unable to make a payment on an obligation to a seller of goods, the bank (i.e., the guarantor) will make that payment. Because the issuer of a financial standby letter of credit cannot avoid making a payment upon a default of a third party, such letters of credit are within the scope of ASC 460.

Footnote 5 of the Basis for Conclusions of Interpretation 45 states that a commercial letter of credit “is a document issued typically by a financial institution on behalf of its customer (the account party) authorizing a third party (the beneficiary), or in special cases the account party, to draw drafts on the institution up to a stipulated amount and with specified terms and conditions; it is a conditional commitment (except when prepaid by the account party) on the part of the institution to provide payment on drafts drawn in accordance with the terms of the document.” A commercial letter of credit is similar to a loan commitment. Neither of those instruments possesses the characteristics in ASC 460-10-15-4(a) because they do not guarantee payment of a money obligation and do not provide for payment in the event of default by the account party. Like loan commitments, commercial letters of credit customarily contain material adverse change clauses or similar provisions that allow the issuing institution (i.e., the bank) to avoid making a loan (or other payment) if the borrower encounters financial difficulties after the instrument is issued.

Example 5-1

Financial Standby Letter of Credit

Company J is a purveyor of fine meats and cheeses and is based in the United States. Company J wishes to purchase $1 million of goods from Company W, which is based in Italy, for J to resell in the United States. While J is an established company with a history of reselling meats and cheeses, W has had no prior business dealings with J and requests additional assurance that it will ultimately collect amounts owed for selling its products to J.

Accordingly, J obtains a financial standby letter of credit from Company L (i.e., the guarantor) for up to $1 million, which guarantees payment to W (i.e., the guaranteed party) in the event that J is unable to meet its contractual financial obligation. The guarantee is effective for up to one year from the issuance date. In exchange for issuing the financial standby letter of credit, L charges J a fee commensurate with J’s credit evaluation and collateral provided.

Upon receipt of evidence of the financial standby letter of credit, W provides the goods to J on June 1, 20X1, with payment due on July 1, 20X1. As of July 1, 20X1, J is only able to make a payment on $600,000 of its contractual financial obligation. Therefore, L must provide $400,000 to W.

Example 5-2

Commercial Letter of Credit

Assume the same facts as in the example above except that J is a newly incorporated entity as of January 1, 20X1. Because J does not have an established operating history, to provide goods to J, W demands payment for the goods upon delivery.

To ensure payment to W upon delivery, J obtains from Bank T a commercial letter of credit that allows W to draw down from the bank up to $1 million upon J’s receipt of the goods. Bank T charges J a fee commensurate with J’s credit evaluation and collateral provided for issuing the commercial letter of credit.

On June 1, 20X1, J receives the goods from W. Accordingly, T makes a direct payment to W for $1 million. As a result, J now owes T $1 million. This arrangement is similar to a loan commitment.

Example 5-3

Ability of a Guarantor to Avoid Payment

Company J and Company V form a joint venture (JV), and V issues a financial standby letter of credit to the JV. If the JV does not perform (i.e., defaults), V is obligated to make payments to the financial institution that issued a line of credit to the JV. Company V’s investment in the JV is appropriately accounted for under the equity method. The JV does not need V’s approval to draw down on the line of credit.

Company V’s guarantee of the line of credit is within the scope of ASC 460-10-15-4(a) because V is required to make a payment to the institution that issued the line of credit if the JV defaults. Company V is unable to avoid payment. The guarantee does not qualify for the scope exception in ASC 460-10-25-1(g) for guarantees made by a parent on a subsidiary’s debt to a third party since V is not the JV’s parent (i.e., it applies the equity method to account for its investment in the JV).

Further, at the inception of the guarantee, V does not factor the outstanding balance of the line of credit into its conclusion regarding whether the guarantee is within the scope of ASC 460. As noted in ASC 460-10-25-2 and discussed in Section 5.3.2, a guarantee obligation consists of two components: (1) a noncontingent portion arising from the guarantor’s undertaking of “an obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur” and (2) a contingent portion representing the guarantor’s “obligation to make future payments if those triggering events or conditions occur.” At a minimum, when a guarantor enters into the guarantee arrangement, it must record a liability for the fair value of its noncontingent obligation to stand ready to perform. The amount of any subsequent balance drawn down by the JV on its line of credit would factor into the determination of the contingent portion of the guarantee obligation; the amounts JV expects to draw on the line of credit could affect the fair value ascribed to the noncontingent portion that is recognized at inception of the guarantee liability.

Additional Scenario

If the scenario described above was changed to specify that the JV needs V’s approval before drawing down on the line of credit, V’s guarantee of the line of credit would not be within the scope of ASC 460. If the JV needs V’s approval before drawing down on the line of credit, V can avoid payment under the guarantee by not providing approval to the JV. The guidance in ASC 460 is applicable as soon as V gives approval since, at that point, V cannot avoid its contingent obligation to pay.

5.2.1.1.2 Financial Guarantees — Market Value Guarantees

A market value guarantee is a type of financial guarantee that includes a guarantee of the price of a financial asset (such as a security), a nonfinancial asset, or the common stock of a guaranteed party. Payments are based on changes in the underlying that is related to an asset, liability, or equity security of the guaranteed party. This consideration is important because payments must be based on such changes to be within the scope of ASC 460-10-15-4(a).

Option-based contracts in which any net potential contingent payment flows only from the guarantor to the guaranteed party are the most common type of market value guarantees. Option-based contracts can take the form of a put option or call option. A put option gives the holder the right, but not the obligation, to sell a specified amount of an underlying at a certain price and time. A call option gives the holder the right, but not the obligation, to buy a specified amount of an underlying at a certain price and time. For these types of contracts, only the issuer (writer) of the option could potentially represent the guarantor. As further described below, these contracts may be within the scope of ASC 460.

5.2.1.1.2.1 Market Value Guarantees — Put Options

There are two main considerations that entities should evaluate to determine whether a written put option is within the scope of ASC 460:

Whether the written put option is a derivative in accordance with ASC 815.
Whether the put option represents a freestanding instrument.

5.2.1.1.2.1.1 Evaluating Whether the Written Put Option Represents a Derivative in Accordance With ASC 815

In evaluating whether a written put option is within the recognition and measurement provisions of ASC 460, an entity should first assess whether the option is within the scope of ASC 815. Written put options accounted for as derivatives in accordance with ASC 815 are not subject to the recognition and measurement provisions of ASC 460, as noted in Section 5.3.1. However, the disclosure requirements of ASC 460 apply to written put options that possess the characteristics in ASC 460-10-15-4(a) even if those options are accounted for as derivatives under ASC 815.

ASC 815-10

15-83 A derivative instrument is a financial instrument or other contract with all of the following characteristics:

Underlying, notional amount, payment provision. The contract has both of the following terms, which determine the amount of the settlement or settlements, and, in some cases, whether or not a settlement is required:
1. One or more underlyings
2. One or more notional amounts or payment provisions or both.
Initial net investment. The contract requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors.
Net settlement. The contract can be settled net by any of the following means:
1. Its terms implicitly or explicitly require or permit net settlement.
2. It can readily be settled net by a means outside the contract.
3. It provides for delivery of an asset that puts the recipient in a position not substantially different from net settlement.

An entity’s evaluation of whether a written put option is within the scope of ASC 460 may depend on the settlement terms in the contract.

5.2.1.1.2.1.2 Gross-Settled Written Put Options

A written put option that must be gross-settled is within the scope of ASC 460 since the issuer (the guarantor) is contingently required to make payments to the option holder on the basis of changes in an underlying asset, liability, or equity security of the option holder (the guaranteed party). As discussed in ASC 460-10-55-5, a written put option that must be gross-settled by delivery of an asset related to the underlying of the option possesses the characteristics described in ASC 460-10-15-4(a) irrespective of whether the entity knows whether the option holder owns an asset or owes a liability related to the underlying.

Written put options that must be gross-settled will be accounted for as derivatives if the net settlement characteristic in ASC 815-10-15-83(c) is present (e.g., if the underlying asset is readily convertible to cash).

Connecting the Dots

For a contract to be considered a derivative and accounted for under ASC 815, it must be required or permitted to be net-settled, it “can readily be settled net by a means outside the contract” (i.e., a market mechanism), or it “puts the recipient in a position not substantially different from net settlement” (i.e., the underlying asset is readily convertible to cash or is itself a derivative). Therefore, an entity must carefully consider the settlement provisions of written put options.

Written put options accounted for as derivatives are not subject to the recognition and measurement provisions of ASC 460 (see ASC 460-10-25-1(a)). However, as specified in ASC 460-10-50-1, the disclosure requirements of ASC 460 apply to written put options that possess the characteristics in ASC 460-10-15-4(a) even if those options are accounted for as derivatives under ASC 815. Accordingly, gross-settleable written put options accounted for as derivatives (i.e., that meet the net settlement characteristic as described above) are subject to the disclosure requirements of ASC 460.

5.2.1.1.2.1.3 Net-Settled Written Put Options

As discussed in ASC 460-10-55-7, if a put option is permitted or required to be net-settled, the issuer (the guarantor) must assess whether it is probable that the option holder (the guaranteed party), on or around the date of the put option’s issuance, owns an asset or owes a liability related to the underlying of the option. If it is probable that the holder has such an asset or liability, the put option possesses the characteristics described in ASC 460-10-15-4(a) and therefore is within the scope of ASC 460 because the put option contractually requires the writer of the option to purchase the asset or liability related to the option’s underlying if the option is exercised. In performing this assessment, the issuer must consider its business relationship with the option holder and other circumstances related to the issuance of the put option. If the issuer has no basis for concluding that it is probable that the option holder owns an asset or owes a liability related to the underlying, the option is not a guarantee under ASC 460-10-15-4(a).

The assessment of whether the guaranteed party owns an asset or owes a liability associated with the underlying of the put option is performed only at inception of the option. There is no reassessment of whether the guaranteed party owns the underlying asset or owes the underlying liability during the term of the option.

Generally, net-settled written put options are (1) within the scope of ASC 815 and (2) accounted for as derivatives. Written put options accounted for as derivatives are not subject to the recognition and measurement provisions of ASC 460 (see ASC 460-10-25-1(a)). However, as specified in ASC 460-10-50-1, the disclosure requirements of ASC 460 apply to written put options that have the characteristics in ASC 460-10-15-4(a) even if those options are accounted for as derivatives under ASC 815. Accordingly, net-settleable written put options accounted for as derivatives are subject to the disclosure requirements of ASC 460, provided that, as discussed above, it is probable that the option holder owns an asset or owes a liability related to the underlying on or around the date of the issuance of the put option.

Example 5-4

Market Value Guarantee — Interaction With Derivative Accounting

Farmer enters into a put option traded on the Chicago Mercantile Exchange (CME) with Farmers Market. The put option gives Farmer the right to sell 5,000 bundles of corn at $10 per bundle to Farmers Market. Physical settlement is contractually required for the put option.

The written put option is not subject to the recognition and measurement provisions of ASC 460 because it is accounted for as a derivative instrument in accordance with ASC 815. Although physical settlement is contractually required for the put option, there is a market mechanism to facilitate net settlement (i.e., the put option is traded on the CME); therefore, the option meets the net settlement criterion for a derivative.

In contrast, assume that Supplier enters into a put option with Clothing Market under which Supplier has the right to sell 5,000 bundles of yarn at $10 per bundle to Clothing Market. The put option is not traded on an exchange, the yarn is not readily convertible to cash, and physical settlement is contractually required for the put option. In that case, the written put option is subject to the recognition and measurement provisions of ASC 460 since it is not accounted for in accordance with ASC 815 because physical settlement is contractually required for the put option and the option does not allow for implicit net settlement.

Example 5-5

Determining Whether an Underlying Is Related to an Asset or Liability of the Guaranteed Party

Company W sells a weather-based derivative contract to Company X. Contract payouts depend on whether rainfall exceeds 5 inches in Seattle during January 20X1. The contract is not within the scope of ASC 460. Weather derivatives are typically option-based contracts that involve a payment to the guaranteed party on the basis of a climatic or geological variable (e.g., whether a specified amount of rainfall occurs). The characteristic in ASC 460-10-15-4(a) involves payments based on changes in an underlying that is related only to an asset, liability, or equity security of the guaranteed party. Since the climatic variable is not an asset, liability, or equity security of the guaranteed party, the weather derivative is not within the scope of ASC 460.

5.2.1.1.2.1.4 Evaluating Whether the Put Option Represents a Freestanding Instrument

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.” Section 3.2.1 of Deloitte’s Roadmap Contracts on an Entity’s Own Equity describes the different considerations related to identifying freestanding contracts that should be viewed as separate units of account.

A written put option that is embedded (i.e., not a freestanding instrument) in its underlying asset, liability, or equity security does not possess the characteristics in ASC 460-10-15-4(a) because the guaranteed party’s asset is an investment in the entire contract (the puttable security) and not an investment in a nonputtable security. Therefore, a written put option embedded in its underlying security typically would be outside the scope of ASC 460. This concept is explained in paragraph A10 of the Basis for Conclusions of FASB Interpretation 45, which states, in part:

For example, the put option that is embedded in a puttable bond (but is not accounted for separately as a derivative) could be viewed by the investor (the guaranteed party) as a guarantee against the market value of the remaining instrument (a bond absent the put option) declining below the put price; however, the embedded put option does not meet characteristic (a) because the guaranteed party’s asset is an investment in the entire contract, a puttable bond, and not an investment in a nonputtable bond.

Example 5-6

Put Option — Freestanding Contract

Entity X issues a structured note that contains a written put option allowing the holder, at maturity or upon a triggering event, to put bonds issued by Entity Y to X in exchange for the principal amount of the notes issued by X plus the principal amount of the bonds issued by Y.

In this example, the written put option is not embedded in the structured note but the underlying of the put option is a separate bond issued by Y. Since the guarantee is not considered embedded, it would be within the scope of ASC 460, provided that it possesses the characteristics in ASC 460-10-15-4(a).

5.2.1.1.2.2 Market Value Guarantees — Call Options

ASC Master Glossary

Call Option

A contract that allows the holder to buy a specified quantity of stock from the writer of the contract at a fixed price for a given period. See Option and Purchased Call Option.

ASC 460 does not provide specific guidance on written call options. Therefore, the writer of the option should consider its business relationship with the holder and the other circumstances related to the issuance of the option. If the writer of the option has knowledge that the holder is purchasing the option to cover a short position in the same asset as the underlying in the option, the written call option is within the scope of ASC 460-10-15-4(a), since the writer of the call option is required to transfer an asset to the option holder on the basis of the changes in a liability of the option holder (i.e., the underlying short position).

If the writer of the call option has no factual basis to conclude that the holder of the call option is purchasing the option to cover a short position in the asset, the written call option is not within the scope of ASC 460, since the writer of the call option does not have the information necessary to conclude that the option holder has an underlying short position. In practice, written call options are generally not accounted for as guarantees because the writers of such options are typically unaware of whether the purchaser has a short position in the same underlying asset.

Example 5-7

Evaluating Whether a Call Option Is Within the Scope of ASC 460

A short position is created when an entity sells a security or other asset that it does not own. Such transactions occur because the seller expects the price of the security or other asset to decline. To settle the short position, the entity must purchase the security or other asset before the maturity of the sale transaction so that the sale is “covered.”

For example, assume that on April 1, 20X0, Trader A sells gold for $2,000 an ounce to Entity B and that the settlement date is December 15, 20X0. On July 1, 20X0, the price of gold has declined to $1,800 an ounce. Trader A expects that the price of gold will continue to decline and will be lower as of the settlement date of the short sale. However, A wants to “lock in” a profit on the short sale. To do so, A purchases an option to buy gold at $1,900 an ounce from Entity C, a third party; the settlement date is December 15, 20X0. (Note that the option premium payable to purchase gold at $1,800 an ounce [December 15, 20X0, settlement date] was too expensive.)

Entity C would consider the presence of the short position, to the extent known, in determining whether the call option is within the scope of ASC 460. If C is aware of A’s short position, the call option written by C would be within the scope of ASC 460. However, if C is not aware of the short position and has no basis for concluding that A is purchasing the option to cover a short position in the asset, C’s written call option would not be within the scope of ASC 460.

5.2.1.1.3 Financial Guarantees — Contractual Cash Flows of a Special-Purpose Entity

A guarantee of the contractual cash flows of the financial assets or financial liabilities of a special-purpose entity (SPE) is a type of financial guarantee. SPEs are distinct legal entities whose permitted activities are significantly limited, as defined in the legal documents that established the SPE, and that typically only hold financial assets. Companies may use SPEs to sell financial assets, such as receivables, to isolate financial risks (e.g., interest rate risk and credit risk).

Example 5-8

Guarantee of an SPE’s Receivables

Company X, a financial services company, transfers certain mortgage receivables that arose from its commercial property business to a nonconsolidated SPE in exchange for cash consideration. Company X guarantees the status of the receivables transferred at the time of the transfer to the SPE. For example, X guarantees that the receivables transferred will not become overdue by more than 180 days. If the transferred mortgage receivables become overdue by more than 180 days, X will be obligated to make a cash payment to the SPE.

This contract meets the definition of a guarantee in accordance with ASC 460-10-15-4(a) as follows:

It requires the guarantor (X) to make contingent payments to a guaranteed party (SPE) — Company X is required to make cash payments to the SPE in the event that the transferred receivables fail to perform in a manner as guaranteed at the time of transfer.
It is related to an underlying — The occurrence or nonoccurrence of a specified event (such as a scheduled payment under a contract) is a variable that is considered an underlying. In X’s case, a specified event, such as an event that brings to light the fact that a receivable becomes overdue would be considered a change related to an underlying.
It is related to an asset, liability, or equity security of the guaranteed party — The underlying is related to the transferred mortgage receivables, which are assets of the SPE.

5.2.1.1.4 Financial Guarantees — Minimum Revenue Guarantees

Minimum revenue guarantees are a type of financial guarantee. The ASC master glossary defines a minimum revenue guarantee as a “guarantee granted to a business or its owners that the revenue of the business (or a specific portion of the business) for a specified period of time will be at least a specified minimum amount.” As noted above, ASC 460-10-15-4(a) includes “[c]ontracts that contingently require a guarantor to make payments (as described in the following paragraph) to a guaranteed party based on changes in an underlying that is related to an asset, a liability, or an equity security of the guaranteed party.”

Connecting the Dots

A minimum revenue guarantee is within the scope of ASC 460-10 because the guarantee’s underlying (the business’s gross revenue) is considered related to an asset or equity security of the guaranteed party. For example, if the guaranteed party is the owner of the business, the business’s gross revenues are considered related to changes in the owner’s investment in the business (i.e., an equity security of the guaranteed party). If, however, the guaranteed party is the business itself, the business’s gross revenues are considered related to changes in the net assets of the business because of transactions with customers.

ASC 460-10-55-10 gives an example of a minimum revenue guarantee.

ASC 460-10

55-10 An example of the type of guarantee described in paragraph 460-10-55-2(e) is a minimum revenue guarantee granted to a new day-care center by a corporation as an incentive for the center to locate near the corporation’s main plant. The corporation, as the guarantor, has agreed to make monthly payments to the day-care center (the guaranteed party) over a specified term for any shortfall from the guaranteed minimum amount of revenue for each month.

The example below further illustrates a minimum revenue guarantee contract.

Example 5-9

Minimum Revenue Guarantee

A regional hospital recruits nonemployee physicians to establish independent practices in nearby communities. As part of an incentive package, the regional hospital guarantees a physician’s practice a minimum level of revenue over a predetermined period (e.g., one year). Thus, during this period, the physician will be able to bill (or collect) a minimum amount of monthly revenue from the private practice. If actual monthly billings are below this minimum amount, the regional hospital will pay the physician for the difference. In exchange for this guarantee, the physician agrees to offer services for a specified period (e.g., three years). The physician also agrees to provide on-call coverage at the regional hospital in her area of specialization.

According to the guarantee agreement, if the physician fails to provide services for the agreed-upon service period, the physician is required to pay the regional hospital back for any payments made under the guarantee (the clawback feature). The terms of the agreement reduce the amount due under the clawback feature on a pro rata basis over the required service period. That is, for each month the physician works, a portion of the regional hospital’s clawback potential is reduced.

This minimum revenue guarantee is within the scope of ASC 460. Specifically, the scope of ASC 460-10-55-2(e) includes a “guarantee granted to a business or its owner(s) that the revenue of the business (or a specific portion of the business) for a specified period of time will be at least a specified amount.”

Further, ASC 460-10-55-11 gives an example of a guarantee that is within the scope of ASC 460-10-55-2(e) and states the following:

Another example is a guarantee granted to a nonemployee physician by a not-for-profit health care facility that has recruited the physician to move to the facility’s geographical area to establish a practice. The health care facility, as the guarantor, has agreed to make payments to the newly arrived physician (the guaranteed party) at the end of specific periods of time if the gross revenues (gross receipts) generated by the physician’s new practice during that period of time do not equal or exceed a specific dollar amount. This Topic applies to minimum revenue guarantees granted to physicians regardless of whether the physician’s practice qualifies as a business.

The regional hospital concludes that its guarantee to the nonemployee physician meets the criterion in ASC 460-10-15-4(a) and that it does not qualify for one of the scope exceptions in ASC 460-10-15-7, as discussed in Section 5.2.2.

Initial Measurement

Section 5.3.2 discusses the recognition and measurement of a guarantee liability. The regional hospital should apply the guidance in ASC 460-10-30-2(b) and ASC 460-10-30-3 and 30-4, which require, at the inception of the guarantee, recognition of a liability that is equal to the greater of (1) the estimated contingent loss (if probable) under ASC 450-20-25-2 or (2) the amount that satisfies the fair value objective discussed in ASC 460-10-30-2(b). In estimating the liability, the regional hospital should not rely solely on simple averages of historical payouts under similar arrangements. Rather, the estimate should be refined on a contract-by-contract basis. For example, if past patterns of revenue guarantees varied because of discernible factors such as geographic location, type of physician practice, experience level of the physician, or amount of the revenue guarantee or other commitments, the regional hospital should consider such factors in estimating the fair value of the stand-ready obligation or the ASC 450 contingent minimum revenue guarantee obligation.

Offsetting Entry

Section 5.3.2.4 discusses the offsetting entry upon the initial recognition of a guarantee liability. ASC 460-10-55-23 describes four situations involving offsetting entries, none of which accurately reflect the regional hospital’s circumstances. However, ASC 460-10-55-23(a) indicates that “[i]f the guarantee were issued in a standalone transaction for a premium, the offsetting entry would be consideration received (such as cash or a receivable).”

Although the regional hospital did not issue a guarantee for a premium, the regional hospital concludes that ASC 460-10-55-23(a) would apply by analogy. The regional hospital has received a commitment from the physician to locate her practice to the region for a specified number of years. If the physician leaves before fulfilling her obligation, she must repay the regional hospital a pro rata portion of the payments received under the guarantee. These commitments are a form of consideration. The physician’s presence in the community has a positive impact on the hospital’s financial performance, since patients are more likely to stay in the community to receive treatment and, therefore, to use the hospital’s facilities. The regional hospital is not providing a guarantee for no consideration on a stand-alone basis, as described in ASC 460-10-55-23(e) (i.e., the guarantee is not within the scope of the guidance on contributions in ASC 720-25).

The regional hospital can conclude that its guarantee meets the definition of an asset in FASB Concepts Statement 8, Chapter 4. The physician’s obligation to operate a practice in the regional hospital’s area (or pay back certain amounts if the obligation is not fulfilled) represents a probable future economic benefit that the regional hospital has obtained as a result of the contractual relationship with the physician. Accordingly, the offsetting entry should be an asset.

Subsequent Accounting

Section 5.4 discusses the (1) subsequent accounting for a guarantee liability and (2) offsetting entry, if applicable. In determining the appropriate subsequent accounting for the minimum revenue guarantee liability and offsetting entry (i.e., the asset), the regional hospital considers that the overriding principle of ASC 460 is the recognition of a liability at the inception of a guarantee and the derecognition of the remaining carrying amount of that guarantee liability at the end of the guarantee period.

In accordance with ASC 460-10-35-1 and 35-2, amortization should occur in a systematic and rational manner over the period of the guarantee (three years in the example presented). At the end of the minimum revenue guarantee period, no stand-ready obligation should remain. That is, the only remaining liability should be any unpaid guarantee benefits.

The offsetting entry (i.e., the asset) should be amortized over the useful life of the asset — generally the period the physician is contractually required to stay in the community (three years in the example). The regional hospital should periodically assess the asset for impairment.

ASC 460 does not permit subsequent adjustments to the guarantee liability or to the related asset on the basis of actual cash payments under the guarantee. The stand-ready obligation is separate from the ASC 450 contingent liability for probable cash payments under the guarantee. During the guarantee period, the regional hospital will need to continually monitor whether it should remeasure its contingent liability in accordance with ASC 450.

As discussed above, revenues are changes in a business’s net assets because of transactions with customers. Expenses and net income also represent changes in a business’s net assets. In addition, the form of an arrangement should not override its substance in the determination of whether the arrangement is a guarantee under ASC 460-10-55-2. Accordingly, certain net income reimbursement arrangements and expense reimbursement arrangements are within the scope of ASC 460-10-15-4(a), as illustrated in the example below.

Example 5-10

Minimum Revenue Guarantee — Expense Reimbursement

Assume the same facts as in Example 5-9, except that the hospital agrees to reimburse the physician for allowable expenses that exceed a stated amount up to a maximum reimbursable amount (e.g., a reimbursement of expenses in excess of $400,000 up to a maximum amount of $1 million). Examples of allowable expenses include office rent, equipment rental, and other similar expenses associated with establishing and maintaining a medical practice.

Although the guarantee is not based on the level of the physician’s revenue, it is within the scope of ASC 460-10-55-2(e). The medical practice assistance agreement is similar in substance to a minimum revenue guarantee. That is, the substance of the medical practice assistance is a guarantee of the performance (net assets) of the physician’s practice.

Like a traditional minimum revenue guarantee, a medical practice assistance arrangement creates an obligation for the hospital providing the protection. The substance of an agreement to reimburse expenses of a physician’s practice is a guarantee of the performance of the physician’s practice. Accordingly, the medical practice assistance is within the scope of the recognition, measurement, and disclosure provisions of ASC 460.

5.2.1.2 Performance Guarantees

ASC 460-10-15-4(b) defines a performance guarantee as a contractual arrangement that “contingently require[s] a guarantor to make payments . . . to a guaranteed party based on another entity’s failure to perform under an obligating agreement.” An important item to note, as highlighted in ASC 460-10-15-7(i), is that an entity’s guarantee of its own performance is only within the scope of ASC 460 if it is related to the entity’s past performance. Conversely, a guarantee of a third party’s performance is subject to ASC 460 regardless of whether it is related to future or past performance. This concept is illustrated in the example below.

Example 5-11

Performance Guarantees on an Entity’s Future Performance

Company A engages Contractor C to construct a building in accordance with certain specifications outlined in the contract. In exchange for a premium from C, Company B issues a guarantee to A such that A is guaranteed compensation from B if C fails to follow the contractual specifications for the building.

The guarantee provided by B is within the scope of ASC 460. Company B is providing a guarantee to A for a third party’s future performance in constructing the building.

ASC 460-10-55-12 lists common examples of performance guarantees such as performance standby letters of credit, bid bonds, and performance bonds. The ASC master glossary defines a performance standby letter of credit as “[a]n irrevocable undertaking by a guarantor to make payments in the event a specified third party fails to perform under a nonfinancial contractual obligation.” This guarantee is within the scope of ASC 460 because it contingently requires the guarantor to make payments to the guaranteed party on the basis of another entity’s failure to perform under an agreement.

Connecting the Dots

A financial standby letter of credit is a guarantee within the scope of ASC 460-10-15-4(a), while a performance standby letter of credit is within the scope of ASC 460-10-15-4(b). A financial standby letter of credit requires the guarantor to make a payment in the event of a third party’s default (i.e., failure to pay a financial obligation), while a performance standby letter of credit requires the guarantor to make a payment in the event that a third party fails to perform a nonfinancial obligation.

5.2.1.3 Indemnifications

ASC 460-10-15-4(c) describes indemnification agreements. Further, ASC 460-10-55-13 gives examples of common types of indemnification arrangements that are within the scope of ASC 460.

ASC 460-10

55-13 The following are examples of contracts of the type described in paragraph 460-10-15-4(c):

An indemnification agreement (contract) that contingently requires the indemnifying party (guarantor) to make payments to the indemnified party (guaranteed party) based on an adverse judgment in a lawsuit or the imposition of additional taxes due to either a change in the tax law or an adverse interpretation of the tax law.
A lessee’s indemnification of the lessor for any adverse tax consequences that may arise from a change in the tax laws, because only a legislative body can change the tax laws, and the lessee therefore has no control over whether payments will be required under that indemnification. In contrast, as discussed in paragraph 460-10-55-18(a), when a lessee indemnifies a lessor against adverse tax consequences that may arise from acts, omissions, and misrepresentations of the lessee, that indemnification is outside the scope of this Topic because the lessee is, in effect, guaranteeing its own future performance.
A seller’s indemnification against additional income taxes due for years before a business combination, because the indemnification relates to the seller-guarantor’s past performance, not its future performance.

Indemnification agreements require the issuer (i.e., the guarantor) to compensate the guaranteed party upon the occurrence of certain conditional events. The examples in ASC 460-10-55-13 illustrate that for an indemnification agreement to be within the scope of ASC 460, it can be related to either (1) the future or past performance of another entity or (2) the past performance of the issuing entity. In a manner similar to that discussed in Section 5.2.1.2, when an entity issues an indemnification related to its own performance, the indemnification is only within the scope of ASC 460 if it is related to the entity’s past performance.

The examples below illustrate scenarios in which an entity indemnifies a third party.

Example 5-12

Indemnifications for Losses by a Contracting Party

Company A engages Company B to perform certain duties on behalf of A. Company A indemnifies B for third-party damage claims and lawsuits that could be filed against B in performing the contracted services.

The indemnification provided by A is within the scope of ASC 460. The indemnification contingently requires A to make a payment to B on the basis of changes in B’s contingent liability. This indemnification possesses the characteristics defined in ASC 460-10-15-4(c) and is within the scope of ASC 460.

Example 5-13

Indemnification of Taxes in a Business Combination

Company C enters into an agreement to sell 100 percent of the outstanding stock in its wholly owned subsidiary, Company Y, to Company D. Before the sale, Y files a separate tax return in which a tax position is taken that requires the recognition of a liability for an unrecognized tax benefit. Because Y filed a separate tax return, C is not directly liable for any of Y’s tax obligations after the sale. As part of the purchase agreement, C indemnifies D for any future settlement with the tax authority in connection with the uncertain tax position taken by Y in its prior tax return.

Company C would not account for the tax indemnification related to Y’s previously taken tax position after the sale under ASC 740. Rather, by indemnifying D for any loss related to Y’s prior tax position, C has entered into a guarantee contract that is within the scope of ASC 460-10-15-4(c) and ASC 460-10-55-13(c). Therefore, C would recognize a guarantee liability on the sale date and on each reporting date thereafter in accordance with the recognition and measurement provisions of ASC 460-10.

Company C makes the following assumptions in recording journal entries as of the date on which Y is sold:

The amount of Y’s uncertain tax benefit is $100 (i.e., Y recognizes this amount as a liability under ASC 740-10 before and after the sale).
Settlement of the indemnification liability would result in a tax deduction for C.
The initial guarantee liability determined under ASC 460-10 is $40.
Company C has an effective tax rate of 25 percent.

The journal entries recorded would be as follows:

The deferred tax entry is recognized because there is a deductible temporary difference related to the difference between the reported amount and the tax basis of the indemnification liability (i.e., 25 percent of $40).

It is common for a party to issue indemnification agreements (i.e., the guarantor) to a third party (i.e., the guaranteed party) in connection with a contingent liability of the third party. The underlying’s relationship to an unrecognized liability is irrelevant to the assessment of whether the indemnification is within the scope of ASC 460. Therefore, such an indemnification would be within the scope of ASC 460 even if the guaranteed party has not recognized a liability. This conclusion is consistent with the example in ASC 460-10-55-13(c) (see above).

The examples below illustrate the analysis an entity must perform for such indemnifications.

Example 5-14

Indemnifications — Underlying Analysis

Company Z enters into an alliance agreement with Company Y, an unrelated party, under which Z and Y plan to jointly launch a generic version of Product A. Product A is currently patent-protected; thus, any launch of a generic version would be an at-risk launch (i.e., at risk for litigation). The following outcomes are possible according to the terms of the alliance agreement:

Scenario 1 — Companies Z and Y mutually agree to jointly launch a generic version of Product A. All profits and costs will be shared equally, and each company has agreed to indemnify the other for litigation costs in such a way that any costs incurred by either party will be shared equally.
Scenario 2 — Either Z or Y can compel the other party to go forward with an at-risk launch of the generic version of Product A. The compelling party would receive 90 percent of the profits and cover 90 percent of the costs from the sale of the generic product. In addition, the compelling party agrees to indemnify the other party for 100 percent of any litigation costs that may be incurred.
Scenario 3 — Companies Z and Y agree not to launch a generic version of Product A and effectively terminate the alliance agreement. Upon termination, Z and Y will share in any inventory losses equally.

In Scenarios 1 and 2, both Z and Y can avoid placing themselves in a guarantor capacity, since both parties have control over whether they proceed with a particular scenario. The analysis of these scenarios is discussed below. Scenario 3 does not address an indemnification arrangement.

Underlying Analysis

The litigation indemnification in the alliance agreement is within the scope of ASC 460. Indemnification agreements that contingently require payments to be made on the basis of changes in an underlying related to an asset, liability, or equity security of the indemnified party are within the scope of ASC 460, as stated in ASC 460-10-15-4(c). Scenarios 1 and 2 both include this type of indemnification. From Z’s perspective, if the terms of the litigation indemnification included in the alliance agreement become effective, these terms will contingently require Z to make payments to Y on the basis of changes in Y’s contingent liability associated with potential litigation — the underlying. Although the underlying is not related to a recognized asset, liability, or equity security of the indemnified party, the change in an underlying related to an unrecognized contingent liability is within the scope of ASC 460. Since the indemnification possesses the characteristics defined in ASC 460-10-15-4(c), it is within the scope of ASC 460.

Recognition of a Stand-Ready Obligation

Company Z should not recognize a stand-ready obligation under ASC 460 until it places itself in a guarantor capacity. At the inception of the alliance agreement, Z had not yet obligated itself to contingently make payments to Y. The decision that would place Z in a stand-ready capacity to indemnify future litigation costs to Y is currently within Z’s control; that event had not yet occurred as of inception and may never occur. Under Scenario 1, Z would control the decision to mutually agree to go forward with an at-risk launch because mutual agreement requires the consent of both parties and would obligate Z to stand ready to perform under the indemnification. Under Scenario 2, Z would control the decision about whether to compel Y to go forward with an at-risk launch. Upon compelling Y in this scenario, Z would become obligated to stand ready to perform under the indemnification. Company Z should record a stand-ready obligation under ASC 460 when the litigation indemnifications under either Scenario 1 or Scenario 2 become effective.

Example 5-15

Indemnifications — Underlying Analysis for Contingent Liabilities

Company A has in the past issued certain indemnifications to underwriters and is likely to issue similar indemnifications in the future. The terms of these indemnifications are as follows:

The Company agrees to indemnify and hold harmless each underwriter, the directors, officers, employees, and agents of each underwriter and each person who controls any underwriter, within the meaning of either the Act or the Exchange Act, against any and all losses, claims, damages, or liabilities, joint or several, to which they or any of them may become subject under the Act, the Exchange Act, or other federal or state statutory law or regulation, at common law or otherwise, insofar as such losses, claims, damages, or liabilities (or actions in respect thereof) (1) arise out of or are based on any untrue statement or alleged untrue statement of a material fact contained in the registration statement as originally filed or in any amendment thereof, or in the basic prospectus, any preliminary final prospectus or the final prospectus, or in any amendment thereof or supplement thereto, or (2) arise out of or are based on the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading.

The above indemnification is subject to the recognition and measurement provisions of ASC 460. Under ASC 460-10-15-4(c), an indemnification is within the scope of ASC 460 if contingent payments are “based on changes in an underlying that is related to an asset, a liability, or an equity security of the indemnified party.” Since A would be required to make payments to the underwriter in the event that the underwriter is held liable for losses, damages, or claims resulting from any untrue statement contained in a registration statement, A has satisfied the contingent payment condition.

A specified event, such as a requirement by a court of law requiring an underwriter to make a payment to a third party because of an untrue statement in a registration statement, would be considered an underlying. Thus, A has also satisfied the “underlying” condition in ASC 460-10-15-4(c).

ASC 460-10-15-4(c) also requires entities to assess whether the underlying is related to an asset, liability, or equity security of the underwriter. In A’s case, the underlying is related to a contingent liability of the underwriter that may arise if the future specified event occurs. As noted above in this section, an indemnification in which the underlying is an unrecognized contingent liability of the indemnified party is within the scope of ASC 460.

Example 5-16

Indemnification — Environmental Liability

Company A sells a building to Company B. As part of the sale, A indemnifies B from future claims resulting from environmental liabilities existing on or before the date of sale. Assume that on the date of purchase, B is not required to recognize an environmental liability under GAAP.

The indemnification provided by A to B is within the scope of ASC 460. The indemnification applies to environmental contamination that occurred before the date of sale and may result in a liability to B because of changes in environmental laws or subsequent discovery of contamination. ASC 460-10-15-4(c) states that “[i]ndemnification agreements (contracts) that contingently require an indemnifying party (guarantor) to make payments to an indemnified party (guaranteed party) based on changes in an underlying that is related to an asset, a liability, or an equity security of the indemnified party” are within the scope of ASC 460.

Company A’s indemnification of B from changes in B’s contingent liability related to the discovery of contamination that occurred on or before the date of sale is within the scope of ASC 460 because it meets the definition of a guarantee (A is assuming the risk of the environmental liabilities resulting from the condition of the building at the time of sale). It does not matter that the liability has not been recognized in the financial statements of the guaranteed party.

5.2.1.4 Indirect Guarantees of the Indebtedness of Others

ASC 460-10-15-4(d) describes indirect guarantees of the indebtedness of others. Indirect guarantees were originally within the scope of FASB Interpretation 34, which was later incorporated into FASB Interpretation 45 (codified in ASC 460). Paragraph 9 of FASB Interpretation 34 clarifies the difference between a direct guarantee and an indirect guarantee and states:

Some respondents requested clarification of the definition of an indirect guarantee and the difference between direct and indirect guarantees of indebtedness of others. Both direct and indirect guarantees of indebtedness involve three parties: a debtor, a creditor, and a guarantor. In a direct guarantee, the guarantor states that if the debtor fails to make payment to the creditor when due, the guarantor will pay the creditor. If the debtor defaults, the creditor has a direct claim on the guarantor. Under an indirect guarantee, there is an agreement between the debtor and the guarantor requiring the guarantor to transfer funds to the debtor upon the occurrence of specified events. The creditor has only an indirect claim on the guarantor by enforcing the debtor’s claim against the guarantor. After funds are transferred from the guarantor to the debtor, the funds become available to the creditor through its claim against the debtor.

The ASC master glossary defines both direct and indirect guarantees of indebtedness.

ASC Master Glossary

Direct Guarantee of Indebtedness

An agreement in which a guarantor states that if the debtor fails to make payment to the creditor when due, the guarantor will pay the creditor. If the debtor defaults, the creditor has a direct claim on the guarantor.

Indirect Guarantee of Indebtedness

An agreement that obligates the guarantor to transfer funds to a debtor upon the occurrence of specified events, under conditions whereby:

After funds are transferred from the guarantor to the debtor, the funds become legally available to creditors through their claims against the debtor
Those creditors may enforce the debtor’s claims against the guarantor under the agreement.

In contrast, with a direct guarantee of indebtedness, if the debtor defaults, the creditor has a direct claim on the guarantor. Examples of indirect guarantees include agreements to advance funds if a debtor’s net income, coverage of fixed charges, or working capital falls below a specified minimum.

As demonstrated in the graphic below, a creditor has a direct claim on a guarantor in a direct guarantee of indebtedness. Conversely, a creditor may enforce the debtor’s claim against a guarantor in an indirect guarantee of indebtedness rather than making a claim against the guarantor itself.

The example in ASC 460-10-55-15 illustrates an indirect guarantee of the indebtedness of others, as that term is addressed in ASC 460-10-15-4(d).

ASC 460-10

55-15 A community foundation has a loan guarantee program to assist not-for-profit entities (NFPs) in obtaining bank financing at a reasonable cost. Under that program, the community foundation issues a guarantee of an NFP’s bank debt. That guarantee is within the scope of this Topic, and on the issuance of the guarantee, the community foundation would recognize a liability for the fair value of that guarantee. The issuance of that guarantee would not be considered merely a conditional promise to give under paragraphs 958-605-25-11 through 25-13 because, upon the issuance of the guarantee, the NFP will have received the gift of the community foundation’s credit support. That credit support enables the NFP to obtain a lower interest rate on its borrowing.

The example below further illustrates an indirect guarantee of the indebtedness of others.

Example 5-17

Indirect Guarantee of the Indebtedness of Others

Company A is a distributor of mobile devices. Company B provides wireless communication services to consumers and often leases mobile devices to its customers. Company B leases its mobile devices from Company L (the “head lease”), which B then uses to lease to its customers (the “sublease”). Assume that B has not applied ASC 842 and therefore has not recognized any assets or liabilities related to these leases (i.e., they are operating leases).

Companies A and B enter into a program (the “Program”) under which B will offer its customers the right to upgrade or replace their mobile devices at any time. The customer will pay B $5 a month for this right in addition to an incremental fee upon upgrade. This incremental fee is determined on the basis of the quality of the device as well as the date on which the upgrade occurs throughout its sublease term.

Under the Program, A assumes B’s obligations in exchange for a portion of the monthly fee from the customer and the incremental upgrade fee. Upon an upgrade, A will pay B an amount that represents the purchase price of the device, less an amount that reflects the lease payments previously received by B from its customer. Company B will then use these proceeds to repay its head lease payment to L. Company A cannot cancel this agreement with B and is obligated to perform under the Program.

Company A concludes that the Program represents an obligation to B rather than to L. Company L and its creditors must look solely to B for consideration related to early termination of the head lease. Company B has a direct claim for payment from A regardless of whether B satisfies its obligation to L. If B did not make the payment to L for an early termination of the head lease, L could pursue a claim against A to make its payment under the Program to B, which L could then recover. The Program represents an obligation of A that is based on changes in an underlying related to an unrecognized asset and unrecognized liability of B.

5.2.2 Transactions Outside the Scope of ASC 460

Guarantee arrangements that qualify as one of the four types of arrangements discussed in ASC 460-10-15-4, but that are subject to a scope exception in ASC 460-10-15-7, are outside the scope of ASC 460. Such arrangements should be accounted for under other applicable authoritative literature such as that on revenue recognition, derivative accounting, leasing, or industry-specific topics. The scope exceptions in ASC 460-10-15-7 are included because other Codification topics already address the relevant accounting considerations.

ASC 460-10

15-7 The guidance in this Topic does not apply to the following types of guarantee contracts:

A guarantee or an indemnification that is excluded from the scope of Topic 450 (see paragraph 450-20-15-2 — primarily employment-related guarantees)
A lessee’s guarantee of the residual value of the underlying asset at the expiration of the lease term under Topic 842
A contract that meets the characteristics in paragraph 460-10-15-4(a) but is accounted for as variable lease payments under Topic 842
A guarantee (or an indemnification) that is issued by either an insurance entity or a reinsurance entity and accounted for under Topic 944 (including guarantees embedded in either insurance contracts or investment contracts)
A contract that meets the characteristics in paragraph 460-10-15-4(a) but provides for payments that constitute a vendor rebate (by the guarantor) based on either the sales revenues of, or the number of units sold by, the guaranteed party
A contract that provides for payments that constitute a vendor rebate (by the guarantor) based on the volume of purchases by the buyer (because the underlying relates to an asset of the seller, not the buyer who receives the rebates)
A guarantee or an indemnification whose existence prevents the guarantor from being able to either account for a transaction as the sale of an asset that is related to the guarantee’s underlying or recognize in earnings the profit from that sale transaction
A registration payment arrangement within the scope of Subtopic 825-20 (see Section 825-20-15)
A guarantee or an indemnification of an entity’s own future performance (for example, a guarantee that the guarantor will not take a certain future action)
A guarantee that is accounted for as a credit derivative at fair value under Topic 815.
A sales incentive program in which a manufacturer contractually guarantees to reacquire the equipment at a guaranteed price or guaranteed prices at a specified time, or at specified time periods (for example, the entity is obligated to reacquire the equipment or the entity is obligated at the customer’s request to reacquire the equipment). That program shall be evaluated in accordance with Topic 606 on revenue from contracts with customers, specifically the implementation guidance on repurchase agreements in paragraphs 606-10-55-66 through 55-78.

For related implementation guidance, see Section 460-10-55.

5.2.2.1 Scope Exceptions That Are Outside the Scope of ASC 450

Section 2.2 discusses the scope exceptions in ASC 450-20-15-2, which include (1) stock issued to employees (addressed in ASC 718), (2) certain employment-related costs (addressed in ASC 710, ASC 712, and ASC 715),1 (3) uncertainty in income taxes (addressed in ASC 740-10-25), and (4) accounting and reporting by insurance entities (addressed in ASC 944). Because FASB Interpretation 45 (codified in ASC 460) was originally issued as an interpretation of FASB Statement 5 (ASC 450), the scope of ASC 460 does not include contingencies and uncertainties that are outside the scope of ASC 450.

Connecting the Dots

A company’s indemnification of its employees against litigation that arises in connection with their employment is outside the scope of ASC 460 because it is considered an employment-related cost that is outside the scope of ASC 450. Similarly, a company’s indemnification of its nonemployee directors, such as board members, is also outside the scope of ASC 460 since nonemployee directors are considered employees as defined by ASC 718-10-20.

5.2.2.2 Guarantee or Indemnification of an Entity’s Own Future Performance

As discussed in Section 5.2.1.3, to be within the scope of ASC 460, an indemnification can be related to either (1) the future or past performance of another entity or (2) the past performance of the issuing entity. That is, the scope exception in ASC 460-10-15-7(i) specifically excludes guarantees or indemnifications of an entity’s own future performance, which is illustrated in the example below.

Example 5-18

Guarantees of an Entity’s Own Performance — Employment-Related Arrangements

Company A has many employees who are paid in accordance with a union contract. The contract stipulates that, in the event that a facility is idled, employees will continue to receive payments throughout the contract period in amounts equaling approximately 95 percent of their base pay.

This provision of the union contract is not a guarantee within the scope of ASC 460 both in circumstances in which the idling of the facility is within A’s control and in circumstances outside A’s control. ASC 460-10-15-7(i) excludes guarantees of an entity’s own future performance from the scope of ASC 460 (see further discussion below).

However, although the guarantee is not within the scope of ASC 460, A is still required to apply the recognition and disclosure requirements of ASC 450 and ASC 712 for its postemployment obligations under the union contract, as described in Section 2.2.2.

ASC 712 establishes the accounting for benefits provided to former or inactive employees, their beneficiaries, and covered dependents. ASC 712-10-20 defines inactive employees as “[e]mployees who are not currently rendering service to the employer and who have not been terminated. They include those who have been laid off and those on disability leave, regardless of whether they are expected to return to active status.”

In addition, ASC 712-10-05-5 gives the following examples of other postemployment benefits:

“Other postemployment benefits include, but are not limited to, the following:

Salary continuation
Supplemental unemployment benefits
Severance benefits
Disability-related benefits (including workers’ compensation)
Job training and counseling
Continuation of benefits such as health care benefits and life insurance coverage.”

As described in Section 2.2.2, an entity accounts for certain postemployment contracts in accordance with ASC 450 by applying ASC 712; therefore, such contracts could be within the scope of ASC 460 (i.e., the scope exception in ASC 460-10-15-7(a) does not apply). Accordingly, A must determine whether the scope provisions of ASC 460-10-15-4 apply to the guarantee. The table below summarizes whether the guarantee is within the scope of ASC 460.

Scope	Within Scope?
ASC 460-10-15-4(a) — “Contracts that contingently require a guarantor to make payments (as described in [ASC 460-10-15-5]) to a guaranteed party based on changes in an underlying that is related to an asset, a liability, or an equity security of the guaranteed party.”	No — The guaranteed party would not record a related asset, liability, or equity security in connection with the contract.
ASC 460-10-15-4(b) — “Contracts that contingently require a guarantor to make payments (as described in [ASC 460-10-15-5]) to a guaranteed party based on another entity’s failure to perform under an obligating agreement (performance guarantees).”	No — There is no third-party performance guarantee.
ASC 460-10-15-4(c) — “Indemnification agreements (contracts) that contingently require an indemnifying party (guarantor) to make payments to an indemnified party (guaranteed party) based on changes in an underlying that is related to an asset, a liability, or an equity security of the indemnified party.”	No — There is no indemnification agreement. Furthermore, the entity is guaranteeing its own future performance.
ASC 460-10-15-4(d) — “Indirect guarantees of the indebtedness of others, even though the payment to the guaranteed party may not be based on changes in an underlying that is related to an asset, a liability, or an equity security of the guaranteed party.”	No — There is no indirect guarantee of the indebtedness of others.

As outlined in the table, the guarantee does not meet the scope requirements in ASC 460-10-15-4 and is therefore outside the scope of ASC 460. This conclusion is appropriate because the guarantee is considered related to the entity’s own future performance.

5.2.2.3 Transactions Accounted for Under Other Applicable GAAP

ASC 460-10-15-7 lists scope exceptions (in addition to those described in Sections 5.2.2.1 and 5.2.2.2) under which an entity would not apply ASC 460 to certain transactions that are addressed in other Codification topics.

5.2.2.3.1 Lease Accounting

Under ASC 460-10-15-7(c), the scope of ASC 460 excludes a contract that has the characteristics in ASC 460-10-15-4(a) but is accounted for as variable lease payment under ASC 842.

5.2.2.3.2 Insurance Accounting

ASC 460-10-15-7(d) excludes from the scope of ASC 460 a “guarantee (or an indemnification) that is issued by either an insurance entity or a reinsurance entity and accounted for under Topic 944 (including guarantees embedded in either insurance contracts or investment contracts).”

5.2.2.3.3 Revenue Recognition

ASC 460-10-15-7(e), (f), and (k) contain certain scope exceptions from ASC 460 for items within the scope of ASC 606 related to revenue from contracts with customers. As noted in ASC 460-10-15-7(e) and (f), “payments that constitute a vendor rebate” are generally outside the scope of ASC 460 since the accounting for such payments is addressed by ASC 606, specifically with respect to consideration payable to a customer as described in Chapter 6 of Deloitte’s Roadmap Revenue Recognition. Furthermore, as described in ASC 460-10-15-7(k), sales incentive programs in which a manufacturer contractually guarantees to reacquire the equipment at a guaranteed price are outside the scope of ASC 460 and are accounted for under ASC 606, as described in Section 8.7 of Deloitte’s Roadmap Revenue Recognition.

5.2.2.3.4 Guarantees That Prevent a Sale or Recognition of Profits From That Sale

ASC 460-10-15-7(g) excludes from the scope of ASC 460 guarantee arrangements whose existence prevents the guarantor from being able to either account for a transaction as the sale of an asset that is related to the guarantee’s underlying or recognize in earnings the profit from that sale transaction. The FASB’s rationale for including this scope exception was that if the guarantee serves as an impediment to sale accounting (under ASC 860) or to recognizing the profit from a sale, the guarantor and guaranteed party will both have the asset on their books. The FASB considered that other GAAP adequately addressed the accounting for such situations and therefore did not want to include guidance in ASC 460.

5.2.2.3.5 Registration Payment Arrangements

ASC 460-10-15-7(h) excludes from the scope of ASC 460 a registration payment arrangement within the scope of ASC 825-20 (see ASC 825-20-15).

5.2.2.3.6 Credit Derivatives

ASC 460-10-15-7(j) excludes from the scope of ASC 460 credit derivatives accounted for in accordance with ASC 815. Although credit derivatives that are within the scope of ASC 815 would nevertheless be outside the scope of ASC 460’s recognition and measurement provisions under ASC 460-10-25-1(a), this exception clarifies that the disclosure provisions of ASC 460 do not apply to credit derivatives. Rather, the disclosures that apply to these instruments are addressed in ASC 815-10-50-4H and ASC 815-10-50-4J through 50-4L.

The ASC master glossary defines a credit derivative as follows:

ASC Master Glossary

Credit Derivative

A derivative instrument that has both of the following characteristics:

One or more of its underlyings are related to any of the following:
1. The credit risk of a specified entity (or a group of entities)
2. An index based on the credit risk of a group of entities.
It exposes the seller to potential loss from credit-risk-related events specified in the contract.

Examples of credit derivatives include, but are not limited to, credit default swaps, credit spread options, and credit index products.

The example below illustrates a credit derivative that is not subject to the provisions of ASC 460.

Example 5-19

Credit Derivatives

Bank A makes a loan to Customer B. To hedge its credit risk related to the loan, A enters into a credit derivative with Bank C. Under the credit derivative, C agrees to pay A if B’s credit rating declines below investment-grade, B defaults on the loan, or B defaults on any other debt obligation.

For C, the credit derivative is accounted for under ASC 815. Therefore, it qualifies for the scope exception from ASC 460 under ASC 460-10-15-7(j). Moreover, all derivatives accounted for under ASC 815 qualify for the scope exception applicable to recognition and measurement under ASC 460-10-25-1(a) and ASC 460-10-30-1.

For C, the credit derivative is also not subject to the disclosure provisions of ASC 460. Rather, the disclosure requirements in ASC 815-10-50 apply.

Footnotes

As discussed in Section 2.2.2, certain postemployment benefits are within the scope of ASC 450.

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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.