5.3 Initial Recognition and Measurement Provisions of ASC 460

5.3.1 Guarantees Not Subject to Recognition and Measurement Provisions of ASC 460

For certain types of guarantees, the guarantor is exempt from the recognition of such a liability but is still subject to the financial statement disclosure requirements in ASC 460-10-50 (see Section 5.5).

ASC 460-10

25-1 The following types of guarantees are not subject to the recognition provisions of this Subsection:

A guarantee that is accounted for as a derivative instrument at fair value under Topic 815.
A product warranty or other guarantee for which the underlying is related to the performance (regarding function, not price) of nonfinancial assets that are owned by the guaranteed party (see paragraph 460-10-15-9 for related guidance).
A guarantee issued in a business combination or an acquisition by a not-for-profit entity that represents contingent consideration (as addressed in Subtopics 805-30 and 958-805).
A guarantee for which the guarantor’s obligation would be reported as an equity item rather than a liability under generally accepted accounting principles (GAAP) (see Topics 480 and 505).
A guarantee by an original lessee that has become secondarily liable under a new lease that relieved the original lessee from being the primary obligor (that is, principal debtor) under the original lease, as discussed in paragraph 842-20-40-3. This exception shall not be applied by analogy to other secondary obligations.
A guarantee issued either between parents and their subsidiaries or between corporations under common control.
A parent’s guarantee of its subsidiary’s debt to a third party (whether the parent is a corporation or an individual).
A subsidiary’s guarantee of the debt owed to a third party by either its parent or another subsidiary of that parent.

30-1 The types of guarantees identified in paragraph 460-10-25-1 are not subject to the initial measurement provisions of this Subsection.

5.3.1.1 Transactions Accounted for Under Other Applicable GAAP

Certain arrangements, such as those described in ASC 460-10-25-1(a) and ASC 460-10-25-1(c)–(e), are outside the scope of the recognition and measurement provisions of ASC 460 because the accounting treatment is prescribed by other U.S. GAAP. Product warranties and other guarantee contracts for which the underlying is related to the functional performance of nonfinancial assets that are owned by the guaranteed party are addressed separately in ASC 460. See Section 5.6 for more information.

5.3.1.2 Guarantees Between Commonly Controlled Entities

Guarantees that are issued between a parent and its subsidiary or among entities under common control are subject to an exception from the recognition and measurement guidance in ASC 460 (see ASC 460-10-25-1(f)–(h)). These exceptions are written in the context of the entity’s preparation of financial statements (i.e., consolidated financial statements or stand-alone financial statements of either the parent or the subsidiary).

With respect to the consolidated financial statements, the following guarantees are not subject to ASC 460’s recognition and measurement guidance:

Any guarantee issued by any entity in the consolidated group to another entity in the consolidated group (i.e., both the guarantor and the guaranteed party are included in the consolidated financial statements).
Any guarantee of debt recognized in the consolidated financial statements, regardless of the entity within the consolidated group that (1) is the obligor of the debt and (2) issues the guarantee.

Guarantees that are issued by an investor directly or indirectly to an equity method investee (e.g., guarantees of the investee’s debt) are not subject to the scope exception discussed above. Furthermore, while the investor that issues such a guarantee must perform in the event that the underlying event for which payment is required occurs, it is not appropriate for the investor to conclude that such a guarantee represents a guarantee of its future performance.

Connecting the Dots

ASC 460-10-25-1(f)–(h) and ASC 460-10-50-1 imply that guarantees between entities under common control are subject to the disclosure provisions in ASC 460 but are outside the scope of ASC 460’s recognition and measurement guidance. However, paragraph A23 of the Basis for Conclusions of FASB Interpretation 45 indicates that in consolidated financial statements, the parent’s guarantee of a subsidiary’s debt to a third party is not “subject to the recognition, measurement, and disclosure provisions of the Interpretation.”

In the consolidated financial statements that include both the guarantor (e.g., parent) and the obligor (e.g., subsidiary) of debt that is recognized in the consolidated financial statements, the guarantee is outside the scope of ASC 460’s disclosure provisions because the debt obligation is included and fully disclosed in the consolidated financial statements. The guarantee is akin to a guarantee of the consolidated entity’s own future performance, as described in ASC 460-10-15-7(i).

SEC Considerations

While certain guarantees involving entities within a consolidated group are outside the scope of the recognition, measurement, and disclosure provisions of ASC 460, SEC regulations include specific disclosure requirements for registered guaranteed securities. Debt or preferred stock registered under the Securities Act may be guaranteed by one or more affiliates of the issuer. Guarantees of registered securities are considered securities themselves under the Securities Act. As a result, registration of guaranteed securities under the Securities Act can result in a requirement for both the issuer of the guaranteed security and the guarantor(s) of the security to file Exchange Act periodic reports (i.e., Form 10-K and Form 10-Q). However, in most circumstances, the SEC has provided relief from this requirement for each issuer and guarantor. Under Regulation S-X, Rules 3-10 and 13-01, entities can provide alternative financial disclosures or qualitative disclosures in lieu of such separate financial statements when certain criteria have been met. For more information, see Deloitte’s Roadmap SEC Reporting Considerations for Guarantees and Collateralizations.

Example 5-20

Consolidated Financial Statements — Guarantees Outside the Scope of ASC 460

In accordance with ASC 810, Parent A is preparing consolidated financial statements that include both Subsidiary B and Subsidiary C. Parent A concludes that each of the guarantees discussed below are outside the scope of ASC 460’s recognition, measurement, and disclosure provisions.

Parent’s Direct Guarantee of Subsidiary’s Indebtedness

Bank D, a third party, issues $100 million of debt to B. In conjunction with this issuance, A issues a guarantee directly to D, on behalf of B, stating that in the event of B’s default on the debt, A will make all remaining scheduled payments to D.

Parent A presents the $100 million debt obligation in its consolidated financial statements and concludes that this guarantee represents a direct guarantee of indebtedness. Because A presents the underlying obligation (i.e., the $100 million debt) in its consolidated financial statements, this guarantee represents a guarantee of A’s own performance; accordingly, A would not account for the guarantee in accordance with the recognition and measurement provisions of ASC 460, nor would it provide the disclosures required by ASC 460.

Parent A further observes that, with respect to its consolidated financial statements, disclosures related to this guarantee would not provide any incremental information relevant to users of its financial statements, since A has properly disclosed all relevant information about the debt obligation. Further, A observes that if it had recognized a guarantee obligation related to B’s debt, this obligation would need to be eliminated in consolidation.

Parent A’s conclusion would be similar if this debt arrangement was reversed. If D had issued $100 million in debt proceeds to A, and B had guaranteed payment to D upon A’s default, the analysis described above would be equally applicable.

Parent’s Indirect Guarantee of Subsidiary’s Indebtedness

In a separate transaction, B borrows $50 million from Bank E, a third party. As part of B’s agreement with E, A agrees to guarantee B’s obligation to Bank E. If B defaults, A will transfer funds to B so that B can pay E. Parent A presents the $50 million obligation in its consolidated financial statements and concludes that this represents an indirect guarantee of the indebtedness of others. For the same reasons described above related to the direct guarantee of the indebtedness of others, A concludes that this guarantee is outside the scope of the recognition, measurement, and disclosure provisions of ASC 460.

Subsidiary’s Direct Guarantee of Another Subsidiary’s Indebtedness

Subsidiary C borrows $20 million from Bank F, a third party. Subsidiary B provides a direct guarantee to F that it will make all remaining scheduled payments to F in the event of C’s default. Parent A presents this $20 million obligation in its consolidated financial statements. With respect to its consolidated financial statements, A concludes that this guarantee between entities under common control is outside the scope of ASC 460’s recognition, measurement, and disclosure provisions because A already presents this obligation in its consolidated financial statements; therefore, this guarantee is a guarantee of A’s own performance.

In the stand-alone financial statements of a guarantor that does not consolidate the financial statements of a commonly controlled entity that is the obligor of debt, the guarantor is subject to ASC 460’s disclosure provisions even though the recognition and measurement guidance in ASC 460 does not apply. For example, if Subsidiary A guarantees the debt of its sister company, Subsidiary B, to a third party, A must disclose this fact in its stand-alone financial statements since the affiliate’s debt is not included in the guarantor’s stand-alone financial statements. However, in that case, the guarantee would be outside the scope of the recognition and measurement provisions in accordance with ASC 460-10-25-1(h).

Upon the deconsolidation of a subsidiary, the parent entity and subsidiary should account for such guarantee arrangements in accordance with ASC 460 since they no longer would qualify for the recognition and measurement scope exception in ASC 460-10-25-1(f)–(h). This conclusion is illustrated in the examples below.

Example 5-21

Impact of Deconsolidation of a Subsidiary

Company A, a calendar-year-end entity, owns 100 percent of Company B, another calendar-year-end entity, and includes B in its consolidated financial statements. Company A guarantees B’s debt to a third-party bank. Both the debt agreement and the guarantee were entered into on July 1, 20X2; no provisions of the debt agreement or the guarantee have since been modified. With respect to its consolidated financial statements for the year ended December 31, 20X2, A concludes that the guarantee is outside the scope of ASC 460 because of the scope exception in ASC 460-10-25-1(g).

Subsequently, on December 15, 20X3, A reduces its ownership interest in B to 49 percent. Because B is not a variable interest entity under ASC 810, A deconsolidates B in accordance with ASC 810. Upon its deconsolidation of B, A should recognize its guarantee of B’s debt to the third-party bank at its then fair value.

Although the terms of the guarantee have not changed, the relationship between the guarantor, A, and the subject of the guarantee, B, has been modified upon the reduction in ownership, which occurred after December 31, 20X2. Company A’s reduced ownership interest in B and deconsolidation of B eliminates the relationship between the parent and subsidiary. Accordingly, A may no longer apply the scope exception in ASC 460-10-25-1(g).

The example above specifically applies to the deconsolidation of a subsidiary; however, the same logic applies to a spin-off transaction, as highlighted in the example below.

Example 5-22

Impact of a Spin-Off

Assume that Entity A is spinning off one of its subsidiaries (Entity B) as an independent, publicly traded company by distributing its equity interests in B to A’s shareholders on a pro rata basis (i.e., B will no longer be a subsidiary of A). The separation is accounted for as a spin-off transaction at historically recorded amounts in accordance with ASC 845-10-05-4 and ASC 845-10-30-10.

Further assume that before the spin-off, various guarantee obligations are established between the two entities. One example is a guarantee to a landlord by A on behalf of B in connection with a lease. Another example is a lease obligation that cannot be legally assigned from A to B but for which B will be responsible. For such guarantees, B agrees to indemnify A for payments made by A in accordance with such obligations. Before the spin-off, the guarantees qualify for the scope exception in ASC 460-10-25-1(g) and (h). (Note that such guarantees would also represent guarantees of an entity’s own future performance, since A consolidated B.)

Both A and B would be required to recognize their respective guarantee obligations upon spin-off at fair value in accordance with the recognition and measurement provisions of ASC 460. Once the spin-off occurs, those guarantee obligations no longer qualify for the scope exceptions in ASC 460-10-25-1(g) or (h). Although the terms of the guarantees have not changed, the relationships between the guarantors and the guaranteed parties have changed. That is, once the spin-off occurs, the former parent entity, A, no longer controls the resources of the spinnee, B, and the entities operate as independent entities.

Although spin-off transactions are recorded at historically recorded amounts, guarantee obligations between the formerly related entities should be recognized at fair value upon the spin-off in accordance with ASC 460 given that the guarantee is essentially created contemporaneously with the spin-off and that the fair value can be reliably determined.

These views are consistent with those expressed in a speech by Eric West, associate chief accountant in the SEC’s Office of the Chief Accountant, at the 2007 AICPA Conference on Current SEC and PCAOB Developments. Specifically, Mr. West stated that the SEC staff believes that “the FIN 45 [codified as ASC 460] parent-subsidiary scope exception applies only during the parent-subsidiary relationship since the guarantee is not relevant to the consolidated financial statements.”

Offsetting Entry

Section 5.3.2.4 discusses the accounting for the offsetting entry upon initial recognition of a guarantee liability. Both guarantors conclude that the offsetting entry (i.e., the debit) should be in equity.

ASC 460-10-25-4 specifies that the “offsetting entry depends on the circumstances in which the guarantee was issued.” As discussed in ASC 845-10-05-4, spin-off transactions are recorded as nonreciprocal transfers between an enterprise and its owners (i.e., as equity transactions). Both guarantors consider that, given the facts and circumstances of a spin-off accounted for at historical cost (i.e., as an equity transaction), the offsetting entry should be within equity.

Economically, the guarantees are similar to other adjustments to the net assets (either via adjustments to current assets or the debt levels) included in the spin-off of B. Therefore, recording the debit side of the entry for the guarantee in equity is consistent with recording what the entry would have been if the net assets included in the spin-off were adjusted.

Subsequent Accounting

Section 5.4 discusses the subsequent accounting for guarantee liabilities. In this example, both guarantors conclude that it would not be appropriate to release the guarantee liability related to the noncontingent liability to equity (i.e., where the offsetting entry was recognized). ASC 460-10-35-1 specifies that the liability that the guarantor initially recognized would typically be reduced (by a credit to earnings) since the guarantor is released from risk under the guarantee. For example, both guarantors might derecognize the liability ratably over the remaining life of the lease, with a credit to earnings. ASC 450-20 addresses the recognition and subsequent accounting for any liability related to the contingent loss for the guarantee.

As noted above (and further described in Section 5.3.2), a parent company is required to consider the guidance in ASC 450-20 in determining whether it needs to record in its stand-alone, parent-only financial statements an estimated loss from a loss contingency for its guarantee of its subsidiary’s debt under ASC 450-20-25. The example below illustrates application of ASC 450-20-25.

Example 5-23

Determining When to Recognize a Liability for the Guarantee of a Subsidiary’s Debt

On October 15, 20X4, Entity A purchases a controlling interest in Investee B and consolidates B in A’s consolidated financial statements. Entity A also guarantees B’s third-party debt of $1 million. The entire $1 million of debt is recognized in A’s consolidated financial statements owing to A’s controlling interest in B.

In preparing its stand-alone, parent-only financial statements, A continually reassesses the guidance in ASC 450 in each reporting period. On December 31, 20X5, A determines that (1) it is probable that B will default on its debt in the future and (2) the amount of the loss can be reasonably estimated. In accordance with ASC 450-20-25-2, A should recognize a liability in its stand-alone, parent-only financial statements for its probable payment of B’s debt. The amount of the liability is determined by identifying the best estimate, or minimum amount within a range, as indicated in ASC 450-20-30-1.

In a scenario in which an investment fund, in accordance with ASC 946-810, does not consolidate a noninvestment company investee in which it has a controlling interest, the fund nonetheless would apply the scope exception in ASC 460-10-25-1(g) related to “[a] parent’s guarantee of its subsidiary’s debt to a third party” with respect to a guarantee issued by the investment fund for a debt that the noninvestment company investee owes to a third party. This is because, even though the investment fund has not consolidated the noninvestment company investee, the nature of their relationship is that between a parent and its subsidiary. In this case, the investment fund should consider the guidance in ASC 450-20-25 when determining whether a loss contingency should be recorded for the guarantee of its investee’s debt.

If an investment fund provides a guarantee in conjunction with initially investing in a noninvestment company investee, it should consider whether the unit of account represented by the transaction price paid differs from the unit of account for the investment as subsequently measured at fair value. Generally, it would be inappropriate to recognize a gain in earnings as a result of (1) including the impact of the guarantee when the investment is initially measured and (2) excluding the guarantee’s impact when the investment is subsequently measured at fair value.

Note that the scope exception in ASC 460-10-25-1(g) applies only to the recognition and measurement provisions of ASC 460. The investment fund is still required to adhere to the disclosure requirements in ASC 460 and the guidance on subsequent recognition and measurement in ASC 450.

5.3.1.3 Guarantees in Which the Obligation Is Not a Liability

ASC 480 requires (1) issuers to classify certain shares and share-settled contracts as liabilities or, in some circumstances, as assets, and (2) SEC registrants to classify certain redeemable equity instruments as temporary equity. Certain contracts that an entity is not required to classify as a liability (or asset) under ASC 480 are evaluated for classification within equity in accordance with ASC 815-40. If a guarantee meets the indexation and classification conditions in ASC 815-40 in such a way that it is recognized within equity (e.g., a requirement to deliver a fixed number of equity shares upon the occurrence of a specified event), the transaction is not subject to the recognition and measurement requirements of ASC 460.

5.3.2 Guarantees Subject to the Recognition and Measurement Provisions of ASC 460

ASC 460-10

25-2 The issuance of a guarantee obligates the guarantor (the issuer) in two respects:

The guarantor undertakes an obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur (the noncontingent aspect).
The guarantor undertakes a contingent obligation to make future payments if those triggering events or conditions occur (the contingent aspect).

For guarantees that are not within the scope of Subtopic 326-20 on financial instruments measured at amortized cost, no bifurcation and no separate accounting for the contingent and noncontingent aspects of the guarantee are required by this Topic. For guarantees that are within the scope of Subtopic 326-20, the expected credit losses (the contingent aspect) shall be measured and accounted for in addition to and separately from the fair value of the guarantee (the noncontingent aspect) in accordance with paragraph 460-10-30-5.

25-3 Because the issuance of a guarantee imposes a noncontingent obligation to stand ready to perform in the event that the specified triggering events or conditions occur, the provisions of Section 450-20-25 regarding a guarantor’s contingent obligation under a guarantee should not be interpreted as prohibiting a guarantor from initially recognizing a liability for a guarantee even though it is not probable that payments will be required under that guarantee. Similarly, for guarantees within the scope of Subtopic 326-20, the requirement to measure a guarantor’s expected credit loss on the guarantee should not be interpreted as prohibiting a guarantor from initially recognizing a liability for the noncontingent aspect of a guarantee.

25-4 At the inception of a guarantee, a guarantor shall recognize in its statement of financial position a liability for that guarantee. This Subsection does not prescribe a specific account for the guarantor’s offsetting entry when it recognizes a liability at the inception of a guarantee. That offsetting entry depends on the circumstances in which the guarantee was issued. See paragraph 460-10-55-23 for implementation guidance.

30-2 Except as indicated in paragraphs 460-10-30-3 through 30-5, the objective of the initial measurement of a guarantee liability is the fair value of the guarantee at its inception. For example:

If a guarantee is issued in a standalone arm’s-length transaction with an unrelated party, the liability recognized at the inception of the guarantee shall be the premium received or receivable by the guarantor as a practical expedient.
If a guarantee is issued as part of a transaction with multiple elements with an unrelated party (such as in conjunction with selling an asset), the liability recognized at the inception of the guarantee should be an estimate of the guarantee’s fair value. In that circumstance, a guarantor shall consider what premium would be required by the guarantor to issue the same guarantee in a standalone arm’s-length transaction with an unrelated party as a practical expedient.
If a guarantee is issued as a contribution to an unrelated party, the liability recognized at the inception of the guarantee shall be measured at its fair value, consistent with the requirement to measure the contribution made at fair value, as prescribed in Section 720-25-30. For related implementation guidance, see paragraph 460-10-55-14.

Guarantees Not Within the Scope of Subtopic 326-20

30-3 In the event that, at the inception of the guarantee, the guarantor is required to recognize a liability under Section 450-20-25 for the related contingent loss, the liability to be initially recognized for that guarantee shall be the greater of the following:

The amount that satisfies the fair value objective as discussed in the preceding paragraph
The contingent liability amount required to be recognized at inception of the guarantee by Section 450-20-30.

30-4 For many guarantors, it would be unusual at the inception of the guarantee for the contingent liability amount under (b) in the preceding paragraph to exceed the amount that satisfies the fair value objective under (a) in the preceding paragraph. An example of that unusual circumstance is a guarantee for which, at inception, there is a high (probable) likelihood that the guarantor will be required to pay the maximum potential settlement at the end of the six-month term and a low likelihood that the guarantor will not be required to make any payment at the end of the six-month term. The amount that satisfies the fair value objective would include consideration of the low likelihood that no payment will be required, but the accrual of the contingent loss under Section 450-20-30 would be based solely on the best estimate of the settlement amount whose payment is probable (the maximum potential settlement amount in this case). This example is considered to be an unusual circumstance because of the high likelihood at inception that the maximum potential settlement amount will be paid, resulting in a substantial initial fair value for that guarantee. Another example in which the contingent liability amount required to be recognized under (b) in the preceding paragraph exceeds the fair value at inception under (a) in the preceding paragraph would involve an undiscounted accrual under Subtopic 450-20 for a guarantee payment that is expected to occur many years in the future.

Guarantees Within the Scope of Subtopic 326-20

30-5 At the inception of a guarantee within the scope of Subtopic 326-20 on financial instruments measured at amortized cost, the guarantor is required to recognize both of the following as liabilities:

The amount that satisfies the fair value objective in accordance with paragraph 460-10-30-2
The contingent liability related to the expected credit loss for the guarantee measured under Subtopic 326-20.

An entity that issues a guarantee obligates itself to the guaranteed party in two ways: (1) a noncontingent stand-ready obligation and (2) a contingent obligation. The noncontingent liability represents the guarantor’s obligation to stand ready to perform under the guarantee in the event of the occurrence of the event or condition specified in the terms of the guarantee. The contingent obligation represents the liability for the future payments if the event or condition specified in the terms of the guarantee occurs.

ASC 460 explains the distinction between the contingent and noncontingent aspects of a guarantee obligation to clarify that a guarantor is required to recognize a liability at the inception of a guarantee within the scope of ASC 460’s recognition and measurement guidance even if a loss on the contract is not probable. If a guarantee is not a freestanding transaction with a separate premium (i.e., it is embedded in a sales contract or other agreement), the failure to recognize a liability may result in an overstatement of the related income statement impact of the transaction. ASC 460 addresses this issue by requiring an entity to record a liability for the stand-ready obligation component of a guarantee.

5.3.2.1 Noncontingent Liability

For guarantee arrangements that are within the scope of ASC 460’s recognition and measurement guidance, the guarantor is required to record a liability for the stand-ready component of the guarantee at the inception of the guarantee arrangement. The overall principle in ASC 460 is that the guarantee liability should be initially recognized at fair value.

As noted in Section 5.1, one of the objectives in ASC 460 is to achieve comparability of financial reporting for guarantees irrespective of whether they are issued in return for a separately identified premium. Even if there is no explicit payment or premium receivable at the inception of a guarantee arrangement, the guarantor is still required to stand ready to perform over the term of the arrangement and, therefore, a liability should be recognized. The guarantee liability recognized at inception generally represents unearned income for standing ready to perform, which, as discussed in Section 5.4, will be reduced by a credit to earnings as the guarantor is released from risk under the guarantee.2

The liability that a guarantor incurs upon issuing a guarantee should be initially recognized at fair value regardless of the probability that the guarantor will be required to transfer assets or provide services to satisfy its guarantee obligation. A stand-ready obligation is a type of liability even though it may not result in the eventual transfer of cash or other assets. For example, assume that Entity A issues a guarantee to pay Entity C upon Entity B’s default on an obligation that B has to C. Upon issuing the guarantee, A does not believe that B’s default is probable; thus, it is not probable that the event that would trigger payment will occur. Regardless of whether A received a separately identified premium at the inception of the guarantee as consideration for entering into this obligation, A has a contractual obligation to stand ready to make payments to C upon B’s default. For A to extinguish its contractual obligation, it would have to make a payment to another party to step into its legal obligation to stand ready to perform in the event that B defaults. Accordingly, upon issuing the guarantee, A has a liability to stand ready to perform or to make a payment to a third party to exit this obligation. The fact that A would have to pay another party to exit the obligation serves as evidence of the liability’s existence.

ASC 460 describes the two aspects of a guarantee to emphasize that the guidance in ASC 450-20 on loss contingencies does not prohibit the recognition of a liability arising from the issuance of a guarantee. If entities considered guarantees as representing only contingent liabilities, there often would be no recognition at issuance because it would not be probable that the event or condition that triggers the guarantor’s performance would occur.

ASC 460 contains additional discussion of the initial recognition of a guarantee obligation.

ASC 460-10

55-21 In many cases, the one-time premium received by a guarantor for issuing a guarantee will be an appropriate practical expedient for the initial measurement of the guarantee obligation (see paragraph 460-10-30-2[a]). However, if a one-time premium is specified for a guarantee that is issued in conjunction with another transaction (such as the sale of assets by the guarantor), the specified premium may not be an appropriate initial measurement of the guarantor’s liability because the amount specified as being applicable to the guarantee may or may not be its fair value (see paragraph 460-10-30-2[b]).

55-22 In accordance with paragraph 460-10-30-2, a liability shall be recognized at the inception of the guarantee even if the guarantor does not receive a separately identified premium when it issues the guarantee. For example, in conjunction with the cash sale of equipment to a customer, a manufacturer may issue to its customer’s bank a guarantee of the customer’s loan for which the proceeds are used to pay for the equipment. There is no separately identified premium for the guarantee, although the sales arrangement may impound an implicit premium. The manufacturer may simply view the guarantee as an accommodation to its customer. The seller-guarantor has incurred an obligation identical to the obligation it would incur if it required its customer to pay an explicit premium for the guarantee. Thus, the seller-guarantor shall immediately recognize a liability for its obligations under a newly issued guarantee, even if a separately identified premium was not received. If an entity guaranteed a customer’s bank loan purely as an accommodation to an important longstanding customer, unrelated to a specific transaction, the liability for the entity’s obligations under the guarantee should be recognized.

The general principle in ASC 460 is that a guarantee obligation should be initially recognized at fair value. ASC 820 defines fair value as “[t]he price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Under ASC 820, fair value represents a measurement based on an exit price — that is, the price that would be received to sell an asset or paid to transfer a liability. Initially measuring a guarantee at fair value in accordance with ASC 820’s exit price notion is consistent with the objective in ASC 460 to determine the amount of consideration a guarantor would have to pay another party to step into the guarantor’s stand-ready obligation to perform under the terms of a guarantee.

Connecting the Dots

The fair value of a guarantee obligation will be affected by the nonperformance risk (e.g., credit risk) of the guarantor. However, this does not mean that the guarantor qualifies for the recognition exception that applies to guarantees of an entity’s own performance.

Although the initial measurement objective for guarantees recognized under ASC 460 is fair value, ASC 460-10-30-2(a) contains a practical expedient that allows a guarantor to use the premium received or receivable as its initial measurement for a guarantee issued in a stand-alone, arm’s-length transaction. Such measurement represents an entry price rather than an exit price. As discussed in Section 9.1 of Deloitte’s Roadmap Fair Value Measurements and Disclosures (Including the Fair Value Option), an entry price (i.e., the transaction price) and an exit price are not always the same. Nevertheless, ASC 460 contains a practical expedient that allows for initial measurement on the basis of an entry price.

A guarantee issued as part of a multiple-element arrangement may be more difficult to measure than one in which a separate premium is received, but the guidance in ASC 460-10-30-2(b) indicates that a guarantor should consider the premium that would have been received for the same guarantee if it were issued in a stand-alone transaction. While the measurement examples in both ASC 460-10-30-2(a) and (b) represent an entry price rather than an exit price (which is required for fair value measurements), the guidance indicates that an entry price may be used as a practical expedient to achieve the fair value measurement objective. For further discussion of the interaction of this practical expedient and fair value under ASC 820, see Section 2.3.4 of Deloitte’s Roadmap Fair Value Measurements and Disclosures (Including the Fair Value Option).

5.3.2.2 Contingent Liability — Guarantees Within the Scope of ASC 326-20

Some financial guarantees are also within the scope of ASC 326-20.3 For a guarantee that is within the scope of ASC 326-20, the guarantor must recognize the amount that meets the fair value objective of the guarantee (as described in Section 5.3.2.1) as well as a liability related to the expected credit losses on the guarantee.

Example 5-24

Guarantee Within the Scope of ASC 326-20

Company A sells medical equipment to Hospital H for $100 million. Hospital H pays for the medical equipment by taking out a loan with Bank B. As part of the sale transaction, A provides a guarantee of the repayment of H’s loan to B. Company A determines that the initial fair value of the guarantee is $5 million. Company A should record the following entry related to the sale and the stand-ready obligation associated with the guarantee:

In addition, A must separately record a liability for the expected credit losses on the guarantee. Company A determines that the current expected credit loss in accordance with ASC 326-20 is $2 million. Therefore, A will recognize the following additional entry:

5.3.2.3 Contingent Liability — Guarantees Not Within the Scope of ASC 326-20

A guarantor assumes the risk that it will need to perform under a guarantee. In an arm’s-length transaction between unrelated parties, a guarantor would be expected to charge a premium, either separately or embedded within the purchase price of a multiple-element contract. That premium is expected to be commensurate with the amount of risk incurred. It would be unusual for a guarantor to charge a premium that is less than the amount that is probable to be paid under the contract as of its inception date. Accordingly, for guarantees that are not within the scope of ASC 326-20, entities often only recognize the fair value of the obligation at the inception of a guarantee; they generally do not recognize an amount for the contingent liability component as of that date. If, however, an entity does consider that, at the inception of a guarantee, it is probable (according to ASC 450-20-25-2) that it will have to perform in accordance with the contingent aspect of the guarantee, the entity should recognize the larger of (1) the fair value of the guarantee or (2) the contingent liability.

ASC 460-10-30-4 acknowledges that it would be unusual at the inception of the guarantee for the contingent liability measured in accordance with the principles of ASC 450 to be greater than the fair value estimate.

ASC 460-10

Example 5-25

Contingent Liability Exceeds Fair Value at Inception

Company A engages Company B to perform certain duties on behalf of A as part of a 10-year contract. Company A indemnifies B for third-party damage claims and lawsuits that could be filed against B in performing the contracted services over the course of the long-term contract.

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

Company A determines that the probable loss is $10 million, which is payable after the end of the contract. As discussed in Section 2.4.3.1, contingent liabilities are rarely discounted; thus, the liability under ASC 450-20 is $10 million. Company A may calculate the fair value of the guarantee by using the same projected cash flows, discounted back to present value. Because the fair value measurement reflects the time value of money but the contingent liability does not, the liability calculated in accordance with ASC 450-20 is greater than the amount of the guarantee determined by using fair value.

5.3.2.4 Offsetting Entry

As noted in ASC 460-10-25-4, ASC 460 does not prescribe a specific offsetting entry upon the initial recognition of a guarantee obligation; the offsetting entry will depend on the facts and circumstances. ASC 460-10-55-23 gives examples of a guarantor’s offsetting entries for different guarantee arrangements:

Transaction Type	Offsetting Entry
Guarantee is issued in a stand-alone transaction for a premium (i.e., for separate consideration received) (ASC 460-10-55-23(a))	Consideration received (e.g., cash or a receivable).
Guarantee is issued in conjunction with the sale of assets, a product, or a business (ASC 460-10-55-23(b))	The overall proceeds (such as the cash received or receivable) would be allocated between the consideration being remitted to the guarantor for issuing the guarantee and the proceeds from the sale.
Guarantee is issued in conjunction with the formation of a partially owned business or a venture accounted for under the equity method (ASC 460-10-55-23(c))	Recognition of the liability for the guarantee would result in an increase to the carrying amount of the investment.
Guarantee is issued to an unrelated party for no consideration on a stand-alone basis (ASC 460-10-55-23(e))	Expense.

SAB Topic 5.E provides interpretive guidance on the accounting for divestiture of a subsidiary or other business operation when a guarantee is issued in conjunction with such a transaction. This guidance further expands on the ASC 460 implementation guidance related to guarantees issued in conjunction with the sale of assets, a product, or a business and would also apply to entities that are not SEC registrants. SAB Topic 5.E states the following:

Facts: Company X transferred certain operations (including several subsidiaries) to a group of former employees who had been responsible for managing those operations. Assets and liabilities with a net book value of approximately $8 million were transferred to a newly formed entity — Company Y — wholly owned by the former employees. The consideration received consisted of $1,000 in cash and interest bearing promissory notes for $10 million, payable in equal annual installments of $1 million each, plus interest, beginning two years from the date of the transaction. The former employees possessed insufficient assets to pay the notes and Company X expected the funds for payments to come exclusively from future operations of the transferred business. Company X remained contingently liable for performance on existing contracts transferred and agreed to guarantee, at its discretion, performance on future contracts entered into by the newly formed entity. Company X also acted as guarantor under a line of credit established by Company Y.

The nature of Company Y’s business was such that Company X’s guarantees were considered a necessary predicate to obtaining future contracts until such time as Company Y achieved profitable operations and substantial financial independence from Company X.

Question: If deconsolidation of the subsidiaries and business operations is appropriate, can Company X recognize a gain?

Interpretive Response: Before recognizing any gain, Company X should identify all of the elements of the divesture arrangement and allocate the consideration exchanged to each of those elements. In this regard, we believe that Company X would recognize the guarantees at fair value in accordance with FASB ASC Topic 460, Guarantees; the contingent liability for performance on existing contracts in accordance with FASB ASC Topic 450, Contingencies; and the promissory notes in accordance with FASB ASC Topic 310, Receivables, and FASB ASC Topic 835, Interest.

ASC 460-10-55-23(b) does not explicitly distinguish between the sale of services and the sale of assets; therefore, the concepts are considered the same, as illustrated in the example below.

Example 5-26

Guarantee Issued in Connection With a Service Contract

A company provides management services for a group of hotels to be constructed and owned by an unrelated master limited partnership (MLP). The management contract is exclusive for a five-year term and specifies the company’s annual fixed fee as well as an annual contingent fee that is based on operating cash flows at the hotels. In connection with obtaining the contract, the company agrees to provide a guarantee of mezzanine debt to be issued by the MLP for the funding of the hotel construction. The debt has scheduled principal repayment on a straight-line basis over five years.

The company has determined that it should recognize a liability for the guarantee separately and apart from the management agreement at inception of the arrangement (see ASC 460-10-30-2(b)). The amount of the liability recognized is an estimate of the fair value of the guarantee.

ASC 460-10-55-23 gives examples of various circumstances and the appropriate offsetting entries. ASC 460-10-55-23(b) states:

If the guarantee were issued in conjunction with the sale of assets, a product, or a business, the overall proceeds (such as the cash received or receivable) would be allocated between the consideration being remitted to the guarantor for issuing the guarantee and the proceeds from the sale. That allocation would affect the calculation of the gain or loss on the sale transaction.

The company should allocate the total expected fees during the five-year service agreement between collection of the premium for issuing the guarantee and the future services to be provided. The offset to the guarantee liability at inception is a receivable equal to the fair value of the expected fees to be received for issuing the guarantee. When the company receives payments from the MLP in connection with the contract, the cash flow allocated to the guarantee premium should be credited to the asset previously recognized upon inception of the guarantee. The asset would be accreted up to the amount of cash to be received, resulting in recognition of interest income. The amount of service revenue the company would record over the course of the agreement would be reduced by the amount of the proceeds initially allocated to the premium for the debt guarantee and by the related accretion of interest.

Additional Fact

At the end of the third year, the debt is retired early because of better-than-expected cash flows at the MLP.

Subsequent Accounting at the End of Year 3

At the time of the debt’s extinguishment, the remaining balance of the guarantee liability should be recognized immediately in income because the specific guarantee no longer exists. The accounting for the receivable should not change because of the extinguishment of the debt as long as the management agreement itself is not terminated. The receivable should not be written off as an offset to the extinguishment of the guarantee liability since the receivable is still collectible. The company has essentially financed its receipt of the premium for writing the guarantee over a period longer than the actual life of the guarantee.

Certain guarantee transactions may not be addressed by the examples in ASC 460-10-55-3. In these situations, the guarantor will need to use judgment to determine the offsetting entry. Just because a guarantor does not receive a separately identified payment for entering into a guarantee does not mean that the guarantee was issued for no consideration. In some transactions, it may be appropriate to recognize an asset other than cash or a receivable. Example 5-9 illustrates an entity’s determination that the offsetting entry upon initial recognition should be an asset. Although not a specific example in ASC 460-10-55-23, the recognition of the offsetting entry in equity may be appropriate in certain transactions. See Example 5-22 for an illustration.

ASC 460-10-55-23(c) provides guidance on the offsetting entry that a guarantor would record when a guarantee is issued in conjunction with the formation of a partially owned business or a venture accounted for under the equity method. See Section 4.2.1 of Deloitte’s Roadmap Equity Method Investments and Joint Ventures for additional discussion and examples. In addition, Section 5.2.1 of that same Roadmap discusses the offsetting entry that would be recorded when a guarantee is issued in connection with an entity’s investment in a joint venture but that guarantee was not contemplated or required by the formation documents.

Footnotes

Under ASC 606-10-15-2(d), guarantees (other than product or service warranties) that are within the scope of ASC 460 are outside the scope of ASC 606.

See Chapter 2 of Deloitte’s Roadmap Current Expected Credit Losses for additional discussion of the scope of ASC 326-20.

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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.