2.3 Derivatives
2.3.1 Interaction With Derivative Accounting Requirements in ASC 815-10
ASC 480-10
35-1 Financial instruments within the scope of Topic 815 shall be measured subsequently as required by the provisions of that Topic.
ASC 815-10
15-74 Notwithstanding the conditions of paragraphs 815-10-15-13 through 15-139, the reporting entity shall not consider the following contracts to be derivative instruments for purposes of this Subtopic: . . .
d. Forward contracts that require settlement by the reporting entity’s delivery of cash in exchange for the acquisition of a fixed number of its equity shares (forward purchase contracts for the reporting entity’s shares that require physical settlement) that are accounted for under paragraphs 480-10-30-3 through 30-5, 480-10-35-3, and 480-10-45-3.
15-83 A
derivative instrument is a financial instrument or other
contract with all of the following characteristics:
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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:
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One or more underlyings
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One or more notional amounts or payment provisions or both.
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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.
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Net settlement. The contract can be settled net by any of the following means:
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Its terms implicitly or explicitly require or permit net settlement.
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It can readily be settled net by a means outside the contract.
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It provides for delivery of an asset that puts the recipient in a position not substantially different from net settlement.
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Some instruments that must be classified as assets or liabilities under ASC 480-10 have all of the characteristics of a derivative instrument in ASC 815-10-15-83. In accordance with ASC 815-10-15-74(d), if such instruments are physically settled forward contracts to repurchase equity shares for cash, they are exempt from the scope of the derivative accounting requirements in ASC 815-10. Instead, the accounting guidance in ASC 480-10 applies (see Chapter 5). Other instruments within the scope of ASC 480-10 that have all the characteristics of derivative instruments fall within the scope of both ASC 480-10 and ASC 815-10 unless one of the scope exceptions in ASC 815 applies. Practically, this means that an entity may be required to apply the disclosure requirements of both ASC 480 and ASC 815 to such instruments. Further, in accordance with ASC 815-10, such instruments are measured subsequently at fair value, with changes in fair value recognized in earnings, unless they qualify as hedging instruments in a cash flow or net investment hedge, in which case all or a portion of the change in fair value is recognized in other comprehensive income.
An option or forward that is outside the scope of the derivative accounting
requirements in ASC 815-10 (e.g., because it does
not meet the net settlement characteristic in the
FASB’s definition of a derivative) would
nevertheless be accounted for at fair value, with
changes in fair value recognized in earnings, if
it is within the scope of ASC 480-10 unless it is
a forward contract that requires physical
settlement by repurchase of a fixed number of the
issuer’s equity shares in exchange for cash (see
Section 5.3).
2.3.2 Interaction With Embedded Derivative Requirements in ASC 815-15
ASC 480-10
15-5 Because paragraph 480-10-15-3 limits the scope of this Topic to freestanding instruments, this Topic does not apply to a feature embedded in a financial instrument that is not a derivative instrument in its entirety.
25-2 For purposes of applying paragraph 815-10-15-74(a) in analyzing an embedded feature as though it were a separate instrument, paragraphs 480-10-25-4 through 25-14 shall not be applied to the embedded feature. Embedded features shall be analyzed by applying other applicable guidance.
ASC 480-10 does not apply in an entity’s evaluation of whether an embedded feature should be bifurcated as an embedded derivative under ASC 815-15. For example, in determining whether an embedded feature qualifies for the scope exception in ASC 815-10-15-74(a) for certain contracts that are both indexed to, and classified in, stockholders’ equity (e.g., a written put option embedded in a share), an entity disregards the classification guidance in ASC 480-10. Instead, the entity assesses whether the feature qualifies for that scope exception by applying the indexation and classification guidance in ASC 815-40 (see Section 2.3.3) and any other relevant guidance other than ASC 480-10 to the embedded put feature.
A financial instrument within the scope of ASC 480-10 could potentially contain
a feature that must be bifurcated as an embedded
derivative under ASC 815-15-25-1. For example, the
redemption amount of a mandatorily redeemable
financial instrument that is classified as a
liability under ASC 480-10 might be indexed to the
price of gold. If so, the issuer should assess
whether the indexation to gold must be separated
as an embedded derivative under ASC 815-15. ASC
815-15-55-110 through 55-113 illustrate the
application of the “clearly and closely related”
criterion in an entity’s bifurcation analysis to
mandatorily redeemable preferred stock for which
the redemption amount is indexed to the price of
gold or a fixed amount of a specified foreign
currency. The host contract that remains after an
embedded feature has been bifurcated as an
embedded derivative under ASC 815-15 should be
analyzed separately from the embedded derivative
in the measurement under ASC 480-10-35 (see
Section 4.2.1).
2.3.3 Interaction With Accounting Requirements for Own-Equity Contracts in ASC 815-40
ASC 815-40
15-3 The guidance in this Subtopic does not apply to any of the following: . . .
e. Financial instruments that are within the scope of Topic 480 (see paragraph 815-40-15-12).
15-12 Paragraph 480-10-15-5 explains that Topic 480 does not apply to a feature embedded in a financial instrument that is not a derivative instrument in its entirety (for example, a written put option embedded in a nonderivative host contract) in analyzing the embedded feature as though it were a separate instrument as required by paragraph 815-15-25-1(c). Therefore, this Subtopic applies in evaluating those embedded features under Subtopic 815-15.
ASC 815-40 addresses the accounting for contracts indexed to, and potentially
settled in, the issuer’s equity shares (e.g.,
purchased put or call options, written call
options, and forward sale contracts). ASC
815-40-15-3(e) specifies that freestanding
financial instruments within the scope of ASC
480-10 are exempt from ASC 815-40. Accordingly,
ASC 815-40 does not apply to freestanding
contracts indexed to, and potentially settled in,
the issuer’s equity shares if they are required to
be classified as assets or liabilities under ASC
480-10 (e.g., freestanding written put options and
freestanding forward purchase contracts on own
equity). This implies that an entity needs to
assess whether a contract is within the scope of
ASC 480-10 before it can determine whether to
apply ASC 815-40 to the contract. See Deloitte’s
Roadmap Contracts
on an Entity’s Own Equity for a
comprehensive discussion of the application of ASC
815-40.
2.3.4 Application of ASC 480-10 to Freestanding Written Puts and Forward Purchase Contracts
ASC 480-10
55-63
The following table addresses classification of
freestanding written put options and forward purchase
contracts within the scope of this Subtopic.
Note: In all cases above, the contracts must be reassessed at each reporting period in order to determine whether or not the contract must be reclassified.
The table in ASC 480-10-55-63 illustrates how an entity would classify, in accordance with ASC 480-10, freestanding written put options and forward purchase contracts under which the issuer has agreed to buy shares at a specified price on a future date. Irrespective of whether such an instrument requires physical settlement, net cash settlement, or net share settlement, or whether it gives the issuer or the counterparty a choice of settlement methods, the instrument is classified as an asset or a liability under ASC 480-10.
If a forward contract requires physical settlement by repurchase of a fixed number of the issuer’s equity shares for cash, it is classified as a liability under ASC 480-10-25-8 and accounted for in accordance with ASC 480-10-30-3 and ASC 480-10-35-3 in a manner similar to a treasury stock repurchase with borrowed funds (see Section 5.3.1). Other forward purchase contracts and written put options that require or may require the issuer to settle its obligation under the contract by transferring assets are classified as assets or liabilities under ASC 480-10-25-8 and accounted for at fair value under ASC 480-10-30-7, ASC 480-10-35-1, ASC 480-10-35-4A, or ASC 480-10-35-5 (see Sections 5.1 and 5.3.2). Such contracts include those that require net cash settlement, permit the issuer to choose between net cash or physical settlement (but not net share settlement), and give the counterparty a settlement choice if at least one of the options is physical settlement or net cash settlement. Forward purchase contracts and written put options that require or permit the issuer to settle its obligation under the contract net in shares are classified as assets or liabilities under ASC 480-10-25-14(c) and accounted for at fair value in accordance with ASC 480-10-30-7 as well as ASC 480-10-35-1, ASC 480-10-35-4A, or ASC 480-10-35-5 (see Sections 6.1.4 and 6.3).