Chapter 2 — Scope
Chapter 2 — Scope
2.1 Entities
2.1.1 Issuers
ASC 480-10
10-1 The objective of this Subtopic is to require issuers to classify as liabilities (or assets in some circumstances) three classes of freestanding financial instruments that embody obligations for the issuer.
15-2 The guidance in the Distinguishing Liabilities from Equity Topic applies to all entities.
ASC 480-10 — Glossary
Issuer
The entity that issued a financial instrument or may be required under the terms of a financial instrument to issue its equity shares.
ASC 480 applies to both public business entities (including SEC registrants) and
private companies that are issuers of financial instruments within its scope.
Under ASC 480-10-20, an issuer is defined as an entity that either “issued a
financial instrument” (e.g., an outstanding common or preferred share) or “may
be required under the terms of a financial instrument to issue its equity
shares” (e.g., certain obligations to deliver a variable number of equity
shares). An entity that enters into an obligation to repurchase its equity
shares by transferring assets (e.g., an entity that writes a put option or
enters into a forward purchase contract on its equity shares) is also considered
an “issuer” under ASC 480 because it issued the shares underlying the contract.
Conversely, ASC 480 does not apply to investors in the entity’s equity shares or
to the counterparty to a financial instrument on the entity’s equity shares.
2.1.2 Exempt Entities
Some of the requirements in ASC 480 do not apply
to certain mandatorily redeemable financial instruments that either represent
noncontrolling interests or are issued by nonpublic entities that are not SEC
registrants. The following table provides an overview of these exceptions:
Affected Entities
|
Instruments for Which Some or All of the
Guidance in ASC 480 Does Not Apply
|
Exempt Guidance
|
Scope Exception in ASC 480-10-15
|
---|---|---|---|
Parents preparing consolidated financial statements (both public and nonpublic) | Mandatorily redeemable noncontrolling interests that do not have to be classified as liabilities by the subsidiary under the only-upon-liquidation exception in ASC 480-10- 25-4 and 25-6 | The classification and measurement provisions (but not the disclosure
provisions) in ASC 480 | 7E(a) |
Other mandatorily redeemable noncontrolling interests that were issued before November 5, 2003 | The measurement provisions (but not the classification and disclosure
provisions) in ASC 480 | 7E(b) | |
Subsidiaries (both public and nonpublic) | Mandatorily redeemable noncontrolling interests that were issued before November 5, 2003 | The measurement provisions (but not the classification and disclosure
provisions) in ASC 480 | 7E(b) |
Nonpublic entities that are not SEC registrants | Mandatorily redeemable financial instruments other than those that are mandatorily redeemable on fixed dates for amounts that either are fixed or are determined by reference to an interest rate index, currency index, or another external index | The classification, measurement, and disclosure provisions in ASC 480 | 7A |
These exceptions are described in more detail in Section 4.1.5.
2.2 Instruments
ASC
480-10
10-1 The
objective of this Subtopic is to require issuers to classify
as liabilities (or assets in some circumstances) three
classes of freestanding financial instruments that embody
obligations for the issuer.
15-3 The
guidance in the Distinguishing Liabilities from Equity Topic
applies to any freestanding financial instrument, including
one that has any of the following attributes:
- Comprises more than one option or forward contract
- Has characteristics of both a liability and equity and, in some circumstances, also has characteristics of an asset (for example, a forward contract to purchase the issuer’s equity shares that is to be net cash settled). Accordingly, this Topic does not address an instrument that has only characteristics of an asset.
15-4 For
example, an instrument that consists of a written put option
for an issuer’s equity shares and a purchased call option
and nothing else is a freestanding financial instrument
(paragraphs 480-10-55-18 through 55-20 provide examples of
such instruments). That freestanding financial instrument
embodies an obligation to repurchase the issuer’s equity
shares and is subject to the requirements of this
Topic.
ASC 480 applies only to items that have all of the following
characteristics:
-
They embody one or more obligations of the issuer (see Section 2.2.1).
-
They meet the definition of a financial instrument (see Section 2.2.2).
-
They meet the definition of a freestanding financial instrument (see Sections 2.2.3 and 3.3); that is, they are not features embedded in a freestanding financial instrument.
-
Their legal form is that of a share, or they could result in the receipt or delivery of shares or are indexed to an obligation to repurchase shares (see Section 2.2.4).
ASC 480 requires an instrument that has all of the above
characteristics to be classified outside of equity if it falls within one of the
following classes of instruments:
The fact that an instrument is not required to be classified as an
asset or a liability under ASC 480 does not necessarily mean that it qualifies for
equity classification. To determine whether an instrument qualifies for
classification in equity in whole or in part, an entity must also consider other
GAAP (e.g., ASC 470-20, ASC 815-10, ASC 815-15, and ASC 815-40). Further, under ASC
480-10-S99-3A, an entity that is subject to SEC guidance should consider whether an
equity-classified instrument must be classified outside of permanent equity (see
Chapter 9).
2.2.1 Obligations of the Issuer
2.2.1.1 The Concept of an Obligation
ASC 480-10 — Glossary
Obligation
A conditional or unconditional duty
or responsibility to transfer assets or to issue
equity shares. Because Topic 480 relates only to
financial instruments and not to contracts to
provide services and other types of contracts, but
includes duties or responsibilities to issue equity
shares, this definition of obligation differs from
the definition found in FASB Concepts Statement No.
6, Elements of Financial Statements, and is
applicable only for items in the scope of that
Topic.
ASC 480-10
05-2 All of the following are
examples of an obligation:
- An entity incurs a conditional obligation to transfer assets by issuing (writing) a put option that would, if exercised, require the entity to repurchase its equity shares by physical settlement. (Further, an instrument that requires the issuer to settle its obligation by issuing another instrument [for example, a note payable in cash] ultimately requires settlement by a transfer of assets.)
- An entity incurs a conditional obligation to transfer assets by issuing a similar contract that requires or could require net cash settlement.
- An entity incurs a conditional obligation to issue its equity shares by issuing a similar contract that requires net share settlement.
05-3 In contrast, by issuing
shares of stock, an entity generally does not incur
an obligation to redeem the shares, and, therefore,
that entity does not incur an obligation to transfer
assets or issue additional equity shares. However,
some issuances of stock (for example, mandatorily
redeemable preferred stock) do impose obligations
requiring the issuer to transfer assets or issue its
equity shares.
ASC 480 applies to a freestanding financial instrument only
if it embodies one or more obligations of the issuer. If not, it cannot be a
liability under ASC 480. Therefore, in evaluating whether the instrument
must be classified outside of equity under ASC 480, the issuer should
determine whether it contains at least one obligation. ASC 480 defines an obligation as a “conditional or unconditional duty or responsibility to transfer assets or to issue equity shares.” This definition is based in part on the definition of a liability in paragraphs 35 and 36 of FASB Concepts Statement 6.
Chapter
4 discusses mandatorily redeemable financial instruments,
which are one of the three classes of financial instruments that must be
classified outside of equity under ASC 480. ASC 480-10-20 defines a
mandatorily redeemable financial instrument as “[a]ny of various financial
instruments issued in the form of shares that embody an unconditional
obligation requiring the issuer to redeem the instrument by transferring its
assets at a specified or determinable date (or dates) or upon an event that
is certain to occur.”
Chapter
5 discusses the second of the three classes: financial
instruments, other than outstanding shares, that embody an obligation to
repurchase shares (or an obligation that is indexed to such an obligation)
in exchange for cash or other assets (e.g., a physically settled forward
purchase or written put option on the issuer’s equity shares).
Chapter
6 discusses the third of the three classes: certain obligations to deliver a variable number of equity shares. As noted in paragraph B17 of the Background Information and Basis for Conclusions of FASB Statement 150, the Board concluded that some financial instruments
“that embody obligations to issue shares place the holder of the instrument
in a position fundamentally different from the position of a holder of the
issuer’s equity shares, that such obligations do not result in an ownership
relationship, and that an instrument that embodies an obligation that does
not establish an ownership relationship should be a liability.” For example,
the economic payoff profile of an obligation to issue equity shares worth a
fixed monetary amount resemble that of a debt obligation. Even though it is
share settled, such an obligation could adversely affect the economic
interests of current holders of the entity’s equity shares by diluting their
ownership interest.
Under FASB Concepts Statement 6, an obligation to issue equity shares is not a liability. Nevertheless, an entity should apply ASC 480 in evaluating whether a share-settled obligation within the scope of ASC 480 should be classified as a liability since FASB concepts statements are not an authoritative source of U.S. GAAP (see ASC 105-10-05-3). When the FASB developed the requirements that are now in ASC 480, its plan was to amend the definition of a liability in Concepts Statement 6 to include
certain share-settled obligations, but the Board has not yet done so.
An obligation can be either unconditional or conditional. An
obligation is unconditional if no condition needs to be satisfied (other
than the passage of time) to trigger a duty or responsibility for the
obligated party to perform. Examples of unconditional obligations
include:
An obligation is conditional if the obligated party only has
a duty or responsibility to perform if a specified condition is met (e.g.,
the occurrence or nonoccurrence of an uncertain future event or the
counterparty’s election to exercise an option). Examples of conditional
obligations include:
- Physically settled written put options that, if exercised, could require the issuer to purchase equity shares and transfer assets (see Chapter 5).
- Physically settled forward contracts that require the issuer to purchase equity shares upon the occurrence or nonoccurrence of an event that is outside the issuer’s control (see Chapter 5).
- Net-settled forward contracts to purchase equity shares that could require the issuer to transfer cash or a variable number of equity shares to settle the contracts’ fair value if they are in a loss position (see Sections 5.2.3 and 6.2.5).
- Net-settled written options that require the issuer to transfer assets or shares if the counterparty elects to exercise the options (see Sections 5.2.3 and 6.2.6).
ASC 480 does not address the accounting for financial
instruments that do not embody any obligation of the issuer. Examples of
such instruments include:
-
Outstanding equity shares that do not have any redemption or conversion provisions.
-
Purchased call options that permit but do not require the issuer to purchase equity shares for cash (see ASC 480-10-55-35).
-
Purchased put options that permit but do not require the issuer to sell equity shares for cash.
An obligation to provide services does not meet the
definition of a financial instrument and is therefore outside the scope of
ASC 480 (see Section
2.2.2).
Connecting the Dots
Call options that are exercisable at the issuer’s discretion
generally do not embody obligations of the issuer. However, if the
holder of the instrument controls the entity (i.e., the board of
directors or voting power) and there are no contractual provisions
that would prevent the holder from directing the entity to exercise
the call option, the call option is in substance a put option that
embodies an obligation that is subject to ASC 480. See
Section 5.1.3 for an example of this type
of instrument.
2.2.1.2 Economic Compulsion
An instrument would not necessarily be classified outside of
equity even if its terms have been designed to economically compel the
issuer to redeem it. For example, a perpetual preferred share without any
contractual redemption requirements may have an increasing, discretionary
dividend designed to incentivize the issuer to redeem the instrument by a
certain date. That instrument would not be within the scope of ASC 480
because it embodies no obligation.
In developing the guidance in ASC 480, the FASB considered
whether an instrument in the form of a share should be viewed to embody an
obligation to redeem the share if the issuer could be economically compelled
to redeem the share but is not legally required to do so. However, the Board
decided not to establish any such requirement.
While the existence of economic compulsion itself is not
sufficient to cause an instrument to be classified as a liability under ASC
480, it may be a factor in the evaluation of whether a feature is
substantive. Further, note that the SEC staff has issued guidance on the
accounting for increasing-rate preferred stock (see ASC 505-10-S99-7).
Example 2-1
Increasing-Rate
Preferred Stock
A
perpetual preferred share has the following
terms:
- A fixed par amount ($100).
- A stated dividend rate (5 percent per annum) for an initial period (five years).
- An increasing dividend-rate. As of a specified date in the future, the dividend rate will have increased to an interest rate that is likely to be significantly in excess of market rates (20 percent per annum).
- Discretionary dividends. The issuer has discretion over whether to declare a dividend (i.e., the issuer has no legally enforceable obligation to pay the dividend).
- A call option. The issuer has the right to repurchase the preferred share at its par amount if it also pays all unpaid and accumulated dividends on the preferred share.
- A dividend stopper. The issuer is not permitted to declare and pay any dividends on common shares before it pays all accumulated and unpaid dividends on the preferred share.
In these circumstances, the issuer may be expected to have a strong economic
incentive to call the preferred stock before the
cumulative undeclared dividends become too large. If
it does not call the instrument, the issuer will
either pay significantly above-market dividends to
the preferred shareholders or be unable to pay
dividends on common stock (potentially resulting in
the loss of much of the value of its common stock).
Nevertheless, the preferred stock is outside the
scope of ASC 480 because it does not meet the
definition of a mandatorily redeemable financial
instrument and does not contain an unconditional
obligation to deliver a variable number of shares.
(Note also that the issuer’s incentive to redeem the
instrument would weaken if the market’s required
return on similar instruments approached or exceeded
20 percent per annum, for example, because the
issuer’s financial situation deteriorated
sufficiently or market interest rates
increased.)
2.2.1.3 Issuer Discretion to Avoid a Transfer of Assets or Equity Shares
An issuer does not have an obligation under ASC 480 if it
has complete discretion to avoid the transfer of assets or equity shares.
ASC 480 does not address the accounting for a financial instrument that does
not embody any obligation of the issuer. Therefore, the following are
examples of instruments that are outside the scope of ASC 480:
-
An agreement to repurchase an entity's own stock by transferring assets, or to issue equity shares, that permits the issuer to cancel the agreement at any time at its sole discretion without penalty.
-
An agreement that requires the issuer to transfer assets or issue equity shares upon the occurrence of an event that is solely within its control. In this case, the entity has no obligation before the event occurs since the entity could not be forced to transfer assets or issue shares unless it decides to proceed with the event or allows it to occur.
The table in Section 9.4.2 lists examples of events
and circumstances that may be considered solely and not solely within the
issuer’s control when their occurrence triggers a duty or responsibility for
the issuer to transfer assets or issue shares. Note, however, that the
determination of whether a specific event is within the issuer’s control
could differ depending on the specific facts and circumstances. For example,
an event that would ordinarily be considered to be solely within the
issuer’s control may not qualify as such if either (1) the counterparty
controls the issuer’s decision to cause the event to occur through board
representation or other rights or (2) the issuer is firmly committed to
undertake an action that will cause the event to occur.
Example 2-2
Callable and Puttable Warrant
A
warrant:
- Permits Holder H to purchase a fixed number of Entity E’s perpetual common shares for a fixed amount of cash.
- Contains:
- A call option that permits E to repurchase the warrant for a fixed price in cash at any time.
- A put option that permits H to put the warrant to E for a fixed price in cash 30 days after giving notice of its intent to exercise the put. If H gives notice of its intent to exercise the put, E has the right to exercise its call option before the put option becomes exercisable. Accordingly, E can prevent the put option from ever becoming exercised.
In evaluating whether the warrant embodies one or more obligations that cause it
to fall within the scope of ASC 480, E must consider
all of the warrant’s terms and features.
The warrant
contains two conditional requirements: (1) delivery
of a fixed number of shares for cash if H elects to
exercise the warrant and (2) delivery of a fixed
amount of cash if H elects to put the warrant.
The first conditional requirement represents an obligation of E, because E has
no discretion to avoid it. To be within the scope of
ASC 480, however, an obligation to deliver shares
must be for the delivery of a variable number of
shares (see Chapter 6).
Since this conditional obligation is to deliver a
fixed number of equity shares, it does not cause the
instrument to be classified as an asset or a
liability under ASC 480.
In assessing the second conditional
requirement, E notes that it is able to prevent the
exercise of the put option by exercising its call
option after the counterparty has notified E of its
intent to exercise the put in 30 days.
Despite E’s ability to prevent exercise of the put option, E has a conditional
obligation to transfer assets (pay cash) since it
(1) it cannot prevent H from giving notice of its
intent to exercise the put option and (2) is
required to pay cash irrespective of whether it
exercises its call option or allows the put option
to be exercised (i.e., it has no discretion to avoid
the requirement to pay cash). Under ASC 480-10-25-8,
E classifies the warrant as a liability because it
(1) is not an outstanding share, (2) embodies an
obligation that is indexed to an obligation to
repurchase E’s equity shares, and (3) may require E
to settle the obligation by transferring assets;
that is, it contains a conditional obligation to
deliver cash (see Section 5.1). If
the put option was removed, however, ASC 480 would
not require E to classify the warrant as an asset or
a liability because the conditional obligation to
deliver a fixed number of equity shares is not
within the scope of ASC 480 and the call option does
not represent an obligation. Instead, E would apply
other GAAP (e.g., ASC 815-40) to determine how to
account for the warrant.
2.2.1.4 Asset-Classified Instruments Embodying Obligations
ASC 480-10
25-12 Certain financial
instruments that embody obligations that are
liabilities within the scope of this Subtopic also
may contain characteristics of assets but be
reported as single items. Some examples include the
following:
- Net-cash-settled or net-share-settled forward purchase contracts
- Certain combined options to repurchase the issuer’s shares.
Those instruments are
classified as assets or liabilities initially or
subsequently depending on the instrument’s fair
value on the reporting date.
Although ASC 480 applies only to instruments that embody
obligations of the issuer, not all instruments within its scope are
liabilities. For example, an issuer may pay a net premium to purchase a
single freestanding financial instrument, such as a collar that includes
both a purchased call option and a written put option on the issuer’s
shares. Because of the written option component, that instrument embodies an
obligation that is within the scope of ASC 480. If the fair value of the
purchased option component (a valuable right) exceeds the fair value of the
written option component, however, the collar is an asset rather than a
liability. Similarly, a net-settled forward contract to purchase the
entity’s equity shares embodies a conditional obligation to transfer assets
or equity shares if the stock price is less than the contracted forward
price on the forward settlement date, but it is an asset if the contract is
in a gain position for the issuer on that date.
2.2.1.5 Prepaid Obligations
ASC 480 does not apply to a contract that does not contain
any obligation of the issuing entity to transfer assets or issue equity
shares because the issuer fully prepays its obligation at inception. For
example, a prepaid written put option does not meet the criteria to be
accounted for as an asset or a liability under ASC 480-10-25-8 or ASC
480-10-25-14 because it does not represent an obligation of the issuing
entity (i.e., the option writer) to transfer assets or issue equity shares.
(Prepaid written put option strategies and economically equivalent
arrangements have been marketed under names such as Dragons, Caesars, or
ZCalls.)
Although such an instrument is not within the scope of ASC
480, the issuing entity (i.e., the option writer) will need to consider the
applicability of other relevant GAAP. For example, the issuing entity should
consider whether the prepaid contract represents a hybrid financial
instrument that includes an embedded derivative that should be bifurcated in
accordance with ASC 815-15-25-1. The issuing entity should also consider the
guidance in ASC 815-40 on contracts related to an entity’s own equity (see
Deloitte’s Roadmap Contracts on an Entity’s Own Equity) and in ASC
505-10-45-2 on receivables for the issuance of equity. See Section
5.2.1.4 for additional discussion.
In accordance with a 2004 speech by Scott Taub, then deputy chief
accountant in the SEC’s Office of the Chief Accountant (OCA), the issuing
entity should also provide transparent disclosures about the transaction and
the related accounting considerations.
Example 2-3
Prepaid Written Put Option
As part of its share repurchase strategy, Entity Y
issues a prepaid written put option on its own
common shares to Bank B. The relevant facts and
circumstances are as follows:
- The notional amount of the option is 100,000 common shares of Y.
- The strike price of the option is $20 per share, which also represents the fair value of Y’s common shares on the option issuance date.
- The option premium is $4 per share.
- On the option issuance date, Y pays B $16 per share (or $1.6 million = $16 per share × 100,000), which represents the prepayment of the option strike price less the amount of the option premium due from B ($16 = $20 – $4).
- The prepaid written put option is a European-style option; it can be exercised (and will also expire) one year after the option issuance date (the exercise date).
- If the fair value of Y’s common shares on the exercise date is equal to or greater than the option strike price, B will pay Y $20 per share (or $2 million = $20 per share × 100,000).
- If the fair value of Y’s common shares on the exercise date is less than the option strike price, B will deliver 100,000 of Y’s common shares to Y.
The effect of Y’s
issuance of the prepaid written put option to B is
as follows:
Possible Outcome | Economic Result |
---|---|
The fair value of Y’s common
shares on the exercise date is greater than the
option strike price. | Entity Y receives a return on the
written option equal to the difference between the
strike price ($2 million = $20 per share × 100,000
shares) and the prepayment amount ($1.6 million =
$16 per share × 100,000 shares), or $400,000: an
annual return of 25 percent. |
The fair value of Y’s common
shares on the exercise date is equal to or less
than the option strike price. | Entity Y reacquires 100,000 of
its common shares for $16 per share (the
prepayment amount) under more favorable terms than
the fair value of the shares on the option
issuance date ($20 per share). |
As an alternative to
the written put option strategy, Y and B could have
entered into an economically equivalent arrangement
(i.e., one that has the same payoff profile)
involving a purchased call option with a strike
price of $0 per share and a written call option with
a strike price of $20 per share. Under this
alternative approach, the prepayment amount of $16
per share represents the premium due on the
in-the-money purchased call option ($20), reduced by
the premium received from the written call option
($4).
Under either approach,
Y would not apply ASC 480-10-25-8 through 25-13 to
the contract. It would, however, consider other
relevant GAAP to determine the appropriate
accounting for its share repurchase
strategy.
Unlike a fully prepaid contract, a partially prepaid contract such as a
partially prepaid forward purchase contract or a partially prepaid written
put option does contain a remaining obligation of the issuing entity to
transfer assets. See Section 5.2.1.4 for additional
discussion.
2.2.2 Financial Instruments
ASC
480-10 — Glossary
Financial Instrument
Cash, evidence of an ownership interest
in an entity, or a contract that both:
- Imposes on one entity a contractual obligation either:
- To deliver cash or another financial instrument to a second entity
- To exchange other financial instruments on potentially unfavorable terms with the second entity.
- Conveys to that second entity a contractual right either:
- To receive cash or another financial instrument from the first entity
- To exchange other financial instruments on potentially favorable terms with the first entity.
The use of the term
financial instrument in this definition is recursive
(because the term financial instrument is included in
it), though it is not circular. The definition requires
a chain of contractual obligations that ends with the
delivery of cash or an ownership interest in an entity.
Any number of obligations to deliver financial
instruments can be links in a chain that qualifies a
particular contract as a financial instrument.
Contractual rights and contractual
obligations encompass both those that are conditioned on
the occurrence of a specified event and those that are
not. All contractual rights (contractual obligations)
that are financial instruments meet the definition of
asset (liability) set forth in FASB Concepts Statement
No. 6, Elements of Financial Statements, although some
may not be recognized as assets (liabilities) in
financial statements — that is, they may be
off-balance-sheet — because they fail to meet some other
criterion for recognition.
For
some financial instruments, the right is held by or the
obligation is due from (or the obligation is owed to or
by) a group of entities rather than a single entity.
The scope of ASC 480 is limited to financial instruments, which
include:
-
Ownership interests (e.g., common or preferred shares or interests in a partnership or limited liability company).
-
Contracts to deliver cash (e.g., net-cash-settled options or forward contracts).
-
Contracts to deliver shares (e.g., share-settled debt or net-share-settled options or forward contracts).
-
Contracts to exchange financial instruments (e.g., physically settled written options or forward contracts that involve the exchange of equity shares for cash or another financial asset).
An obligation to provide services does not meet the definition
of a financial instrument and is thus outside the scope of ASC 480. However, a
financial instrument (e.g., an outstanding share) may contain embedded features
(e.g., an obligation to deliver gold) that would not have met the definition of
a financial instrument on a stand-alone basis. ASC 480 applies to such a hybrid
financial instrument. ASC 815-15-55-110 and 55-111 contain an example of
“mandatorily redeemable preferred stock whose preferred dividends are payable in
cash but that requires redemption at the end of 1 year for a payment of 312
ounces of gold.” That example implies that ASC 480 applies to the preferred
stock and further suggests that the preferred stock contains an embedded
derivative whose underlying is the price of gold, which is not clearly and
closely related to the host preferred stock contract.
2.2.3 Freestanding Financial Instruments
ASC
480-10 — Glossary
Freestanding Financial
Instrument
A financial
instrument that meets either of the following
conditions:
- It is entered into separately and apart from any of the entity’s other financial instruments or equity transactions.
- It is entered into in conjunction with some other transaction and is legally detachable and separately exercisable.
ASC
480-10
25-1 The guidance in this
Section shall be applied to a freestanding financial
instrument in its entirety. . . .
ASC 480 applies only to financial instruments that are
freestanding in accordance with the definition of a freestanding financial
instrument in ASC 480-10-20. Accordingly, an entity does not apply ASC 480
separately to a feature that is embedded in a financial instrument (see
Section
2.3.2).
For example, if an outstanding share that is not mandatorily
redeemable contains an embedded put option feature that permits the holder to
require the issuer to repurchase the share for a fixed amount of cash, that
option would not be analyzed separately from the share under ASC 480 unless the
share is minimal (see Section
3.2). ASC 480 does not require classification of that outstanding
share as a liability even though the share contains a component (i.e., the
embedded written put) for which liability classification would have been
required if the component had been issued as a freestanding financial instrument
that was separate from the share.
The definition of a freestanding financial instrument helps not
only in the identification of whether an item is within the scope of ASC 480 but
also in the determination of the appropriate units of account; that is, whether
an item should be aggregated or disaggregated for accounting purposes (see
Section 3.3).
2.2.4 Legal Form of Share or Involves Equity Shares
ASC
480-10
05-6 For purposes of this
Subtopic, three related terms — shares, equity shares,
and issuer’s equity shares — are used in the particular
ways defined in the glossary.
The instruments in each of the three classes of freestanding
financial instruments that must be classified outside of equity under ASC 480
either (1) have the legal form of a share (see Section 2.2.4.1) or could result in the
receipt or delivery of the issuer’s equity shares (see Sections 2.2.4.2 and
2.2.4.3) or (2)
are indexed to an obligation to repurchase its equity shares:
-
Mandatorily redeemable financial instruments (the first class; see Chapter 4) applies only to “instruments issued in the form of shares” (emphasis added).
-
The second class (see Chapter 5) applies only to financial instruments that embody “an obligation to repurchase the issuer’s equity shares, or is indexed to such an obligation” (emphasis added).
-
The third class (see Chapter 6) applies only to obligations that “the issuer must or may settle by issuing a variable number of its equity shares” (emphasis added).
If a contract is not in the legal form of a share and does not
involve the potential receipt or delivery of the issuer’s equity shares or is
not indexed to an obligation to repurchase the issuer’s equity shares, it would
be outside the scope of ASC 480. Accordingly, financial instruments that are in
the legal form of debt are outside the scope of ASC 480. For example, a note in
the legal form of debt that has a stated maturity, stated coupon rate, and
creditor rights is outside the scope of ASC 480 even if it is mandatorily
exchangeable into a specified number of common shares on a future date (e.g.,
certain premium income-exchangeable securities). The issuer should present such
a security as a liability on the basis of its legal form.
An instrument that represents a legal-form debt obligation
should be classified as a liability even if it has certain economic
characteristics that are similar to an equity instrument. For example, an
instrument that represents a legal-form debt obligation in the jurisdiction in
which it is issued and carries creditor rights (e.g., an ability to seek
recourse in a bankruptcy court) should be classified as a liability even if the
issuer only has a de minimis amount of common equity capital and the instrument
is described as an “equity certificate,” has a long maturity (e.g., 40 years),
is subordinated to all other creditors, contains conversion rights into common
equity, and provides dividend rights that are similar to those of a holder of
common equity (e.g., payable only if declared). If it is not readily apparent
whether a claim on the entity legally represents debt or equity, an entity may
need to seek an opinion from legal counsel.
In this Roadmap, the term “share-settled debt” is used to
describe a share-settled obligation that is not in the legal form of debt but
has the same economic payoff profile as debt (see Chapter 6).
2.2.4.1 Shares
ASC 480-10 — Glossary
Shares
Shares includes various forms of
ownership that may not take the legal form of
securities (for example, partnership interests), as
well as other interests, including those that are
liabilities in substance but not in form. (Business
entities have interest holders that are commonly
known by specialized names, such as stockholders,
partners, and proprietors, and by more general
names, such as investors, but all are encompassed by
the descriptive term owners. Equity of business
entities is, thus, commonly known by several names,
such as owners’ equity, stockholders’ equity,
ownership, equity capital, partners’ capital, and
proprietorship. Some entities [for example, mutual
organizations] do not have stockholders, partners,
or proprietors in the usual sense of those terms but
do have participants whose interests are essentially
ownership interests, residual interests, or
both.)
In ASC 480, the term “share” is not limited to a financial
instrument in the form of equity securities but broadly applies to any
financial instrument that takes the form of an ownership interest. For
example, shares include common and preferred stock, partnership interests
(e.g., participating securities in the form of preferred limited partnership
interests issued by investment funds licensed as SBICs), membership
interests in limited liability companies or cooperative entities, and
policyholder interests in mutual insurance companies.
The following table lists
examples of instruments that, unless a legal analysis of their form suggests
otherwise, would and would not be considered shares under ASC 480:
Share | Not a Share |
---|---|
|
|
Under U.S. GAAP, instruments that are in the legal form of
shares (i.e., instruments that evidence a claim to the net assets of the
issuer and do not provide the holder with creditor rights) generally are
classified in the stockholders’ equity section of the balance sheet (either
permanent or temporary equity) unless they meet the criteria for liability
classification in ASC 480. Thus, a preferred stock instrument that is not
classified as a liability under ASC 480 generally would be presented in
equity even if it has a stated liquidation preference, a stated dividend,
redemption features, and a claim to net assets that is senior to that of
common stockholders.
2.2.4.2 Equity Shares
ASC 480-10 — Glossary
Equity Shares
Equity shares refers only to shares
that are accounted for as equity.
ASC 480-10-20 suggests that the term “equity share” is
limited to shares that qualify, and are classified, as equity (including
both permanent and temporary equity) in the reporting entity’s financial
statements. The term does not apply to shares that are classified as
liabilities. Nevertheless, ASC 480-10-25-8 applies to financial instruments,
such as warrants, options, or forwards, that involve the issuance of
mandatorily redeemable shares that would be accounted for as liabilities
when they are issued; see ASC 480-10-25-13(b) and ASC 480-10-55-33 and
Sections
5.1.3 and 5.2.1.
Surplus notes, which are defined in ASC 944-470-20 as
“financial instruments issued by insurance entities that are includable in
surplus for statutory accounting purposes as prescribed or permitted by
state laws and regulations,” do not qualify as equity shares under ASC
944-470-25-1 but are reported as debt instruments. ASC 944-470-05-1
indicates that such notes are also known as “certificates of contribution,
surplus debentures, or capital notes.”
2.2.4.3 Issuer’s Equity Shares
ASC 480-10 — Glossary
Issuer’s Equity
Shares
The equity shares
of any entity whose financial statements are
included in the consolidated financial statements.
Noncontrolling Interest
The portion of equity (net assets)
in a subsidiary not attributable, directly or
indirectly, to a parent. A noncontrolling interest
is sometimes called a minority interest.
ASC 480-10
15-6 Paragraphs 480-10-55-53
through 55-58 apply to the specific circumstances
described by those paragraphs in which a majority
owner enters into a transaction in the shares of a
consolidated subsidiary and a derivative instrument
indexed to the noncontrolling interest in that
subsidiary.
References in ASC 480 to the “issuer’s equity shares”
include equity shares issued by any consolidated subsidiary. For example, if
a parent writes a freestanding put option on a noncontrolling interest in a
subsidiary, the put option might fall within the scope of ASC 480 in the
parent’s consolidated financial statements even if it is not recognized in
the subsidiary’s financial statements. Similarly, an entity should evaluate
a put option written by a subsidiary on its own or its parent’s equity
shares to determine whether the option falls within the scope of ASC 480 in
the consolidated financial statements. ASC 480-10-55-53 through 55-58
contain special accounting guidance on transactions involving noncontrolling
interests (see Section
7.1).
Conversely, shares issued by entities that are not
consolidated in the reporting entity’s financial statements are not the
issuer’s equity shares. For example, if a subsidiary enters into a contract
to purchase the parent’s equity shares for cash, that contract would be
within the scope of ASC 480 in the parent’s consolidated financial
statements but not in the subsidiary’s separate financial statements.1 Further, shares issued by an equity method investee or a third party
are not considered the issuer’s equity shares and are therefore outside the
scope of ASC 480. Accordingly, an entity that enters into a contract to
purchase or deliver shares of an equity method investee or a third party
would apply other GAAP in accounting for the contract (e.g., ASC 815, ASC
321, or ASC 323).
Footnotes
1
See Section 4.2.2 of Deloitte’s
Roadmap Noncontrolling Interests for further
discussion of the accounting for a subsidiary that owns shares of
its parent.
2.3 Derivatives
2.3.1 Interaction With Derivative Accounting Requirements in ASC 815
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:
-
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:
-
One or more underlyings
-
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:
-
Its terms implicitly or explicitly require or permit net settlement.
-
It can readily be settled net by a means outside the contract.
-
It provides for delivery of an asset that puts the recipient in a position not substantially different from net settlement.
-
Some instruments that must be classified as assets or liabilities under ASC 480
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. Instead, the accounting guidance in ASC 480
applies (see Chapter 5).
Other instruments within the scope of ASC 480 that have all the characteristics of
derivative instruments fall within the scope of both ASC 480 and ASC 815 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, 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 (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 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 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. 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 to the
embedded put feature.
A financial instrument within the scope of ASC 480 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 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 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 (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 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 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, 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.
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 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 (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 under
ASC 480 (see Sections 6.1.4
and 6.3).
2.4 Share-Based Payments
ASC Master Glossary
Share-Based Payment Arrangements
An arrangement under which either of the following conditions
is met:
- One or more suppliers of goods or services (including employees) receive awards of equity shares, equity share options, or other equity instruments.
- The entity incurs liabilities to suppliers that meet
either of the following conditions:
- The amounts are based, at least in part, on the price of the entity’s shares or other equity instruments. (The phrase at least in part is used because an award may be indexed to both the price of the entity’s shares and something other than either the price of the entity’s shares or a market, performance, or service condition.)
- The awards require or may require settlement by issuance of the entity’s shares.
The term shares includes various forms of ownership interest
that may not take the legal form of securities (for example,
partnership interests), as well as other interests,
including those that are liabilities in substance but not in
form. Equity shares refers only to shares that are accounted
for as equity.
Also called share-based compensation arrangements.
Employee Stock Ownership Plan
An employee stock ownership plan is an employee benefit plan
that is described by the Employee Retirement Income Security
Act of 1974 and the Internal Revenue Code of 1986 as a stock
bonus plan, or combination stock bonus and money purchase
pension plan, designed to invest primarily in employer
stock. Also called an employee share ownership plan.
ASC 480-10
15-8 The
guidance in the Distinguishing Liabilities from Equity Topic
does not apply to an obligation under share-based
compensation arrangements if that obligation is accounted
for under Topic 718. For example, employee stock ownership
plan shares or freestanding agreements to repurchase those
shares are not within the scope of this Topic because those
shares are accounted for under Subtopic 718-40 through the
point of redemption. However, this Topic does apply to a
freestanding financial instrument that was issued under a
share-based compensation arrangement but is no longer
subject to Topic 718. For example, this Topic applies to a
mandatorily redeemable share issued upon a grantee’s
exercise of a share option. (Topic 718 provides accounting
guidance for dividends on allocated shares, redemption of
shares, recognition of expense, and computing earnings per
share [EPS].) However, employee stock ownership plan shares
that are mandatorily redeemable or freestanding agreements
to repurchase those shares continue to be subject to other
applicable guidance related to Subtopic 718-40.
ASC 718-10
25-7
Topic 480 excludes from its scope instruments that are
accounted for under this Topic. Nevertheless, unless
paragraphs 718-10-25-8 through 25-19A require otherwise, an
entity shall apply the classification criteria in Section
480-10-25 and paragraphs 480-10-15-3 through 15-4 in
determining whether to classify as a liability a
freestanding financial instrument given to a grantee in a
share-based payment transaction. Paragraphs 718-10-35-9
through 35-14 provide criteria for determining when
instruments subject to this Topic subsequently become
subject to Topic 480 or to other applicable GAAP.
25-8
In determining the classification of an instrument, an
entity shall take into account the classification
requirements as established by Topic 480. In addition, a
call option written on an instrument that is not classified
as a liability under those classification requirements (for
example, a call option on a mandatorily redeemable share for
which liability classification is not required for the
specific entity under the requirements) also shall be
classified as equity so long as those equity classification
requirements for the entity continue to be met, unless
liability classification is required under the provisions of
paragraphs 718-10-25-11 through 25-12.
Awards May Become Subject to Other Guidance
35-9 Paragraphs 718-10-35-10
through 35-14 are intended to apply to those instruments
issued in share-based payment transactions with employees
and nonemployees accounted for under this Topic, and to
instruments exchanged in a business combination for
share-based payment awards of the acquired business that
were originally granted to grantees of the acquired business
and are outstanding as of the date of the business
combination.
35-9A Paragraph
superseded by Accounting Standards Update No. 2020-06.
35-10 A freestanding financial
instrument or a convertible security issued to a grantee
that is subject to initial recognition and measurement
guidance within this Topic shall continue to be subject to
the recognition and measurement provisions of this Topic
throughout the life of the instrument, unless its terms are
modified after any of the following:
-
Subparagraph superseded by Accounting Standards Update No. 2019-08.
-
Subparagraph superseded by Accounting Standards Update No. 2019-08.
-
A grantee vests in the award and is no longer providing goods or services.
-
A grantee vests in the award and is no longer a customer.
-
A grantee is no longer an employee.
35-10A
Only for purposes of paragraph 718-10-35-10, a modification
does not include a change to the terms of an award if that
change is made solely to reflect an equity restructuring
provided that both of the following conditions are met:
- There is no increase in fair value of the award (or the ratio of intrinsic value to the exercise price of the award is preserved, that is, the holder is made whole) or the antidilution provision is not added to the terms of the award in contemplation of an equity restructuring.
- All holders of the same class of equity instruments (for example, stock options) are treated in the same manner.
35-11 Other modifications of that
instrument that take place after a grantee vests in the
award and is no longer providing goods or services, is no
longer a customer, or is no longer an employee should be
subject to the modification guidance in paragraph
718-10-35-14. Following modification, recognition and
measurement of the instrument shall be determined through
reference to other applicable GAAP.
35-12
Once the classification of an instrument is determined, the
recognition and measurement provisions of this Topic shall
be applied until the instrument ceases to be subject to the
requirements discussed in paragraph 718-10-35-10. Topic 480
or other applicable GAAP, such as Topic 815, applies to a
freestanding financial instrument that was issued under a
share-based payment arrangement but that is no longer
subject to this Topic. This guidance is not intended to
suggest that all freestanding financial instruments shall be
accounted for as liabilities pursuant to Topic 480, but
rather that freestanding financial instruments issued in
share-based payment transactions may become subject to that
Topic or other applicable GAAP depending on their
substantive characteristics and when certain criteria are
met.
35-14
An entity may modify (including cancel and replace) or
settle a fully vested, freestanding financial instrument
after it becomes subject to Topic 480 or other applicable
GAAP. Such a modification or settlement shall be accounted
for under the provisions of this Topic unless it applies
equally to all financial instruments of the same class
regardless of the holder of the financial instrument.
Following the modification, the instrument continues to be
accounted for under that Topic or other applicable GAAP. A
modification or settlement of a class of financial
instrument that is designed exclusively for and held only by
grantees (or their beneficiaries) may stem from the
employment or vendor relationship depending on the terms of
the modification or settlement. Thus, such a modification or
settlement may be subject to the requirements of this Topic.
See paragraph 718-10-35-10 for a discussion of changes to
awards made solely to reflect an equity restructuring.
ASC 480 does not apply to a contract issued to a grantee that is subject to ASC
718. This includes share-based payment awards granted to (1) an employee as
compensation for rendering service, (2) a nonemployee as compensation for the
acquisition of goods or services by the entity, or (3) a customer in conjunction
with the entity’s sale of goods or services that are within the scope of ASC 606.
ASC 480 also does not apply to shares of employee stock ownership plans (ESOPs). An
entity applies ASC 718 in determining (1) whether such contracts should be
classified as equity or as liabilities or assets and (2) how to account for them.
For example, ASC 718 applies to puttable employee stock options and shares of
ESOPs.
Therefore, ESOP shares or freestanding agreements to repurchase ESOP shares are not
within the scope of ASC 480. Rather, they are accounted for under ASC 718-40 through
the date of redemption.
Although share-based payment awards subject to ASC 718 are outside
the scope of ASC 480, ASC 718-10-25-7 requires entities to apply the classification
criteria in ASC 480-10-25 and in ASC 480-10-15-3 and 15-4 unless ASC 718-10-25
requires otherwise. For detailed guidance on the application of these requirements,
see Chapter 5 of
Deloitte’s Roadmap Share-Based
Payment Awards.
A contract originally issued to a grantee in a share-based payment
arrangement that is subject to ASC 718 may become subject to ASC 480 after the
contract’s issuance if its terms are modified. ASC 718 ceases to apply if the terms
of a share-based payment award originally subject to ASC 718 are modified and the
holder is no longer an employee or, for awards granted to nonemployees, a vested
award is modified and the grantee is no longer providing goods or services or is no
longer a customer. However, ASC 718 continues to apply if the modification is made
solely to reflect an equity restructuring and (1) there is no increase in the fair
value of the award (or the ratio of intrinsic value to the exercise price of the
award is preserved — that is, the holder is made whole) or the antidilution
provision is not added to the terms of the award in contemplation of an equity
restructuring and (2) all holders of the same class of equity instruments are
treated in the same manner. If a contract originally issued to a grantee in a
share-based payment arrangement subject to ASC 718 becomes subject to ASC 480, the
classification of the contract as equity or as an asset or a liability may change as
a result of the application of ASC 480.
Connecting the Dots
Although a contract originally granted in a share-based
payment arrangement that is subject to ASC 718 may become subject to other
GAAP, including ASC 480, as a result of a modification of its terms, the
modification should be accounted for under ASC 718. The classification and
subsequent accounting for the instrument under other applicable GAAP are
determined after the application of ASC 718’s guidance on accounting for
modifications.
ASC 480-10-15-8 indicates that if an employee exercises a stock
option within the scope of ASC 718 and receives mandatorily redeemable shares, those
shares would not be within the scope of ASC 718 but would need to be evaluated under
ASC 480.
ASC 718-10-15-5(b) exempts from the scope of ASC 718 transactions
involving equity instruments granted to a lender or investor that provides financing
to the issuer. For example, if an entity obtains a loan in exchange for issuing a
contract on its own equity, that contract would not be within the scope of ASC 718
but would be evaluated under ASC 480 along with any other applicable literature
(e.g., ASC 815-40).
2.5 Convertible Preferred Shares
Entities are not often required to classify a convertible preferred share as a
liability under ASC 480. However, such a share would be classified as a liability
under ASC 480 if:
-
It has a mandatory redemption date and requires the issuer to settle the liquidation value (i.e., par amount) in cash upon a conversion into common stock (see Section 4.2.4). Such an instrument is also subject to the guidance on convertible debt in ASC 470-20, including the disclosure requirements in ASC 470-20-50 (see ASC 470-20-15-2D).
-
It has a mandatory redemption date and a conversion feature that is not substantive (see Sections 3.2 and 4.1.3).
-
It has a mandatory redemption date and is reclassified as a liability once a substantive conversion option expires (see Section 4.1.3).
-
It has a mandatory redemption date and is convertible into shares that are unconditionally redeemable for cash or other assets (see Section 4.1.3).
-
It is mandatorily convertible into a variable number of shares whose monetary value is based solely or predominantly on a fixed monetary amount, variations in something other than the fair value of the issuer’s stock, or variations inversely related to the fair value of the issuer’s stock (see Section 6.1).
2.6 Contingent Consideration in a Business Combination
ASC 480-10
15-9 Subtopic 805-30 provides guidance on the recognition and initial measurement of consideration issued in a business combination, including contingent consideration.
15-10 However, when recognized, a financial instrument within the scope of this Topic that is issued as consideration (whether contingent or noncontingent) in a business combination shall be classified pursuant to the requirements of this Topic.
35-4A Contingent consideration issued in a business combination that is classified as a liability in accordance with the requirements of this Topic shall be subsequently measured at fair value in accordance with 805-30-35-1.
ASC 805-30 — Glossary
Contingent Consideration
Usually an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. However, contingent consideration also may give the acquirer the right to the return of previously transferred consideration if specified conditions are met.
In business combinations, the parties often agree to contingent consideration (i.e., consideration that depends on future events or conditions). Contingent consideration arrangements permit the parties to proceed with a business combination without agreeing on the final purchase price. For example, the acquirer may agree to deliver a specified number of its own equity shares if the acquiree’s earnings exceed a specified target in the year after the combination. Other examples of events that may trigger contingent consideration payments include reaching a specified stock price or achieving a milestone in a research and development project.
In determining the appropriate classification of a contingent consideration
arrangement, the acquirer considers the
classification guidance in ASC 480 and any other
applicable guidance (e.g., ASC 815-40). To measure
the arrangement, however, the acquirer applies ASC
805-30 instead of ASC 480. Contingent
consideration is part of the total consideration
transferred for the acquiree and must therefore be
measured and recognized at fair value as of the
acquisition date under ASC 805-30. ASC 805-30-35-1
provides guidance on how to recognize changes in
the fair value of contingent consideration other
than measurement-period adjustments. Contingent
consideration classified as equity is not
remeasured, and its settlement is recognized in
equity. Contingent consideration classified as an
asset or liability is remeasured to fair value in
each reporting period, with changes in fair value
recognized in earnings, unless it qualifies for
recognition in other comprehensive income under
the hedge accounting guidance in ASC 815 (which
would be unusual).
Under ASC 805, the acquirer recognizes as revisions to goodwill those adjustments made during the measurement period that pertain to facts and circumstances that existed as of the acquisition date. The acquirer must consider all pertinent factors in determining whether information obtained after the acquisition date should result in an adjustment to the provisional amounts recognized or whether that information stems from events that occurred after the acquisition date. For example, if earnings targets are met, share prices change, or FDA approvals are obtained after the acquisition date, resulting changes in fair value are recognized in earnings and not as adjustments to goodwill.
2.7 Registration Payment Arrangements
ASC 480-10
15-8A The guidance in this Topic does not apply to the following instruments:
- Registration payment arrangements within the scope of Subtopic 825-20.
ASC Master Glossary
Registration Payment Arrangement
An arrangement with both of the following characteristics:
- It specifies that the issuer will endeavor to do either of the following:
- File a registration statement for the resale of specified financial instruments and/or for the resale of equity shares that are issuable upon exercise or conversion of specified financial instruments and for that registration statement to be declared effective by the U.S. Securities and Exchange Commission (SEC) (or other applicable securities regulator if the registration statement will be filed in a foreign jurisdiction) within a specified grace period
- Maintain the effectiveness of the registration statement for a specified period of time (or in perpetuity).
- It requires the issuer to transfer consideration to the counterparty if the registration statement for the resale of the financial instrument or instruments subject to the arrangement is not declared effective or if effectiveness of the registration statement is not maintained. That consideration may be payable in a lump sum or it may be payable periodically, and the form of the consideration may vary. For example, the consideration may be in the form of cash, equity instruments, or adjustments to the terms of the financial instrument or instruments that are subject to the registration payment arrangement (such as an increased interest rate on a debt instrument).
ASC 825-20
15-4 The guidance in this
Subtopic does not apply to any of the following:
- Arrangements that require registration or listing of convertible debt instruments or convertible preferred stock if the form of consideration that would be transferred to the counterparty is an adjustment to the conversion ratio. See Subtopic 470-20 on debt with conversion and other options or Subtopic 505-10 on equity for related guidance.
- Arrangements in which the amount of
consideration transferred is determined by reference
to either of the following:
- An observable market other than the market for the issuer’s stock
- An observable index.
For example, if the consideration to be transferred if the issuer is unable to obtain an effective registration statement is determined by reference to the price of a commodity. See Subtopic 815-15 for related guidance. - Arrangements in which the financial instrument or instruments subject to the arrangement are settled when the consideration is transferred (for example, a warrant that is contingently puttable if an effective registration statement for the resale of the equity shares that are issuable upon exercise of the warrant is not declared effective by the SEC within a specified grace period).
25-1 An entity shall recognize a registration payment arrangement as a separate unit of account from the financial instrument(s) subject to that arrangement.
25-2 The financial instrument(s) subject to the registration payment arrangement shall be recognized in accordance with other applicable generally accepted accounting principles (GAAP) (for example, Subtopics 815-10; 815-40; and 835-30) without regard to the contingent obligation to transfer consideration pursuant to the registration payment arrangement.
30-1 An entity shall measure a registration payment arrangement as a separate unit of account from the financial instrument(s) subject to that arrangement.
30-2 The financial instrument(s) subject to the registration payment arrangement shall be measured in accordance with other applicable generally accepted accounting principles (GAAP) (for example, Subtopics 815-10; 815-40; and 835-30) without regard to the contingent obligation to transfer consideration pursuant to the registration payment arrangement.
In connection with issuances of equity shares, convertible instruments, and equity-linked contracts, an issuer may agree to pay amounts if it is unable to deliver registered shares or maintain an effective registration. For example, a warrant or other equity-linked contract may require the issuer to:
- Use its “best efforts” to file a registration statement for the resale of shares and have the registration statement declared effective by the end of a specified grace period (e.g., within 90 to 180 days).
- Maintain the effectiveness of a registration statement for a specified period.
If the issuer fails to meet the conditions, the contract may require it to make cash payments to the counterparty unless or until a registration statement is declared effective. For example, the contract may require the entity to pay the investor 2 percent of the contract purchase price in each month after the end of a 180-day grace period during which there is no registration statement in effect covering the shares that will be delivered under the contract.
ASC 480 does not apply to registration payment arrangements within the scope of
ASC 825-20. Such arrangements are accounted for separately from any related
financial instrument (such as a share or contract on own equity) even if they are
included in the contractual terms of that instrument (see ASC 825-20-25-1 as well as
ASC 825-20-30-1 and 30-2).
ASC 825-20-15-4 implies that an arrangement does not qualify for the scope
exception in ASC 480 for registration payment arrangements if any of the following
criteria apply:
-
The form of consideration transferred is a contingently adjustable conversion ratio in a convertible instrument.
-
The payment is adjusted by reference to either an observable market other than the issuer’s stock (e.g., a commodity price) or an observable index.
-
The payment is made when the contract subject to the arrangement is settled (e.g., a payment that is made upon the exercise of an option on own stock that is subject to the arrangement).
Accordingly, provisions of the types contemplated in ASC 825-20-15-4 would be
considered in the analysis under ASC 480 of the financial instrument that contains
them.
2.8 Guarantee Obligations
ASC 480-10
55-23 An
entity’s guarantee of the value of an asset, liability, or
equity security of another entity may require or permit
settlement in the entity’s equity shares. For example, an
entity may guarantee that the value of a counterparty’s
equity investment in another entity will not fall below a
specified level. The guarantee contract requires that the
guarantor stand ready to issue a variable number of its
shares whose fair value equals the deficiency, if any, on a
specified date between the guaranteed value of the
investment and its current fair value. Upon issuance, unless
the guarantee is accounted for as a derivative instrument,
the obligation to stand ready to perform is a liability
addressed by Topic 460. If, during the period the contract
is outstanding, the fair value of the guaranteed investment
falls below the specified level, absent an increase in
value, the guarantor will be required to issue its equity
shares. At that point in time, the liability recognized in
accordance with that Topic would be subject to the
requirements of Topic 450. This Subtopic establishes that,
even though the loss contingency is settleable in equity
shares, the obligation under that Topic is a liability under
paragraph 480-10-25-14(b) until the guarantor settles the
obligation by issuing its shares. That is because the
guarantor’s conditional obligation to issue shares is based
on the value of the counterparty’s equity investment in
another entity and not on changes in the fair value of the
guarantor’s equity instruments.
A guarantee obligation within the scope of ASC 460 might be subject to the
guidance in ASC 480 if it requires or permits the guarantor to settle its obligation
in a variable number of its equity shares (e.g., the contract is a liability under
ASC 480-10-25-14(b); see Sections
6.1.3, 6.2.2, and 6.2.3). When assessing such a contract, an entity should consider
the guidance in both ASC 480 and ASC 460 (e.g., the disclosure requirements in ASC
460-10-50). For more information about guarantees, see Chapter 5 of Deloitte’s Roadmap Contingencies, Loss Recoveries, and Guarantees.