5.3 Accounting
The initial and subsequent accounting for a financial instrument
classified as an asset or a liability under ASC 480-10-25-8 depends on whether it is
a forward contract that requires physical settlement by repurchase of a fixed number
of equity shares in exchange for cash (including foreign currency).
5.3.1 Forward Contracts That Require Physical Settlement by Repurchase of a Fixed Number of Shares for Cash
5.3.1.1 Scope
Under ASC 480, unconditional forward purchase contracts that
require physical settlement by repurchase of a fixed number of the issuer’s
shares for cash are treated as treasury stock transactions that use borrowed
funds (i.e., debit to equity, credit to payable) rather than as derivatives
(see ASC 815-10-15-74(d)) or executory contracts. In other words, such
transactions are treated as if the repurchase has already occurred and the
payment for the shares has been financed with interest on the financing
arising from the difference between the spot price of the shares repurchased
and the ultimate settlement amount paid on the forward settlement date.
The special accounting for physically settled forward
contracts to repurchase shares applies irrespective of whether the amount of
cash the issuer will pay is fixed or variable (e.g., a stated amount of cash
plus interest at a variable interest rate). However, the accounting does not
apply to forward contracts that have settlement alternatives (e.g., the
holder or the issuer has the option to elect net cash settlement or net
share settlement). Further, the guidance does not apply to forward contracts
that require the issuer to transfer noncash assets (e.g., debt securities)
rather than cash to settle the contract. That is, the special accounting and
measurement guidance applies only if the obligation to purchase is
unconditional and requires physical settlement in exchange for cash. A
forward purchase contract that requires the delivery of noncash assets
(e.g., gold) in exchange for the issuer’s equity shares is considered to be
akin to a barter contract as opposed to a contract to repurchase equity
shares with borrowed funds. Therefore, it must be accounted for in the same
manner as conditional obligations to purchase the issuer’s equity shares
(i.e., at fair value, with changes in fair value reported in earnings).
Forward contracts that require physical settlement by
repurchase of a fixed number of the issuer’s shares for cash are outside the
scope of the derivative accounting literature under ASC 815-10-15-74(d) and
cannot be designated as derivative hedging instruments (see Section 2.3.1).
However, the scope exception does not apply to forward contracts that (1) do
not require physical settlement or (2) require physical settlement in
exchange for something other than cash.
5.3.1.2 Initial Measurement
ASC 480-10
30-3 Forward contracts that
require physical settlement by repurchase of a fixed
number of the issuer’s equity shares in exchange for
cash shall be measured initially at the fair value
of the shares at inception, adjusted for any
consideration or unstated rights or
privileges.
30-4 Two ways to obtain the
adjusted fair value include:
- Determining the amount of cash that would be paid under the conditions specified in the contract if the shares were repurchased immediately
- Discounting the settlement amount, at the rate implicit at inception after taking into account any consideration or unstated rights or privileges that may have affected the terms of the transaction.
30-5 Equity shall be reduced
by an amount equal to the fair value of the shares
at inception.
30-6 Cash (as that term is
used in paragraph 480-10-30-3) includes foreign
currency, so physically settled forward purchase
contracts in exchange for foreign currency shall be
measured as provided in paragraphs 480-10-30-3
through 30-5 and 480-10-35-3, then remeasured under
Topic 830.
Although ASC 480-10-30-3 specifies that a forward contract
that requires settlement by repurchase of a fixed number of shares for cash
should initially be measured at the “fair value of the shares at inception,
adjusted for any consideration or unstated rights or privileges,” ASC
480-10-30-4 permits an entity to use the following approaches in determining
that amount:
- The “amount of cash that would be paid under the conditions specified in the contract if the shares were repurchased immediately.” This amount is not discounted. In a manner consistent with the guidance on subsequent measurement in ASC 480-10-35-3(b), this method may be suitable when either the amount to be paid or the settlement date varies.
- The present value of “the settlement amount [discounted] at the rate implicit at inception.” In a manner consistent with the guidance on subsequent measurement in ASC 480-10-35-3(a), this method may be suitable when the amount to be paid and the settlement date are both fixed.
Regardless of the approach used, the entity should consider the need to adjust the accounting for the forward contract to reflect any consideration (e.g., if either party made an up-front cash payment) or unstated (or stated) rights or privileges that may have affected the terms of the transaction (e.g., off-market terms). Unlike ASC 480-10-30-3 and 30-4(b), ASC 480-10-30-4(a) does not specifically mention the need for such an adjustment when the initial measurement is determined on the basis of the amount of cash that would be paid under the conditions specified in the contract if the shares were repurchased immediately. However, in paragraph B61 of the Background Information and Basis for Conclusions of FASB Statement 150, the Board suggests that, in such a scenario, an entity also
should adjust the accounting “for any consideration or unstated rights or
privileges.”
The requirement in ASC 480-10-30 to adjust the initial
measurement to reflect any consideration or unstated rights or privileges is
analogous to the requirement in ASC 835-30-25-6 to separately recognize any
unstated (or stated) rights or privileges upon the issuance of a note (e.g.,
when an entity lends cash at no interest in exchange for a contract to
purchase products at a below-market price, the difference between the amount
of cash lent and the present value of the receivable may represent an
addition to the cost of the products purchased).
The issuer recognizes the forward by crediting liabilities
and debiting equity for the amount of the initial measurement. (If the
forward is over the shares of a consolidated subsidiary, the noncontrolling
interest would be debited.) In effect, the forward is accounted for as if
two transactions had occurred: (1) a spot repurchase of the shares that will
be repurchased under the contract and (2) the issuance of debt for the
obligation to pay the share repurchase price on the forward settlement
date.
Connecting the Dots
The Inflation Reduction Act of 2022, which was signed into law on
August 16, 2022, imposes a 1 percent excise tax on stock repurchases
that occur after December 31, 2022, by publicly traded companies.
Specifically, a covered corporation would be subject to a tax equal
to 1 percent of (1) the fair market value of any of its stock that
it (or certain affiliates) repurchased during any taxable year, with
limited exceptions, minus (2) the fair market value of any of its
stock that it (or certain affiliates) issued during the taxable year
(including compensatory stock issuances). The 1 percent excise tax
would also be imposed on acquisitions of stock in certain mergers or
acquisitions involving covered corporations.
Because the excise tax is not based on a measure of
income, it is not an income tax and thus is outside the scope of ASC
740. While the accounting for taxes paid in connection with the
repurchase of stock is not specifically addressed in U.S. GAAP,
entities may consider the guidance in AICPA Technical Q&As
Section 4110.09, which indicates that direct and incremental legal
and accounting costs associated with the acquisition of treasury
stock may be added to the cost of the treasury stock. Therefore, it
is acceptable for an entity to account for an excise tax obligation
that results from the repurchase of common stock classified within
permanent equity as a cost of the treasury stock transaction.
Any reductions in such excise tax obligation arising from share
issuances would also be recognized as part of the original treasury
stock transaction regardless of the nature of the share issuances.
Additional considerations are necessary when redemptions of
preferred stock result in an excise tax obligation, which would be
recognized as a cost of redeeming the preferred stock. The
accounting for redemptions of preferred stock differs depending on
the classification of the preferred stock as permanent equity,
temporary equity, or a liability. An entity that has repurchased
both common stock and preferred stock during a taxable period would
need to use a systematic and rational allocation approach to account
for the effect of share issuances on the excise tax obligation.
For more information about the stock repurchase tax under the
Inflation Reduction Act of 2022, see Deloitte’s April 27, 2023,
Heads Up.
5.3.1.3 Subsequent Measurement
ASC 480-10
35-3 Forward contracts that
require physical settlement by repurchase of a fixed
number of the issuer’s equity shares in exchange for
cash and mandatorily redeemable financial
instruments shall be measured subsequently in either
of the following ways:
- If both the amount to be paid and the settlement date are fixed, those instruments shall be measured subsequently at the present value of the amount to be paid at settlement, accruing interest cost using the rate implicit at inception.
- If either the amount to be paid or the settlement date varies based on specified conditions, those instruments shall be measured subsequently at the amount of cash that would be paid under the conditions specified in the contract if settlement occurred at the reporting date, recognizing the resulting change in that amount from the previous reporting date as interest cost.
35-4 Cash (as that term is
used in the preceding paragraph) includes foreign
currency, so physically settled forward purchase
contracts in exchange for foreign currency shall be
measured as provided in the preceding paragraph then
remeasured under Topic 830.
The subsequent measurement
guidance that applies to forward contracts that require physical settlement
by repurchase of a fixed number of the issuer’s equity shares in exchange
for cash is similar to the guidance applicable to mandatorily redeemable
financial instruments (see Section 4.3). Thus, the “debt” component of such a forward
contract is measured subsequently in one of two ways depending on whether
the repurchase amount or the repurchase date varies on the basis of
specified conditions:
|
Repurchase Amount
|
Repurchase Date
|
Subsequent Measurement
|
|---|---|---|
Fixed | Fixed | Present value of the amount to be paid at
settlement discounted by using the implicit rate at
inception (i.e., effective interest
method) |
Fixed Varies Varies | Varies Fixed Varies | Amount of cash that would be paid under the
conditions specified in the contract if settlement
occurred as of the reporting date (settlement
value) |
5.3.1.3.1 Fixed Date and Fixed Amount
If the repurchase date and the repurchase amount are
both fixed, the instrument is subsequently measured at the present value
of the amount to be paid at settlement, discounted by using the implicit
rate at inception. The implicit rate is calculated by using the
effective interest method (i.e., the rate that makes the present value
of the instrument’s cash flows equal to the initial measurement
amount).
5.3.1.3.2 Variable Date or Redemption Amount
If either the repurchase date or the repurchase amount
or both vary, the instrument is subsequently measured at the amount of
cash that would be paid under the conditions specified in the contract
if settlement occurred as of the reporting date. Under this method, the
amount to be paid is not discounted. Examples of instruments with a
varying redemption amount include those for which the repurchase amount
is based on the issuer’s stock price or a formula (e.g., one that
depends on the issuer’s most recent financial year’s EBIT or EBITDA). An
example of an instrument for which the redemption date varies includes
one that will be settled upon the occurrence of an event that is certain
to occur but whose timing is uncertain.
In estimating the amount of cash that would be paid
under the conditions specified in the contract if settlement occurred as
of the reporting date, an issuer should not incorporate projected
changes in the factors that affect a variable repurchase price (e.g.,
forward projections of EBITDA if the repurchase price is a function of
EBITDA). Instead, the issuer should calculate the repurchase amount on
the basis of the conditions that exist as of the balance sheet date
(e.g., the most recent EBITDA measure if the repurchase price is a
function of EBITDA). This view is consistent with the guidance that
applies to redeemable equity securities classified in temporary equity
under ASC 480-10-S99-3A (see Section 9.5.2). Paragraph 14 of
ASC 480-10-S99-3A states, in part:
If the maximum redemption amount is contingent
on an index or other similar variable (for example, the fair
value of the equity instrument at the redemption date or a
measure based on historical EBITDA), the amount presented in
temporary equity should be calculated based on the conditions
that exist as of the balance sheet date (for example, the
current fair value of the equity instrument or the most recent
EBITDA measure).
If the repurchase amount varies (e.g., as a function of
EBITDA), an entity should not reduce the carrying amount of the
liability below the initially recorded amount, because ASC 480-10-45-3
implies that the amount of reported interest cost cannot be less than
zero on a cumulative basis from the date of initial recognition. This is
consistent with the view that an entity cannot recognize interest income
on a liability as well as with the guidance that applies to redeemable
securities classified in temporary equity under ASC 480-10-S99-3A (see
Section
9.5.2). Paragraph 16(e) of ASC 480-10-S99-3A states, in
part:
[T]he amount presented in temporary equity
should be no less than the initial amount reported in temporary
equity for the instrument. That is, reductions in the carrying
amount of a redeemable equity instrument . . . are appropriate
only to the extent that the registrant has previously recorded
increases in the carrying amount of the redeemable equity
instrument.
If the instrument is redeemed for an amount less than
its net carrying amount, the issuer recognizes the difference as an
extinguishment gain.
5.3.1.3.3 Interest Cost
ASC 480-10
45-3 Any amounts paid or to
be paid to holders of the contracts discussed in
paragraph 480-10-35-3 in excess of the initial
measurement amount shall be reflected in interest
cost.
After the execution of a forward contract that requires
physical settlement by repurchase of a fixed number of the issuer’s
equity shares in exchange for cash, changes in the contract’s carrying
amount and any amounts paid to the holder in excess of the initial
measurement amount must be presented as interest cost.
5.3.1.4 Example
ASC 480-10
55-14 For example, an entity
may enter into a forward contract to repurchase 1
million shares of its common stock from another
party 2 years later. At inception, the forward
contract price per share is $30, and the current
price of the underlying shares is $25. The
contract’s terms require that the entity pay cash to
repurchase the shares (the entity is obligated to
transfer $30 million in 2 years). Because the
instrument embodies an unconditional obligation to
transfer assets, it is a liability under paragraphs
480-10-25-8 through 25-12. The entity would
recognize a liability and reduce equity by $25
million (which is the present value, at the 9.54
percent rate implicit in the contract, of the $30
million contract amount, and also, in this example,
the fair value of the underlying shares at
inception). Interest would be accrued over the
2-year period to the forward contract amount of $30
million, using the 9.54 percent rate implicit in the
contract. If the underlying shares are expected to
pay dividends before the repurchase date and that
fact is reflected in the rate implicit in the
contract, the present value of the liability and
subsequent accrual to the contract amount would
reflect that implicit rate. Amounts accrued are
recognized as interest cost.
55-15 In this example, no
consideration or other rights or privileges changed
hands at inception. If the same contract price of
$30 per share had been agreed to even though the
current price of the issuer’s shares was $30,
because the issuer had simultaneously sold the
counterparty a product at a $5 million discount,
that right or privilege unstated in the forward
purchase contract would be taken into consideration
in arriving at the appropriate implied discount rate
— 9.54 percent rather than 0 percent — for that
contract. That entity would recognize a liability
for $25 million, reduce equity by $30 million, and
increase its revenue for the sale of the product by
$5 million. Alternatively, if the same contract
price of $30 per share had been agreed to even
though the current price of the issuer’s shares was
only $20, because the issuer received a $5 million
payment at inception of the contract, the issuer
would recognize a liability for $25 million and
reduce equity by $20 million. In both examples,
interest would be accrued over the 2-year period
using the 9.54 percent implicit rate, increasing the
liability to the $30 million contract
price.
55-16 If a variable-rate
forward contract requires physical settlement, a
different measurement method is required
subsequently, as set forth in paragraph
480-10-35-3.
The three related examples in ASC 480-10-55-14 and 55-15
illustrate the accounting for physically settled forward purchase contracts
that require the repurchase of a fixed number of equity shares for cash. In
each of the examples, the issuer is obligated to repurchase equity shares in
exchange for cash of $30 million in two years. Further, the initial amount
of the liability recognized is the same in the examples ($25 million).
However, the fair value of the shares at inception differs and, in two of
the examples, consideration or other rights or privileges are exchanged.
In the example in ASC
480-10-55-14, no consideration or other rights or privileges are exchanged
at the inception of the contract, and the fair value of the shares at
inception is $25 million. Under ASC 480-10-30-3, the liability is initially
recognized at an amount equal to fair value of the shares at inception ($25
million). In accordance with ASC 480-10-30-5, the offsetting entry is to
equity. Accordingly, the accounting entries at inception are (in
millions):
In the two examples in ASC 480-10-55-15, consideration or
other unstated rights or privileges are exchanged at inception:
- In the first example in ASC 480-10-55-15, the fair value of the shares at inception is $30 million. The repurchase price in two years is also $30 million, which is favorable to the issuer. To compensate the counterparty, the issuer provides a sales discount of $5 million to the counterparty at the same time as the issuance of the forward contract. In accordance with ASC 480-10-30-3, the liability is initially recognized at $25 million, which is the fair value of the shares at inception ($30 million) adjusted for the value of the sales discount ($5 million). Under ASC 480-10-30-5, the offsetting entry reduces equity. The value of the sales discount represents consideration paid for the off-market element of the contract to repurchase equity shares and reduces equity by another $5 million, with an offsetting entry to sales revenue. Thus, the accounting entries at inception are (in millions):
- In the second example in ASC 480-10-55-15, the fair value of the shares at inception is $20 million. The repurchase price in two years is $30 million, which is unfavorable to the issuer. To compensate the issuer, the counterparty pays $5 million at the inception of the forward contract. In accordance with ASC 480-10-30-3, the liability is initially recognized at an amount equal to the fair value of the shares at inception ($20 million), adjusted for the cash payment received ($5 million). The initial measurement of the liability is therefore $25 million. Under ASC 480-10-30-5, the offsetting entry is to equity. The up-front cash payment of $5 million is consideration received from the counterparty for the off-market element of the contract to repurchase equity shares and increases cash and equity by $5 million. Therefore, the accounting entries at inception are as follows (in millions):While not discussed in ASC 480-10-55-14 and 55-15, the implicit rate used to calculate interest cost over the life of the instrument in each of the three examples is determined by solving for the interest rate that equates the present value of $30 million in two years to the initial measurement amount of $25 million. If annual compounding is used, this rate is approximately 9.545 percent. In year one, the issuer records interest cost of $2.386 million by increasing the carrying amount of the liability to $27.386 million. In year two, the issuer records interest cost of $2.614 million by increasing the carrying amount to $30 million, which equals the settlement amount to be paid in cash at that time.
5.3.2 Other Contracts
ASC
480-10
30-7 All other financial
instruments recognized under the guidance in Section
480-10-25 shall be measured initially at fair
value.
35-1 Financial instruments
within the scope of Topic 815 shall be measured
subsequently as required by the provisions of that
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.
35-5 All other financial
instruments recognized under the guidance in Section
480-10-25 shall be measured subsequently at fair value
with changes in fair value recognized in earnings,
unless either this Subtopic or another Subtopic
specifies another measurement attribute.
55-17 In contrast to forward
purchase contracts that require physical settlement in
exchange for cash, forward purchase contracts that
require or permit net cash settlement, require or permit
net share settlement, or require physical settlement in
exchange for specified quantities of assets other than
cash are measured initially and subsequently at fair
value, as provided in paragraphs 480-10-30-2,
480-10-30-7, 480-10-35-1, and 480-10- 35-5 (as
applicable), and classified as assets or liabilities
depending on the fair value of the contracts on the
reporting date.
Except for forward contracts that require the issuer to
repurchase a fixed number of shares for cash, contracts that are classified as
assets or liabilities under ASC 480-10-25-8 are measured initially and
subsequently at their fair value (i.e., they are accounted for in a manner
similar to derivatives under ASC 815). For example, this measurement applies
to:
-
Net-cash-settled forward purchase contracts on own stock.
-
Forward purchase contracts on own stock that permit the counterparty to elect either net cash settlement or net share settlement.
-
Forward contracts that require or may require the repurchase of a variable number of equity shares for cash.
-
Forward contracts that require or may require the repurchase of equity shares for noncash assets.
-
Written put options on own equity shares that require or may require the repurchase of equity shares by the transfer of assets.
-
Written warrants or call options on own equity shares that require or may require the repurchase of the warrants or options by the transfer of assets.
-
Written warrants or call options on equity shares that require or may require the repurchase of the equity shares that would be delivered upon the exercise of the warrant or option by the transfer of assets.