Chapter 6 — Certain Variable-Share Obligations

6.1 Classification

6.1.1 Overview

ASC 480-10

25-14 A financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares shall be classified as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominantly on any one of the following:

A fixed monetary amount known at inception (for example, a payable settleable with a variable number of the issuer’s equity shares)
Variations in something other than the fair value of the issuer’s equity shares (for example, a financial instrument indexed to the Standard and Poor’s S&P 500 Index and settleable with a variable number of the issuer’s equity shares)
Variations inversely related to changes in the fair value of the issuer’s equity shares (for example, a written put option that could be net share settled).

See paragraph 480-10-55-21 for related implementation guidance.

In certain circumstances, ASC 480 requires an issuer to classify share-settled obligations as assets or liabilities even if the issuer is not required to deliver cash or other assets. ASC 480-10-25-14 applies to a financial instrument with all of the following characteristics:

It embodies an obligation (see Section 6.1.1.1). If the instrument is an outstanding share, the obligation must be unconditional. For other instruments, the obligation may be either conditional or unconditional.
It requires or may require the issuer to settle the obligation by delivering a variable number of its equity shares (see Section 6.1.1.2).
The monetary value of the obligation is based solely or predominantly on one of three specified factors (see Sections 6.1.1.3, 6.1.2, 6.1.3, and 6.1.4).

If a financial instrument embodies an obligation that the entity must or may settle by delivering its own equity shares, the issuer should evaluate whether the instrument must be classified as an asset or a liability under ASC 480-10-25-14.

6.1.1.1 Obligation

Like other requirements in ASC 480, ASC 480-10-25-14 applies only to instruments that embody obligations of the issuer (see Section 2.2.1).

For outstanding shares (e.g., convertible preferred stock), that guidance is limited to obligations that are unconditional and for which the delivery of a variable number of equity shares is certain to occur (e.g., mandatory conversion of preferred shares into a variable number of common shares). If an outstanding share conditionally requires the issuer to deliver a variable number of shares (e.g., upon an IPO, a change of control, or the holder’s exercise of an embedded put option), ASC 480-10-25-14 does not apply.

For financial instruments other than an outstanding share (e.g., net-share-settled written put options and forward contracts), ASC 480-10-25-14 applies irrespective of whether the obligation is unconditional or conditional (e.g., contingent on the counterparty's exercise of an option). The issuer's purchased put or call option on the issuer’s equity shares would not be within the scope of ASC 480, however, because it does not embody an obligation of the issuer.

6.1.1.2 Requires or May Require the Transfer of a Variable Number of Equity Shares

Certain obligations to deliver equity shares must be classified as liabilities under ASC 480-10-25-14 (see Section 2.2.1.1). The FASB developed this requirement because it was concerned that some share-settled obligations have risks and benefits that are dissimilar from ownership interests.

Example 6-1

Variable-Share-Settled Obligation

An instrument embodies an obligation that the issuer must or may settle in its own equity shares. The terms of the instrument specify that the number of shares that will be delivered is variable and that the shares will have an aggregate settlement-date fair value equal to the monetary amount of the obligation. The monetary amount of the obligation might be fixed (e.g., $10,000), indexed (e.g., $10,000 adjusted for changes in the price of gold), or move inversely with changes in the entity’s stock price (e.g., when the stock price increases, the monetary amount of the obligation decreases). Accordingly, although the issuer uses its own equity shares to settle the obligation, the risks and benefits associated with holding the obligation are dissimilar from those associated with holding equity shares. Effectively, the issuer is using its own shares as a means of payment (currency) to settle an obligation whose risks and characteristics are different from those of equity shares.

ASC 480-10-25-14 only applies to contracts that may require the issuance of a variable number of shares. It does not apply to contracts that require the issuance of a fixed number of shares.

Example 6-2

Fixed-Share-Settled Obligation

Under a range forward sales contract, an issuer agrees to sell a fixed number of its own shares in exchange for cash. The cash price is defined as the current stock price subject to a cap ($80) and a floor ($60). Accordingly, the issuer’s economic payoff profile is similar to the purchase of a put option (the floor) and the sale of a call option (the cap) on its own stock. The contract would be outside the scope of ASC 480 because it is not a mandatorily redeemable financial instrument, it does not embody an obligation to repurchase shares by transferring assets (it is selling shares), and it requires the issuance of a fixed number of shares for a variable amount of cash. Instead, the contract should be evaluated under ASC 815-40; see Deloitte’s Roadmap Contracts on an Entity’s Own Equity. (Note, however, that if the issuer instead was obligated to deliver a variable number of shares subject to a cap and a floor, the contract potentially would be within the scope of ASC 480. See Section 6.2.4.)

ASC 480-10-25-14 does not apply to obligations that require or may require the issuer to deliver cash or other assets. Such obligations are instead evaluated under ASC 480-10-25-4 and ASC 480-10-25-8 (see Chapters 4 and 5). Obligations that the issuer is permitted to settle either in cash or a variable number of shares, however, should be assessed under ASC 480-10-25-14 (see Section 6.2.6).

6.1.1.3 Monetary Value

ASC 480-10

05-4 For certain financial instruments, Section 480-10-25 requires consideration of whether monetary value would remain fixed or would vary in response to changes in market conditions.

05-5 How the monetary value of a financial instrument varies in response to changes in market conditions depends on the nature of the arrangement, including, in part, the form of settlement.

In determining whether a financial instrument that embodies a share-settled obligation must be accounted for as an asset or a liability, an issuer is required under ASC 480-10-25-14 to evaluate the monetary value of the obligation. That value is defined in ASC 480-10-20 by reference to the fair value of the shares or other items the issuer is required to deliver on the settlement date of the instrument. The notion of monetary value can be helpful in an entity’s assessment of whether there are similarities between (1) the risks or benefits from changes in the fair value of the issuer’s equity shares that a holder of a financial instrument is exposed to and (2) those that a holder of outstanding shares is exposed to.

Under ASC 480-10-25-14, a share-settled obligation (which must be unconditional if the instrument is an outstanding share but otherwise could be either conditional or unconditional) is classified as an asset or a liability if, at inception, the obligation’s monetary value is based solely or predominantly on one of three factors:

A fixed monetary amount known at inception (see Section 6.1.2).
Variations in something other than the fair value of the issuer’s equity shares (see Section 6.1.3).
Variations inversely related to changes in the fair value of the issuer’s equity shares (see Section 6.1.4).

ASC 480-10-25-14 applies not just to obligations whose monetary value is based solely on one of the three factors identified in that paragraph but also to those whose monetary value is based predominantly on one of them. Otherwise, an entity might structure transactions to circumvent the recognition of a liability for an obligation. For example, an issuer is not able to avoid liability classification by “embedding a small amount of monetary value variation in response to changes in the fair value of the issuer’s equity shares [if] the overall variation would predominantly respond to something else” (see paragraph B47 of the Background Information and Basis for Conclusions of FASB Statement 150).

ASC 480 does not define “predominantly.” Therefore, an entity will need to use judgment in assessing predominance and should consider, for example, whether the instrument embodies a single, dual-indexed obligation (see Section 6.2.3) or multiple-component obligations (see Section 6.2.4).

A share-settled obligation may have multiple possible outcomes, and some (but not all) of those outcomes may have a monetary value that is determined on the basis of one of the three factors in ASC 480-10-25-14. In practice, we have considered an outcome to be predominant if it is more likely than not (i.e., greater than 50 percent) to occur. Accordingly, if an outcome is reasonably possible, but not more likely than not, to occur, it is not predominant.

The following table provides some examples of contracts that would be accounted for as assets or liabilities because they require or may require the issuer to deliver a variable number of equity shares and have a monetary value that is based solely or predominantly on one of the factors in ASC 480-10-25-14:

Fixed monetary value (see Section 6.1.2)	Share-settled debt (e.g., an obligation to pay a supplier for goods or services that will be settled in a variable number of the issuer’s equity shares worth a fixed monetary amount) A preferred equity security that is mandatorily convertible into a variable number of common shares worth a fixed monetary amount A prepaid variable share forward on the entity’s stock that obligates the entity to deliver shares with a monetary value that is predominantly a fixed monetary amount known at inception A puttable warrant that gives the counterparty the right to either (1) purchase a fixed number of the issuer’s equity shares for cash or (2) require the issuer to repurchase the warrant for a specified fixed monetary amount payable in a variable number of shares A prepaid forward sale contract on a variable number of shares worth a fixed monetary amount
Monetary value based on something other than stock price (see Section 6.1.3)	A contract to issue a variable number of shares equal in value to 20 ounces of gold A contract to issue a variable number of shares equal in value to $10,000, adjusted for changes in the S&P 500 index
Monetary value moves inversely with stock price (see Section 6.1.4)	A net-share-settled forward contract to purchase the issuer’s equity shares at a fixed forward price A net-share-settled written put option on the issuer’s equity shares with a fixed strike price

Examples of contracts that would not be accounted for as assets or liabilities under ASC 480-10-25-14 because their monetary value moves directly with the fair value of the issuer’s equity shares include:

Fixed-for-fixed net-share-settled forward contracts to sell the issuer’s equity shares.
Fixed-for-fixed net-share-settled written call options on the issuer’s equity shares.

ASC 480-10

55-2 Paragraph 480-10-05-5 explains that how the monetary value of a financial instrument varies in response to changes in market conditions depends on the nature of the arrangement, including, in part, the form of settlement. For example, for a financial instrument that embodies an obligation that requires:

Settlement either by transfer of $100,000 in cash or by issuance of $100,000 worth of equity shares, the monetary value is fixed at $100,000, even if the share price changes.
Physical settlement by transfer of $100,000 in cash in exchange for the issuer’s equity shares, the monetary value is fixed at $100,000, even if the fair value of the equity shares changes.
Net share settlement by issuance of a variable number of shares based on the change in the fair value of a fixed number of the issuer’s equity shares, the monetary value varies based on the number of shares required to be issued to satisfy the obligation. For example, if the exercise price of a net-share-settled written put option entitling the holder to put back 10,000 of the issuer’s equity shares is $11, and the fair value of the issuing entity’s equity shares on the exercise date decreases from $13 to $10, that change in fair value of the issuer’s shares increases the monetary value of that obligation at settlement from $0 to $10,000 ($110,000 minus $100,000), and the option would be settled by issuance of 1,000 shares ($10,000 divided by $10).
Net cash settlement based on the change in the fair value of a fixed number of the issuer’s equity shares, the monetary value varies in the same manner as in (c) for net share settlement, but the obligation is settled with cash. In a net-cash-settled variation of the previous example, the option would be settled by delivery of $10,000.
Settlement by issuance of a variable number of shares that is based on variations in something other than the issuer’s equity shares, the monetary value varies based on changes in the price of another variable. For example, a net-share-settled obligation to deliver the number of shares equal in value at settlement to the change in fair value of 100 ounces of gold has a monetary value that varies based on the price of gold and not on the price of the issuer’s equity shares.

55-51 Some financial instruments that are composed of more than one option or forward contract embody an obligation to issue a fixed number of shares and, once those shares are issued, potentially to issue a variable number of additional shares. The issuer must analyze that kind of financial instrument, at inception, to assess whether the possibility of issuing a variable number of shares in which the monetary value of that obligation meets one of the conditions in paragraph 480-10-25-14 is predominant.

ASC 480-10-55-2 illustrates how the monetary value of various financial instruments may be defined:

The financial instruments in ASC 480-10-55-2(a) and (b) represent obligations for a fixed monetary amount.
The financial instruments in ASC 480-10-55-2(c) and (d) have a monetary value that is based on the issuer’s equity shares.
The financial instrument in ASC 480-10-55-2(e) has a monetary value that is based on a variable other than the issuer’s stock price (e.g., the price of gold).

6.1.2 Fixed Monetary Amount Known at Inception

ASC 480-10

a. A fixed monetary amount known at inception (for example, a payable settleable with a variable number of the issuer’s equity shares). . . .

55-22 Certain financial instruments embody obligations that require (or permit at the issuer’s discretion) settlement by issuance of a variable number of the issuer’s equity shares that have a value equal to a fixed monetary amount. For example, an entity may receive $100,000 in exchange for a promise to issue a sufficient number of its own shares to be worth $110,000 at a future date. The number of shares required to be issued to settle that unconditional obligation is variable, because that number will be determined by the fair value of the issuer’s equity shares on the date of settlement. Regardless of the fair value of the shares on the date of settlement, the holder will receive a fixed monetary value of $110,000. Therefore, the instrument is classified as a liability under paragraph 480-10-25-14(a). . . .

The first of the three categories of instruments that are classified as assets or liabilities under ASC 480-10-25-14 consists of those instruments that embody obligations that the issuer must or may satisfy by delivering a variable number of shares that have a monetary value that is fixed or predominantly fixed. For such instruments, the number of shares delivered is determined on the basis of (1) the fixed monetary amount and (2) the current stock price at settlement, so that the aggregate fair value of the shares delivered equals the monetary value of the obligation. Accordingly, the holder is not significantly exposed to gains and losses attributable to changes in the fair value of the issuer’s equity shares. Instead, the issuer is using its own equity shares as currency to settle a monetary obligation. Even though it will be settled in equity shares, this type of instrument must be classified as a liability because it does not establish an ownership relationship (i.e., the holder’s return is fixed).

Example 6-3

Variable-Share-Settled Obligation — Fixed Monetary Amount

The terms of a contract specify that the number of shares to be delivered will have an aggregate settlement-date fair value of $10,000 (i.e., the number of shares is defined as $10,000 divided by the current stock price). Although the number of equity shares to be delivered depends on the entity’s stock price, the aggregate value of those shares does not depend on the stock price but represents a fixed monetary amount known at inception. If the stock price is $20 at settlement, the entity would deliver 500 shares. If the share price is $10, the entity would deliver 1,000 shares. In both cases, the value of the shares delivered equals $10,000.

A share is classified as a liability if it embodies an obligation that the issuer must or may satisfy by delivering a variable number of shares that have a monetary value that is fixed or predominantly fixed and the obligation is unconditional. Under this guidance, preferred stock is classified as a liability if it is mandatorily convertible into a variable number of common shares worth a fixed monetary amount on a specified date. ASC 480 does not apply if a share embodies a conditional obligation to deliver a variable number of shares (e.g., preferred stock that is mandatorily converted into a variable number of shares worth a fixed monetary amount upon an event that is not certain to occur, such as an IPO or the holder’s exercise of a put option).

Instruments other than outstanding shares that embody an obligation that the issuer must or may satisfy by delivering a variable number of shares that have a monetary value that is fixed or predominantly fixed are classified as an asset or a liability irrespective of whether the obligation is conditional or unconditional.

Examples of obligations that are required to be classified as liabilities under ASC 480-10-25-14(a) include:

Share-settled debt (i.e., a share-settled obligation that is not in the legal form of debt but has the same economic payoff profile as debt, such as an unconditional obligation to deliver a variable number of common shares worth a fixed monetary amount upon settlement of a preferred share).
Preferred shares that are mandatorily convertible into a variable number of common shares equal in value to a fixed monetary amount. (However, the requirement does not apply to preferred shares that are optionally convertible, because outstanding shares that embody conditional obligations are exempt.)
Warrants that upon exercise would be settled in a variable number of equity shares worth a fixed monetary amount.
Mandatorily redeemable preferred shares that are contingently convertible into a variable number of shares worth a fixed monetary amount.

Some instruments permit multiple settlement methods that are triggered by predefined conditions. If only one of those methods requires the issuer to settle its obligation by issuing a variable number of shares equal in value to a fixed monetary amount known at inception, a question arises regarding whether the obligation’s monetary value is based predominantly on a fixed monetary amount known at inception. A variable-share forward (VSF) contract that involves the issuance of the entity’s common stock is one example of this type of instrument. A VSF has different outcomes depending on the price of the issuer’s common stock as of the date the forward contract settles. If the stock price is within a specified range, the issuer will deliver a variable number of shares equivalent to a fixed monetary amount known at inception (the “dead zone”). This type of VSF contract should be classified as a liability if it is more likely than not that the VSF will settle within the range in which the company will issue a variable number of shares equal to a fixed monetary amount. An entity assesses this likelihood at inception of the contract (see Section 6.2.4).

6.1.3 Amount Indexed to Something Other Than Own Equity

ASC 480-10

b. Variations in something other than the fair value of the issuer’s equity shares (for example, a financial instrument indexed to the Standard and Poor’s S&P 500 Index and settleable with a variable number of the issuer’s equity shares) . . . .

The second of the three categories of instruments that are classified as assets or liabilities under ASC 480-10-25-14 consists of those instruments that require the issuer to deliver a variable number of shares that have a monetary value that is based solely or predominantly on variations in something other than the fair value of the issuer’s equity shares. For instance, the amount may be calculated on the basis of changes in a stock market index (e.g., the S&P 500) or changes in a commodity price (e.g., the price of a specified quantity of gold). For such instruments, the number of shares delivered is determined on the basis of (1) the monetary value of the obligation and (2) the current stock price at settlement, so that the aggregate fair value of the shares delivered equals or approximates the monetary value of the obligation.

A share that embodies such an obligation is classified as a liability if the obligation is unconditional and the issuer must or may settle it in equity shares. Under this guidance, preferred stock that is mandatorily convertible into a variable number of common shares that have a monetary value that is based solely or predominantly on variations in something other than the fair value of the issuer’s equity shares is classified as a liability. If a share embodies a conditional obligation to deliver a variable number of shares upon an event that is not certain to occur, such as an IPO or the holder’s exercise of a put option, ASC 480 does not apply. However, the instrument may contain an embedded derivative that must be accounted for separately under ASC 815-15-25-1.

A contract other than shares that embody such an obligation is classified as an asset or a liability if the issuer must or may settle it in equity shares irrespective of whether the obligation is conditional or unconditional. For instance, certain contingent consideration arrangements in business combinations may fall within the scope of this requirement.

Examples of obligations that are required to be classified as liabilities under ASC 480-10-25-14(b) include:

Preferred equity securities that are mandatorily convertible into a variable number of shares equal in value to the face value of the preferred stock adjusted for changes in the price of crude oil.
Written call options on a fixed quantity of gold at a fixed strike price if the options are required to be settled in a variable number of the issuer’s equity shares whose fair value at settlement is equal to the fair value of the options.
Certain share-settled guarantee obligations (see Section 6.2.2).

6.1.4 Amount Inversely Related to Own Equity

ASC 480-10

c. Variations inversely related to changes in the fair value of the issuer’s equity shares (for example, a written put option that could be net share settled). . . .

55-26 A freestanding forward purchase contract, a freestanding written put option, or a net written option (otherwise similar to the example in paragraphs 480-10-55-18 through 55-19) that must or may be net share settled is a liability under paragraph 480-10-25-14(c), because the monetary value of the obligation to deliver a variable number of shares embodied in the contract varies inversely in relation to changes in the fair value of the issuer’s equity shares; when the issuer’s share price decreases, the issuer’s obligation under those contracts increases. Such a contract is measured initially and subsequently at fair value (with changes in fair value recognized in earnings) and classified as a liability or an asset, depending on the fair value of the contract on the reporting date. . . .

The monetary value of certain share-settled obligations is inversely proportional to changes in the price of the entity’s equity shares. The number of shares to be delivered is determined on the basis of (1) the monetary value of the obligation and (2) the current stock price at settlement, so that the aggregate fair value of the shares delivered equals or approximates the monetary value of the obligation. As the entity’s stock price increases, the aggregate fair value of the equity shares to be delivered at settlement decreases and, conversely, as the entity’s stock price decreases, the aggregate fair value of the equity shares to be delivered at settlement increases. Accordingly, the counterparty’s exposure to the value of the entity’s equity shares is the inverse of that of a holder of the entity’s equity shares. Because the interests of the holders of these types of instruments are antithetical to those of the holders of the issuer’s equity shares, the issuer’s obligations under these instruments cannot be considered equity interests; therefore, they must be classified as liabilities (or as assets in some circumstances).

An outstanding share that embodies such an obligation is classified as a liability if the obligation is unconditional. One example is a preferred equity security that is mandatorily convertible into a variable number of common shares equal in value to an amount that declines as the price of the issuing entity’s common shares increases. An instrument other than an outstanding share that embodies such an obligation is classified as an asset or a liability irrespective of whether the obligation is conditional or unconditional. Examples include forward purchase contracts, written put options, and net written (or purchased or zero-cost) options or collars that require or permit net share settlement.

The monetary value of a net-share-settled fixed-for-fixed written call option or forward sale contract on the issuer’s equity shares moves directly with the price of the issuer’s equity shares. Similarly, a net-share-settled written call option or forward sale contract on the issuer’s equity shares that includes a standard-dilution adjustment intended to neutralize the impact on the fair value of the contract of dilutive events involving the issuer’s equity shares would have a monetary value that moves directly with the price of the issuer’s equity shares. Therefore, the counterparty in such contracts does not have an exposure to the value of the entity’s equity shares that is inverse to that of a holder of the entity’s equity shares. Accordingly, the contracts do not fall within the scope of the guidance in ASC 480-10-25-14(c) even though their settlement might require the issuer to deliver a variable number of equity shares.

ASC 480-10-25-14(c) only applies to instruments that embody obligations of the issuer. Therefore, it does not apply to the following types of contracts even if their monetary value moves inversely with changes in the fair value of the issuer’s equity shares:

Prepaid written put options on own equity.
Prepaid forward purchase contracts on own equity.
Purchased options on own equity.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.