6.2 Application Issues
6.2.1 Obligations to Deliver a Variable Number of Shares on the Basis of an Average Stock Price
ASC
480-10
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. . . . Some
share-settled obligations of this kind require that the
variable number of shares to be issued be based on an
average market price for the shares over a stated period
of time, such as the average over the last 30 days
before settlement, instead of the fair value of the
issuer’s equity shares on the date of settlement. Thus,
if the average market price differs from the share price
on the date of settlement, the monetary value of the
obligation is not entirely fixed at inception and is
based, in small part, on variations in the fair value of
the issuer’s equity shares. Although the monetary amount
of the obligation at settlement may differ from the
initial monetary value because it is tied to the change
in fair value of the issuer’s equity shares over the
last 30 days before settlement, the monetary value of
the obligation is predominantly based on a fixed
monetary amount known at inception. The obligation is
classified as a liability under paragraph
480-10-25-14(a). Upon issuance of the shares to settle
the obligation, equity is increased by the amount of the
liability and no gain or loss is recognized for the
difference between the average and the ending market
price.
For an instrument to be classified as a liability under ASC
480-10-25-14, the number of shares used to settle the variable-share obligation
does not necessarily need to be determined on the basis of the stock price on
the settlement date. The number of shares might alternatively be calculated on
the basis of an average stock market price over some period (e.g., the last 30
days before settlement). The instrument is a liability under ASC 480-10-25-14 as
long as the monetary value of the obligation (i.e., the current value of the
shares delivered to settle the obligation) is based predominantly on a fixed
monetary amount, on variations in something other than the fair value of the
issuer’s equity shares, or on variations inversely related to changes in the
fair value of the issuer’s equity shares.
However, if the monetary amount of a variable-share obligation
moves directly with the stock price (e.g., the monetary amount increases when
the stock price increases and vice versa), the obligation would not be a
liability under ASC 480-10-25-15 irrespective of whether the stock price used in
the calculation of the settlement value is a current stock price or an average
stock price. ASC 815-40-55-38 contains an example that suggests that a forward
contract to sell shares at a fixed price in which the stock price used in the
calculation of the settlement amount is based on a 30-day
volume-weighted-average daily market price of the issuer’s equity shares would
be considered indexed to the issuer’s stock (see Section 4.3.5.1 of Deloitte’s Roadmap Contracts on an Entity’s Own
Equity).
6.2.2 Share-Settled 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.
ASC 480-10-25-14(b) applies to guarantee contracts that will be
settled in a variable number of the issuer’s equity shares (see Sections 2.8, 6.1.3, and 6.2.3). For example, an
entity might issue a guarantee that it will settle in a variable number of the
issuer’s equity shares that equals the deficiency between the guaranteed value
of an investment and its current market value as opposed to settling such
obligation in cash. Even though the obligation will be settled in equity shares,
it is a liability under ASC 480-10-25-14(b) because such arrangement does not
establish an ownership relationship.
6.2.3 Financial Instruments That Embody Dual-Indexed Obligations
6.2.3.1 Overview
If a financial instrument embodies only one obligation, and
that obligation must or may be share settled, the financial instrument is
classified as an asset or a liability under ASC 480-10-25-14 if at
inception, the obligation’s monetary value is based either solely or
predominantly on one of three factors: (1) a fixed monetary amount, (2)
variations in something other than the fair value of the issuer’s equity
shares, or (3) variations inversely related to changes in the fair value of
the issuer’s equity shares. If the monetary value of a financial instrument
embodies only one obligation that must be share settled, and that monetary
value is not based solely on one of these three factors, the issuer should
evaluate whether the monetary value is based predominantly on one of them.
Special considerations apply to instruments with multiple component
obligations (see Section
6.2.4).
If a financial instrument embodies only one obligation, and
that obligation must or may (1) be share settled and (2) has a monetary
value that varies at least in part with the price of the issuer’s equity
shares, the financial instrument is outside the scope of ASC 480 unless its
monetary value is based predominantly on one of the three factors in ASC
480-10-25-14. If an obligation is dual-indexed both to the entity’s stock
price and to something other than the entity’s stock price (e.g., both to
the fair value of the issuer’s equity shares and to a foreign currency or
the entity’s sales revenue), ASC 480 therefore does not apply unless the
monetary value of the obligation is based predominantly on the variable
other than the fair value of the issuer’s equity shares. (Dual-indexed
contracts should be assessed under ASC 815 if ASC 480 does not apply.)
If a contract is solely and explicitly indexed to a variable
other than the fair value of the issuer’s equity shares, an entity would not
consider the contract to be based on the fair value of the issuer’s equity
shares even if that variable is highly correlated with the fair value of the
issuer’s equity shares. For example, the monetary value of an obligation to
deliver shares may be solely indexed to a multiple of the issuer’s trailing
EBITDA (e.g., 10 times EBITDA). In such a scenario, there is no assurance
that the formula will produce a monetary value that equals the fair value of
the issuer’s equity shares because the EBITDA multiple applied in the
marketplace may vary significantly over time, and all the factors that may
affect fair value of the issuer’s equity shares are not captured in EBITDA.
Thus, even though a formula for determining the number of shares to be
delivered by the issuer under a contract may be designed to approximate the
fair value of the issuer’s equity shares, the fact that a contract is not
explicitly indexed at least in part to the fair value of the equity shares
suggests that the contract should be classified as a liability under ASC 480
irrespective of the degree of correlation between the changes in the
variable and the fair value of the issuer’s shares. In other words, the
evaluation of predominance applies to obligations that are dual-indexed to
the issuer’s shares and one or more additional variables. It does not apply
to obligations that are explicitly and solely indexed to a variable other
than the issuer’s equity shares.
6.2.3.2 Evaluating Predominance — Contract Indexed to Issuer’s Stock Price and Foreign Exchange Rate
ASC 480-10
55-25 . . . For example, an
instrument meeting the definition of a derivative
instrument that requires delivery of a variable
number of the issuer’s equity shares with a monetary
value equaling changes in the price of a fixed
number of the issuer’s shares multiplied by the
Euro/U.S. dollar exchange rate embodies an
obligation with a monetary value that is based on
variations in both the issuer’s share price and the
foreign exchange rate and, therefore, is not within
the scope of this Subtopic. (However, that
instrument would be a derivative instrument under
Topic 815. Paragraphs 815-10-15-74(a) and
815-10-15-75(b) address derivative instruments that
are dual indexed and require an issuer to report
those instruments as derivative instrument
liabilities or assets.)
As illustrated in ASC 480-10-55-25, an instrument that
embodies no other obligation than one to deliver a variable number of equity
shares equal in value to the change in the price of a fixed number of the
issuer’s equity shares multiplied by the change in a foreign exchange rate
would not be within the scope of ASC 480, because the monetary value of that
obligation is not based predominantly on foreign exchange rates or on any of
the other factors that would cause an instrument to be an asset or a
liability under ASC 480-10-25-14. Note, however, that if an issuer concludes
that a dual-indexed instrument is not required to be classified outside of
equity under ASC 480, the issuer must assess whether the instrument is
required to be classified outside of equity under other GAAP (including ASC
815 and ASC 815-40). A contract on own equity that is indexed in part to a
currency other than the issuer’s functional currency would not qualify as
equity under ASC 815-40-15-7I (see Section 4.3.8 of Deloitte’s Roadmap
Contracts on an
Entity’s Own Equity).
6.2.3.3 Evaluating Predominance — Dual-Indexed Guarantee Obligation
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. . . .
55-24 If this example were
altered so that the monetary value of the obligation
is based on the deficiency on a specified date
between the guaranteed value of the investment in
another entity and its current fair value plus .005
times the change in value of 100 of the guarantor’s
equity shares, the monetary value of the obligation
would not be solely based on variations in something
other than the fair value of the issuer’s
(guarantor’s) equity shares.
55-25 However, the monetary
value of the obligation would be predominantly based
on variations in something other than the fair value
of the issuer’s (guarantor’s) equity shares and,
therefore, the obligation would be classified as a
liability under paragraph 480-10-25-14(b). That
obligation differs in degree from the obligation
under a contract that is indexed in part to the
issuer’s shares and in part (but not predominantly)
to something other than the issuer’s shares
(commonly called a dual-indexed obligation). The
latter contract is not within the scope of this
Subtopic. That paragraph applies only if the
monetary value of an obligation to issue equity
shares is based solely or predominantly on
variations in something other than the fair value of
the issuer’s equity shares. . . .
ASC 480-10-55-24 and 55-25 address a guarantee obligation
that requires the issuer to deliver a variable number of its equity shares
with a monetary value that is based on both (1) the fair value of the
issuer’s equity shares (0.005 times the change in the value of 100 of the
issuer’s equity shares) and (2) any deficiency in the fair value of a
third-party equity investment held by the counterparty below a specified
level. Because the monetary value of the obligation is based predominantly
on something other than the fair value of the issuer’s equity shares, ASC
480-10-25-14(b) requires the obligation to be classified as a liability.
Alternatively, an instrument may embody no obligation other
than one to deliver a variable number of equity shares worth a fixed
monetary amount plus 0.005 times the change in the value of 100 of the
issuer’s equity shares. That instrument would be classified as a liability
under ASC 480-10-25-14(a) because it embodies an obligation to deliver a
variable number of shares that have a value equal to a predominantly fixed
monetary amount.
6.2.4 Financial Instruments That Embody Multiple Obligations
6.2.4.1 Overview
ASC 480-10
55-42 A financial instrument
composed of more than one option or forward contract
embodying obligations to issue shares must be
analyzed to determine whether the obligations under
any of its components have one of the
characteristics in paragraph 480-10-25-14, and if
so, whether those obligations are predominant
relative to other obligations. For example, a
puttable warrant that allows the holder to purchase
a fixed number of the issuer’s shares at a fixed
price that also is puttable by the holder at a
specified date for a fixed monetary amount to be
paid, at the issuer’s discretion, in cash or in a
variable number of shares.
55-43 The analysis can be
summarized in two steps:
- Identify any component obligations that, if freestanding, would be liabilities under paragraph 480-10-25-14. Also identify the other component obligation(s) of the financial instrument.
- Assess whether the monetary value of any obligations embodied in components that, if freestanding, would be liabilities under paragraph 480-10-25-14 is (collectively) predominant over the (collective) monetary value of other component obligation(s). If so, account for the entire instrument under that paragraph. If not, the financial instrument is not in the scope of this Subtopic and other guidance applies.
Freestanding instruments sometimes contain multiple
obligations, and only some of those obligations would be classified as
liabilities under ASC 480 if they were issued on a freestanding basis. For
example, a single freestanding financial instrument may contain both (1) a
physically settled written call option that requires the issuer to deliver a
fixed number of equity shares for cash if exercised by the holder and (2) a
written put option that requires the issuer to deliver a variable number of
shares equal in value to a fixed monetary amount if the holder elects to put
the instrument to the issuer.
The evaluation of whether a freestanding financial
instrument (other than a mandatorily redeemable financial instrument) that
contains multiple obligations must be classified as an asset or a liability
under ASC 480 differs depending on whether the instrument embodies at least
one obligation to which ASC 480-10-25-8 applies (i.e., obligations to
repurchase equity shares by transferring assets):
-
If any of an instrument’s component obligations requires or may require the issuer to repurchase equity shares by transferring assets, the entire instrument is classified as an asset or a liability under ASC 480-10-25-8, and there is no assessment of the predominance of individual component obligations or settlement outcomes.
-
If ASC 480-10-25-8 does not apply, and the instrument embodies at least one component obligation to transfer a variable number of shares as described in ASC 480-10-25-14 (e.g., a net-share-settled written put component), the issuer must consider all possible outcomes to determine whether the component obligation is predominant relative to any component obligations to which ASC 480 does not apply (e.g., a fixed-for-fixed written call option on equity shares). If a component obligation to which ASC 480-10-25-14 applies is predominant, the entire instrument is classified as an asset or a liability under ASC 480 irrespective of the other component obligations and potential settlement outcomes.
ASC 480-10-55-42 and 55-43 suggest that entities apply a
two-step approach in performing this assessment:
-
Step 1 — Identify each of the component obligations of the financial instruments (e.g., forwards and written options). Separately identify those obligations that would be classified as liabilities under ASC 480-10-25-14 if they were freestanding.
-
Step 2 — Evaluate whether the monetary value of the component obligations that would be classified as liabilities under ASC 480-10-25-14 if the obligations were freestanding is (collectively) predominant relative to the (collective) monetary value of any component obligations that would not be within the scope of ASC 480. If it is, the entire instrument is classified as an asset or a liability under ASC 480-10-25-14. If it is not, the instrument is outside the scope of ASC 480.
An obligation could have multiple outcomes, and some 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 such a scenario, an outcome
is predominant if it is more likely than not (i.e., greater than 50 percent)
to occur (see Section
6.1.1.3).
Example 6-4
Variable-Share-Settled Preferred Stock — Range of
Monetary Amounts
A
preferred stock instrument will be automatically
converted into nonredeemable common stock on a
specified date. The number of common shares that the
issuer will deliver to settle the instrument depends
on the current price of common stock at settlement.
If the stock price exceeds $25, the issuer delivers
40 common shares. If the stock price is less than
$20, the issuer delivers 50 common shares. If the
stock price is between $20 and $25 (the “dead
zone”), the issuer delivers a variable number of
common shares equal in value to $1,000.
The issuer should evaluate whether dead-zone conversion (i.e., delivering common
shares equal in value to a fixed monetary amount of
$1,000) is the predominant settlement outcome. If it
is, the issuer must classify the preferred stock as
a liability under ASC 480-10-25-14(a). In evaluating
whether an outcome in the dead zone is predominant,
the issuer considers the expected growth rate of,
and expected variability in, the price of its common
stock. If all else is unchanged, the smaller the
price range in which dead-zone conversion will be
triggered, the more likely the stock price will be
outside of the dead zone at settlement. If dead-zone
conversion is not the predominant settlement
outcome, the preferred stock would not be classified
as a liability under ASC 480.
6.2.4.2 Warrant With Share-Settleable Put
ASC 480-10
55-44 In an instrument that
allows the holder either to purchase a fixed number
of the issuer’s shares at a fixed price or to compel
the issuer to reacquire the instrument at a fixed
date for shares equal to a fixed monetary amount
known at inception, the holder’s choice will depend
on the issuer’s share price at the settlement date.
The issuer must analyze the instrument at inception
and consider all possible outcomes to judge which
obligation is predominant. To do so, the issuer
considers all pertinent information as applicable,
which may include its current stock price and
volatility, the strike price of the instrument, and
any other factors. If the issuer judges the
obligation to issue a variable number of shares
based on a fixed monetary amount known at inception
to be predominant, the instrument is a liability
under paragraph 480-10-25-14. Otherwise, the
instrument is not a liability under this Subtopic
but is subject to other applicable guidance such as
Subtopic 815-40.
55-45 Entity C issues a
puttable warrant to Holder. The warrant feature
allows Holder to purchase 1 equity share at a strike
price of $10 on a specified date. The put feature
allows Holder instead to put the warrant back to
Entity C on that date for $2, settleable in
fractional shares. If the share price on the
settlement date is greater than $12, Holder would be
expected to exercise the warrant, obligating Entity
C to issue a fixed number of shares in exchange for
a fixed amount of cash; the monetary value of the
shares varies directly with changes in the share
price above $12. If the share price is equal to or
less than $12, Holder would be expected to put the
warrant back to Entity C obligating the entity to
issue a variable number of shares with a fixed
monetary value, known at inception, of $2. Thus, at
inception, the number of shares that the puttable
warrant obligates Entity C to issue can vary, and
the financial instrument must be examined under
paragraph 480-10-25-14.
55-46 The facts and
circumstances should be considered in judging
whether the monetary value of the obligation to
issue a number of shares that varies is
predominantly based on a fixed monetary amount known
at inception; if so, it is a liability under
paragraph 480-10-25-14(a). For example, if the
following circumstances existed, they would suggest
that the monetary value of the obligation to issue
shares would be judged to be based predominantly on
a fixed monetary amount known at inception ($2 worth
of shares), and the instrument would be classified
as a liability:
- Entity C’s share price is well below the $10 exercise price of the warrant at inception of the instrument.
- The warrant has a short life.
- Entity C’s stock is determined to have very low volatility.
The example in ASC 480-10-55-44 through 55-46 illustrates
the issuer’s assessment of predominance in connection with a freestanding
financial instrument that consists of multiple component obligations. The
financial instrument in that example contains (1) a warrant on own equity
that allows the holder to purchase a fixed number of the issuer’s shares at
a fixed price and (2) a share-settled put option that permits the holder to
put the instrument on a specified date for a fixed monetary amount
settleable in a variable number of shares.
The instrument is not subject to ASC 480-10-25-4 because it
does not represent an outstanding share. It is also not subject to ASC
480-10-25-8 because it neither requires nor may require the issuer to
transfer assets. In analyzing the instrument at inception, the issuer
concludes that the instrument contains two component obligations that the
issuer must consider in determining whether ASC 480-10-25-14 applies:
-
A conditional obligation to deliver a fixed number of shares if the holder exercises the warrant.
-
A conditional obligation to issue a variable number of shares if the holder puts the instrument back to the issuer.
The first obligation does not cause the instrument to be
within the scope of ASC 480-10-25-14 because it does not involve the
delivery of a variable number of shares. However, the second obligation
would be classified as a liability under ASC 480-10-25-14(a) if it were
freestanding since it involves the delivery of a variable number of shares
worth a fixed monetary amount. Accordingly, the issuer must assess whether
the second obligation is predominant (relative to the first) and, if it is,
must classify the entire instrument as a liability under ASC
480-10-25-14(a).
In this scenario, the actual settlement outcome will depend
on the warrant’s exercise price and the price of the issuer’s equity shares
on the settlement date because those factors will affect whether the holder
elects to exercise the warrant or put it back to the issuer for a variable
number of shares. In assessing whether the component obligation to deliver a
variable number of shares worth a fixed monetary amount is predominant at
inception, the issuer considers factors such as the relationship between the
current stock price and the warrant strike price, expected stock price
growth, expected stock price volatility, and the time to expiration of the
warrant. If the stock price is significantly lower than the strike price,
the stock price volatility is very low, and the warrant term is short, the
likelihood increases that the issuer will determine that the obligation to
issue a variable number of shares if the holder puts the instrument back to
the issuer is predominant relative to the obligation to deliver a fixed
number of shares if the holder exercises the warrant. If the obligation to
deliver a variable number of shares worth a fixed monetary amount is judged
not to be predominant relative to the obligation to deliver a fixed number
of shares, the entire instrument is outside the scope of ASC 480 and is
evaluated under other GAAP, including ASC 815-40.
6.2.4.3 Warrant With Share-Settleable Make-Whole Put
ASC 480-10
55-47 Entity E issues a
warrant to Holder allowing Holder to purchase 1
equity share at a strike price of $10. The warrant
has an embedded liquidity make-whole put that
entitles Holder to receive from Entity E the net
amount of any difference between the share price on
the date the warrants are exercised and the sales
price the holder receives when the shares are later
sold. The make-whole provision is not legally
detachable. Entity E can settle by issuing a
variable number of shares. For example, if on the
date Holder exercises the warrant, the share price
is $15 and the share price subsequently decreases to
$12 at the date Holder sells the shares, Holder
would receive $3 worth of equity shares from Entity
E.
55-48 The financial
instrument embodies an obligation to deliver a
number of shares that varies-either a fixed number
of shares under exercise of the warrant or
additional shares if the share price declines after
the warrant is exercised. However, unless it is
judged that the possibility of having to issue a
variable number of shares with a monetary value that
is inversely related to the share price is
predominant, the financial instrument is not in the
scope of paragraph 480-10-25-14(c) and would be
evaluated under Subtopic 815-40.
ASC 480-10-55-47 and 55-48 illustrate the issuer’s
assessment of predominance in connection with a freestanding financial
instrument that contains multiple component obligations. The financial
instrument contains (1) a warrant on own equity that allows the holder to
purchase a fixed number of the issuer’s shares at a fixed price and (2) a
net-share-settled make-whole provision that gives the holder the right to
compensation for any loss it incurs if it subsequently sells the shares it
receives upon the exercise of the warrants at a price lower than the stock
price on the warrant exercise date.
This instrument is not subject to ASC 480-10-25-4 because it
does not represent an outstanding share. It is also not subject to ASC
480-10-25-8 because it neither requires nor may require the issuer to
transfer assets. In analyzing this instrument at inception to determine
whether ASC 480-10-25-14 applies, the issuer concludes that the instrument
contains two component obligations that must be considered:
-
A conditional obligation to deliver a fixed number of shares if the holder exercises the warrant.
-
A conditional obligation to issue a variable number of shares if the holder sells the shares it receives upon exercise of the warrants at a price lower than the stock price on the warrant exercise date.
The first conditional obligation does not cause the
instrument to be within the scope of ASC 480-10-25-14 because it does not
involve the delivery of a variable number of shares. However, the second
conditional obligation would be classified as a liability under ASC
480-10-25-14(c) if it were freestanding since it involves the delivery of a
variable number of shares with a monetary value that is inversely related to
the issuer’s stock price. Accordingly, the issuer must assess whether the
second obligation is predominant (relative to the first). If it is, the
issuer must classify the entire instrument as a liability under ASC
480-10-25-14(c). If the second obligation is not predominant, the entire
instrument is outside the scope of ASC 480 and is evaluated under other
GAAP, including ASC 815-40. (The guidance in ASC 815-40-25-30 suggests that
a make-whole provision would not cause a contract to be classified as an
asset or a liability under ASC 815-40 if the provision can be net share
settled and the maximum number of shares that could be required to be
delivered under the contract, including the make-whole provision, is both
fixed and less than the number of available and authorized shares. See
Section 5.3.6 of Deloitte’s Roadmap
Contracts on an
Entity’s Own Equity.)
6.2.4.4 VSF Sales Contracts
ASC 480-10
55-50 Entity D enters into a
contract to issue shares of Entity D’s stock to
Counterparty in exchange for $50 on a specified
date. If Entity D’s share price is equal to or less
than $50 on the settlement date, Entity D will issue
1 share to Counterparty. If the share price is
greater than $50 but equal to or less than $60,
Entity D will issue $50 worth of fractional shares
to Counterparty. Finally, if the share price is
greater than $60, Entity D will issue .833 shares.
At inception, the share price is $49. Entity D has
an obligation to issue a number of shares that can
vary; therefore, paragraph 480-10-25-14 may apply.
However, unless it is determined that the monetary
value of the obligation to issue a variable number
of shares is predominantly based on a fixed monetary
amount known at inception (as it is in the $50 to
$60 share price range), the financial instrument is
not in the scope of this Subtopic.
VSF contracts are frequently issued as a component of a unit
offering that consists of a separable (1) debt security and (2) the VSF. A
VSF contract can bear various acronyms, depending on the underwriter,
including PRIDES, FELINE PRIDES, PEPS, and DECS. The contract has different
settlement outcomes depending on the price of the issuer’s common stock as
of the date it settles.
Example 6-5
Variable-Share-Settled Forward Contract — Range
of Monetary Values
The terms of a VSF are as follows:
-
The per-share fair value of the issuer’s common stock at the inception of the contract is $100.
-
On a stipulated fixed date in the future, the counterparty is required to pay the share issuer $100 in exchange for a variable number of shares of the issuer’s common stock.
-
The variable number of shares is based on the fair value of the issuer’s common stock on the date the contract settles, as shown in the table below.
-
The counterparty cannot compel the issuer to settle on a net cash basis, and the contract complies with the requirements of ASC 815-40-25-10 to be accounted for as an equity instrument (thus, the VSF is accounted for as an equity instrument unless it must be classified outside of equity under ASC 480).
Share settlement amounts are as follows:
|
Company Stock Price at
Contract Settlement Date
|
Number of Common Shares
Forward Counterparty Receives
|
Observations
|
|---|---|---|
Below $100 | One share of stock | The counterparty is exposed to
declines in the price of the issuer’s stock below
$100 |
Above $100 but below
$120 | A number of shares equal in value
to $100 | The counterparty neither benefits
nor loses as the price of the common stock
changes |
$120 and above | 0.8333 shares | The counterparty participates in
a portion of the appreciation of the issuer’s
stock above $120* |
* For example,
assume that the stock price closes at $135 per
share on the date the contract settles. The
counterparty will receive 0.8333 shares, worth
$112.50, in exchange for $100. The counterparty
only partially participated in the $15
appreciation above the upper limit of the original
range. | ||
As the table
indicates, the VSF is a hybrid instrument whose
components consist of (from the issuer’s
perspective) (1) a purchased put option on its own
shares, (2) an agreement to issue shares at fair
value, and (3) a written call option on its own
shares.
Under ASC 480-10-25-14(a), contracts that require the issuance of a variable
number of shares worth a fixed dollar amount are
accounted for as assets or liabilities. Under
certain scenarios, a VSF requires this type of
settlement (in the example above, if the price of
one share of the issuer’s common stock is between
$100 and $120 on the contract settlement date, the
issuer receives a fixed amount of cash [$100] and
delivers a variable number of shares that have a
monetary value equal to $100).
When the VSF settles within the range, the company will issue a variable number
of shares equal to a fixed monetary amount. An
instrument that consists entirely of this
characteristic is a liability. If an instrument
embodies such an obligation (as does the VSF
described in this example), it is an asset or a
liability according to ASC 480 when the possibility
of settling within the range is predominant (see ASC
480-10-55-51).
There are two possible outcomes for a VSF that has terms
similar to those in Example 6-5: (1) it can be settled in a manner consistent
with equity treatment (above or below the specified range) or (2) it can be
settled in a manner consistent with ASC 480 asset or liability treatment
(within the specified range). Accordingly, if at the inception of the
contract it is more likely than not that the VSF will settle within the
specified range, the VSF should be accounted for as an asset or a
liability.
Factors that an issuer should consider in evaluating the
likelihood of a VSF’s outcomes include:
- The terms of the VSF, including its maturity date and the formula for adjustments to the range.
- The volatility of the underlying stock.
- The relationship between the price of the common stock on the date the VSF is entered into and the low and high end of the original range.
- Historical and expected dividend levels.
When evaluating the likelihood of a VSF’s outcomes, an
issuer may want to engage a third-party valuation specialist to help with
quantitative determinations.
Other financial instruments may incorporate features that
are similar to those of a VSF, such as a mandatorily convertible preferred
stock in which the conversion feature is settled in (1) a fixed number of
common shares if the price of the issuer’s common share on the settlement
date is above a ceiling price per share or below a floor price per share or
(2) a variable number of shares equal to the face amount of the convertible
preferred stock if the price of the issuer’s common share on the settlement
date is between the ceiling and the floor price per share. To evaluate
whether such instruments are liabilities or equity under ASC 480, the issuer
should apply the same guidance as that on VSFs. Accordingly, if it is more
likely than not that the mandatorily convertible preferred stock will
convert within the variable-share range, it should be classified as a
liability under ASC 480-10-25-14.
6.2.5 Financial Instruments With Contingent Obligation
6.2.5.1 Outstanding Shares
ASC 480 only applies to outstanding shares that embody
unconditional obligations that fall within the scope of either ASC
480-10-25-4 or ASC 480-10-25-14. Accordingly, an outstanding share that
embodies an obligation that is contingent on the occurrence or nonoccurrence
of an uncertain future event would not be within the scope of ASC 480.
An outstanding share may contain both (1) a conditional
obligation to deliver a variable number of shares whose monetary value is
based on one of the factors in ASC 480-10-25-14 (i.e., a fixed monetary
amount, variations in something other than the fair value of the issuer’s
equity shares, or variations inversely related to changes in the fair value
of the issuer’s equity shares) and (2) a conditional obligation to
repurchase the share for cash or other assets. Even though those conditional
obligations would individually be outside the scope of ASC 480, the
outstanding share would be classified as a liability under ASC 480 if the
obligations in combination represent an unconditional obligation to
repurchase the shares by either transferring assets or issuing a variable
number of shares in accordance with one of the factors in ASC 480-10-25-14
(see ASC 480-10-55-28 for analogous guidance). For example, an outstanding
share would be classified as a liability if the obligations are contingent
upon the occurrence or nonoccurrence of the same event (e.g., an obligation
to repurchase an outstanding share for cash if an IPO occurs and an
obligation to repurchase the share in exchange for a variable number of
shares worth a fixed monetary amount if an IPO does not occur).
Alternatively, a preferred share with a stated redemption date on which it
will be settled in a fixed monetary amount of cash may include an option for
the issuer to settle the share instead by delivering a variable number of
common shares equal in value to the fixed monetary amount. That preferred
share would be classified as a liability under ASC 480 since the obligations
in combination represent an unconditional obligation to repurchase the
shares by either transferring assets or issuing a variable number of shares
worth a fixed monetary amount.
However, for the outstanding share to be classified as a
liability under ASC 480, each individual obligation would need to meet the
criteria for liability classification under ASC 480-10-25-4 or ASC
480-10-25-14 on the basis of an assumption that it was individually
unconditional. That is, an outstanding share with multiple embedded
obligations would not be classified as a liability even if the obligations
in combination represent an unconditional obligation to repurchase the
shares by either transferring assets or issuing a variable number of shares
in a circumstance in which the variable-share obligation does not meet the
criteria for liability classification in ASC 480-10-25-14.
Example 6-6
Redeemable Convertible Preferred Stock — Fixed and
Variable Conversion Features
Entity A has issued preferred stock for $1,000 that has a stated redemption date
of 10 years, at which time A must redeem the stock
for cash or other assets. The preferred stock
contains an automatic conversion feature under which
the preferred stock is exchanged for A’s shares of
common stock upon an IPO. The conversion rate has
both a fixed and variable component; upon any
conversion, A must deliver a fixed number of shares,
subject to a floor on the fair value of the shares
delivered that is equal to $1,000 as of the date of
conversion. Thus, if the fair value of the fixed
number of shares that is required to be delivered
upon a conversion is less than $1,000, A must
deliver an additional number of shares so that the
aggregate fair value of the shares delivered equals
$1,000. Under ASC 480, A must determine at inception
whether it is more likely than not that it would
deliver a variable number of shares worth a fixed
monetary amount of $1,000 if a conversion were to
occur at any time before the stated redemption date.
In other words, A would assess whether its
obligation to deliver a variable number of shares
worth a fixed monetary amount is predominant (see
Section 6.1.1.3), assuming that an
automatic conversion occurred because of an IPO.
Entity A would classify the preferred stock as a
liability under ASC 480 only if the obligation to
deliver shares worth a fixed monetary amount was
predominant, assuming that an IPO were to occur.
6.2.5.2 Instruments Other Than Outstanding Shares
ASC 480-10
55-49 If exercisability of a
feature into a fixed or variable number of shares is
contingent on both the occurrence or nonoccurrence
of a specified event and the issuer’s share price, a
financial instrument settleable in a number of
shares that can vary should be analyzed following
the same method as for the examples in paragraphs
480-10-55-45 and 480-10-55-50 to consider all
possibilities. In some cases, it may be determined
that the instrument may not be within the scope of
paragraph 480-10-25-14 and thus not a liability
under this Subtopic. That determination depends on
whether the obligation to deliver a variable number
of shares, with a monetary value based on either a
fixed monetary amount known at inception or an
inverse relationship with the share price, is
predominant at inception.
55-52 Entity F has a
share-settleable puttable warrant that provides that
the put feature is exercisable only if Entity F
fails to accomplish an operational plan (for
example, failure to complete a building within two
years). If at inception the possibility that both
the building will not be completed in two years and
the put will be exercised is judged to be
predominant, the put warrant would be recognized as
a liability under paragraph
480-10-25-14(a).
If a financial instrument other than an outstanding share
contains more than one obligation, and one of those obligations is
contingent on the occurrence or nonoccurrence of a specified event as well
as the issuer’s stock price, the analysis of whether ASC 480-10-25-14
applies is similar to that for other instruments that embody multiple
obligations (see Section
6.2.4). In assessing whether a contingent obligation to
deliver a variable number of shares whose monetary value is based on one of
the factors in ASC 480-10-25-14 is predominant, the issuer would consider
the contingency’s likelihood of being met by assessing it separately from
any other factors that may affect the settlement outcome. If the issuer
determines that ASC 480 does not apply, the contract would be evaluated
under ASC 815-40.
6.2.6 Obligations With Settlement Alternatives
Some obligations give one of the parties the choice of whether
the obligation will be settled by the issuer’s transfer of assets or by its
issuance of shares. In these circumstances, the issuer should determine whether
ASC 480-10-25-4, ASC 480-10-25-8, or ASC 480-10-25-14 takes precedence in the
assessment of whether the contract must be accounted for outside of equity.
6.2.6.1 Issuer Choice
If a financial instrument in the form of a share embodies an
unconditional redemption obligation, and the issuer can choose to settle the
obligation by either transferring assets or delivering a variable number of
nonredeemable shares of equal value, the instrument should be assessed as a
variable-share obligation under ASC 480-10-25-14 rather than as a
mandatorily redeemable financial instrument under ASC 480-10-25-4. Such an
instrument does not meet the definition of a mandatorily redeemable
financial instrument because the issuer has no unconditional obligation to
transfer assets.
Example 6-7
Redeemable Preferred Share — Issuer Choice to
Settle in Cash or Shares
An outstanding preferred share contains an unconditional obligation that
requires the issuer to redeem the share for a fixed
monetary amount (e.g., $100,000) on a specified
date. The issuer has the option to settle the
obligation by either transferring cash or delivering
a variable number of equity shares equal in value to
the fixed monetary amount on the settlement date.
The share would be evaluated under ASC 480-10-25-14
rather than ASC 815-40-25-4 because the issuer does
not have an unconditional obligation to transfer
assets. In this example, the instrument is a
liability under ASC 480 even though it does not
represent a mandatorily redeemable financial
instrument. If, however, the obligation involving
the delivery of a variable number of shares was not
solely or predominantly based on a fixed monetary
amount, on variations in something other than the
fair value of the issuer’s equity shares, or on
variations inversely related to changes in the fair
value of the issuer’s equity shares, classification
of the instrument as a liability under ASC 480 would
not be required.
If a financial instrument other than an outstanding share
embodies a conditional or unconditional obligation to repurchase shares (or
is indexed to such an obligation), and the issuer can choose to settle the
obligation by either transferring assets or delivering a variable number of
nonredeemable equity shares of equal value, the instrument should be
assessed as a variable-share obligation under ASC 480-10-25-14 rather than
as an obligation to repurchase shares by transferring assets under ASC
480-10-25-8. However, the instrument would still be a liability under ASC
480-10-25-14 because the monetary value of the shares delivered on
settlement is based on variations that are inversely related to changes in
the fair value of the issuer's equity shares.
Paragraph B48 of the Background Information and Basis for Conclusions of FASB Statement 150 states:
Certain financial instruments embody obligations
that permit the issuer to determine whether it will settle
the obligation by transferring assets or by issuing equity shares.
Because those obligations provide the issuer with discretion to
avoid a transfer of assets, the Board concluded that those
obligations should be treated like obligations that require
settlement by issuance of equity shares. That is, the Board
concluded that this Statement should require liability
classification of obligations that provide the issuer with the
discretion to determine how the obligations will be settled if, and
only if, the conditions in [ASC 480-10-25-14] related to changes in
monetary value are met.
If a financial instrument embodying an obligation to
repurchase shares gives the issuer a choice of settling the obligation by
transferring either assets or a fixed number of nonredeemable equity shares,
the instrument is outside the scope of ASC 480 because it embodies neither
an obligation to transfer assets nor an obligation to deliver a variable
number of shares.
6.2.6.2 Counterparty Choice
If a financial instrument in the form of a share embodies an
unconditional redemption obligation, and the holder can choose to require
the issuer to settle the redemption obligation by either transferring assets
or delivering a variable number of shares of equal value, the instrument
should be assessed as a variable-share obligation under ASC 480-10-25-14
rather than as a mandatorily redeemable financial instrument because the
issuer does not have an unconditional obligation to transfer assets. In
accordance with ASC 480-10-55-28, such a share would be classified as a
liability under ASC 480 if the issuer has an unconditional obligation that
may require the issuance of a variable number of shares on the basis of one
of the factors in ASC 480-10-25-14.
If the share instead gave the holder a choice of requiring
the issuer to repurchase the share by transferring either assets or a fixed
number of equity shares, the share would fall outside the scope of ASC 480
because it embodies neither an unconditional obligation to transfer assets
nor an obligation to deliver a variable number of shares.
If a financial instrument other than an outstanding share
embodies a conditional or unconditional obligation to repurchase shares (or
is indexed to such an obligation), and the holder has the choice of
requiring the issuer to settle the redemption obligation by transferring
either assets or a variable number of shares of equal value, the issuer
should assess the contract under ASC 480-10-25-8. Such a contract would not
be analyzed as a variable-share obligation under ASC 480-10-25-14 because
the issuer could be forced to settle it by transferring assets depending on
the holder’s settlement election. If the financial instrument instead gave
the holder a choice of assets or a fixed number of shares, the instrument
would still be assessed under ASC 480-10-25-8 because it embodies an
obligation that may require the entity to transfer assets.
6.2.6.3 Summary
The following table summarizes the analysis under ASC 480 of
financial instruments embodying obligations to repurchase shares that give
either the issuer or the holder a choice of settlement in assets or
nonredeemable equity shares.
Issuer Choice | Counterparty Choice | |
|---|---|---|
Settlement
Alternatives — Transfer of Assets or Variable Number
of Nonredeemable Equity Shares | ||
Outstanding share | Evaluate as variable-share obligation under ASC
480-10-25-14 | Evaluate as variable-share obligation under ASC
480-10-25-14 |
Financial instrument other than an outstanding
share | Evaluate as variable-share obligation under ASC
480-10-25-14 | Evaluate as an obligation to repurchase shares by
transferring assets under ASC
480-10-25-8 |
Settlement
Alternatives — Transfer of Assets or Fixed Number of
Nonredeemable Equity Shares | ||
Outstanding share | Outside scope of ASC 480 | Outside scope of ASC 480 |
Financial instrument other than an outstanding
share | Outside scope of ASC 480 | Evaluate as an obligation to repurchase shares by
transferring assets under ASC
480-10-25-8 |
6.2.6.4 Illustration
ASC 480-10
55-27 Some instruments do not
require the issuer to transfer assets to settle the
obligation but, instead, unconditionally require the
issuer to settle the obligation either by
transferring assets or by issuing a variable number
of its equity shares. Because those instruments do
not require the issuer to settle by transfer of
assets, those instruments are not within the scope
of paragraphs 480-10-25-4 through 25-6. However,
those instruments may be classified as liabilities
under paragraph 480-10-25-14.
55-28 For example, an entity
may issue 1 million shares of cumulative preferred
stock for cash equal to the stock’s liquidation
preference of $25 per share. The entity is required
either to redeem the shares on the fifth anniversary
of issuance for the issuance price plus any accrued
but unpaid dividends in cash or to settle by issuing
sufficient shares of its common stock to be worth
$25 per share. Preferred stockholders are entitled
to a mandatory dividend, payable quarterly at a rate
of 6 percent per annum based on the $25 per share
liquidation preference ($1.50 per share annually).
The dividend is cumulative and is payable in cash or
in a sufficient number of additional shares of the
preferred stock based on the liquidation preference
of $25 per share. That obligation does not represent
an unconditional obligation to transfer assets and,
therefore, is not a mandatorily redeemable financial
instrument subject to paragraph 480-10-25-4. But it
is still a liability, under paragraph
480-10-25-14(a), because the preferred shares embody
an unconditional obligation that the issuer may
settle by issuing a variable number of its equity
shares with a monetary value that is fixed and known
at inception. Because the preferred shares are
liabilities, payments to holders are reported as
interest cost, and accrued but not-yet-paid payments
are part of the liability for the shares.
6.2.7 Financial Instruments That Embody Both Rights and Obligations
ASC
480-10
55-26 . . . A net written or
net purchased option or a zero-cost collar similar to
the examples in paragraphs 480-10-55-18 through 55-20
that must or may be net share settled is classified as a
liability (or asset) under paragraph 480-10-25-14(c),
because the monetary value of the issuer’s obligation to
deliver a variable number of shares under the written
put option varies inversely in relation to changes in
the fair value of the issuer’s share price. The
purchased call option element of that freestanding
instrument does not embody an obligation to deliver a
variable number of shares and does not affect the
classification of the entire instrument when applying
that paragraph. In addition, a freestanding purchased
call option is not within the scope of this Subtopic
because it does not embody an obligation.
In assessing whether ASC 480-10-25-14 applies, an issuer
considers only terms and features that represent obligations (e.g., forward
obligations and written options). Issuer rights that could not require the
transfer of assets or equity shares do not affect the accounting analysis.
Accordingly, an issuer does not assess predominance among the potential
settlement outcomes for a share-settled instrument that embodies only one
obligation, even if the instrument has other potential settlement outcomes that
could result in the issuer’s receipt of assets or equity shares because of
issuer rights.
For a freestanding financial instrument such as a
net-share-settled collar that contains both a purchased call option that could
result in the issuer’s receipt of assets or equity shares and a written put
option that could result in the issuer’s delivery of assets or equity shares,
the purchased call option component does not affect the analysis under ASC
480-10-25-14. Instead, the written put option component causes the entire
instrument to be classified as a liability (or as an asset in some
circumstances) under ASC 480-10-25-14. Such accounting applies even if the fair
value of the purchased option component equals or exceeds the written option
component so that the collar represents a zero-cost collar or a net-purchased
option on the issuer’s own stock.