Chapter 6 — Certain Variable-Share Obligations
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)
|
|
|
Monetary value based on something
other than stock price (see Section
6.1.3)
|
|
|
Monetary value moves inversely with
stock price (see Section
6.1.4)
|
|
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
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. 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
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: . . .
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
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: . . .
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.
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.
6.3 Accounting
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.
A financial instrument that must be accounted for as an asset or a liability
under ASC 480-10-25-14 is initially and subsequently measured at fair value, with
changes in fair value recognized in earnings unless a different accounting treatment
is permitted or required by other GAAP (e.g., share-settled debt that is accounted
for at amortized cost by using the interest method in accordance with ASC
835-30).
Unless the fair value option is elected, share-settled debt1 whose monetary value represents a fixed or predominantly fixed monetary amount
should be accounted for at amortized cost in accordance with the interest method in
ASC 835-30. For example, if a financial instrument must be settled by the issuance
of $200,000 worth of equity shares, this arrangement would generally be more like a
debtor-creditor relationship than an ownership relationship. Further, the last
sentence of ASC 480-10-55-22 (i.e., 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”)
implicitly acknowledges that a fixed-monetary-value share-settled debt arrangement
is not required to be measured at fair value through earnings. The paragraph
provides guidance on whether a gain or loss should be recognized related to the
difference between the average and ending market price upon the settlement of a
share-settled debt arrangement for which the number of shares that will be delivered
is determined on the basis of an average stock price as opposed to the ending stock
price. Had the instrument in ASC 480-10-55-22 been measured on an ongoing basis at
fair value (i.e., on the basis of a current stock price), there should have been no
difference to address at settlement after the issuer had updated its prior fair
value estimate.
Example 6-8
Variable-Share-Settled Obligation — Fixed Monetary
Amount
In October 20X0, Issuer T issued an obligation to deliver a variable number of its equity shares to Entity K, which can elect to require settlement of the obligation at any time starting in January 20X1. The obligation is not in the form of an outstanding share. Upon settlement, T will issue a variable number of shares of its common stock that has a fair value equal to $20 million. The fair value of common stock will be determined on the basis of the weighted average price of the common stock for the 20 consecutive trading days preceding settlement. The obligation is classified as a liability under ASC 480-10-25-14 because the monetary value of its settlement amount is predominantly fixed and the obligation is not in the form of an outstanding share. Company T determines that it would be appropriate to account for the obligation as share-settled debt at amortized cost since the obligation is repayable on demand at a predominantly fixed monetary amount.
On January 15, 20X1, K exercised its option to demand settlement. Company T
issued 225,000 shares of common stock, which had a fair
value of approximately $25 million measured on the basis of
the current stock price on the settlement date. The excess
of the fair value of the common stock over the $20 million
carrying amount of the liability was the result of an
increase in the common stock price during the averaging
period. That is, the weighted average stock price for the 20
days in the averaging period was less than the current stock
price at settlement. In a manner consistent with ASC
480-10-55-22, T should not recognize a loss for the excess
of the current fair value of the common shares delivered at
settlement over the $20 million carrying amount of the
liability for the obligation.
Some freestanding financial instruments qualify as derivative instruments under ASC
815-10-15-83 but are not accounted for as such because they meet one of the
derivative accounting exceptions. However, an instrument may be a liability under
ASC 480-10-25-14 because the issuer is required or permitted to settle the
instrument in a variable number of equity shares. Entities are not necessarily
required to subsequently account for these types of instruments at fair value
through earnings under the subsequent measurement guidance in ASC 480. Rather, other
applicable GAAP may address the subsequent measurement.
Footnotes
1
In this Roadmap, the term “share-settled debt” is used to
describe a share-settled obligation that is not in the legal form of debt
but has the same economic payoff profile as debt. Financial instruments that
are in the legal form of debt are outside the scope of ASC 480 (see
Section
2.2.4).
6.4 Reassessment
Under ASC 480-10-25-14, an entity assesses whether an obligation has a monetary value that is based either solely or 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. Such assessment is performed only at inception or upon a modification that is treated as a new instrument for accounting purposes (e.g., as a result of a modification or exchange that is accounted for as an extinguishment of the existing instrument; see ASC 470-50). There is no subsequent reassessment of whether the monetary value is based solely or predominantly on one of those factors. Further, as discussed in Section 3.2.1, the issuer does not reassess whether a feature is nonsubstantive or minimal after inception.
Example 6-9
Variable-Share-Settled Obligation — Number of Shares
Becomes Fixed
On January 1, 20X0, Issuer W issued an obligation to deliver
a variable number of its equity shares to Entity M.
Significant terms of the obligation are as follows:
- The number of shares to be issued depends on specified revenue targets achieved by a nonconsolidated joint venture that is owned equally by W and M.
- The number of shares issuable will be determined at the end of 20X2 on the basis of the revenue targets achieved for the two years ending December 31, 20X2, and W’s weighted average stock price for the 30-day period ending December 31, 20X2.
- Issuer W is obligated to issue the shares owed to M on December 31, 20X3. This delayed delivery exists as a result of a regulatory ownership restriction.
At the inception of the contract, W determined that it was
required to classify the share-issuance obligation as a
liability under ASC 480-10-25-14. Although the number of
shares issuable became fixed on December 31, 20X2, W is not
permitted to reclassify the liability amount into equity
because the monetary value of a variable-share settled
obligation may only be assessed at the contract’s inception.