7.2 Illustrations of the Application of ASC 480 to Certain Option Combinations

The application of the scope provisions and the accounting requirements in ASC 480 depends on how an issuer’s contractual rights and obligations are aggregated or disaggregated into units of account (see Section 3.3). ASC 480-10-55-19 and 55-20 and in ASC 480-10-55-34 through 55-37 illustrate the application of ASC 480 to sets of options that involve the same counterparty and are executed contemporaneously. Each freestanding financial instrument is assessed separately under ASC 480, whereas a freestanding financial instrument that includes multiple components is analyzed in its entirety.

ASC 480-10

Combination of Written Put Option and Purchased Call Option Issued as a Freestanding Instrument

55-18 If a freestanding financial instrument consists solely of a written put option to repurchase the issuer’s equity shares and another option, that freestanding financial instrument in its entirety is subjected to paragraphs 480-10-25-4 through 25-14 to determine if it meets the requirements to be classified as a liability.

55-19 For example, an entity may enter into a contract that requires it to purchase 100 shares of its own stock on a specified date for $20 if the stock price falls below $20 and entitles the entity to purchase 100 shares on that date for $21 if the stock price is greater than $21. That contract shall be analyzed as the combination of a written put option and a purchased call option and not as a forward contract. The written put option on 100 shares has a strike price of $20, and the purchased call option on 100 shares has a strike price of $21. If at issuance the fair value of the written put option exceeds the fair value of the purchased call option, the issuer receives cash and the contract is a net written option — a liability. If required to be physically settled, that contract is a liability under the provisions in paragraphs 480-10-25-8 through 25-12 because it embodies an obligation that may require repurchase of the issuer’s equity shares and settlement by a transfer of assets. If the issuer must or can net cash settle the contract, the contract is a liability under the provisions of those paragraphs because it embodies an obligation that is indexed to an obligation to repurchase the issuer’s equity shares and may require settlement by a transfer of assets. If the issuer must or can net share settle the contract, that contract is a liability under the provisions in paragraph 480-10-25-14(c), because the monetary value of the obligation varies inversely in relation to changes in the fair value of the issuer’s equity shares.

55-20 If, in this example, the fair value of the purchased call option at issuance exceeds the fair value of the written put option, the issuer pays out cash and the contract is a net purchased option, to be initially classified as an asset under either paragraphs 480-10-25-8 through 25-12 or 480-10-25-14(c). If the fair values of the two options are equal and opposite at issuance, the financial instrument has an initial fair value of zero, and is commonly called a zero-cost collar. Thereafter, if the fair value of the instrument changes, the instrument is classified as an asset or a liability and measured subsequently at fair value.

Three Freestanding Instruments

55-34 An issuer has the following three freestanding instruments with the same counterparty, entered into contemporaneously:

A written put option on its equity shares
A purchased call option on its equity shares
Outstanding shares of stock.

55-35 Under this Subtopic those three contracts would be separately evaluated. The written put option is reported as a liability under either paragraphs 480-10-25-8 through 25-12 or 480-10-25-14(c) (depending on the form of settlement) and is measured at fair value. The purchased call option does not embody an obligation and, therefore, is not within the scope of this Subtopic. The outstanding shares of stock also are not within the scope of this Subtopic, because the shares do not embody an obligation for the issuer. Under paragraph 480-10-25-15, neither the purchased call option nor the shares of stock are to be combined with the written put option in applying paragraphs 480-10-25-4 through 25-14 unless otherwise required by Topic 815. If that Topic required the freestanding written put option and purchased call option to be combined and viewed as a unit, the unit would be accounted for as a combination of options, following the guidance in paragraphs 480-10-55-18 through 55-20.

Two Freestanding Instruments

55-36 An issuer has the following two freestanding instruments with the same counterparty entered into contemporaneously:

A contract that combines a written put option at one strike price and a purchased call option at another strike price on its equity shares
Outstanding shares of stock.

55-37 As required by paragraph 480-10-25-1, paragraphs 480-10-25-4 through 25-14 are applied to the entire freestanding instrument that comprises both a put option and a call option. Because the put option element of the contract embodies an obligation to repurchase the issuer’s equity shares, the freestanding instrument that comprises a put option and a call option is reported as a liability (or asset) under either paragraphs 480-10-25-8 through 25-12 or 480-10-25-14(c) (depending on the form of settlement) and is measured at fair value. Under paragraphs 480-10-15-3 through 15-4 and 480-10-25-1, that freestanding financial instrument is within the scope of this Subtopic regardless of whether at current prices it is a net written, net purchased, or zero-cost collar option and regardless of the form of settlement. The outstanding shares of stock are not within the scope of this Subtopic and, under paragraph 480-10-25-15, are not combined with the freestanding written put and purchased call option. (Some outstanding shares of stock are within the scope of this Subtopic, for example, mandatorily redeemable shares or shares subject to a physically settled forward purchase contract in exchange for cash.)

ASC 480-10-55-19 and 55-20, and ASC 480-10-55-35 and 55-36 contain two similar examples of a freestanding financial instrument that consists of a combination of a written put option and a purchased call option on own stock. The accounting analysis of this option combination under ASC 480 depends on whether the issuer could be required to settle its obligation under the written put option component by transferring assets or may settle it by transferring a variable number of equity shares. If the issuer could be required to settle the obligation by transferring assets (either in a physical settlement or net in cash), the instrument is classified as a liability (or as an asset in some circumstances) under ASC 480-10-25-8 because it is not an outstanding share and it embodies an obligation to repurchase the issuer’s equity shares or is indexed to such an obligation (see Chapter 5). If the issuer must or can elect to settle the obligation by delivering a variable number of shares, the instrument is classified as a liability (or as an asset in some circumstances) under ASC 480-10-25-14(c) because (1) it is 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 shares and (2) its monetary value is inversely related to the issuer’s stock price (see Chapter 6). In either case, the instrument is classified outside of equity because of the written put option component. The purchased call option does not affect the analysis of the appropriate classification of the instrument because the call option does not represent an obligation of the issuer.

Although the classification analysis in these two examples focuses on the written put option component, the option combination is accounted for in its entirety since it represents a single freestanding financial instrument. For example, in the fair value measurement of the instrument, both the written put option and the purchased call option components are considered. Note, however, that the purchased call option component of the combination would have been outside the scope of ASC 480 had it been issued as a freestanding instrument that is separate from the written put option, as illustrated in ASC 480-10-55-34 and 55-35, since it (1) would have represented a unit of account that is separate from the written put option and (2) embodies no obligation of the issuer. Similarly, outstanding shares of stock that are freestanding financial instruments and separate from the put and call options are analyzed independently of the options, as illustrated in ASC 480-10-55-34 through 55-37.

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