2.7 Guarantee Contracts
ASC 815-40
15-10 Topic 460 provides an exception from its initial recognition and initial measurement requirements, but not its disclosure provisions, for a guarantee for which the guarantor’s obligation would be reported as an equity item (rather than a liability) under generally accepted accounting principles (GAAP).
15-11 If
a contract under this Subtopic is required to be accounted
for as a liability under this Subtopic and also meets the
definition of a guarantee under Topic 460 (for example, a
physically settled written put option), both this Subtopic
and that Topic are consistent with respect to requiring the
issuer to account for the contract at fair value at the
initial measurement date. In that situation, the guarantee
would also be subject to the disclosure requirements of
Topic 460.
A contract potentially indexed to, and potentially settled in, an entity’s own
stock might fall within the scope of both ASC
815-40 and ASC 460. ASC 460-10-15-4 states that
with certain exceptions, ASC 460 applies to the
following types of guarantee contracts:
-
Contracts that contingently require a guarantor to make payments [including cash, financial instruments, other assets, shares of its stock, or provision of services] to a guaranteed party based on changes in an underlying that is related to an asset, a liability, or an equity security of the guaranteed party. . . .
-
Contracts that contingently require a guarantor to make payments . . . to a guaranteed party based on another entity’s failure to perform under an obligating agreement (performance guarantees). . . .
-
Indemnification agreements (contracts) that contingently require an indemnifying party (guarantor) to make payments to an indemnified party (guaranteed party) based on changes in an underlying that is related to an asset, a liability, or an equity security of the indemnified party.
-
Indirect guarantees of the indebtedness of others, even though the payment to the guaranteed party may not be based on changes in an underlying that is related to an asset, a liability, or an equity security of the guaranteed party.
ASC 460-10-25-1(d) and ASC 460-10-30-1 exempt from the scope of the recognition
and initial measurement guidance on guarantee contracts in ASC 460 “[a] guarantee
for which the guarantor’s obligation would be reported as an equity item” (e.g.,
under ASC 815-40) rather than as a liability. However, the disclosure requirements
for guarantees in ASC 460 would apply to such contracts unless they are eligible for
a scope exception in ASC 460-10-15-7 (e.g., guarantees of an entity’s own future
performance are excluded from the scope of ASC 460).
Example 2-4
Guarantee Contracts
Assume:
- An entity writes a call option that gives the holder the right to purchase equity securities of the option issuer in exchange for payment of cash by the holder.
- The entity knows that the holder of the call option is purchasing the option to cover a short position in the entity’s equity securities.
In this example, the entity may conclude that the contract is within the scope of ASC 460 on the basis of ASC 460-10-15-4(a) since the issuer is required to transfer an equity security to the option holder as a result of the changes in a liability of the option holder (the underlying short position).
However, if the issuer has no factual basis on which to conclude that the holder
of the call option is purchasing the option to cover a short
position in the asset, the written call option is not within
the scope of ASC 460 since the issuer does not have the
information necessary to conclude that the option holder has
an underlying short position.