6.3 Freestanding Instruments Not Indexed to an Entity’s Own Stock (Before Adoption of ASU 2020-06)

If a freestanding equity-linked instrument does not meet the conditions in ASC 815-40-15 to be considered indexed to the entity’s stock, ASC 815-40 precludes classification of the instrument as equity (i.e., the contract must be classified as an asset or a liability). The subsequent measurement guidance in ASC 815-40-35-4 applies to a freestanding equity-linked instrument that is not classified as an asset or as a liability because it is not indexed to the entity’s stock. Under this guidance, such a contract must be initially and subsequently measured at fair value, with changes in fair value reported in earnings in each reporting period, regardless of whether the contract meets the characteristics of a derivative instrument in ASC 815-10-15-83. The disclosure requirements in ASC 815 apply only if the equity-linked instrument meets the definition of a derivative.

In evaluating whether a freestanding equity-linked instrument has the net settlement characteristic, an entity should consider the equity classification conditions in ASC 815-40-25 (discussed in Chapter 5). An instrument that fails to meet any of the conditions for equity classification would typically possess the net settlement characteristic because it would be presumed that the entity would be required to net cash settle the instrument.