ASC 815-40
Contracts in Entity's Own Equity
815 Derivatives and Hedging
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ASC 815-40 governs contracts (freestanding or embedded) that are indexed to, and potentially settled in, an entity's own stock — warrants, written/purchased options, forward sale and purchase contracts, and conversion features. It supplies the two-part test for the derivative scope exception in 815-10-15-74(a): whether the instrument is "indexed to the entity's own stock" (two-step analysis in 815-40-15-7 through 15-7I) and whether it would be classified in stockholders' equity (conditions in 815-40-25-7 through 25-30). Equity-classified contracts stay in permanent equity with no remeasurement; contracts failing either part are assets or liabilities measured at fair value through earnings, with classification reassessed every balance sheet date.
Key points (7)
- Indexation is tested in two steps: Step 1 evaluates exercise contingencies, which do not preclude indexation unless based on an observable market other than the market for the issuer's stock or an observable index not measured solely by reference to the issuer's own operations (815-40-15-7A); Step 2 evaluates settlement provisions (815-40-15-7C).
- Under Step 2 an instrument is indexed to the entity's own stock if its settlement amount equals the difference between the fair value of a fixed number of shares and a fixed monetary amount, or if the only variables affecting settlement are inputs to the fair value of a fixed-for-fixed forward or option (strike price, term, dividends, stock borrow cost, interest rates, volatility, credit spread, hedgeability) (815-40-15-7D through 15-7F); a strike price denominated in a currency other than the issuer's functional currency precludes indexation (815-40-15-7I), and a down round feature is excluded from the Step 2 analysis (815-40-15-5D).
- Classification defaults: contracts requiring net cash settlement, or giving the counterparty a choice of net cash settlement, are assets or liabilities; contracts requiring physical or net share settlement, or giving the entity the choice, are equity — unless settlement alternatives lack the same economic value, in which case economic substance controls (815-40-25-1 through 25-4).
- Equity classification requires all of the conditions in 815-40-25-10: sufficient authorized and unissued shares after other commitments, an explicit share limit, no required net cash settlement if the entity fails to make timely SEC filings, and no cash-settled top-off or make-whole provisions; registered-share delivery requirements, superior counterparty rights, and collateral posting do not preclude equity classification (815-40-25-10A).
- Any provision that could require net cash settlement precludes equity classification, except where holders of the underlying shares would also receive cash (e.g., certain change-in-control or nationalization provisions) (815-40-25-7 through 25-9; 815-40-55-2 through 55-6); likelihood of the triggering event is irrelevant except for payments due only on final liquidation.
- All contracts in scope are initially measured at fair value (815-40-30-1); equity-classified contracts remain in permanent equity with no recognition of fair value changes (815-40-35-2), while asset/liability contracts are remeasured at fair value through earnings (815-40-35-4).
- Classification must be reassessed at each balance sheet date with no limit on reclassifications (815-40-35-8); reclassification out of equity adjusts stockholders' equity for the equity-period change, and prior gains/losses are not reversed on reclassification into equity (815-40-35-9 through 35-10); modifications or exchanges of freestanding equity-classified written call options are treated as an exchange of the old instrument for a new one, with the fair value effect recognized as equity issuance cost, debt discount/issuance cost, a debt modification, or a dividend (815-40-35-16 through 35-17).
For students. This is the gatekeeper for whether warrants, convertible-debt conversion features, and SPAC-style instruments sit in equity or get marked to market through earnings — a frequent source of restatements. The common misunderstanding is treating "indexed to own stock" (Section 15) and "would be classified in equity" (Section 25) as one test; both parts of the 815-10-15-74(a) scope exception must be satisfied, and any potential adjustment to the strike price or share count — however remote or within the entity's control — defeats "fixed."
indexed to entity's own stockfixed-for-fixedexercise contingencynet cash settlementnet share settlementequity classification conditionsdown round featurewarrant modification
Machine-generated study aid for ASC 815-40. Check the source paragraphs below.
815-40-00Status
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815-40-00-1
The following table identifies the changes made to this Subtopic.
815-40-05Overview and Background
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815-40-05-1
For a number of business reasons, an entity may enter into contracts that are indexed to, and sometimes settled in, its own stock. This Subtopic provides guidance on accounting for such contracts. Examples of these contracts include put and call options (both written and purchased) and forward contracts (for both sales and purchases). These contracts may be settled using a variety of settlement methods, or the issuing entity or counterparty may have a choice of settlement methods. The contracts may be either freestanding or embedded in another financial instrument.
815-40-15Scope and Scope Exceptions
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Entities
815-40-15-1
The guidance in this Subtopic applies to all entities.
Instruments
815-40-15-2
The guidance in this Subtopic applies to freestanding contracts that are potentially indexed to, and potentially settled in, an entity's own stock.
815-40-15-2A
The scope of this Subtopic includes security price guarantees or other financial instruments indexed to, or otherwise based on, the price of the entity's stock that are issued in connection with a business combination and that are accounted for as contingent consideration.
815-40-15-3
The guidance in this Subtopic does not apply to any of the following:
- a
- bContracts that are issued to compensate grantees in a share-based payment arrangementwithin the scope of Topic 718
- c
- dA written put option and a purchased call option embedded in the shares of a noncontrolling interest of a consolidated subsidiary if the arrangement is accounted for as a financing under the guidance beginning in paragraph 480-10-55-53
- eFinancial instruments that are within the scope of Topic 480 (see paragraph 815-40-15-12).
815-40-15-4
The guidance in this Subtopic applies to derivatives embedded in contracts in analyzing the embedded feature under paragraphs 815-15-25-1(c) and 815-15-25-14 as though it were a freestanding instrument (as further discussed in paragraphs ).
Evaluating Whether an Instrument or Embedded Feature Is Considered Indexed to an Entity's Own Stock
815-40-15-5
The guidance in this paragraph through paragraph 815-40-15-8 applies to any freestanding financial instrument or embedded feature that has all the characteristics of a derivative instrument (see the guidance beginning in paragraph 815-10-15-83). That guidance applies for the purpose of determining whether that instrument or embedded feature qualifies for the first part of the scope exception in paragraph 815-10-15-74(a). That guidance does not address the second part of the scope exception in paragraph 815-10-15-74(a), which is addressed in Section 815-40-25. The guidance also applies to any freestanding financial instrument that is potentially settled in an entity's own stock, regardless of whether the instrument has all the characteristics of a derivative instrument for purposes of determining whether the instrument is within the scope of this Subtopic.
815-40-15-5A
The guidance in this paragraph through paragraph 815-40-15-8 does not apply to share-based payment awards within the scope of Topic 718 for purposes of determining whether instruments are classified as liability awards or equity awards under that Topic. Equity-linked financial instruments issued to investors for purposes of establishing a market-based measure of the grant-date fair value of employee stock options are not within the scope of Topic 718 themselves. Consequently, the guidance in this paragraph through paragraph 815-40-15-8 applies to such market-based share-based payment stock option valuation instruments for purposes of making the determinations described in paragraph 815-40-15-5.
815-40-15-5B
The guidance in paragraphs shall be applied to the appropriate unit of accounting, as determined under other applicable U.S. generally accepted accounting principles. For example, if an entity issues two freestanding financial instruments and concludes that those two instruments are required to be accounted for separately, then the guidance in paragraphs shall be applied separately to each instrument. In contrast, if an entity issues two freestanding financial instruments and concludes that those two instruments are required to be linked and accounted for on a combined basis as a single financial instrument (for example, pursuant to the guidance in paragraph 815-10-15-8), then the guidance in paragraphs shall be applied to the combined financial instrument.
815-40-15-5C
Freestanding financial instruments (and embedded features) for which the payoff to the counterparty is based, in whole or in part, on the stock of a consolidated subsidiary are not precluded from being considered indexed to the entity's own stock in the consolidated financial statements of the parent if the subsidiary is a substantive entity. If the subsidiary is not a substantive entity, the instrument or embedded feature shall not be considered indexed to the entity's own stock. If the subsidiary is considered to be a substantive entity, the guidance beginning in paragraph 815-40-15-5 shall be applied to determine whether the freestanding financial instrument (or an embedded feature) is indexed to the entity's own stock and shall be considered in conjunction with other applicable GAAP (for example, this Subtopic) in determining the classification of the freestanding financial instrument (or an embedded feature) in the financial statements of the entity. The guidance in this paragraph applies to those instruments (and embedded features) in the consolidated financial statements of the parent, whether the instrument was entered into by the parent or the subsidiary. The guidance in this paragraph does not affect the accounting for instruments (or embedded features) that would not otherwise qualify for the scope exception in paragraph 815-10-15-74(a). For example, freestanding instruments that are classified as liabilities (or assets) under Topic 480 and put and call options embedded in a noncontrolling interest that is accounted for as a financing arrangement under Topic 480 are not affected by this guidance. For guidance on presentation of an equity-classified instrument (including an embedded feature that is separately recorded in equity under applicable GAAP) within the scope of the guidance in this paragraph, see paragraph 810-10-45-17A.
815-40-15-5D
When classifying a financial instrument with a down round feature, the feature is excluded from the consideration of whether the instrument is indexed to the entity's own stock for the purposes of applying paragraphs (Step 2).
815-40-15-6
The guidance in this paragraph applies to both the issuer and the holder of the instrument. Outstanding instruments within the scope of the guidance in paragraphs shall always be considered issued for accounting purposes, except as discussed in the next sentence. Lock-up options shall not be considered issued for accounting purposes unless and until the options become exercisable.
815-40-15-7
An entity shall evaluate whether an equity-linked financial instrument (or embedded feature), as discussed in paragraphs is considered indexed to its own stock within the meaning of this Subtopic and paragraph 815-10-15-74(a) using the following two-step approach:
- aEvaluate the instrument's contingent exercise provisions, if any.
- bEvaluate the instrument's settlement provisions.
815-40-15-7A
An exercise contingency shall not preclude an instrument (or embedded feature) from being considered indexed to an entity's own stock provided that it is not based on either of the following:
- aAn observable market, other than the market for the issuer's stock (if applicable)
- bAn observable index, other than an index calculated or measured solely by reference to the issuer's own operations (for example, sales revenue of the issuer; earnings before interest, taxes, depreciation, and amortization of the issuer; net income of the issuer; or total equity of the issuer).
815-40-15-7B
If an instrument's strike price or the number of shares used to calculate the settlement amount would be adjusted upon the occurrence of an exercise contingency, the exercise contingency shall be evaluated under Step 1 (see the preceding paragraph) and the potential adjustment to the instrument's settlement amount shall be evaluated under Step 2 (see the guidance beginning in the following paragraph).
815-40-15-7C
Unless paragraph 815-40-15-7A precludes it, an instrument (or embedded feature) shall be considered indexed to an entity's own stock if its settlement amount will equal the difference between the following:
- aThe fair value of a fixed number of the entity's equity shares
- bA fixed monetary amount or a fixed amount of a debt instrument issued by the entity.
815-40-15-7D
An instrument's strike price or the number of shares used to calculate the settlement amount are not fixed if its terms provide for any potential adjustment, regardless of the probability of such adjustment(s) or whether such adjustments are in the entity's control. If the instrument's strike price or the number of shares used to calculate the settlement amount are not fixed, the instrument (or embedded feature) shall still be considered indexed to an entity's own stock if the only variables that could affect the settlement amount would be inputs to the fair value of a fixed-for-fixed forward or option on equity shares (provided that paragraph 815-40-15-7A does not preclude such a conclusion).
815-40-15-7E
A fixed-for-fixed forward or option on equity shares has a settlement amount that is equal to the difference between the price of a fixed number of equity shares and a fixed strike price. The fair value inputs of a fixed-for-fixed forward or option on equity shares may include the entity's stock price and additional variables, including all of the following:
- aStrike price of the instrument
- bTerm of the instrument
- cExpected dividends or other dilutive activities
- dStock borrow cost
- eInterest rates
- fStock price volatility
- gThe entity's credit spread
- hThe ability to maintain a standard hedge position in the underlying shares.
815-40-15-7F
An instrument (or embedded feature) shall not be considered indexed to the entity's own stock if its settlement amount is affected by variables that are extraneous to the pricing of a fixed-for-fixed option or forward contract on equity shares. An instrument (or embedded feature) shall not be considered indexed to the entity's own stock if either:
- aThe instrument's settlement calculation incorporates variables other than those used to determine the fair value of a fixed-for-fixed forward or option on equity shares.
- bThe instrument contains a feature (such as a leverage factor) that increases exposure to the additional variables listed in the preceding paragraph in a manner that is inconsistent with a fixed-for-fixed forward or option on equity shares.
815-40-15-7G
Standard pricing models for equity-linked financial instruments contain certain implicit assumptions. One such assumption is that the stock price exposure inherent in those instruments can be hedged by entering into an offsetting position in the underlying equity shares. For example, the Black-Scholes-Merton option-pricing model assumes that the underlying shares can be sold short without transaction costs and that stock price changes will be continuous. Accordingly, for purposes of applying Step 2, fair value inputs include adjustments to neutralize the effects of events that can cause stock price discontinuities. For example, a merger announcement may cause an immediate jump (up or down) in the price of shares underlying an equity-linked option contract. A holder of that instrument would not be able to continuously adjust its hedge position in the underlying shares due to the discontinuous stock price change. As a result, changes in the fair value of an equity-linked instrument and changes in the fair value of an offsetting hedge position in the underlying shares will differ, creating a gain or loss for the instrument holder as a result of the merger announcement. Therefore, inclusion of provisions that adjust the terms of the instrument to offset the net gain or loss resulting from a merger announcement or similar event do not preclude an equity-linked instrument (or embedded feature) from being considered indexed to an entity's own stock.
815-40-15-7H
Some equity-linked financial instruments contain provisions that provide an entity with the ability to unilaterally modify the terms of the instrument at any time, provided that such modification benefits the counterparty. For example, the terms of a convertible debt instrument may explicitly permit the issuer to reduce the conversion price at any time to induce conversion of the instrument. For purposes of applying Step 2, such provisions do not affect the determination of whether an instrument (or embedded feature) is considered indexed to an entity's own stock.
815-40-15-7I
The issuer of an equity-linked financial instrument incurs an exposure to changes in currency exchange rates if the instrument's strike price is denominated in a currency other than the functional currency of the issuer. An equity-linked financial instrument (or embedded feature) shall not be considered indexed to the entity's own stock if the strike price is denominated in a currency other than the issuer's functional currency (including a conversion option embedded in a convertible debt instrument that is denominated in a currency other than the issuer's functional currency). The determination of whether an equity-linked financial instrument is indexed to an entity's own stock is not affected by the currency (or currencies) in which the underlying shares trade.
815-40-15-8
Examples 2-21 (see paragraphs ) illustrate the application of the guidance in paragraphs . These examples do not address whether an instrument (or embedded feature) is classified in equity (or would be classified in equity if freestanding). These examples also do not address whether the instrument is within the scope of Topic 480 or whether the instrument would be subject to the two-class method under Topic 260.
815-40-15-8A
If the instrument does not meet the criteria to be considered indexed to an entity's own stock as described in paragraphs , it shall be classified as a liability or an asset. See paragraph 815-40-35-4 for subsequent measurement guidance for those instruments. See paragraph 815-40-15-9 for guidance on the interaction with this Subtopic and Subtopics 815-10 and 815-15 for derivative instruments and embedded derivatives.
Other Considerations
815-40-15-9
For guidance on the interaction of this Subtopic and Subtopic 815-10, see paragraphs . For guidance on the interaction of this Subtopic and Subtopic 815-15, see paragraph 815-15-25-15.
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).
815-40-15-11
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.
815-40-15-12
Paragraph 480-10-15-5 explains that Topic 480 does not apply to a feature embedded in a financial instrument that is not a derivative instrument in its entirety (for example, a written put option embedded in a nonderivative host contract) in analyzing the embedded feature as though it were a separate instrument as required by paragraph 815-15-25-1(c). Therefore, this Subtopic applies in evaluating those embedded features under Subtopic 815-15.
815-40-25Recognition
Source downloaded: .Record version f15b820da5aa. Effective date must be checked in the source.
815-40-25-1
The guidance in this Section applies for the purpose of determining whether an instrument or embedded feature qualifies for the second part of the scope exception in paragraph 815-10-15-74(a). The first part of the scope exception in paragraph 815-10-15-74(a) is addressed in Section 815-40-15. The initial balance sheet classification of contracts within the scope of this Subtopic generally is based on the concept that:
- aContracts that require net cash settlement are assets or liabilities.
- bContracts that require settlement in shares are equity instruments.
815-40-25-2
Further, an entity shall observe both of the following:
- aIf the contract provides the counterparty with a choice of net cash settlement or settlement in shares, this Subtopic assumes net cash settlement.
- bIf the contract provides the entity with a choice of net cash settlement or settlement in shares, this Subtopic assumes settlement in shares.
815-40-25-3
Except as noted in the last sentence of this paragraph, the approach discussed in paragraphs does not apply if settlement alternatives do not have the same economic value attached to them or if one of the settlement alternatives is fixed or contains caps or floors. In those situations, the accounting for the instrument (or combination of instruments) shall be based on the economic substance of the transaction. For example, if a freestanding contract, issued together with another instrument, requires that the entity provide to the holder a fixed or guaranteed return such that the instruments are, in substance, debt, the entity shall account for both instruments as liabilities, regardless of the settlement terms of the freestanding contract. However, the approach discussed in paragraphs does apply to contracts that have settlement alternatives with different economic values if the reason for the difference is a limit on the number of shares that must be delivered by the entity pursuant to a net share settlement alternative.
815-40-25-4
Accordingly, unless the economic substance indicates otherwise:
- aContracts shall be initially classified as either assets or liabilities in both of the following situations:
- 1Contracts that require net cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the entity)
- 2Contracts that give the counterparty a choice of net cash settlement or settlement in shares (physical settlement or net share settlement).
- 1
- bContracts shall be initially classified as equity in both of the following situations:
- 1Contracts that require physical settlement or net share settlement
- 2Contracts that give the entity a choice of net cash settlement or settlement in its own shares (physical settlement or net share settlement), assuming that all the criteria set forth in paragraphs and have been met.
- 1
815-40-25-5
Paragraph 815-20-55-33 explains that derivative instruments that are indexed to an entity's own stock and recorded as assets or liabilities can be hedging instruments.
815-40-25-6
The remainder of this Section addresses the following matters:
- aAdditional conditions necessary for equity classification
- bSettlement alternatives that differ in gain and loss positions
- cApplication of additional criteria to convertible debt and other hybrid instruments
- dEffect of a registration payment arrangement.
Additional Conditions Necessary for Equity Classification
815-40-25-7
Contracts that include any provision that could require net cash settlement cannot be accounted for as equity of the entity (that is, asset or liability classification is required for those contracts), except in those limited circumstances in which holders of the underlying shares also would receive cash (as discussed in the following two paragraphs and paragraphs ).
815-40-25-8
Generally, if an event that is not within the entity's control could require net cash settlement, then the contract shall be classified as an asset or a liability. However, if the net cash settlement requirement can only be triggered in circumstances in which the holders of the shares underlying the contract also would receive cash, equity classification is not precluded.
815-40-25-9
This Subtopic does not allow for an evaluation of the likelihood that an event would trigger cash settlement (whether net cash or physical), except that if the payment of cash is only required upon the final liquidation of the entity, then that potential outcome need not be considered when applying the guidance in this Subtopic.
815-40-25-10
Because any contract provision that could require net cash settlement precludes accounting for a contract as equity of the entity (except for those circumstances in which the holders of the underlying shares would receive cash, as discussed in paragraphs and paragraphs ), all of the following conditions must be met for a contract to be classified as equity:
- a
- bEntity has sufficient authorized and unissued shares. The entity has sufficient authorized and unissued shares available to settle the contract after considering all other commitments that may require the issuance of stock during the maximum period the derivative instrument could remain outstanding.
- cContract contains an explicit share limit. The contract contains an explicit limit on the number of shares to be delivered in a share settlement.
- dNo required cash payment (with the exception of penalty payments) if entity fails to timely file. There is no requirement to net cash settle the contract in the event the entity fails to make timely filings with the Securities and Exchange Commission (SEC).
- eNo cash-settled top-off or make-whole provisions. There are no cash settled top-off or make-whole provisions.
- f
- g
815-40-25-10A
The following conditions are not required to be considered in an entity's evaluation of net cash settlement (that is, if any one of these provisions is in a contract [or the contract is silent on these points], they should not preclude equity classification, except as described below):
- aWhether settlement is required in registered shares, unless the contract explicitly states that an entity must settle in cash if registered shares are unavailable. Requirements to deliver registered shares do not, by themselves, imply that an entity does not have the ability to deliver shares and, thus, do not require a contract that otherwise qualifies as equity to be classified as a liability.
- bWhether counterparty rights rank higher than shareholder rights. If the provisions of the contract indicate that the counterparty has rights that rank higher than the rights of a shareholder of the stock underlying the contract, this provision does not preclude equity classification.
- cWhether collateral is required. A provision requiring the entity to post collateral at any time for any reason does not preclude equity classification.
815-40-25-18
If a settlement alternative includes a penalty that would be avoided by an entity under other settlement alternatives, the uneconomic settlement alternative shall be disregarded in classifying the contract.
815-40-25-19
If an entity could be required to obtain shareholder approval to increase the entity's authorized shares to net share or physically settle a contract, share settlement is not controlled by the entity.
815-40-25-20
Accordingly, an entity shall evaluate whether a sufficient number of authorized and unissued shares exists at the classification assessment date to control settlement by delivering shares. In that evaluation, an entity shall compare both of the following amounts:
- aThe number of currently authorized but unissued shares, less the maximum number of shares that could be required to be delivered during the contract period under existing commitments, including any of the following:
- 1Outstanding convertible debt that is convertible during the contract period
- 2Outstanding stock options that are or will become exercisable during the contract period
- 3Other derivative financial instruments indexed to, and potentially settled in, an entity's own stock.
- 1
- bThe maximum number of shares that could be required to be delivered under share settlement (either net share or physical) of the contract.
815-40-25-21
When evaluating whether there are sufficient authorized and unissued shares available to settle a contract, an entity shall consider the maximum number of shares that could be required to be delivered under a registration payment arrangement to be an existing share commitment, regardless of whether the instrument being evaluated is subject to that registration payment arrangement.
815-40-25-22
If the amount in paragraph 815-40-25-20(a) exceeds the amount in paragraph 815-40-25-20(b) and the other conditions in this Subtopic are met, share settlement is within the control of the entity and the contract shall be classified as a permanent equity instrument. Otherwise, share settlement is not within the control of the entity and asset or liability classification is required.
815-40-25-23
For purposes of this calculation, if a contract permits both (a) net share and (b) physical settlement by delivery of shares at the entity's option (both alternatives permit equity classification if the other conditions in this Section are met), the alternative that results in the lesser number of maximum shares shall be included in this calculation.
815-40-25-24
If a contract is classified as either an asset or a liability because the counterparty has the option to require settlement of the contract in cash, then the maximum number of shares that the counterparty could require to be delivered upon settlement of the contract (whether physical or net share) shall be assumed for purposes of this calculation.
815-40-25-26
For certain contracts, the number of shares that could be required to be delivered upon net share settlement is essentially indeterminate. If the number of shares that could be required to be delivered to net share settle the contract is indeterminate, an entity will be unable to conclude that it has sufficient available authorized and unissued shares and, therefore, net share settlement is not within the control of the entity.
815-40-25-27
If a contract limits or caps the number of shares to be delivered upon expiration of the contract to a fixed number, that fixed maximum number can be compared to the available authorized and unissued shares (the available number after considering the maximum number of shares that could be required to be delivered during the contract period under existing commitments as addressed in paragraph 815-40-25-20 and including top-off or make-whole provisions as discussed in paragraph 815-40-25-30) to determine if net share settlement is within the control of the entity. A contract termination trigger alone (for example, a provision that requires that the contract will be terminated and settled if the stock price falls below a specified price) does not satisfy this requirement because, in that circumstance, the maximum number of shares deliverable under the contract is not known with certainty unless there is a stated maximum number of shares.
815-40-25-28
This paragraph addresses a contract structure that caps the number of shares that must be delivered upon net share settlement but would also provide that any contract valued in excess of that capped amount may be delivered to the counterparty in cash or by delivery of shares (at the entity's option) when authorized, unissued shares become available. The structure requires the entity to use its best efforts to authorize sufficient shares to satisfy the obligation. Under the structure, the number of shares specified in the cap is less than the entity's authorized, unissued shares less the number of shares that are part of other commitments (see paragraph 815-40-25-20). Use of the entity's best efforts to obtain sufficient authorized shares to settle the contract is within the entity's control. If the contract provides that the number of shares required to settle the excess obligation is fixed on the date that net share settlement of the contract occurs, the excess shares need not be considered when determining whether the entity has sufficient, authorized, unissued shares to net share settle the contract pursuant to paragraph 815-40-25-20. However, the contract may provide that the number of shares that must be delivered to settle the excess obligation is equal to a dollar amount that is fixed on the date of net share settlement (which may or may not increase based on a stated interest rate on the obligation) and that the number of shares to be delivered will be based on the market value of the stock at the date the excess amount is settled. In that case, the excess obligation represents stock-settled debt and shall preclude equity classification of the contract (or, if partial net share settlement is permitted under the contract pursuant to paragraph 815-40-35-11, precludes equity classification of the portion represented by the excess obligation).
815-40-25-29
The ability to make timely SEC filings is not within the control of the entity. Accordingly, if a contract permits share settlement but requires net cash settlement in the event that the entity does not make timely filings with the SEC, that contract shall be classified as an asset or a liability.
815-40-25-30
A top-off or make-whole provision would not preclude equity classification if both of the following conditions exist:
- aThe provision can be net share settled.
- bThe maximum number of shares that could be required to be delivered under the contract (including any top-off or make-whole provisions) is both:
- 1Fixed
- 2Less than the number of available authorized shares (authorized and unissued shares less the maximum number of shares that could be required to be delivered during the contract period under existing commitments as discussed in paragraph 815-40-25-20).
- 1
Settlement Alternatives Differ in Gain and Loss Positions
815-40-25-36
This guidance addresses two circumstances in which settlement alternatives differ in gain and loss positions:
- aNet cash payment required in loss position
- bNet-stock alternative in loss position.
815-40-25-37
A contract indexed to, and potentially settled in, an entity's own stock, with multiple settlement alternatives that require the entity to pay net cash when the contract is in a loss position but receive (a) net stock or (b) either net cash or net stock at the entity's option when the contract is in a gain position shall be accounted for as an asset or a liability.
815-40-25-38
A contract indexed to, and potentially settled in, an entity's own stock, within the scope of this Subtopic and with multiple settlement alternatives that require the entity to receive net cash when the contract is in a gain position but pay (a) net stock or (b) either net cash or net stock at the entity's option when the contract is in a loss position shall be accounted for as an equity instrument. This guidance does not apply to a contract that is predominantly a purchased option in which the amount of cash that could be received when the contract is in a gain position is significantly larger than the amount that could be paid when the contract is in a loss position because, for example, there is a small contractual limit on the amount of the loss. Those contracts shall be accounted for as assets or liabilities.
Application of Additional Criteria to Convertible Debt Instruments and Other Hybrid Instruments
815-40-25-39
For purposes of evaluating under paragraph 815-15-25-1 whether an embedded derivative indexed to an entity's own stock would be classified in stockholders' equity if freestanding, the requirements of paragraphs and do not apply if the hybrid contract is a convertible debt instrument in which the holder may only realize the value of the conversion option by exercising the option and receiving the entire proceeds in a fixed number of shares or the equivalent amount of cash (at the discretion of the issuer).
815-40-25-40
However, the requirements of paragraphs and do apply if an issuer is evaluating whether any other embedded derivative is an equity instrument and thereby excluded from the scope of Subtopic 815-10.
815-40-25-41
Instruments that provide the holder with an option to convert into a fixed number of shares (or equivalent amount of cash at the discretion of the issuer) for which the ability to exercise the option is based on the passage of time or a contingent event shall qualify for the exceptions included in paragraph 815-40-25-39. Standard antidilution provisions contained in an instrument do not preclude a conclusion that the instrument is convertible into a fixed number of shares.
815-40-25-42
Convertible preferred stock with a mandatory redemption date may qualify for the exception included in paragraph 815-40-25-39 if the economic characteristics indicate that the instrument is more akin to debt than equity. An entity shall consider the guidance in paragraph 815-15-25-17 in assessing whether the instrument is more akin to debt or equity. That paragraph explains that, if the preferred stock is more akin to equity than debt, an equity conversion feature would be clearly and closely related to that host instrument.
Effect of a Registration Payment Arrangement
815-40-25-43
Subtopic 825-20 requires that an entity recognize and measure a registration payment arrangement (see paragraph 825-20-15-3) as a separate unit of account from the financial instrument(s) subject to that arrangement. Accordingly, under that Subtopic (see paragraphs 825-20-25-2 and 825-20-30-2), a financial instrument that is both within the scope of this Subtopic and subject to a registration payment arrangement shall be recognized and measured in accordance with this Subtopic without regard to the contingent obligation to transfer consideration pursuant to the registration payment arrangement.
815-40-30Initial Measurement
Source downloaded: .Record version e840d2c2e0c7. Effective date must be checked in the source.
815-40-30-1
All contracts within the scope of this Subtopic shall be initially measured at fair value.
815-40-35Subsequent Measurement
Source downloaded: .Record version 5a86877d4ddf. Effective date must be checked in the source.
Overall
815-40-35-2
Contracts that are initially classified as equity under Section 815-40-25 shall be accounted for in permanent equity as long as those contracts continue to be classified as equity. Subsequent changes in fair value shall not be recognized as long as the contracts continue to be classified as equity. Both of the following shall be reported in permanent equity:
- aContracts that require that the entity deliver shares as part of a physical settlement or a net share settlement
- bContracts that give the entity a choice of either of the following:
- 1Net cash settlement or settlement in shares (including net share settlement and physical settlement that requires that the entity deliver shares)
- 2Either net share settlement or physical settlement that requires that the entity deliver cash.
- 1
815-40-35-3
See paragraphs for guidance on an issuer's accounting for modifications or exchanges of freestanding equity-classified written call options that remain equity classified after modification or exchange.
815-40-35-4
All other contracts classified as assets or liabilities under Section 815-40-25or paragraph 815-40-15-8Ashall be measured subsequently at fair value, with changes in fair value reported in earnings and disclosed in the financial statements as long as the contracts remain classified as assets or liabilities (see paragraph 815-40-50-1).
Settlement Assumptions
815-40-35-5
Net share settlement should be assumed for contracts that are classified under Section 815-40-25 as equity instruments that provide the entity with a choice of either of the following:
- aNet share settlement
- bPhysical settlement that may require that the entity deliver cash.
815-40-35-6
Physical settlement should be assumed for contracts that are classified under Section 815-40-25 as equity instruments that provide the counterparty with a choice of either of the following:
- aNet share settlement
- bPhysical settlement that may require that the entity deliver cash.
Reclassification of Contracts
815-40-35-8
The classification of a contract (including freestanding financial instruments and embedded features) shall be reassessed at each balance sheet date. If the classification required under this Subtopic changes as a result of events during the period (if, for example, as a result of voluntary issuances of stock the number of authorized but unissued shares is insufficient to satisfy the maximum number of shares that could be required to net share settle the contract [see discussion in paragraph 815-40-25-20]), the contract shall be reclassified as of the date of the event that caused the reclassification. There is no limit on the number of times a contract may be reclassified.
815-40-35-9
If a contract is reclassified from permanent or temporary equity to an asset or a liability, the change in fair value of the contract during the period the contract was classified as equity shall be accounted for as an adjustment to stockholders' equity. The contract subsequently shall be marked to fair value through earnings. If an embedded feature no longer qualifies for the derivatives scope exception under this Subtopic, the feature shall be separated from its host contract and accounted for as a derivative instrument in accordance with Subtopic 815-10 and Subtopic 815-15 (if all of the criteria in paragraph 815-15-25-1 are met).
815-40-35-10
If a contract is reclassified from an asset or a liability to equity, gains or losses recorded to account for the contract at fair value during the period that the contract was classified as an asset or a liability shall not be reversed. The contract shall be marked to fair value immediately before the reclassification. An embedded derivative that qualifies for the derivatives scope exception upon reassessment under this Subtopic that was separated from its host contract and accounted for as a derivative instrument in accordance with Subtopic 815-10 shall be reclassified to equity. The previously bifurcated embedded derivative shall not be recombined with its host contract.
815-40-35-11
If a contract permits partial net share settlement and the total notional amount of the contract no longer can be classified as permanent equity, any portion of the contract that could be net share settled as of that balance sheet date shall remain classified in permanent equity. That is, a portion of the contract shall be classified as permanent equity and a portion of the contract shall be classified as an asset, a liability, or temporary equity, as appropriate.
815-40-35-12
If an entity has more than one contract subject to this Subtopic, and partial reclassification is required, there may be different methods that could be used to determine which contracts, or portions of contracts, shall be reclassified. Methods that would comply with this Section could include any of the following:
- aPartial reclassification of all contracts on a proportionate basis
- bReclassification of contracts with the earliest inception date first
- cReclassification of contracts with the earliest maturity date first
- dReclassification of contracts with the latest inception or maturity date first
- eReclassification of contracts with the latest maturity date first.
815-40-35-13
The method of reclassification shall be systematic, rational, and consistently applied.
Issuer's Accounting for Modifications or Exchanges of Freestanding Equity-Classified Written Call Options
815-40-35-14
The guidance in paragraphs applies to an issuer's accounting for a modification of the terms or conditions or an exchange of a freestanding equity-classified written call option (for example, a warrant) that remains equity classified in accordance with this Subtopic after the modification or exchange and is not within the scope of another Topic. An entity shall account for the effects of a modification or an exchange in accordance with paragraphs . The disclosure requirements in paragraphs and 505-10-50-3 shall apply to a modification or an exchange of a freestanding equity-classified written call option. The guidance in paragraphs does not apply to freestanding equity-classified written call options that are modified or exchanged to compensate grantees in a share-based payment arrangement. An entity shall recognize the effect of such modifications of freestanding equity-classified written call options by applying the requirements in Topic 718; however, classification of the instrument will remain subject to the requirements in this Subtopic.
815-40-35-15
An entity shall consider the circumstances of the modification or exchange of a freestanding equity-classified written call option to determine whether the modification or exchange is related to a financing or other arrangement or a multiple-element arrangement (for example, an arrangement involving both debt financing and equity financing). In making that determination, an entity shall consider all of the terms and conditions of the modification or exchange, other transactions entered into contemporaneously or in contemplation of the modification or exchange, other rights and privileges obtained or obligations incurred (including services) as a result of the modification or exchange, and the overall economic effects of the modification or exchange. If the modification or exchange is not within the scope of another Topic, an entity shall apply the guidance in paragraphs .
815-40-35-16
An entity shall treat a modification of the terms or conditions or an exchange of a freestanding equity-classified written call option as an exchange of the original instrument for a new instrument. In substance, the entity repurchases the original instrument by issuing a new instrument. For transactions recognized in accordance with paragraph 815-40-35-17(c), the effect of a modification or an exchange shall be measured as the difference between the fair value of the modified or exchanged instrument and the fair value of that instrument immediately before it is modified or exchanged. For all other transactions recognized in accordance with paragraph 815-40-35-17, the effect of a modification or an exchange shall be measured as the excess, if any, of the fair value of the modified or exchanged instrument over the fair value of that instrument immediately before it is modified or exchanged. In a multiple-element transaction, the total effect of the modification or exchange shall be allocated to the respective elements in the transaction.
815-40-35-17
An entity shall recognize the effect of a modification or an exchange (calculated in accordance with paragraph 815-40-35-16) in the same manner as if cash had been paid as consideration, as follows:
- aEquity issuance. An entity shall recognize the effect of a modification or an exchange that is directly attributable to a proposed or actual equity offering as an equity issuance cost. For additional guidance see SAB Topic 5.A, Expenses of Offering (paragraph 340-10-S99-1).
- bDebt origination. An entity shall recognize the effect of a modification or an exchange that is a part of or directly related to an issuance of a debt instrument as a debt discount or debt issuance cost in accordance with the guidance in Topic 835 on interest.
- cDebt modification. An entity shall recognize the effect of a modification or an exchange that is a part of or directly related to a modification or an exchange of an existing debt instrument in accordance with the guidance in Subtopic 470-50 on debt modifications and extinguishments and Subtopic 470-60 on troubled debt restructurings by debtors.
- dOther. An entity shall recognize the effect of a modification or an exchange that is not related to a financing transaction in (a) through (c) and is not within the scope of any other Topics (such as Topic 718) as a dividend. Additionally, for an entity that presents earnings per share (EPS) in accordance with Topic 260, that effect shall be treated as a reduction of income available to common stockholders in basic earnings per share in accordance with the guidance in paragraph 260-10-45-15.
815-40-35-18
Example 22 (see paragraphs ) illustrates the application of the guidance in paragraphs .
815-40-40Derecognition
Source downloaded: .Record version 38394e5f45ec. Effective date must be checked in the source.
815-40-40-1
If contracts classified as permanent equity are ultimately settled in a manner that requires that the entity deliver cash, the amount of cash paid or received shall be reported as a reduction of, or an addition to, contributed capital.
815-40-40-2
If contracts classified as assets or liabilities are ultimately settled in shares, any gains or losses on those contracts shall continue to be included in earnings.
815-40-50Disclosure
Source downloaded: .Record version 319aedb64b1d. Effective date must be checked in the source.
815-40-50-1A
The disclosure guidance in this Section should help a user of financial statements understand the following:
- aInformation about the terms and features of contracts in an entity's own equity within the scope of this Subtopic
- bHow those instruments have been reflected in the issuer's statement of financial position and statement of financial performance
- cInformation about events, conditions, and circumstances that can affect how to assess the amount or timing of an entity's future cash flows but has not yet been reflected in the financial statements.
815-40-50-2
The disclosure guidance in this Subtopic applies to freestanding instruments that are potentially indexed to, and potentially settled in, an entity's own equity, regardless of whether the contract meets the criteria to qualify for the scope exception in Sections 815-40-15 and 815-40-25. Some contracts that are classified as assets or liabilities meet the definition of a derivative instrument under the provisions of Subtopic 815-10. The related disclosures that are required by Sections 815-10-50, 815-25-50, 815-30-50, and 815-35-50 also are required for those contracts. Equity-classified contracts under the provisions of this Subtopic are not required to provide the disclosures required by Section 505-10-50, other than those described in paragraph 815-40-50-5.
Fair Value Disclosures
815-40-50-2A
Changes in the fair value of all contracts classified as assets or liabilities shall be disclosed in the financial statements as long as the contracts remain classified as assets or liabilities.
Transition date:(P) December 16, 2027; (N) December 16, 2028Transition guidance:
270-10-65-1For interim and annual reporting periods, changes in the fair value of all contracts classified as assets or liabilities shall be disclosed in the financial statements as long as the contracts remain classified as assets or liabilities. Reclassifications and Related Accounting Policy Disclosures
815-40-50-3
Contracts within the scope of this Subtopic may be required to be reclassified into (or out of) equity during the life of the instrument (in whole or in part) pursuant to the provisions of paragraphs . An issuer shall disclose contract reclassifications (including partial reclassifications), the reason for the reclassification, and the effect on the issuer's financial statements.
815-40-50-4
The determination of how to partially reclassify contracts subject to this Subtopic is an accounting policy decision that shall be disclosed pursuant to Topic 235.
Interaction with Disclosures about Capital Structure
815-40-50-5
The disclosures required by Section 505-10-50 apply to all contracts within the scope of this Subtopic as follows:
- aIn the case of an option or forward contract indexed to the issuer's equity, the pertinent information to be disclosed under Section 505-10-50 about the contract includes all of the following:
- 1The forward rate
- 2The option strike price
- 3The number of issuer's shares to which the contract is indexed
- 4The settlement date or dates of the contract
- 5The issuer's accounting for the contract (that is, as an asset, liability, or equity).
- 1
- bIf the terms of the contract provide settlement alternatives, those settlement alternatives shall be disclosed under Section 505-10-50, including all of the following:
- 1Who controls the settlement alternatives and a description of those alternatives
- 2The maximum number of shares that could be required to be issued to net share settle a contract, if applicable. Paragraph 505-10-50-3 requires additional disclosures for actual issuances and settlements that occurred during the accounting period.
- 1
- cIf a contract does not have a fixed or determinable maximum number of shares that may be required to be issued, the fact that a potentially infinite number of shares could be required to be issued to settle the contract shall be disclosed under Section 505-10-50.
- dFor each settlement alternative, the amount that would be paid, or the number of shares that would be issued and their fair value, determined under the conditions specified in the contract if the settlement were to occur at the reporting date and how changes in the fair value of the issuer's equity shares affect those settlement amounts (for example, the issuer is obligated to issue an additional X shares or pay an additional Y dollars in cash for each $1 decrease in the fair value of one share) shall be disclosed under Section 505-10-50. (For some issuers, a tabular format may provide the most concise and informative presentation of these data.)
- eThe disclosures required by paragraph 505-10-50-11 shall be made for any equity instrument in the scope of this Subtopic that is (or would be if the issuer were a public entity) classified as temporary equity. (That paragraph applies to redeemable stock issued by nonpublic entities, regardless of whether the private entity chooses to classify those securities as temporary equity.)
- fThe disclosures required by paragraph 505-10-50-18 also shall be made for an equity-classified contract within the scope of this Subtopic that is entered into in connection with the issuance of convertible preferred stock.
Issuer's Accounting for Modifications or Exchanges of Freestanding Equity-Classified Written Call Options
815-40-50-6
For a freestanding equity-classified written call option modified or exchanged during any of the periods presented and for which an entity has recognized the effect in accordance with paragraph 815-40-35-17, an entity shall disclose the following:
- aInformation about the nature of the modification or exchange transaction (see paragraph 815-40-35-15)
- bThe amount of the effect of the modification or exchange (see paragraph 815-40-35-16)
- cThe manner in which the effect of the modification or exchange has been recognized (see paragraph 815-40-35-17).
815-40-55Implementation Guidance and Illustrations
Source downloaded: .Record version 8c7a5cbccfbd. Effective date must be checked in the source.
Implementation Guidance
815-40-55-2
An event that causes a change in control of an entity is not within the entity's control and, therefore, if a contract requires net cash settlement upon a change in control, the contract generally must be classified as an asset or a liability.
815-40-55-3
However, if a change-in-control provision requires that the counterparty receive, or permits the counterparty to deliver upon settlement, the same form of consideration (for example, cash, debt, or other assets) as holders of the shares underlying the contract, permanent equity classification would not be precluded as a result of the change-in-control provision. In that circumstance, if the holders of the shares underlying the contract were to receive cash in the transaction causing the change in control, the counterparty to the contract could also receive cash based on the value of its position under the contract.
815-40-55-4
If, instead of cash, holders of the shares underlying the contract receive other forms of consideration (for example, debt), the counterparty also must receive debt (cash in an amount equal to the fair value of the debt would not be considered the same form of consideration as debt).
815-40-55-5
Similarly, a change-in-control provision could specify that if all stockholders receive stock of an acquiring entity upon a change in control, the contract will be indexed to the shares of the purchaser (or issuer in a business combination accounted for as a pooling of interests) specified in the business combination agreement, without affecting classification of the contract.
Transition date:(P) December 16, 2026; (N) December 16, 2026Transition guidance:
105-10-65-10Similarly, a change-in-control provision could specify that if all stockholders receive stock of an acquiring entity upon a change in control, the contract will be indexed to the shares of the purchaser specified in the business combination agreement, without affecting classification of the contract. 815-40-55-6
In the event of nationalization, cash compensation would be the consideration for the expropriated assets and, as a result, a counterparty to the contract could receive only cash, as is the case for a holder of the stock underlying the contract. Because the contract counterparty would receive the same form of consideration as a stockholder, a contract provision requiring net cash settlement in the event of nationalization does not preclude equity classification of the contract.
815-40-55-7
The following guidance reflects the application of this Subtopic to certain freestanding derivative financial instruments that are indexed to, and potentially settled in, an entity's own stock, specifically:
- a
- bForward sale contracts, written call options or warrants, and purchased put options
- cPurchased call options
- dDetachable stock purchase warrants
- ePut warrants.
815-40-55-13
The issuing entity (the seller) agrees to sell shares of its stock to the buyer of the contract at a specified price at some future date. The contract may be settled by physical settlement, net share settlement, or net cash settlement, or the issuing entity or counterparty may have a choice of settlement methods. The guidance in this Subtopic would be applied as follows.
One Settlement Method Entity Choice Counterparty Choice Physical (a) Net Share Net Cash Net Share or Physical(a) Net Share or Net Cash Net Cash or Physical(a) Net Share or Physical(a) Net Share or Net Cash Net Cash or Physical(a) (1) Initial Classification: Equity (b) x x x x x x Asset or Liability x x x "(2) Initial Measurement, Subsequent Classification and Measurement:" "Fair value, permanent equity-no changes in fair value(b)" x x x x(c) x(c) x "Fair value, asset or liability- adjusted for changes in fair value (d)" x x(e) x(e) (a) Physical settlement of the contract requires that the entity deliver shares to the holder in exchange for cash. (b) Equity or temporary equity classification is only appropriate if the conditions in Section 815-40-25 do not require asset or liability classification of the contract. (c) "If the contracts are ultimately settled in net cash, the amount of cash paid or received should be reported as a reduction of, or an addition to, contributed capital." (d) Subsequent changes in fair value should be reported in earnings and disclosed in the financial statements. (e) "If the contracts are ultimately settled in shares, any gains or losses on those contracts should continue to be included in earnings." "Note: In all cases above, the contracts must be reassessed at each reporting period in order to determine whether or not the contract must be reclassified."
815-40-55-14
The entity (the buyer) purchases call options that provide it with the right, but not the obligation, to buy from the seller, shares of the entity's stock at a specified price. If the options are exercised, the contract may be settled by physical settlement, net share settlement, or net cash settlement, or the issuing entity or the counterparty may have a choice of settlement methods. The entity should follow the preceding table in accounting for purchased call options.
815-40-55-15
An entity issues senior subordinated notes with a detachable warrant that gives the holder both the right to purchase 6,250 shares of the entity's stock for $75 per share and the right (that is, a put) to require that the entity repurchase all or any portion of the warrant for at least $2,010 per share at a date several months after the maturity of the notes in about 7 years. The proceeds should be allocated between the debt liability and the warrant based on their relative fair values, and the resulting discount should be amortized in accordance with Subtopic 835-30. The warrants should be considered, in substance, debt and accounted for as a liability because the settlement alternatives for the warrants do not have the same economic value attached to them and they provide the holder with a guaranteed return in cash that is significantly in excess of the value of the share-settlement alternative on the issuance date.
815-40-55-16
Put warrants are frequently issued concurrently with debt securities of the entity, are detachable from the debt, and may be exercisable only under specified conditions. The put feature of the instrument may expire under varying circumstances, for example, with the passage of time or if the entity has a public stock offering. Under Subtopic 470-20, a portion of the proceeds from the issuance of debt with detachable warrants must be allocated to those warrants.
815-40-55-17
Put warrants are instruments with characteristics of both warrants and put options. The holder of the instrument is entitled to do any of the following:
- aExercise the warrant feature to acquire the common stock of the entity at a specified price
- bExercise the put option feature to put the instrument back to the entity for a cash payment
- cExercise both the warrant feature to acquire the common stock and the put option feature to put that stock back to the entity for a cash payment.
815-40-55-18
Because the contract gives the counterparty the choice of cash settlement or settlement in shares, entities should report the proceeds from the issuance of put warrants as liabilities and subsequently measure the put warrants at fair value with changes in fair value reported in earnings as required by Topic 480. That is, a put warrant that embodies an obligation to repurchase the issuer's equity shares, or is indexed to such an obligation, and that requires or may require a transfer of assets is within the scope of that Topic and therefore is to be recognized as a liability.
Illustrations
815-40-55-25A
The Examples in paragraphs illustrate the application of the guidance beginning in paragraph 815-40-15-5.
815-40-55-26
Entity A issues warrants that permit the holder to buy 100 shares of its common stock for $10 per share. The warrants have 10-year terms; however, they only become exercisable if Entity A completes an initial public offering.The warrants are considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The exercise contingency (that is, the initial public offering) is not an observable market or an observable index, so the evaluation of Step 1 does not preclude the warrants from being considered indexed to the entity's own stock. Proceed to Step 2.
- bUpon exercise, the settlement amount would equal the difference between the fair value of a fixed number of the entity's equity shares (100 shares) and a fixed strike price ($10 per share).
815-40-55-27
Entity A issues warrants that permit the holder to buy 100 shares of its common stock for $10 per share. The warrants have 10-year terms; however, they only become exercisable after Entity A accumulates $100 million in sales to third parties. The warrants are considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The exercise contingency (that is, the accumulation of $100 million in sales to third parties) is an observable index. However, it can only be calculated or measured by reference to Entity A's sales, so the evaluation of Step 1 does not preclude the warrants from being considered indexed to the entity's own stock. Proceed to Step 2.
- bStep 2. Upon exercise, the settlement amount would equal the difference between the fair value of a fixed number of the entity's equity shares (100 shares) and a fixed strike price ($10 per share).
815-40-55-28
Entity A issues warrants that permit the holder to buy 100 shares of its common stock for $10 per share. The warrants have 10-year terms; however, they only become exercisable if the Standard & Poor's S&P 500 Index increases 500 points within any given calendar year during that 10-year period.The warrants are not considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The exercise contingency (that is, the increase of 500 points in Standard & Poor's S&P 500 Index) is based on an observable index that is not measured solely by reference to the issuer's own operations.
- bStep 2. It is not necessary to evaluate Step 2.
815-40-55-29
Entity A issues warrants that permit the holder to buy 100 shares of its common stock in exchange for one ounce of gold. The warrants have 10-year terms; however, they only become exercisable if Entity A completes an initial public offering. The warrants are not considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The exercise contingency (that is, the initial public offering) is not an observable market or an observable index, so the evaluation of Step 1 does not preclude the warrants from being considered indexed to the entity's own stock. Proceed to Step 2.
- bStep 2. The settlement amount would not equal the difference between the fair value of a fixed number of the entity's equity shares (100 shares) and a fixed strike price. Although the number of shares that would be issued at settlement is fixed, the strike price varies based on the price of one ounce of gold. The price of gold is not an input to the fair value of a fixed-for-fixed option on equity shares.
815-40-55-30
Entity A issues warrants that permit the holder to buy 100 shares of its common stock for $10 per share. The warrants have 10-year terms and are exercisable at any time. However, the terms of the warrants specify that if there is an announcement of a merger involving Entity A, the strike price of the warrants will be adjusted to offset the effect of the merger announcement on the net change in the fair value of the warrants and of an offsetting hedge position in the underlying shares. The strike price adjustment must be determined using commercially reasonable means based on an assumption that the counterparty has entered into a hedge position in the underlying shares to offset the share price exposure from the warrants. That strike price adjustment is not affected by the counterparty's actual hedging position (for example, the strike price adjustment does not differ in circumstances when the counterparty is over-hedged or under-hedged). The warrants are considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instruments do not contain an exercise contingency. Proceed to Step 2.
- bStep 2. The settlement amount would equal the difference between the fair value of a fixed number of the entity's equity shares (100 shares) and a fixed strike price ($10 per share), unless there is a merger announcement. If there is a merger announcement, the settlement amount would be adjusted to offset the effect of the merger announcement on the fair value of the warrants. In that circumstance, the only variables that could affect the settlement amount would be inputs to the fair value of a fixed-for-fixed option on equity shares. For further discussion, see paragraphs 815-40-15-7E and 815-40-15-7G.
815-40-55-31
Entity A issues warrants that permit the holder to buy 100 shares of its common stock for an initial price of $10 per share. The warrants have 10-year terms and are exercisable at any time. However, the terms of the warrants specify that the strike price is reduced by $0.50 after any year in which Entity A does not achieve revenues of at least $100 million. The warrants are not considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instruments do not contain an exercise contingency. Proceed to Step 2.
- bStep 2. The settlement amount would not equal the difference between the fair value of a fixed number of the entity's equity shares (100 shares) and a fixed strike price. Although the number of shares that would be issued at settlement is fixed, the strike price would be adjusted after any year in which Entity A does not achieve revenues of at least $100 million. The amount of an entity's annual revenues is not an input to the fair value of a fixed-for-fixed option on equity shares.
815-40-55-32
Entity A purchases net-settled call options that permit it to buy 100 shares of its common stock for $10 per share. However, the maximum appreciation on the call options is capped when Entity A's stock price reaches $15 per share (that is, the counterparty's maximum obligation is $500 [($15 − $10) x 100 shares]). The call options have 10-year terms and are exercisable at any time. The call options are considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instruments do not contain an exercise contingency. Proceed to Step 2.
- bStep 2. The settlement amount would equal the difference between the fair value of a fixed number of the entity's equity shares (100 shares) and a fixed strike price when Entity A's stock price is between the $10 stated exercise price and the $15 price cap. However, whenever Entity A's stock price exceeds $15, the strike price of the call options increases and decreases in amounts equal to the corresponding increases and decreases in Entity A's stock price, such that the intrinsic value of each call option always equals $5. Because the only variable that can affect the settlement amount is the entity's stock price, which is an input to the fair value of a fixed-for-fixed option contract, the call options are considered indexed to the entity's own stock.
815-40-55-33
This Example illustrates the application of the guidance beginning in paragraph 815-40-15-5for a financial instrument that includes a down round feature. Entity A issues warrants that permit the holder to buy 100 shares of its common stock for $10 per share. The warrants have 10-year terms and are exercisable at any time. However, the terms of the warrants specify both of the following:
- aIf the entity sells shares of its common stock for an amount less than $10 per share, the strike price of the warrants is reduced to equal the issuance price of those shares.
- bIf the entity issues an equity-linked financial instrument with a strike price below $10 per share, the strike price of the warrants is reduced to equal the strike price of the newly issued equity-linked financial instrument.
815-40-55-34
The warrants are considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instruments do not contain an exercise contingency. Proceed to Step 2.
- bStep 2. In accordance with paragraph 815-40-15-5D, when classifying a financial instrument with a down round feature, an entity shall exclude that feature when considering whether the instrument is indexed to the entity's own stock for the purposes of applying paragraphs (Step 2). The instrument does not contain any other features to be assessed under Step 2.
815-40-55-34A
See paragraph 260-10-45-12B for earnings-per-share considerations, paragraph 260-10-25-1 for recognition considerations, and paragraphs 505-10-50-3 through 50-3A for disclosure considerations.
815-40-55-35
Entity A issues warrants that permit the holder to buy 100 shares of its common stock for $10 per share. The warrants have 10-year terms and are exercisable at any time. However, the terms of the warrants specify that if Entity A does not obtain regulatory approval of a particular drug compound within 5 years, the holder can surrender the warrants to Entity A for $2 per warrant (settleable in shares). The contingently puttable warrants are not considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instruments do not contain an exercise contingency. Proceed to Step 2.
- bStep 2. The settlement amount would equal the difference between the fair value of a fixed number of the entity's equity shares (100 shares) and a fixed strike price ($10 per share), unless regulatory approval of a particular drug compound is not obtained within 5 years. If that approval is not obtained within the allotted time period, the holder could elect to surrender the warrants to Entity A in exchange for $2 per warrant. The contingent obligation to settle the warrants by transferring consideration with a fixed monetary value if regulatory approval of a particular drug compound is not obtained within a specified time period does not represent an input to the fair value of a fixed-for-fixed option on equity shares. A freestanding equity-linked instrument that provides for a fixed payoff upon the occurrence of a contingent event which is not based on the issuer's share price is not indexed to an entity's own stock.
815-40-55-36
Entity A, whose functional currency is U.S. dollars (USD), issues warrants with a strike price denominated in Canadian dollars (CAD). The warrants permit the holder to buy 100 shares of its common stock for CAD 10 per share. Entity A's shares trade on an exchange on which trades are denominated in CAD. The warrants have 10-year terms and are exercisable at any time. The warrants are not considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instruments do not contain an exercise contingency. Proceed to Step 2.
- bStep 2. The strike price of the warrants is denominated in a currency other than the entity's functional currency, so the warrants are not considered indexed to the entity's own stock.
815-40-55-37
Entity A enters into a forward contract to sell 100 shares of its common stock for $10 per share in 1 year. Historically, Entity A has paid a dividend of $0.10 per quarter on its common shares. Under the terms of the forward contract, if dividends per common share differ from $0.10 during any 3-month period, the strike price of the forward contract will be adjusted to offset the effect of the dividend differential (actual dividend versus $0.10) on the fair value of the instrument. Additionally, the terms of the forward contract provide for an adjustment to the strike price, using commercially reasonable means, to offset the effect of any increased cost of borrowing Entity A's shares in the stock loan market on the fair value of the instrument. The forward contract is considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instrument does not contain an exercise contingency. Proceed to Step 2.
- bStep 2. The only circumstances in which the settlement amount will not equal the difference between the fair value of 100 shares and $1,000 ($10 per share) are if dividends per common share differ from $0.10 during any 3-month period or if there is an increased cost of borrowing Entity A's shares in the stock loan market. The adjustments to the strike price resulting from those events are intended to offset their effects on the instrument's fair value. In those circumstances, the only variables that could affect the settlement amount (dividends and stock borrow cost) would be inputs to the fair value of a fixed-for-fixed forward contract on equity shares.
815-40-55-38
Entity A enters into a net-settleable forward contract to sell 100 shares of its common stock in 1 year for an amount equal to $10 per share plus interest calculated at a variable interest rate (Federal Funds rate plus a fixed spread). The share price used to determine the settlement amount is based on the volume-weighted average daily market price of Entity A's common stock for the 30-day period before the settlement date. The forward contract is considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instrument does not contain an exercise contingency. Proceed to Step 2.
- bStep 2. The settlement amount will not equal the difference between the fair value of a fixed number of the entity's equity shares (100 shares) and a fixed strike price. However, the only variables that cause the settlement amount to differ from a fixed-for-fixed settlement amount are the 30-day volume-weighted average daily market price of Entity A's common stock and an interest rate index. The pricing inputs of a fixed-for-fixed forward contract include the entity's stock price and interest rates. Additionally, the floating interest rate feature does not introduce a leverage factor or otherwise increase the effects of interest rate changes on the instrument's fair value.
815-40-55-39
Entity A enters into a forward contract to sell 100 shares of its common stock in 1 year for an amount equal to $10 per share plus interest calculated at a variable interest rate that varies inversely with changes in the London Interbank Offered Rate (LIBOR) (similar to an "inverse floater," as described in paragraphs ). The forward contract is not considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instrument does not contain an exercise contingency. Proceed to Step 2.
- bStep 2. The settlement amount will not equal the difference between the fair value of a fixed number of the entity's equity shares (100 shares) and a fixed strike price. Although the number of shares that would be issued at settlement is fixed, the strike price varies inversely with changes in an interest rate index. The inverse floating interest rate feature increases the effects of interest rate changes on the instrument's fair value (that is, the feature increases the instrument's fair value exposure to interest rate changes) when compared to the exposure to interest rate changes of a fixed-for-fixed forward contract.
815-40-55-40
Entity A enters into a net-settled forward contract to sell 100 shares of its common stock in 1 year for $1,000. However, the maximum amount payable to the counterparty at maturity is capped when Entity A's stock price is greater than or equal to $15 per share (that is, Entity A's maximum obligation is $500 [($15 − $10) x 100 shares]). Additionally, the maximum amount receivable from the counterparty at maturity is capped when Entity A's stock price is less than or equal to $5 per share (that is, the counterparty's maximum obligation is $500 [($5 − $10) x 100 shares]). The forward contract is considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instrument does not contain an exercise contingency. Proceed to Step 2.
- bStep 2. The settlement amount would equal the difference between the fair value of a fixed number of the entity's equity shares (100 shares) and a fixed strike price ($1,000) when Entity A's stock price is between $5 and $15. However, whenever Entity A's stock price is greater than or equal to $15 at maturity, the amount payable to the counterparty always equals $500. Additionally, whenever Entity A's stock price is less than or equal to $5 at maturity, the amount receivable from the counterparty always equals $500. Because the only variable that can affect the settlement amount is the entity's stock price, which is an input to the fair value of a fixed-for-fixed forward contract, the instrument is considered indexed to the entity's own stock.
815-40-55-41
Entity A enters into a forward contract to sell a variable number of its common shares in 1 year for $1,000. If Entity A's stock price is equal to or less than $10 at maturity, Entity A will issue 100 shares of its common stock to the counterparty. If Entity A's stock price is greater than $10 but equal to or less than $12 at maturity, Entity A will issue a variable number of its common shares worth $1,000. Finally, if the share price is greater than $12 at maturity, Entity A will issue 83.33 shares of its common stock. The forward contract is considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instrument does not contain an exercise contingency. Proceed to Step 2.
- bStep 2. The settlement amount will not equal the difference between the fair value of a fixed number of the entity's equity shares and a fixed strike price ($1,000). Although the strike price to be received at settlement is fixed, the number of shares to be issued to the counterparty varies based on the entity's stock price on the settlement date. Because the only variable that can affect the settlement amount is the entity's stock price, which is an input to the fair value of a fixed-for-fixed forward contract on equity shares, the instrument is considered indexed to the entity's own stock.
815-40-55-42
Entity A enters into a forward contract to sell 100 shares of its common stock for $10 per share in 1 year. Under the terms of the forward contract, the strike price of the forward contract would be adjusted to offset the resulting dilution (except for issuances and repurchases that occur upon settlement of outstanding option or forward contracts on equity shares) if Entity A does any of the following:
- aDistributes a stock dividend or ordinary cash dividend
- bExecutes a stock split, spinoff, rights offering, or recapitalization through a large, nonrecurring cash dividend
- cIssues shares for an amount below the then-current market price
- dRepurchases shares for an amount above the then-current market price.
815-40-55-43
The forward contract is considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instrument does not contain an exercise contingency. Proceed to Step 2.
- bStep 2. The only circumstances in which the settlement amount will not equal the difference between the fair value of 100 shares and $1,000 ($10 per share) are upon the occurrence of any of the following:
- 1The distribution of a stock dividend or ordinary cash dividend
- 2The execution of a stock split, spinoff, rights offering, or recapitalization through a large, nonrecurring cash dividend
- 3The issuance of shares for an amount below the then-current market price
- 4The repurchase of shares for an amount above the then-current market price.
- 1
815-40-55-44
Entity A, whose functional currency is US$, enters into a forward contract that requires Entity A to sell 100 shares of its common stock for 120 euros per share in 1 year. The forward contract is not considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The instrument does not contain an exercise contingency. Proceed to Step 2.
- bStep 2. The strike price of the forward contract is denominated in a currency other than the entity's functional currency, so the forward contract is not considered indexed to the entity's own stock.
815-40-55-45
Entity A issues a contingently convertible debt instrument with a par value of $1,000 that is convertible into 100 shares of its common stock. The convertible debt instrument has a 10-year term and is convertible at any time after any of the following events occurs:
- aEntity A's stock price exceeds $13 per share (market price trigger).
- bThe convertible debt instrument trades for an amount that is less than 98 percent of its if-converted value (parity provision).
- cThere is an announcement of a merger involving Entity A.
815-40-55-46
The terms of the convertible debt instrument also include a make-whole provision. Under that provision, if Entity A is acquired for cash before a specified date, the holder of the convertible debt instrument can convert into a number of shares equal to the sum of the fixed conversion ratio (100 shares per bond) and the make-whole shares. The number of make-whole shares is determined by reference to a table with axes of stock price and time. That table was designed such that the aggregate fair value of the shares deliverable (that is, the fair value of 100 shares per bond plus the make-whole shares) would be expected to approximate the fair value of the convertible debt instrument at the settlement date, assuming no change in relevant pricing inputs (other than stock price and time) since the instrument's inception. The embedded conversion option is considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The market price trigger and parity provision exercise contingencies are based on observable markets; however, those contingencies relate solely to the market prices of the entity's own stock and its own convertible debt. Also, the merger announcement exercise contingency is not an observable market or an index. Therefore, Step 1 does not preclude the warrants from being considered indexed to the entity's own stock. Proceed to Step 2.
- bStep 2. An acquisition for cash before the specified date is the only circumstance in which the settlement amount will not equal the difference between the fair value of 100 shares and a fixed strike price ($1,000 fixed par value of the debt). The settlement amount if Entity A is acquired for cash before the specified date is equal to the sum of the fixed conversion ratio (100 shares per bond) and the make-whole shares. The number of make-whole shares is determined based on a table with axes of stock price and time, which would both be inputs in a fair value measurement of a fixed-for-fixed option on equity shares.
815-40-55-47
Entity A, whose functional currency is the Chinese yuan (CNY), issues a debt instrument denominated in CNY with a par value of CNY 1,000 that is convertible into 100 shares of its common stock. Entity A's shares only trade on an exchange in which trades are denominated in US$. Those shares do not trade on an exchange (or other established marketplace) in which trades are denominated in CNY. The convertible debt instrument has a 10-year term and is convertible at any time. The embedded conversion option is considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The embedded conversion option does not contain an exercise contingency. Proceed to Step 2.
- bStep 2. Upon exercise of the embedded conversion option, the settlement amount would equal the difference between the fair value of a fixed number of the entity's equity shares (100 shares) and a fixed strike price denominated in its functional currency (CNY 1,000 fixed par value of the debt). The determination of whether the embedded conversion option is indexed to the entity's own stock is not affected by the currency (or currencies) in which the underlying shares trade.
815-40-55-48
Entity A issues a security to investors for purposes of establishing a market-based measure of the grant-date fair value of a grant of stock options issued in a share-based payment transaction. Under the terms of that market-based stock option valuation instrument, Entity A is obligated to make variable quarterly payments to the investors that are a function of the net intrinsic value received by a pool of Entity A's grantees, based on actual stock option exercises by those grantees each period. The market-based stock option valuation instrument has a 10-year term, consistent with the contractual term of the underlying stock options. The market-based stock option valuation instrument is not considered indexed to Entity A's own stock based on the following evaluation:
- aStep 1. The analysis of the exercise contingency (or contingencies) depends on the particular terms and features of the instrument. However, as indicated in Step 2 below, a market-based stock option valuation instrument would not be considered indexed to the entity's own stock.
- bStep 2. The settlement amount will not equal the difference between the fair value of a fixed number of the entity's equity shares and a fixed strike price. The instrument provides for variable quarterly payments to investors that are based on actual stock option exercises for the period. Because a variable that affects the instrument's settlement amount is stock option exercise behavior, which is not an input to the fair value of a fixed-for-fixed option or forward contract on equity shares, the instrument is not considered indexed to the entity's own stock.
815-40-55-49
This Example illustrates the application of the guidance in paragraphs . Entity A issues warrants that permit the holder to buy 100 shares of its common stock for $10 per share. The warrants have a 10-year term and are exercisable at any time. At issuance, Entity A determines that the warrants are equity classified in accordance with this Subtopic. Prior to the modifications described in Cases A, B, and C, the warrants have not been modified since issuance and remain equity classified.
815-40-55-50
Entity A reduces the exercise price of the warrants to $9 per share for a 60-day period to induce exercise of the outstanding warrants. Entity A determines that the warrants remain equity classified in accordance with this Subtopic after the modification. Entity A considers the guidance in paragraphs and determines that the circumstances of the warrant modification indicate that the modification is executed in contemplation of an equity offering (that is, to induce the imminent exercise of the outstanding warrants and raise equity capital). Entity A concludes that the incremental fair value of the outstanding warrants is an incremental cost directly attributable to a proposed equity offering. Entity A recognizes the incremental fair value of the outstanding warrants as an equity issuance cost in accordance with paragraph 815-40-35-17(a). At the date on which the modification is executed by Entity A and the warrant holder, Entity A recognizes deferred costs of an offering (calculated in accordance with paragraph 815-40-35-16) to be charged against the gross proceeds of the offering. See paragraphs and 505-10-50-3 for disclosure guidance.
815-40-55-51
Entity A extends the term of the outstanding warrants, which results in an increase in the fair value of the outstanding warrants. Entity A determines that the warrants remain equity classified in accordance with this Subtopic after the modification. The warrant holder is a nonemployee investor that has no other commercial relationship with Entity A. The modification is not executed in contemplation of an imminent equity offering or a financing transaction. Entity A considers the guidance in paragraphs and determines that the circumstances of the warrant modification do not indicate that there are other transactions entered into contemporaneously or in contemplation of the warrant modification or other rights and privileges obtained or obligations incurred to achieve an overall economic effect. Entity A concludes that the warrant modification is not related to a financing or compensation for goods and services and is not within the scope of another Topic. At the date on which Entity A and the warrant holder execute the modification, Entity A recognizes the incremental fair value of the outstanding warrants as a dividend to the warrant holder in accordance with paragraph 815-40-35-17(d). See paragraphs 260-10-45-15 and for earnings-per-share guidance and paragraphs and 505-10-50-3 for disclosure guidance.
815-40-55-52
Entity A reduces the exercise price of the warrants to $8 per share for the remaining term as a consideration for certain services received from the warrant holder. Entity A determines that the warrants remain equity classified in accordance with this Subtopic after the modification. Entity A considers the guidance in paragraphs and determines that the circumstances of the warrant modification indicate that the modification is executed to compensate the warrant holder for the services provided to Entity A. Because the warrant modification is executed to compensate the warrant holder in a share-based payment arrangement, Entity A accounts for that modification by applying the requirements in Topic 718 (that is, the guidance in paragraphs is not applicable).
815-40-65Transition and Open Effective Date Information
Source downloaded: .Record version 08c4113bea96. Effective date must be checked in the source.
815-40-65-1
Paragraph superseded on 06/30/2025 after the end of the transition period stated in Accounting Standards Update No. 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity's Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity's Own Equity.
815-40-65-2
Paragraph superseded on 07/10/2023 after the end of the transition period stated in Accounting Standards Update No. 2021-04, Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entity's Own Equity (Subtopic 815-40): Issuer's Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options.
815-40-S50DisclosureSEC
Source downloaded: .Record version 13bf7967942d. Effective date must be checked in the source.
Warrants or Rights Outstanding
815-40-S50-1
See paragraph 235-10-S99-1, Regulation S-X Rule 4-08(i), for presentation requirements for warrants or rights outstanding.