Re: Technical Corrections and Improvements Related to Contracts on an Entity s Own Equity

Deloitte & Touche LLP 695 East Main Street P.O. Box 10098 Stamford, CT 06901-2150 Tel: + 1 203 761 3000 www.deloitte.com August 24, 2015 Ms. Susan M. Cosper Technical Director Financial Accounting Standards Board 401 Merritt 7 P.O. Box 5116 Norwalk, CT 06856-5116 Re: Technical Corrections and Improvements Related to Contracts on an Entity s Own Equity Dear Ms. Cosper: In applying the FASB Accounting Standards Codification guidance on contracts on an entity s own equity, we have identified certain provisions that we believe are incorrect and others that we think could be clarified. Therefore, we are writing to propose that the Board make certain technical corrections and improvements to this guidance. We describe our proposed technical corrections in Appendix A of this letter and our other proposed improvements in Appendix B. We support the Board s commitment to its ongoing project to make technical corrections, clarifications, and minor improvements to keep the Codification up to date. Limiting this project to minor changes that do not significantly affect current practice is the most practical and efficient way to resolve technical issues related to the Codification. We would be happy to discuss our comments with Board members or staff. If you have any questions concerning our proposed technical corrections and improvements, please contact Magnus Orrell at 203-761-3402. Yours truly, Deloitte & Touche LLP cc: Bob Uhl Jonathan Howard

Appendix A Proposed Technical Corrections Classification of Detachable Stock Purchase Warrants (ASC 470-20) ASC 470-20 contains guidance on accounting for detachable stock purchase warrants that are sold together with a debt instrument and suggests that the amount allocated to such warrants should be accounted for as paid-in capital. ASC 470-20-25-2 and 25-3 state, in part: Proceeds from the sale of a debt instrument with stock purchase warrants (detachable call options) shall be allocated to the two elements based on the relative fair values of the debt instrument without the warrants and of the warrants themselves at time of issuance. The portion of the proceeds so allocated to the warrants shall be accounted for as paid-in capital. The remainder of the proceeds shall be allocated to the debt instrument portion of the transaction. This usually results in a discount (or, occasionally, a reduced premium), which shall be accounted for under Topic 835. [Emphasis added] The same accounting treatment applies to issues of debt instruments (issued with detachable warrants) that may be surrendered in settlement of the exercise price of the warrant. The requirement to allocate the amount attributable to the warrants to paid-in capital conflicts with other GAAP that may require entities to classify the warrants as liabilities. In particular, we believe that the portion of the proceeds allocated to the warrant should be accounted for as paidin capital only if the warrant (1) does not have to be classified as a liability under ASC 480-10 and (2) meets the conditions for equity classification in ASC 815-40 (unless other GAAP apply, such as ASC 718). Further, the relative-fair-value allocation approach described in ASC 470-20- 25-2 is only applied in practice if the detachable warrant qualifies for classification in equity, not if the warrant must be accounted for at fair value with changes in fair value recognized in earnings on a recurring basis. 1 Before the FASB s codification of U.S. GAAP, this guidance was found in APB Opinion 14. 2 When the FASB and EITF subsequently issued guidance on evaluating whether warrants and other contracts on an entity s own equity should be classified as equity or liabilities (e.g., FASB Statement 150 3 and EITF Issue 00-19 4 ), they did not make consequential amendments to Opinion 14. In practice, however, it was generally understood that the guidance in Opinion 14 regarding the classification of detachable stock purchase warrants should be interpreted in light of the FASB s and the EITF s subsequent guidance regarding the classification of contracts on an entity s own equity. There are no scope exceptions in ASC 480-10 or ASC 815-40 for stock purchase warrants to which ASC 470-20-25-2 or 25-3 applies. Therefore, we believe that those Codification subtopics apply to the determination of the appropriate classification of the types of detachable stock purchase warrants that are described in ASC 470-20-25-2 and 25-3. However, because ASC 470-20 contains no scope exception for contracts within the scope of ASC 480-10 and does not indicate that an entity also must consider the guidance in ASC 815-40 (or other GAAP) to determine the appropriate accounting for a stock purchase warrant, practitioners may be misled. 1 A 2006 working draft of a Technical Practice Aid, which was prepared by the Convertible Debt, Convertible Preferred Shares, Warrants, and Other Equity-Related Financial Instruments Task Force and the AICPA staff, states, in part: In practice, for financing transactions that include debt or equity instruments and other freestanding financial instruments that are recorded at fair value each period with changes in fair value recorded in earnings, practitioners generally record the freestanding mark-to-fair value instrument at its initial fair value, and allocate the residual proceeds to the debt or equity instrument. 2 APB Opinion No. 14, Accounting for Convertible Debt and Debt Issued With Stock Purchase Warrants. 3 FASB Statement No. 150, Accounting for Certain Financial Instruments With Characteristics of Both Liabilities and Equity. 4 EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, an Entity s Own Stock. 2

We propose that the Board resolve the conflict between ASC 470-20 and other Codification topics by amending ASC 470-20-25-2 as follows: Proceeds from the sale of a debt instrument with stock purchase warrants (detachable call options) shall be allocated to the two elements. If the detachable warrant qualifies as equity under other applicable GAAP (including Subtopics 480-10 and 815-40), the based on the relative fair values of the debt instrument without the warrants and of the warrants themselves at time of issuance. The portion of the proceeds so allocated to the warrants shall be accounted for as paid-in capital. In this case, allocation shall be based on the relative fair values of the debt instrument without the warrants and of the warrants themselves at the time of issuance (provided that the entity does not elect the fair value option in Subtopic 825-10 for the debt instrument). Irrespective of the allocation method, the The remainder of the proceeds shall be allocated to the debt instrument portion of the transaction. This usually results in a discount (or, occasionally, a reduced premium), which shall be accounted for under Topic 835. Unit-of-Account Guidance for Certain Freestanding Contracts Indexed to, and Potentially Settled in, a Noncontrolling Interest (ASC 480-10) ASC 480-10-55 contains conflicting guidance on whether certain freestanding option contracts indexed to, and potentially settled in, a noncontrolling interest (NCI) in a subsidiary ( Derivative 2 ) should be accounted for on a combined basis with the related NCI. ASC 480-10-55-53(b) describes the terms of Derivative 2 as follows: A controlling majority owner (parent) holds 80 percent of a subsidiary s equity shares. The remaining 20 percent (the noncontrolling interest) is owned by an unrelated entity (the noncontrolling interest holder). Simultaneous with the acquisition of the noncontrolling interest, the noncontrolling interest holder and the parent enter into a derivative instrument that is indexed to the subsidiary s equity shares. The terms of the derivative instrument may be any of the following:... b. The parent has a call option to buy the other 20 percent at a fixed price at a stated future date, and the noncontrolling interest holder has a put option to sell the other 20 percent to the parent under those same terms, that is, the fixed price of the call is equal to the fixed price of the put option. (Derivative 2) ASC 480-10-55-55 specifies that freestanding option contracts with the terms of Derivative 2 should not be accounted for on a combined basis with the related NCI: If Derivative 2 was issued as a single freestanding instrument, under this Subtopic it would be accounted for in its entirety as a liability (or an asset in some circumstances), initially and subsequently measured at fair value. If the written put option and the purchased call option in Derivative 2 were issued as freestanding instruments, the written put option would be accounted for under this Subtopic as a liability measured at fair value, and the purchased call option would be accounted for under Subtopic 815-40. Under both of those situations, the noncontrolling interest is accounted for separately from the derivative instrument under applicable guidance. [Emphasis added] Further, ASC 480-10-55-57 notes that freestanding financial instruments generally should not be combined with the related NCI: In applying paragraphs 480-10-25-4 through 25-14 to determine classification, a freestanding financial instrument within this Subtopic s scope is precluded from being combined with another freestanding financial instrument, unless combination is required under the provisions of Topic 815; therefore, unless under the particular facts and circumstances that Topic provides otherwise, freestanding derivative instruments in the scope of this Subtopic would not be combined with the noncontrolling interest. [Emphasis added] Similarly, ASC 480-10-25-15 prohibits the combination of freestanding financial instruments within the scope of ASC 480-10 unless combination is required by ASC 815: A freestanding financial instrument that is within the scope of this Subtopic shall not be combined with another freestanding financial instrument in applying paragraphs 480-10-25-4 through 25-14 unless 3

combination is required under the provisions of Topic 815. For example, a freestanding written put option that is classified as a liability under this Subtopic shall not be combined with an outstanding equity share. However, ASC 480-10-55-59 directly contradicts the aforementioned guidance, stating that freestanding option contracts with the terms of Derivative 2 should be accounted for on a combined basis with the related NCI: If the derivative instrument in Derivative 2 is freestanding of the noncontrolling interest, it should be combined with the noncontrolling interest and accounted for as a financing. That is, the combination of option contracts should be viewed on a combined basis with the noncontrolling interest and accounted for as a financing of the parent s purchase of the noncontrolling interest. [Emphasis added] We believe that ASC 480-10-55-59 does not accurately reflect U.S. GAAP as of the date of the FASB s Codification thereof (July 1, 2009). The guidance in ASC 480-10-55-59 was carried forward from the consensus in EITF Issue 00-04. 5 Paragraph 18 in the status section of EITF 00-04 specifies that the guidance had been nullified for freestanding derivatives with the terms of Derivative 2: Statement 150 [i.e., ASC 480-10] nullifies the consensus reached in this issue unless the derivative in Derivative 2 is not freestanding of the noncontrolling interest. Further, paragraph 16 of Issue 00-04 states: Derivative 2 Depending on how the derivative was issued, one of three different accounting methods applies. If Derivative 2 was issued as a single freestanding instrument, under Statement 150 it is accounted for in its entirety as a liability (or an asset in some circumstances), initially and subsequently measured at fair value. If the written put option and the purchased call option in Derivative 2 were issued as freestanding instruments, the written put option is accounted for under Statement 150 as a liability measured at fair value, and the purchased call option would be accounted for under Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company s Own Stock, Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity s Own Stock, and Issue No. 08-8, Accounting for an Instrument (or an Embedded Feature) with a Settlement Amount That Is Based on the Stock of an Entity s Consolidated Subsidiary. Under both of those situations, the noncontrolling interest is accounted for separately from the derivatives under applicable guidance. However, if the written put option and purchased call option are embedded in the shares (noncontrolling interest) and the shares are not mandatorily redeemable, the freestanding instrument is not in the scope of Statement 150 and continues to be accounted for under this Issue with the parent consolidating 100 percent of the subsidiary. [Emphasis added] Accordingly, the guidance in ASC 480-10-55-59 should not have been incorporated into the Codification. We propose the following modifications to ASC 480-10-55-59 and 55-60 to clarify that they apply to option contracts with terms of Derivative 2 that are embedded in the NCI: If the derivative instrument in Derivative 2 is embedded in freestanding of the shares (noncontrolling interest) and the shares are not classified as liabilities under Subtopic 480-10, the derivative instrument it should be combined with the noncontrolling interest and accounted for as a financing. That is, the combination of option contracts should be viewed on a combined basis with the noncontrolling interest and accounted for as a financing of the parent's purchase of the noncontrolling interest. Under that approach, the parent would consolidate 100 percent of the subsidiary and would attribute the stated yield earned under the combined derivative instrument and noncontrolling interest position to interest expense (that is, the financing would be accreted to the strike price of the forward or option over the period until settlement). No gain or loss would be recognized on the sale of the noncontrolling interest by the parent to the noncontrolling interest holder at the inception of the derivative instrument. 5 EITF Issue No. 00-04, Majority Owner s Accounting for a Transaction in the Shares of a Consolidated Subsidiary and a Derivative Indexed to the Noncontrolling Interest in That Subsidiary. 4

Classification of Contracts That Require Physical Settlement or Net Share Settlement (ASC 815-40) ASC 815-40-25-4 includes classification guidance for contracts on an entity s own equity that require physical settlement or net share settlement. It states, in part: Accordingly, unless the economic substance indicates otherwise:... b. Contracts shall be initially classified as equity in both of the following situations: 1. Contracts that require physical settlement or net share settlement 2. Contracts 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 815-40-25-7 through 25-35 and 815-40-55-2 through 55-6 have been met. [Emphasis added] As worded, ASC 815-40-25-4 gives the impression that the criteria in ASC 815-40-25-7 through 25-35 and 815-40-55-2 through 55-6 apply to contracts that give the entity a choice of net cash settlement or settlement in its own shares (physical settlement or net share settlement) and not to contracts that require physical settlement or net share settlement. However, the criteria apply in both circumstances. The criteria indicate that it is not sufficient that a contract requires physical settlement or net share settlement. For instance, ASC 815-40-25-14 requires asset or liability classification for contracts in which physical settlement or net share settlement by delivery of registered shares is required and the contract does not provide a noncash alternative if the entity is unable to deliver registered shares (cash settlement is assumed). We propose that the Board amend ASC 815-40-25-4 as follows: Accordingly, unless the economic substance indicates otherwise:... b. Contracts shall be initially classified as equity if all the criteria in paragraphs 815-40-25-7 through 25-35 and 815-40-55-2 through 55-6 have been met in both of the following situations: 1. Contracts that require physical settlement or net share settlement 2. Contracts 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 815-40-25-7 through 25-35 and 815-40-55-2 through 55-6 have been met. 5

Appendix B: Proposed Improvements Scope Exception in ASC 815-40 for Embedded Features ASC 815-40-15-3(a) exempts certain hybrid contracts and embedded features from the scope of ASC 815-40: The guidance in this Subtopic does not apply to any of the following: a. Either the derivative instrument component or the financial instrument if the derivative instrument component is embedded in and not detachable from the financial instrument [Emphasis added] The scope exception in ASC 815-40-15-3(a) refers to derivative instrument components. The term derivative instrument is defined in ASC 815-40-20 by reference to ASC 815-10. Not all embedded features meet the definition of a derivative instrument in ASC 815-10. For example, an equity conversion feature embedded in a debt security may not have the net settlement characteristic of a derivative instrument in ASC 815-10 if it must be physically settled in privatecompany stock upon conversion. Because ASC 815-40-15-3 refers to derivative instrument components and ASC 815-40 defines a derivative instrument by reference to ASC 815-10, one gets the impression that an entity would need to evaluate whether the feature meets the definition of a derivative instrument in ASC 815-10 to determine whether the feature is outside the scope of ASC 815-40 under ASC 815-40-15-3. We think that an embedded feature is outside the scope of ASC 815-40 irrespective of whether the feature has all of the characteristics of a derivative instrument in ASC 815-10 (except when an entity evaluates whether the feature must be bifurcated as an embedded derivative under ASC 815-10-15). Not only is the guidance applied this way in practice but also it is consistent with the EITF s original intention in providing the scope exception. There is no scope provision in ASC 815-40 under which embedded features would be included within the scope of ASC 815-40 other than when an entity evaluates whether such features must be bifurcated as embedded derivatives under ASC 815-15. When the EITF developed the wording of the scope exception in deliberating EITF Issue 96-13, 6 the current definition of a derivative instrument in ASC 815-10 did not yet exist. Issue Summary No. 1 (dated June 19, 1996) for Issue 96-13 states, in part: The Task Force decided to not include embedded contracts in the scope of the Issues comprising the 94-7 Framework [i.e., the accounting for financial instruments indexed to, and potentially settled in, a company s own stock]. Accordingly, this Issue does not address written call options and warrants that are embedded in and not detachable from other financial instruments. We propose the following amendment to the scope exception in ASC 815-40-15-3(a): The guidance in this Subtopic does not apply to any of the following: a. Either a feature that is indexed to, and potentially settled in, an entity s own stock if it is embedded in and not detachable from another financial instrument or the financial instrument (other than an option, warrant, or forward) that includes such a feature. Either the derivative instrument component or the financial instrument if the derivative instrument component is embedded in and not detachable from the financial instrument 6 EITF Issue No. 96-13, Accounting for Derivative Instruments Indexed to, and Potentially Settled in, a Company s Own Stock. 6

Unit-of-Account Guidance in ASC 815-40-15 ASC 815-40-15-5B states: The guidance in paragraphs 815-40-15-5 through 15-8 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 815-40-15-5 through 15-8 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 815-40-15-5 through 15-8 shall be applied to the combined financial instrument. [Emphasis added] Before the FASB s codification of U.S. GAAP, the guidance in ASC 815-40-15-5B was located in paragraph 7 of EITF Issue 07-5. 7 With the exception of its illustrative examples, Issue 07-5 was codified in ASC 815-40-15-5 through 15-8. Therefore, the wording of ASC 815-40-15-5B is not necessarily inaccurate. However, the guidance is potentially misleading because all of the guidance in ASC 815-40, not just ASC 815-40-15-5 through 15-8, ought to be applied to the appropriate unit of account. We believe the unit of account for a contract is the same throughout ASC 815-40. It would be illogical to identify the unit of account differently in applying different provisions of ASC 815-40. Further, the term unit of accounting should be replaced with unit of account to conform to the FASB Codification Master Glossary. We therefore propose that the FASB amend ASC 815-40-15-5B as follows: The guidance in this Subtopic paragraphs 815-40-15-5 through 15-8 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 this Subtopic paragraphs 815-40-15-5 through 15-8 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 this Subtopic paragraphs 815-40-15-5 through 15-8 shall be applied to the combined financial instrument. Accounting for Lock-Up Options ASC 815-40-15-6 states: 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 815-40-15-5 through 15-8 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. Unlike other guidance in ASC 815-40, the guidance in this paragraph applies to the counterparty to a contract on an entity s own equity (i.e., an entity that is a party to a contract on another entity s equity). Further, under this paragraph, lock-up options are outside the scope of the derivative accounting in ASC 815-10 until such options become exercisable. Because this guidance is located in ASC 815-40, however, there is a risk that practitioners may overlook it in applying ASC 815-10. 7 EITF Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity s Own Stock. 7

We propose that the FASB add a scope exception to ASC 815-10 for lock-up options that meet the criteria in ASC 815-40-15-6 by amending ASC 815-10-15-13 and adding a new paragraph ASC 815-10-15-82A as follows: Notwithstanding the conditions in paragraphs 815-10-15-83 through 15-139, the following contracts are not subject to the requirements of this Subtopic if specified criteria are met:... o. Certain lock-up options. A lock-up option is not subject to the requirements of this Subtopic unless and until the option becomes exercisable. Relationship Between Steps 1 and 2 of ASC 815-40-15 ASC 815-40-15-7C states, in part: 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: a. The fair value of a fixed number of the entity's equity shares b. A fixed monetary amount or a fixed amount of a debt instrument issued by the entity. [Emphasis added] ASC 815-40-15-7C is potentially misleading because an instrument (or embedded feature) is not necessarily considered indexed to an entity s own equity even if its settlement amount will equal the difference between the two amounts described in ASC 815-40-15-7C. To be considered indexed to the entity s own equity, the instrument (or feature) cannot contain an impermissible exercise contingency under ASC 815-40-15-7A. The same issue is discussed in ASC 815-40-15-7D, which states: 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. [Emphasis added] We propose that the FASB amend ASC 815-40-15-7C and 15-7D as follows: Unless ASC 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: a. The fair value of a fixed number of the entity's equity shares b. A fixed monetary amount or a fixed amount of a debt instrument issued by the entity.... 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 ASC 815-40- 15-7A does not preclude such a conclusion). 8

Definition of a Lock-Up Option Although ASC 815-40-20 does not define the term lock-up option, the Codification Master Glossary defines it as follows: Contingently exercisable options to purchase equity securities of another party to a business combination, at favorable prices, to encourage successful completion of that combination. If the merger is consummated as proposed, the options expire unexercised. If, however, a specified event occurs that interferes with the planned business combination, the options become exercisable. We propose that the FASB incorporate the Codification Master Glossary s definition of a lockup option into ASC 815-40-20. If the FASB agrees with our recommendation to add a scope exception to ASC 815-10 for lock-up options, it should add the Codification s definition of lockup option to ASC 815-10-20 as well. Settlement Alternatives With Different Economic Values ASC 815-40-25-3 states: Except as noted in the last sentence of this paragraph, the approach discussed in the preceding two 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, this Subtopic 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. [Emphasis added] The reference to this Subtopic in the last sentence of this paragraph is misleading because ASC 815-40 applies irrespective of whether the condition in the last sentence is met. We therefore propose the following amendment to ASC 815-40-25-3, which would be consistent with the first sentence of the paragraph: Except as noted in the last sentence of this paragraph, the approach discussed in the preceding two 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 the preceding two paragraphs this Subtopic 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. Disclosures About Settlement Alternatives ASC 815-40-50-5(d) states: The disclosures required by Section 505-10-50 apply to all contracts within the scope of this Subtopic as follows:... d. A contract's current fair value for each settlement alternative (denominated, as relevant, in monetary amounts or quantities of shares) and how changes in the price of the issuer's equity instruments affect those settlement amounts (for example, the issuer is obligated to issue an 9

additional X shares or pay an additional Y dollars in cash for each $1 decrease in stock price) 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.) [Emphasis added] The wording of this paragraph is puzzling because fair value is an amount (the FASB Codification Master Glossary defines fair value as an amount or price). By definition, fair value cannot be a quantity of shares. Further, a contract that contains settlement alternatives would not have multiple fair values even though the wording of the requirement suggests that a fair value might exist for each settlement alternative. We believe that the intent of the guidance in ASC 815-40-50-5(d) is to obtain the same type of information that must be disclosed for financial instruments subject to the guidance in ASC 480-10-25. ASC 480-10-50-2 states, in part: Additionally, for all outstanding financial instruments recognized under the guidance in Section 480-10-25 and for each settlement alternative, issuers shall disclose all of the following: a. 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 b. How changes in the fair value of the issuer's equity shares would 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") We propose that the FASB modify the wording of ASC 815-40-50-5(d) as follows to make it parallel to that in ASC 480-10-50-2: The disclosures required by Section 505-10-50 apply to all contracts within the scope of this Subtopic as follows:... d. For each A contract's current fair value for each settlement alternative, the amount that would be paid, or the number (denominated, as relevant, in monetary amounts or quantities 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 price of the issuer's equity shares instruments would 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 stock price) 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.) Disclosures About Contracts Classified in Temporary Equity ASC 815-40-50-5(e) states: The disclosures required by Section 505-10-50 apply to all contracts within the scope of this Subtopic as follows:... e. The 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.) [Emphasis added] We believe that there are no freestanding contracts within the scope of ASC 815-40 that would be classified as temporary equity. As noted in paragraph 3(b) of ASC 480-10-S99-3A, freestanding financial instruments that were previously classified outside of permanent equity under ASC 815-40 are now classified as assets or liabilities under ASC 480-10. A redeemable equity instrument that would be classified in temporary equity under ASC 480-10-S99-3A is 10

outside the scope of ASC 815-40 except in the evaluation of whether the embedded redemption feature (e.g., an embedded written put option) should be bifurcated as an embedded derivative under ASC 815-15 (see ASC 815-40-15-2 through 15-4). Accordingly, there are no contracts or features to which ASC 815-40-15-5(e) applies. We therefore propose that the FASB delete ASC 815-40-50-5(e). Table for Embedded Written Put Options and Embedded Forward Purchase Contracts ASC 815-40-55-11 includes a table that describes how ASC 815-40 applies to embedded written put options and embedded forward purchase contracts. This table includes rows for both (1) initial classification and (2) initial measurement, and subsequent classification and measurement. ASC 815-40 does not apply to hybrid contracts or embedded features except when an entity is analyzing whether an embedded feature must be bifurcated as an embedded derivative under ASC 815-15-25-1(c) (see ASC 815-40-15-2 through 15-4). ASC 815-40 is relevant to the bifurcation analysis because it provides guidance on whether the embedded feature meets the scope exception in ASC 815-10-15-74(a) for certain contracts on an entity s own equity (i.e., whether the embedded feature would have been classified as equity under ASC 815-40 if it were a freestanding contract). Accordingly, the classification guidance, but not the measurement guidance, in ASC 815-40 is relevant to embedded features. However, the table may give the impression that embedded written put options and embedded forward purchase contracts are accounted for separately and measured as set out in the table. Consider, for example, a debt instrument with an embedded net-share-settled written put option on an entity s own stock. The table implies that the embedded option (or maybe the hybrid contract) would be initially measured at fair value and classified in permanent equity, with no changes in fair value recognized after initial recognition. However, such an application of GAAP would not be correct. Instead, the debt instrument would be accounted for similarly to other financial liabilities and the net-share-settled written put option would be exempt from recognition as an embedded derivative under ASC 815-15 (provided that it meets the scope exception from derivative accounting in ASC 815-10-15-74(a)). We propose that the FASB amend the table by deleting the guidance on initial and subsequent measurement (i.e., by keeping only the classification guidance). Puttable Warrants ASC 815-40-55-15 states: 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. The warrants described in ASC 815-40-55-15 would be classified as liabilities under ASC 480-10 even if they did not provide the holder with a guaranteed return in cash that is significantly 11

greater than the value of the share-settlement alternative on the issuance date. This is because the warrants embody an obligation that is indexed to an obligation to repurchase the issuer s shares and may require a transfer of assets (see, for example, ASC 480-10-55-31 and ASC 815-40-55-18). However, ASC 815-40-55-15 gives the impression that an entity needs to evaluate whether the guaranteed return in cash is significantly greater than the value of the share-settlement alternative on the issuance date to determine whether the warrant should be classified as a liability. We propose that the FASB amend ASC 815-40-55-15 as follows: 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. (Such warrants would be classified as liabilities under Topic 480 even if they did not 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.) 12