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For various reasons a reporting entity may choose to sell its own shares for future delivery using a derivative instrument; these contracts can require or permit the reporting entity to issue shares or give the investor the option to buy shares. Figure FG 8-1 summarizes certain common contracts.
Figure FG 8-1
Summary of certain common contracts to issue shares
Contract
Summary of terms
Mandatory or optional settlement
Forward sale
Reporting entity agrees to sell a fixed number of shares to an investor on a specified date in the future, typically at a fixed price
Mandatory
Warrant (written call option)
The investor can buy a fixed number of shares on or by a specified date in the future or upon the occurrence of an event, typically at a fixed price
Investor’s option
Variable share forward delivery agreement
The reporting entity agrees to sell a variable number of shares, based on its stock price or some other variable, to an investor at a fixed price on a specified date in the future
Mandatory
A fixed price contract typically allows for a price adjustment upon the occurrence of specified events.
Settlement may involve “gross physical settlement” where the full number of shares underlying the contract and exercise prices are exchanged or “net settlement” where the unrealized economic gain or loss on the contract is settled by the payment of cash or shares.

8.2.1 Forward sale contracts

A forward sale contract obligates the holder to buy (and obligates the reporting entity to sell) a specified number of the reporting entity’s shares at a specified date and price. A forward contract effectively fixes the price a holder will pay for the reporting entity’s stock.
Most forward sale contracts are not within the scope of ASC 480, Distinguishing Liabilities from Equity; however, the terms of each contract should be evaluated to determine whether that is the case. Certain forward sale contracts are within the scope of ASC 480, including:
  • A prepaid forward contract to deliver a variable number of the reporting entity’s own shares equal to a fixed monetary amount
  • A forward contract to sell redeemable shares

See FG 5.5 for further information on ASC 480.
If a reporting entity concludes that a forward contract is not within the scope of ASC 480, the next step is to determine whether the contract should be classified as a liability or equity under the guidance in ASC 815-40, Derivatives and Hedging–Contracts in Entity’s Own Equity. See FG 5.6 for further information on the analysis of a freestanding equity-linked instrument under ASC 815 after the adoption of ASU 2020-06 or FG 5.6A for further information on the analysis of a freestanding equity-linked instrument before the adoption of ASU 2020-06.

8.2.1.1 Forward sale contracts on redeemable equity

A reporting entity may enter into a forward sale contract on any class of equity instrument, including preferred shares that are redeemable or contingently redeemable for cash or other assets upon the occurrence of events outside the control of the reporting entity.
A forward sale contract on redeemable shares should be classified as a liability (or, in some cases, an asset, depending on the contract’s stock price) based on the guidance in ASC 480 because it creates an obligation for the reporting entity to repurchase its shares. As discussed in ASC 480-10-55-33, this guidance not only applies to mandatorily redeemable and puttable shares, but also to shares that are redeemable, or contingently redeemable upon a defined contingency; the probability of the contingency occurring should not be considered.
See FG 5.5 for information on the application of ASC 480, including initial and subsequent measurement.

8.2.2 Warrants (written call options)

A warrant (or written call option) on a reporting entity’s own stock gives the holder the right, but not the obligation, to buy the reporting entity’s shares on or by a certain date, at a specified price. The reporting entity receives a premium from the holder when it issues a warrant on its own stock, although oftentimes the premium may be in the form of a lower interest rate on a debt instrument or some other noncash consideration. See FG 8.4.1 for information on accounting for warrants issued with another instrument.
A warrant to sell common or preferred equity is generally outside the scope of ASC 480; however, some warrants, including puttable warrants and warrants on redeemable shares, are within the scope of ASC 480. See FG 8.2.2.1 for information on puttable warrants and FG 8.2.2.2 for information on warrants on redeemable shares.
If a reporting entity concludes that a warrant is not within the scope of ASC 480, the next step is to determine whether the contract should be classified as a liability or equity under the guidance in ASC 815-40. See FG 5.6 for further information on the analysis of a freestanding equity-linked instrument after the adoption of ASU 2020-06 or FG 5.6A for further information on the analysis of a freestanding equity-linked instrument before the adoption of ASU 2020-06.
See FG 8.3 for guidance related to modifications or exchanges of equity-classified warrants (written call options).

8.2.2.1 Puttable warrants

A puttable warrant is an instrument that allows the holder to either (1) exercise the warrant and receive shares or (2) put the warrant to the reporting entity in exchange for a cash payment. The put feature may be conditional or unconditional.
As discussed in ASC 480-10-55-30, a puttable warrant creates a conditional obligation for the reporting entity to repurchase its shares for cash (or other assets); therefore, it is a liability within the scope of ASC 480. Share-settled put warrants that create an obligation for the reporting entity to issue a variable number of shares may also be within the scope of ASC 480.

ASC 480-10-55-30

Consider, for example, a puttable warrant that allows the holder to purchase a fixed number of the issuer’s shares at a fixed price that also is puttable by the holder at a specified date for a fixed monetary amount that the holder could require the issuer to pay in cash. The warrant is not an outstanding share and therefore does not meet the exception for outstanding shares in paragraphs 480-10-25-8 through 25-12. As a result, the example puttable warrant is a liability under those paragraphs, because it embodies an obligation indexed to an obligation to repurchase the issuer’s shares and may require a transfer of assets. It is a liability even if the repurchase feature is conditional on a defined contingency in addition to the level of the issuer’s share price.

Even if the put right can be only be exercised upon the occurrence of certain events, a puttable warrant should be classified as a liability within the scope of ASC 480. See FG 5.5 for further information on ASC 480.

8.2.2.2 Warrants on redeemable shares

As discussed in ASC 480-10-55-33, a warrant on redeemable shares (i.e., puttable or mandatorily redeemable shares) is a liability within the scope of ASC 480 because it creates a conditional obligation for the reporting entity to repurchase its shares for cash (or other assets).

ASC 480-10-55-33

A warrant for puttable shares conditionally obligates the issuer to ultimately transfer assets—the obligation is conditioned on the warrant’s being exercised and the shares obtained by the warrant being put back to the issuer for cash or other assets. Similarly, a warrant for mandatorily redeemable shares also conditionally obligates the issuer to ultimately transfer assets—the obligation is conditioned only on the warrant’s being exercised because the shares will be redeemed. Thus, warrants for both puttable and mandatorily redeemable shares are analyzed the same way and are liabilities under paragraphs 480-10-25-8 through 25-12, even though the number of conditions leading up to the possible transfer of assets differs for those warrants. The warrants are liabilities even if the share repurchase feature is conditional on a defined contingency.

The classification of the underlying shares issued upon exercise should not be considered to determine the classification of the warrants. The fact that the shares are puttable (which allows the holder to compel the reporting entity to redeem the shares) is the key fact in determining the warrant’s classification as a liability.
See FG 5.5 for further information on ASC 480.

8.2.2.3 Penny warrants

A penny warrant is an instrument that requires the holder to pay little or no consideration to receive the shares upon exercise of the warrant. Since the shares underlying the warrant are issuable for little or no consideration (assuming $0.01 is non-substantive in relation to the current share price), they should be considered outstanding in the context of basic earnings per share, as discussed in ASC 260-10-45-13. See FSP 7 for information on including penny warrants in earnings per share.
Penny warrants often do not meet the definition of a derivative under ASC 815 because their fair value at issuance is essentially equal to the fair value of the shares underlying the warrant. As such, they have the characteristics of a prepaid forward sale of equity. A reporting entity should evaluate the penny warrants to determine whether the instrument is considered indexed to the entity’s own stock (see FG 5.6.2 (after adoption of ASU 2020-06) or FG 5.6.2A (before adoption of ASU 2020-06)) and evaluate whether the instrument meets the requirements for equity classification (see FG 5.6.3 (after adoption of ASU 2020-06) or FG 5.6.3A (before adoption of ASU 2020-06)). If the instrument contains a feature that may preclude the instrument from being considered indexed to the entity’s own stock, a reporting entity should also consider whether that feature is substantive in light of the $0.01 exercise price. If the feature results in an adjustment to the $0.01 exercise price, it may be considered nonsubstantive and thus would not preclude the instrument from being indexed to the entity’s own stock. We believe this is the case because if the $0.01 exercise price is nonsubstantive, then a fraction of the $0.01 exercise price must also be nonsubstantive. However, if the feature results in an adjustment to the number of shares underlying the contract, it is a substantive feature which should be analyzed under the guidance and may preclude the instrument from being considered indexed to the entity’s own stock. In addition, if the instrument does not meet the requirements for equity classification in ASC 815-40-25 (e.g., if there are not sufficient authorized but unissued shares to satisfy exercise), we believe that it is generally appropriate to account for the instrument as a liability.
Penny warrants may also be issued on redeemable preferred stock or redeemable common stock, which, similar to a penny warrant on non-redeemable common stock, is economically similar to holding the underlying shares (assuming that the $0.01 exercise price is non-substantive). However, although the penny warrant on redeemable shares is economically similar to owning the underlying shares, the penny warrant is not legally an outstanding share. As such, the penny warrant on redeemable common or redeemable preferred shares may be subject to ASC 480-10-55-33 (see FG 8.2.2.2) and generally should be recorded as a liability.

8.2.2.4 Warrants to participate in a future equity offering

A reporting entity may issue a warrant that allows the holder to purchase shares of the reporting entity’s next issuance of preferred stock at the same price paid by other investors in that preferred stock. A warrant to participate in a future equity offering is typically issued to a debt or equity investor. The terms of the future issuance of preferred stock are generally unknown and subject to negotiation with potential investors. Absent a future preferred stock issuance, the warrant holder is not entitled to exercise the warrant for any other consideration.
At issuance, these warrants are generally not a liability within the scope of ASC 480 if it is within the reporting entity’s control to decide whether it will sell preferred stock or not. Further, since the terms of any future preferred stock issuance have not been determined, and when determined will generally be based upon market terms, reporting entities generally do not recognize these contracts until the terms of the underlying shares are determined.
See FG 7.6 for information on tranches of preferred stock.

8.2.2.5A BCFs in warrants to acquire convertible shares—before adoption of ASU 2020-06

The following guidance related to BCFs in warrants to acquire convertible shares will no longer be applicable upon a reporting entity’s adoption of ASU 2020-06 as the beneficial conversion feature model has been eliminated.
A beneficial conversion feature (BCF) is an embedded conversion option that is in the money at the commitment date. FG 7.3.2.2A provides a detailed discussion on BCFs; this section only discusses the accounting for BCFs in warrants to acquire convertible shares. See FG 7.3.2.2A for further information on the accounting for BCFs.
Whether a BCF in a warrant to acquire convertible shares should be recognized when the warrant is issued or when the warrant is exercised (and the convertible shares are issued), depends on the classification of the warrant itself.
The Emerging Issues Task Force considered whether a warrant to acquire convertible shares may have a BCF during its deliberations of EITF No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments. Although this guidance was not finalized, we believe the EITF’s tentative conclusions may be applied in the absence of other guidance. The EITF tentatively concluded that, for warrants classified as a liability, a reporting entity should not assess whether there is a BCF until the warrant is exercised and the convertible shares are issued, provided the warrant can only be physically settled in shares. To determine the intrinsic value upon exercise, the EITF concluded that a reporting entity should compare the fair value of the reporting entity’s common stock (or other shares into which the security is convertible) on the exercise date with the effective conversion price. The effective conversion price should be calculated as the sum of the carrying amount of the warrant liability plus the exercise price of the warrant divided by the number of common shares the warrant holder receives if the conversion feature embedded in the convertible share is exercised.
Example FG 8-1A illustrates the application of this guidance to the recognition of a BCF in warrants classified as liabilities to purchase convertible preferred stock.
EXAMPLE FG 8-1A
Recognition of a BCF in warrants classified as liabilities
FG Corp issues 100 warrants that allow each holder to buy convertible preferred shares. The exercise price is $10 per warrant. Each convertible preferred share is convertible into 5 shares of FG Corp common stock, or 500 shares in total.
FG Corp determines that the warrants should be classified as a liability with a fair value of $1,000.
Two years after the warrants are issued, the warrant holder exercises the warrants and receives 100 shares of FG Corp convertible preferred stock. On that date, the fair value of FG Corp common stock is $25 and the carrying value (fair value) of the warrants is $13,000.
When and how should FG Corp determine whether there is a BCF in the warrants that holders can exercise to buy its convertible preferred stock?
Analysis
Since the warrants are classified as a liability, FG Corp assesses whether there is a BCF to be recognized when the warrant is exercised, not when the warrant is issued.
Upon exercise of the warrants, FG Corp compares (1) the fair value of the common shares on the exercise date ($25) with (2) the effective conversion price of $28 and determines there is no BCF. The effective conversion price is calculated as follows:
($13,000 carrying amount of the warrant liability plus $1,000 exercise price of the warrant) ÷ 500 shares (the number of common shares received upon conversion of the convertible shares).
The effective conversion price on the date warrants are exercised is typically greater than the fair value of the common shares. Therefore, there is generally no BCF.

The EITF tentatively reached a different conclusion for warrants classified as equity that will be physically settled in shares. For those warrants, the EITF concluded that a reporting entity should assess whether there is a BCF on the date warrants are issued. This conclusion assumes the reporting entity receives fair value for the warrants (or for the warrants and any other instruments issued at the same time) upon issuance. If the reporting entity receives less than the fair value of the warrants, it should assess whether there is a BCF when the warrants are exercised and the convertible shares are received, similar to liability-classified warrants.
To determine the intrinsic value of an equity-classified warrant, the EITF concluded that a reporting entity should compare the fair value of the reporting entity’s common stock (or other shares into which the security is convertible) on the date the warrant is issued with the effective conversion price. The effective conversion price should be calculated as the sum of the proceeds received for (or amount allocated to) the warrant plus the exercise price of the warrant divided by the number of common shares the warrant holder receives if the conversion feature embedded in the convertible share is exercised.
If a reporting entity determines that a BCF should be recognized, it should be recorded as a deemed distribution to the warrant holder. The amount of the BCF cannot exceed the proceeds allocated to the warrant, and should be amortized over the life of the warrants. Upon exercise of the warrants, the unamortized BCF amount should be amortized from the exercise date of the warrant through the stated maturity date of the underlying convertible instrument. If the underlying convertible instrument does not have a stated maturity date, the remaining BCF should be amortized from the exercise date through the date the shares are first convertible.
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