Derivatives Scope Refinements and Scope Clarification for a Share-Based Noncash Consideration
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Summary
The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2025-07, Derivatives Scope Refinements and Scope Clarification for Share-Based Noncash Consideration from a Customer in a Revenue Contract, to refine the scope of derivative accounting under ASC 815, Derivatives and Hedging, and clarify the treatment of share-based noncash consideration under ASC 606, Revenue from Contracts with Customers.
First, the ASU excludes certain nonexchange-traded contracts from derivative accounting when their settlement is based on operations or activities specific to one of the parties (like regulatory approvals or earnings targets). Those contracts are subject to the new exception from derivative accounting unless the underlying is tied to market rates, the price or performance of financial instruments, the reporting entity’s equity, or call and put options on debt. This change is intended to reduce unnecessary complexity and better reflect the economic substance of contracts like research and development funding arrangements, litigation finance, or environmental, social, and governance-linked instruments, which were previously subject to derivative accounting.
Second, the ASU clarifies that when an entity receives share-based noncash consideration (like warrants or shares) from a customer in a revenue contract, it must initially apply ASC 606 to recognize and measure the consideration and only apply ASC 815 or ASC 321, Investments — Equity Securities, after the right to receive or retain the consideration becomes unconditional. This clarification addresses confusion about when to apply the financial instruments guidance and aims to improve consistency in practice, reduce diversity in interpretation, and lower compliance costs.
Main Provisions
Derivatives Scope Refinement
Entities must account for a contract that meets the definition of a derivative instrument at fair value under ASC 815 except when the contract meets a scope exception. Similarly, an embedded feature must be accounted for separately as a derivative under ASC 815 if the criteria for bifurcation are met and no derivative scope exception applies. ASC 815 provides a number of exceptions from derivative accounting, including one that applies to contracts that are not traded on an exchange. The ASU expands the scope exception in ASC 815-10-15-59(e) and excludes from derivative accounting those contracts that have underlyings based on operations or activities specific to one of the parties to the contract. For example, the scope exception applies to underlyings based on the:
- Occurrence or nonoccurrence of an event related to the operations or activities specific to one of the parties to the contract, such as change in control, initial public offering (IPO), obtaining regulatory approval, achieving a product development milestone, or meeting a greenhouse gas emissions target.
- Financial operating results (or components of those results) of one of the parties to the contract, such as revenues, net income, expenses, or EBITDA.
Some contracts reference activities at the consolidated-level or parent-entity level rather than at an individual reporting entity level. Solely for purposes of evaluating whether a contract meets the scope exception for contracts that are not traded on an exchange, the phrase “party to the contract” refers to any entity within a consolidated group (that is, the evaluation is not limited to activities or operations of the legal entity that entered the contract).
Also, when evaluating whether operations or activities are specific to one of the parties to the contract, it is irrelevant whether the outcome is within or outside the entity’s control.
If a contract has multiple underlyings and all of them meet the scope exception, the entire contract (or embedded feature) is exempt from derivative accounting. For example, two parties may enter a funding arrangement, in which the funding entity provides $50 million to a biotech company to commercialize a drug compound. The biotech company must pay $20 million upon Food and Drug Administration (FDA) approval and an additional $80 million to the funding entity upon sales of the drug exceeding $500 million. The occurrence of FDA approval related to the drug the biotech company is developing and the sales of the drug exceeding $500 million are based on biotech company’s operations or activities. As such, the funding arrangement qualifies for the scope exception and is not accounted for as a derivative under ASC 815. Instead, both parties must apply other U.S. GAAP.
For contracts that have multiple underlyings in which some, but not all, qualify for the scope exception, an entity must perform a predominant characteristics assessment.
Further, the ASU includes guardrails to avoid changing the accounting for some types of contracts for which the accounting is well-known in practice. The table includes the types of contracts or underlyings that do not qualify for the exception in ASC 815-10-15-59(e) (the “new scope exception”).
| Description | Examples |
|---|---|
| Underlying based on market rate, market price, or market index (including those listed in ASC 815-10-15-88(a) through (f)) | Contracts (for example, interest rate swaps) that have only an interest rate or interest rate index underlying do not qualify for the new scope exception and would generally continue to be accounted for as derivatives. Similarly, commodity contracts that are based only on a commodity price or index do not qualify for the new scope exception. Instead, an entity continues to assess whether another scope exception applies, such as the normal purchases and normal sales exception. |
| Underlying based on the price or performance of a financial asset or financial liability of one of the parties | A guarantee contract with a payoff based on the performance of a financial asset or financial liability (for example, debt) of one of the parties to the contract does not qualify for the new scope exception. Instead, an entity continues to assess whether such contract qualifies for other scope exceptions, such as the exception for financial guarantee contracts in ASC 815-10-15-58. |
| Contracts or embedded features that are in the scope of ASC 815-40 | An instrument that is convertible into the issuer’s shares upon a change in control does not qualify for the new scope exception. Instead, the issuer continues to assess whether the conversion feature meets the scope exception in ASC 815-10-15-74(a) for instruments indexed to an entity’s own stock. |
| Calls and put options on debt subject to ASC 815-15-25-41 through 25-43 | A debt instrument that requires repayment if the issuer completes an IPO does not qualify for the new scope exception. Instead, the parties continue to assess whether the put feature meets the criteria for bifurcation without regard to the new scope exception. |
Share-Based Noncash Consideration
Vendors sometimes receive share-based noncash consideration (for example, shares, share options, or other equity instruments) from a customer that is contingent on the satisfaction of one or more performance obligations or on a specified outcome of the vendor’s performance. The ASU clarifies that such consideration must be accounted for under the noncash consideration guidance in ASC 606-10-32-21 through 32-24.
In accordance with ASC 606, share-based noncash consideration is:
- Measured at fair value at contract inception and
- Recognized as an asset when the entity’s right to receive or retain the share-based payment is no longer contingent on the satisfaction of a performance obligation.
ASC 606 applies to share-based noncash consideration from a customer until the vendor has an unconditional right to receive or retain the consideration. Only at that point will the vendor apply other guidance, such as ASC 815 and ASC 321, to the noncash consideration received.
To assess whether a right is unconditional under ASC 606, a vendor evaluates only the contract terms that relate to its performance obligations or a specific outcome of its performance. That evaluation is consistent with the guidance on recognizing a receivable, which states that a right to consideration is unconditional if only the passage of time is required before payment is due. As a result of the amendments, share-based noncash consideration from a customer in a revenue contract is expected to be accounted for in the same periods and in a similar manner to cash consideration and other forms of noncash consideration.
The ASU similarly amends ASC 610-20, Other Income — Gains and Losses from the Derecognition of Nonfinancial Assets, to specify that an entity must apply ASC 610-20 to share-based noncash consideration in exchange for the transfer of a nonfinancial asset until the entity has an unconditional right to receive or retain the consideration under ASC 610-20.
The ASU added the following new example to the implementation guidance to demonstrate application of the noncash consideration guidance:
For more information on accounting treatment under ASC 606, see BDO’s Blueprint on Revenue Recognition Under ASC 606.
Effective Date and Transition
The following table summarizes transition for ASU 2025-07:
| Derivatives Scope Refinements — All Entities | Share-Based Noncash Consideration — All Entities | |
|---|---|---|
| Effective date | Annual reporting periods beginning after December 15, 2026, including interim periods within those annual reporting periods. | Annual reporting periods beginning after December 15, 2026, including interim periods within those annual reporting periods. |
| Early adoption | Early adoption is allowed, including adoption in an interim or annual period for which an entity’s financial statements have not yet been issued (or made available for issuance). If early adopted, the entity must apply the transition requirements as of the beginning of the annual reporting period. If an entity early adopts the amendments on derivative scope refinement, the entity also shall early adopt the amendments on share-based noncash consideration simultaneously. | Early adoption is allowed, including adoption in an interim or annual period for which an entity’s financial statements have not yet been issued (or made available for issuance). If early adopted, the entity must apply the transition requirements as of the beginning of the annual reporting period. If an entity early adopts the amendments on share-based noncash consideration, the entity also shall early adopt the amendments on derivatives scope refinement simultaneously. |
| Transition | An entity must select one of the following approaches:
| An entity must apply the amendments either:
|
| Special instructions | Under the modified retrospective method of adoption:
| None. |
| Transition disclosures | Disclose the following in both the interim and annual period of adoption:
| Disclose the following in both the interim and annual period of adoption:
|
Link to ASU 2025-07