This free, guided checker walks your finance team through the key decision points for ASC 815-40 Contracts in an Entity's Own Equity. Answer a few questions to see the likely treatment and the evidence to document.
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This tool is a high-level US GAAP screening aid for general information only and is not accounting, audit or legal advice. Conclusions require entity-specific evidence and judgement - confirm the treatment with your advisor.
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The classification sequence matters: ASC 480-10 is applied first, then the derivative and own-equity analysis under ASC 815-10 and ASC 815-40. A warrant on shares that are themselves puttable or mandatorily redeemable, a forward to repurchase shares for cash, and a fixed-dollar obligation settleable in a variable number of shares are common ASC 480 captures. Skipping this screen is the most frequent ordering error in practice.
ASC 480-10 takes precedence; an instrument within its scope is a liability (or asset in some cases) before ASC 815-40 is ever reached.
Official guidance: FASB Accounting Standards Codification
ASC 815-40 applies to freestanding contracts on the entity's own equity and, through ASC 815-10-15-74(a), to embedded features tested for bifurcation. In consolidated financial statements, shares of the parent and of consolidated subsidiaries can qualify as the entity's own equity under ASC 815-40-15-5; shares of an equity-method investee or an unrelated issuer cannot. Confirm the instrument is freestanding rather than embedded using the definition of a freestanding financial instrument before proceeding.
The contract is not indexed to the reporting entity's own stock; ASC 815-40 does not apply and the instrument is evaluated under other guidance.
Official guidance: FASB Accounting Standards Codification
Step 1 of the two-step indexation test in ASC 815-40-15-7 looks only at exercise contingencies, not at how the contingency affects the settlement amount. A contingency based on the issuer's own stock price or its own operations (an IPO, a financing, a sales milestone) does not fail step 1; a contingency based on an unrelated observable market or index does. Read every trigger in the agreement, including automatic exercise and early termination clauses.
The exercise contingency fails step 1 of the indexation test; the instrument is not considered indexed to the entity's own stock under ASC 815-40-15-7B.
Official guidance: FASB Accounting Standards Codification
Step 2 asks whether the settlement amount equals the difference between the fair value of a fixed number of shares and a fixed monetary amount, or whether any adjustments depend only on inputs to the fair value of such a contract (stock price, strike, term, expected dividends, volatility, and the risk-free rate per ASC 815-40-15-7E). A down round feature is excluded from this assessment under ASC 815-40-15-5D, although triggering one has earnings-per-share consequences under ASC 260-10-25. Holder-dependent settlement was the central defect identified in the SEC staff's April 2021 statement on warrants issued by special-purpose acquisition companies.
The settlement adjustments incorporate variables that are not inputs to a fixed-for-fixed valuation; the instrument fails step 2 of the indexation test under ASC 815-40-15-7D. Settlement terms that vary with the holder are not inputs to the fair value of a fixed-for-fixed contract; the instrument is not indexed to the entity's own stock.
Official guidance: FASB Accounting Standards Codification
Even when every adjustment variable is a permitted valuation input, ASC 815-40-15-7F fails the test if a feature such as a leverage factor increases the holder's exposure beyond that of a plain fixed-for-fixed contract. Separately, ASC 815-40-15-7I treats a strike price fixed in a currency other than the issuer's functional currency as an additional variable, so a US-dollar functional parent issuing euro-strike warrants fails indexation; US GAAP provides no foreign currency exception here, unlike IFRS practice under IAS 32 rights issues. Test each anti-dilution formula numerically rather than relying on the drafting labels.
A leverage factor or a strike price fixed in a non-functional currency precludes the instrument from being considered indexed to the entity's own stock.
Official guidance: FASB Accounting Standards Codification
Under ASC 815-40-25-1 through 25-4, contracts requiring net cash settlement are assets or liabilities, and contracts requiring or permitting settlement in shares are equity only if share settlement is within the issuer's control in all circumstances. The analysis assumes the least favorable settlement outcome: if any provision, however remote, lets the counterparty or an external event force cash, equity classification fails unless all shareholders would receive cash in the same event. Scrutinize fundamental change, make-whole, and dissolution clauses drafted deep in the agreement.
Because net cash settlement could be required outside the issuer's control, the contract is classified as an asset or liability under ASC 815-40-25-4.
Official guidance: FASB Accounting Standards Codification
ASC 815-40-25-7 through 25-35 elaborate the conditions an indexed contract must meet for equity classification, summarized in ASC 815-40-25-10: sufficient authorized and unissued shares, an explicit share limit, no required cash payment for failure to make timely SEC filings, and no cash-only top-off or make-whole provisions. The authorized-share analysis must aggregate every outstanding commitment (options, warrants, convertible instruments) against the charter limit at each balance sheet date. ASU 2020-06 removed the former conditions concerning settlement in unregistered shares, collateral, and counterparty rights ranking ahead of shareholders.
The contract is indexed to the entity's own stock and meets the equity classification conditions; classify in stockholders' equity. Without sufficient authorized shares and an explicit share cap, share settlement is not within the issuer's control; classify as an asset or liability at fair value. Required cash payments for filing failures or cash-only make-whole provisions preclude equity classification under ASC 815-40-25-10. After ASU 2020-06, collateral and counterparty-rights provisions do not preclude equity classification when the remaining ASC 815-40-25-10 conditions are met.
Official guidance: FASB Accounting Standards Codification
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