This free, guided checker walks your finance team through the key decision points for ASC 815-15 Embedded Derivative Bifurcation. 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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ASC 815-15-25-1(b) blocks bifurcation only when fair value changes run through earnings. The common trap is an available-for-sale debt security: it is remeasured at fair value, but the changes are reported in other comprehensive income, so this criterion is still met and the bifurcation analysis continues. Confirm the measurement attribute in the entity's accounting policy documentation before answering.
Bifurcation is not permitted because the hybrid is already remeasured at fair value through earnings (ASC 815-15-25-1(b)).
Official guidance: FASB Accounting Standards Codification
The clearly-and-closely-related test compares the feature's economics with the host's economics, so the host must be characterized first. For a hybrid instrument issued in the form of a share, ASC 815-15-25-17A through 25-17D require weighing all stated and implied substantive terms: mandatorily redeemable preferred stock typically indicates a debt-like host, while perpetual, participating preferred stock typically indicates an equity host. Do not assume legal form decides the question.
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Official guidance: FASB Accounting Standards Codification
For a debt host, only interest rate, credit, and inflation risks are ordinarily clearly and closely related. Test leverage under ASC 815-15-25-26: separation is required if the hybrid could settle so the investor does not recover substantially all of its initial recorded investment, or if the feature could at least double the investor's initial rate of return and double the otherwise-market return. Evaluate puts and calls with the four-step decision sequence in ASC 815-15-25-42, which applies whether or not the option is contingently exercisable.
The feature is clearly and closely related to the debt host; bifurcation is not required under ASC 815-15-25-1(a). The redemption feature passes the four-step decision sequence in ASC 815-15-25-42 and is clearly and closely related; bifurcation is not required.
Official guidance: FASB Accounting Standards Codification
ASC 815-15-25-16 explains that when the host contract encompasses a residual interest in an entity, an embedded feature must possess principally equity characteristics related to that same entity to be clearly and closely related. A conversion option embedded in preferred shares with an equity host is typically clearly and closely related, while a redemption feature that guarantees return of the holder's investment behaves like debt and is not. The host determination from the prior step drives this answer, so revisit it if the conclusion seems strained.
An equity-like feature is clearly and closely related to an equity host; bifurcation is not required (ASC 815-15-25-16).
Official guidance: FASB Accounting Standards Codification
For leases, insurance contracts, and supply arrangements, compare the pricing variable with the economics of the deliverable itself. Unleveraged inflation indexation for the host's own economic environment, and adjustments based on the contracted asset's market price, are ordinarily clearly and closely related; leveraged indexation and unrelated variables are not. Separately, an embedded foreign currency feature may avoid bifurcation under ASC 815-15-15-10 when payments are denominated in the functional currency of a substantial party to the contract or in a currency routinely used for that good or service in international commerce.
The pricing feature is clearly and closely related to the nonfinancial host; bifurcation is not required (ASC 815-15-25-1(a)).
Official guidance: FASB Accounting Standards Codification
Test each characteristic of ASC 815-10-15-83 separately and document the net settlement analysis with particular care; the qualifying forms of net settlement are described beginning at ASC 815-10-15-99. Shares of a public company are generally readily convertible to cash when the quantity deliverable would not overwhelm daily trading volume, while private company shares generally are not. Reassess this conclusion if the issuer completes an initial public offering or the shares otherwise become readily convertible to cash.
A standalone instrument with the same terms would not meet the derivative definition in ASC 815-10-15-83; criterion (c) of ASC 815-15-25-1 fails and the feature is not bifurcated.
Official guidance: FASB Accounting Standards Codification
The own-equity exception is issuer-specific: an identical conversion option is analyzed under ASC 815-10-15-74(a) by the issuer but offers no exception to the investor holding the hybrid. Apply the two-part model - indexation to the entity's own stock under ASC 815-40-15, then equity classification under ASC 815-40-25 - and reassess the conclusion at each reporting date, because settlement alternatives, authorized share sufficiency, and share delivery requirements can all change the answer after inception.
The own-equity scope exception in ASC 815-10-15-74(a) applies to the issuer; the feature is not bifurcated, but the conclusion must be reassessed each reporting date. A scope exception in ASC 815-10-15 applies to the standalone feature; criterion (c) of ASC 815-15-25-1 fails and the feature is not bifurcated.
Official guidance: FASB Accounting Standards Codification
The election in ASC 815-15-25-4 is available instrument by instrument for hybrid financial instruments that would otherwise require bifurcation, and it is irrevocable once made. Certain instruments are ineligible under ASC 815-15-25-5, and the election does not extend to hybrids with nonfinancial hosts, so confirm eligibility before electing. Weigh the earnings volatility of full fair value measurement against the recurring operational burden of separately valuing the embedded derivative every period.
The entire hybrid financial instrument is measured at fair value through earnings under the irrevocable election in ASC 815-15-25-4. All three criteria in ASC 815-15-25-1 are met; separate the embedded derivative and measure it at fair value with changes recognized in earnings.
Official guidance: FASB Accounting Standards Codification
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