EITF - Emerging Issues Task Force
1996\Issue 96-13: Accounting for Derivative Financial Instruments Indexed to, 
and Potentially Settled in, a Company's Own Stock
Abstract


                                                   EITF ABSTRACTS

                                                                              
                            Issue No. 96-13

 Title:
                        Accounting for Derivative Financial Instruments 
Indexed to, and Potentially Settled in, a Company's Own Stock

 Dates Discussed

                        November 12-13, 1987; January 19, 1995; March 23, 
1995; May 18-19, 1995; July 20-21, 1995; September 20-21, 1995;
                        January 18, 1996; July 18, 1996; September 18-19, 
1996; November 14, 1996; January 23, 1997

 References

                        FASB Statement No. 80, Accounting for Futures 
Contracts 
                        FASB Statement No. 123, Accounting for Stock-Based 
Compensation 
                        FASB Statement No. 128, Earnings per Share 
                        FASB Discussion Memorandum, Recognition and 
Measurement of Financial Instruments, November 18, 1991 
                        APB Opinion No. 9, Reporting the Results of 
Operations 
                        APB Opinion No. 14, Accounting for Convertible Debt 
and Debt Issued with Stock Purchase Warrants 
                        APB Opinion No. 15, Earnings per Share 
                        APB Opinion No. 21, Interest on Receivables and 
Payables 
                        SEC Accounting Series Release No. 268, Presentation 
in Financial Statements of "Redeemable Preferred Stocks" 


ISSUE

For a number of business reasons, a company may enter into contracts that are 
indexed to, and sometimes settled in, its own stock. Examples of these
contracts include written put options, written call options (and warrants), 
purchased put options, purchased call options, forward sale contracts, and 
forward
purchase contracts. These contracts may be settled using a variety of 
settlement methods, or the issuing company or counterparty may have a choice 
of
settlement methods. The settlement methods are:

     Physical settlement - the party designated in the contract as the buyer 
delivers the full stated amount of cash to the seller, and the seller 
delivers the full
     stated number of shares to the buyer.

     Net share settlement - the party with a loss delivers to the party with 
a gain shares with a current fair value equal to the gain.

     Net cash settlement - the party with a loss delivers to the party with a 
gain a cash payment equal to the gain, and no shares are exchanged.

The contracts described above may be either freestanding or embedded in 
another financial instrument. A freestanding contract is entered into 
separate and
apart from any of the company's other financial instruments or equity 
transactions, or it is entered into in conjunction with some other 
transaction and is legally
detachable and separately exercisable.

This Issue applies only to freestanding derivative financial instruments (for 
example, forward contracts, options, and warrants). This Issue does not apply 
to
security price guarantees or other financial instruments indexed to, or 
otherwise based on, the price of the issuer's stock that are issued in 
connection with a
purchase business combination [Note See STATUS section.], nor does it address 
the accounting for either the derivative component or the financial instrument
when the derivative component is embedded in and not detachable from the 
financial instrument. This Issue does not address the accounting for 
contracts that
are issued to compensation employees or to acquire goods or services from 
nonemployees.

The issue is how freestanding contracts that are indexed to, and potentially 
settled in, a company's own stock should be classified and measured.

EITF DISCUSSION

A. Framework for Accounting

The Task Force discussed the accounting for freestanding contracts that are 
indexed to, and potentially settled in, a company's own stock and reached 
several
consensuses, as described below. The consensuses in this Issue are to be 
applied to all freestanding derivative financial instruments that are indexed 
to, and
potentially settled in, a company's own stock; however, nonpublic companies 
may continue to apply the consensus in Issue No. 88-9, "Put Warrants ," to the
instruments covered by that Issue. Hereinafter, the framework for accounting 
that is established in this Issue is referred to as the "Model."

(1) Initial balance sheet classification

The initial balance sheet classification generally is based on the concept 
that contracts that require net cash settlement are assets or liabilities and 
contracts that
require settlement in shares are equity instruments. If the contract provides 
the company with a choice of net cash settlement or settlement in shares, the 
Model
assumes settlement in shares; if the contract provides the counterparty with 
a choice of net cash settlement or settlement in shares, the Model assumes 
net cash
settlement. However, this Model is not applicable when settlement 
alternatives do not have the same economic value attached to them or when one 
of the
settlement alternatives is fixed or contains caps or floors. In those 
situations, the accounting for the instrument (or combination of instruments) 
should be based
on the economic substance of the transaction.1

          1 For example, if a freestanding contract, issued together with 
another instrument, requires that the issuer provide to the holder a fixed or
          guaranteed return such that the instruments are, insubstance, debt, 
the issuer should account for both instruments as liabilities, regardless of 
the
          settlement terms of the freestanding contract.

Accordingly, unless the economic substance indicates otherwise, contracts 
would be initially classified as equity, or as assets or liabilities, in the 
following
situations:

Equity instruments

     Contracts that require physical settlement or net share settlement

     Contracts that give the company a choice of net cash settlement or 
settlement in its own shares (physical settlement or net share settlement).

Assets or liabilities

     Contracts that require net cash settlement

     Contracts that give the counterparty a choice of net cash settlement or 
settlement in shares (physical settlement or net share settlement).

(2) Initial measurement, and subsequent balance sheet classification and 
measurement

The Model requires that all instruments be initially measured at fair value 
and subsequently accounted for based on the initial classification and the 
assumed or
required settlement method in (1) above.2 Contracts that are initially 
classified as equity are accounted for in permanent equity. If physical 
settlement was
assumed or required and the company is obligated to deliver cash as part of 
the physical settlement,3 then public companies should refer to ASR 268, which
provides guidance by analogy for those transactions, and account for the 
transactions as provided below under "Equity instruments - temporary equity."

          2 For contracts that are classified as equity instruments that 
provide the company with a choice between either net share settlement or 
physical
          settlement that may require that the company deliver cash, net 
share settlement should be assumed. For contracts that are classified as 
equity
          instruments that provide the counterparty with a choice of either 
net share settlement or physical settlement that may require that the company
          deliver cash, physical settlement should be assumed.

          3 For example, if the company sells put options indexed to its own 
stock that enable the holder to sell shares back to the company at the strike
          price.

Equity instruments - permanent equity

     Contracts that require that the company deliver shares as part of a 
physical settlement or a net share settlement should be initially measured at 
fair value
     and reported in permanent equity. Subsequent changes in fair value 
should not be recognized.

     Contracts that give the company a choice of (a) net cash settlement or 
settlement in shares (including net share settlement, or physical settlement 
that
     requires that the company deliver shares) or (b) either net share 
settlement or physical settlement that requires that the company deliver cash 
should be
     initially measured at fair value and reported in permanent equity. 
Subsequent changes in fair value should not be recognized. If such contracts 
are
     ultimately settled in a manner that requires that the company deliver 
cash, the amount of cash paid or received should be reported as a reduction 
of, or
     an addition to, contributed capital.

Equity instruments - temporary equity4

          4 Classification and measurement in temporary equity is required 
for public companies. ASR 268 provides guidance by analogy for transactions
          classified as temporary equity.

     Contracts that (a) require that the company deliver cash as part of a 
physical settlement, (b) give the company a choice of either net cash 
settlement or
     physical settlement that requires that the company deliver cash, or (c) 
give the counterparty a choice of either net share settlement or physical 
settlement
     that requires that the company deliver cash should be initially measured 
at fair value and reported in permanent equity, and an amount equal to the 
cash
     redemption amount under the physical settlement should be transferred to 
temporary equity.

Assets or liabilities

     Contracts that are initially classified as assets or liabilities should 
be measured at fair value, with changes in fair value reported in earnings 
and disclosed
     in the financial statements. If contracts initially classified as assets 
or liabilities are ultimately settled in shares, any gains or losses on those 
contracts
     should continue to be included in earnings.

B. Hedging

The SEC Observer stated that the SEC staff has consistently held the position 
that hedge accounting is not permitted for transactions involving the 
contracts
within the scope of this Issue because those transactions have not met all 
the criteria of Statement 80. The SEC staff also believes that hedge 
accounting for
transactions involving those contracts is inconsistent with paragraph 28 of 
Opinion 9.

Because of the SEC staff's position, the Task Force decided to end its 
discussion of whether the contracts described above can qualify for hedge 
accounting.

C. Application of the Model to Specific Instruments

The following reflects several Task Force consensuses with respect to the 
application of the Model, described in Section A of this Issue, to certain 
freestanding
derivative financial instruments that are indexed to, and potentially settled 
in, a company's own stock.

(1) Written put options5 and forward purchase contracts

          5 Includes shareholder rights (SHARP rights) issued by the company 
to shareholders that give the shareholders the right to put a specified number
          of common shares to the company for cash.

Description

The company (the buyer) agrees to buy from the seller shares at a specified 
price at some future date. The contract may be settled by physical 
settlement, net
share settlement, or net cash settlement, or the issuing company or the 
counterparty may have a choice of settlement methods.6

          6 Application of the Model to purchased call options is discussed 
in C(3).

Consensus

The Model would be applied as follows:
                                                One Settlement Method

                                                                 Physical (a)
                                                                              
        Net Share
                                                                              
                            Net Cash



 (1) Initial Classification:

 Equity

                                                                      x

                                                                              
            x

 Asset Liability
                                                                              
                               x

 (2) Initial Measurement, Subsequent Classification and Measurement:

 Fair value, permanent equity - no changes in fair value

                                                                              
            x

 Fair value, transfer to temporary equity an amount equal to cash redemption
 amount (b)

                                                                      x

 Fair value, asset/liability - adjusted for changes in fair value (c)

                                                                              
                               x


(a) Physical settlement of the contract requires that the company deliver 
cash to the holder in exchange for the shares.

(b) Classification and measurement guidance within temporary equity applies 
only to public companies.

(c) Subsequent changes in fair value should be reported in earnings and 
disclosed in the financial statements.

(d) If the contracts are ultimately settled in shares, any gains or losses on 
those contracts should continue to be included in earnings.

(e) If the contracts are ultimately physically settled by the company, 
requiring that the company deliver cash, or are ultimately settled in net 
cash, the amount of
cash paid or received should be reported as a reduction of, or as an addition 
to, contributed capital.

(f) If the contracts are ultimately settled in net cash or net shares, the 
amount reported in temporary equity should be transferred and reported as an 
addition to
permanent equity.

                                                   Company Choice

                                                             Net Share or 
Physical
                                                                     (a)
                                                                              
   Net Share or Net Cash
                                                                              
                       Net Cash or Physical
                                                                              
                               (a)



 (1) Initial Classification:

 Equity

                                                                      x

                                                                              
            x

                                                                              
                               x

 Asset Liability

 (2) Initial Measurement, Subsequent Classification and Measurement:

 Fair value, permanent equity - no changes in fair value

                                                                     x(e)

                                                                              
           x(e)

 Fair value, transfer to temporary equity an amount equal to cash redemption
 amount (b)

                                                                      x

                                                                              
                               x(f)

 Fair value, asset/liability - adjusted for changes in fair value (c)


(a) Physical settlement of the contract requires that the company deliver 
cash to the holder in exchange for the shares.

(b) Classification and measurement guidance within temporary equity applies 
only to public companies.

(c) Subsequent changes in fair value should be reported in earnings and 
disclosed in the financial statements.

(d) If the contracts are ultimately settled in shares, any gains or losses on 
those contracts should continue to be included in earnings.

(e) If the contracts are ultimately physically settled by the company, 
requiring that the company deliver cash, or are ultimately settled in net 
cash, the amount of
cash paid or received should be reported as a reduction of, or as an addition 
to, contributed capital.

(f) If the contracts are ultimately settled in net cash or net shares, the 
amount reported in temporary equity should be transferred and reported as an 
addition to
permanent equity.

                                                  Counterparty Choice

                                                             Net Share or 
Physical
                                                                     (a)
                                                                              
   Net Share or Net Cash
                                                                              
                       Net Cash or Physical
                                                                              
                               (a)



 (1) Initial Classification:

 Equity

                                                                      x

 Asset Liability
                                                                              
            x
                                                                              
                               x

 (2) Initial Measurement, Subsequent Classification and Measurement:

 Fair value, permanent equity - no changes in fair value

                                                                              
            x

 Fair value, transfer to temporary equity an amount equal to cash redemption
 amount (b)

                                                                     x(f)

 Fair value, asset/liability - adjusted for changes in fair value (c)

                                                                              
           x(d)

                                                                              
                              x(d)


(a) Physical settlement of the contract requires that the company deliver 
cash to the holder in exchange for the shares.

(b) Classification and measurement guidance within temporary equity applies 
only to public companies.

(c) Subsequent changes in fair value should be reported in earnings and 
disclosed in the financial statements.

(d) If the contracts are ultimately settled in shares, any gains or losses on 
those contracts should continue to be included in earnings.

(e) If the contracts are ultimately physically settled by the company, 
requiring that the company deliver cash, or are ultimately settled in net 
cash, the amount of
cash paid or received should be reported as a reduction of, or as an addition 
to, contributed capital.

(f) If the contracts are ultimately settled in net cash or net shares, the 
amount reported in temporary equity should be transferred and reported as an 
addition to
permanent equity.


(2) Forward sale contracts, written call options or warrants, and purchased 
put options

Description

The issuing company (the seller) agrees to sell shares of its stock to the 
buyer of the contract at a specified price at some future date. The contract 
may be
settled by physical settlement, net share settlement, or net cash settlement, 
or the issuing company or counterparty may have a choice of settlement 
methods.

Consensus

The Model would be applied as follows:
                                                One Settlement Method

                                                                 Physical (a)
                                                                              
        Net Share
                                                                              
                            Net Cash



 (1) Initial Classification

 Equity

                                                                      x

                                                                              
            x

 Asset/Liability
                                                                              
                               x

 (2) Initial Measurement, Subsequent Classification and Measurement:

 Fair value, permanent equity - no changes in fair value

                                                                      x

                                                                              
            x

 Fair value, asset/liability - adjusted changes in fair value (b)
                                                                              
                               x


(a) Physical settlement of the contract requires that the company deliver 
shares to the holder in exchange for cash.

(b) Subsequent changes in fair value should be reported in earnings and 
disclosed in the financial statements.

(c) If the contracts are ultimately settled in net cash, the amount of cash 
paid or received should be reported as a reduction of, or an addition to, 
contributed
capital.

(d) If the contracts are ultimately settled in shares, any gains or losses on 
those contracts should continue to be included in earnings.
                                                   Company Choice

                                                             Net Share or 
Physical
                                                                     (a)
                                                                              
   Net Share or Net Cash
                                                                              
                       Net Cash or Physical



 (1) Initial Classification

 Equity

                                                                      x

                                                                              
            x

                                                                              
                               x

 Asset/Liability

 (2) Initial Measurement, Subsequent Classification and Measurement:

 Fair value, permanent equity - no changes in fair value

                                                                      x

                                                                              
           x(c)

                                                                              
                              x(c)

 Fair value, asset/liability - adjusted changes in fair value (b)


(a) Physical settlement of the contract requires that the company deliver 
shares to the holder in exchange for cash.

(b) Subsequent changes in fair value should be reported in earnings and 
disclosed in the financial statements.

(c) If the contracts are ultimately settled in net cash, the amount of cash 
paid or received should be reported as a reduction of, or an addition to, 
contributed
capital.

(d) If the contracts are ultimately settled in shares, any gains or losses on 
those contracts should continue to be included in earnings.
                                                  Counterparty Choice

                                                             Net Share or 
Physical
                                                                     (a)
                                                                              
   Net Share or Net Cash
                                                                              
                       Net Cash or Physical
                                                                              
                               (a)



 (1) Initial Classification

 Equity

                                                                      x

 Asset/Liability
                                                                              
            x
                                                                              
                               x

 (2) Initial Measurement, Subsequent Classification and Measurement:

 Fair value, permanent equity - no changes in fair value

                                                                      x

 Fair value, asset/liability - adjusted changes in fair value (b)
                                                                              
           x(d)
                                                                              
                              x(d)


(a) Physical settlement of the contract requires that the company deliver 
shares to the holder in exchange for cash.

(b) Subsequent changes in fair value should be reported in earnings and 
disclosed in the financial statements.

(c) If the contracts are ultimately settled in net cash, the amount of cash 
paid or received should be reported as a reduction of, or an addition to, 
contributed
capital.

(d) If the contracts are ultimately settled in shares, any gains or losses on 
those contracts should continue to be included in earnings.


(3) Purchased call options

Description

The company (the buyer) purchases call options that provide it with the 
right, but not the obligation, to buy from the seller, shares of the 
company's stock at a
specified price. If the options are exercised, the contract may be settled by 
physical settlement, net share settlement, or net cash settlement, or the 
issuing
company or the counterparty may have a choice of settlement methods.

Consensus

The company should follow the table included in (2) above in accounting for 
the call options.

(4) Detachable stock purchase warrants

Description

An enterprise issues senior subordinated notes with a detachable warrant that 
gives the holder both the right to purchase 6,250 shares of the enterprise's 
stock
for $75 per share and the right (that is, a put) to require that the 
enterprise 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.

Consensus

The proceeds should be allocated between the debt liability and the warrant 
and the resulting discount should be amortized in accordance with Opinion 21.
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.

(5) Put warrants

Description

Put warrants are instruments with characteristics of both warrants and put 
options. The holder of the instrument is entitled to exercise (a) the warrant 
feature to
acquire the common stock of the issuer at a specified price, (b) the put 
option feature to put the instrument back to the issuer for a cash payment, 
or in some
cases, (c) both the warrant feature to acquire the common stock and the put 
option feature to put that stock back to the issuer for a cash payment. Put
warrants are frequently issued concurrently with debt securities of the 
issuer, are detachable from the debt, and may be exercisable only under 
specified
conditions. The put feature of the instrument may expire under varying 
circumstances, for example, with the passage of time or if the issuer has a 
public stock
offering. Under Opinion 14, a portion of the proceeds from the issuance of 
debt with detachable warrants must be allocated to those warrants.

Consensus

Because the contract gives the counterparty the choice of cash settlement or 
settlement in shares, public companies should report the proceeds from the
issuance of put warrants as liabilities and subsequently measure the put 
warrants at fair value with changes in fair value reported in earnings. 
Nonpublic
companies may continue to classify and measure the put warrants in accordance 
with the consensus in Issue 88-9.

D. Earnings per Share

The Task Force reached the following consensus on how written put options 
affect the earnings-per-share calculation:

If the written put options are "in the money" during the period being 
reported on, the potential dilutive effect on earnings per share should be 
computed using
the reverse treasury stock method. Under that method, the incremental number 
of shares is computed as (a) the number of shares that would need to be issued
for cash at the then current market price to obtain cash to satisfy the put 
obligation less (b) the number of shares received from satisfying the puts.

The Task Force discussed whether it should comprehensively address issues 
relating to earnings per share in this Issue. The Task Force agreed that the 
FASB
should address the issues relating to earnings per share as part of its 
project on earnings per share. [Note: See STATUS section.]

STATUS

In February 1997, the FASB issued Statement 128, which supersedes Opinion 15. 
Statement 128 is effective for financial statements for both interim and
annual periods ending after December 15, 1997, and earlier application is not 
permitted.

Statement 128 affirms the consensus reached by the Task Force on how written 
put options affect the earnings per share calculation. That is, in computing
diluted EPS, Statement 128 requires use of the reverse treasury stock method 
to account for the dilutive effect of written put options and similar 
contracts that
are "in the money" during the reporting period. Statement 128 states that 
purchased options should not be reflected in the computation of diluted EPS 
because
to do so would be antidilutive. At the July 23 and November 18-19, 1998 
meetings, an FASB staff representative made an announcement (Topic No. D-72,
"Effects of Contracts That May Be Settled in Stock or Cash on the Computation 
of Diluted Earnings per Share ") that for those contracts that provide the
company with a choice of settlement methods, the company shall assume that 
the contract will be settled in shares. That presumption may be overcome if 
past
experience or a stated policy provides a reasonable basis to believe that it 
is probable that the contract will be paid partially or wholly in cash. For 
contracts in
which the counterparty controls the means of settlement, past experience or a 
stated policy is not determinative. Accordingly, in those situations, the more
dilutive of cash or share settlement should be used.

At the July 23-24, 1997 meeting, the Task Force addressed the accounting for 
contingent consideration issued to effect a purchase business combination in
Issue No. 97-8. "Accounting for Contingent Consideration Issued in a Purchase 
Business Combination ." The Task force observed that Issue 96-13 should
be applied to freestanding contracts that are indexed to, and potentially 
settled in, a company's own stock if those instruments meet the criteria in 
Issue 97-8
for recording as part of the cost of the business acquired in a purchase 
business combination.

A related issue has been discussed in Issue No. 98-12, "The Application of 
Issue No. 96-13 to Forward Equity Sales Transactions ." That Issue deals with
the accounting and earnings per share treatment of situations in which a 
freestanding derivative instrument (a forward contract) that is indexed to, 
and
potentially settled in, a company's own stock is issued concurrent with the 
issuance of shares of the company's stock. This Issue is limited to 
situations in which
the party to whom the common stock was sold is also the counterparty to the 
forward contract.

Another related issue has been discussed in Issue No. 99-1, "Accounting for 
Debt Convertible into the Stock of a Consolidated Subsidiary ." That Issue
deals with the accounting in the consolidated financial statements for debt 
issued by a consolidated subsidiary or a parent company that is convertible 
into the
stock of a consolidated subsidiary. As part of the discussion of Issue 99-1, 
Task Force members agreed to consider further whether to clarify this Issue by
indicating that equity shares of any entity under the control of the 
consolidated entity are considered "a company's own stock."

A related issue was discussed at the May 19-20, 1999 meeting in Issue No. 
99-3, "Application of Issue No. 96-13 to Derivative Instruments with Multiple
Settlement Alternatives ." That Issue deals with how certain derivative 
contracts indexed to, and potentially settled in, a company's own stock that 
contain
multiple settlement alternatives should be accounted for.

The Task Force discussed another related issue in Issue No. 99-7, "Accounting 
for an Accelerated Share Repurchase Program ." That Issue addressed the
accounting for, and pooling-of-interests implications of, purchasing treasury 
stock and simultaneously entering into a forward contract indexed to the
company's own shares.

At the March 16, 2000 meeting, the Task Force discussed a related issue in 
Issue No. 00-6, "Accounting for Freestanding Derivative Financial Instruments
Indexed to, and Potentially Settled in, the Stock of a Consolidated 
Subsidiary ." That Issue addresses how freestanding derivative instruments 
entered into
by a parent company that are indexed to, and potentially settled in, the 
stock of a consolidated subsidiary should be classified and measured in the
consolidated financial statements.

Another related issue was discussed at the March 16, 2000 meeting in Issue 
No. 00-7, "Application of Issue No. 96-13 to Equity Derivative Instruments 
That
Contain Certain Provisions That Require Net Cash Settlement If Certain Events 
outside the Control of the Issuer Occur ." That Issue deals with how certain
derivative contracts indexed to, and potentially settled in, a company's own 
stock that require a cash payment by the issuer upon the occurrence of future
events outside the control of the issuer should be accounted for.

No further EITF discussion is planned.