The accounting standards applicable to derivatives covers basically two areas: hedge accounting and non-hedge accounting. Hedge accounting provides potentially advantageous accounting results to a company since some or all of the changes in fair can be excluded from income. As a result, the FASB includes in the ASC a list of contract and transaction types that are scoped out of derivative accounting. These scope exceptions are primarily intended to limit the use of hedge accounting OR are intended to avoid conflicts with other accounting standards. With __ notable exceptions, most of these scope limitations are very unlikely to apply to an equity-linked transaction that was never intended to be a hedge of any kind. The list of scope exceptions intended to divert agreement and transactions from derivative accounting include (ASC 815-10-15-3):
1) Regular way security trades
2) Normal purchases and normal sales
3) Certain insurance contracts
4) Certain financial guarantee contracts
5) Certain contracts that are not traded on an exchange
6) Derivative instruments that impede sales accounting
7) Investment in life insurance
8) Certain investment contracts
9) Certain loan commitments
10) Certain interest-only strips and principal-only strips
12) Registration payment arrangements
An in-depth analysis of all the exceptions is provided here (add link). Other exceptions that may possibly apply to an equity-linked transaction are evaluated in later steps of this analysis. These exceptions include:
Certain contracts involving an entity’s own stock – Contracts issued or held by the reporting entity that are both 1) indexed to its own stock and 2) classified in stockholders’ equity. This exception is subject to numerous complex exceptions and is evaluated in later steps.
Leases – Leases are not subject to derivative accounting. However, an embedded feature can be subject to derivative accounting and should be evaluated separately using this tool.