Upon issuance and at all times during the life of the embedded derivative, the entity must have sufficient authorized and unissued shares to satisfy share settlement requirements of the instrument. All contracts that are potentially settled in shares must be evaluated and there must be sufficient authorized and unissued shares for all contracts or this criteria is not met. For example, if the entity has a warrant whose exercise price is variable based upon changes in fair value of the company’s stock, an outside index or some other variable, there is no means of determining how many shares will be required to satisfy the warrant. Since the number of shares can not be determined, there is therefore no way for the entity to determine whether it has sufficient authorized and unissued shares to satisfy the derivative instrument.
The entity must continuously evaluate this during the life of the instrument since new contracts entered into by the entity may taint the classification determination made at inception. Likewise, if there is no way to determine if there are sufficient authorized and unissued shares at inception, this may become possible during the term of the instrument as one or tainting instruments expire or are exercised. For these reasons, it is important to maintain a schedule of all contract expiration dates to monitor the timing of expirations that affect this criterion.