Alert

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2025-07, Derivatives and Hedging (Topic 815) and Revenue from Contracts with Customers (Topic 606): Derivatives Scope Refinements and Scope Clarification for Share-Based Noncash Consideration from a Customer in a Revenue Contract.

To address stakeholders’ concerns and to reduce diversity in practice, the amendments clarify the application of derivative accounting to contracts with features based on the operations or activities of one of the parties to a contract. In addition, the amendments clarify the scope and accounting for share-based noncash consideration from a customer that’s consideration for the transfer of goods or services.

The derivative scope refinements apply to all entities that enter into nonexchange-traded contracts with variables (referred to as underlyings) based on operations or activities specific to one of the parties to the contract.

The scope clarifications to share-based noncash consideration apply to all entities that enter into contracts to receive share-based noncash consideration from a customer for the transfer of goods or services.

Derivatives Scope Refinements

Feedback received during the 2021 FASB Invitation to Comment noted challenges in applying the guidance in Topic 815, Derivatives and Hedging, and indicated that the definition of a derivative is too broad.

Because of the broad application of the definition of a derivative, many types of contracts are being evaluated and potentially accounted for as derivatives, including:

• Certain emerging transactions, such as bonds in which interest payments may vary based on environmental, social, and governance (ESG)-linked metrics.
• Certain longstanding transactions, such as research and development funding arrangements and litigation funding arrangements.

Feedback received noted that because these contracts relate to the performance of a party to the contract, accounting for such contracts as derivatives measured at fair value doesn’t reflect the economics.

Derivative Scope Exception

To address the feedback received, the amendments add a derivative scope exception for nonexchange-traded contracts with underlyings that are based on the operations or activities of one of the parties to the contract. The scope exception applies to underlyings based on financial operating results and the occurrence or nonoccurrence of an event specific to the operations or activities of one of the parties to the contact, such as obtaining regulatory approval, achieving a successful litigation outcome, achieving a product development milestone, or achieving a greenhouse gas emissions reduction target.

When evaluating whether operations or activities are specific to one of the parties to the contract, an entity doesn’t need to consider whether the outcome is within its control.

For purposes of applying this scope exception, the term party to the contract includes the parent, subsidiaries, or other entities consolidated by the parent for both consolidated financial statements and the standalone financial statements of individual entities within the consolidated group.

However, the scope exception doesn’t apply to:

• Variables based on a market rate, market price, or market index
• Variables based on the price or performance of a financial asset or financial liability of one of the parties to the contract
• Contracts, or features, involving the issuer’s own equity that are evaluated under the guidance in Subtopic 815-40, Derivatives and Hedging—Contracts in Entity’s Own Equity
• Call options and put options on debt instruments

A contract with multiple underlyings will need to be evaluated under the predominant characteristics assessment in Topic 815 if not all of the underlyings qualify for a derivative scope exception.

Share-Based Noncash Consideration from a Customer in a Revenue Contract

Feedback received in a technical inquiry indicates there’s a lack of clarity in the recognition of share-based noncash consideration, such as warrants, shares, or other equity instruments, received from a customer that’s consideration for the transfer of goods or services.

For example, when entities receive share-based noncash consideration from a customer that’s contingent on the satisfaction of performance obligations, it’s unclear whether that consideration should be recognized at contract inception as a derivative asset under Topic 815 or an equity security under Topic 321, Investments—Equity Securities.

To address the feedback received, the amendments clarify that entities should apply the guidance in Topic 606, including the guidance on noncash consideration, to a contract with share-based noncash consideration. This means the share-based noncash consideration should be initially measured at the estimated fair value and included in the transaction price, subject to the variable constraint guidance if applicable. A contract asset or contract liability should be recognized when there is a timing difference between when the entity performs and when its right to receive or retain the share-based noncash consideration becomes unconditional.

Once the entity’s right to receive or retain the share-based noncash consideration is unconditional under Topic 606, the contract asset or contract liability would be derecognized and the share-based noncash consideration would become subject to other guidance, such as Topic 815 and Topic 321.

In the basis for conclusions to the ASU, the board further clarifies that when assessing whether an entity’s right to receive or retain share-based noncash consideration is unconditional, the entity should evaluate only contract terms that relate to its performance obligations within the scope of Topic 606. Once the performance-related contingencies have been resolved, an entity’s right to receive or retain share-based noncash consideration from a customer is unconditional and the entity should begin accounting for the share-based noncash consideration under other topics. A contingent event that is unrelated to an entity’s performance obligation won’t prevent the entity from accounting for share-based noncash consideration under other topics.

Effective Dates

The derivative scope refinements and the amendments to share-based noncash consideration are effective for all entities for annual reporting periods, including interim reporting periods within those annual reporting periods, beginning after December 15, 2026.

Early adoption is permitted in both interim and annual reporting periods in which financial statements haven’t yet been issued or made available for issuance.  An entity that elects early adoption is required to early adopt the derivative scope refinements and the amendments to share-based noncash consideration simultaneously.  

Transition Requirements

The ASU permit entities to apply the amended guidance on a prospective or modified retrospective basis.

• Prospective Basis. Entities should apply the amendments to new contracts entered into on or after the date of adoption. For the amendments to share-based noncash consideration this would include modified contracts accounted for as separate contracts.
• Modified Retrospective Basis. Entities should apply the amendments through a cumulative-effect adjustment to the opening balance of retained earnings beginning as of the annual reporting period of adoption for contracts existing as of the beginning of the annual reporting period of adoption. Upon adoption of the derivative refinements, entities may elect the fair value option on an instrument-by-instrument basis for contracts previously accounted for as derivatives that are no longer accounted for as derivatives under the amendments. Entities may also revoke the fair value option for embedded derivatives that previously would have been bifurcated but are no longer required to be bifurcated under the amendments.

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