ASC 460, Guarantees, consists of one subtopic:
ASC 460-10 has two Subsections:
Additional sources of guidance are listed in the Other Sources section at the end of this chapter.
ASC 460 applies to all entities. ASC 460 applies to guarantee contracts that contingently require the guarantor to make payments (either in cash, financial instruments, shares of its stock, other assets, or in services) to the guaranteed party based on any of the following circumstances (ASC 460-10-15-4):
(ASC 460-10-55-2, with reference to ASC 460-10-15-4(a))
One common example of this type of situation is where a hospital lures a doctor to open a practice in an underserved community with a guarantee of fee income for an initial period. ASC 460 explicitly states that these types of assurances are guarantees and must be given accounting recognition.
Per ASC 460-10-15-7, ASC 460 does not apply to:
(ASC 460-10-15-7)
Initial measurements. ASC 460's requirement to recognize an initial liability does not apply to the following types of guarantees (i.e., these guarantees are subject only to ASC 460's disclosure requirements):
(ASC 460-10-25-1)
Product warranties. Per ASC 460-10-15-9 the guidance in the Product Warranties Subsections applies only to product warranties, which include all of the following:
Guarantees embody two separate obligations:
As a result of this bifurcation of the obligation, many guarantees are now required to be recognized as liabilities on the statement of financial position.
Source: ASC 460-10-20. Also see Appendix A, Definition of Terms, for other terms relevant to this topic: Acquiree, Acquirer, Acquisition by a Not-for-Profit Entity, Business, Business Combination, Contingency, Fair Value, Gain Contingency, Legal Entity, Loss Contingency, Not-for-Profit Entity, Performance Obligation, Probable, Related Parties, Revenue, Underlying, Variable Interest Entity, Weather Derivative.
Commercial Letter of Credit. Document issued typically by a financial institution on behalf of its customer (the account party) authorizing a third party (the beneficiary), or in special cases the account party, to draw drafts on the institution up to a stipulated amount and with specified terms and conditions; it is a conditional commitment (except if prepaid by the account party) on the part of the institution to provide payment on drafts drawn in accordance with the terms of the document.
Direct Guarantee of Indebtedness. An agreement in which a guarantor states that if the debtor fails to make payment to the creditor when due, the guarantor will pay the creditor. If the debtor defaults, the creditor has a direct claim on the guarantor.
Financial Standby Letter of Credit. An undertaking (typically by a financial institution) to guarantee payment of a specified financial obligation.
Indirect Guarantee of Indebtedness. An agreement that obligates the guarantor to transfer funds to a debtor upon the occurrence of specified events, under conditions whereby:
In contrast with a direct guarantee of indebtedness, if the debtor defaults, the creditor has a direct claim on the guarantor. Examples of indirect guarantees include agreements to advance funds if a debtor's net income, coverage of fixed charges, or working capital falls below a specified minimum.
Indirectly Related to the Leased Property. The provisions or conditions that in substance are guarantees of the lessor's debt or loans to the lessor by the lessee that are related to the leased property but are structured in such a manner that they do not represent a direct guarantee or loan. Examples include a party related to the lessee guaranteeing the lessor's debt on behalf of the lessee, or the lessee financing the lessor's purchase of the leased asset using collateral other than the leased property.
Minimum Revenue Guarantee. A guarantee granted to a business or its owners that the revenue of the business (or a specific portion of the business) for a specified period of time will be at least a specified minimum amount.
Noncancelable Lease Term. That portion of the lease term that is cancelable only under any of the following conditions:
Penalty. Any requirement that is imposed or can be imposed on the lessee by the lease agreement or by factors outside the lease agreement to do any of the following:
Performance Standby Letter of Credit. An irrevocable undertaking by a guarantor to make payments in the event a specified third party fails to perform under a nonfinancial contractual obligation.
Warranty. A guarantee for which the underlying is related to the performance (regarding function, not price) of nonfinancial assets that are owned by the guaranteed party. The obligation may be incurred in connection with the sale of goods or services; if so, it may require further performance by the seller after the sale has taken place.
ASC 460:
These two obligations have quite different accounting implications:
At the inception of a guarantee, the guarantor recognizes a liability for both the noncontingent and contingent obligations at their fair values. However, in the unusual circumstance that a liability is recognized under ASC 450-20 for the contingent obligation (i.e., because it is deemed probable of occurrence and reasonable of estimation that the guarantor will pay), the liability initially recognized for the noncontingent obligation would only be the portion, if any, of the guarantee's fair value not already recognized to comply with ASC 450-20.
It is important to stress that this does not mean that the guarantor records the entire face amount of the guarantee; rather, it is the fair value of the stand-ready obligation that is recognized. When a guarantee is issued in a stand-alone, arm's-length transaction with an unrelated party, the fair value of the guarantee (and thus the amount to be recognized as a liability) is the premium received by the guarantor. When a guarantee is issued as part of another transaction (such as the sale or lease of an asset) or as a contribution to an unrelated party, the fair value of the liability is measured by the premium that would be required by the guarantor to issue the same guarantee in a stand-alone, arm's-length transaction with an unrelated party.
In practice, if the likelihood that the guarantor will have to perform is judged to be only “reasonably possible” or “remote,” the only amount recorded is the fair value of the noncontingent obligation to stand ready to perform. If, however, the contingency is probable of occurrence and can be reasonably estimated under ASC 450-20, that amount must be recognized and the liability under the guarantee arrangement will be the greater of
When initially issued, the guidance on computing guarantees where no market information is available made reference to CON 7. In so doing, FASB endorsed the use of the discounted, probability-weighted cash flow method for estimating the stand-ready obligation.
Since, in the author's opinion, in the absence of other, better input data, such as the pricing of insurance to assume the risk of performing on the guarantee, the probability-weighted present value of possible future cash flows could serve as useful input to determining the fair value of guarantees made, the following example is presented.
The entry to record the liability depends upon the circumstances under which the guarantee arose. If the guarantee was issued in a stand-alone transaction for a premium, the offset would be to the asset accepted for the premium's payment (most likely, cash or a receivable). If the guarantee was issued in conjunction with the sale of assets, the proceeds would be allocated between the sale of the asset and the guarantee obligation, so that the profit (loss) on the sale of the asset would be reduced (increased). If the guarantee was issued in conjunction with the formation of a business accounted for under the equity method, the offset would be an increase in the carrying amount of the investment. If the guarantee was issued to an unrelated party for no consideration, an immediate expense would be recognized. If a residual value guarantee was provided by a lessee-guarantor, the offset would be reported as prepaid rent and then amortized over the term of the lease to rent expense. The residual value of equipment by the manufacturer is recognized by the manufacturer as an asset (included in the seller/lessor's net investment in lease).
After initial recognition, the liability is adjusted as the guarantor either is released from risk or is subject to increased risk. ASC 460 does not prescribe the accounting for guarantees subsequent to initial recognition, and there is no requirement to reassess the fair value of the guarantee after inception. In fact, ASC 460 only addresses measurement of a guarantor's liability at the inception of the guarantee and fair value is only to be used in subsequent accounting for the guarantee if the use of that method can be justified under other authoritative guidance. ASC 460 cannot be cited to support adjustments to fair value subsequent to initial recognition.
However, if the guarantor is subsequently released from risk, logically that could be recognized in one of three ways, in the authors' opinion, although no guidance is provided by ASC 460. First, the liability could simply be written off at its expiration or settlement. Second, the liability could be amortized systematically over the guarantee period. Third, the liability might be adjusted to reflect changing fair value, which presumably declines over time as the risk of having to perform decreases. Furthermore, changes dictated by the provisions of ASC 450 (e.g., as a previously “remote” contingency becomes a “probable” one) must be accounted for under that requirement, apart from the requirements of ASC 460.
According to ASC 605-20-25-9, fees received for guaranteeing another entity's obligation are to be recognized as income over the guarantee period, rather than at the time of receipt, consistent with other standards governing service fee income recognition. (Upon implementation of ASU 2014-09, ASC 605-20-25-9 will be superseded by ASC 606.) The guarantor is to perform ongoing assessments of the probability of loss related to the guarantee and recognize a liability if the conditions in ASC 450 are met. Upon entering into a guarantee arrangement, the guarantor is required to recognize the stand-ready obligation under the guarantee. The contingent aspect of the guarantee would only be recognized if the conditions defined by ASC 450 are met.
The authoritative GAAP governing lease accounting holds that manufacturers are precluded from recognizing sales of equipment when they provide purchasers with guarantees of resale value, unless the criteria for sales-type lease accounting are met (ASC 840-10-55-12 et seq.). It states that minimum lease payments, used to ascertain whether a given lease would be an operating or sales-type (capital) lease, are to include the difference between the initial proceeds and the guaranteed amount. Under these circumstances, the fair value of the resale value guarantee is not recognized by the manufacturer, because ASC 460 does not apply to an asset of the guarantor. Given that the manufacturer would report the residual value as an asset, the guarantee does not fall within the domain of ASC 460.
Disclosures can be found in the checklist in the Appendix.
Product warranties providing for repair or replacement of defective products may be sold separately or may be included in the sale price of the product. ASC 460-10-25-5 points out that “because of the uncertainty surrounding claims that may be made under warranties, warranty obligation fall within the definition of a contingency” and losses are accrued under the conditions in ASC 450-20-25 are met:
These conditions may be made for individual elements or groups of items and the particular parties making claims my not be identified at the time of the accrual.
If the warranty extends into the next accounting period, a current liability for the estimated amount of warranty expense expected in the next period must be recorded. If the warranty spans more than the next period, the estimated liability must be partitioned into a current and long-term portion. ASC 460 requires disclosure of product warranties in the notes to financial statements. Disclosure requirements can be found in the Appendix.
Software vendors/licensors often include, as part of their customary contractual terms, an indemnification clause that indemnifies the licensee against liability and damages (including costs of legal defense) that could arise in the event that a third party claims patent, copyright, trademark, or trade secret infringement with respect to the licensor's software. The indemnification requires the licensor/guarantor to make a payment to the licensee/guaranteed party based on the occurrence of an infringement claim against the licensor that results in liabilities or damages related to the licensed software being used by the licensee. Under such a scenario, an infringement claim covered by the indemnification could impair the ability of the licensee to use the licensed software if, for example, a court orders an injunction or assesses damages.
The indemnification qualifies for the scope exception in ASC 460-10-25-1(b) (discussed in the Scope and Scope Exceptions at the beginning of this chapter) as a product warranty or other guarantee for which the underlying is related to the performance of a nonfinancial asset (the software) owned (leased) by the guaranteed party since the licensed software cannot function as intended until the seller-licensor cures the alleged infringement defect.
These arrangements are subject to the same disclosure requirements imposed on other warranty obligations.
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ASC 323-10-35-20 | Guaranteed obligations of an investee that is accounted for using the equity method |
ASC 340-10-25-3 | Contractual guarantees for reimbursement of design and development costs related to long-term supply arrangements |
ASC 360-20-40-41 | A seller's guarantee of a return of the buyer's investment in real estate or a seller's guarantee of a return on that investment for an extended period |
ASC 405-20-40-2 | The guarantee obligation that results if a primary debtor becomes secondarily liable upon a release by a creditor |
ASC 480-10-55-23 | An entity's guarantee of the value of an asset, liability, or equity security of another entity that may require or permit settlement in the entity's equity shares |
ASC 480-10-55-53 through 55-58 | A freestanding put option indexed to a subsidiary's equity shares |
ASC 480-10-55-59 through 55-62 | Embedded put options indexed to the stock of a consolidated subsidiary |
ASC 605-20-25-8 through 25-12 | Recognition of guarantee fees |
ASC 605-15-25-1 through 25-4 | Guaranteed sales (arrangements in which customers buy products for resale with the right to return products) |
ASC 605-35 | For guaranteed maximum reimbursable costs of construction contracts or production contracts |
ASC 718-40-25-9 | An employer's guarantee of the debt of an employee stock option plan |
ASC 805-30 | Guarantees that represent contingent consideration in a business combination |
ASC 810-10-55-25 through 55-26 | Guarantees of the value of the assets or liabilities of a variable interest entity (VIE), written put options on the assets of the VIE, or similar obligations |
ASC 815-10-15-77 and 810-10-45-16A | Freestanding derivative instruments indexed to, and potentially settled in, the stock of a consolidated subsidiary |
ASC 815-45 | Weather derivatives |
Definition of lease term | The effect on the lease term of a provision or condition that in substance is a guarantee of a lessor's debt or a loan to a lessor by the lessee that is related to the leased property but is structured in such a manner that it does not represent a direct guarantee or loan |
ASC 840-10-25-5 | The effects on minimum lease payments of a guarantee by the lessee of the lessor's debt |
ASC 840-10-25-6 and 840-10-55-8 through 55-10 | The effects on minimum lease payments of a guarantee by the lessee of the residual value of the leased property at the expiration of the lease term |
ASC 840-10-15-20 | A determination of whether a residual value guarantee is subject to the requirements of Topic 815 |
ASC 840-10-25-21 through 25-22 | Allocation of a residual value or first-loss guarantee to minimum lease payments in leases involving land and building(s) |
ASC 840-10-25-42 through 25-43 | The classification of a lease that includes a commitment by a lessor to guarantee performance of the leased property in a manner more extensive than a typical product warranty or to effectively protect the lessee from obsolescence of the leased property |
ASC 840-10-55-12 through 55-25 | A manufacturer's guarantee of the resale value of equipment to the purchaser |
ASC 840-10-25-13 | A lessee's indemnification for environmental contamination |
ASC 840-20-30-1 | A guarantee by a lessee of the leased property's residual value in an operating lease transaction |
ASC 840-30-35 | A guarantee by a lessee of the leased property's residual value in a capital lease transaction |
ASC 840-40-25-14 | The effect of providing an independent third-party guarantee of the lease payments in a sale-leaseback transaction |
ASC 840-40-25-15 | Classification of a lease that contains an entity's unsecured guarantee of its own lease payments |
ASC 840-40-25-16 | Classification of a lease that contains an unsecured guarantee of the lease payments of one member of a consolidated group by another member of the consolidated group |
ASC 840-40-55-9 | An indemnification or guarantee of an owner-lessor against third-party claims relating to construction completion in a sale-leaseback transaction |
ASC 840-40-55-15 | An indemnification or guarantee of an owner-lessor against third-party damage claims other than claims caused by or resulting from the lessee's own actions or failures to act while in possession or control of the construction project in a sale-leaseback transaction |
ASC 840-40-55-15 | An indemnification or guarantee by the seller-lessee to a party other than the owner-lessor in a sale-leaseback transaction |
ASC 840-40-55-26 | A guarantee by the seller-lessee of the leased property's residual value in a sale-leaseback transaction |
ASC 860-10-35-6 | Subordination agreements, which are commonly thought of as guarantees issued by subordinated investors |
ASC 860-20-55-20 | Transactions that involve the sale of a marketable security to a third-party buyer, with the buyer's having an option to put the security back to the seller at a specified future date or dates for a fixed price |
ASC 860-50-40-7 through 40-9 | A sale of mortgage servicing rights with a subservicing agreement in which the seller-subservicer directly or indirectly guarantees a yield to the buyer |
ASC 926-605-25-19 through 25-21 | Nonrefundable minimum guarantees contained in certain film licensing arrangements |
ASC 960-325-35-3 | Guaranteed investment contracts held by defined benefit pension plans |
ASC 970-470-25-3 | An entity's agreement to either make up shortfalls in the annual debt service requirements or guarantee a tax increment financing entity's debt |
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