Subtopic

ASC 460, Guarantees, consists of one subtopic:

• ASC 460-10, Overall, which provides requirements to be met by a guarantor for certain guarantees issued and outstanding.

ASC 460-10 has two Subsections:

• General, which discusses the guarantor's recognition and disclosure of a liability at the inception of a guarantee
• Product Warranties.

Additional sources of guidance are listed in the Other Sources section at the end of this chapter.

Scope and Scope Exceptions

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):

1. Changes in a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, or any other variable, including the occurrence or nonoccurrence of a specified event that is related to an asset or liability of the guaranteed party. For example, the provisions apply to the following, as cited by ASC 460:
   1. A financial standby letter of credit
   2. A market value guarantee on either securities (including the common stock of the guaranteed party) or a nonfinancial asset owned by the guaranteed party
   3. A guarantee of the market price of the common stock of the guaranteed party
   4. A guarantee of the collection of the scheduled contractual cash flows from individual financial assets held by a variable interest entity (VIE)
   5. A guarantee granted to a business or its owners that the revenue received by the business will equal or exceed some stated amount.

      (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.

2. Another entity's failure to perform under an obligating agreement. For example, the provisions apply to a performance standby letter of credit, which obligates the guarantor to make a payment if the specified entity fails to perform its nonfinancial obligation.
3. The occurrence of a specified event or circumstance (an indemnification agreement), such as an adverse judgment in a lawsuit or the imposition of additional taxes due to either a change in the tax law or an adverse interpretation of the tax law, provided that the guarantor is an entity other than an insurance or reinsurance company.
4. The occurrence of specified events under conditions whereby payments are legally available to creditors of the guaranteed party and those creditors may enforce the guaranteed party's claims against the guarantor under the agreement (an indirect guarantee of the indebtedness of others).

Per ASC 460-10-15-7, ASC 460 does not apply to:

1. A guarantee or an indemnification that is excluded from the scope of Topic 450, Contingencies, primarily employment-related guarantees
2. A lessee's guarantee of the residual value of leased property if the lessee accounts for the lease as a capital lease
3. Contingent rents
4. A guarantee contract or an indemnification agreement, accounted for under ASC 944, that is issued by either an insurance or a reinsurance company
5. Vendor rebates (by the guarantor) based on either the sales revenues of or the number of units sold by the guaranteed party
6. Vendor rebates (by the guarantor) based on the volume of purchases by the buyer (because the underlying relates to an asset of the seller not the buyer who receives the rebate)
7. Guarantees that prevent the guarantor from recognizing either the sale of the asset underlying the guarantee or the profits from that sale
8. A registration payment arrangement within the scope of ASC 825-20-15, Financial Instruments, Registration Payment Arrangements
9. A guarantee or an indemnification of an entity's own future performance.
10. A guarantee accounted for as a credit derivative instrument at fair value under ASC 815-10-50-4J through 4L
11. A sales incentive program where a manufacturer guarantees to recognize the equipment at a specified time or place. Exception under Topic 606 upon effective date of ASU 2014-09.

    (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):

1. A guarantee that is accounted for as a derivative instrument at fair value under ASC 815.
2. A contract that guarantees the functionality of nonfinancial assets that are owned by the guaranteed party (product warranties)
3. Contingent consideration in a business combination or an acquisition of a business or nonprofit activity by a not-for-profit entity
4. A guarantee that requires the guarantor to issue its own equity shares
5. A guarantee by an original lessee that has become secondarily liable under a new lease that relieved the original lessee of the primary obligation under the original lease
6. A guarantee issued between parents and their subsidiaries or between corporations under common control
7. A parent's guarantee of a subsidiary's debt to a third party (irrespective of whether the parent is a corporation or an individual)
8. A subsidiary's guarantee of a parent's debt to a third party or the debt of another subsidiary of the parent.

   (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:

1. Product warranties issued by the guarantor, regardless of whether the guarantor is required to make payment in services or cash
2. Separately priced extended warranty or product maintenance contracts and (per ASC 606) “warranties that provide a customer with a service in addition to the assurance that product complies with agreed-upon specifications.”
3. Warranty obligations that are incurred in connection with the sale of the product, that is, obligations that are not separately priced or sold but are included in the sale of the product.

Overview

Guarantees embody two separate obligations:

1. The contingent obligation to make future payments under the guarantee in the event of nonperformance by the party whose obligation is guaranteed, and
2. An obligation to be ready to perform, referred to as a standby obligation, during the period that the guarantee is in effect.

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.

Guarantees

ASC 460:

• Requires that the fair value of guarantees be recognized as a liability, and
• Establishes the notion that a guarantee actually consists of two distinct components.

These two obligations have quite different accounting implications:

• Noncontingent obligation. The first of these components is a noncontingent obligation, namely, the obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur. This stand-ready obligation is unconditional and thus is not considered a contingent obligation.
• Contingent obligation. The second component, which is a contingent obligation, is the obligation to make future payments if those triggering events or conditions occur.

Product Warranties

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:

1. If it is probable that an obligation has been incurred because of a transaction or event that occurred on or before the date of the financial statements, and
2. If the amount of the obligation can be reasonably estimated.

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.

Other Sources