Guarantees and joint and several obligations
2.4 ASC 460 scope exceptions
ASC 460-10-15-7 provides a number of scope exceptions. When a reporting has a contract that is not in the scope of ASC 460, it should apply other applicable U.S.
GAAP. This can result in guarantees being accounted for using a variety of different accounting standards including leasing, revenue recognition, derivatives, and insurance.
ASC 460-10-15-7
The guidance in this Topic does not apply to the following types of guarantee contracts:
a. A guarantee or an indemnification that is excluded from the scope of Topic 450 (see paragraph 450-20-15-2—primarily employment-related guarantees) b. A lessee’s guarantee of the residual value of the leased property at the expiration
of the lease term, if the lessee (guarantor) accounts for the lease as a capital lease under Subtopic 840-30
c. A contract that meets the characteristics in paragraph 460-10-15-4(a) but is accounted for as contingent rent under Subtopic 840-30
d. A guarantee (or an indemnification) that is issued by either an insurance entity or a reinsurance entity and accounted for under Topic 944 (including guarantees embedded in either insurance contracts or investment contracts)
e. A contract that meets the characteristics in paragraph 460-10-15-4(a) but
provides for payments that constitute a vendor rebate (by the guarantor) based on either the sales revenues of, or the number of units sold by, the guaranteed party
f. A contract that provides for payments that constitute a vendor rebate (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 rebates g. A guarantee or an indemnification whose existence prevents the guarantor from
being able to either account for a transaction as the sale of an asset that is related to the guarantee’s underlying or recognize in earnings the profit from that sale transaction
h. A registration payment arrangement within the scope of Subtopic 825-20 (see Section 825-20-15)
i. A guarantee or an indemnification of an entity’s own future performance (for example, a guarantee that the guarantor will not take a certain future action) j. A guarantee that is accounted for as a credit derivative at fair value under Topic
815.
Employment related guarantees such as vacation pay, pension costs, deferred compensation contracts, and stock issued to employees are generally scoped out of ASC 460.
2.4.1 Guarantees that prevent sale accounting
ASC 460-10-55-17 provides examples of guarantees that are outside the scope of ASC 460 because they prevent sale accounting.
ASC 460-10-55-17
The following are examples of contracts that are outside the scope of this Topic because they are of the type described in paragraph 460-10-15-7(g):
a. A seller’s guarantee of the return of a buyer’s investment or return on investment of a real estate property as discussed in paragraph 360-20-40-41.
b. A seller’s guarantee of a specified level of operations of a real estate property, as discussed in paragraphs 360-20-40-42 through 40-44.
c. A transaction that involves sale of a marketable security to a third-party buyer with the buyer having an option to put the security back to the seller at a specified future date or dates for a fixed price, if the existence of the put option prevents the transferor from accounting for the transaction as a sale, as described in
paragraphs 860-20-55-20 through 55-23.
d. A lessee’s residual value guarantee if that guarantee results in the seller-lessee deferring profit from the sale greater than or equal to the gross amount of the guarantee (see paragraphs 840-40-55-26 through 55-28).
e. A sales incentive program in which a manufacturer contractually guarantees that the purchaser will receive a minimum resale amount at the time the equipment is disposed of, if that guarantee prevents the manufacturer from being able to account for a transaction as a sale of an asset, as described in paragraphs 840-10-55-12 through 55-25. (Because a manufacturer continues to recognize the residual value of the equipment it guaranteed [it is included in the seller-lessor’s net investment in the lease], if the sales incentive program qualified to be reported as a sales-type lease, it still would not be within the scope of this Topic because this Topic does not apply to a guarantee for which the underlying is related to an asset of the guarantor.)
The following example illustrates a guarantee that is outside the scope of ASC 460 because it prevents sale accounting.
EXAMPLE 2-3
Impact of sale accounting on accounting for guarantees
J&N Corp manufactures equipment and sells it to a third party finance company. The finance company then leases the equipment under an operating lease to an end user lessee. To facilitate the sale, J&N Corp provides the finance company with the following guarantees:
A credit guarantee to protect the finance company from losses incurred from default by the lessee
A residual value guarantee to protect the finance company from decreases in the fair value of the equipment, when it is returned by the end user at the end of the lease term, below a specified threshold
Should the J&N Corp account for the guarantees under the guidance in ASC 460?
Analysis
J&N Corp determines that the guarantees cause it to retain a substantial risk of ownership in the equipment; thus, sale accounting is precluded under the guidance in ASC 840, Leases.
Because the guarantees preclude sale accounting, they qualify for the scope exception in ASC 460-10-15-7. J&N Corp should not account for the guarantees under the guidance in ASC 460.
2.4.2 Guarantees on a reporting entity’s own performance
Guarantees related to a reporting entity’s past performance are often within the scope of ASC 460. Guarantees related to a reporting entity’s future performance are not. For example, product warranties for goods are within the scope of ASC 460 because the warrantied product was produced and sold in the past. On the other hand, a warranty
on the guarantor’s future services is excluded from the scope of ASC 460 because it relates to the guarantor’s own future performance. Warranties on future service include warranties on completion of a contract by a specified deadline, and service contracts that guarantee a customer a specified amount of cost savings in the future.
In some cases a reporting entity may need to assess whether a guarantee relates to its own performance or the performance of another entity to determine whether the scope exception for a guarantee of its own performance should be applied. If a reporting entity has guaranteed its own past performance, it should still assess whether it qualifies for other scope exceptions within ASC 460.
The following example illustrates a guarantee that is outside the scope of ASC 460 because it is a guarantee of a reporting entity’s own performance.
EXAMPLE 2-4
Indemnification of performance under a joint business arrangement
LCD Corp and J&N Corp enter into a joint business arrangement. As part of the arrangement, LCD Corp and J&N Corp agree to indemnify and “hold harmless” each other from any third party claims relating to their performance under the
arrangement. Accordingly, LCD Corp agrees to indemnify J&N Corp for claims related to LCD Corp’s performance under the joint business arrangement, and J&N Corp agrees to indemnify LCD Corp for claims related to J&N’s performance.
Are the indemnifications guarantees within the scope of ASC 460?
Analysis
No, neither the indemnification that LCD Corp provides to J&N Corp nor the
indemnification that J&N Corp provides to LCD Corp are within the scope of ASC 460 because each indemnification is related to the indemnitor’s own future performance under the joint business arrangement.
2.4.3 Credit derivatives
To determine whether a credit derivative is within the scope of ASC 460, a reporting entity should first determine whether the credit derivative contract should be
accounted for as a derivative under the guidance in ASC 815. If the reporting entity is an insurance company, it must also consider the guidance in ASC 944. If a credit derivative is within the scope of ASC 815 or ASC 944, it should be accounted for using that guidance. If it is not within the scope of ASC 815 or ASC 944, it should be
accounted for using the guidance in ASC 460.