Considerations for derivative instruments under ASC 815

In the simplest terms, a derivative is an instrument whose value depends on (or is derived from) the value of an underlying variable or variables, such as the prices of traded assets. Most derivatives are net-settled contracts that allow the holder to benefit from changes in the value of a referenced asset or other market variable while making a smaller initial investment than would be required to own that asset and experience similar gains and losses.

There are different types of derivative contracts, but the most common ones are forwards, futures, options, and swaps. When an entity enters into these types of contracts, it may be fairly obvious that such a contract meets the definition of a derivative. However, the accounting definition of a derivative sometimes encompasses other types of contracts that are not commonly thought of as derivatives, such as financial guarantees and contracts to purchase materials or power, or commodity contracts that require the physical delivery of assets that are readily convertible to cash.

In accordance with ASC 815-10-15-83, all three of the following criteria must be satisfied for a contract to meet the definition of a derivative:

An instrument that does not meet the definition of a derivative in its entirety may contain contractual terms or features that affect the cash flows, values, or other exchanges required by the terms of the instrument in a manner similar to a derivative. Such terms or features are “embedded” in the overall arrangement or contract and are referred to as “embedded derivatives.”

Under ASC 815-15-25-1, an entity is required to bifurcate and separately account for a feature embedded within another contract (the host contract) if all three of the following conditions are met:

A key underlying principle of ASC 815 is that derivatives represent either assets or liabilities in the statement of financial position, and those assets or liabilities should be measured initially and subsequently at fair value by applying the concepts of ASC 820. See Deloitte’s Roadmap Fair Value Measurements and Disclosures (Including the Fair Value Option) for more guidance. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated as a hedging instrument in a qualified hedging relationship. Derivatives that are designated as a hedging instrument in a qualified hedging relationship are eligible for specialized hedge accounting. See Deloitte’s Roadmap Hedge Accounting for more information. Other than in limited scenarios, the gain or loss on a derivative instrument that has not been designated as a hedging instrument should be recognized in current-period earnings.

In addition, if any feature of an instrument has been identified and bifurcated as an embedded derivative, the entity should apply the accounting in ASC 815 related to measurement and recognition as if that embedded derivative were a free-standing derivative. Therefore, such an embedded derivative should be initially recorded at fair value and remeasured to its fair value in each reporting period. Unless the bifurcated embedded derivative is designated in a qualified hedging relationship, changes in the derivative’s fair value are recognized through earnings in each reporting period.

Derivatives scope refinements (ASC 815) — FASB recognition and measurement project

On September 29, 2025, the FASB issued ASU 2025-07 which (1) refines the scope of the guidance on derivatives in ASC 815 and (2) clarifies the guidance on share-based payments from a customer in ASC 606. The ASU is intended to address concerns about the application of derivative accounting to contracts that have features based on the operations or activities of one of the parties to the contract and to reduce diversity in the accounting for share-based payments in revenue contracts.

The ASU adds a new scope exception in ASC 815-10-15-59(e) for certain contracts that are not traded on an exchange and have “[a]n underlying that is based on operations or activities specific to one of the parties to the contract.” Contracts that may qualify for this exception include those in which the underlying is linked to the “occurrence or nonoccurrence of an event,” such as achieving specified financial operating results or environmental, social, and governance (ESG) metrics, obtaining regulatory approval, or reaching specified product development milestones. In addition, the scope exception may apply to certain R&D funding arrangements as well as certain litigation funding arrangements.

The ASU also clarifies that when an entity has a right to receive a share-based payment from its customer in exchange for the transfer of goods or services, the share-based payment should be accounted for as noncash consideration within the scope of ASC 606. That is, the ASU specifies that the guidance in ASC 815 or ASC 321 does not apply to share-based payments from a customer “unless and until the entity’s right to receive or retain the share-based noncash consideration is unconditional” in accordance with ASC 606. ASC 606-10-45-4 states that a “right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.”

ASU 2025-07 is effective for annual reporting periods beginning after December 15, 2026, including interim reporting periods within those annual reporting periods. Early adoption of the standard is permitted in an interim or annual reporting period for which financial statements have not been issued or made available for issuance. If an entity elects to early adopt the standard in an interim period, the entity must apply the standard as of the beginning of the fiscal year that includes the interim period. Further, an entity that elects to early adopt the ASU is required to early adopt the guidance for both Issue 1 and Issue 2 in the standard.

For more information about the ASU, see Deloitte’s September 29, 2025, Heads Up.