FASB Issues Derivatives Scope Refinements

In under a minute

• On Sept. 29, 2025, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2025-07, which amends Topic 815 (“Derivatives and Hedging”), to expand the scope exception for certain non-exchange-traded contracts for which settlement is based on the operations or activities specific to one of the parties to the contract.
• The expanded scope exception does not apply to certain market-based variables, variables based on the price or performance of financial assets or financial liabilities of one of the parties to the contract, equity-linked contracts, or call options and put options on debt instruments.
• The ASU also clarifies that share-based noncash consideration received from customers as consideration for goods or services is first subject to Topic 606 (“Revenue From Contracts With Customers”) before Topic 815 or Topic 321 is applied, which is addressed in the Crowe article “Accounting for Share-Based Payment From Customers.”
• The amendments are effective for annual reporting periods beginning after Dec. 15, 2026, with early adoption permitted.

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Background

The FASB issued 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,” in response to stakeholder concerns, raised in the 2021 Agenda Consultation, that Topic 815’s “derivative” definition was applied too broadly. Stakeholders noted difficulties applying the definition and scope exceptions to contracts that do not resemble traditional derivatives, including environmental, social, and governance (ESG) linked instruments; research and development (R&D) funding arrangements; and litigation funding arrangements. Preparers also cited high compliance costs, questionable relevance of fair value measurement, and structural work-arounds designed to avoid derivative classification.

To address these concerns, ASU 2025-07 expands an existing scope exception in Topic 815 to reduce the cost and complexity of applying the guidance and better align accounting outcomes with the economic substance of certain contracts.

Breaking it down

The standard adds to the list of derivative scope exceptions an exception for non-exchange-traded contracts with underlyings based on the operations or activities specific to one of the contract parties. Under Topic 815, an underlying is a variable that affects the settlement amount, including the exercisability, of a contract (for example, market rates, security and commodity prices, and the occurrence or nonoccurrence of an event). The scope exception includes (but is not limited to) the following underlyings that are specific to one of the contract parties:

• Financial statement metrics – for example, EBITDA, net income, and expenses
• Achievement of ESG targets – for example, additional interest required under a debt instrument upon the failure to meet certain ESG measures
• Regulatory approval or attainment of other product development milestone – for example, under certain R&D funding arrangements
• Litigation outcomes – for example, under certain litigation funding arrangements

The ASU provides that an entity is not required to consider whether such events are within its control in determining whether the contract qualifies for the scope exception. In addition, when assessing whether an underlying is specific to a party to the contract, the scope exception could be met, for the purposes of both consolidated financial statements and stand-alone financial statements, if the underlying was specific to any entity within the consolidated group.

The scope exception does not apply to features based on market rates, market indexes, or the price or performance (including default) of a financial asset or financial liability. In a change from the proposed ASU issued in July 2024, the board decided that the scope exception also would not apply to freestanding and embedded contracts involving an entity’s own equity (for example, warrants and conversion features embedded in debt) that require the application of Accounting Standards Codification (ASC) 815-10-15-74(a) and Subtopic 815-40, as well as call options and put options on debt instruments that require the application of ASC 815-15-25-41 through 25-43.

Crowe observation: The board’s decision to exclude contracts on an entity’s own equity and call options and put options on debt significantly reduced the scope of the final ASU as these contracts and features are far more common than the contracts and features initially raised by stakeholders as causing concern. In another change from the proposed update, the board decided not to amend the current guidance in ASC 815-10-15-60 on contracts and features with multiple underlyings that is applied when some underlyings qualify for the exception and others do not. We believe that these decisions will significantly reduce the cost and complexity of applying the ASU as compared to the proposed update.

The ASU provides numerous examples beginning in paragraph 815-10-55-143A, two of which are summarized in the following table:

Effective date and transition

The amendments are effective for annual reporting periods (including interim reporting periods within annual reporting periods) beginning after Dec. 15, 2026, for all entities. Early adoption is permitted for both interim and annual financial statements that have not yet been issued (or made available for issuance), and if an entity adopts the amendments in an interim period, the entity is required to adopt them as of the beginning of the annual reporting period that includes that interim period.

Entities may elect to apply the amendments in either of the following ways:

• Prospectively to new contracts entered into on or after the effective date
• Using a modified retrospective approach to existing contracts and embedded features as of the beginning of the fiscal year of adoption through a cumulative-effect adjustment to the opening balance of retained earnings (or other appropriate components of equity)

If an entity elects the modified retrospective approach and has contracts or embedded features that are no longer derivatives under the ASU, it may elect to apply the fair value option, as of the beginning of the annual period for which the ASU is adopted if that instrument is within the scope of ASC 825-10-15-4. This election is available on an instrument-by-instrument basis. If an entity had previously applied the fair value option to contracts with embedded features that would otherwise have required bifurcation but no longer require bifurcation under the ASU, the entity may revoke, on an instrument-by-instrument basis, the fair value option as of the beginning of the annual period of adoption and measure the contract under other applicable GAAP.

In both the interim period (if applicable) and the annual period of adoption, entities must disclose:

• The nature of and reason for the change in accounting principle
• If applying modified retrospective transition, the cumulative effect of the change on retained earnings or other components of equity as of the beginning of the fiscal year of adoption

FASB materials reprinted with permission. Copyright 2025 by Financial Accounting Foundation, Norwalk, Connecticut. Copyright 1974-1980 by American Institute of Certified Public Accountants.