Which of our current contracts with operations-based underlyings should be reclassified out of derivative accounting, and what is the cumulative retained earnings impact of retroactive application?

- Share-Based Customer Consideration (Topic 606): Clarification that Topic 606 applies to share-based noncash consideration from a customer that constitutes consideration for transferring goods or services. - Transition Methods: Entities may adopt either prospectively (to new contracts on or after adoption) or via modified retrospective basis (cumulative-effect adjustment to retained earnings at adoption date). The amendments are effective for annual reporting periods beginning after December 15, 2026, and interim periods within those years. Early adoption is permitted. Entities may elect prospective or modified retrospective application.

Do any of our derivative contracts fall within the carve-outs (market indices, financial asset performance, own equity, or debt options) and therefore must remain subject to fair value accounting?

- All entities entering into non-exchange-traded contracts with operation-specific underlyings (R&D funding, litigation funding, ESG-linked bonds, etc.) - Companies receiving share-based consideration (e.g., equity instruments) from customers as part of revenue contracts - Industries with emerging transaction types (ESG-linked debt, contingent funding arrangements) - Any entity with existing derivative contracts that may qualify for the new scope exclusion 1. Inventory Non-Exchange-Traded Contracts: Finance teams should identify all current contracts with underlyings tied to a party's operations or activities (R&D spend, litigation outcomes, ESG metrics). Evaluate whether each qualifies for the new scope exception and whether reclassification from derivative to non-derivative accounting is appropriate upon adoption. 2. Document Carve-Out Analysis: For each in-scope contract, document whether it involves market rates/indices, financial asset/liability performance, issuer equity, or debt call/put options—all of which remain subject to derivative accounting regardless of operations-based underlyings.

How should we account for share-based noncash consideration received from customers under Topic 606, and does this change our revenue recognition pattern or contract asset valuation?

3. Assess Share-Based Customer Consideration: Review revenue contracts that include share-based compensation or equity instruments received from customers. Ensure Topic 606 measurement and recognition requirements are applied (rather than alternative treatments) and update revenue recognition policies accordingly. Consider the impact on contract asset/liability balances and revenue timing upon transition.

FASB Accounting Standards Update (ASU) 2025-07

What this ASU does

ASU 2025-07 addresses two key areas of accounting diversity and complexity in US GAAP. First, it narrows the scope of derivative accounting (Topic 815) by excluding non-exchange-traded contracts whose settlement is based on operations or activities specific to one of the contracting parties—such as research and development funding arrangements, litigation funding arrangements, and ESG-linked bonds. This change responds to stakeholder concerns that derivative accounting was being applied too broadly to contracts that do not provide decision-useful information when measured at fair value and for which other GAAP guidance may be more appropriate. Second, the ASU clarifies that Topic 606 (Revenue from Contracts with Customers) applies to share-based noncash consideration received from customers for the transfer of goods or services, reducing practice diversity in this area.

Key provisions

Derivatives Scope Exclusion (Topic 815): Non-exchange-traded contracts with underlyings based on operations or activities specific to one party to the contract are excluded from derivative accounting.

Carve-outs from the Exclusion: The new scope exception does not apply to:

- Variables based on market rates, market prices, or market indices

- Variables based on the price or performance of a financial asset or liability of one party

- Contracts or features in an entity's own equity (ASC 815-40)

- Call and put options on debt instruments

Share-Based Customer Consideration (Topic 606): Clarification that Topic 606 applies to share-based noncash consideration from a customer that constitutes consideration for transferring goods or services.

Transition Methods: Entities may adopt either prospectively (to new contracts on or after adoption) or via modified retrospective basis (cumulative-effect adjustment to retained earnings at adoption date).

Effective date

The amendments are effective for annual reporting periods beginning after December 15, 2026, and interim periods within those years. Early adoption is permitted. Entities may elect prospective or modified retrospective application.

Who is affected

All entities entering into non-exchange-traded contracts with operation-specific underlyings (R&D funding, litigation funding, ESG-linked bonds, etc.)
Companies receiving share-based consideration (e.g., equity instruments) from customers as part of revenue contracts
Industries with emerging transaction types (ESG-linked debt, contingent funding arrangements)
Any entity with existing derivative contracts that may qualify for the new scope exclusion

What preparers should do

Inventory Non-Exchange-Traded Contracts: Finance teams should identify all current contracts with underlyings tied to a party's operations or activities (R&D spend, litigation outcomes, ESG metrics). Evaluate whether each qualifies for the new scope exception and whether reclassification from derivative to non-derivative accounting is appropriate upon adoption.

Document Carve-Out Analysis: For each in-scope contract, document whether it involves market rates/indices, financial asset/liability performance, issuer equity, or debt call/put options—all of which remain subject to derivative accounting regardless of operations-based underlyings.

Assess Share-Based Customer Consideration: Review revenue contracts that include share-based compensation or equity instruments received from customers. Ensure Topic 606 measurement and recognition requirements are applied (rather than alternative treatments) and update revenue recognition policies accordingly. Consider the impact on contract asset/liability balances and revenue timing upon transition.