To determine whether a contract has an embedded derivative which criteria must be met?

Question

Options

• AIt must be considered a derivative if freestanding
• BIt is clearly and closely related to the host
• CThe contract is already carried at fair value through earnings
• DAll of the above

• A
  79% (15)
• B
  11% (2)
• C
  5% (1)
• D
  5% (1)

Explanation

Option A correctly states one of the three required criteria under ASC 815 for bifurcating an embedded derivative: the embedded feature must meet the definition of a derivative instrument if it were a standalone (freestanding) contract. This is a genuine threshold requirement - if the embedded feature wouldn't qualify as a derivative on its own, bifurcation is never required.

Option B is stated backwards - the actual criterion is that the embedded derivative's risks are not clearly and closely related to the host contract. If it is clearly and closely related, bifurcation is not required, so B as written describes a situation that excludes the need to separate the derivative.

Option C is also backwards - the actual criterion is that the hybrid contract is not already measured at fair value through earnings. If the whole contract is already at FV through earnings, separation is unnecessary because the economic effect is already captured.

Option D fails because B and C are incorrectly stated (wrong direction of the condition), making "all of the above" logically false.

Memory tip: Think "FAN" - Freestanding it would be a derivative, Attributes are not closely related to the host, and Not already at fair value through earnings. All three FAN criteria must be met to require bifurcation.

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