5.3 Share-Based Compensation Granted by an Investor to Employees or Nonemployees of an Equity Method Investee

ASC 323-10

Share-Based Compensation Granted to Employees and Nonemployees of an Equity Method Investee

25-3 Paragraphs 323-10-25-4 through 25-6 provide guidance on accounting for share-based payment awards granted by an investor to employees or nonemployees of an equity method investee that provide goods or services to the investee that are used or consumed in the investee’s operations when no proportionate funding by the other investors occurs and the investor does not receive any increase in the investor’s relative ownership percentage of the investee. That guidance assumes that the investor’s grant of share-based payment awards to employees or nonemployees of the equity method investee was not agreed to in connection with the investor’s acquisition of an interest in the investee. That guidance applies to share-based payment awards granted to employees or nonemployees of an investee by an investor based on that investor’s stock (that is, stock of the investor or other equity instruments indexed to, and potentially settled in, stock of the investor).

25-4 In the circumstances described in paragraph 323-10-25-3, a contributing investor shall expense the cost of share-based payment awards granted to employees and nonemployees of an equity method investee as incurred (that is, in the same period the costs are recognized by the investee) to the extent that the investor’s claim on the investee’s book value has not been increased.

25-5 In the circumstances described in paragraph 323-10-25-3, other equity method investors in an investee (that is, noncontributing investors) shall recognize income equal to the amount that their interest in the investee’s net book value has increased (that is, their percentage share of the contributed capital recognized by the investee) as a result of the disproportionate funding of the compensation costs. Further, those other equity method investors shall recognize their percentage share of earnings or losses in the investee (inclusive of any expense recognized by the investee for the share-based compensation funded on its behalf).

25-6 Example 2 (see paragraph 323-10-55-19) illustrates the application of this guidance for share-based compensation granted to employees of an equity method investee.

Share-Based Compensation Granted to Employees and Nonemployees of an Equity Method Investee

30-3 Share-based compensation cost recognized in accordance with paragraph 323-10-25-4 shall be measured initially at fair value in accordance with Topic 718. Example 2 (see paragraph 323-10-55-19) illustrates the application of this guidance.

ASC 505-10

25-3 Paragraphs 323-10-25-3 through 25-5 provide guidance on accounting for share-based compensation granted by an investor to employees or nonemployees of an equity method investee that provide goods or services to the investee that are used or consumed in the investee’s operations. An investee shall recognize the costs of the share-based payment incurred by the investor on its behalf, and a corresponding capital contribution, as the costs are incurred on its behalf (that is, in the same period(s) as if the investor had paid cash to employees and nonemployees of the investee following the guidance in Topic 718 on stock compensation.

ASC 323-10 — SEC Materials — SEC Staff Guidance

SEC Observer Comment: Accounting by an Investor for Stock-Based Compensation Granted to Employees of an Equity Method Investee

S99-4 The following is the text of SEC Observer Comment: Accounting by an Investor for Stock-Based Compensation Granted to Employees of an Equity Method Investee.

Paragraph 323-10-25-3 provides guidance on the accounting by an investor for stock-based compensation based on the investor’s stock granted to employees of an equity method investee. Investors that are SEC registrants should classify any income or expense resulting from application of this guidance in the same income statement caption as the equity in earnings (or losses) of the investee.

Share-based payment awards may be (1) issued by an equity method investor to employees or nonemployees of an equity method investee and (2) indexed to, or settled in, the equity of the investor. If such awards are issued to employees of an equity method investee and are indexed to, or settled in, the equity of the investor, the awards are not within the scope of ASC 718. This conclusion is supported by analogy to paragraph 10 of FASB Interpretation 44. While the guidance in Interpretation 44 was nullified by FASB Statement 123(R), the conclusion in paragraph 10 of Interpretation 44 remains applicable by analogy since it is the only available guidance on this issue. Paragraph 10 of Interpretation 44 states, in part:

[Opinion No. 25] does not apply to the accounting by a grantor for stock compensation granted to nonemployees. For example, Opinion 25 does not apply to the accounting by a corporate investor of an unconsolidated investee (or a joint venture owner) for stock options or awards granted by the investor (owner) to employees of the investee (joint venture) accounted for under the equity method because the grantees are not employees of the grantor.

However, since neither Interpretation 44 nor ASC 718 specifically addresses the accounting for these awards, an entity must account for them under other guidance. Such guidance includes ASC 323-10-25-3 through 25-5 and ASC 505-10-25-3, which address the accounting related to the financial statements of the equity method investor, the equity method investee, and the noncontributing investor(s). This guidance does not apply to share-based payment awards issued to grantees for goods or services provided to the investor that are indexed to, or settled in, the equity of the investee (as opposed to the equity of the investor). See Section 2.11 of Deloitte’s Roadmap Share-Based Payment Awards for further guidance on the accounting for awards that are issued to grantees and indexed to, and settled in, shares of an unrelated entity.

Example 2 in ASC 323-10-55-19 through 55-26 illustrates the accounting for stock compensation granted by an investor to employees of an equity method investee:

ASC 323-10

Example 2: Share-Based Compensation Granted to Employees of an Equity Method Investee

55-19 This Example illustrates the guidance in paragraphs 323-10-25-3 and 323-10-30-3 for share-based compensation by an investor granted to employees of an equity method investee. This Example is equally applicable to share-based awards granted by an investor to nonemployees that provide goods or services to an equity method investee that are used or consumed in the investee’s operations.

55-20 Entity A owns a 40 percent interest in Entity B and accounts for its investment under the equity method. On January 1, 20X1, Entity A grants 10,000 stock options (in the stock of Entity A) to employees of Entity B. The stock options cliff-vest in three years. If an employee of Entity B fails to vest in a stock option, the option is returned to Entity A (that is, Entity B does not retain the underlying stock). The owners of the remaining 60 percent interest in Entity B have not shared in the funding of the stock options granted to employees of Entity B on any basis and Entity A was not obligated to grant the stock options under any preexisting agreement with Entity B or the other investors. Entity B will capitalize the share-based compensation costs recognized over the first year of the three-year vesting period as part of the cost of an internally constructed fixed asset (the internally constructed fixed asset will be completed on December 31, 20X1).

55-21 Before granting the stock options, Entity A’s investment balance is $800,000, and the book value of Entity B’s net assets equals $2,000,000. Entity B will not begin depreciating the internally constructed fixed asset until it is complete and ready for its intended use and, therefore, no related depreciation expense (or compensation expense relating to the stock options) will be recognized between January 1, 20X1, and December 31, 20X1. For the years ending December 31, 20X2, and December 31, 20X3, Entity B will recognize depreciation expense (on the internally constructed fixed asset) and compensation expense (for the cost of the stock options relating to Years 2 and 3 of the vesting period). After recognizing those expenses, Entity B has net income of $200,000 for the fiscal years ending December 31, 20X1, December 31, 20X2, and December 31, 20X3.

55-22 Entity C also owns a 40 percent interest in Entity B. On January 1, 20X1, before granting the stock options, Entity C’s investment balance is $800,000.

55-23 Assume that the fair value of the stock options granted by Entity A to employees of Entity B is $120,000 on January 1, 20X1. Under Topic 718, the fair value of share-based compensation should be measured at the grant date. This Example assumes that the stock options issued are classified as equity and ignores the effect of forfeitures.

55-24 Entity A would make the following journal entries.

55-25 A rollforward of Entity B’s net assets and a reconciliation to Entity A’s and Entity C’s ending investment accounts follows.

55-26 A summary of the calculation of share-based compensation cost by year follows.

5.3.1 Accounting in the Financial Statements of the Contributing Investor Issuing the Awards

ASC 323-10-25-3 and 25-4 indicate that an investor should recognize (1) the entire cost (not just the portion of the cost associated with the investor’s ownership interest) of the share-based payment awards granted to employees of an investee as an expense and (2) a corresponding amount recognized in the investor’s equity. However, the cost associated with the investor’s ownership interest will be recognized as an expense when it records its share of the investee’s earnings (because its share of the investee’s earnings includes the awards’ expense). In addition, the entire cost (and corresponding equity) should be recorded as incurred (i.e., in the same period(s) as if the investor had paid cash to the investee’s employees). The cost of the share-based payment awards is a fair-value-based amount that is consistent with the definition of such a cost under ASC 718. As noted in ASC 323-10-S99-4, “[i]nvestors that are SEC registrants should classify any income or expense resulting from application of this guidance in the same income statement caption as the equity in earnings (or losses) of the investee.” Although ASC 323-10-S99-4 refers to SEC registrants, reporting entities that are not SEC registrants should consider applying the same guidance.

5.3.2 Accounting in the Financial Statements of the Investee Receiving the Awards

ASC 505-10-25-3 indicates that an investee should recognize (1) the entire cost of the share-based payment awards incurred by an investor on the investee’s behalf as compensation cost and (2) a corresponding amount as a capital contribution. The cost of the share-based payment awards is a fair-value-based amount that is consistent with the definition of such a cost in ASC 718. In addition, the compensation cost (and corresponding capital contribution) should be recorded as incurred (i.e., in the same period(s) as if the investor had paid cash to the investee’s employees).

5.3.3 Accounting in the Financial Statements of the Noncontributing Investors

ASC 323-10-25-5 states that the noncontributing investors “shall recognize income equal to the amount that their interest in the investee’s net book value has increased (that is, their percentage share of the contributed capital recognized by the investee)” as a result of the capital contribution by the investor issuing the awards. In addition, the noncontributing investors “shall recognize their percentage share of earnings or losses in the investee (inclusive of any expense recognized by the investee for the share-based compensation funded on its behalf).” That is, the noncontributing investors should recognize their share of the investee’s earnings or losses (including the compensation cost recognized for the share-based payment awards issued by the equity method investor) in accordance with ASC 323-10. As noted in ASC 323-10-S99-4, “[i]nvestors that are SEC registrants should classify any income or expense resulting from application of this guidance in the same income statement caption as the equity in earnings (or losses) of the investee.” Although ASC 323-10-S99-4 refers to SEC registrants, reporting entities that are not SEC registrants should consider applying the same guidance.

5.3.4 Stock-Based Compensation Granted by an Investor to Employees of an Equity Method Investee When the Investee Reimburses the Contributing Investor

If an investee reimburses a contributing investor for share-based payment awards, the contributing investor generally records income, with a corresponding amount recorded in equity, in the same periods as the cost that is recognized for issuing the awards. Therefore, the issuance of the awards by the contributing investor and the subsequent reimbursement by the investee may not affect the net income (loss) of the contributing investor. That is, if the reimbursement received by the investor equals the compensation cost recognized for the awards granted, the cost of issuing the awards and the income for their reimbursement will be equal and offsetting and will be recorded in the same reporting periods in the contributing investor’s income statement.

If an investee reimburses a contributing investor for share-based payment awards, the investee generally accrues a dividend to the contributing investor for the amount of the reimbursement in the same periods as the capital contribution from the contributing investor. The recognition of a dividend is generally appropriate given that the issuance of the awards resulted in a capital contribution from the contributing investor. See Section 5.3.2 for a more detailed discussion of the investee’s accounting related to the awards.

If an investee reimburses a contributing investor for share-based payment awards, the noncontributing investor or investors generally recognize a loss equal to the amount by which their interest in the investee’s net book value has decreased (i.e., their percentage share of the distributed capital recognized by the investee) as a result of the reimbursement to the contributing investor. The recognition of a loss by the noncontributing investor is typically appropriate given that its interest in the investee’s net book value has decreased as a result of the reimbursement provided to the investor issuing the awards.

Under U.S. GAAP, there is no explicit guidance on the accounting for an arrangement in which the investee reimburses the contributing investor; therefore, other views may be acceptable for the accounting by the contributing investor, the investee, and the noncontributing investor.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.