10.2 Allocating Replacement Awards Between Consideration Transferred and Postcombination Compensation Cost

ASC 805-30

30-11 To determine the portion of a replacement award that is part of the consideration transferred for the acquiree, the acquirer shall measure both the replacement awards granted by the acquirer and the acquiree awards as of the acquisition date in accordance with Topic 718. The portion of the fair-value-based measure of the replacement award that is part of the consideration transferred in exchange for the acquiree equals the portion of the acquiree award that is attributable to precombination vesting.

30-12 The acquirer shall attribute a portion of a replacement award to postcombination vesting if it requires postcombination vesting, regardless of whether grantees had rendered all of the service or delivered all of the goods required in exchange for their acquiree awards before the acquisition date. The portion of a nonvested replacement award attributable to postcombination vesting equals the total fair-value-based measure of the replacement award less the amount attributed to precombination vesting. Therefore, the acquirer shall attribute any excess of the fair-value-based measure of the replacement award over the fair value of the acquiree award to postcombination vesting.

30-13 Paragraphs 805-30-55-6 through 55-13, 805-740-25-10 through 25-11, 805-740-45-5 through 45-6, and Example 2 (see paragraph 805-30-55-17) provide additional guidance and illustrations on distinguishing between the portion of a replacement award that is attributable to precombination vesting, which the acquirer includes in the consideration transferred in the business combination, and the portion that is attributed to postcombination vesting, which the acquirer recognizes as compensation cost in its postcombination financial statements.

Replacement Share-Based Payment Awards

35-3 Topic 718 provides guidance on subsequent measurement and accounting for the portion of replacement share-based payment awards issued by an acquirer that is attributable to future goods or services.

Acquirer Share-Based Payment Awards Exchanged for Awards Held by the Grantees of the Acquiree

55-6 If the acquirer is obligated to replace the acquiree’s share-based payment awards, paragraph 805-30-30-9 requires the acquirer to include either all or a portion of the fair-value-based measure of the replacement awards in the consideration transferred in the business combination. Paragraphs 805-30-55-7 through 55-13, 805-740-25-10 through 25-11, 805-740-45-5 through 45-6, and Example 2 (see paragraph 805-30-55-17) provide additional guidance on and illustrate how to determine the portion of an award to include in consideration transferred in a business combination and the portion to recognize as compensation cost in the acquirer’s postcombination financial statements.

55-7 To determine the portion of a replacement award that is part of the consideration exchanged for the acquiree and the portion that is compensation for postcombination vesting, the acquirer first measures both the replacement awards and the acquiree awards as of the acquisition date in accordance with the requirements of Topic 718. In most situations, those requirements result in use of the fair-value-based measurement method, but that Topic permits use of the calculated value method or the intrinsic value method in specified circumstances. This discussion focuses on the fair-value-based method, but the guidance in paragraphs 805-30-30-9 through 30-13 and the additional guidance cited in the preceding paragraph also apply in situations in which Topic 718 permits use of either the calculated value method or the intrinsic value method for both the acquiree awards and the replacement awards.

55-8 The portion of an employee replacement award attributable to precombination vesting is the fair-value-based measure of the acquiree award multiplied by the ratio of the precombination employee’s service period to the greater of the total service period or the original service period of the acquiree award. (Example 2, Cases C and D [see paragraphs 805-30-55-21 through 55-24] illustrate that calculation.) The total service period is the sum of the following amounts:

The part of the employee’s requisite service period for the acquiree award that was completed before the acquisition date
The postcombination employee’s requisite service period, if any, for the replacement award.

55-9 The employee’s requisite service period includes explicit, implicit, and derived service periods during which employees are required to provide service in exchange for the award (consistent with the requirements of Topic 718).

55-9A The portion of a nonemployee replacement award attributable to precombination vesting is based on the fair-value-based measure of the acquiree award multiplied by the percentage that would have been recognized had the grantor paid cash for the goods or services instead of paying with a nonemployee award. For this calculation, the percentage that would have been recognized is the lower of:

The percentage that would have been recognized calculated on the basis of the original vesting requirements of the nonemployee award
The percentage that would have been recognized calculated on the basis of the effective vesting requirements. Effective vesting requirements are equal to the services or goods provided before the acquisition date plus any additional postcombination services or goods required by the replacement award.

55-10 The portion of a nonvested replacement award (for employee and nonemployee) attributable to postcombination vesting, and therefore recognized as compensation cost in the postcombination financial statements, equals the total fair-value-based measure of the replacement award less the amount attributed to precombination vesting. Therefore, the acquirer attributes any excess of the fair-value-based measure of the replacement award over the fair value of the acquiree award to postcombination vesting and recognizes that excess as compensation cost in the postcombination financial statements.

55-13 The same requirements for determining the portions of a replacement award attributable to precombination and postcombination vesting apply regardless of whether a replacement award is classified as a liability or an equity instrument in accordance with the provisions of paragraphs 718-10-25-6 through 25-19A. All changes in the fair-value-based measure of awards classified as liabilities after the acquisition date and the related income tax effects are recognized in the acquirer’s postcombination financial statements in the period(s) in which the changes occur.

Illustrations

Example 2: Acquirer Replacement of Employee Awards

55-17 The following Cases illustrate the guidance referred to in paragraph 805-30-55-6 for replacement awards that the acquirer was obligated to issue. The Cases assume that all awards are classified as equity and that the awards have only an explicit service period. As discussed in paragraphs 805-30-55-8 through 55-9, the acquirer also must take any implicit or derived employee’s service periods into account in determining the employee’s requisite service period for a replacement award. In these Cases, the acquiring entity is referred to as Acquirer and the acquiree is referred to as Target:

Awards that require no postcombination vesting that are exchanged for acquiree awards for which employees:
1. Have rendered the required service as of the acquisition date (Case A)
2. Have not rendered all of the required service as of the acquisition date (Case D).
Awards that require postcombination vesting that are exchanged for acquiree awards for which employees:
1. Have rendered the required service as of the acquisition date (Case B)
2. Have not rendered all of the required service as of the acquisition date (Case C).

Case A: No Required Postcombination Vesting, All Requisite Service for Acquiree Awards Rendered as of Acquisition Date

55-18 Acquirer issues replacement awards of $110 (fair-value-based measure) at the acquisition date for Target awards of $100 (fair-value-based measure) at the acquisition date. No postcombination vesting is required for the replacement awards, and Target’s employees had rendered all of the required service for the acquiree awards as of the acquisition date.

55-19 The amount attributable to precombination vesting is the fair-value-based measure of Target’s awards ($100) at the acquisition date; that amount is included in the consideration transferred in the business combination. The amount attributable to postcombination vesting is $10, which is the difference between the total value of the replacement awards ($110) and the portion attributable to precombination vesting ($100). Because no postcombination vesting is required for the replacement awards, Acquirer immediately recognizes $10 as compensation cost in its postcombination financial statements.

Case B: Postcombination Vesting Required, All Requisite Service for Acquiree Awards Rendered as of Acquisition Date

55-20 Acquirer exchanges replacement awards that require one year of postcombination vesting for share-based payment awards of Target for which employees had completed the requisite service period before the business combination. The fair-value-based measure of both awards is $100 at the acquisition date. When originally granted, Target’s awards had a requisite service period of four years. As of the acquisition date, the Target employees holding unexercised awards had rendered a total of seven years of service since the grant date. Even though Target employees had already rendered all of the requisite service, Acquirer attributes a portion of the replacement award to postcombination compensation cost in accordance with paragraphs 805-30-30-12 through 30-13 because the replacement awards require one year of postcombination vesting. The total service period is five years — the requisite service period for the original acquiree award completed before the acquisition date (four years) plus the requisite service period for the replacement award (one year). The portion attributable to precombination vesting equals the fair-value-based measure of the acquiree award ($100) multiplied by the ratio of the precombination vesting period (4 years) to the total vesting period (5 years). Thus, $80 ($100 × 4 ÷ 5 years) is attributed to the precombination vesting period and therefore included in the consideration transferred in the business combination. The remaining $20 is attributed to the postcombination vesting period and therefore is recognized as compensation cost in Acquirer’s postcombination financial statements in accordance with Topic 718.

Case C: Postcombination Vesting Required, All Requisite Service for Acquiree Awards Not Rendered as of Acquisition Date

55-21 Acquirer exchanges replacement awards that require one year of postcombination vesting for share-based payment awards of Target for which employees had not yet rendered all of the required services as of the acquisition date. The fair-value-based measure of both awards is $100 at the acquisition date. When originally granted, the awards of Target had a requisite service period of four years. As of the acquisition date, the Target employees had rendered two years’ service, and they would have been required to render two additional years of service after the acquisition date for their awards to vest. Accordingly, only a portion of Target’s awards is attributable to precombination vesting.

55-22 The replacement awards require only one year of postcombination vesting. Because employees have already rendered two years of service, the total requisite service period is three years. The portion attributable to precombination vesting equals the fair-value-based measure of the acquiree award ($100) multiplied by the ratio of the precombination vesting period (2 years) to the greater of the total service period (3 years) or the original service period of Target’s award (4 years). Thus, $50 ($100 × 2 ÷ 4 years) is attributable to precombination vesting and therefore included in the consideration transferred for the acquiree. The remaining $50 is attributable to postcombination vesting and therefore recognized as compensation cost in Acquirer’s postcombination financial statements in accordance with Topic 718.

Case D: No Required Postcombination Vesting, All Requisite Service for Acquiree Awards Not Rendered as of Acquisition Date

55-23 Assume the same facts as in Case C, except that Acquirer exchanges replacement awards that require no postcombination vesting for share-based payment awards of Target for which employees had not yet rendered all of the requisite service as of the acquisition date. The terms of the replaced Target awards did not eliminate any remaining requisite service period upon a change in control. (If the Target awards had included a provision that eliminated any remaining requisite service period upon a change in control, the guidance in Case A would apply.) The fair-value-based measure of both awards is $100. Because employees have already rendered two years of service and the replacement awards do not require any postcombination vesting, the total service period is two years.

55-24 The portion of the fair-value-based measure of the replacement awards attributable to precombination vesting equals the fair-value-based measure of the acquiree award ($100) multiplied by the ratio of the precombination vesting period (2 years) to the greater of the total service period (2 years) or the original service period of Target’s award (4 years). Thus, $50 ($100 × 2 ÷ 4 years) is attributable to precombination vesting and therefore included in the consideration transferred for the acquiree. The remaining $50 is attributable to postcombination vesting. Because no postcombination vesting is required to vest in the replacement award, Acquirer recognizes the entire $50 immediately as compensation cost in the postcombination financial statements.

Example 3: Acquirer Replacement of Nonemployee Awards

55-25 The following Cases illustrate the guidance referred to in paragraph 805-30-55-6 for replacement awards that the acquirer was obligated to issue and the attribution guidance for a nonemployee replacement award to precombination and postcombination vesting referenced in paragraph 805-30-55-9A.

55-26 In these Cases, the acquiring entity is referred to as Acquirer and the acquiree is referred to as Target:

Awards that require no postcombination vesting that are exchanged for acquiree awards for which grantees:
1. Have met the vesting condition as of the acquisition date (Case A)
2. Have not met the vesting condition as of the acquisition date (Case D).
Awards that require postcombination vesting that are exchanged for acquiree awards for which grantees:
1. Have met the vesting condition as of the acquisition date (Case B)
2. Have not met the vesting condition as of the acquisition date (Case C).

55-27 The Cases assume the following:

All awards are classified as equity.
The only vesting condition included in the awards, if any, involves the delivery of engines.
Target and Acquirer typically pay cash as each engine is delivered to their suppliers.

Case A: No Required Postcombination Vesting and the Vesting Condition for Acquiree Awards Has Been Met as of Acquisition Date

55-28 Acquirer issues replacement awards of $110 (fair-value-based measure) at the acquisition date for Target awards of $100 (fair-value-based measure) at the acquisition date. No postcombination vesting is required for the replacement awards, and Target’s grantee has delivered all the engines necessary for the acquiree awards as of the acquisition date.

55-29 The amount attributable to precombination vesting is the fair-value-based measure of Target’s awards ($100) at the acquisition date; that amount is included in the consideration transferred in the business combination. The amount attributable to postcombination vesting is $10, which is the difference between the total value of the replacement awards ($110) and the portion attributable to precombination vesting ($100). Because no postcombination vesting is required for the replacement awards, Acquirer immediately recognizes $10 as compensation cost in its postcombination financial statements.

Case B: Postcombination Vesting Required and the Vesting Condition for Acquiree Awards Has Been Met as of Acquisition Date

55-30 Acquirer exchanges replacement awards that require the delivery of another 10 engines postcombination for share-based payment awards of Target for which the grantee had met the necessary vesting condition to deliver 40 engines before the business combination. The fair-value-based measure of both awards is $100 at the acquisition date. Even though the grantee already had met the vesting condition for the acquiree’s award, Acquirer attributes a portion of the replacement award to postcombination compensation cost in accordance with paragraphs 805-30-30-12 through 30-13 because the replacement awards require the delivery of an additional 10 engines.

55-31 The portion attributable to precombination vesting equals the fair-value-based measure of the acquiree award ($100) multiplied by the percentage that would have been recognized for the award. The percentage that would have been recognized is the lower of the calculation on the basis of the original vesting requirements and the percentage that would have been recognized on the basis of the effective vesting requirements as described in paragraph 805-30-55-9A. The percentage that would have been recognized on the basis of the original vesting requirements equals 100 percent, which is calculated as 40 engines delivered divided by 40 engines required to be delivered. The percentage that would have been recognized on the basis of the effective vesting requirements equals 80 percent, which is calculated as 40 engines delivered divided by 50 engines (the sum of 40 engines delivered plus 10 engines required postcombination). Thus, $80 ($100 × 80%) is attributed to the precombination vesting period and therefore is included in the consideration transferred in the business combination. The remaining $20 is attributed to the postcombination vesting period and therefore is recognized as compensation cost in Acquirer’s postcombination financial statements in accordance with Topic 718.

Case C: Postcombination Vesting Required and the Vesting Condition for Acquiree Awards Has Not Been Met as of Acquisition Date

55-32 Acquirer exchanges replacement awards that require the delivery of 10 engines postcombination for share-based payment awards of Target for which the grantee had not met the necessary vesting condition to deliver 40 engines before the business combination. The fair-value-based measure of both awards is $100 at the acquisition date. As of the acquisition date, Target grantee has delivered 20 engines, and Target grantee would have been required to deliver an additional 20 engines after the acquisition date for its awards to vest. Accordingly, only a portion of Target’s awards is attributable to precombination vesting.

55-33 The portion attributable to precombination vesting equals the fair-value-based measure of the acquiree award ($100) multiplied by the percentage that would have been recognized on the award. The percentage that would have been recognized is the lower of the percentage that would have been recognized on the basis of the original vesting requirements and the percentage that would have been recognized on the basis of the effective vesting requirements as described in paragraph 805-30-55-9A. The percentage that would have been recognized on the basis of the original vesting requirements equals 50 percent, which is calculated as 20 engines delivered divided by 40 engines required to be delivered. The percentage that would have been recognized on the basis of the effective vesting requirements equals 66.67 percent, which is calculated as 20 engines delivered divided by 30 engines (the sum of 20 engines delivered plus 10 engines required postcombination). Thus, $50 ($100 × 50%) is attributed to precombination vesting and therefore is included in the consideration transferred in the business combination. The remaining $50 is attributed to the postcombination vesting and therefore is recognized as compensation cost in Acquirer’s postcombination financial statements in accordance with Topic 718.

Case D: No Postcombination Vesting Required and the Vesting Condition for Acquiree Awards Has Not Been Met as of Acquisition Date

55-34 Assume the same facts as in Case C, except that Acquirer exchanges replacement awards that require no postcombination vesting for share-based payment awards of Target for which the grantee had not met the necessary vesting condition to deliver 40 engines before the business combination. The terms of the replaced Target awards did not eliminate the vesting condition upon a change in control. (If the Target awards had included a provision that eliminated the vesting condition upon a change in control, the guidance in Case A [see paragraph 805-30-55-28] would apply.) The fair-value-based measure of both awards is $100.

55-35 The portion attributable to precombination vesting equals the fair-value-based measure of the acquiree award ($100) multiplied by the percentage that would have been recognized on the award. The percentage that would have been recognized is the lower of the percentage that would have been recognized on the basis of the original vesting requirements and the percentage that would have been recognized on the basis of the effective vesting requirements as described in paragraph 805-30-55-9A. The percentage that would have been recognized on the basis of the original vesting requirements equals 50 percent, which is calculated as 20 engines delivered divided by 40 engines required to be delivered. The percentage that would have been recognized on the basis of the effective vesting requirements equals 100 percent, which is calculated as 20 engines delivered divided by 20 engines (the sum of 20 engines delivered plus zero engines required postcombination). Thus, $50 ($100 × 50%) is attributed to the precombination vesting and is therefore included in the consideration transferred in the business combination. The remaining $50 is attributed to the postcombination vesting. Because no postcombination vesting is required to vest in the replacement award, Acquirer recognizes the entire $50 immediately as compensation cost in the postcombination financial statements.

Replacement share-based payment awards issued by the acquirer may represent consideration transferred in the business combination if the award is related to precombination vesting (past goods or services provided), postcombination compensation cost for future vesting (future goods or services provided), or both.

Entities should carefully analyze any modifications to or replacements of acquiree awards to determine whether they are part of, or separate from, the business combination. ASC 805-10-25-20 states, in part, that the “acquirer shall recognize as part of applying the acquisition method only the consideration transferred for the acquiree and the assets acquired and liabilities assumed in the exchange for the acquiree. Separate transactions shall be accounted for in accordance with the relevant [GAAP].” In addition, ASC 805-10-25-21 states, in part, that a “transaction entered into by or on behalf of the acquirer or primarily for the benefit of the acquirer or the combined entity, rather than primarily for the benefit of the acquiree (or its former owners) before the combination, is likely to be a separate transaction.”

Further, ASC 805-10-55-18 provides three factors for entities to consider in determining whether the transaction is part of a business combination or should be accounted for separately (these factors are not mutually exclusive or individually conclusive).

ASC 805-10

55-18 Paragraphs 805-10-25-20 through 25-22 establish the requirements to identify amounts that are not part of the business combination. The acquirer should consider the following factors, which are neither mutually exclusive nor individually conclusive, to determine whether a transaction is part of the exchange for the acquiree or whether the transaction is separate from the business combination:

The reasons for the transaction. Understanding the reasons why the parties to the combination (the acquirer, the acquiree, and their owners, directors, managers, and their agents) entered into a particular transaction or arrangement may provide insight into whether it is part of the consideration transferred and the assets acquired or liabilities assumed. For example, if a transaction is arranged primarily for the benefit of the acquirer or the combined entity rather than primarily for the benefit of the acquiree or its former owners before the combination, that portion of the transaction price paid (and any related assets or liabilities) is less likely to be part of the exchange for the acquiree. Accordingly, the acquirer would account for that portion separately from the business combination.
Who initiated the transaction. Understanding who initiated the transaction may also provide insight into whether it is part of the exchange for the acquiree. For example, a transaction or other event that is initiated by the acquirer may be entered into for the purpose of providing future economic benefits to the acquirer or combined entity with little or no benefit received by the acquiree or its former owners before the combination. On the other hand, a transaction or arrangement initiated by the acquiree or its former owners is less likely to be for the benefit of the acquirer or the combined entity and more likely to be part of the business combination transaction.
The timing of the transaction. The timing of the transaction may also provide insight into whether it is part of the exchange for the acquiree. For example, a transaction between the acquirer and the acquiree that takes place during the negotiations of the terms of a business combination may have been entered into in contemplation of the business combination to provide future economic benefits to the acquirer or the combined entity. If so, the acquiree or its former owners before the business combination are likely to receive little or no benefit from the transaction except for benefits they receive as part of the combined entity.

Further, understanding the business purpose of a modification will help an acquirer assess which party benefits from the modification. The acquirer should particularly consider terms that accelerate vesting upon a change in control (see Section 10.4), cash settlement upon a change in control (see Section 10.5), and other compensation arrangements affected by a change in control (see Section 10.7).

10.2.1 Allocation Steps

The diagram below illustrates the steps in an entity’s determination of the amount to recognize as consideration transferred in a business combination and as postcombination compensation cost. Sections 10.2.1.1 through 10.2.1.3 discuss the steps in detail. If the acquirer is not obligated to replace the acquiree’s awards, and replacement awards are issued, generally the entire replacement award is accounted for as postcombination compensation cost (see Section 10.1).

10.2.1.1 Considerations Related to Step 1

The acquirer must determine the fair-value-based measure of both the acquirer’s replacement awards and the acquiree’s replaced awards as of the acquisition date, in accordance with the guidance in ASC 718.

ASC 805 requires acquirers to use the guidance in ASC 820, with limited exceptions, to measure the consideration transferred, the assets acquired, and any liabilities assumed in a business combination at their acquisition-date fair values. One of the exceptions is share-based payment awards, which are measured by using the guidance in ASC 718. Unlike a fair value measure, a fair-value-based measure under ASC 718 excludes certain considerations such as vesting conditions (i.e., service or performance conditions). However, a market condition is directly factored into the fair-value-based measure of an award and should be taken into consideration in the calculation of the fair value-based measure of the acquiree’s replaced awards and the acquirer’s replacement awards. See Section 4.1 for additional discussion of the fair-value-based measure method prescribed in ASC 718.

In certain circumstances, ASC 718 also permits the use of a calculated value and an intrinsic value. Those measurement methods are discussed in Sections 4.13.2 and 4.13.3. If either is used, the acquirer’s replacement awards and the acquiree’s replaced awards are measured on such a basis.

10.2.1.2 Considerations Related to Step 2

If there is an excess of the fair-value-based measure of the acquirer’s replacement awards over the fair-value-based measure of the acquiree’s replaced awards as of the acquisition date, incremental value is recognized as compensation cost in the acquirer’s postcombination financial statements in accordance with ASC 805-30-30-12. Such cost is recognized over the period from the acquisition date through the end of the employee’s requisite service period or nonemployee’s vesting period of the replacement awards. If there is no postcombination vesting requirement, all of the excess is generally recognized immediately in the postcombination financial statements (i.e., on day 1). This is illustrated in Case A of Example 2 in ASC 805-30-55-18 and 55-19, which addresses employees, and Case A of Example 3 in ASC 805-30-55-28 and 55-29, which addresses nonemployees.

10.2.1.3 Considerations Related to Step 3

10.2.1.3.1 Allocation to Precombination Vesting

The portion of the replacement share-based payment awards that is attributable to precombination vesting, and therefore included in the consideration transferred, is calculated as follows:

The practical effect of requiring the use of the greater of the total vesting period or the original vesting period of the acquiree’s replaced awards is that an acquirer will always reflect at least the proportion of the compensation cost in the postcombination financial statements, as it would have under the original terms of the award. In a scenario in which the acquirer accelerates vesting, this “greater of” calculation is consistent with the accounting for an acceleration of vesting that is determined to primarily benefit the acquirer, as described in Section 10.4.1. An acquirer’s decision to immediately accelerate vesting of replacement awards does not decrease its proportion of compensation expense in the postcombination financial statements but merely accelerates the timing of recognition. This is illustrated in Case D of Example 2 in ASC 805-30-55-23 and 55-24, which addresses employee awards, and Case D of Example 3 in ASC 805-30-55-34 and 55-35, which addresses nonemployee awards.

The total vesting period is calculated as follows:

For employee awards, the requisite service period (i.e., the vesting period) may be explicit, implicit, or derived and will depend on the terms of the share-based payment awards (see Section 3.6 for additional information). For nonemployee awards, the vesting period is calculated on the basis of the percentage that would have been recognized had the grantor paid cash for the goods or services instead of paying with a nonemployee award.

If the acquirer decides to extend the vesting period rather than accelerate vesting, use of the “greater of” calculation would result in a greater share of the compensation cost attributed to the post-combination period and is consistent with the increase in grantee services to be provided to the acquirer. For acquiree awards that were fully vested before the acquisition date and that were replaced by new awards for which an additional future vesting period is required, the total vesting period is the sum of the vesting period of the acquiree-replaced awards and the vesting period of the replacement awards. It excludes the period from the precombination vesting date of the acquiree-replaced awards to the acquisition date. This is illustrated in Case B of Example 2 in ASC 805-30-55-20, which addresses employee awards, and Case B of Example 3 in ASC 805-30-55-30 and 55-31, which addresses nonemployee awards.

The examples below illustrate how to determine the total service period for employee awards.

Example 10-1

Determining the Total Service Period of a Replacement Award When the Replaced Award Is Fully Vested

An employee is awarded 100 options on Entity B’s common stock that became fully vested on June 30, 20X1. A three-year service period was originally associated with this award, but the options have not been exercised yet. On January 1, 20X2, Entity A acquires B in a transaction accounted for as a business combination and is obligated to replace the employee’s options. As part of the acquisition, A is obligated to replace B’s fully vested options with A’s new options that require an additional three years of service.

The total service period of the replacement award is six years, which is the sum of the service period of B’s original award (the replaced award) plus the service period of A’s new award (the replacement award). The total service period does not include the period from the original vesting date (i.e., June 30, 20X1) to the acquisition date (i.e., January 1, 20X2).

Example 10-2

Determining the Total Service Period of Replacement Awards When the Service Period Is the Same as That for the Replaced Awards

On January 1, 20X1, Entity B grants 100 share-based payment awards to an employee that vest at the end of the fourth year of service (cliff vesting). On January 1, 20X3, Entity A acquires B in a transaction accounted for as a business combination and is obligated to replace the employee’s awards with 100 new awards that have the same service terms as B’s original award (i.e., the replacement awards will vest at the end of two additional years).

The total service period of the replacement awards is four years, which is equal to the service period of B’s original awards. In the calculation of the portion attributable to precombination service, the precombination service period is two years (January 1, 20X1, to January 1, 20X3).

See Section 9.6 for an example of how to determine the total vesting period for nonemployee awards.

10.2.1.3.2 Allocation to Postcombination Vesting

The portion of the replacement awards attributable to postcombination vesting, and therefore included in postcombination compensation cost, is calculated as follows:

The example below illustrates how to allocate the replacement awards between consideration transferred and postcombination compensation cost for an employee award.

Example 10-3

Allocation of Consideration

On January 1, 20X1, Entity B grants 100 share-based payment awards to an employee that vest at the end of the third year of service (cliff vesting).

On January 1, 20X2, Entity A acquires B in a transaction accounted for as a business combination and is obligated to replace the employee’s awards with 100 new awards that have the same service terms as B’s original awards (i.e., the replacement awards will vest at the end of two additional years). On January 1, 20X2, the fair-value-based measure of both A’s replacement awards and B’s replaced awards is $10 per award.

The total fair-value-based measure of the replacement awards as of the acquisition date is $1,000 (100 awards × $10 fair-value-based measure), of which $333 (one of three years) is attributable to precombination service and $667 (two of three years) is attributable to postcombination service. The $333 is included in the consideration transferred, and the $667 is recognized as compensation cost by A as the service is rendered by the employee (i.e., from January 1, 20X2, to December 31, 20X3). Note that the grant-date fair-value-based measure assigned to the awards issued by B is not relevant as of the acquisition date.

See Section 9.6 for an example of how to allocate the replacement awards between consideration transferred and postcombination compensation cost for a nonemployee award.

10.2.2 Forfeitures

ASC 805-30

55-11 Regardless of the accounting policy elected in accordance with paragraph 718-10-35-1D or 718-10-35-3, the portion of a nonvested replacement award included in consideration transferred shall reflect the acquirer’s estimate of the number of replacement awards for which the service is expected to be rendered or the goods are expected to be delivered (that is, an acquirer that has elected an accounting policy to recognize forfeitures as they occur in accordance with paragraph 718-10-35-1D or 718-10-35-3 should estimate the number of replacement awards for which the service is expected to be rendered or the goods are expected to be delivered when determining the portion of a nonvested replacement award included in consideration transferred). For example, if the fair-value-based measure of the portion of a replacement award attributed to precombination vesting is $100 and the acquirer expects that the service will be rendered for only 95 percent of the instruments awarded, the amount included in consideration transferred in the business combination is $95. Changes in the number of replacement awards for which the service is expected to be rendered or the goods are expected to be delivered are reflected in compensation cost for the periods in which the changes or forfeitures occur — not as adjustments to the consideration transferred in the business combination. If an acquirer’s accounting policy is to account for forfeitures as they occur, the amount excluded from consideration transferred (because the service is not expected to be rendered or the goods are not expected to be delivered) should be attributed to the postcombination vesting and recognized in compensation cost over the employee’s requisite service period or the nonemployee’s vesting period. Recognition of compensation cost for nonemployees should consider the recognition guidance provided in paragraph 718-10-25-2C. That is, recognition of the fair value of the nonemployee share-based payment award should be recognized in the same manner as if the grantor had paid cash for the goods or services instead of paying with or using the share-based payment awards.

ASC 718 allows an entity to make an entity-wide accounting policy election to either (1) estimate forfeitures when the awards are granted and update its estimate when information becomes available indicating that actual forfeitures will differ from previous estimates or (2) account for forfeitures when they occur. See Section 3.4.1 for examples illustrating how to account for forfeitures under either accounting policy election.

ASC 718 permits an entity to make an entity-wide policy election for all nonemployee awards to either (1) estimate forfeitures or (2) recognize forfeitures when they occur. This policy election can be different from the entity’s policy election for employee awards.

Regardless of the accounting policy elected for forfeitures, ASC 805-30-55-11 requires that the portion of the fair-value-based measure of the replacement share-based payment awards included in consideration transferred (i.e., the amount attributable to precombination vesting) reflect the acquirer’s forfeiture estimate as of the acquisition date. If the acquirer’s accounting policy is to account for forfeitures when they occur, the amount that is excluded from consideration transferred on the basis of the acquirer’s estimate of forfeitures as of the acquisition date should be attributed to postcombination vesting and recognized in compensation cost over the employee’s requisite service period or nonemployee’s vesting period. Changes in the forfeiture estimate or actual forfeitures (i.e., an increase or decrease in the number of awards expected to vest or awards that actually vest) are recorded in postcombination compensation cost and not as adjustments to the consideration transferred in the business combination. There is diversity in practice regarding how such changes should be reflected in the financial statements (see Section 10.3).

10.2.3 Employee Awards With a Graded Vesting Schedule

ASC 805-30

55-12 Similarly, the effects of other events, such as modifications or the ultimate outcome of awards with performance conditions, that occur after the acquisition date are accounted for in accordance with Topic 718 in determining compensation cost for the period in which an event occurs. If the replacement award for an employee award has a graded vesting schedule, the acquirer shall recognize the related compensation cost in accordance with its policy election for other awards with graded vesting in accordance with paragraph 718-10-35-8.

Graded vesting awards are awards that are split into multiple tranches, each of which legally and separately vests as service is provided. For example, an entity may grant an employee 100 share-based payment awards, 25 of which legally vest at the end of each of the four years of service provided. Under ASC 718-10-35-8, the entity can make an accounting policy election about whether to recognize compensation cost for its employee awards with only service conditions that have a graded vesting schedule on either (1) an accelerated basis as though each separately vesting portion of the award was, in substance, a separate award or (2) a straight-line basis over the requisite service period for the entire award (i.e., over the requisite service period of the last separately vesting portion of the award).2 An acquiree may have made an accounting policy election regarding the recognition of the compensation cost for an award with a graded vesting schedule (i.e., as a single award or as in-substance multiple awards) that is different from the election made by the acquirer. Regardless of how the acquiree elected to account for its replaced share-based payment awards with a graded vesting schedule, the acquirer applies its existing accounting policy election for similar awards with a graded vesting schedule to recognize compensation cost for the replacement awards.

This guidance is also important in the determination of the portion of the fair-value-based measure of the replacement award that is attributable to (1) precombination service and therefore included in consideration transferred and (2) postcombination service and therefore included in postcombination compensation cost. The acquirer should determine its attribution of compensation cost on the basis of its accounting policy election (see Section 3.6.5 for further discussion of attribution methods for awards with graded vesting). If it has elected to treat an award with a graded vesting schedule as a single award, the determination of the total service period and the original service period will be based on a single award (e.g., a single award with four years of required service). Conversely, if it has elected to treat an award with a graded vesting schedule as, in substance, multiple awards, the determination of the total service period and the original service period will be based on each tranche of the award as though the award is, in substance, multiple awards (e.g., four separate awards with required service of one, two, three, and four years, respectively). The examples below illustrate this guidance.

Note that if the accounting policy elections of the acquiree and the acquirer differ, on a combined basis (i.e., in the acquiree’s financial statements and the acquirer’s financial statements) compensation cost (1) may not be recorded in either the acquiree’s precombination financial statements or the acquirer’s postcombination financial statements or (2) may be recorded in both the acquiree’s precombination financial statements and the acquirer’s postcombination financial statements. This concept is illustrated in Example 10-5.

Example 10-4

Replacement Awards With Graded Vesting

On January 1, 20X1, Entity B grants 1,000 employee share-based payment awards. The awards vest in 25 percent increments each year over the next four years (i.e., a graded vesting schedule) and have only a service condition. On December 31, 20X3, Entity A acquired B in a transaction accounted for as a business combination and is obligated to replace B’s awards with new awards that have the same terms and conditions. (Section 10.1 discusses how to determine when an acquirer is obligated to exchange an acquiree’s awards.) Both A and B have chosen, as their policy election, to recognize compensation cost on a straight-line basis over the requisite service period for the entire award (i.e., as though the award is a single award).

The fair-value-based measure of both awards (i.e., the replaced awards and the replacement awards) is $10 per award as of the acquisition date. The portion of the fair-value-based amount of the replacement award attributable to (1) precombination service and therefore included in consideration transferred is $7,500 ($10 fair-value-based measure of the replaced award × 1,000 awards × 75% for three of four years of services rendered) and (2) postcombination service and therefore included in postcombination compensation cost is $2,500 ($10 fair-value-based measure of the replacement award × 1,000 awards × 25% for one of four years of services rendered).

Example 10-5

Replacement Awards With Graded Vesting When the Policy Elected by the Acquirer to Recognize Compensation Cost Is Different From the Policy Elected by the Acquiree

Assume the same facts as in the example above, except that the acquirer has elected, as a policy decision, to recognize compensation cost over the requisite service period for each separately vesting portion of the award (i.e., as though the award is, in substance, multiple awards). The acquirer has also made a policy election to value such share-based payment awards as a single award. The table below summarizes the attribution of the fair-value-based amount of the replaced awards ($10,000 = 1,000 awards × $10 fair-value-based measure of the replaced award) over each of the first three years of service and the related amount attributable to precombination service and therefore included in consideration transferred.

The portion of the fair-value-based amount of the replacement awards attributable to (1) precombination service and therefore included in consideration transferred is $9,375 (even though the acquiree would have only recognized $7,500 in compensation cost because of the difference in policies) and (2) postcombination service and therefore included in postcombination compensation cost is $625.

Footnotes

Note that regardless of an entity’s policy decision regarding the recognition of compensation cost, it may elect to value the awards as (1) a single award or (2) in-substance multiple awards. That is, even though each portion of the awards may directly or indirectly be treated by certain valuation techniques as individual awards, the entity is able to make a policy decision to recognize compensation cost as (1) a single award or (2) in-substance multiple awards.

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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.