10.5 Cash Settlement Upon a Change in Control

In some business combinations, acquirers may, upon a change in control, cash settle share-based payment awards instead of either accelerating the awards’ vesting provisions or replacing the awards. Like vesting provisions that are accelerated upon a change in control (see Section 10.4), cash settlement provisions should be analyzed carefully in the determination of 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.” As noted in Section 10.2, ASC 805-10-55-18 also provides three factors to help entities determine whether the transaction primarily benefits the acquirer or the acquiree (i.e., “[t]he reasons for the transaction,” “[w]ho initiated the transaction,” and “[t]he timing of the transaction”).

10.5.1 Acquirer Cash Settles the Acquiree’s Awards (Cash-Settlement Provision Is Not Included in the Original Terms of the Award)

If there is no preexisting change-in-control cash settlement provision in the original terms of awards (but the acquirer is obligated to issue replacement awards) and the acquirer decides to cash settle the acquiree’s awards, the cash settlement is treated in the same manner as if the acquirer was required to replace the awards with share-based payment awards of the acquirer.

An acquirer’s decision to cash settle the acquiree’s share-based payment awards does not affect the portion of the fair-value-based measure of the replacement awards (i.e., cash) that is attributable to postcombination vesting and therefore included in postcombination compensation cost; rather, it affects the timing of the recognition of postcombination compensation cost (i.e., if the acquiree’s awards were previously unvested, the cash settlement would effectively accelerate vesting in such a manner that postcombination compensation cost would be recognized immediately). Further, cash settlement does not affect the classification of the acquiree’s replaced awards because there was no preexisting change-in-control cash settlement provision in the original awards’ terms.

10.5.1.1 Fully Vested Awards That Are Cash Settled Upon a Change in Control

Rather than issuing replacement shares, an acquirer may choose to settle the acquiree’s awards with cash or a promissory note. If awards are fully vested as of the acquisition date, the fair value of the settlement amount should be included in consideration transferred unless it exceeds the fair-value-based measure of the settled acquiree awards. If the fair value of the settlement amount exceeds the fair-value-based measure of the settled acquiree awards, the excess would be immediately recognized as compensation cost in the acquirer’s postcombination financial statements.

10.5.1.2 Partially Vested Awards That Are Cash Settled Upon a Change in Control

If awards are partially vested as of the acquisition date, the acquirer has effectively accelerated the vesting of the unvested portion of the award and settled the entire award. The amount of the fair-value-based measure of the acquiree’s replaced award attributable to precombination vesting and therefore included in consideration transferred is based on the ratio of precombination vesting to the original vesting period of the acquiree’s replaced award (see Section 10.2.1.3.1). The amount recognized as compensation cost in the postcombination financial statements represents (1) any excess of the cash settlement over the fair-value-based measure of the vested replaced awards plus (2) the portion of the fair-value-based measure attributable to the postcombination period.

10.5.2 Cash-Settlement Provision Is Included in the Original Terms of the Award

In some circumstances, an acquiree’s share-based payment awards must be cash settled as a result of a change in control because of a preexisting provision in the awards’ original terms.

In such a case, as long as all other criteria for equity classification have been met, the awards would be classified as equity until it becomes probable that the change in control will occur (i.e., when it is probable that the awards will be cash settled). A change in control is generally not considered probable until the event has occurred (i.e., when the business combination has been consummated). See Section 5.4.2 for more information about the classification of share-based payment awards with contingent cash settlement features.

Contemporaneously with the closing of the business combination (when it is probable that the awards will be cash settled), the awards will become a share-based liability. As a result of the change in the probable settlement outcome, an entity would account for the awards in accordance with ASC 718-10-35-15; that is, the entity would account for them in a manner similar to a modification from equity awards to liability awards (see Section 6.8.1 for a discussion and examples of the accounting for the modification of awards whose classification changes from equity to liability). Because the awards are liability-classified in the acquiree’s financial statements at the time of the acquisition (i.e., the cash settlement triggers a modification from equity to liability in the acquiree’s financial statements upon the acquisition), the awards would be accounted for as an assumed liability by the acquirer in the business combination rather than as consideration transferred. See Section 10.7.1 for more information about determining whether amounts should be accounted for as consideration transferred or an assumed liability in the acquirer’s acquisition accounting.

There is diversity in practice related to the acquiree’s recognition of the associated compensation cost resulting from the modification. One acceptable view is that all of the acquiree’s acquisition expenses, even those that are contingent on a change in control, should be recognized in the period in which they were incurred (i.e., in the acquiree’s precombination financial statements). Another acceptable view is that the compensation costs should not be recognized in the acquiree’s financial statements but instead recognized on the “black line.”

10.5.2.1 Fully Vested Awards That Are Cash Settled Upon a Change in Control

If awards are fully vested as of the acquisition date and include a cash settlement provision in their original terms, the acquirer assumes and recognizes a share-based liability (because it is now probable that the awards will be cash settled) for their fair-value-based measure on the acquisition date. If the fair-value-based measure of the share-based liability is greater than the original grant-date fair-value-based measure of the equity awards, the difference is recognized as additional compensation cost in the acquiree’s precombination financial statements or on the “black line.” Conversely, if the fair-value-based measure of the share-based liability is less than or equal to the original grant-date fair-value-based measure of the equity awards, the offsetting amount is recorded to APIC in the acquiree’s precombination financial statements.

Example 10-16

Fully Vested Unexercised Options That Are Cash Settled Upon a Change in Control

On January 1, 20X1, Entity B issues 1,000 options to its employees, each with a grant-date fair-value-based measure of $5, that vest at the end of the third year of service (cliff vesting). Under a preexisting provision in the original terms of the option award, cash settlement is required in the event of a change in control. Because a change in control is generally not considered probable until it occurs, B classifies the options as equity (as long as all other criteria for equity classification are met).

On January 1, 20X5, Entity A acquires B in a transaction accounted for as a business combination. On January 1, 20X5, the fair-value-based measure of B’s options is $6 per option.

Contemporaneously with the closing of the business combination, B (1) reclassifies the amount currently residing in APIC as a share-based liability (i.e., $5,000, or 1,000 options × $5 grant-date fair-value-based measure × 100% of service rendered) and (2) records the excess $1,000, or ($6 acquisition-date fair-value-based measure – $5 grant-date fair-value-based measure) × 1,000 options × 100% of service rendered, as additional compensation cost in the acquiree’s precombination financial statements or on the “black line” (if the acquiree elects to apply pushdown accounting) to record the share-based liability at its fair-value-based measure, with a corresponding adjustment to the share-based liability. Entity A accounts for the share-based liability as an assumed liability in the business combination rather than as consideration transferred.

10.5.2.2 Partially Vested Awards That Are Cash Settled Upon a Change in Control

If awards are partially vested as of the acquisition date, a preexisting cash settlement provision may immediately cause them to be vested because such provision accelerates vesting for any remaining unvested awards. Accordingly, any unrecognized compensation cost associated with the original equity awards is recognized as compensation cost in the acquiree’s precombination financial statements or on the “black line.” Since the awards are now fully vested, if the fair-value-based measure of the acquiree’s awards as of the acquisition date is greater than the awards’ original grant-date fair-value-based measure, the difference is recognized as additional compensation cost in the acquiree’s precombination financial statements or on the “black line.” Conversely, if the fair-value-based measure is less than the awards’ original grant-date fair-value-based measure, the offsetting amount is recorded to APIC in the acquiree’s precombination financial statements. In addition, the acquirer accounts for the share-based liability as an assumed liability in the business combination at an amount equal to the awards’ fair-value-based measure on the acquisition date (i.e., generally for the amount of cash that it would expect to settle the acquiree’s awards).

Example 10-17

Partially Vested Options That Are Cash Settled Upon a Change in Control

Assume the same facts as in Example 10-16, except that the options granted by Entity B vest at the end of the fifth year of service (cliff vesting) and cash settlement is required even if the awards are unvested.

Contemporaneously with the closing of the business combination, B (1) recognizes $1,000 (1,000 options × $5 grant-date fair-value-based measure × 1 of 5 years of service remaining) for the remaining unrecognized compensation cost associated with the original equity options because the cash settlement provision immediately vests the remaining unvested options; (2) reclassifies the amount now residing in APIC as a share-based liability (i.e., $5,000, or 1,000 options × $5 grant-date fair-value-based measure × 100% of service rendered); and (3) records the excess $1,000, or ($6 acquisition-date fair-value-based measure – $5 grant-date fair-value-based measure) × 1,000 options × 100% of service rendered, as additional compensation cost in the acquiree’s precombination financial statements or on the “black line” (if the acquiree elects to apply pushdown accounting) to record the share-based liability at its fair-value-based measure, with a corresponding adjustment to the share-based liability.

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.