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.” See Section
A.16.1 of Deloitte’s Roadmap Business Combinations for information about the
presentation of certain acquiree expenses triggered by a business
combination.
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.