Chapter 10 — Business Combinations
Chapter 10 — Business Combinations
In a business combination, share-based payment awards held by grantees of the
acquiree are often exchanged for share-based payment awards of the acquirer. ASC 805
refers to the new awards as “replacement awards.” The acquirer must analyze the
terms of both the preexisting and the replacement awards to determine what portion
of the replacement awards is related to precombination vesting (i.e., past goods or
services) and therefore part of the consideration transferred in the business
combination. The portion of replacement awards that is related to postcombination
vesting (i.e., future goods or services) should be recognized as compensation cost
in the postcombination period.
10.1 Replacement of Acquiree Awards
ASC 718-20
Equity Restructuring or Business Combination
35-6 Exchanges of share options or other equity instruments or changes to their terms in conjunction with an
equity restructuring or a business combination are modifications for purposes of this Subtopic. An entity shall
apply the guidance in paragraph 718-20-35-2A to those exchanges or changes to determine whether it shall
account for the effects of those modifications. Example 13 (see paragraph 718-20-55-103) provides further
guidance on applying the provisions of this paragraph. See paragraph 718-10-35-10 for an exception.
ASC 805-30
Acquirer Share-Based Payment Awards Exchanged for Awards
Held by the Acquiree’s Grantees
30-9 An acquirer may exchange
its share-based payment awards for awards held by grantees
of the acquiree. This Topic refers to such awards as
replacement awards. Exchanges of share options or other
share-based payment awards in conjunction with a business
combination are modifications of share-based payment awards
in accordance with Topic 718. If the acquirer is obligated
to replace the acquiree awards, either all or a portion of
the fair-value-based measure of the acquirer’s replacement
awards shall be included in measuring the consideration
transferred in the business combination. The acquirer is
obligated to replace the acquiree awards if the acquiree or
its grantees have the ability to enforce replacement. For
example, for purposes of applying this requirement, the
acquirer is obligated to replace the acquiree’s awards if
replacement is required by any of the following:
-
The terms of the acquisition agreement
-
The terms of the acquiree’s awards
-
Applicable laws or regulations.
Exchanges of share-based payment awards in a business combination are considered
modifications under ASC 718. An acquirer must assess whether the replacement awards
are part of the consideration transferred, are recognized as compensation cost in
the postcombination financial statements, or are a combination of both in accordance
with ASC 805. Before it can make its determination, the acquirer must assess whether
it is “obligated” to replace the acquiree’s awards. If it is obligated to replace
the awards, the acquirer must include all or a portion of the fair-value-based
measure1 of the replacement awards in its measurement of the consideration transferred
in the business combination. The portion not included in the measurement of
consideration transferred is included in postcombination compensation cost.
ASC 805-30-30-9 notes that the acquirer is obligated to replace the acquiree’s
share-based payment awards “if the acquiree or its grantees have the ability to
enforce replacement.” It further indicates that the acquirer is obligated to replace
the awards if replacement is required by (1) the terms of the acquisition agreement,
(2) the terms of the acquiree’s awards, or (3) applicable laws or regulations. It is
not uncommon for the terms of the acquiree’s awards to be silent or give the
acquiree discretion regarding the awards’ treatment upon a business combination. If
an obligation to replace the acquiree’s awards is based on the terms of the
acquisition agreement, acquirers should carefully consider the awards’ preexisting
terms to determine the portion of the fair-value-based-measure to include in the
consideration transferred and in postcombination compensation cost. In addition,
acquirers may wish to consult with legal counsel for assistance in assessing the
terms of award agreements and their requirements under applicable laws and
regulations.
Accordingly, an entity should consider the original terms of the acquiree’s awards
(as well as applicable laws or regulations) and whether the acquirer was obligated
to issue replacement awards in the event of a change in control. While some awards
may contractually expire upon a change in control (see Section 10.10), it is more common for the terms of the acquiree’s
awards to be silent on the matter or give the acquiree discretion regarding the
awards’ treatment upon a change in control event such as a business combination. In
these circumstances, if the acquiree’s awards are replaced under the terms of the
acquisition agreement, an entity generally accounts for the replacement awards as if
the replacement obligation exists. Acquirers may wish to consult with legal counsel
for assistance in assessing the terms of award agreements and their requirements
under applicable laws and regulations.
See Section 10.2 for additional
information about allocating replacement awards between consideration transferred
and postcombination compensation cost.
In addition, Section 10.9
discusses situations in which the acquiree’s share-based payment awards are not
modified but remain outstanding after the business combination. For guidance that
applies when the acquiree’s share-based payment awards expire as a result of the
business combination, see Section 10.10.
Footnotes
1
While the term “fair-value-based measure” is used in this
chapter, ASC 718 permits the use of a calculated value or an intrinsic value
in specified circumstances. Accordingly, the guidance in this chapter also
applies in situations in which a calculated or an intrinsic value is
used.
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:
-
Have rendered the required service as of the acquisition date (Case A)
-
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:
-
Have rendered the required service as of the acquisition date (Case B)
-
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:
- Have met the vesting condition as of the acquisition date (Case A)
- 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:
- Have met the vesting condition as of the acquisition date (Case B)
- 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
2
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.
10.3 Changes Reflected in Postcombination Compensation Cost
ASC 805-30
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.
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.
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.
10.3.1 Changes in Forfeiture Estimates or Actual Forfeitures in the Postcombination Period
ASC 805-30-55-11 (see Section 10.2.2)
requires an acquirer to reflect changes in (1) the
acquirer’s forfeiture estimate (if the acquirer’s accounting
policy is to estimate forfeitures) or (2) actual forfeitures
(if the acquirer’s accounting policy is to account for
forfeitures when they occur) in the postcombination period
in compensation cost for the period in which the changes
occur. If the acquirer’s accounting policy is to account for
forfeitures when they occur, it should attribute to
postcombination vesting, and recognize in compensation cost
over the employee’s requisite service period or the
nonemployee’s vesting period, the amount excluded from
consideration transferred (i.e., attributable to
precombination vesting) on the basis of the acquirer’s
estimate of forfeitures as of the acquisition date. However,
views differ on how the acquirer should reflect changes in
its forfeiture estimate or actual forfeitures (i.e., a
decrease in the number of awards expected to vest or awards
that actually vest) in postcombination compensation
cost.
The following are two acceptable views on accounting for circumstances in which
the forfeiture estimate or actual forfeitures have increased
since the acquisition-date forfeiture estimate (in the event
of a decrease, only View B would apply):
-
View A — An increase in an acquirer’s forfeiture estimate or actual forfeitures (i.e., a decrease in the number of awards expected to vest or that actually vest) should result in the reversal of compensation cost associated with the acquisition-date fair-value-based measure of the awards not expected to vest or that do not actually vest that was solely attributed to postcombination vesting as of the acquisition date.
-
View B — An increase in the acquirer’s forfeiture estimate or actual forfeitures (i.e., a decrease in the number of awards expected to vest or that actually vest) should result in the reversal of compensation cost associated with the acquisition-date fair-value-based measure of the awards not expected to vest or that do not actually vest, regardless of whether that measure was attributed to precombination or postcombination vesting as of the acquisition date. This reversal of compensation cost may exceed the amounts previously recognized as compensation cost in the acquirer’s postcombination financial statements. View B is consistent with the guidance in ASC 805-30-55-13, which states that the acquirer must recognize, in its postcombination financial statements, “[a]ll changes in the fair-value-based measure of awards classified as liabilities after the acquisition date . . . in the period(s) in which the changes occur.”
An acquirer may elect either view as an accounting policy.
Regardless of the view selected, however, the acquirer must recognize in the
current-period income tax provision the reversal of the
corresponding deferred tax asset (DTA) related to the
acquisition-date fair-value-based measure attributed to both
precombination and postcombination vesting. ASC 805-740
provides specific income tax accounting guidance on
replacement awards. For a discussion of this guidance, see
Section 10.7
of Deloitte’s Roadmap Income
Taxes.
The examples below illustrate the accounting for an increase in
the acquirer’s forfeiture estimate or actual forfeitures
under View A and View B. In the examples, it is assumed that
the acquirer recognizes a DTA in purchase accounting in
accordance with the guidance in ASC 805-740 and (for the
portion of the award that vests postcombination) ASC
718-740.
Example 10-6
View A — Entity Elects to Estimate Forfeitures
On January 1, 20X1, Entity D grants employees 100 nonqualified (tax-deductible)
stock options that vest at the end of the fifth
year of service (cliff vesting). On December 31,
20X4, Entity C acquires D in a transaction
accounted for as a business combination and is
obligated to replace the employees’ awards with
100 replacement awards that have the same service
terms as D’s original awards (i.e., the
replacement awards will vest at the end of one
additional year of service). The fair-value-based
measure of each award on the acquisition date is
$10. Accordingly, the fair-value-based measure of
both C’s awards (the replacement awards) and D’s
awards (the replaced awards) is $1,000 as of the
acquisition date. Entity C attributes $800 of the
acquisition-date fair-value-based measure of the
replacement awards to precombination service and
the remaining $200 to postcombination service. The
$200 attributed to the postcombination service is
recognized as postcombination compensation cost
over the replacement awards’ remaining one-year
service period. On the acquisition date, C
estimates that 25 percent of the replacement
awards granted will be forfeited. Entity C’s
applicable tax rate is 25 percent and its policy
is to estimate forfeitures.
Journal
Entries: December 31, 20X4, Acquisition
Date
Journal Entries: Quarter Ended
March 31, 20X5
Journal
Entries: Quarter Ended June 30, 20X5
During the third quarter, C goes through a
restructuring, and many of D’s former employees
terminate their employment before their
replacement awards vest. Accordingly, C changes
its forfeiture estimate for the replacement awards
from 25 percent to 80 percent.
Journal
Entries: Quarter Ended September 30,
20X5
There were no additional changes to the
forfeiture estimate in the fourth quarter;
therefore, 20 of the 100 replacement awards
vested.
Journal
Entries: Quarter Ended December 31,
20X5
Example 10-7
View B — Entity Elects to Estimate Forfeitures
Assume the same facts as in the example above. Under View B, there is no
difference in the accounting as of the acquisition
date and for the first two quarters of service in
the postcombination period (i.e., the journal
entries are the same). However, Entity C’s
accounting in the third quarter for the change in
forfeiture estimate will differ from that under
View A.
Because C’s forfeiture estimate has increased to 80 percent in the third
quarter, only $200 of the $1,000 acquisition-date
fair-value-based measure of the replacement awards
should be allocated between the precombination and
postcombination service periods. Accordingly, C
recognizes an adjustment in postcombination
compensation cost for the sum of (1) the amount of
the acquisition-date fair-value-based measure of
the replacement awards that was originally
included in consideration transferred but that is
associated with replacement awards of $440 that
are no longer expected to vest — ($800
acquisition-date fair-value-based measure
allocated to precombination service × 20% revised
awards expected to vest) – $600 previously
recognized as consideration transferred — and (2)
the amount of the acquisition-date
fair-value-based measure of the replacement awards
that was originally included in postcombination
compensation cost but that is associated with
replacement awards of $45 that are no longer
expected to vest: ($200 acquisition-date
fair-value-based measure allocated to
postcombination service × 20% revised awards
expected to vest × 75% service rendered) – $75
previously recognized as compensation cost.
With respect to the income tax adjustments, the offsetting entry for the reversal of the DTA associated with the amount that was previously recorded in consideration transferred would be recorded in the income tax provision along with the offsetting entry for the reversal of the DTA associated with the amount that was previously recorded in postcombination compensation cost.
Journal
Entries: Quarter Ended September 30,
20X5
As in the example above, there were no additional changes to the forfeiture
estimate in the fourth quarter; therefore, 20 of
the 100 originally issued awards vested.
Journal
Entries: Quarter Ended December 31,
20X5
Example 10-8
View A — Entity Elects to Account for Forfeitures as They Occur
Assume the same facts as in Example 10-6, except that Entity C
elects to account for forfeitures as they occur,
and all forfeitures (80 awards) occur in the
quarter ended September 30, 20X5. Entity C is
still required to estimate the number of awards
that will vest in calculating the portion of the
fair-value-based measure of the replacement awards
included in consideration transferred (i.e.,
attributable to precombination service). In
addition, in a manner consistent with its
accounting policy election, C recognizes
compensation cost of $200 for the portion of all
outstanding awards attributable to postcombination
service. However, C is also required to include
the amount ($200) excluded from consideration
transferred (on the basis of C’s estimate of
forfeitures as of the acquisition date) as
compensation cost attributed to postcombination
service ($800 acquisition-date fair-value-based
measure initially allocated to precombination
service × 25% awards not expected to vest).
There is no difference in the accounting as of the acquisition date (i.e., the journal entries are the same) because C is still required to estimate forfeitures to determine the portion of the acquisition-date fair-value-based measure of the replacement awards attributed to precombination service.
Journal
Entries: Quarter Ended March 31, 20X5
Journal
Entries: Quarter Ended June 30, 20X5
Since C’s accounting policy is to account for forfeitures as they occur, and it
was required to recognize as compensation cost the
amount excluded from consideration transferred
related to its estimate of forfeitures as of the
acquisition date, it also makes an adjustment to
recognize an increase in actual forfeitures
related to the amount it would have recognized as
consideration transferred if the acquisition-date
estimate of forfeitures were equal to actual
forfeitures. Because C’s actual forfeitures are 80
percent in the third quarter, it should allocate
only $200 of the $1,000 acquisition-date
fair-value-based measure of the replacement awards
between the precombination and postcombination
service periods. Accordingly, C recognizes an
adjustment in postcombination compensation cost
for the sum of (1) the amount of the
acquisition-date fair-value-based measure of the
replacement awards that was initially allocated to
precombination service and is associated with
replacement awards of $540 that are forfeited —
($800 acquisition-date fair-value-based measure
initially allocated to precombination service ×
20% of awards outstanding) – $600 previously
recognized as consideration transferred – $100
previously recognized as compensation cost for the
amount excluded from consideration transferred —
and (2) the amount of the acquisition-date
fair-value-based measure of the replacement awards
that was originally included in postcombination
compensation cost but that is associated with
replacement awards of $70 that are now forfeited:
($200 acquisition-date fair-value-based measure
allocated to postcombination service × 20% of
awards outstanding × 75% service rendered) – $100
previously recognized as compensation cost.
However, under View A, the adjustment is limited
to the $100 previously recognized as compensation
cost (based on the amount excluded from
consideration transferred related to A’s estimate
of forfeitures at the acquisition date). In
addition, an adjustment related to the DTA
previously recorded in purchase accounting
(attributable to precombination service) is
recognized because actual forfeitures during the
third quarter exceeded the amount of forfeitures
estimated as of the acquisition date.
Journal
Entries: Quarter Ended September 30,
20X5
Because all the forfeitures occurred in the third quarter, there are no additional adjustments, and 20 of the 100 replacement awards vested.
Journal
Entries: Quarter Ended December 31,
20X5
Example 10-9
View B — Entity Elects to Account for Forfeitures as They Occur
Assume the same facts as in the previous example. Under View B, there is no
difference in the accounting as of the acquisition
date and for the first two quarters of service in
the postcombination period (i.e., the journal
entries are the same). However, Entity C’s
accounting in the third quarter for the change in
actual forfeitures will differ from the accounting
under View A because the adjustment is not limited
to the amount previously recognized as
compensation cost.
Journal
Entries: Quarter Ended September 30,
20X5
As in the previous example, because all the forfeitures occurred in the third
quarter, there are no additional adjustments, and
20 of the 100 replacement awards vested.
Journal
Entries: Quarter Ended December 31,
20X5
10.3.2 Changes in the Probability of Meeting a Performance Condition in the Postcombination Period
ASC 805-30-55-12 states that the effects of the ultimate outcome of awards with performance conditions that occur after the acquisition date should be accounted for in accordance with ASC 718 in the period that the event occurs. However, views differ on how an acquirer should reflect a change in the expected outcome of a performance condition that results in a decrease in the number of awards expected to vest (e.g., a performance condition that was deemed probable as of the acquisition date that is subsequently considered improbable) in postcombination compensation cost.
The following are two acceptable views on accounting for circumstances in which
the achievement of a performance condition is deemed
probable as of the acquisition date and is subsequently
considered improbable:
-
View A — A change in the expected outcome of a performance condition from probable to improbable should result in the reversal of compensation cost associated with the acquisition-date fair-value-based measure that was solely attributed to postcombination vesting as of the acquisition date.
-
View B — A change in the expected outcome of a performance condition from probable to improbable should result in the reversal of compensation cost associated with the acquisition-date fair-value-based measure of all awards not expected to vest, regardless of whether that acquisition-date fair-value-based measure was attributed to precombination or postcombination vesting as of the acquisition date. This reversal of compensation cost may exceed the amounts previously recognized as compensation cost in the acquirer’s postcombination financial statements. As discussed previously, View B is consistent with the guidance in ASC 805-30-55-13, under which the acquirer must recognize in its postcombination financial statements “[a]ll changes in the fair-value-based measure of awards classified as liabilities after the acquisition date . . . in the period(s) in which the changes occur.”
An acquirer may elect either view as an accounting policy.
Regardless of the view selected, the acquirer must recognize in
the current-period income tax provision the reversal of the
corresponding DTA related to the acquisition-date
fair-value-based measure attributed to both precombination
and postcombination vesting. ASC 805-740 provides specific
income tax accounting guidance on replacement awards. For a
discussion of this guidance, see Section 10.7 of Deloitte’s Roadmap
Income
Taxes.
If the achievement of a performance condition is deemed
improbable as of the acquisition date for either the
acquiree’s awards or the acquirer’s replacement awards, no
amount is recognized as either precombination or
postcombination services. However, if the performance
conditions subsequently become probable for the replacement
awards, an approach similar to View B would apply. For
example, if the performance condition changes from
improbable to probable for the replacement awards, the
acquirer would recognize compensation cost in the
postcombination financial statements on the basis of the
acquisition-date fair-value-based measure of the replacement
awards. No adjustments would be made to the consideration
transferred in the business combination.
The examples below illustrate the accounting for a change in the expected
outcome of a performance condition from probable to
improbable under View A and View B. In the examples, it is
assumed that the acquirer recognizes a DTA in purchase
accounting in accordance with the guidance in ASC 805-740
and (for the portion of the award that vests
postcombination) ASC 718-740.
Example 10-10
View A
On January 1, 20X1, Entity D grants employees 100 nonqualified (tax-deductible) stock options that vest only if D’s cumulative net income over the succeeding five years is greater than $5 million. On the grant date, it is deemed probable that the performance condition will be met. Accordingly, D begins to recognize compensation cost on a straight-line basis over the five-year service period.
On December 31, 20X4, Entity C acquires D in a transaction accounted for as a business combination and is obligated to replace the employees’ awards with 100 new awards that have the same terms as D’s original awards (i.e., the replacement awards will vest at the end of one additional year of service if the performance condition is met). The fair-value-based measure of each award on the acquisition date is $10. Accordingly, the fair-value-based measure of both C’s awards (the replacement awards) and D’s awards (the replaced awards) is $1,000 as of the acquisition date.
Entity C attributes $800 of the acquisition-date fair-value-based measure of the
replacement awards to precombination service and
the remaining $200 to postcombination service. The
$200 attributed to the postcombination service is
recognized as postcombination compensation cost
over the replacement awards’ remaining one-year
service period. On the acquisition date, it is
still probable that the performance condition will
be met. Assume that C’s applicable tax rate is 25
percent.
Journal
Entries: December 31, 20X4, Acquisition
Date
Journal
Entries: Quarter Ended March 31, 20X5
Journal
Entries: Quarter Ended June 30, 20X5
During the third quarter, C loses one of its largest customers and no longer believes that meeting the performance condition is probable.
Journal
Entries: Quarter Ended September 30,
20X5
Entity C ultimately did not meet the performance condition. Therefore, none of the awards vested, and no additional journal entries were necessary.
Example 10-11
View B
Assume all the same facts as in the example above. Under View B, there is no
difference in the accounting as of the acquisition
date and for the first two quarters of service in
the postcombination period (i.e., the journal
entries are the same). However, Entity C’s
accounting in the third quarter for the change in
the expected outcome of the performance condition
from probable to improbable will differ from its
accounting under View A.
Because C has now determined that meeting the performance condition is no longer probable, it recognizes an adjustment to postcombination compensation cost for the sum of (1) the amount of the acquisition-date fair-value-based measure of the replacement awards that was originally included in consideration transferred but that is associated with replacement awards of $800 that are no longer expected to vest and (2) the amount of the acquisition-date fair-value-based measure of the replacement awards that was originally included in postcombination compensation cost but that is associated with replacement awards of $100 that are no longer expected to vest ($200 acquisition-date fair-value-based measure allocated to postcombination service × 50% of service rendered).
With respect to the income tax adjustments, the offsetting entry for the reversal of the DTA associated with the amount that was previously recorded in consideration transferred would be recorded in the income tax provision along with the offsetting entry for the reversal of the DTA associated with the amount that was previously recorded in postcombination compensation cost.
Journal
Entries: Quarter Ended September 30,
20X5
As in the example above, C ultimately did not meet the performance condition.
Therefore, none of the awards vested, and no
additional journal entries were necessary.
10.4 Acceleration of Vesting Upon a Change in Control
In some cases, the vesting of an acquiree’s share-based payment awards is
accelerated upon a change in control of the
acquiree. The accounting for the accelerated
vesting of an award upon a change in control
depends on which party initiated the acceleration
as well as on whether the acceleration is a
preexisting provision in the terms of the
acquiree’s awards.
10.4.1 Acquirer Accelerates Vesting
An acquirer’s decision to immediately vest or reduce the future vesting period
of awards held by grantees of the acquiree does
not affect the portion of the fair-value-based
measure of the replacement awards 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.
This is because the allocation of compensation
expense to precombination and postcombination
periods is based on the greater of (1) the
total vesting period or (2) the original vesting
period of the replaced awards (see Section 10.2.1.3).
Therefore, in instances in which the acquirer
accelerates vesting, the allocation will still be
based on the original vesting period of the
replaced awards. For example, if the acquirer
decides to immediately vest the replacement
awards, the portion of the fair-value-based
measure of the awards attributable to
postcombination vesting would be immediately
recognized as compensation cost in the acquirer’s
postcombination financial statements. The amount
of the compensation cost would not be
affected.
Example 10-12
Acquirer Accelerates Vesting Upon the Acquisition Date
On January 1, 20X1, Entity B issues 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. On January 1, 20X2, the fair-value-based measure of both A’s replacement awards and B’s replaced awards is $10 per award. Entity A then immediately vests all of the outstanding replacement awards on the date of the business combination.
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 in the postcombination financial statements immediately upon the business combination.
If the fair-value-based measure of the replacement awards had been greater than the acquisition-date fair-value-based measure of B’s replaced awards, any excess would have been recognized immediately as compensation cost in A’s postcombination financial statements.
10.4.2 Acceleration of Vesting Included in the Original Terms of the Awards
If share-based payment awards of the acquiree become immediately vested on the
acquisition date because of a preexisting
provision in the awards’ terms that accelerates
their vesting (commonly referred to as a
“change-in-control” provision), the portion of the
replacement awards that is attributable to
precombination vesting, and therefore included in
consideration transferred, would be affected. As
noted in Section 10.2,
the portion of the replacement awards attributable
to precombination vesting is the acquisition-date
fair-value-based measure of the replaced awards
multiplied by the ratio of the precombination
vesting period to the greater of the (1) total
vesting period or (2) original vesting period of
the replaced awards. Since (1) all of the goods or
services have been provided in the precombination
period, (2) there is no requirement for future
vesting, and (3) the original vesting period is
complete, the entire
fair-value-based measure of the replaced awards would be
attributable to precombination vesting and
therefore included in consideration transferred.
If the fair-value-based measure of the replacement
awards is the same as that of the replaced awards,
there is no postcombination compensation cost
recognized. If, however, the fair-value-based
measure of the replacement awards is greater than
that of the replaced awards, the excess is
recognized as postcombination compensation
cost.
Note that there is diversity in practice related to the acquiree’s recognition
of the remaining unrecognized compensation cost. One view is that any remaining
unrecognized compensation cost associated with the original grant-date
fair-value-based measure of the awards should be recognized in the acquiree’s
precombination financial statements. Alternatively, the compensation cost may be
presented in neither the acquiree’s precombination financial statements nor the
combined entity’s postcombination financial statements (i.e., it is 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 the
consummation of a business combination.
Example 10-13
Acceleration of Vesting Included in the Original Terms of the Award
Assume the same facts as in Example 10-12, except that the
original terms of Entity B’s awards included a
preexisting provision that accelerates their
vesting upon B’s acquisition. Since (1) all of the
service has been rendered in the precombination
period, (2) there is no requirement for future
vesting, and (3) the original vesting period is
complete, the entire $1,000 would be attributable
to precombination service and therefore included
in consideration transferred.
10.4.3 Modification to the Original Terms of the Awards to Add a Change-in-Control Provision in Contemplation of a Business Combination
In some instances, share-based payment awards are modified to add a change-in-control provision in contemplation of a business combination. A modification could also result from the decision to exercise a discretionary change-in-control provision that was part of the original terms of the award (or was added in contemplation of the business combination). Such modifications may be initiated by the acquiree or requested by the acquirer. As discussed in Section 10.2, entities should carefully analyze a modification to determine whether it is part of, or separate from, the business combination. A transaction that is entered into by or on behalf of the acquirer or primarily for the benefit of the acquirer or the combined entity is likely to be a separate transaction.
Under ASC 805-10-55-18, factors for entities to consider in determining whether
a transaction primarily benefits the acquirer or the acquiree include the reason
for the transaction, which party initiated it, and when it occurred.
Understanding the business purpose of a modification will help an acquirer
assess which party benefits from it. It is generally presumed that the acquirer
benefits when an award’s original terms are modified to (1) add a
change-in-control provision during the negotiation of a business combination
with the acquirer or (2) exercise a discretionary change-in-control provision.
On the other hand, the acquirer is generally not presumed to benefit if an
acquiree, before entering into negotiations with the acquirer, modifies the
award’s original terms as part of actively exploring exit strategies. Given the
high degree of judgment involved in these determinations, discussion with
accounting advisers is encouraged.
When a modification to accelerate the vesting of awards upon a change in control
is determined to be primarily for the benefit of the acquirer, the modification
is accounted for in accordance with ASC 718 (i.e., compensation cost is
recognized over the remaining portion of the modified requisite service period;
see Section 6.3.6.1 for a discussion of
modifications that reduce the requisite service period of an award). The
acceleration of vesting upon the consummation of the business combination would
be considered a transaction that is separate from the business combination and
would be accounted for as though the acquirer had decided to accelerate the
vesting of the replacement awards immediately upon the acquisition. That is, the
acquirer’s decision to accelerate the vesting of the awards would affect the
timing of the recognition of postcombination compensation cost — any remaining
unrecognized compensation cost associated with the modified awards would not be
recognized as compensation cost in the acquiree’s precombination financial
statements; instead, it would be recognized as compensation cost immediately in
the postcombination financial statements (i.e., on day 1). The acceleration of
vesting would not affect the determination of the portion of the awards that is
attributable to (1) precombination vesting and therefore included in the
consideration transferred and (2) postcombination vesting and therefore included
in postcombination compensation cost.
Example 10-14
Modification to Add a Change-in-Control Provision
Assume the same facts as in Example 10-12, except that to retain the
employee until at least the acquisition date, Entity B
modified the employee’s existing awards during the
negotiations of the business combination so that they
automatically vest upon a change in control. It was also
determined that the modification was made to benefit
Entity A as it was initiated and discussed between the
parties as part of the negotiations. The modification is
therefore, in substance, the acceleration of the vesting
of the awards by the acquirer and is accounted for as a
transaction that is separate from the business
combination.
This accounting treatment is the same as that in Example 10-12; that is, one-third of
the awards are attributable to precombination
service and two-thirds are attributable to
postcombination service (which is immediately
recognized). As indicated above, acceleration of
the vesting of awards by the acquirer does not
affect the portion of the fair-value-based measure
of the replacement awards that is attributable to
postcombination service and therefore included in
postcombination compensation cost (i.e., the
$667); rather, it affects the timing of the
recognition of postcombination compensation cost
(i.e., immediate).
Example 10-15
Modification as a Result of Exercising a Discretionary Change-in-Control Provision
Assume the same facts as in Example 10-12, except that the original
awards included a discretionary change-in-control
provision that allowed Entity B to elect whether upon a
change in control the awards would (1) be replaced or
(2) vest in full (i.e., accelerated vesting). Entity B
elected to accelerate vesting and further determined
that exercise of the discretionary provision benefitted
A because it was initiated and discussed between the
parties as part of the negotiations.
As in Example 10-12 and the example
above, the modification is, in substance, the
acceleration of the vesting of the awards by the
acquirer and is accounted for as a transaction
that is separate from the business combination.
The amount attributable to (1) precombination
service (i.e., included in consideration
transferred) and (2) postcombination service
(i.e., recognized as postcombination compensation
cost by the acquirer) is determined in a manner
consistent with that described in Example 10-12 and the
example above.
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.
10.6 Arrangements for Contingent Payments to Employees or Selling Shareholders
During negotiations of a business combination, an acquirer may agree to make a
payment at some point in the future to one or more selling
shareholders or to acquiree employees who become employees of the
combined entity (or otherwise provide goods or services to the
combined entity) after the acquisition date. For example, a payment
to a selling shareholder may be contingent on whether the following
continue to be employed at the combined entity after the
acquisition: the selling shareholder, a different selling
shareholder, or a nonshareholder employee. See Section 6.2.3 of Deloitte’s
Roadmap Business
Combinations for additional guidance.
There may also be circumstances in which one or more of the selling
shareholders decide to share some of the proceeds that they are
entitled to receive with one or more of the acquiree’s
nonshareholder employees. Payments made by selling shareholders to
such nonshareholder employees that become employees of the acquirer
should be carefully evaluated under SAB Topic 5.T (which refers to
ASC 718-10-15-4, included in Section 2.5), which
discusses payments made by economic interest holders (e.g., selling
shareholders) on behalf of an entity. Also see Section
6.2.5 of Deloitte’s Roadmap Business Combinations for
more information. Acquirers must evaluate conditional future
payments (i.e., payments that include conditions other than the
passage of time) to former shareholders of the acquiree and to
individuals who become employees of the combined entity (or
otherwise provide goods or services to the combined entity) to
determine whether such payments represent (1) consideration
transferred (i.e., contingent consideration) or (2) compensation
cost that is separate from the business combination.
See Deloitte’s Roadmap Business
Combinations for additional guidance
on contingent consideration.
10.7 Compensation Arrangements
An acquiree in a business combination may have agreements in place to provide
specified employees with additional compensation
predicated upon a change in control of the
acquiree. Such arrangements could have been
established either before or after the
negotiations began for the business combination.
When determining whether the acquirer should
account for these arrangements as part of the
business combination or separately as
compensation, entities must use judgment and
consider the specific facts and circumstances as
discussed below and in Section 10.2. However, if a business
combination results in additional compensation
arrangements payable to the acquirer’s employees,
these payments are always accounted for as
compensation costs in the acquirer’s financial
statements.
10.7.1 Arrangements to Pay an Acquiree’s Employee Upon a Change in Control
Arrangements may be established with the objective of retaining one or more of
the acquiree’s employees until the acquisition
date and possibly for a defined period thereafter.
Such arrangements — often referred to in practice
as “stay bonuses,” “change in control payments,”
or “golden parachutes” — may also provide
additional compensation for performance related to
the business combination or compensate employees
who are terminated after the combination.
Arrangements to pay an
acquiree’s employees upon a change in control must
be assessed to determine whether they should be
accounted for as part of or separately from the
business combination. In assessing the substance
of an arrangement, an entity should consider the
factors listed in ASC 805-10-55-18 (i.e., “[t]he
reasons for the transaction,” “[w]ho initiated the
transaction,” and “[t]he timing of the
transaction”; see Section 10.2 for
discussion) to determine whether the arrangement
should be accounted for as part of, or separately
from, the business combination. See Section
10.4.3 for more information about
making that determination. Arrangements to pay an
acquiree’s employees upon a change in control that
are determined to be separate from the business
combination represent compensation cost of the
acquirer. If no future service is required, the
acquirer should recognize compensation cost on the
acquisition date. There may also be circumstances
in which a payment needs to be allocated between
the portion attributable to precombination
services and postcombination compensation
cost.
ASC 805-10-55-34 through 55-36 provide an example of a contingent payment to an
acquiree’s employee:
ASC 805-10
Example 4: Arrangement for Contingent Payment to an Employee
55-34 This Example illustrates the guidance in paragraphs 805-10-55-24 through 55-25 relating to contingent payments to employees in a business combination. Target hired a candidate as its new chief executive officer under a 10-year contract. The contract required Target to pay the candidate $5 million if Target is acquired before the contract expires. Acquirer acquires Target eight years later. The chief executive officer was still employed at the acquisition date and will receive the additional payment under the existing contract.
55-35 In this Example, Target entered into the employment agreement before the negotiations of the combination began, and the purpose of the agreement was to obtain the services of the chief executive officer. Thus, there is no evidence that the agreement was arranged primarily to provide benefits to Acquirer or the combined entity. Therefore, the liability to pay $5 million is included in the application of the acquisition method.
55-36 In other circumstances, Target might enter into a similar agreement with the chief executive officer at the suggestion of Acquirer during the negotiations for the business combination. If so, the primary purpose of the agreement might be to provide severance pay to the chief executive officer, and the agreement may primarily benefit Acquirer or the combined entity rather than Target or its former owners. In that situation, Acquirer accounts for the liability to pay the chief executive officer in its postcombination financial statements separately from application of the acquisition method.
In accounting for the acquisition, the acquirer will need to assess whether to
recognize amounts that have been determined to be
part of the business combination as part of the
consideration transferred or as a liability
assumed.
If the acquirer issues cash, other assets, or its equity instruments to settle
the acquiree’s awards that were equity-classified
in the acquiree’s precombination financial
statements, the portion determined to be part of
the business combination represents consideration
transferred since the acquiree’s employees were
owners of (or increased their ownership in) the
acquiree as a result of the arrangement.
By contrast, if the acquirer issues cash, other assets, or its equity
instruments to settle a bonus arrangement (e.g.,
stay bonus) with the acquiree’s employees or to
settle the acquiree’s awards that were
liability-classified in the acquiree’s
precombination financial statements, the portion
determined to be part of the business combination
would be treated in the acquisition accounting as
a liability assumed.
If arrangements to pay an acquiree’s employees upon a change in control are
settled in cash or in other assets after the
acquisition date rather than at the closing of the
business combination, the acquirer would need to
recognize a liability in its acquisition
accounting for the portion determined to be part
of the business combination. In the acquisition
accounting, the nature of that liability as either
consideration transferred or a liability assumed
should be determined on the basis of the analysis
described above.
10.7.2 Dual- or Double-Trigger Arrangements
An employment agreement entered into before negotiations began for the business
combination may include terms that require a
payment or accelerate vesting upon (1) a change in
control and (2) a second defined event or
“trigger,” which is why such provisions are
commonly called “dual trigger” or “double trigger”
arrangements. The second defined event is
generally the separation of the employee from the
acquirer and might be limited to involuntary
terminations or might also include resignation of
the employee in specified conditions (sometimes
referred to as “good reasons”) such as:
-
A demotion or significant reduction in the employee’s duties or responsibilities after the acquisition date.
-
A significant reduction in the employee’s salary or compensation after the acquisition date.
-
The relocation of the employee’s job site beyond a specified radius after the acquisition date.
The objective of such employment agreements, which are typically entered into before negotiations have begun for a business combination, is generally to obtain the employee’s services. While the three factors in ASC 805-10-55-18 (i.e., “[t]he reasons for the transaction,” “[w]ho initiated the transaction,” and “[t]he timing of the transaction”) might indicate that the payments should be accounted for as part of the business combination, such arrangements are generally accounted for separately from the business combination. This is because the decision to effect the second trigger (i.e., the employee’s involuntary termination or voluntary termination for “good reason”) is under the control of the acquirer and is therefore presumed to be made primarily for the acquirer’s benefit (e.g., to reduce cost by eliminating the unneeded employee).
Example 10-18
Dual- or Double-Trigger Arrangement Involving the Termination of Employment
Company A acquires Company B in a transaction accounted for as a business combination. Company B has an existing employment agreement with its CEO that was put in place before negotiations began for the combination. Under the agreement, all of the CEO’s unvested awards will fully vest upon (1) a change in the control of B and (2) the involuntary termination of the CEO’s employment within one year after the acquisition date.
Before the closing, A determines that it will not offer employment to the CEO
after the combination has been completed. Thus,
both conditions are triggered, and the vesting of
the CEO’s unvested awards is accelerated upon the
closing of the acquisition.
The decision not to employ B’s former CEO was under A’s control and was made for
A’s benefit (i.e., to reduce costs). Therefore, A
should recognize the compensation cost related to
the accelerated vesting of the unvested awards in
its postcombination financial statements and not
as part of the business combination.
Example 10-19
Dual- or Double-Trigger Arrangement in Which Employee Resigns for “Good Reason”
As in the example above, Company A acquires Company B in a transaction accounted
for as a business combination, and B has an
existing employment agreement with its CEO.
However, in this example, the agreement provides
that all of the CEO’s unvested awards will fully
vest upon (1) a change in the control of B
and (2) either the involuntary termination
of the CEO or the voluntary departure of the CEO
for “good reason” within one year after the
acquisition date. The agreement specifies that a
significant reduction in job responsibilities
would be a good reason. After the acquisition
date, B’s CEO will not assume the role of CEO of
the combined entity but instead will be assigned a
position with reduced responsibilities. In
response, B’s CEO will resign upon the change in
control.
The decision to reduce the responsibilities of B’s former CEO after the acquisition date is within A’s control. Therefore, A should recognize the compensation cost related to the accelerated vesting of the awards in its postcombination financial statements and not as part of the business combination.
10.7.3 Arrangements to Reallocate Forfeited Awards or Amounts to Remaining Shareholders/Employees
An acquirer may issue share-based payment awards to a group of shareholders of
the acquiree, all of whom become employees of the
combined entity with such awards subject to
vesting based on continued employment. The awards
may be placed in a trust by the acquirer on the
acquisition date. Such arrangements are sometimes
referred to as “last man standing” arrangements
because any forfeited awards must be reallocated
to the remaining participants in the group. Some
arrangements may not specify what happens if none
of the participants are still employed by the
acquirer at the end of the term; however, since
these arrangements typically encompass many
employees, it would be unlikely that none remain.
Other arrangements may specify that the amounts
revert to the acquiree’s former shareholders if
none of the participants are still employed at the
end of the term.
In his remarks at the 2000 AICPA Conference on Current SEC Developments, then SEC OCA Professional Accounting Fellow R. Scott Blackley provided the following example of such an arrangement:
For illustration, consider an example business combination where a company acquires another enterprise, XYZ Company, for cash and stock. All of the shareholders of XYZ Company are also employees. The acquiring company expects and desires to have the employee shareholders of XYZ Company continue as employees of the combined companies. Accordingly, of the shares issued to the shareholders of XYZ Company, a portion is held in an irrevocable trust, subject to a three year vesting requirement (“forfeiture shares”).
The forfeiture provision requires that if, prior to vesting, a shareholder resigns from employment or is terminated for cause, the shares held in the trust allocable to the employee shareholder be forfeited. Additionally, any shares actually forfeited are reallocated to the remaining employee shareholders based on their remaining ownership interests such that all of the forfeiture shares in the trust will ultimately be issued.
Mr. Blackley said that in this scenario, the SEC staff concluded that “the forfeiture shares must be accounted for as a compensation arrangement.” He noted that the staff placed “significant weight” on the shares’ vesting on the basis of continued employment even though the amount of consideration was fixed because it would not be returned to the acquirer under any circumstances. Although Mr. Blackley made these remarks before FASB Statement 141(R), as
codified in ASC 805, was issued, we believe that they remain relevant.
Therefore, in an arrangement in which share-based payment awards are issued to a group of shareholders of the acquiree, all of whom become employees of the combined entity on the basis of a requirement to continue employment, the forfeiture and subsequent redistribution of the awards are accounted for as (1) the forfeiture of the original award and (2) the grant of a new award. That is, the acquirer would reverse any compensation previously recognized for the forfeited award (on the basis of the original grant-date fair-value-based measure) and then recognize compensation for the new award (on the basis of the fair-value-based measure on the date the award is redistributed) over the remaining requisite service period.
Example 10-20
Arrangement to Reallocate Forfeited Awards to Remaining Shareholders/Employees
On January 1, 20X1, Company A acquires Company B and, as part of the acquisition agreement, grants each of B’s 10 shareholders/employees 100 new share-based payment awards that vest at the end of five years of service (cliff vesting). The grant-date fair-value-based measure of each award as of the acquisition date is $10.
The terms of the award state that if employment is terminated before the end of five years (i.e., the vesting date), the employee’s awards are forfeited and redistributed among the remaining employees within the group.
The total grant-date fair-value-based measure of the awards as of the acquisition date is $10,000 (10 employees × 100 awards × $10 grant-date fair-value-based measure), which A recognizes in the postcombination financial statements as compensation cost over the five-year service period ($2,000 per year). On December 31, 20X3, two employees in the group terminate their employment and forfeit their awards, which are then redistributed to the eight remaining group members. The fair-value-based measure of each redistributed (i.e., new) award is $12 on the date the awards are redistributed.
On December 31, 20X3, A should reverse $1,200 of previously recognized
compensation cost (2 employees × 100 awards × $10
grant-date fair-value-based measure × 60% for 3
out of 5 years of services rendered) corresponding
to the forfeited awards. Company A should continue
to recognize $1,600 in annual compensation cost (8
employees × 100 awards × $10 grant-date fair value
÷ 5 years) over each of the remaining two years of
service for the original awards provided to the
remaining employees. In addition, A should
recognize $1,200 in additional annual compensation
cost (200 awards × $12 grant-date fair-value-based
measure ÷ 2 years of remaining service) over each
of the remaining two years of service for the
redistributed awards.
In some cases, payments to the shareholders/employees may be made in cash rather than forfeitable shares. We do not believe that the form of the payment affects the conclusion that such arrangements are based on continued employment and therefore should be accounted for as compensation and not as part of the exchange for the acquiree.
10.8 Tax Effects of Replacement Awards Issued in a Business Combination
See Chapter 11 of
Deloitte’s Roadmap Income Taxes for guidance on the
accounting for the tax effects of replacement awards issued in a
business combination. In addition, see Section 10.3 of this
Roadmap for a discussion and examples of the accounting for the tax
effects of replacement awards issued in a business combination.
10.9 Acquiree Awards Remain Outstanding
In some cases, the acquirer is not required to replace the
acquiree’s share-based payment awards and they remain outstanding after the
acquisition. For example, if the acquiree becomes a subsidiary of the acquirer, the
share-based payment awards that were issued by the acquiree before the business
combination might remain outstanding after the business combination. In that case,
assuming that they qualify for equity classification, we believe that those awards
represent a noncontrolling interest in the subsidiary in the parent’s consolidated
financial statements. While the guidance in ASC 805-30-30-1(a)(2) states that any
noncontrolling interests should be measured and recognized at fair value, we believe
that unvested share-based payment awards should be measured in the same manner as
replacement awards; that is, a fair-value-based measure is used in accordance with
ASC 718.
While ASC 805 does not address awards that have postcombination vesting requirements,
we believe that the acquirer should apply the replacement award guidance by analogy
and determine the portion of the acquisition-date fair-value-based measure of the
acquiree award that is attributable to precombination vesting and recognize that
amount as noncontrolling interest (as opposed to consideration transferred). The
portion related to postcombination vesting should be recognized as compensation cost
in the postcombination financial statements. See Section
10.2 for more information about determining that allocation.
10.10 Acquiree Awards That Expire as a Result of the Business Combination
ASC 805-30
30-10 In situations in which
acquiree awards would expire as a consequence of a business
combination and the acquirer replaces those awards even
though it is not obligated to do so, all of the
fair-value-based measure of the replacement awards shall be
recognized as compensation cost in the postcombination
financial statements. That is, none of the fair-value-based
measure of those awards shall be included in measuring the
consideration transferred in the business combination.
In accordance with ASC 805-30-30-10, if an acquiree’s share-based
payment awards will expire as a result of a business combination under the terms of
the original award but the acquirer issues replacement awards even though it is not
obligated to do so, “all of the fair-value-based measure of the replacement awards
shall be recognized as compensation cost in the postcombination financial
statements. That is, none of the fair-value-based measure of those awards shall be
included in measuring the consideration transferred in the business combination.”
In most cases, however, an acquirer is obligated to replace the
acquiree’s awards or they remain outstanding after the acquisition.