Chapter 13 — Disclosure
Chapter 13 — Disclosure
13.1 Disclosure Objective
ASC 718 specifies the information entities must disclose about their share-based payment arrangements in the notes to the financial statements. The disclosure objectives related to such arrangements are outlined in ASC 718-10-50-1.
ASC 718-10
50-1 An entity with one or more share-based payment arrangements shall disclose information that enables users of the financial statements to understand all of the following:
- The nature and terms of such arrangements that existed during the period and the potential effects of those arrangements on shareholders
- The effect of compensation cost arising from share-based payment arrangements on the income statement
- The method of estimating the fair value of the equity instruments granted (or offered to grant), during the period
- The cash flow effects resulting from share-based payment arrangements.
This disclosure is not required for interim reporting. For interim reporting see Topic 270. See Example 9 (paragraphs 718-10-55-134 through 55-137) for an illustration of this guidance.
See Section 13.3 for examples of the disclosures required under ASC 718.
13.2 Minimum Disclosures
ASC 718-10-50-2 and 50-2A outline the “minimum information” an entity must disclose in its annual financial statements to achieve the four objectives specified in ASC 718-10-50-1.
ASC 718-10
50-2 The following list indicates the minimum information needed to achieve the objectives in paragraph 718-10-50-1 and illustrates how the disclosure requirements might be satisfied. In some circumstances, an entity may need to disclose information beyond the following to achieve the disclosure objectives:
- A description of the share-based payment arrangement(s), including the general terms of awards under the arrangement(s), such as:
- The employee’s requisite service period(s) and, if applicable, the nonemployee’s vesting period and any other substantive conditions (including those related to vesting)
- The maximum contractual term of equity (or liability) share options or similar instruments
- The number of shares authorized for awards of equity share options or other equity instruments.
- The method it uses for measuring compensation cost from share-based payment arrangements.
- For the most recent year for which an income statement is provided, both of the following:
- The number and weighted-average exercise prices (or conversion ratios) for each of the following groups of share options (or share units):
- Those outstanding at the beginning of the year
- Those outstanding at the end of the year
- Those exercisable or convertible at the end of the year
- Those that during the year were:01. Granted02. Exercised or converted03. Forfeited04. Expired.
- The number and weighted-average grant-date fair value (or calculated value for a nonpublic entity that uses that method or intrinsic value for awards measured pursuant to paragraph 718-10-30-21) of equity instruments not specified in (c)(1), for all of the following groups of equity instruments:
- Those nonvested at the beginning of the year
- Those nonvested at the end of the year
- Those that during the year were:01. Granted02. Vested03. Forfeited.
- For each year for which an income statement is provided, both of the following:
- The weighted-average grant-date fair value (or calculated value for a nonpublic entity that uses that method or intrinsic value for awards measured at that value pursuant to paragraphs 718-10-30-21 through 30-22) of equity options or other equity instruments granted during the year
- The total intrinsic value of options exercised (or share units converted), share-based liabilities paid, and the total fair value of shares vested during the year.
- For fully vested share options (or share units) and share options expected to vest (or unvested share options for which the employee’s requisite service period or the nonemployee’s vesting period has not been rendered but that are expected to vest based on the achievement of a performance condition, if an entity accounts for forfeitures when they occur in accordance with paragraph 718-10-35-1D or 718-10-35-3) at the date of the latest statement of financial position, both of the following:
- The number, weighted-average exercise price (or conversion ratio), aggregate intrinsic value (except for nonpublic entities), and weighted-average remaining contractual term of options (or share units) outstanding
- The number, weighted-average exercise price (or conversion ratio), aggregate intrinsic value (except for nonpublic entities), and weighted-average remaining contractual term of options (or share units) currently exercisable (or convertible).
- For each year for which an income statement is presented, both of the following (An entity that uses the intrinsic value method pursuant to paragraphs 718-10-30-21 through 30-22 is not required to disclose the following information for awards accounted for under that method):
- A description of the method used during the year to estimate the fair value (or calculated value) of awards under share-based payment arrangements
- A description of the significant assumptions used during the year to estimate the fair value (or calculated value) of share-based compensation awards, including (if applicable):
- Expected term of share options and similar instruments, including a discussion of the method used to incorporate the contractual term of the instruments and grantees’ expected exercise and postvesting termination behavior into the fair value (or calculated value) of the instrument.
- Expected volatility of the entity’s shares and the method used to estimate it. An entity that uses a method that employs different volatilities during the contractual term shall disclose the range of expected volatilities used and the weighted-average expected volatility. A nonpublic entity that uses the calculated value method shall disclose the reasons why it is not practicable for it to estimate the expected volatility of its share price, the appropriate industry sector index that it has selected, the reasons for selecting that particular index, and how it has calculated historical volatility using that index.
- Expected dividends. An entity that uses a method that employs different dividend rates during the contractual term shall disclose the range of expected dividends used and the weighted-average expected dividends.
- Risk-free rate(s). An entity that uses a method that employs different risk-free rates shall disclose the range of risk-free rates used.
- Discount for postvesting restrictions and the method for estimating it.
-
Practical expedient for current price input. A nonpublic entity that elects to apply the practical expedient in paragraphs 718-10-30-20C through 30-20F shall disclose that election.
- An entity that grants equity or liability instruments under multiple share-based payment arrangements shall provide the information specified in paragraph (a) through (f) separately for different types of awards (including nonemployee versus employee) to the extent that the differences in the characteristics of the awards make separate disclosure important to an understanding of the entity’s use of share-based compensation. For example, separate disclosure of weighted-average exercise prices (or conversion ratios) at the end of the year for options (or share units) with a fixed exercise price (or conversion ratio) and those with an indexed exercise price (or conversion ratio) could be important. It also could be important to segregate the number of options (or share units) not yet exercisable into those that will become exercisable (or convertible) based solely on fulfilling a service condition and those for which a performance condition must be met for the options (share units) to become exercisable (convertible). It could be equally important to provide separate disclosures for awards that are classified as equity and those classified as liabilities. In addition, an entity that has multiple share-based payment arrangements shall disclose information separately for different types of awards under those arrangements to the extent that differences in the characteristics of the awards make separate disclosure important to an understanding of the entity’s use of share-based compensation.
- For each year for which an income statement is presented, both of the following:
- Total compensation cost for share-based payment arrangements
- Recognized in income as well as the total recognized tax benefit related thereto
- Capitalized as part of the cost of an asset.
- A description of significant modifications, including:
- The terms of the modifications
- The number of grantees affected
- The total (or lack of) incremental compensation cost resulting from the modifications.
- As of the latest balance sheet date presented, the total compensation cost related to nonvested awards not yet recognized and the weighted-average period over which it is expected to be recognized
- Subparagraph superseded by Accounting Standards Update No. 2016-09
- If not separately disclosed elsewhere, the amount of cash used to settle equity instruments granted under share-based payment arrangements
- A description of the entity’s policy, if any, for issuing shares upon share option exercise (or share unit conversion), including the source of those shares (that is, new shares or treasury shares). If as a result of its policy, an entity expects to repurchase shares in the following annual period, the entity shall disclose an estimate of the amount (or a range, if more appropriate) of shares to be repurchased during that period.
- If not separately disclosed elsewhere, the policy for estimating expected forfeitures or recognizing forfeitures as they occur.
50-2A Another item of minimum information needed to achieve the objectives in paragraph 718-10-50-1 is the
following:
- If not separately disclosed elsewhere, the amount of cash received from exercise of share options and similar instruments granted under share-based payment arrangements and the tax benefit from stock options exercised during the annual period
50-3 Paragraph not used.
50-4 In addition to the information required by this Topic, an entity may disclose supplemental information
that it believes would be useful to investors and creditors, such as a range of values calculated on the basis
of different assumptions, provided that the supplemental information is reasonable and does not lessen
the prominence and credibility of the information required by this Topic. The alternative assumptions shall
be described to enable users of the financial statements to understand the basis for the supplemental
information.
13.3 Examples of Required Disclosures
ASC 718-10-55-134 through 55-137 contain examples that illustrate the disclosure requirements
described in ASC 718-10-50-1 through 50-2A (see Sections 13.1 and 13.2).
ASC 718-10
Example 9: Disclosure
55-134 This Example illustrates
disclosures (see paragraphs 718-10-50-1 through 50-2) of a
public entity’s share-based compensation arrangements. The
illustration assumes that compensation cost has been
recognized in accordance with this Topic for several years.
The amount of compensation cost recognized each year
includes both costs from that year’s grants and costs from
prior years’ grants. The number of options outstanding,
exercised, forfeited, or expired each year includes options
granted in prior years. Although this Example focuses on
employee share-based payment plans, the disclosures are
equally applicable to share-based payment awards issued to
nonemployees. An entity should refer to the guidance in
paragraph 718-10-50-2(g) when evaluating whether separate
disclosure of nonemployee share-based payment awards is
warranted.
55-135 On December 31, 20Y1,
the Entity has two share-based compensation plans: The
compensation cost that has been charged against income for
those plans was $29.4 million, $28.7 million, and $23.3
million for 20Y1, 20Y0, and 20X9, respectively. The total
income tax benefit recognized in the income statement for
share-based compensation arrangements was $10.3 million,
$10.1 million, and $8.2 million for 20Y1, 20Y0, and 20X9,
respectively. Compensation cost capitalized as part of
inventory and fixed assets for 20Y1, 20Y0, and 20X9 was $0.5
million, $0.2 million, and $0.4 million, respectively.
Case A: Share Option Plan
55-136 The following
illustrates disclosure for a share option plan.
The Entity’s 20X4 employee share option plan, which is shareholder-approved, permits the grant of
share options and shares to its employees for up to 8 million shares of common stock. Entity A believes
that such awards better align the interests of its employees with those of its shareholders. Option
awards are generally granted with an exercise price equal to the market price of Entity A’s stock at the
date of grant; those option awards generally vest based on 5 years of continuous service and have 10-
year contractual terms. Share awards generally vest over five years. Certain option and share awards
provide for accelerated vesting if there is a change in control (as defined in the employee share option
plan).
The fair value of each option award is estimated on the date of grant using a lattice-based option
valuation model that uses the assumptions noted in the following table. Because lattice-based option
valuation models incorporate ranges of assumptions for inputs, those ranges are disclosed. Expected
volatilities are based on implied volatilities from traded options on Entity A’s stock, historical volatility of
Entity A’s stock, and other factors. Entity A uses historical data to estimate option exercise and employee
termination within the valuation model; separate groups of employees that have similar historical
exercise behavior are considered separately for valuation purposes. The expected term of options
granted is derived from the output of the option valuation model and represents the period of time that
options granted are expected to be outstanding; the range given below results from certain groups of
employees exhibiting different behavior. The risk-free rate for periods within the contractual life of the
option is based on the U.S. Treasury yield curve in effect at the time of grant.
A summary of option activity under the employee share option plan as of December 31, 20Y1, and
changes during the year then ended is presented below.
The weighted-average grant-date fair value of options granted during the years 20Y1, 20Y0, and 20X9
was $19.57, $17.46, and $15.90, respectively. The total intrinsic value of options exercised during the
years ended December 31, 20Y1, 20Y0, and 20X9, was $25.2 million, $20.9 million, and $18.1 million,
respectively.
A summary of the status of Entity A’s nonvested shares as of December 31, 20Y1, and changes during
the year ended December 31, 20Y1, is presented below.
As of December 31, 20Y1, there was $25.9 million of total unrecognized compensation cost related to
nonvested share-based compensation arrangements granted under the employee share option plan.
That cost is expected to be recognized over a weighted-average period of 4.9 years. The total fair value
of shares vested during the years ended December 31, 20Y1, 20Y0, and 20X9, was $22.8 million, $21
million, and $20.7 million, respectively.
During 20Y1, Entity A extended the contractual life of 200,000 fully vested share options held by 10
employees. As a result of that modification, the Entity recognized additional compensation expense of
$1.0 million for the year ended December 31, 20Y1.
Case B: Performance Share Option Plan
55-137 The following
illustrates disclosure for a performance share option
plan.
Under its 20X7 performance share option plan, which is
shareholder-approved, each January 1 Entity A grants
selected executives and other key employees share option
awards whose vesting is contingent upon meeting various
departmental and company-wide performance goals, including
decreasing time to market for new products, revenue growth
in excess of an index of competitors’ revenue growth, and
sales targets for Segment X. Share options under the
performance share option plan are generally granted
at-the-money, contingently vest over a period of 1 to 5
years, depending on the nature of the performance goal, and
have contractual lives of 7 to 10 years. The number of
shares subject to options available for issuance under this
plan cannot exceed 5 million.
The fair value of each option grant under the performance
share option plan was estimated on the date of grant using
the same option valuation model used for options granted
under the employee share option plan and assumes that
performance goals will be achieved. If such goals are not
met, no compensation cost is recognized and any recognized
compensation cost is reversed. The inputs for expected
volatility, expected dividends, and risk-free rate used in
estimating those options’ fair value are the same as those
noted in the table related to options issued under the
employee share option plan. The expected term for options
granted under the performance share option plan in 20Y1,
20Y0, and 20X9 is 3.3 to 5.4 years, 2.4 to 6.5 years, and
2.5 to 5.3 years, respectively.
A summary of the activity under the performance share
option plan as of December 31, 20Y1, and changes during the
year then ended is presented below.
The weighted-average grant-date fair value of options
granted during the years 20Y1, 20Y0, and 20X9 was $17.32,
$16.05, and $14.25, respectively. The total intrinsic value
of options exercised during the years ended December 31,
20Y1, 20Y0, and 20X9, was $5 million, $8 million, and $3
million, respectively. As of December 31, 20Y1, there was
$16.9 million of total unrecognized compensation cost
related to nonvested share-based compensation arrangements
granted under the performance share option plan; that cost
is expected to be recognized over a period of 4 years.
Cash received from option exercise under all share-based
payment arrangements for the years ended December 31, 20Y1,
20Y0, and 20X9, was $32.4 million, $28.9 million, and $18.9
million, respectively. The actual tax benefit for the tax
deductions from option exercise of the share-based payment
arrangements totaled $11.3 million, $10.1 million, and $6.6
million, respectively, for the years ended December 31,
20Y1, 20Y0, and 20X9.
Entity A has a policy of repurchasing shares on the open
market to satisfy share option exercises and expects to
repurchase approximately 1 million shares during 20Y2, based
on estimates of option exercises for that period.
13.4 Interim Reporting
ASC 270-10
Accounting Principles and Practices
45-1 Interim financial information is essential to provide investors and others with timely information as to the
progress of the entity. The usefulness of such information rests on the relationship that it has to the annual
results of operations. Accordingly, each interim period should be viewed primarily as an integral part of an
annual period.
Disclosure of Summarized Interim Financial Data by Publicly Traded Companies
50-1 Many publicly traded companies report summarized financial information at periodic interim dates in
considerably less detail than that provided in annual financial statements. While this information provides
more timely information than would result if complete financial statements were issued at the end of each
interim period, the timeliness of presentation may be partially offset by a reduction in detail in the information
provided. As a result, certain guides as to minimum disclosure are desirable. (It should be recognized that
the minimum disclosures of summarized interim financial data required of publicly traded companies do
not constitute a fair presentation of financial position and results of operations in conformity with generally
accepted accounting principles [GAAP].) If publicly traded companies report summarized financial information
at interim dates (including reports on fourth quarters), the following data should be reported, as a minimum: . . .
g. Changes in accounting principles or changes in accounting estimates (see paragraphs 270-10-45-12
through 45-16)
h. Significant changes in financial position (see paragraph 270-10-50-4) . . . .
50-2 If interim financial data and disclosures are not separately reported for the fourth quarter, users of the
interim financial information often make inferences about that quarter by subtracting data based on the third
quarter interim report from the annual results. In the absence of a separate fourth quarter report or disclosure
of the results (as outlined in the preceding paragraph) for that quarter in the annual report, disposals of
components of an entity and unusual or infrequently occurring items recognized in the fourth quarter, as well
as the aggregate effect of year-end adjustments that are material to the results of that quarter (see paragraphs
270-10-05-2 and 270-10-45-10) shall be disclosed in the annual report in a note to the annual financial
statements. If a publicly traded company that regularly reports interim information makes an accounting
change during the fourth quarter of its fiscal year and does not report the data specified by the preceding
paragraph in a separate fourth quarter report or in its annual report, the disclosures about the effect of the
accounting change on interim periods that are required by paragraphs 270-10-45-12 through 45-14 or by
paragraph 250-10-45-15, as appropriate, shall be made in a note to the annual financial statements for the
fiscal year in which the change is made.
50-3 Disclosure of the impact of the financial results for interim periods of the matters discussed in paragraphs
270-10-45-12 through 45-16 and 270-10-50-5 through 50-6 is desirable for as many subsequent periods as
necessary to keep the reader fully informed. There is a presumption that users of summarized interim financial
data will have read the latest published annual report, including the financial disclosures required by generally
accepted accounting principles (GAAP) and management’s commentary concerning the annual financial
results, and that the summarized interim data will be viewed in that context. In this connection, management
is encouraged to provide commentary relating to the effects of significant events upon the interim financial
results.
50-4 Publicly traded companies are encouraged to publish balance sheet and cash flow data at interim dates
since these data often assist users of the interim financial information in their understanding and interpretation
of the income data reported. If condensed interim balance sheet information or cash flow data are not
presented at interim reporting dates, significant changes since the last reporting period with respect to liquid
assets, net working capital, long-term liabilities, or stockholders’ equity shall be disclosed.
ASC 718-10-50-1 states that the disclosure requirements for annual periods (see Sections 13.1 and
13.2) are not required for interim periods. In addition, ASC 718 does not specify the requirements for share-based compensation disclosures in interim financial statements. However, paragraph B239 of the Basis for Conclusions of FASB Statement 123(R) refers to the requirements for disclosing “information about changes in accounting principles or estimates and significant changes in financial position,” which were codified in ASC 270-10-50-1.
Paragraph B239 of Statement 123(R) also notes that when “share-based
compensation cost is significant [registrants] may
wish to provide additional information, including
the total amount of that cost, on a quarterly
basis.” This may apply to registrants that grant a
substantial portion of their share-based payment
awards at a single time each year.
In addition, SEC Regulation S-X, Rule 10-01(a)(5), requires registrants to
disclose in their quarterly financial statements information that is “sufficient so
as to make the interim information presented not misleading.” When assessing the
volume and type of information to be disclosed in quarterly financial statements,
registrants should consider factors such as the amount and timing of grants of
share-based payment awards, material modifications to existing share-based payment
awards, material share repurchases, material changes in assumptions used in the
valuation of awards, and material changes to the type of awards issued.
13.5 Subsidiary Disclosures
SEC Staff Accounting Bulletins
SAB Topic 1.B.1, Allocation of Expenses and
Related Disclosure in Financial Statements of Subsidiaries,
Divisions or Lesser Business Components of Another Entity:
Costs Reflected in Historical Income Statements [Excerpt;
Reproduced in ASC 220-10-S99-3]
Facts: A company
(the registrant) operates as a subsidiary of another company
(parent). Certain expenses incurred by the parent on behalf
of the subsidiary have not been charged to the subsidiary in
the past. The subsidiary files a registration statement
under the Securities Act of 1933 in connection with an
initial public offering.
Question 1: Should
the subsidiary’s historical income statements reflect all of
the expenses that the parent incurred on its behalf?
Interpretive
Response: In general, the staff believes that the
historical income statements of a registrant should reflect
all of its costs of doing business. Therefore, in specific
situations, the staff has required the subsidiary to revise
its financial statements to include certain expenses
incurred by the parent on its behalf. Examples of such
expenses may include, but are not necessarily limited to,
the following (income taxes and interest are discussed
separately below):
-
Officer and employee salaries,
-
Rent or depreciation,
-
Advertising,
-
Accounting and legal services, and
-
Other selling, general and administrative expenses.
When the subsidiary’s financial statements
have been previously reported on by independent accountants
and have been used other than for internal purposes, the
staff has accepted a presentation that shows income before
tax as previously reported, followed by adjustments for
expenses not previously allocated, income taxes, and
adjusted net income.
A subsidiary must comply with the disclosure requirements of ASC 718-10-50 in
its stand-alone financial statements. SAB Topic 1.B.1 notes that a registrant
(subsidiary) should reflect all the costs of doing business in the subsidiary’s
financial statements (to help financial statement users understand such costs). SAB
Topic 1.B.1 also requires a registrant to reflect expenses incurred by a parent on
behalf of its subsidiary in the historical financial statements of the subsidiary
and provides examples of such expenses.
In determining what to disclose in their stand-alone financial statements, subsidiaries (regardless of
whether they are SEC registrants) should apply the same requirement as that in SAB Topic 1.B.1. In
addition, subsidiaries’ disclosures should be similar to those of their parent.
13.6 Nonemployee Awards
The disclosure requirements in ASC 718-10-50-1 and 50-2 apply to nonemployee
awards. As noted in ASC 718-10-50-2(g), an entity must consider whether it should
provide the disclosures required by ASC 718-10-50-2(a)–(f) separately for employee
and nonemployee awards if the differences between the awards’ characteristics are
important to an investor’s understanding of them.
13.7 Change in Valuation Techniques
ASC 718-10
Consistent Use of Valuation Techniques and Methods for Selecting Assumptions
55-27 Assumptions used to estimate the fair value of equity and liability instruments granted in share-based payment transactions shall be determined in a consistent manner from period to period. For example, an entity might use the closing share price or the share price at another specified time as the current share price on the grant date in estimating fair value, but whichever method is selected, it shall be used consistently. The valuation technique an entity selects to estimate fair value for a particular type of instrument also shall be used consistently and shall not be changed unless a different valuation technique is expected to produce a better estimate of fair value. A change in either the valuation technique or the method of determining appropriate assumptions used in a valuation technique is a change in accounting estimate for purposes of applying Topic 250, and shall be applied prospectively to new awards.
SEC Staff Accounting Bulletins
SAB Topic 14.C, Valuation Methods
[Excerpt]
Question 3: In
subsequent periods, may a company change the valuation
technique or model chosen to value instruments with similar
characteristics?21
Interpretive
Response: As long as the new technique or model
meets the fair value measurement objective as described in
Question 2 above, the staff would not object to a company
changing its valuation technique or model.22 A
change in the valuation technique or model used to meet the
fair value measurement objective would not be considered a
change in accounting principle.23 As such, a
company would not be required to file a preferability letter
from its independent accountants as described in Rule
10-01(b)(6) of Regulation S-X when it changes valuation
techniques or models. However, the staff would not expect
that a company would frequently switch between valuation
techniques or models, particularly in circumstances where
there was no significant variation in the form of
share-based payments being valued. Disclosure in the
footnotes of the basis for any change in technique or model
would be appropriate.24
______________________________
21 FASB ASC paragraph
718-10-55-17 indicates that an entity may use different
valuation techniques or models for instruments with
different characteristics.
22 The staff believes that a
company should take into account the reason for the change
in technique or model in determining whether the new
technique or model meets the fair value measurement
objective. For example, changing a technique or model from
period to period for the sole purpose of lowering the fair
value estimate of a share option would not meet the fair
value measurement objective of the Topic.
23 FASB ASC paragraph 718-10-55-27.
24
See generally FASB ASC paragraph 718-10-50-1.
ASC 718-10-55-27 states, in part, that the “valuation technique an entity
selects . . . shall be used consistently and shall not be changed unless a different
valuation technique is expected to produce a better estimate of fair value.” It also
states that a change in valuation technique should be accounted for as a change in
accounting estimate under ASC 250 and applied prospectively to new awards. In
addition, Question 3 of SAB Topic 14.C states that the SEC staff would not object to
a change in an entity’s valuation technique or model as long as the new technique or
model meets the fair value measurement objective of ASC 718.
ASC 250-10-50-5 indicates that entities do not need to disclose the information required by ASC 250-10-
50-4 for a change in estimate that results from a change in valuation technique. However, SAB Topic
14.C states that for a share-based payment award, “[d]isclosure in the footnotes of the basis for any
change in technique or model would be appropriate.” Accordingly, entities are encouraged to disclose
the basis for a change in their technique for valuing share-based payment awards. In addition, SEC
registrants may consider additional disclosures in MD&A if the change in estimate materially affected the
entity’s results of operations.
13.8 Transition From Nonpublic to Public Entity Status
Question 4 of SAB Topic 14.B discusses the SEC staff’s views on the disclosure
requirements for share-based payment awards during an entity’s transition from
nonpublic to public entity status (e.g., when filing its initial registration
statement with the SEC).
SEC Staff Accounting Bulletins
SAB Topic 14.B, Transition From Nonpublic to
Public Entity Status [Excerpt]
Facts: Company A is
a nonpublic entity4 that first files a
registration statement with the SEC to register its equity
securities for sale in a public market on January 2, 20X8.
As a nonpublic entity, Company A had been assigning value to
its share options5 under the calculated value
method prescribed by FASB ASC Topic 718, Compensation —
Stock Compensation,6 and had elected to measure
its liability awards based on intrinsic value. Company A is
considered a public entity on January 2, 20X8 when it makes
its initial filing with the SEC in preparation for the sale
of its shares in a public market. . . .
Question 4: Upon
becoming a public entity, what disclosures should Company A
consider in addition to those prescribed by FASB ASC Topic
718?13
Interpretive
Response: In the registration statement filed on
January 2, 20X8, Company A should clearly describe in
MD&A the change in accounting policy that will be
required by FASB ASC Topic 718 in subsequent periods and the
reasonably likely material future effects.14 In
subsequent filings, Company A should provide financial
statement disclosure of the effects of the changes in
accounting policy. In addition, Company A should consider
the requirements of Item 303(b)(3) of Regulation S-K
regarding critical accounting estimates in MD&A.
______________________________
4 Defined in the FASB ASC Master
Glossary.
5 For purposes of this staff
accounting bulletin, the phrase “share options” is used to
refer to “share options or similar instruments.”
6 FASB ASC paragraph 718-10-30-20
requires a nonpublic entity to use the calculated value
method when it is not able to reasonably estimate the fair
value of its equity share options and similar instruments
because it is not practicable for it to estimate the
expected volatility of its share price. FASB ASC paragraph
718-10-55-51 indicates that a nonpublic entity may be able
to identify similar public entities for which share or
option price information is available and may consider the
historical, expected, or implied volatility of those
entities’ share prices in estimating expected volatility.
The staff would expect an entity that becomes a public
entity and had previously measured its share options under
the calculated value method to be able to support its
previous decision to use calculated value and to provide the
disclosures required by FASB ASC subparagraph
718-10-50-2(f)(2)(ii).
13 FASB ASC Section
718-10-50.
14
See Item 303 of Regulation S-K.
SEC Financial Reporting Manual
9520 Share-Based
Compensation in IPOs
9520.1 Estimates
used to determine share-based compensation are often
considered critical by companies going public. In
particular, estimating the fair value of the underlying
shares can be highly complex and subjective because the
shares are not publicly traded. The staff will consider if a
company performing these estimates is providing the
following critical accounting estimate disclosures in its
IPO prospectus:
- The methods that management used to determine the fair value of the company’s shares and the nature of the material assumptions involved. For example, companies using the income approach should disclose that this method involves estimating future cash flows and discounting those cash flows at an appropriate rate.
- The extent to which the estimates are considered highly complex and subjective.
- The estimates will not be necessary to determine the fair value of new awards once the underlying shares begin trading.
Companies may cross-reference to the extent that this, or
other material information relevant to share-based
compensation, is provided elsewhere in the prospectus.
9520.2 The staff may issue comments
asking companies to explain the reasons for valuations that
appear unusual (e.g., unusually steep increases in the fair
value of the underlying shares leading up to the IPO). These
comments are intended to elicit analyses that the staff can
review to assist it in confirming the appropriate accounting
for the share-based compensation, not for the purpose of
requesting changes to disclosure in the MD&A or
elsewhere in the prospectus.
9520.3 The staff will also consider
other MD&A requirements related to share-based
compensation, including known trends or uncertainties
including, but not limited to, the expected impact on
operating results and taxes.
Typically, a registrant undergoing an IPO of its equity securities identifies share-based compensation
as a critical accounting estimate because the lack of a public market for the pre-IPO shares makes the
estimation process complex and subjective.
Further, paragraph
7520.1 of the FRM outlines considerations related to the
“estimated fair value of [stock that] is substantially below the IPO price” (often
referred to as “cheap stock”). Registrants should be able to reconcile the change in
the estimated fair value of the underlying equity between the award grant date and
the IPO by taking into account, among other things, intervening events and changes
in assumptions that support the change in fair value.
The SEC staff had historically asked registrants to expand the disclosures in their critical accounting
estimates to add information about the valuation methods and assumptions used for share-based
compensation in an IPO. In 2014, however, it updated Section 9520 of the FRM to indicate that
registrants should significantly reduce, in the critical accounting estimates section of MD&A, their
disclosures about share-based compensation and the valuation of pre-IPO common stock. Nevertheless,
paragraph 9520.2 of the FRM notes that the SEC staff may continue to request that companies “explain
the reasons for valuations that appear unusual (e.g., unusually steep increases in the fair value of the
underlying shares leading up to the IPO).” Such requests are meant to ensure that a registrant’s analysis
and assessment support its accounting for share-based compensation; they do not necessarily indicate
that the registrant’s disclosures need to be enhanced.
At the Practising Law Institute’s “SEC Speaks in 2014” Conference, the SEC staff discussed the types of
detailed disclosures it had observed in IPO registration statements that had prompted the updates to
Section 9520 of the FRM. The staff noted that registrants have historically included:
- A table of equity instruments issued during the past 12 months.
- A description of the methods used to value the registrant’s pre-IPO common stock (i.e., income approach or market approach).
- Detailed disclosures about certain select assumptions used in the valuation.
- Discussion of changes in the fair value of the company’s pre-IPO common stock, which included each grant leading up to the IPO and resulted in repetitive disclosures.
The staff indicated that despite the volume of share-based compensation information included in IPO
filings, disclosures of such information were typically incomplete because registrants did not discuss all
assumptions related to their common stock valuations. Further, disclosures about registrants’ pre-IPO
common stock valuations were not relevant after an IPO and were generally removed from their
periodic filings after the IPO. The SEC staff expressed the view that in addition to reducing the volume of
information, streamlined share-based compensation disclosures also make reporting more meaningful.
The staff also indicated that by eliminating unnecessary information, registrants could reduce “down to
one paragraph” many of their prior disclosures.
At the conference, the SEC staff also provided insights into how registrants would be expected to apply
the guidance in paragraph 9520.1 of the FRM (and thereby reduce the share-based compensation
disclosures in their IPO registration statements):
- The staff does not expect much detail about the valuation method registrants used to determine the fair value of their pre-IPO shares. A registrant need only state that it used the income approach, the market approach, or a combination of both.Further, while registrants are expected to discuss the nature of the material assumptions they used, they would not be required to quantify such assumptions. For example, if a registrant used an income approach involving a discounted cash flow method, it would only need to provide a statement that a discounted cash flow method was used and involved cash flow projections that were discounted at an appropriate rate. No additional details would be needed.
- Registrants would have to include a statement indicating that the estimates in their share-based compensation valuations are highly complex and subjective but would not need to provide additional details about the estimates. Registrants would also need to include a statement disclosing that such valuations and estimates will no longer be necessary once the entity goes public because it will then rely on the market price to determine the fair value of its common stock.
The staff emphasized that its ultimate concern is whether registrants correctly
accounted for pre-IPO share-based compensation. Accordingly, the staff will continue
to ask them for supplemental information to support their valuations and accounting
conclusions — especially when the fair value of a company’s pre-IPO common stock is
significantly less than the expected IPO price.1 See Section
4.12.1 for additional considerations related to cheap stock.
Footnotes
1
At the conference, the SEC staff noted that valuations that
appear to be unusual may be attributable to the peer companies selected when
a market approach is used. Specifically, the staff indicated that there are
often inconsistencies between the peer companies used by registrants and
those used by the underwriters, which result in differences in the
valuations. Accordingly, the staff encouraged registrants to talk to the
underwriters “early and often” to avoid such inconsistencies.
13.9 MD&A Disclosures — Expected Volatility
Question 5 of SAB Topic 14.D.1 presents the SEC staff’s views on the disclosures about expected
volatility related to share-based payment awards that registrants would be expected to provide in their
financial statements and MD&A.
SEC Staff Accounting Bulletins
SAB Topic 14.D.1, Certain Assumptions Used
in Valuation Methods: Expected Volatility [Excerpt]
Facts: Company B is a public entity whose common
shares have been publicly traded for over twenty years.
Company B also has multiple options on its shares
outstanding that are traded on an exchange (“traded
options”). Company B grants share options on January 2,
20X6. . . .
Question 5: What disclosures would the staff expect
Company B to include in its financial statements and
MD&A regarding its assumption of expected
volatility?
Interpretive
Response: FASB ASC paragraph 718-10-50-2 prescribes
the minimum information needed to achieve the Topic’s
disclosure objectives.52 Under that guidance,
Company B is required to disclose the expected volatility
and the method used to estimate it.53
Accordingly, the staff expects that, at a minimum, Company B
would disclose in a footnote to its financial statements how
it determined the expected volatility assumption for
purposes of determining the fair value of its share options
in accordance with FASB ASC Topic 718. For example, at a
minimum, the staff would expect Company B to disclose
whether it used only implied volatility, historical
volatility, or a combination of both, and how it determined
any significant adjustments to historical volatility.
In addition, Company B should consider the
requirements of Regulation S-K Item 303(b)(3) regarding
critical accounting estimates in MD&A. A company should
determine whether its evaluation of any of the factors
listed in Questions 2 and 3 of this section, such as
consideration of future events in estimating expected
volatility, resulted in an estimate that involves a
significant level of estimation uncertainty and has had or
is reasonably likely to have a material impact on the
financial condition or results of operations of the
company.
______________________________
52 FASB ASC paragraph
718-10-50-1.
53 FASB ASC subparagraph
718-10-50-2(f)(2)(ii).
13.10 Disclosures of Spring-Loaded Awards
In November 2021, the SEC staff issued SAB
120, which amends SAB Topic 14.D and provides the SEC staff’s
views on the measurement and disclosure of certain share-based payment awards
granted when entities possess material nonpublic information (i.e., “spring-loaded”
awards).
SAB 120 describes a spring-loaded award as follows:
A share-based payment award granted when a company is in possession of
material nonpublic information to which the market is likely to react
positively when the information is announced is sometimes referred to as
being “spring-loaded.”
As amended by SAB 120, Question 2 of SAB Topic 14.D.3 provides the SEC staff’s views
on the disclosure expectation regarding spring-loaded awards:
Facts: Company D is a public company that entered into a material
contract with a customer after market close. Subsequent to entering into the
contract but before the market opens the next trading day, Company D awards
share options to its executives. The share option award is non-routine, and
the award is approved by the Board of Directors in contemplation of the
material contract. Company D expects the share price to increase
significantly once the announcement of the contract is made the next day.
Company D’s accounting policy is to consistently use the closing share price
on the day of the grant as the current share price in estimating the
grant-date fair value of share options. . . .
Question 2: What disclosures would the staff expect Company D to
include in its financial statements regarding its determination of the
current price of shares underlying newly-granted share options?
Interpretive Response: FASB ASC paragraph 718-10-50-1 requires
disclosure of information that enables users of the financial statements to
understand, among other things, the nature and terms of share-based payment
arrangements that existed during the period and the potential effects of
those arrangements on shareholders. FASB ASC paragraph 718-10-50-2
prescribes the minimum information needed to achieve the Topic’s disclosure
objectives, including a description of the method used and significant
assumptions used to estimate the fair value of awards under share-based
payment arrangements.
Accordingly, the staff expects that, at a minimum, Company D would disclose
in a footnote to its financial statements how it determined the current
price of shares underlying share options for purposes of determining the
grant-date fair value of its share options in accordance with FASB ASC Topic
718. For example, the staff would expect Company D to disclose its
accounting policy related to how it identifies when an adjustment to the
closing price is required, how it determined the amount of the adjustment to
the closing share price, and any significant assumptions used to determine
such adjustment, if material. Further, the characteristics of the share
options, including their spring-loaded nature, may differ from Company D’s
other share-based payment arrangements to such an extent Company D should
disclose information regarding these share options separately from other
share-based payment arrangements to allow investors to understand Company
D’s use of share-based compensation.
Additionally, Company D should consider the applicability of
MD&A and other disclosure requirements, including those related to
liquidity and capital resources, results of operations, critical accounting
estimates, executive compensation, and transactions with related persons.
[Footnotes omitted]
See Section 4.9.2.6 for additional information
related to spring-loaded awards.