Chapter 14 — Accounting for Share-Based Payments Issued as Sales Incentives to Customers

14.4 Initial Measurement

ASC 606-10

32-25A Equity instruments granted by an entity in conjunction with selling goods or services shall be measured and classified under Topic 718 on stock compensation. The equity instrument shall be measured at the grant date in accordance with Topic 718 (for both equity-classified and liability-classified share-based payment awards). Changes in the measurement of the equity instrument (through the application of Topic 718) after the grant date that are due to the form of the consideration shall not be included in the transaction price. Any changes due to the form of the consideration shall be reflected elsewhere in the grantor’s income statement. See paragraphs 606-10-55-88A through 55-88B for implementation guidance on equity instruments granted as consideration payable to a customer.

Share-based sales incentives are reflected as a reduction in the transaction price on the basis of the grant-date fair-value-based measure in accordance with ASC 718 (for both equity-classified and liability-classified awards). In addition, share-based sales incentives may contain vesting conditions (i.e., service or performance conditions that must be satisfied for the customer to vest in an award) or conditions that affect factors other than the vesting of an award (i.e., market conditions, service or performance conditions that affect factors other than vesting or exercisability, or “other” conditions that do not meet the definition of a service, performance, or market condition). Both vesting and nonvesting conditions should be evaluated in accordance with ASC 718, which specifies that vesting conditions, unlike nonvesting conditions, are not directly factored into the fair-value-based measure of the award. Therefore, the amount recognized as a share-based sales incentive would (1) reflect the actual outcome of any vesting condition and (2) incorporate in its measurement any nonvesting conditions.

Connecting the Dots

An entity is required to use judgment when determining whether a vesting condition related to a share-based sales incentive is a service condition or a performance condition.

The recognition of a share-based sales incentive with a service condition that affects vesting will depend on the entity’s accounting policy for forfeitures of nonemployee share-based payment awards. For example, if the entity elects to estimate forfeitures, it bases its estimate of the share-based sales incentive on the probable outcome for both service and performance conditions. However, if the entity elects to recognize forfeitures when they occur, it reflects the entire share-based sales incentive with a service condition that affects vesting in the transaction price unless the award is forfeited.

Many share-based sales incentives include conditions that are tied to customer purchase levels (or to a customer’s remaining purchases for a specified period). We believe that such conditions are akin to service conditions.

Example 14-1

Share-Based Sales Incentive Issued for Each Purchase

On January 1, 20X1, Entity A executes a one-year master supply agreement (MSA) to sell and deliver widgets to Customer B. The MSA includes general terms and conditions but does not contain any minimum purchase requirements. Accordingly, legally enforceable rights and obligations associated with a revenue contract between A and B do not exist until B issues a purchase order for a specific number of widgets. In other words, the criteria in ASC 606-10-25-1 that must all be met for an entity to conclude that a contract with a customer exists are only met each time B issues a subsequent purchase order under the MSA.

Customer B agrees to pay A $1,000 for each widget purchased under the MSA. As a share-based sales incentive, A includes terms in the MSA that grant B 500 fully vested shares of A’s common stock for each widget that B purchases. The share-based sales incentive is not in exchange for distinct goods or services and is equity-classified in accordance with the guidance in ASC 718. Entity B issues three separate purchase orders, each for one widget, on January 31, March 1, and December 31, 20X1. On the same day on which A receives each purchase order, it transfers control of each widget to B and also issues to B 500 shares of A’s common stock in fulfillment of the terms of the MSA.

The fair value of A’s common stock is $1.00 per share on January 1, 20X1, and appreciates during 20X1 as follows:

Entity A concludes that the terms of the MSA are sufficient to establish a grant date for the share-based sales incentive in accordance with the guidance in ASC 718. Entity A measures the share-based sales incentive issued to B on January 1, 20X1, because a grant date exists for the share-based sales incentive in accordance with the criteria in ASC 718. For each separately sold widget, A will thus recognize revenue reduced by the grant-date fair-value-based measure of the share-based sales incentive of $500 (500 shares × $1.00), measured as of January 1, 20X1. Accordingly, A will recognize the following revenue during 20X1:

Entity A will classify the share-based sales incentive in accordance with the guidance in ASC 718. Likewise, A will continue to apply ASC 718 to classify and measure the share-based sales incentive unless it is subsequently modified when it vests and B is no longer a customer. Although there are changes to the fair-value-based measure of the common stock after the grant date, if the award remains within the scope of ASC 718 and is not modified, there is no accounting effect for those changes because the measurement date for an equity-classified award is the grant date.

Example 14-2

Share-Based Sales Incentive Contingent on Cumulative Purchases

Assume the same facts as in the example above except that Customer B will earn 1,000 shares of Entity A’s common stock when it purchases five widgets within one year of the MSA’s execution. Entity A concludes that the share-based sales incentive includes a service condition and applies its policy election under ASC 718-10-35-1D for nonemployee share-based payment awards to recognize forfeitures as they occur. Entity A calculates the reduction in transaction price as $1,000 (1,000 shares × $1 grant-date fair-value-based measure), which A will recognize with the related revenue. If at the end of 20X1 B has purchased five or more widgets, there is no effect on the total reduction in transaction price. By contrast, if at the end of 20X1 B has purchased fewer than five widgets and therefore forfeits the share-based sales incentive, A will reverse the portion of the $1,000 that it previously recorded as a reduction of revenue.

While vesting and nonvesting conditions are not subject to the variable consideration guidance in ASC 606, such guidance could still be applicable in certain circumstances. For example, an entity should apply ASC 606-10-32-7 and estimate the fair-value-based measure of an equity instrument before the grant date when a grant date has not been established but (1) the customer has a valid expectation that a share-based sales incentive will be issued (e.g., because of an entity’s history of issuing share-based sales incentives or its ongoing negotiations related to the issuance of a share-based sales incentive for which the terms of the equity instruments have not yet been finalized) or (2) other facts and circumstances indicate that the entity intends to issue a share-based sales incentive. In the period in which a grant date is established, the entity adjusts the transaction price for the cumulative effect of calculating the fair-value-based measure on the grant date. This treatment is similar to the accounting applied when the service inception date precedes the grant date for employee awards.2 For example, an entity could enter into a revenue contract with a customer for the purchase of goods or services while negotiating a share-based sales incentive with that customer. If a grant date has not been established for that award because the terms are still being negotiated, the entity would be required to estimate the fair-value-based measure of the award and reflect that estimate (or a portion of the estimate) as a reduction of the transaction price. That estimate will be adjusted in each reporting period until a grant date has been established.

Changing Lanes

At its June 12, 2024, meeting, the FASB commented on the current diversity in practice related to whether conditions in a share-based sales incentive that are tied to customer purchase levels (or to a customer’s remaining purchases for a specified period) should be treated as performance conditions or service conditions. The FASB tentatively decided to revise the definition of a performance condition to include conditions in share-based sales incentives that are tied to customer purchase levels. The Board also tentatively decided that the guidance on variable consideration in ASC 606 does apply to share-based sales incentives before a grant date has been established under ASC 718. The FASB is expected to include these tentative decisions in a forthcoming proposed ASU.

Footnotes

See Section 3.6.4.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.