2.11 Unrelated Entity Awards
ASC 815-10
Options Granted to Employees and Nonemployees
45-10 Subsequent changes in the fair value of an option that was granted to a grantee and is subject to or became subject to this Subtopic shall be included in the determination of net income. (See paragraphs 815-10-55-46 through 55-48A and 815-10-55-54 through 55-55 for discussion of such an option.) Changes in fair value of the option award before vesting shall be characterized as compensation cost in the grantor’s income statement. Changes in fair value of the option award after vesting may be reflected elsewhere in the grantor’s income statement.
Equity Options Issued to Employees and Nonemployees
55-46 Some entities issue stock options to grantees in which the underlying shares are stock of an unrelated entity. Consider the following example:
- Entity A awards an option to a grantee.
- The terms of the option award provide that, if the grantee continues to provide services to Entity A for 3 years, the grantee may exercise the option and purchase 1 share of common stock of Entity B, a publicly traded entity, for $10 from Entity A.
- Entity B is unrelated to Entity A and, therefore, is not a subsidiary or accounted for by the equity method.
55-47 The option award in this example is not within the scope of Topic 718 because the underlying stock is not an equity instrument of the grantor.
55-48 The option award is not subject to Topic 718. Rather, the option award in the example in paragraph 815-10-55-46 meets the definition of a derivative instrument in this Subtopic and, therefore, should be accounted for by the grantor as a derivative instrument under this Subtopic. After vesting, the option award would continue to be accounted for as a derivative instrument under this Subtopic.
Stock options that are indexed to and settled in shares of an unrelated,
publicly traded entity are outside the scope of ASC 718. Such options are recorded
at fair value5 as liabilities at inception, with changes in fair value recorded in earnings.
If the options are indexed to and settled in shares of an unrelated,
non-publicly-traded entity, the same accounting applies by analogy6 to ASC 815-10-45-10 and ASC 815-10-55-46 through 55-48. In addition, EITF
Issue 08-8 states, in part:
The SEC Observer reiterated the SEC
staff’s longstanding position that written options that do not qualify for
equity classification should be reported at fair value and subsequently marked
to fair value through earnings.
ASC 815-10-45-10 requires that the entire change in fair value of the stock options before vesting be immediately characterized as compensation cost; however, changes in fair value after vesting may be reflected elsewhere in the entity’s income statement. ASC 815-10-45-10 and ASC 815-10-55-46 through 55-48 do not provide guidance on accounting for the corresponding debit associated with recognition of the entire derivative liability that will be recorded as of the issuance date of the stock options. However, ASC 815-10-45-10 and ASC 815-10-55-46 through 55-48 imply that these stock options are considered compensation to grantees; therefore, the initial debit upon recording the stock options at fair value is a prepaid compensation asset, with attribution of the issuance-date fair value recognized over the requisite service period. The prepaid compensation asset is not adjusted for subsequent changes in the fair value of the stock options. That is, any changes made to the fair value after the initial measurement of the prepaid compensation asset will not be reflected as additional prepaid compensation but will instead be recognized immediately as an expense (either compensation cost for changes in the fair value of the award before vesting or classification as something other than compensation cost for changes in the fair value of the award after vesting), with a corresponding debit or credit to the derivative liability.
The guidance above also applies to restricted stock that is indexed to and settled in shares of an unrelated entity.
Example 2-6
On January 1, 20X1, Entity A issues restricted stock to an employee. The terms of the award indicate that if the employee remains employed by A for three years, the employee will receive 20 shares of common stock of Entity B, an unrelated publicly traded entity, from A. The fair value of the award on January 1, 20X1, and December 31, 20X1, was $300 and $325, respectively. The following journal entries reflect the accounting for the award:
Because instruments that are indexed to and settled in shares of an unrelated
entity and that are issued to grantees for goods or services are not within the
scope of ASC 718, entities are not permitted to account for forfeitures of these
instruments in accordance with the guidance on share-based payment awards in ASC
718. The likelihood that the grantees will forfeit the awards is factored into the
fair value measurement7 of such instruments at the end of each reporting period.
Example 2-7
On January 1, 20X1, Entity A issues restricted stock to an employee. The terms of the award indicate that if the employee remains employed by A for three years, the employee will receive 20 shares of common stock of Entity B, an unrelated publicly traded entity, from A. The fair value of the award on January 1, 20X1, and December 31, 20X1, was $300 and $325, respectively. On January 1, 20X2, the employee resigns and forfeits the award. The following journal entries reflect the accounting for the award:
Footnotes
5
Because the stock options are not within the scope of ASC
718, “fair value” in this context refers to fair value as determined in
accordance with ASC 820, not to fair-value-based measurement under ASC
718.
6
In this scenario, an entity should apply ASC 815-10-45-10
and ASC 815-10-55-46 through 55-48 to the stock options by analogy rather
than directly because the stock options involve an underlying that is a
non-publicly-traded share of an unrelated entity, while the stock options in
ASC 815-10-45-10 and ASC 815-10-55-46 through 55-48 involve an underlying
that is a publicly traded share of an unrelated entity (and that therefore
meets the definition of a derivative, since it can be net settled in
accordance with ASC 815-10-15-83). Often, option awards on
non-publicly-traded shares of an unrelated entity will not meet the net
settlement criteria of ASC 815-10-15-83 because of the lack of (1) explicit
net settlement, (2) a market mechanism to net settle the options, and (3)
delivery of shares that are readily convertible to cash (since the shares
are not publicly traded). However, because there is no specific guidance in
the accounting literature on accounting for stock options that are indexed
to and settled in shares of an unrelated non-publicly-traded entity, the
fair value accounting in ASC 815-10-45-10 and ASC 815-10-55-46 through 55-48
is appropriate by analogy (since the stock options are outside the scope of
ASC 718, as discussed above), even though they do not meet the definition of
a derivative in ASC 815.
7
Because the instruments are not within the scope of ASC 718,
“fair value” in this context refers to fair value as determined in
accordance with ASC 820, not to fair-value-based measurement under ASC
718.