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 value4 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 analogy5 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.

ASC 718 does not apply to instruments that are indexed to and settled in shares of an unrelated entity or issued to grantees for goods or services. Therefore, entities are not permitted to account for forfeitures of these instruments in accordance with such guidance. The likelihood that grantees will forfeit awards is factored into the fair value measurement6 of those instruments at the end of each reporting period in accordance with ASC 820.

In addition, an award may be settled in the equity of a nonconsolidated entity in which the grantor holds a noncontrolling ownership interest and thus may not be viewed as entirely “unrelated” to the grantor. Nevertheless, the award is not within the scope of ASC 718 because it is settled in equity instruments that are not those of the grantor. The discussion above also applies to restricted stock that is indexed to and settled in shares of an unrelated entity.

Example 2-8

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:

Example 2-9

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

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.

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.

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.

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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.