Chapter 2 — Scope
Chapter 2 — Scope
2.1 General
ASC 718-10
Overall Guidance
15-1 The Scope Section of the Overall Subtopic establishes the pervasive scope for all Subtopics of the Compensation — Stock Compensation Topic. Unless explicitly addressed within specific Subtopics, the following scope guidance applies to all Subtopics of the Compensation — Stock Compensation Topic, with the exception of Subtopic 718-50, which has its own discrete scope.
Entities
15-2 The guidance in the Compensation — Stock Compensation Topic applies to all entities that enter into share-based payment transactions.
15-3 The guidance in the
Compensation — Stock Compensation Topic applies to all
share-based payment transactions in which a grantor acquires
goods or services to be used or consumed in the grantor’s
own operations or provides consideration payable to a
customer by issuing (or offering to issue) its shares, share
options, or other equity instruments or by incurring
liabilities to an employee or a nonemployee that meet either
of the following conditions:
-
The amounts are based, at least in part, on the price of the entity’s shares or other equity instruments. (The phrase at least in part is used because an award of share-based compensation may be indexed to both the price of an entity’s shares and something else that is neither the price of the entity’s shares nor a market, performance, or service condition.)
-
The awards require or may require settlement by issuing the entity’s equity shares or other equity instruments.
Pending Content (Transition
Guidance: ASC 718-10-65-17)
15-3
The guidance in the Compensation — Stock
Compensation Topic applies to all share-based
payment transactions in which a grantor acquires
goods or services to be used or consumed in the
grantor’s own operations or provides consideration
payable to a customer by either of the
following:
- Issuing (or offering to issue) its shares, share options, or other equity instruments to an employee or a nonemployee
- Incurring liabilities to an
employee or a nonemployee that meet either of the
following conditions:
- The amounts are based, at least in part, on the price of the entity’s shares or other equity instruments. (The phrase at least in part is used because an award of share-based compensation may be indexed to both the price of an entity’s shares and something else that is neither the price of the entity’s shares nor a market, performance, or service condition.)
- The awards require or may require settlement by issuing the entity’s equity shares or other equity instruments.
15-3A
Paragraphs 323-10-25-3 through 25-5 provide guidance on
accounting for share-based compensation granted by an
investor to employees or nonemployees of an equity method
investee that provide goods or services to the investee that
are used or consumed in the investee’s operations.
Pending Content (Transition Guidance: ASC
718-10-65-17)
15-3B An entity shall apply the guidance
in paragraph 718-10-15-3 to determine whether a
profits interest or similar award is within the
scope of this Topic. Paragraphs 718-10-55-138
through 55-148 illustrate how the guidance in
paragraph 718-10-15-3 applies to common features
in a profits interest or similar award.
15-5 The guidance in this Topic
does not apply to transactions involving share-based payment
awards granted to a lender or an investor that provides
financing to the issuer. However, see paragraphs
815-40-35-14 through 35-15, 815-40-35-18, 815-40-55-49, and
815-40-55-52 for guidance on an issuer’s accounting for
modifications or exchanges of written call options to
compensate grantees.
- Subparagraph superseded by Accounting Standards Update No. 2018-07.
- Subparagraph superseded by Accounting Standards Update No. 2019-08.
- Subparagraph superseded by Accounting Standards Update No. 2019-08.
15-5A Share-based payment
awards granted to a customer shall be measured and
classified in accordance with the guidance in this Topic
(see paragraph 606-10-32-25A) and reflected as a reduction
of the transaction price and, therefore, of revenue in
accordance with paragraph 606-10-32-25 unless the
consideration is in exchange for a distinct good or service.
If share-based payment awards are granted to a customer as
payment for a distinct good or service from the customer,
then an entity shall apply the guidance in paragraph
606-10-32-26.
15-6 Paragraphs 805-30-30-9 through 30-13 provide guidance on determining whether share-based payment awards issued in a business combination are part of the consideration transferred in exchange for the acquiree, and therefore in the scope of Topic 805, or are for continued service to be recognized in the postcombination period in accordance with this Topic.
15-7 The guidance in the Overall Subtopic does not apply to equity instruments held by an employee stock ownership plan.
Pending Content (Transition
Guidance: ASC 805-60-65-1)
15-8
Paragraph 805-60-25-8 provides
guidance on determining whether share-based
payment awards issued by a joint venture upon
formation are part of the joint venture formation
transaction and, therefore, are within the scope
of Subtopic 805-60, or are for continued service
to be recognized in the postformation period in
accordance with this Topic.
ASC 718 applies to all transactions in which an entity receives goods or
services to be used or consumed in the entity’s own operations in exchange for
share-based instruments. In such transactions, an entity effectively “pays” grantees
in the form of share-based instruments for goods or services. Common examples of
share-based payment awards include stock options, SARs, restricted stock,1 and RSUs. Such awards also include liabilities incurred that (1) are indexed,
in part, to the price of the entity’s shares or other equity instruments or (2)
require or may require settlement by issuing the entity’s equity shares or other
equity instruments.
In addition, entities must apply ASC 718 to measure and classify
share-based payments that are issued as consideration payable to a customer and are
not in exchange for distinct goods or services (i.e., share-based consideration
payable to a customer). Because entities are also required to recognize share-based
consideration payable to a customer in accordance with ASC 606, the accounting for
such awards is unique. See Chapter
14 for additional information.
ASC 718 does not apply to share-based instruments issued
in exchange for cash or other assets (i.e., detachable warrants or similar
instruments issued in a financing transaction) because such instruments are not
issued in exchange for goods or services. Other share-based transactions, or aspects
of these transactions, that are not within the scope of ASC 7182 include:
-
Equity instruments issued as consideration in a business combination — ASC 718 does not address the accounting for equity instruments issued as consideration in a business combination. The measurement date for such equity instruments is described in ASC 805-30-30-7.ASC 805 also provides guidance on determining what portion of share-based payment awards exchanged in a business combination is (1) part of the consideration transferred in a business combination or (2) related to service to be recognized in the postcombination period and therefore is within the scope of ASC 718. ASC 805-20-30-21, ASC 805-30-30-9 through 30-13, ASC 805-30-55-6 through 55-13, ASC 805-30-55-17 through 55-35, ASC 805-740-25-10 and 25-11, and ASC 805-740-45-5 and 45-6 provide guidance on share-based payment awards exchanged in connection with a business combination. See Chapter 10 for additional information.
-
Options or warrants issued for cash or other than for goods or services — Financial instruments issued for cash or other financial instruments (i.e., other than for goods or services) are accounted for in accordance with the relevant literature on accounting for and reporting the issuance of financial instruments, such as ASC 815 and ASC 480.
-
Detachable options or warrants issued in a financing transaction — ASC 470-20 describes how an entity should account for detachable warrants, or similar instruments, issued in a financing transaction.
-
Share-based awards that are granted to employees or nonemployees and settled in shares of an unrelated entity — ASC 815-10-45-10 and ASC 815-10-55-46 through 55-48 describe the accounting for stock options that are issued to grantees and indexed to and settled in publicly traded shares of an unrelated entity. See Section 2.11 for more information about the accounting for awards that are issued to grantees and indexed to and settled in shares of an unrelated entity.
In accordance with ASU 2023-05, an entity that qualifies as either a
“joint venture” or a “corporate joint venture,” as defined in the ASC master
glossary, is required to apply a new basis of accounting upon the formation of the
joint venture. Accordingly, a joint venture or a corporate joint venture
(collectively, “joint ventures”) must initially measure its assets and liabilities
at fair value on the formation date. The ASU also provides guidance on the issuance
of equity interests by joint ventures upon formation and indicates that such
issuance would be excluded from the scope of ASC 718. The amendments in the ASU are
effective prospectively for all joint ventures formed on or after January 1, 2025,
with early adoption “permitted in any interim or annual period in which financial
statements have not yet been issued (or made available for issuance), either
prospectively or retrospectively.” Joint ventures that were formed before January 1,
2025, can “elect to apply the amendments retrospectively if [they have] sufficient
information.” For additional discussion of ASU 2023-05 and the accounting for joint
ventures, see Deloitte’s Roadmap Equity Method Investments and Joint Ventures.
Only share-based payment awards that are issued in exchange for goods or
services or issued as share-based consideration payable to a customer are within the
scope of ASC 718. Further, such awards must be settled (or may require settlement)
by issuing the entity’s equity shares or other equity instruments or they must be
indexed, at least in part, to the value of the entity’s equity shares or other
equity instruments. In this context, the word “indexed” indicates that the value the
grantee receives upon settlement of the award is, at least in part, determined on
the basis of the value of the entity’s equity. For instance, an entity may award a
cash-settled SAR that can only be settled in cash. In such circumstances, the amount
of cash the grantee receives upon settlement of the award is based on the
relationship of the market price of the entity’s equity shares to the exercise price
of the award; therefore, the award is considered indexed to the entity’s equity and
is within the scope of ASC 718.
Example 2-1
Entity A, a public entity, offers a long-term incentive plan (LTIP) to certain of its employees. At the beginning of each year, a target cash bonus based on a specific dollar amount is established for each employee. Each employee in the LTIP will receive a predetermined percentage of his or her target bonus at the end of three years on the basis of the total return on A’s stock price relative to that of its competitors over the three-year performance period. The return on A’s stock price is ranked with that of its competitors from the highest to the lowest performer. On the basis of A’s ranking, each employee will receive a percentage of his or her target bonus that increases or decreases as A’s ranking increases or decreases.
For example, at the beginning of the three-year performance period, A sets a target cash bonus of $100,000 for an employee. Entity A includes nine of its competitors in its peer group to establish a ranking. Depending on the ranking, the employee will receive a percentage that ranges from 0 percent to 200 percent of the target bonus. For instance, if A ranks first in stock price return, the employee will receive 200 percent of $100,000, or $200,000; if A ranks fifth, the employee will receive 100 percent of $100,000, or $100,000; and if A ranks tenth or last, the employee will not receive a bonus.
Because the bonus is settled only in cash, A’s obligation under the LTIP is
classified as a share-based liability. The liability is
based on the price of A’s shares. That is, the share-based
liability is based on the return on A’s stock price relative
to the returns on the stock prices of A’s competitors. While
the bonuses to be paid are not linearly correlated to the
return on A’s stock price, the amount of the bonus does
depend on the return on A’s stock price relative to that of
its competitors. Accordingly, the LTIP is within the scope
of, and therefore is accounted for in accordance with, ASC
718. Under ASC 718-30-35-3, A “shall measure a liability
award under a share-based payment arrangement based on the
award’s fair value remeasured at each reporting date until
the date of settlement.”
Informal discussions with the FASB staff support the conclusion that LTIPs can be within the scope of ASC 718.
If an award offers a grantee a fixed monetary amount that is settled in a variable number of an entity’s shares, the amount the grantee receives upon settlement of the award is not based on the value of the entity’s equity and therefore is not considered indexed to the entity’s own equity. However, the fixed monetary amount will be settled by issuing a variable number of the entity’s shares. Because the award is settled by issuing the entity’s own equity, the award is within the scope of ASC 718.
Example 2-2
An entity sets a bonus of $100,000 for its chief executive if the executive remains employed for a two-year period. The bonus will be settled by issuing enough equity shares whose value equals $100,000. Therefore, if the entity’s share price is $50 at the end of the second year, the entity will settle the bonus by issuing 2,000 ($100,000 bonus ÷ $50 share price) of the entity’s equity shares. This bonus award is within the scope of ASC 718 because it is settled by issuing the entity’s own equity.
ASC 718-10-20 defines share-based payment arrangements, in part, as follows:
The term shares [in ASC 718-10-15-3] includes various forms of ownership interest that may not take the legal form of securities (for example, partnership interests), as well as other interests, including those that are liabilities in substance but not in form. Equity shares refers only to shares that are accounted for as equity.
That is, the legal form of the entity’s award does not preclude it from being within the scope of ASC 718. In this context, the term “shares” broadly represents instruments that entitle the holder to share in the risks and rewards of the entity as an owner.
Example 2-3
Trust Unit Rights
An entity may grant its employees trust unit rights to purchase a unit in a unit
investment trust at a reduced exercise price. Upon exercise
of the unit right, the holder receives publicly traded trust
units, which are equal to fractional undivided interests in
the trust. The trust units are the only voting,
participating equity securities of the trust. The trust
structure is created to purchase and hold a fixed portfolio
of securities or other assets, which represent the “trust
portfolio.” The trust then distributes the income generated
from the portfolio to the holders of the trust units.
Therefore, owning a trust unit allows the holder to share in
the appreciation of the trust portfolio. Common examples of
this type of investment trust structure include mutual funds
and real estate investment trusts.
While the entity is offering to issue unit rights, which are not legal securities themselves, the rights entitle the holder to trust units. Although these trust units are not “shares” in the strictest sense, they provide the holder with the risks and rewards of the entity as an owner (e.g., voting rights). Accordingly, this arrangement is within the scope of ASC 718.
Example 2-4
Phantom Stock Plans
Under a typical phantom stock plan, an employee is granted a theoretical number
of units whose value is equal to the value of an equal
number of shares of the entity’s common stock. These units
are not legal securities themselves and usually are issued
only on a memorandum basis. Further, the units do not have
voting rights with the common stockholders. The value of
each phantom unit is based on the value of the entity’s
stock and, therefore, appreciates and depreciates on the
basis of fluctuations in the value of the entity’s
stock.
Phantom stock unit holders do not have the same rights as common stockholders
(i.e., voting rights), and phantom stock units are generally
cash settled. Thus, such units represent an incurred
liability that is indexed to the entity’s equity and is
within the scope of ASC 718.
Footnotes
1
ASC 718 refers to restricted stock (and RSUs) as nonvested
shares (and nonvested share units).
2
ESOPs are within the scope of ASC 718-40 and are not covered
in this Roadmap. ASC 718-10-20 defines an ESOP as “an employee benefit plan
that is described by the Employee Retirement Income Security Act of 1974 and
the Internal Revenue Code of 1986 as a stock bonus plan, or combination
stock bonus and money purchase pension plan, designed to invest primarily in
employer stock. Also called an employee share ownership plan.” Entities
should continue to account for ESOPs in accordance with ASC 718-40 or SOP
76-3. Although SOP 76-3 was not included in the Codification, entities may
continue to apply it to shares acquired by ESOPs on or before December 31,
1992.
2.2 Definition of Employee
ASC 718-10 — Glossary
Employee
An individual over whom the grantor of a share-based compensation award exercises or has the right to exercise sufficient control to establish an employer-employee relationship based on common law as illustrated in case law and currently under U.S. Internal Revenue Service (IRS) Revenue Ruling 87-41. A reporting entity based in a foreign jurisdiction would determine whether an employee-employer relationship exists based on the pertinent laws of that jurisdiction. Accordingly, a grantee meets the definition of an employee if the grantor consistently represents that individual to be an employee under common law. The definition of an employee for payroll tax purposes under the U.S. Internal Revenue Code includes common law employees. Accordingly, a grantor that classifies a grantee potentially subject to U.S. payroll taxes as an employee also must represent that individual as an employee for payroll tax purposes (unless the grantee is a leased employee as described below). A grantee does not meet the definition of an employee solely because the grantor represents that individual as an employee for some, but not all, purposes. For example, a requirement or decision to classify a grantee as an employee for U.S. payroll tax purposes does not, by itself, indicate that the grantee is an employee because the grantee also must be an employee of the grantor under common law.
A leased individual is deemed to be an employee of the lessee if all of the following requirements are met:
- The leased individual qualifies as a common law employee of the lessee, and the lessor is contractually required to remit payroll taxes on the compensation paid to the leased individual for the services provided to the lessee.
- The lessor and lessee agree in writing to all of the following conditions related to the leased individual:
- The lessee has the exclusive right to grant stock compensation to the individual for the employee service to the lessee.
- The lessee has a right to hire, fire, and control the activities of the individual. (The lessor also may have that right.)
- The lessee has the exclusive right to determine the economic value of the services performed by the individual (including wages and the number of units and value of stock compensation granted).
- The individual has the ability to participate in the lessee’s employee benefit plans, if any, on the same basis as other comparable employees of the lessee.
- The lessee agrees to and remits to the lessor funds sufficient to cover the complete compensation, including all payroll taxes, of the individual on or before a contractually agreed upon date or dates.
A nonemployee director does not satisfy this definition of employee. Nevertheless, nonemployee directors acting in their role as members of a board of directors are treated as employees if those directors were elected by the employer’s shareholders or appointed to a board position that will be filled by shareholder election when the existing term expires. However, that requirement applies only to awards granted to nonemployee directors for their services as directors. Awards granted to those individuals for other services shall be accounted for as awards to nonemployees.
Pending Content (Transition Guidance: ASC
220-40-65-1)
Employee
An individual over whom a reporting entity
exercises or has the right to exercise sufficient
control to establish an employer-employee
relationship based on common law as illustrated in
case law and currently under U.S. Internal Revenue
Service (IRS) Revenue Ruling 87-41. A reporting
entity based in a foreign jurisdiction would
determine whether an employee-employer
relationship exists based on the pertinent laws of
that jurisdiction. Accordingly, an individual
meets the definition of an employee if the
reporting entity consistently represents that
individual to be an employee under common law. The
definition of an employee for payroll tax purposes
under the U.S. Internal Revenue Code includes
common law employees. Accordingly, a reporting
entity that classifies an individual potentially
subject to U.S. payroll taxes as an employee also
must represent that individual as an employee for
payroll tax purposes (unless the individual is a
leased employee as described below). An individual
that meets the definition of an employee includes,
but is not limited to, a full-time, part-time,
temporary, or seasonal employee. An individual
does not meet the definition of an employee solely
because the reporting entity represents that
individual as an employee for some, but not all,
purposes. For example, a requirement or decision
to classify an individual as an employee for U.S.
payroll tax purposes does not, by itself, indicate
that the individual is an employee because the
individual also must be an employee of the
reporting entity under common law.
A leased individual is deemed to be an employee
of the lessee if all of the following requirements
are met:
-
The leased individual qualifies as a common law employee of the lessee, and the lessor is contractually required to remit payroll taxes on the compensation paid to the leased individual for the services provided to the lessee.
-
The lessor and lessee agree in writing to all of the following conditions related to the leased individual:
-
The lessee has the exclusive right to grant compensation to the individual for the employee service to the lessee.
-
The lessee has a right to hire, fire, and control the activities of the individual. (The lessor also may have that right.)
-
The lessee has the exclusive right to determine the economic value of the services performed by the individual (including wages and the number of units and value of stock compensation granted).
-
The individual has the ability to participate in the lessee's employee benefit plans, if any, on the same basis as other comparable employees of the lessee.
-
The lessee agrees to and remits to the lessor funds sufficient to cover the complete compensation, including all payroll taxes, of the individual on or before a contractually agreed upon date or dates.
-
A nonemployee director does not satisfy this
definition of employee. Nevertheless, nonemployee
directors acting in their role as members of a
board of directors are treated as employees if
those directors were elected by the employer's
shareholders or appointed to a board position that
will be filled by shareholder election when the
existing term expires. However, that requirement
applies only to awards and other compensation
granted to nonemployee directors for their
services as directors. Awards granted and
compensation paid to those individuals for other
services shall be accounted for as awards and
compensation to nonemployees.
ASC 718-10
Identifying an Employee of a Physician Practice Management Entity
55-85A A physician practice management entity shall determine whether an employee of the physician practice is considered an employee of the physician practice management entity for purposes of determining the method of accounting for that person’s share-based compensation as follows:
- An employee of a physician practice that is consolidated by the physician practice management entity shall be considered an employee of the physician practice management entity and its subsidiaries.
- An employee of a physician practice that is not consolidated by the physician practice management entity shall not be considered an employee of the physician practice management entity and its subsidiaries.
Determining whether a grantee meets the definition of an employee under ASC 718
is important for certain aspects of the accounting for a share-based payment award.
On the basis of an examination of cases and rules, the IRS issued Revenue Ruling
87-41, which establishes 20 criteria for determining whether an individual is an
employee under common law. The degree of importance of each criterion varies
depending on the context in which the services of an individual are performed. In
addition, the criteria are designed as guides to help an entity determine whether an
individual is an employee. An entity should ensure that the substance of an
arrangement is not obscured by attempts to achieve a particular employment status.
The criteria include the following:
-
Instructions — “A worker who is required to comply with other persons’ instructions about when, where, and how he or she is to work is ordinarily an employee. This control factor is present if the person or persons for whom the services are performed have the right to require compliance with instructions.”
-
Continuing relationship — “A continuing relationship between the worker and the person or persons for whom the services are performed indicates that an employer-employee relationship exists. A continuing relationship may exist where work is performed at frequently recurring although irregular intervals.”
-
Set hours of work — “The establishment of set hours of work by the person or persons for whom the services are performed is a factor indicating control.”
-
Hiring, supervising, and paying assistants — “If the person or persons for whom the services are performed hire, supervise, and pay assistants, that factor generally shows control over the workers on the job. However, if one worker hires, supervises, and pays the other assistants pursuant to a contract under which the worker agrees to provide materials and labor and under which the worker is responsible only for the attainment of a result, this factor indicates an independent contractor status.”
-
Working on the employer’s premises — “If the work is performed on the premises of the person or persons for whom the services are performed, that factor suggests control over the worker, especially if the work could be done elsewhere. . . . Work done off the premises of the person or persons receiving the services, such as at the office of the worker, indicates some freedom from control. However, this fact by itself does not mean that the worker is not an employee. The importance of this factor depends on the nature of the service involved and the extent to which an employer generally would require that employees perform such services on the employer’s premises. Control over the place of work is indicated when the person or persons for whom the services are performed have the right to compel the worker to travel a designated route, to canvass a territory within a certain time, or to work at specific places as required.”
-
Full-time employment requirement — “If the worker must devote substantially full time to the business of the person or persons for whom the services are performed, such person or persons have control over the amount of time the worker spends working and impliedly restrict the worker from doing other gainful work. An independent contractor on the other hand, is free to work when and for whom he or she chooses.”
-
Payment — “Payment by the hour, week, or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of paying a lump sum agreed upon as the cost of a job. Payment made by the job or on a straight commission generally indicates that the worker is an independent contractor.”
See IRS Revenue Ruling 87-41 for additional information about assessing whether an individual is an employee under common law.
2.2.1 Employees of Pass-Through Entities
The ASC master glossary defines share-based payment
arrangements, in part, as follows:
The term shares includes various forms of ownership
interest that may not take the legal form of securities (for example,
partnership interests), as well as other interests, including those that
are liabilities in substance but not in form. Equity shares refers only
to shares that are accounted for as equity.
Since the definition includes awards of pass-through entities
(e.g., partnerships, limited liabilities corporations or limited liability
partnerships), an individual is considered an employee of a pass-through entity
if the individual qualifies as an employee of the entity under common law. The
fact that a pass-through entity does not classify the grantee as an employee for
U.S. payroll tax purposes does not, by itself, indicate that the grantee is not
an employee for accounting purposes.
2.3 Nonemployee Directors
ASC 718-10
Example 2: Definition of Employee
55-89 This Example illustrates the evaluation as to whether an individual meets conditions to be considered an employee under the definition of that term used in this Topic.
55-90 This Topic defines employee as an individual over whom the grantor of a share-based compensation award exercises or has the right to exercise sufficient control to establish an employer-employee relationship based on common law as illustrated in case law and currently under U.S. Internal Revenue Service (IRS) Revenue Ruling 87-41. An example of whether that condition exists follows. Entity A issues options to members of its Advisory Board, which is separate and distinct from Entity A’s board of directors. Members of the Advisory Board are knowledgeable about Entity A’s industry and advise Entity A on matters such as policy development, strategic planning, and product development. The Advisory Board members are appointed for two-year terms and meet four times a year for one day, receiving a fixed number of options for services rendered at each meeting. Based on an evaluation of the relationship between Entity A and the Advisory Board members, Entity A concludes that the Advisory Board members do not meet the common law definition of employee. Accordingly, the awards to the Advisory Board members are accounted for as awards to nonemployees under the provisions of this Topic.
55-91 Nonemployee directors acting in their role as members of an entity’s board of directors shall be treated as employees if those directors were elected by the entity’s shareholders or appointed to a board position that will be filled by shareholder election when the existing term expires. However, that requirement applies only to awards granted to them for their services as directors. Awards granted to those individuals for other services shall be accounted for as awards to nonemployees in accordance with Section 505-50-25. Additionally, consolidated groups may have multiple boards of directors; this guidance applies only to either of the following:
- The nonemployee directors acting in their role as members of a parent entity’s board of directors
- Nonemployee members of a consolidated subsidiary’s board of directors to the extent that those members are elected by shareholders that are not controlled directly or indirectly by the parent or another member of the consolidated group.
Under an exception in ASC 718, a member of an entity’s board of directors who may not meet the common law definition of an employee may be treated as an employee if certain conditions are met.
2.3.1 Parent-Entity Directors
A nonemployee member of a parent entity’s board of directors is treated as an
employee if (1) the director was elected by the entity’s shareholders or (2) the
board position will be subject to shareholder election upon expiration of the
director’s term. (However, see ASC 718-10-55-90 for guidance on awards issued to
members of an advisory board.)
2.3.2 Subsidiary Directors
A nonemployee member of a subsidiary’s board of directors who is granted awards
is treated as an employee in the parent’s
consolidated financial statements if the
individual is granted awards for services as a
member of the parent company’s board of directors
(and meets one of the conditions described in ASC
718-10-55-91 [see the previous section]).
Further, nonemployee members of a consolidated subsidiary’s board of directors
that are granted awards for their director
services to the subsidiary are considered
employees under ASC 718 if they were elected by
minority shareholders who are not directly or
indirectly controlled by the parent or another
member of the consolidated group. Such awards are
accounted for under ASC 718 in the parent
company’s consolidated financial statements and in
the separate financial statements of the
subsidiary. If the directors were not elected by
minority shareholders of the subsidiary (i.e.,
they were elected by the controlling shareholders
or another member of the consolidated group), the
awards should be accounted for as nonemployee
awards under ASC 718 in the parent company’s
consolidated financial statements. However, if
they were elected by the subsidiary’s
shareholders, including controlling shareholders
of the consolidated group, the awards granted for
director services should be accounted for as
awards granted to employees under ASC 718 in the
separate financial statements of the
subsidiary.
2.4 Nonemployee Awards
While most of the guidance on share-based payments granted to nonemployees is
aligned with the requirements for share-based payments granted to employees, there
remain some differences, notably those related to the attribution of compensation
cost and an entity’s election to measure a nonemployee stock option award by using
the contractual term instead of the expected term. See Chapter 9 for additional information about
accounting for nonemployee awards.
Connecting the Dots
If a grantee’s employment status changes from employee to nonemployee, an
entity must consider whether the share-based payment award was modified as a
result of that change. For example, an employee may be granted an
equity-classified share-based payment award under which continued vesting in
the award is permitted notwithstanding a change in employment status (e.g.,
the award will vest as long as the grantee continues to provide services to
the entity, whether as an employee or as an independent contractor). Such an
award would not be modified in connection with the change in employment
status provided that the grantee continues to provide substantive services
to earn the award. The entity would continue to recognize the original
grant-date fair-value-based measure of the award and would recognize the
remaining cost in accordance with the nonemployee recognition guidance (see
Section 9.3.1).
However, an entity may grant an award whose original terms
prohibit the grantee from continuing to vest in the award after a change in
employment status. If the entity modifies such an award concurrently with a
change in employment status to permit continued vesting, that change to the
terms of the award represents a modification. Generally, this would result
in a Type III improbable-to-probable modification (see Section 6.3.3)
because the employee would not have otherwise provided the required service
under the original terms of the award. Accordingly, the modification-date
fair-value-based measure of the award would be recognized in accordance with
the nonemployee recognition guidance (see Section
9.3.1).
2.5 Economic Interest Holders
ASC 718-10
15-4 Share-based payments awarded to a grantee by a related party or other holder of an economic interest in the entity as compensation for goods or services provided to the reporting entity are share-based payment transactions to be accounted for under this Topic unless the transfer is clearly for a purpose other than compensation for goods or services to the reporting entity. The substance of such a transaction is that the economic interest holder makes a capital contribution to the reporting entity, and that entity makes a share-based payment to the grantee in exchange for services rendered or goods received. An example of a situation in which such a transfer is not compensation is a transfer to settle an obligation of the economic interest holder to the grantee that is unrelated to goods or services to be used or consumed in a grantor’s own operations.
ASC 718-10 — Glossary
Economic Interest in an Entity
Any type or form of pecuniary interest or arrangement that an entity could issue or be a party to, including equity securities; financial instruments with characteristics of equity, liabilities, or both; long-term debt and other debt-financing arrangements; leases; and contractual arrangements such as management contracts, service contracts, or intellectual property licenses.
An economic interest holder of a reporting entity may issue share-based payment awards in the reporting entity’s equity for goods or services provided to the reporting entity. If so, the reporting entity typically records the transaction as if it had issued the awards (with a corresponding capital contribution from the economic interest holder) since the entity benefits from the compensation paid to the grantees.
2.5.1 Investor Purchases of Shares From Grantees
On occasion, investors intending to acquire or increase their stake in a
nonpublic entity may purchase shares from the founders of the nonpublic entity
or other individuals who are also considered grantees. The presumption in such
transactions is that any consideration in excess of the fair value of the shares
is compensation paid to grantees. See Section 4.12.3.2 for more information.
2.5.2 Share-Based Payments in an Economic Interest Holder’s Equity
An economic interest holder may issue awards of its own equity to grantees that provide goods or services to a reporting entity (these can be employees of a reporting entity or nonemployees providing goods or services to a reporting entity). An economic interest holder could be, for example, a parent entity, another subsidiary of the parent (e.g., a sister subsidiary), an equity method investor, an unrelated investor, or a third party. If there are various ownership and legal entity structures (particularly partnerships and limited liability companies), it may be difficult for a reporting entity to determine whether the awards are subject to ASC 718 or other U.S. GAAP (e.g., ASC 323 or ASC 815). The determination of which guidance to apply could affect the awards’ classification, measurement, and recognition in the reporting entity’s financial statements as well as the required disclosures. Accordingly, the reporting entity should evaluate the following:
- Which legal entity is issuing the awards and whether the awards are indexed to or settled in that entity’s equity — For example, if awards are settled in the equity of an unrelated investor, they may not be share-based payments of the reporting entity that are accounted for under ASC 718.
- The economic substance of the legal entity issuing the awards — The evaluation should include whether the entity has other substantive (1) investments or operations (outside of its ownership in the reporting entity) and (2) investors. For example, if a legal entity that is an investor in the reporting entity grants awards to employees of the reporting entity but is created solely as a holding company (with no operations) by the reporting entity to issue awards to the reporting entity’s employees, the legal entity’s purpose may be to issue awards to employees that are effectively indexed to the reporting entity’s equity. In this circumstance, issuance of the awards may not be substantively different from the reporting entity’s issuance of equity to its employees. Accordingly, it may be appropriate to account for those awards under ASC 718. See Example 2-5.
- The legal entity’s relationship with the reporting entity — If the legal entity whose equity is the basis for the awards has economic substance other than to issue awards to the reporting entity’s employees or nonemployees, the accounting will depend on that entity’s relationship with the reporting entity. For a discussion of awards issued by an entity to providers of goods or services of another entity within a consolidated group, see Sections 2.8 and 2.9. For a discussion of awards issued by an equity method investor to providers of goods or services of its equity method investee, see Section 2.10.
- Whether the grantees are common law employees of the reporting entity — For example, if a parent entity grants awards of its equity to employees of an entity that is (1) unrelated to the subsidiary reporting entity (e.g., an unrelated management or advisory company) and (2) providing nonemployee services to the reporting entity, the awards may be subject to ASC 718. However, the accounting for nonemployee awards could be different under ASC 718 from that for employee awards (see Chapter 9).
- Whether the reporting entity has an obligation to settle the awards issued — For example, if the reporting entity has an obligation to settle awards granted to its employees or nonemployees in the equity of another entity that is not the reporting entity’s parent, the awards may not be subject to ASC 718. For a discussion of awards issued by a reporting entity that are settled in the equity of an unrelated entity, see Section 2.11.
Example 2-5
Entity C, the reporting entity, is a privately held limited liability company that is wholly owned by Entity B, a limited partnership and holding company with no operations or assets other than its investment in C. Entity B is controlled and consolidated by Entity A, a management company and the general partner, but B is also owned by other investors. The ownership interests are as follows:
- Entity A — 15%
- Other investors — 82%
- Entity D — 3%
Entity D was created by A as a holding company with no operations or assets
other than its investment in B (which also has no
operations or assets other than its investment in C).
Under this structure, recipients of the awards invest
through D (an upper-tier LLC) and remain employees at C
(the lower-tier LLC). Entity D obtained the 3 percent
ownership interest in B solely to grant equity awards
equivalent to its ownership interest in B to certain
employees of C for services provided to C. The
share-based payment awards will be settled in D’s
equity, which is a substantive class of equity that
derives its value entirely from the value of C.
Entity C determines that the equity issued by D is substantively equivalent to its own equity. That is, D’s equity derives its value exclusively from C as a result of D’s 3 percent ownership in B. Entity B’s equity, in turn, derives its value exclusively from B’s 100 percent ownership of C (B and D hold no other assets). Therefore, it is reasonable to conclude that the share-based payment awards issued by D to the employees of C should be accounted for in C’s financial statements under ASC 718 as C’s share-based payment awards since C’s employees effectively received share-based payment awards in C’s equity. That is, in substance and in accordance with ASC 718-10-15-4, D (the economic interest holder) made a capital contribution to C (the reporting entity), and C then made a share-based payment to its employees in exchange for services rendered.
Entity C should provide the disclosures required by ASC
718-10-50 in its stand-alone financial statements.
2.6 Profits Interests and Other Awards Issued by Pass-Through Entities
|
Nonpublic entities such as limited
partnerships, limited liability companies, or similar
pass-through entities may grant special classes of equity,
frequently in the form of “profits interests.” This may
include the grant of profits interests tied to carried
interest on a particular investment fund that an employee
manages or the grant of profits interests in a private
equity backed portfolio company. In many cases, a waterfall
calculation is used to determine the payout to the different
classes of shares or units. While arrangements vary, the
waterfall calculation often is performed to allocate
distributions and proceeds to the profits interests only
after specified amounts (e.g., multiple of invested capital
[MOIC]) or specified returns (e.g., internal rate of return
[IRR] on invested capital) are first allocated to the other
classes of equity. In addition, future profitability
threshold amounts or “hurdles” must be cleared before the
grantee receives distributions so that, for tax purposes on
the grant date, the award has zero liquidation value.
However, the award would have a fair value in accordance
with ASC 718. In certain cases, distributions on and
realization of value from profits interests are expected
only from the proceeds from a liquidity event such as a sale
or IPO of the entity, provided that the sale or IPO exceeds
a target hurdle rate.
|
While the legal and economic form of these awards can vary, they should be
accounted for on the basis of their substance. If an award has the characteristics
of an equity interest, it represents a substantive class of equity that is within
the scope of ASC 718; however, an award that is, in substance, a performance bonus
or a profit-sharing arrangement would be accounted for as such in accordance with
other U.S. GAAP (e.g., typically ASC 710 and ASC 450 for employee arrangements).
In a speech at the 2006 AICPA Conference on Current SEC and PCAOB
Developments, Joseph Ucuzoglu, then a professional accounting fellow in the SEC’s
Office of the Chief Accountant, discussed observations of the SEC staff related to
special classes of equity and associated financial reporting considerations. He
stated that in determining whether an instrument is a “substantive class of equity
for accounting purposes, or is instead similar to a performance bonus or profit
sharing arrangement,” an entity must “look through” its legal form. He also
indicated that “when making this determination, all relevant features of the special
class must be considered [and that there] are no bright lines or litmus tests.”
Mr. Ucuzoglu further noted that Issues 28 and 40 of EITF Issue 00-23 “provided guidance on the accounting . . . for certain of these arrangements.” Although FASB Statement 123(R) (codified in ASC 718) superseded and nullified such guidance, we
believe that some of the indicators identified within this guidance are still
relevant and may be useful in the determination of whether profits interests
represent a substantive class of equity within the scope of ASC 718-10-15-3(a).
Those indicators, as well as others, include:
- The legal form of the instrument (a profits interest can only be a substantive class of equity if it is legal form equity).
- Distribution rights, particularly after vesting.
- Claims to the residual assets of the entity upon liquidation.
- Substantive net assets underlying the interest.
- Retention of vested interests upon termination.
- Any investment required to purchase the shares or units.
- An entity’s intent in issuing the interest (i.e., whether the entity is attempting to align the holder’s interests with those of other substantive equity holders).
- Provisions for realization of value.
- Repurchase features that may affect exposure to risks and rewards.
A key focus in the determination of whether profits interests represent a
substantive class of equity is the ability to retain residual interests upon
vesting, including after termination. This includes the ability to realize value
that is tied to the underlying value of the entity’s net assets, through
distributions that are based on an entity’s profitability and operations as well as
on any liquidity event (even if through a lower level of waterfall distributions).
By contrast, in a profit-sharing arrangement, a grantee typically is only able to
participate in the entity’s profits while providing goods or services to the entity,
and a residual interest is not retained upon termination. A profit-sharing
arrangement may contain provisions (e.g., repurchase features) that limit the
grantee’s risks and rewards upon termination (e.g., a repurchase feature that, upon
termination of employment, is at cost or a nominal amount).
While retention after termination is an important focus in this evaluation, profits
interests retained upon termination may not always represent a substantive class of
equity. For example, certain entities, such as general partnerships, may grant
profits interests that allocate a portion of the general partnership’s carried
interest earned to a grantee for managing a specific investment or fund of
investments that, by design, have a finite life. In these instances, an entity may
conclude that the profits interests do not represent a substantive class of equity
because there are no substantive net assets underlying the profits interest other
than a right to cash distributions solely on the basis of the realization of a
specific investment or fund of investments.
In addition, while voting rights and transferability are not listed as
indicators above (because they are not always relevant and useful for that purpose),
their presence may suggest the possibility of an equity interest; however, the
absence of such features would not preclude the interest from being considered a
substantive class of equity. Nonpublic entities frequently issue equity interests
that lack voting rights (particularly to noncontrolling interest holders) and have
transferability restrictions. Further, if a grantee does not make an initial
investment to purchase an equity interest, the equity interest may still be a
substantive class of equity. In that circumstance, consideration for the shares or
units is in the form of goods or services.
In determining whether a vested residual interest is retained after termination,
an entity typically focuses on what happens to the interest if the grantee is an
employee who voluntarily terminates employment without good reason3 or if the grantee is a nonemployee who ceases to provide goods or services.
For example, if an employee award is legally vested but is substantively forfeited
upon voluntary termination without good reason (e.g., the entity can repurchase the
legally vested award at the lower of cost or fair value upon such termination event)
and the repurchase feature does not expire upon a liquidity event, the award will
most likely be a profit-sharing arrangement (see Section 3.4.3 for a discussion of repurchase
features that function as vesting conditions). By contrast, if an employee award is
legally vested but substantively forfeited only upon termination for cause (e.g.,
the entity can repurchase the legally vested award at the lower of cost or fair
value upon such termination event), that feature would not affect the analysis since
it functions as a clawback provision (see Section 3.9 for a discussion of repurchase
features that function as clawback provisions).
An entity should consider the substance of an award rather than its form. For
example, an award may legally vest immediately under an agreement; however, the
vesting may not be substantive if the award cannot be transferred or otherwise
monetized until an IPO occurs and the entity can repurchase the award for no
consideration if the grantee terminates employment or ceases to provide goods or
services before the IPO. We would most likely conclude that such an award has a
substantive performance condition that affects vesting (i.e., an IPO is a vesting
condition) even though the award was deemed “immediately vested” according to the
agreement.
ASU 2024-01 clarifies how an entity determines whether a profits
interest or similar award is (1) within the scope of ASC 718 or (2) not a
share-based payment arrangement and therefore within the scope of other guidance.
The ASU adds to U.S. GAAP ASC 718-10-55-138 through 55-148, which provide an
illustrative example with four cases (A through D) that show how an entity should
apply the guidance in ASC 718-10-15-3 to determine whether a profits interest award
is within the scope of ASC 718. Since such guidance was not previously included
within U.S. GAAP, the ASU is likely to reduce the diversity in practice associated
with an entity’s scope assessments in circumstances that are similar to those
described in the four cases. In the absence of other relevant factors, however, the
conclusions reached in the four cases would be consistent with those that an entity
might reach by applying the guidance above. For other types of arrangements, an
entity will have to consider the guidance above when determining whether a profits
interest is a substantive class of equity within the scope of ASC 718 or a
profit-sharing arrangement. Entities can apply the ASU’s amendments either “(1)
retrospectively to all prior periods presented in the financial statements or (2)
prospectively to profits interest and similar awards granted or modified on or after
the date at which the entity first applies the amendments.” See Deloitte’s March 22,
2024, Heads Up
for more information about ASU 2024-01, including its effective dates and transition
guidance.
Example 2-6
On January 1, 20X1, Entity A grants
employees profits interest awards that vest quarterly over
four years. The profits interests are legal-form equity, and
the grantees are entitled to receive distributions,
including upon liquidation, on their vested awards once A’s
distributions exceed a threshold amount established on the
grant date. Entity A has substantive net assets.
If a grantee terminates his or her
employment voluntarily, A has the right to repurchase the
vested profits interest at the lesser of fair value or cost
(i.e., $0). The repurchase feature does not expire upon an
IPO or a change in control.
Entity A accounts for this repurchase
feature (i.e., the right to repurchase at the lesser of fair
value or $0) as a forfeiture provision rather than a cash
settlement feature. As a result, the grantees cannot retain
a residual interest in A upon voluntary termination. Rather,
the grantees are entitled to distributions only as long as
they remain employed at A, and any distributions would not
be based on the price of A’s shares or other equity
instruments. Entity A concludes that the profits interest
awards are similar to a performance bonus or profit-sharing
arrangement and are not within the scope of ASC 718.
Note that these awards are different from
the award in the example in Case B in ASC 718-10-55-142
through 55-144, which vests upon an exit event and thus
permits the grantee to retain the profits interest after
voluntary termination. Further, the awards are different
from the award in the example in Case C in ASC 718-10-55-145
and 55-146 because that award vests upon an exit event and
is immediately cash settled by reference to the price of the
Class A units of Entity X in a manner similar to a
cash-settled stock appreciation right. By contrast, the
profits interest awards discussed in this example never
vest; rather, the grantee has only the right to be entitled
to any future distributions until termination of employment,
which is akin to a performance bonus or profit-sharing
arrangement.
Example 2-7
On January 1, 20X1, Entity B grants
employees profits interest awards that vest quarterly over
four years. The profits interests are legal-form equity, and
the grantees are entitled to receive distributions,
including upon liquidation, for the awards that have vested
once B’s distributions exceed a threshold amount established
on the grant date. Entity B has substantive net assets.
If a grantee terminates his or her
employment voluntarily, B has the right to repurchase the
vested profits interest at fair value. Any unvested awards
are forfeited for no consideration upon voluntary
termination.
Entity B accounts for these awards as a
share-based payment arrangement that is within the scope of
ASC 718. Upon voluntary termination, the grantees retain
their vested profits interest, subject to a fair value
repurchase feature. Entity B recognizes compensation cost
for the awards over the requisite service period of four
years in a manner consistent with its policy election to use
either a straight-line or an accelerated attribution method
for awards with only a service condition and graded vesting.
Entity B would separately evaluate whether the awards will
be classified as equity or a liability under ASC 718.
Profits interest awards may also include vesting conditions that are
based on, for example, a target MOIC or an IRR on capital contributions from private
equity investors. See Section
3.7.2.1 for further discussion of how to evaluate an award that vests
when these types of conditions are met.
From a valuation standpoint, nonpublic entities might consider whether the
profits interests that represent a substantive class of equity have no value on the
grant date. For example, if the entity were liquidated on the grant date, the
waterfall calculation would result in no payment to the special class. However, in
the 2006 speech discussed above, Mr. Ucuzoglu noted that profits interests generally
have a fair value because of the upside potential of the equity. He stated:
[W]hen the substance of the arrangement is in fact that of a
substantive class of equity, questions often arise as to the appropriate
valuation of the instrument for the purpose of recording compensation expense
pursuant to FASB Statement No. 123R. These instruments, by design, often derive
all or substantially all of their value from the right to participate in future
share price appreciation or profits. Accordingly, the staff has rejected the use
of valuation methodologies that focus predominantly on the amount that would be
realized by the holder in a current liquidation, as such an approach fails to
capture the substantial upside potential of the security. [Footnote
omitted]
Connecting the Dots
Once a nonpublic entity concludes that the profits interests
are subject to the guidance in ASC 718 because they represent a substantive
class of equity, the entity would next need to assess the conditions in ASC
718-10-25-6 through 25-19A to determine whether the award should be equity-
or liability-classified. See Chapter 5 for a detailed discussion of
how to determine the classification of awards.
Footnotes
3
A significant demotion, a significant reduction in
compensation, or a significant relocation are commonly considered “good
reasons” for termination.
2.7 Rabbi Trusts
Many entities have arrangements that allow their employees to defer some or all
of their earned compensation (i.e., salary or bonus). Sometimes the employer uses a
“rabbi trust”4 to hold assets from which nonqualified deferred compensation payments will be
made. ASC 710 provides guidance on deferred compensation arrangements in which
assets equal to compensation amounts earned (i.e., vested) by employees are placed
in a rabbi trust. Such arrangements often permit employees to diversify their
accounts by investing in cash, the employer’s stock, nonemployer securities, or a
combination of these options. In all cases, the employer consolidates the rabbi
trust in the employer’s financial statements.
The guidance in ASC 710-10-25-15
refers to four types of deferred compensation arrangements involving rabbi trusts.
These four arrangement types, known as plans A, B, C, and D, differ on the basis of
whether the plan permits diversification, whether the employee has elected to
diversify, and the allowable forms of settlement:
|
Plan
|
Diversification
|
Settlement Options Permitted Under Plan
|
|---|---|---|
|
A
|
Not permitted
|
Delivery of a fixed number of shares of employer stock
|
|
B
|
Not permitted
|
Delivery of cash or shares of employer stock
|
|
C
|
Permitted, but employee has not diversified
|
Delivery of cash, shares of employer stock, or diversified
assets
|
|
D
|
Permitted, and employee has diversified
|
Delivery of cash, shares of employer stock, or diversified
assets
|
Deferred compensation arrangements in which the amounts earned are indexed to,
or can be settled in, an entity’s own stock before being placed into a rabbi trust
are within the scope of ASC 718. When the amounts earned in a deferred compensation
arrangement (1) are within the scope of ASC 718 before being placed into a rabbi
trust and (2) can be settled only in the employer’s stock (i.e., Plan A), the
arrangement would be accounted for as an equity award under ASC 718 before the
amounts earned are placed into the trust (provided that all other criteria for
equity classification have been met). In addition, the deferred compensation
arrangement would remain classified in equity and would therefore not need to be
remeasured under ASC 710 after the amounts earned are placed into the rabbi
trust.
Similarly, when the amounts earned in a deferred compensation
arrangement (1) are within the scope of ASC 718 before being placed into a rabbi
trust and (2) can be settled only in the employer’s stock or cash at the election of
the employee (i.e., Plan B), the arrangement may be accounted for as a liability or
equity award under ASC 718 before the amounts earned are placed into the trust. The
deferred compensation arrangement would be classified as a liability after the
amounts earned are placed into the rabbi trust.
For all other deferred compensation arrangements in which amounts earned are placed into a rabbi trust, the accounting depends on the terms of the arrangement and on whether the arrangement is viewed either as one plan or as substantively consisting of two plans.
Connecting the Dots
For all plans except Plan A, SEC registrants (or entities electing to apply
SEC requirements) should consider ASR 268 and ASC 480-10-S99-3A, as
discussed in SAB Topic 14.E, under which presentation must occur outside of
permanent equity (i.e., as temporary or mezzanine equity) when redemption is
outside the control of the entity. See Section
5.10 for discussion on the SEC guidance on temporary
equity.
2.7.1 Accounting for a Deferred Compensation Arrangement as Two Plans (Plans C and D)
For an arrangement to be viewed as substantively consisting of two plans, the
following two criteria must be met:
-
There must be a reasonable period within which the employee is required to be subjected to the risks and rewards of ownership (i.e., to all the stock price movements of the employer’s stock). ASC 718-10-25-9 defines this period as six months or more. Accordingly, once the share-based payment award is vested and placed into the rabbi trust, it would need to remain indexed to the employer’s stock for at least six months. After six months, the employee could elect to diversify his or her vested shares into various different money markets and equity-based mutual funds, which would be the beginning of the deferred compensation arrangement.
-
The option to defer the amounts earned under the share-based payment award must be entirely elective. If the employee is forced into a diversified account, the award would most likely be considered mandatorily redeemable under ASC 480. That is, the deferred compensation arrangement would have to be classified as a liability. Therefore, if the employee is “forced” to accept a liability in satisfaction of the share-based payment award, redemption is deemed mandatory. Accordingly, the entire arrangement would be accounted for as a liability from the grant date of the share-based payment award and not just from the beginning of the deferred compensation arrangement.
If the above two criteria are met, the deferred compensation
arrangement is viewed as a share-based payment arrangement that is subsequently
“converted” into a diversified deferred compensation arrangement (i.e., two
plans). Accordingly, an entity applies the guidance in ASC 718 until the
employee elects to diversify his or her amounts earned (“the share-based payment
award”) and then applies the guidance in ASC 710 until the deferred amounts are
received by the employee (“the deferred compensation arrangement”).
If the above two criteria are met and equity classification is achieved from the
grant date of the share-based payment award until the employee elects to
diversify his or her amounts earned, a public entity also must consider the
guidance in ASR 268 (FRR Section 211) and ASC 480-10-S99-3A. ASC 480-10-S99-3A
addresses share-based payment arrangements with employees whose terms may permit
redemption of the employer’s shares for cash or other assets. Since the
distribution of the amounts earned under the share-based payment award into a
diversified account is viewed as settlement in cash or other assets (i.e.,
because the deferred compensation obligation must be classified as a liability
in accordance with ASC 710 once the employee elects to diversify his or her
amounts earned), the share-based payment award would be subject to the guidance
in ASC 480-10-S99-3A. The guidance in ASC 480-10-S99-3A requires classification
in temporary (mezzanine) equity from the grant date of the share-based payment
award until the beginning of the deferred compensation arrangement. At the
beginning of the deferred compensation arrangement, the amounts diversified
would be classified as a liability under ASC 710.
2.7.2 Accounting for a Deferred Compensation Arrangement as One Plan (Plans C and D)
If the two criteria in the previous section are not met, the deferred
compensation arrangement is viewed as one plan. When an arrangement is viewed as
one plan, diversification would result in liability classification under ASC 718
for the share-based payment award from the grant date to the date the amounts
earned are placed into the rabbi trust. Under ASC 718, an award that allows an
employee to diversify outside of the employer’s stock would be indexed to
something other than a market, performance, or service condition (i.e., the
ultimate value received by the employee also is indexed to the performance of
the assets into which they diversified). In accordance with ASC 718-10-25-13, an
arrangement that is indexed to an “other” condition is classified as a
share-based liability irrespective of whether the employee ultimately receives
cash, other assets, or the employer’s stock. (See Chapter 7 for more detailed guidance on
the accounting treatment of liability awards.) Accordingly, the deferred
compensation arrangement would be classified as a share-based liability from the
grant date until the amounts earned are placed into the rabbi trust. Once placed
into the rabbi trust, the amounts earned would be classified as a liability
pursuant to ASC 710 until the deferred amounts are received by the employee.
Footnotes
4
Rabbi trusts are generally used as funding vehicles to
provide for the deferral of taxation to the employee receiving the
compensation. That is, in a nonqualified deferred compensation plan,
employees defer the receipt of compensation amounts earned by placing the
amounts earned in a rabbi trust. By deferring receipt of the amounts earned,
the employees are also deferring the taxability of those amounts. The
employees will be subsequently taxed upon receiving the amounts that have
been placed in the rabbi trust.
2.8 Consolidated Financial Statements
Share-based payment awards issued to grantees of entities within a consolidated group include, for example, awards that a parent grants to its subsidiary’s employees or nonemployees and that are indexed to or settled in the parent’s equity instruments. A consolidated subsidiary may also grant share-based payment awards to employees or nonemployees of the parent or another subsidiary that are indexed to or settled in the equity of the consolidated subsidiary. In the consolidated financial statements, because the share-based payment awards are issued to employees or nonemployees of the consolidated group and indexed to or settled in the equity of an entity within the consolidated group, the awards are within the scope of ASC 718.
While FASB Statement 123(R) (codified in ASC 718) nullified FASB Interpretation 44, paragraph 11 of Interpretation 44 remains applicable by analogy. It stated, in part:
In consolidated financial statements, the evaluation of whether a grantee is an employee under Opinion 25 is made at the consolidated group level and stock compensation based on the stock of a subsidiary is deemed to be stock compensation based on the stock of the consolidated group (the employer). Therefore, in the consolidated financial statements, stock compensation granted based on the stock of any consolidated group member shall be accounted for under Opinion 25 if the grantee meets the definition of an employee for any entity in the consolidated group. For example, Opinion 25 applies to the accounting in the consolidated financial statements for awards based on parent stock granted to employees of a (consolidated) subsidiary and to awards in stock of a (consolidated) subsidiary granted to employees of the parent. Also, Opinion 25 applies to the accounting in the consolidated financial statements for awards based on a subsidiary’s stock granted to the employees of another subsidiary. This guidance applies only to consolidated financial statements. [Emphasis added]
Accordingly, the parent entity accounts for the awards under ASC 718 when preparing its consolidated financial statements.
Furthermore, a subsidiary’s issuance of equity-classified share-based payment awards
to its employees or nonemployees may decrease the parent’s ownership interest in the
subsidiary. We believe that in such cases, it would be appropriate for the parent to
(1) recognize a share-based payment expense as the awards vest over time at the
subsidiary and (2) record a corresponding credit to the noncontrolling interests.
Other alternatives may also be acceptable. For additional discussion of a parent’s
accounting for a subsidiary’s issuance of share-based payment awards, see Section 7.1.2.7.1 of Deloitte’s Roadmap Noncontrolling Interests.
2.9 Separate Financial Statements
The accounting for share-based payment transactions in the separate financial statements of each entity within a consolidated group is somewhat complicated. Before FASB Statement 123(R) (codified in ASC 718), entities applied the guidance in Question 4 of FASB Interpretation 44 and Issues 21 and 22 of EITF Issue 00-23 when accounting for such transactions. Although FASB Statement 123(R) (codified in ASC 718) subsequently superseded and nullified Interpretation 44 and Issue 00-23,
entities should continue to analogize to this guidance when accounting for
consolidated-group share-based payment transactions.
The share-based payment awards of a consolidated subsidiary that are issued to employees of that subsidiary and are indexed to and settled in equity of the subsidiary’s parent are within the scope of ASC 718. Although ASC 718 does not specifically address such awards, they would be within the scope of ASC 718 by analogy to paragraph 14 of Interpretation 44. Paragraph 14 states, in part:
[A]n exception is made to require the application of Opinion 25 to stock compensation based on stock of the parent company granted to employees of a consolidated subsidiary for purposes of reporting in the separate financial statements of that subsidiary. The exception applies only to stock compensation based on stock of the parent company (accounted for under Opinion 25 in the consolidated financial statements) granted to employees of an entity that is part of the consolidated group. [Emphasis added]
Under the exception in Interpretation 44, an entity treated the stock of the
parent entity as though it were the stock of the consolidated subsidiary when
reporting in the separate financial statements of the subsidiary. We believe that
the same analogy can be applied to awards granted to the subsidiary’s nonemployee
providers of goods or services. The exception did not, however, extend to
share-based payment awards “granted (a) to the subsidiary’s employees based on the
stock of another subsidiary in the consolidated group or (b) by the subsidiary to
employees of the parent or another subsidiary.”
Therefore, the share-based payment awards of a consolidated subsidiary that
reports separate financial statements and grants such awards to employees or
nonemployees of the parent or another subsidiary, and that are indexed to and
settled in the equity of the consolidated subsidiary, are not within the scope of ASC 718. Neither Interpretation 44 nor ASC 718 specifically addresses the accounting for these awards. Such guidance is contained in Issue 21 of EITF Issue 00-23. The conclusion in Issue 21 of EITF Issue 00-23 states that the parent (controlling
entity) can always direct subsidiaries (controlled entities) within the consolidated
group to grant share-based payment awards to the parent’s employees and to the
employees of other subsidiaries in the consolidated group. Therefore, in its
separate financial statements, the subsidiary granting the awards measures the
awards at their fair-value-based measure as of the grant date. That amount is
recognized as a dividend from the subsidiary to the parent; a corresponding amount
is recognized as equity. The EITF’s reasoning is as follows:
Because the controlling entity has the discretion to require entities it
controls to enter into a variety of transactions, recognizing the transaction as
a dividend more closely mirrors the economics of the arrangement because it will
not be clear that the entity granting the stock compensation has received goods
or services in return for that grant, and if so, whether the fair value of those
goods or services approximates the value of the equity awards.
In addition, in its separate financial statements, the subsidiary whose
employees or nonemployees are receiving the awards would apply the guidance in Issue 22 of EITF Issue 00-23, which specifies that the awards are accounted for as
compensation cost on the basis of their fair value. We believe that in a manner
similar to the entity issuing the awards, if the subsidiary whose employees or
nonemployees are receiving the awards has no obligation to settle those awards, it
is acceptable to measure the awards at their fair-value-based measure as of the
grant date provided that the awards are equity classified. The subsidiary would also
account for the offsetting entry to compensation cost as a credit to equity (i.e., a
capital contribution from or on behalf of the parent) to reflect the pushdown of a
cost incurred by the parent on the subsidiary’s behalf. By contrast, if the
subsidiary whose employees or nonemployees are receiving the awards has an
obligation to settle those awards, the awards generally would be accounted for under
ASC 815 (see Section
2.11).
The table below summarizes the accounting for awards in a parent’s consolidated financial statements and the separate financial statements of its wholly owned subsidiaries, A and B, in three scenarios.
|
Awards
|
Parent’s Consolidated Financial
Statements
|
Subsidiary A’s Separate Financial
Statements
|
Subsidiary B’s Separate Financial
Statements
|
|---|---|---|---|
|
Share-based payment awards issued to
employees/nonemployees of A and indexed to and settled in
the parent’s equity
|
The awards are accounted for as share-based
payment awards within the scope of ASC 718.
|
The awards are within the scope of ASC 718.
Compensation cost for the awards is recognized at their
fair-value-based measure as of the grant date.
If A does not reimburse the parent for the
awards, it makes an offsetting entry to equity to represent
a capital contribution by the parent.
Any reimbursement by A to the parent would not result in
incremental cost beyond the compensation cost recognized
under ASC 718.
|
N/A
|
|
Share-based payment awards issued to the
parent’s employees/nonemployees and indexed to and settled
in A’s equity
|
The awards are accounted for as share-based
payment awards within the scope of ASC 718.
|
The awards are not within the scope of ASC
718. Subsidiary A measures the awards at their
fair-value-based measure as of the grant date and recognizes
that amount as a dividend from itself to the parent; it
recognizes a corresponding amount as equity.
|
N/A
|
|
Share-based payment awards issued to
employees/nonemployees of B and indexed to and settled in
A’s equity
|
The awards are accounted for as share-based
payment awards within the scope of ASC 718.
|
The awards are not within the scope of ASC
718. Subsidiary A accounts for them as if (1) they were
issued to the parent and (2) the parent then issued them to
B. Subsidiary A measures the awards at their
fair-value-based measure as of the grant date and recognizes
that amount as a dividend from itself to the parent; it
recognizes a corresponding amount as equity.
|
Subsidiary B recognizes compensation cost
for the awards at their fair-value-based measure as of the
grant date if it does not have an obligation to settle the
awards provided that the awards are equity classified. It
accounts for the offsetting entry to compensation cost as a
credit to equity (i.e., a capital contribution from or on
behalf of the parent) to reflect the pushdown of a cost
incurred by the parent on the subsidiary’s behalf. If it has
an obligation to settle the awards, it would generally apply
ASC 815.
|
2.10 Equity Method Investments
ASC 505-10
25-3 Paragraphs 323-10-25-3 through 25-5 provide guidance on accounting for share-based compensation granted by an investor to employees or nonemployees of an equity method investee that provide goods or services to the investee that are used or consumed in the investee’s operations. An investee shall recognize the costs of the share-based payment incurred by the investor on its behalf, and a corresponding capital contribution, as the costs are incurred on its behalf (that is, in the same period(s) as if the investor had paid cash to employees and nonemployees of the investee following the guidance in Topic 718 on stock compensation.
ASC 323-10
Stock-Based Compensation Granted to Employees and Nonemployees of an Equity Method Investee
25-3 Paragraphs 323-10-25-4
through 25-6 provide guidance on accounting for
share-based payment awards granted by an investor
to employees or nonemployees of an equity method
investee that provide goods or services to the
investee that are used or consumed in the
investee’s operations when no proportionate
funding by the other investors occurs and the
investor does not receive any increase in the
investor’s relative ownership percentage of the
investee. That guidance assumes that the
investor’s grant of share-based payment awards to
employees or nonemployees of the equity method
investee was not agreed to in connection with the
investor’s acquisition of an interest in the
investee. That guidance applies to share-based
payment awards granted to employees or
nonemployees of an investee by an investor based
on that investor’s stock (that is, stock of the
investor or other equity instruments indexed to,
and potentially settled in, stock of the
investor).
25-4 In the circumstances
described in paragraph 323-10-25-3, a contributing
investor shall expense the cost of share-based
payment awards granted to employees and
nonemployees of an equity method investee as
incurred (that is, in the same period the costs
are recognized by the investee) to the extent that
the investor’s claim on the investee’s book value
has not been increased.
25-5 In the circumstances described in paragraph 323-10-25-3, other equity method investors in an investee (that is, noncontributing investors) shall recognize income equal to the amount that their interest in the investee's net book value has increased (that is, their percentage share of the contributed capital recognized by the investee) as a result of the disproportionate funding of the compensation costs. Further, those other equity method investors shall recognize their percentage share of earnings or losses in the investee (inclusive of any expense recognized by the investee for the share-based compensation funded on its behalf).
25-6 Example 2 (see paragraph 323-10-55-19) illustrates the application of this guidance for share-based compensation granted to employees of an equity method investee.
Share-Based Compensation Granted to Employees and Nonemployees of an Equity Method Investee
30-3 Share-based compensation cost recognized in accordance with paragraph 323-10-25-4 shall be measured initially at fair value in accordance with Topic 718. Example 2 (see paragraph 323-10-55-19) illustrates the application of this guidance.
Example 2: Share-Based Compensation Granted to Employees of an Equity Method Investee
55-19 This Example illustrates the guidance in paragraphs 323-10-25-3 and 323-10-30-3 for share-based compensation by an investor granted to employees of an equity method investee. This Example is equally applicable to share-based awards granted by an investor to nonemployees that provide goods or services to an equity method investee that are used or consumed in the investee’s operations.
55-20 Entity A owns a 40 percent interest in Entity B and accounts for its investment under the equity method. On January 1, 20X1, Entity A grants 10,000 stock options (in the stock of Entity A) to employees of Entity B. The stock options cliff-vest in three years. If an employee of Entity B fails to vest in a stock option, the option is returned to Entity A (that is, Entity B does not retain the underlying stock). The owners of the remaining 60 percent interest in Entity B have not shared in the funding of the stock options granted to employees of Entity B on any basis and Entity A was not obligated to grant the stock options under any preexisting agreement with Entity B or the other investors. Entity B will capitalize the share-based compensation costs recognized over the first year of the three-year vesting period as part of the cost of an internally constructed fixed asset (the internally constructed fixed asset will be completed on December 31, 20X1).
55-21 Before granting the
stock options, Entity A’s investment balance is
$800,000, and the book value of Entity B’s net
assets equals $2,000,000. Entity B will not begin
depreciating the internally constructed fixed
asset until it is complete and ready for its
intended use and, therefore, no related
depreciation expense (or compensation expense
relating to the stock options) will be recognized
between January 1, 20X1, and December 31, 20X1.
For the years ending December 31, 20X2, and
December 31, 20X3, Entity B will recognize
depreciation expense (on the internally
constructed fixed asset) and compensation expense
(for the cost of the stock options relating to
Years 2 and 3 of the vesting period). After
recognizing those expenses, Entity B has net
income of $200,000 for the fiscal years ending
December 31, 20X1, December 31, 20X2, and December
31, 20X3.
55-22 Entity C also owns a 40
percent interest in Entity B. On January 1, 20X1,
before granting the stock options, Entity C’s
investment balance is $800,000.
55-23 Assume that the fair value of the stock options granted by Entity A to employees of Entity B is $120,000 on January 1, 20X1. Under Topic 718, the fair value of share-based compensation should be measured at the grant date. This Example assumes that the stock options issued are classified as equity and ignores the effect of forfeitures.
55-24 Entity A would make the following journal entries.
55-25 A rollforward of Entity B’s net assets and a reconciliation to Entity A’s and Entity C’s ending investment accounts follows.
55-26 A summary of the
calculation of share-based compensation cost by year
follows.
Share-based payment awards may be (1) issued by an equity method investor to
employees or nonemployees of an equity method investee and (2) indexed to, or
settled in, the equity of the investor. ASC 323-10-25-3 through 25-5 and ASC
505-10-25-3 address the accounting related to the financial statements of the equity
method investor, the equity method investee, and the noncontributing investor(s).
This guidance does not apply to share-based payment awards issued to grantees for
goods or services provided to the investor that are indexed to, or settled in, the
equity of the investee (as opposed to the equity of the investor). See Section 2.11 for further guidance on the accounting
for awards that are issued to grantees and indexed to and settled in shares of an
unrelated entity.
Note that the guidance in U.S. GAAP does not address an investee’s reimbursements to the contributing investor. Sections 2.10.4 through 2.10.6 discuss this scenario; however, there may be other acceptable views on the contributing investor’s, investee’s, and noncontributing investor’s accounting for such reimbursements.
2.10.1 Accounting in the Financial Statements of the Contributing Investor Issuing the Awards
ASC 323-10-25-3 and 25-4 indicate that an investor should recognize (1) the
entire cost (not just the portion of the cost associated with the investor’s
ownership interest) of share-based payment awards granted to employees or
nonemployees of an investee as an expense and (2) a corresponding amount in the
investor’s equity. However, the cost associated with the investor’s ownership
interest will be recognized as an expense when it records its share of the
investee’s earnings (because its share of the investee’s earnings includes the
awards’ expense). In addition, the entire cost (and corresponding equity) should
be recorded as incurred (i.e., in the same period(s) as if the investor had paid
cash to the investee’s employees or nonemployees). The cost of the share-based
payment awards is a fair-value-based amount that is consistent with the guidance
in ASC 718. As noted in ASC 323-10-S99-4, “[i]nvestors that are SEC registrants
should classify any income or expense resulting from application of this
guidance in the same income statement caption as the equity in earnings (or
losses) of the investee.” Although ASC 323-10-S99-4 refers to SEC registrants,
reporting entities that are not SEC registrants should consider applying the
same guidance.
2.10.2 Accounting in the Financial Statements of the Investee Receiving the Awards
ASC 505-10-25-3 indicates that an investee should recognize (1) the entire cost
of share-based payment awards incurred by the investor on the investee’s behalf
as compensation cost and (2) a corresponding amount as a capital contribution.
The cost of the share-based payment awards is a fair-value-based amount that is
consistent with the guidance in ASC 718. In addition, the compensation cost (and
corresponding capital contribution) should be recorded as incurred (i.e., in the
same period(s) as if the investor had paid cash to the investee’s employees or
nonemployees).
2.10.3 Accounting in the Financial Statements of the Noncontributing Investors
ASC 323-10-25-5 states that noncontributing investors “shall recognize income
equal to the amount that their interest in the
investee’s net book value has increased (that is,
their percentage share of the contributed capital
recognized by the investee)” as a result of the
capital contribution by the investor issuing the
awards. In addition, the noncontributing investors
“shall recognize their percentage share of
earnings or losses in the investee (inclusive of
any expense recognized by the investee for the
share-based compensation funded on its behalf).”
That is, the noncontributing investors should
recognize their share of the earnings or losses of
the investee (including the compensation cost
recognized for the share-based payment awards
issued by the equity method investor) in
accordance with ASC 323-10. As noted in ASC
323-10-S99-4, “[i]nvestors that are SEC
registrants should classify any income or expense
resulting from application of this guidance in the
same income statement caption as the equity in
earnings (or losses) of the investee.” Although
ASC 323-10-S99-4 refers to SEC registrants,
reporting entities that are not SEC registrants
should consider applying the same guidance.
2.10.4 Accounting in the Financial Statements of the Contributing Investor Receiving the Reimbursement
If an investee reimburses a contributing investor for share-based payment awards, the contributing investor generally records income, with a corresponding amount recorded in equity, in the same periods as the cost that is recognized for issuing the awards. Therefore, the issuance of the awards by the contributing investor and the subsequent reimbursement by the investee may not affect the net income (loss) of the contributing investor. That is, if the reimbursement received by the investor equals the compensation cost recognized for the awards granted, the cost of issuing the awards and the income for the reimbursement of the awards will be equal and offsetting and will be recorded in the same reporting periods in the contributing investor’s income statement.
2.10.5 Accounting in the Financial Statements of the Investee Receiving the Awards and Making the Reimbursement
If an investee reimburses a contributing investor for share-based payment awards, the investee generally accrues a dividend to the contributing investor for the amount of the reimbursement in the same periods as the capital contribution from the contributing investor. The recognition of a dividend is generally appropriate given that the issuance of the awards resulted in a capital contribution from the contributing investor.
2.10.6 Accounting in the Financial Statements of the Noncontributing Investors (When the Investee Reimburses the Contributing Investor)
If an investee reimburses a contributing investor for share-based payment awards, the noncontributing investor or investors generally recognize a loss equal to the amount that their interest in the investee’s net book value has decreased (i.e., their percentage share of the distributed capital recognized by the investee) as a result of the reimbursement to the contributing investor. The recognition of a loss by the noncontributing investors is appropriate given that their interest in the investee’s net book value has decreased as a result of the reimbursement provided to the investor issuing the awards.
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 2-8
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:
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 2-9
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
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.
2.12 Escrowed Share Arrangements
ASC 718-10 — SEC Materials — SEC Staff Guidance
SEC Staff Announcement: Escrowed Share Arrangements and the Presumption of Compensation
S99-2
This SEC staff announcement provides the SEC staff’s views
regarding Escrowed Share Arrangements and the Presumption of
Compensation.
The SEC Observer made the following announcement of the SEC
staff’s position on escrowed share arrangements. The SEC
Observer has been asked to clarify SEC staff views on
overcoming the presumption that for certain shareholders
these arrangements represent compensation.
Historically, the SEC staff has expressed the view that an
escrowed share arrangement involving the release of shares
to certain shareholders based on performance-related
criteria is presumed to be compensatory, equivalent to a
reverse stock split followed by the grant of a restricted
stock award under a performance-based
plan.FN1
When evaluating whether the presumption of compensation has
been overcome, registrants should consider the substance of
the arrangement, including whether the arrangement was
entered into for purposes unrelated to, and not contingent
upon, continued employment. For example, as a condition of a
financing transaction, investors may request that specific
significant shareholders, who also may be officers or
directors, participate in an escrowed share arrangement. If
the escrowed shares will be released or canceled without
regard to continued employment, specific facts and
circumstances may indicate that the arrangement is in
substance an inducement made to facilitate the transaction
on behalf of the company, rather than as compensatory. In
such cases, the SEC staff generally believes that the
arrangement should be recognized and measured according to
its nature and reflected as a reduction of the proceeds
allocated to the newly-issued securities.FN2,
3
The SEC staff believes that an escrowed share arrangement
in which the shares are automatically forfeited if
employment terminates is compensation, consistent with the
principle articulated in paragraph 805-10-55-25(a).
__________________________________
FN1 Under these arrangements, which can be between shareholders and a company or directly between the shareholders and new investors, shareholders agree to place a portion of their shares in escrow in connection with an initial public offering or other capital-raising transaction. Shares placed in escrow are released back to the shareholders only if specified performance-related criteria are met.
FN2 The SEC staff notes that discounts on debt instruments are amortized using the effective interest method as discussed in Section 835-30-35, while discounts on common equity are not generally amortized.
FN3 Consistent with the views in paragraph 220-10-S99-4, SAB Topic 5.T., Accounting for Expenses or Liabilities Paid by Principal Stockholder(s), and paragraph 220-10-S99-3, SAB Topic 1.B., Allocation of Expenses and Related Disclosure in Financial Statements of Subsidiaries, Divisions or Lesser Business Components of Another Entity, the SEC staff believes that the benefit created by the shareholder’s escrow arrangement should be reflected in the company’s financial statements even when the company is not party to the arrangement.
As part of completing an IPO or other financing, certain shareholders who are also key employees of an entity may agree to place in escrow a portion of their shares, which would be released to them upon the satisfaction of a specified condition. In many of these arrangements, the shares are released only if the employee shareholders remain employed for a certain period or the entity achieves a specified performance target, and services from the employee shareholders may be explicitly stated in the arrangement or implicitly required in accordance with a performance target.
As indicated in ASC 718-10-S99-2, the SEC staff has historically expressed the view that escrowed share arrangements such as these are presumed to be compensatory and equivalent to reverse stock splits followed by the grant of restricted stock, subject to certain conditions (e.g., service, performance, or market conditions). If the release of shares is tied to continued employment, the presumption cannot be overcome. In addition, even if the entity is not directly a party to the arrangement (e.g., when the arrangement is only between shareholders and new investors), the arrangement should be reflected in the entity’s financial statements.
However, the SEC staff has stated that in certain circumstances, the presumption
can be overcome that an arrangement is compensation. To identify those
circumstances, an entity should assess the substance of the escrowed share
arrangement to determine whether it was “entered into for purposes unrelated to, and
not contingent upon, continued employment.” For example, as a result of concerns
related to the entity’s value, investors may require certain shareholders to
participate in an escrowed share arrangement before the entity can raise financing.
Further, investors may require the entity to achieve certain performance targets
(e.g., an EBITDA target over a specified period) before the shares can be released.
If the arrangement also requires continued employment, the arrangement is considered
compensatory. However, if continued employment is not required (either explicitly or
implicitly), the entity should consider all relevant facts and circumstances to
determine whether the substance of the arrangement is unrelated to employee
compensation.