3.10 Dividend Protected Awards
ASC 718-10
55-45 In certain situations, grantees may receive the dividends paid on the underlying equity shares while the option is outstanding. Dividends or dividend equivalents paid to grantees on the portion of an award of equity shares or other equity instruments that vests shall be charged to retained earnings. If grantees are not required to return the dividends or dividend equivalents received if they forfeit their awards, dividends or dividend equivalents paid on instruments that do not vest shall be recognized as additional compensation cost. If an entity’s accounting policy is to estimate the number of awards expected to be forfeited in accordance with paragraph 718-10-35-1D or 718-10-35-3, the estimate of compensation cost for dividends or dividend equivalents paid on instruments that are not expected to vest shall be consistent with an entity’s estimates of forfeitures. Dividends and dividend equivalents shall be reclassified between retained earnings and compensation cost in a subsequent period if the entity changes its forfeiture estimates (or actual forfeitures differ from previous estimates). If an entity’s accounting policy is to account for forfeitures when they occur in accordance with paragraph 718-10-35-1D or 718-10-35-3, the entity shall reclassify to compensation cost in the period in which the forfeitures occur the amount of dividends and dividend equivalents previously charged to retained earnings relating to awards that are forfeited.
The terms of some share-based payment awards permit holders to receive a dividend during the vesting period and, in some instances, to retain the dividend even if the award fails to vest. Such awards are commonly referred to as “dividend-protected awards.”
The accounting for dividends paid on dividend-protected equity-classified awards
is based on the manner in which the entity has elected to account for
forfeitures.6 If the entity elects, as an accounting policy, to estimate the number of
awards expected to be forfeited, the entity should, in a manner consistent with the
forfeiture estimate it uses to recognize compensation cost of an award, charge to
retained earnings the dividend payment for dividend-protected awards to the extent
that the award is expected to vest. Such dividends are recognized in retained
earnings to prevent their being double-counted as compensation cost since dividends
are already factored into the grant-date fair-value-based measure of the awards. If
a grantee is entitled to retain dividends paid on shares that fail to vest, the
dividend payment for dividend-protected awards that are not expected to vest should
be charged to compensation cost and then periodically adjusted on the basis of any
revisions to the forfeiture estimate, with a final true-up based on actual
forfeitures.
However, if an entity elects as an accounting policy to account for forfeitures as they occur, all dividends paid on dividend-protected equity-classified awards (i.e., both forfeitable and nonforfeitable dividends) are initially charged to retained earnings and, if nonforfeitable, reclassified to compensation cost if and when forfeitures of the underlying awards occur.
While ASC 718 does not specifically address the appropriate treatment of dividend-protected liability-classified awards, we believe that by analogy to ASC 480-10-55-14 and ASC 480-10-55-28, such dividends should be recognized as compensation cost.
ASC 718-740-45-8 indicates that if an entity receives a tax deduction for dividends paid, any income tax expense or benefit related to dividend or dividend equivalents paid to grantees must be recognized in the income statement, even if charged to retained earnings.
An entity that uses an option-pricing model to estimate the fair-value-based measure of a stock option usually takes expected dividends into account because dividends paid on the underlying shares are part of the fair value of those shares, and option holders generally are not entitled to receive those dividends. However, for dividend-protected awards, the entity should appropriately reflect that dividend protection in estimating the fair-value-based measure of a stock option. For example, an entity could appropriately reflect the effect of the dividend protection by using an expected dividend yield input of zero if all dividends paid to shareholders are applied to reduce the exercise price of the options being valued.
Note that if any dividends are nonforfeitable, the awards would be considered
“participating securities” in the EPS calculation. See Section 12.4.3 for a discussion of the effect
of dividend-paying share-based payment awards on the computation of EPS. Further
note that irrespective of whether an award is dividend-protected, the accounting for
a large, nonrecurring cash dividend for an equity-classified award in connection
with an equity restructuring differs from the accounting discussed above and may
result in both a partial settlement of vested awards and a partial modification from
equity to liability classification of unvested awards, as illustrated in Example 6-34 in Section 6.10.2.
Example 3-36
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options, each with a grant-date fair-value-based measure of $100. The options vest at the end of one year of service (cliff vesting). The option holders will receive a cash amount per option that is equal to the dividends paid per share to common shareholders during the vesting period. Employees are not required to return the dividends received if they forfeit their options. On July 1, 20X1, A declares a dividend of $1 per share. Entity A has elected as an accounting policy to estimate the number of awards expected to be forfeited, and it has estimated a forfeiture rate of 10 percent. See the journal entries below.
In the fourth quarter, A experiences lower turnover than expected. On December 31, 20X1, 980 of the 1,000 options that were granted become vested. On that date, A would record the journal entries below.
In the journal entries below, assume the same facts as those above except that
Entity A has elected as an accounting policy to account for
forfeitures as they occur.
In the fourth quarter, 20 options were forfeited, and on December 31, 20X1, the remaining 980 of the 1,000 options that were granted become vested. On that date, A would record the journal entries below.
Footnotes
6
As discussed in Section 3.4.1, an entity can make a
different accounting policy election between employee and nonemployee awards
to either estimate forfeitures or account for forfeitures when they occur.