3.7 Multiple Conditions for Employee Awards

ASC 718-10

Market, Performance, and Service Conditions

25-20 Accruals of compensation cost for an award with a performance condition shall be based on the probable outcome of that performance condition — compensation cost shall be accrued if it is probable that the performance condition will be achieved and shall not be accrued if it is not probable that the performance condition will be achieved. If an award has multiple performance conditions (for example, if the number of options or shares a grantee earns varies depending on which, if any, of two or more performance conditions is satisfied), compensation cost shall be accrued if it is probable that a performance condition will be satisfied. In making that assessment, it may be necessary to take into account the interrelationship of those performance conditions. Example 2 (see paragraph 718-20-55-35) provides an illustration of how to account for awards with multiple performance conditions.

25-21 If an award requires satisfaction of one or more market, performance, or service conditions (or any combination thereof), compensation cost shall be recognized if the good is delivered or the service is rendered, and no compensation cost shall be recognized if the good is not delivered or the service is not rendered. Paragraphs 718-10-55-60 through 55-63 provide guidance on applying this provision to awards with market, performance, or service conditions (or any combination thereof).

Performance or Service Conditions

30-12 Awards of share-based compensation ordinarily specify a performance condition or a service condition (or both) that must be satisfied for a grantee to earn the right to benefit from the award. No compensation cost is recognized for instruments forfeited because a service condition or a performance condition is not satisfied (for example, instruments for which the good is not delivered or the service is not rendered). Examples 1 through 2 (see paragraphs 718-20-55-4 through 55-40) and Example 1 (see paragraph 718-30-55-1) provide illustrations of how compensation cost is recognized for awards with service and performance conditions.

Market, Performance, and Service Conditions That Affect Vesting and Exercisability

55-61 Analysis of the market, performance, or service conditions (or any combination thereof) that are explicit or implicit in the terms of an award is required to determine the employee’s requisite service period or the nonemployee’s vesting period over which compensation cost is recognized and whether recognized compensation cost may be reversed if an award fails to vest or become exercisable (see paragraph 718-10-30-27). If exercisability or the ability to retain the award (for example, an award of equity shares may contain a market condition that affects the grantee’s ability to retain those shares) is based solely on one or more market conditions compensation cost for that award is recognized if the grantee delivers the promised good or renders the service, even if the market condition is not satisfied. If exercisability (or the ability to retain the award) is based solely on one or more market conditions, compensation cost for that award is reversed if the grantee does not deliver the promised good or render the service, unless the market condition is satisfied prior to the end of the employee’s requisite service period or the nonemployee’s vesting period, in which case any unrecognized compensation cost would be recognized at the time the market condition is satisfied. If vesting is based solely on one or more performance or service conditions, any previously recognized compensation cost is reversed if the award does not vest (that is, the good is not delivered or the service is not rendered or the performance condition is not achieved). Examples 1 through 4 (see paragraphs 718-20-55-4 through 55-50) provide illustrations of awards in which vesting is based solely on performance or service conditions.

55-61A An employee award containing one or more market conditions may have an explicit, implicit, or derived service period. Paragraphs 718-10-55-69 through 55-79 provide guidance on explicit, implicit, and derived service periods.

55-62 Vesting or exercisability may be conditional on satisfying two or more types of conditions (for example, vesting and exercisability occur upon satisfying both a market and a performance or service condition). Vesting also may be conditional on satisfying one of two or more types of conditions (for example, vesting and exercisability occur upon satisfying either a market condition or a performance or service condition). Regardless of the nature and number of conditions that must be satisfied, the existence of a market condition requires recognition of compensation cost if the good is delivered or the service is rendered, even if the market condition is never satisfied.

55-63 Even if only one of two or more conditions must be satisfied and a market condition is present in the terms of the award, then compensation cost is recognized if the good is delivered or the service is rendered, regardless of whether the market, performance, or service condition is satisfied (see Example 5 [paragraph 718-10-55-100] for an example of such an employee award).

55-66 The following flowchart provides guidance on determining how to account for an award based on the existence of market, performance, or service conditions (or any combination thereof).

Accounting for Awards With Market, Performance, or Service Conditions

(a) The award shall be classified and accounted for as equity. Market conditions are included in the grant-date fair value estimate of the award.

(b) Performance and service conditions that affect vesting are not included in estimating the grant-date fair value of the award. Performance and service conditions that affect the exercise price, contractual term, conversion ratio, or other pertinent factors affecting the fair value of an award are included in estimating the grant-date fair value of the award.

55-72 An award with a combination of market, performance, or service conditions may contain multiple explicit, implicit, or derived service periods. For such an award, the estimate of the requisite service period shall be based on an analysis of all of the following:

All vesting and exercisability conditions
All explicit, implicit, and derived service periods
The probability that performance or service conditions will be satisfied.

55-73 Thus, if vesting (or exercisability) of an award is based on satisfying both a market condition and a performance or service condition and it is probable that the performance or service condition will be satisfied, the initial estimate of the requisite service period generally is the longest of the explicit, implicit, or derived service periods. If vesting (or exercisability) of an award is based on satisfying either a market condition or a performance or service condition and it is probable that the performance or service condition will be satisfied, the initial estimate of the requisite service period generally is the shortest of the explicit, implicit, or derived service periods.

55-74 For example, a share option might specify that vesting occurs after three years of continuous employee service or when the employee completes a specified project. The employer estimates that it is probable that the project will be completed within 18 months. The employer also believes it is probable that the service condition will be satisfied. Thus, that award contains an explicit service period of 3 years related to the service condition and an implicit service period of 18 months related to the performance condition. Because it is considered probable that both the performance condition and the service condition will be achieved, the requisite service period over which compensation cost is recognized is 18 months, which is the shorter of the explicit and implicit service periods.

55-75 As illustrated in the preceding paragraph, if an award vests upon the earlier of the satisfaction of a service condition (for example, four years of service) or the satisfaction of one or more performance conditions, it will be necessary to estimate when, if at all, the performance conditions are probable of achievement. For example, if initially the four-year service condition is probable of achievement and no performance condition is probable of achievement, the requisite service period is four years. If one year into the four-year requisite service period a performance condition becomes probable of achievement by the end of the second year, the requisite service period would be revised to two years for attribution of compensation cost (at that point in time, there would be only one year of the two-year requisite service period remaining).

55-76 If an award vests upon the satisfaction of both a service condition and the satisfaction of one or more performance conditions, the entity also must initially determine which outcomes are probable of achievement. For example, an award contains a four-year service condition and two performance conditions, all of which need to be satisfied. If initially the four-year service condition is probable of achievement and no performance condition is probable of achievement, then no compensation cost would be recognized unless the two performance conditions and the service condition subsequently become probable of achievement. If both performance conditions become probable of achievement one year after the grant date and the entity estimates that both performance conditions will be achieved by the end of the second year, the requisite service period would be four years as that is the longest period of both the explicit service period and the implicit service periods. Because the performance conditions are now probable of achievement, compensation cost will be recognized in the period of the change in estimate (see paragraph 718-10-35-3) as the cumulative effect on current and prior periods of the change in the estimated number of awards for which the requisite service is expected to be rendered. Therefore, compensation cost for the first year will be recognized immediately at the time of the change in estimate for the awards for which the requisite service is expected to be rendered. The remaining unrecognized compensation cost for those awards would be recognized prospectively over the remaining requisite service period. An entity that has an accounting policy to account for forfeitures when they occur in accordance with paragraph 718-10-35-3 would assume that the achievement of a service condition is probable when determining the amount of compensation cost to recognize unless the award has been forfeited.

If a share-based payment award contains multiple conditions (service, performance, or market) that affect a grantee’s ability to vest in or exercise the award, an entity recognizes compensation cost associated with the award on the basis of whether all or just one of the conditions must be met for the grantee to vest in or exercise the award. For employee awards, this analysis also affects the requisite service period. As discussed in Section 3.6, for certain nonemployee awards, an entity may analogize to the guidance on calculating a requisite service period when that guidance is relevant to the entity’s determination of whether it should recognize compensation cost. For additional discussion of a nonemployee’s vesting period, see Section 9.3.2.

The table below contains answers to questions about various scenarios in which an award has two conditions that affect an employee’s requisite service period and the subsequent recognition of compensation cost.

Answer if the award consists of:
Question	A market condition or a performance/ service condition that must be met for the employee to vest in or exercise the award	A market condition and a performance/ service condition that must be met for the employee to vest in or exercise the award	A service condition or a performance condition that must be met for the employee to vest in or exercise the award	A service condition and a performance condition that must be met for the employee to vest in or exercise the award
What is the requisite service period if all performance/service conditions are probable?	The shortest of the derived, implicit, or explicit service period.	The longest of the derived, implicit, or explicit service period.	The shorter of the implicit or explicit service period.	The longer of the implicit or explicit service period.
How is the requisite service period affected if one of the performance/service conditions is not probable?	The derived service period is the requisite service period because the performance/service condition is excluded from the assessment of the requisite service period. However, If an entity has a policy of recognizing forfeitures when they occur, and there is not a performance condition (i.e., there is a market condition and a service condition), the requisite service period is the shorter of the derived or explicit service period.	Compensation cost is not recorded until it is probable that the award will vest. However, if an entity has a policy of recognizing forfeitures when they occur, and there is not a performance condition (i.e., there is a market condition and a service condition), the requisite service period is the longer of the derived or explicit service period.	The implicit/explicit service period associated with the other vesting condition is the requisite service period. Since meeting the performance/service condition is not probable, it is excluded from the assessment of the requisite service period. However, if an entity has a policy of recognizing forfeitures when they occur and the performance condition is probable, the requisite service period is the shorter of the implicit or explicit service period.	Compensation cost is not recorded until it is probable that the award will vest. If an entity has a policy of recognizing forfeitures when they occur, and meeting the performance condition is probable, the requisite service period is the longer of the implicit or explicit service period.
Under what circumstances can an entity reverse previously accrued compensation cost and record no compensation cost for the award?	The employee is expected to forfeit the award (if an entity’s policy is to estimate forfeitures) or actually forfeits the award (if an entity’s policy is to recognize forfeitures when they occur) before the end of the derived service period and before the performance/service condition is met.	The employee is expected to forfeit the award (if an entity’s policy is to estimate forfeitures) or actually forfeits the award (if an entity’s policy is to recognize forfeitures when they occur) before the end of the derived service period or before the performance/service condition is met.	The employee is expected to forfeit the award (if an entity’s policy is to estimate forfeitures) or actually forfeits the award (if an entity’s policy is to recognize forfeitures when they occur) before the service and performance conditions are met.	The employee is expected to forfeit the award (if an entity’s policy is to estimate forfeitures) or actually forfeits the award (if an entity’s policy is to recognize forfeitures when they occur) before the service or performance condition is met.
Does an entity subsequently revise the initial estimate of the derived service period on the basis of updated assumptions?	No, unless the market condition is met earlier than estimated if the award is equity-classified. If the award is liability-classified, there are two acceptable approaches. See Section 7.2.2.	No, unless the market condition is met earlier than estimated if the award is equity-classified. If the award is liability-classified, there are two acceptable approaches. See Section 7.2.2.	N/A	N/A
Does an entity subsequently revise the estimate of an implicit service period for updated assumptions?	Yes.	Yes.	Yes.	Yes.

3.7.1 Only One Condition Must Be Met — Employee Awards

If the terms of an award contain multiple conditions but only one condition must be met for an employee to vest in or exercise the award, the requisite service period is the shortest of the explicit, implicit, or derived service period because the employee must only remain employed until any one of the conditions is met. Compensation cost should be recognized over that requisite service period.

A condition that is not expected to be met must be excluded from the determination of the shortest of the explicit, implicit, or derived service period. However, if an entity has a policy of recognizing forfeitures when they occur, it would not disregard any service condition in the determination of the requisite service period; rather, the entity would assume that a service condition would be met unless the award is actually forfeited. If the award is forfeited in the future (on the basis of the service condition), the service condition can no longer be used as the basis for the requisite service period.

If an award that is classified as equity includes a market condition and neither that nor any other condition was ultimately met, compensation cost should still be recorded as long as the employee provides the requisite service under the market condition’s derived service period. An entity should not consider the probability that the market condition will be met when it recognizes compensation cost because a market condition is not a vesting condition. Rather, it should factor the probability of meeting the market condition into the fair-value-based measure of the award.

ASC 718-10-55-100 through 55-105 provide an example of an award in which only the market condition or the service condition must be met for the award to vest.

ASC 718-10

Example 5: Employee Share-Based Payment Award With Market and Service Conditions and Multiple Service Periods

55-100 The following Cases illustrate the guidance in paragraph 718-10-35-5 applicable to employee awards in circumstances in which an award includes both a market condition and a service condition:

When only one condition must be met (Case A)
When both conditions must be met (Case B).

55-101 Cases A and B share the following assumptions.

55-102 On January 1, 20X5, Entity T grants an executive 200,000 share options on its stock with an exercise price of $30 per option. The award specifies that vesting (or exercisability) will occur upon the earlier of the following for Case A or both are met for Case B:

The share price reaching and maintaining at least $70 per share for 30 consecutive trading days
The completion of eight years of service.

55-103 The award contains an explicit service period of eight years related to the service condition and a derived service period related to the market condition.

Case A: When Only One Condition Must Be Met

55-104 An entity shall make its best estimate of the derived service period related to the market condition (see paragraph 718-10-55-71). The derived service period may be estimated using any reasonable methodology, including Monte Carlo simulation techniques. For this Case, the derived service period is assumed to be six years. As described in paragraphs 718-10-55-72 through 55-73, if an award’s vesting (or exercisability) is conditional upon the achievement of either a market condition or performance or service conditions, the requisite service period is generally the shortest of the explicit, implicit, and derived service periods. In this Case, the requisite service period over which compensation cost would be attributed is six years (shorter of eight and six years). (An entity may grant a fully vested deep out-of-the-money share option that would lapse shortly after termination of service, which is the equivalent of an award with both a market condition and a service condition. The explicit service period associated with the explicit service condition is zero; however, because the option is deep out-of-the-money at the grant date, there would be a derived service period.)

55-105 Continuing with this Case, if the market condition is actually satisfied in February 20X9 (based on market prices for the prior 30 consecutive trading days), Entity T would immediately recognize any unrecognized compensation cost because no further service is required to earn the award. If the market condition is not satisfied as of that date but the executive renders the six years of requisite service, compensation cost shall not be reversed under any circumstances.

Example 3-24

Service or Performance Condition

On January 1, 20X1, Entity A grants employee stock options that vest upon the earlier of (1) the end of the fifth year of service (cliff vesting) or (2) A’s obtaining a patent for the prescription drug it is currently developing. Entity A believes that it is probable that the patent will be obtained at the end of four years. The options contain an explicit service condition (i.e., the options vest at the end of the fifth year of service) and a performance condition (i.e., the options vest when the entity obtains a patent for the prescription drug it is currently developing), with an implicit service period of four years. Because the options vest when either condition is met, the requisite service period is the shorter of the two service periods: four years.

The implicit service period is simply an estimate. Therefore, if the award becomes exercisable because the patent is obtained before A’s original estimate of four years, A should immediately record any unrecognized compensation cost on the date the performance condition is met.

Example 3-25

Service or Market Conditions

On January 1, 20X1, when Entity A’s share price is $25 per share, A grants equity-classified employee stock options that vest on the earlier of (1) the end of the fifth year of service (cliff vesting) or (2) an increase in A’s share price to $50 per share. By using a lattice model valuation technique, A estimates that its share price will reach $50 in four years.

The options contain an explicit service condition (i.e., the options vest at the end of the fifth year of service) and a market condition (i.e., the options vest if A’s share price increases to $50 per share), with a derived service period of four years. Because the options vest when either condition is met, the requisite service period is the shorter of the two service periods: four years. If the options vest sooner because the $50 share price target is attained before the derived service period of four years, A should immediately record any unrecognized compensation cost on the date the market condition is met. Conversely, if the options never become exercisable because the share price target is never achieved, but the employee remains employed for at least four years, compensation cost should still be recorded.

Example 3-26

Performance or Market Conditions

On January 1, 20X1, when its share price is $30 per share, Entity A grants equity-classified employee stock options that vest on the basis of continued employment through the earlier of (1) the launch of Product X within six years of the grant date (i.e., a performance condition) or (2) an increase in A’s share price to $45 per share within six years of the grant date (i.e., a market condition). By using a lattice model valuation technique, A estimates that its share price will reach $45 in four years and that the grant-date fair-value-based measure of each stock option is $5 if the market condition is included in the calculation and $7 if the market condition is not included.

For an award in which vesting or exercisability is based on a market or performance condition, an entity would determine the grant-date fair-value-based measure separately depending on whether the market condition is included in the calculation. The total amount of compensation recognized over the award’s service period would depend on whether the performance condition is probable.

On January 1, 20X1, it is determined that it is not probable that the performance condition will occur. Accordingly, A concludes that the requisite service period is the derived service period of four years.

If it continues not to be probable that the performance condition will occur during the requisite four-year service period, A would recognize compensation over such period at a grant-date fair-value-based measure of $5 per option. If the options vest sooner because the $45 share price target is attained before the derived service period of four years, A should immediately record any unrecognized compensation cost by using the grant-date fair-value-based measure of $5 on the date the market condition is met.

However, if the entity determines that it is probable that the launch of Product X will occur before the market condition is achieved, A should recognize compensation cost by using the grant-date fair-value-based measure of $7 over the applicable requisite service period.

Conversely, if (1) the options never become exercisable because the share price target is never achieved and Product X is not launched within six years of the grant date and (2) the employee completes the derived service period of four years, A should still record compensation cost but use the grant-date fair-value-based measure of $5.

3.7.2 Multiple Conditions Must Be Met — Employee Awards

If all of the conditions in the terms of an award must be met for an employee to vest in or exercise the award, the requisite service period is the longest of the explicit, implicit, or derived service period because the employee must still be employed when the last condition is met. Compensation cost should be recognized over that requisite service period.

However, when one of the conditions is a service or performance condition, recognition of compensation cost will depend on the probability that the condition will be met. That is, if it is not probable that the service or performance condition will be met, no compensation cost should be recognized.

On the other hand, if one of the conditions is a market condition, the entity should not consider the probability of meeting the market condition when it recognizes compensation cost because a market condition is not a vesting condition. Rather, the probability of meeting the market condition should be factored into the fair-value-based measure of the award. See Section 4.5 for a discussion of how a market condition affects the valuation of a share-based payment award. Even if the market condition is never met, compensation cost should be recognized if the employee provides the requisite service and the other vesting conditions are met.

For awards that include a performance condition and a service condition, an entity should consider the probability that the conditions will be met independently. For example, if it is probable that the performance condition will be met, the entity should still consider its policy election for forfeiture estimates with respect to the service condition when recognizing compensation cost. Conversely, if an entity has a policy of recognizing forfeitures when they occur, it would assume that the service condition will be met unless the award is actually forfeited. In this case, it considers only the probability of a performance condition and would recognize compensation cost only if it is probable that such condition will be met.

Case B in ASC 718-10-55-106 is based on the same facts as in ASC 718-10-55-100 through 55-103 (see Section 3.7.1) and illustrates an award in which both a market condition and a service condition must be met for the award to vest.

ASC 718-10

Case B: When Both the Market and Service Condition Must Be Met

55-106 The initial estimate of the requisite service period for an award requiring satisfaction of both market and performance or service conditions is generally the longest of the explicit, implicit, and derived service periods (see paragraphs 718-10-55-72 through 55-73). For example, if the award described in Case A [see Section 3.7.1] required both the completion of 8 years of service and the share price reaching and maintaining at least $70 per share for 30 consecutive trading days, compensation cost would be recognized over the 8-year explicit service period. If the employee were to terminate service prior to the eight-year requisite service period, compensation cost would be reversed even if the market condition had been satisfied by that time.

Example 3-27

Both a Service Condition and a Performance Condition

On January 1, 20X1, Entity A grants employee stock options that vest at the end of the fourth year of service (cliff vesting). The options can be exercised only by employees who are still employed by the entity when it successfully completes an IPO.

The options contain an explicit service condition (i.e., the options vest at the end of the fourth year of service) and a performance condition (i.e., the options can be exercised only upon successful completion of an IPO by employees who are still employed by A upon the IPO’s completion). Entity A’s treatment of the exercisability condition should be similar to its treatment of a vesting requirement. Under ASC 718-10-55-76, if the vesting (or exercisability) of an award is based on the satisfaction of both a service and performance condition, the entity must initially determine which outcomes are probable and recognize the compensation cost over the longer of the explicit or implicit service period. Because an IPO generally is not considered to be probable until the IPO is effective, no compensation cost would be recognized until the IPO occurs. For example, if an IPO becomes effective on December 31, 20X2, and the four years of service are expected to be rendered upon the IPO’s becoming effective, A would (1) recognize a cumulative-effect adjustment to compensation cost for the service that has already been provided (two of the four years) and (2) record the unrecognized compensation cost ratably over the remaining two years of service.

Example 3-28

Both a Service Condition and a Market Condition

On January 1, 20X1, Entity A grants employee stock options that vest if A’s share price is at least $50 and the employee provides service for at least one year (to exercise the options, the employee must also be employed when the share price is at least $50). Using a Monte Carlo valuation technique, A estimates that its share price will reach $50 in three years.

The options contain an explicit service condition (i.e., the options vest at the end of one year of service) and a market condition (i.e., the options become exercisable if A’s share price is at least $50 per share), with a three-year derived service period. Because the options vest when both conditions are met, the requisite service period is the longer of the two service periods — three years. In addition, because a market condition is not a vesting condition, the market condition should be factored into the fair-value-based measure of the options. In accordance with ASC 718-10-30-14, as long as the employee provides service for three years, compensation cost must be recognized regardless of whether the market condition is satisfied.

If, to vest in the award, the employee was not required to be employed at the time the market condition is met, the derived service period would not be relevant since there would be no requisite service requirement tied to achievement of the target share price.

Example 3-29

Both a Performance Condition and a Market Condition

On January 1, 20X1, Entity A grants employee stock options that vest if (1) A’s share price is at least $50 and (2) A’s cumulative net income over the next two annual reporting periods exceeds $12 million. As of January 1, 20X1, A’s share price is $40. By using a Monte Carlo valuation technique, A estimates that its share price will reach $50 in three years.

The options contain a performance condition (i.e., the options vest if A exceeds $12 million in cumulative net income over the next two annual reporting periods) and a market condition (i.e., the options vest if A’s share price is at least $50 per share), with a derived service period of three years. Since the market condition is not a vesting condition, the market condition should be factored into the fair-value-based measure of the options.

The award’s vesting is based on the satisfaction of both a market condition and a performance condition, and if it is probable that the performance condition will be satisfied in accordance with ASC 718-10-55-73, the initial estimate of the requisite service period would generally be the longest of the explicit, implicit, or derived service period. The performance condition provides an explicit service period of two years. The three-year derived service period is based on an increase in A’s share price to $50. Since the derived service period of three years represents the longer of the two service periods, compensation cost would be recognized over that three-year period.

If the market condition is satisfied on an earlier date, any unrecognized compensation cost would be recognized immediately upon its satisfaction. However, this accelerated service period cannot be shorter than the explicit service period of two years that is associated with the performance condition. Note that in accordance with ASC 718-10-25-20, if meeting the performance condition were to become improbable, all previously recognized compensation cost would be reversed. In addition, if the options never vest because the share price target is never achieved, but the employee remains employed for at least the derived service period of three years and the performance condition is satisfied, compensation cost still should be recorded.

Example 3-30

Both a Performance Condition and a Market Condition — Payoff Matrix

On January 1, 20X1, Entity A grants to its employees 100,000 equity-classified RSUs with a four-year service period (cliff vesting). The number of RSUs that vest will be determined at the end of the four-year service period on the basis of the combination of an EBITDA outcome (i.e., performance conditions) and a TSR outcome (i.e., a market condition). The threshold outcomes for both conditions must be met for the employees to vest in any portion of the award. The number of RSUs that vest is determined in accordance with the following payoff matrix:

Assume that the grant-date fair-value-based measure of each RSU is $25 (determined by using a Monte Carlo valuation technique), which incorporates the possible outcomes of the market condition (i.e., the TSR). Compensation cost is recognized by using the number of shares expected to vest on the basis of (1) the outcome of the performance condition and (2) the target market condition. If A estimates that the service and performance conditions will be achieved at the target outcome, total compensation cost would be $2.5 million (100,000 RSUs × $25 grant-date fair-value-based measure × 100%).

If the outcome of the performance condition is different from the initial estimate, compensation cost is adjusted. However, compensation cost is not adjusted for changes in the outcome of the market condition, because the RSUs’ grant-date fair-value-based measure of $25 already takes into account the potential outcomes of the market condition. For example, if the outcome of the performance condition is the maximum amount, A would recognize $3.75 million (100,000 RSUs × $25 grant-date fair-value-based measure × 150%) of compensation cost, irrespective of the outcome of the market condition.

Example 3-31

Both a Performance Condition and a Market Condition — Two Awards

On January 1, 20X1, Entity A grants to its employees 100,000 equity-classified RSUs. The number of RSUs earned is based on (1) a range of A’s revenue growth objectives (i.e., performance conditions) and (2) a specified stock price objective (i.e., a market condition) over the year ending December 31, 20X1.

A revenue growth objective includes a minimum threshold for vesting in 20 percent (i.e., 20,000) of the RSUs, a target threshold for vesting in 50 percent (i.e., 50,000) of the RSUs, and a maximum threshold for vesting in 100 percent (100,000) of the RSUs. If the target or maximum growth objective is met and the stock price objective is met, the number of RSUs earned will increase by 50 percent. Therefore, up to 150 percent of the awards can be earned if both (1) the maximum (i.e., 100 percent) revenue growth objective and (2) the stock price objective are met. If only the minimum growth objective is met, the stock price objective will have no effect on the RSUs earned.

In this example, unlike the scenario in the previous example, 20,000 RSUs may be earned solely on the basis of the achievement of the performance condition (i.e., the revenue growth objective). Therefore, the 20,000 RSUs may be accounted for separately and the grant-date fair-value-based measurement should not incorporate the market condition associated with the stock price objective because the 20,000 RSUs can be earned and remain unaffected by whether the stock price objective is achieved if only the minimum growth objective is met.

The remainder of the RSUs may be evaluated separately since they are subject to both a performance condition and a market condition. If the stock price objective is met, either 75,000 or 150,000 RSUs may vest depending on the outcome of the revenue growth objective. If the stock price objective is not met, either 50,000 or 100,000 RSUs may vest depending on the outcome of the revenue growth objective. Because it may be challenging to determine the grant-date fair-value-based measure for the portion of an award that excludes RSUs that may be earned solely on the basis of the achievement of a performance condition, companies should consult with their valuation specialists for assistance.

3.7.2.1 Liquidity Event and Target IRR

The accounting for share-based payment awards that contain multiple conditions is based on the type of conditions (service, performance, or market) associated with the awards. For example, certain awards may vest only if both:

A target IRR to shareholders is achieved while the grantee is employed.
The IRR is based on the payment of sufficient proceeds tendered (1) as a result of either a full or partial sale of the shareholders’ equity (e.g., because of a liquidity event) or (2) through distributions (e.g., dividends).

In such cases, we believe that attaining a specified IRR that is based on the payment of sufficient proceeds made as a result of either a full or partial sale of the shareholders’ equity is functionally equivalent to achieving a specified rate of return on an entity’s stock, which is an example of a market condition under ASC 718 (see Section 3.5).

Market conditions are treated as nonvesting conditions that are factored into the award’s fair-value-based measure. Further, the award’s ability to vest on the basis of (1) sufficient proceeds distributed to shareholders (e.g., dividends) or (2) the sale of sufficient equity each represents a performance condition under ASC 718 (see Section 3.4.2). Therefore, this type of award vests on the basis of a performance condition (i.e., sufficient proceeds) or a performance and market condition (i.e., the sale of sufficient equity to achieve the IRR).

In determining the award’s requisite service period, an entity must consider the multiple conditions associated with it (see Section 3.7). Accordingly, during the service (vesting) period, an entity would assess the probability that any performance conditions (i.e., the payment of sufficient proceeds either through distributions or the sale of sufficient equity) will be met (i.e., the probability that the employee will earn the award). However, the entity may conclude that it is not probable that there will be sufficient proceeds through distributions for the specified IRR to be attained and that for the award to vest, a liquidity event would be necessary in which the payment of sufficient proceeds could be made through a full or partial sale of the shareholders’ equity. Therefore, although a liquidity event may not be an explicit vesting condition, the probability that a liquidity event will occur may govern whether the performance condition (i.e., the sale of sufficient equity) is achieved.

An entity generally does not recognize compensation cost related to awards that vest upon certain liquidity events such as a change in control or an IPO until the event takes place (see Section 3.4.2.1). That is, a change in control or an IPO is generally not considered probable until it occurs. This position is consistent with the guidance in ASC 805-20-55-50 and 55-51 on liabilities that are triggered upon the consummation of a business combination. Thus, if it is not probable that (1) the entity will declare and pay sufficient distributions to meet the IRR target and (2) sufficient equity will be sold, the entity should not record any compensation cost. However, if a liquidity event occurs that results in the sale of all relevant equity and satisfaction of the requisite service period, compensation cost should be recognized regardless of whether the IRR target is achieved. Similarly, in circumstances in which it is explicit that the IRR market condition must be met upon the occurrence of a liquidity event, compensation cost would be recognized as of the date of the liquidity event regardless of whether the IRR market condition has been met because a market condition is factored into the fair-value-based measure of the award.

Further, in instances in which the IRR market condition can only be met upon the occurrence of the liquidity event, the entity does not need to calculate a derived service period to determine the requisite service period. In that scenario, the implicit service period is determined on the basis of the expected date of the liquidity event, so the requisite service period would always equal the implicit service period. However, because the occurrence of a liquidity event is generally not considered probable until the event has occurred, no compensation cost would be recognized until such time.

Example 3-32

Entity C was formed with two classes of legal-form equity: Series A Units and Series B Units. The Series A Units were issued by C in exchange for a capital contribution from P, a private equity investment fund.

Entity C granted 1,000 Series B Units to its employees. The Series B Units vest on the basis of a target MOIC and IRR on the capital contribution from P for the Series A Units. The MOIC and IRR on the Series A Units are based on the payment of sufficient proceeds tendered (1) as a result of either a full or partial sale of the target shareholder’s equity (e.g., a liquidity event) or (2) through distributions (e.g., dividends) to the Series A Unit holders. The number of Series B Units that vest on the basis of the target MOIC and the IRR are as follows:

Forty percent upon a 2.00 × MOIC and 15% IRR.
An additional 30% upon a 2.50 × MOIC and 20% IRR.
The remaining 30% upon a 3.00 × MOIC and 25% IRR.

The requirements to achieve a target MOIC and IRR based on the sale of equity represent market conditions because they depend on a specified return on the Series A Units. Market conditions are treated as nonvesting conditions that are factored into the fair-value-based measure of the award. The requirements that the award vest on the basis of sufficient proceeds through distributions or through the sale of sufficient equity by P represent performance conditions under ASC 718.

During the service (vesting) period, an entity must assess the probability that any performance condition (i.e., the payment of sufficient proceeds either through distributions or the sale of sufficient equity) will be met. For example, if it is not probable that the entity will declare and pay sufficient distributions to meet the IRR and MOIC target or that, in the absence of a liquidity event, sufficient equity would be sold, the entity should not record any compensation cost.

3.7.2.2 Multiple Performance Conditions That Affect Vesting and Nonvesting Factors

If a share-based payment award contains multiple performance conditions that affect both vesting factors and nonvesting (e.g., exercise price) factors, a grant-date fair-value-based measure should be calculated for each possible nonvesting condition outcome. If the vesting condition is not expected to be met, no compensation cost should be recorded. If the vesting condition is expected to be met, the amount of compensation cost should be based on the grant-date fair-value-based measure associated with the nonvesting condition outcome whose achievement is probable. This analysis applies to both employee and nonemployee awards. See Section 4.6 for a discussion of the effect of performance conditions that affect factors other than vesting or exercisability.

Example 3-33

On January 1, 20X1, Entity A grants 1,000 equity-classified at-the-money employee stock options with an exercise price of $10. The options vest in two years if its EBITDA growth rate exceeds the industry average by 10 percent. The grant-date fair-value-based measure of this option is $3. However, the exercise price will be reduced to $5 if regulatory approval for Product X is obtained within two years. The grant-date fair-value-based measure of this option with the reduced exercise price is $6.

The EBITDA target is expected to be achieved by December 31, 20X2, but it is not probable that regulatory approval will be obtained by that time. Therefore, compensation cost of $1,500 should be recorded in 20X1 (1,000 options × $3 grant-date fair-value-based measure × 50% for one of two years of service provided).

On December 31, 20X2, regulatory approval is obtained and A’s EBITDA target is met. Therefore, in 20X2, A should recognize compensation cost of $4,500, or (1,000 options × $6 grant-date fair-value-based measure × 100% of services provided) – $1,500 of compensation cost previously recognized.

3.7.3 Multiple Conditions and Multiple Service Periods — Employee Awards

An award’s terms and conditions can sometimes result in multiple service periods. In such cases, an entity must evaluate each condition to determine whether there are multiple (1) grant dates, (2) service inception dates, and (3) service periods. The examples below in ASC 718 illustrate scenarios in which multiple service periods can exist.

3.7.3.1 Multiple Performance Conditions and Multiple Service Periods

ASC 718-10

Example 3: Employee Share-Based Payment Award With a Performance Condition and Multiple Service Periods

55-92 The following Cases illustrate employee share-based payment awards with a performance condition (see paragraphs 718-10-25-20 through 25-21; 718-10-30-27; and 718-10-35-4) and multiple service dates:

Performance targets are set at the inception of the arrangement (Case A).
Performance targets are established at some time in the future (Case B).
Performance targets established up front but vesting is tied to the vesting of a preceding award (Case C).

55-93 Cases A, B, and C share the following assumptions:

On January 1, 20X5, Entity T enters into an arrangement with its chief executive officer relating to 40,000 share options on its stock with an exercise price of $30 per option.
The arrangement is structured such that 10,000 share options will vest or be forfeited in each of the next 4 years (20X5 through 20X8) depending on whether annual performance targets relating to Entity T’s revenues and net income are achieved.

Case A: Performance Targets Are Set at the Inception of the Arrangement

55-94 All of the annual performance targets are set at the inception of the arrangement. Because a mutual understanding of the key terms and conditions is reached on January 1, 20X5, each tranche would have a grant date and, therefore, a measurement date, of January 1, 20X5. However, each tranche of 10,000 share options should be accounted for as a separate award with its own service inception date, grant-date fair value, and 1-year requisite service period, because the arrangement specifies for each tranche an independent performance condition for a stated period of service. The chief executive officer’s ability to retain (vest in) the award pertaining to 20X5 is not dependent on service beyond 20X5, and the failure to satisfy the performance condition in any one particular year has no effect on the outcome of any preceding or subsequent period. This arrangement is similar to an arrangement that would have provided a $10,000 cash bonus for each year for satisfaction of the same performance conditions. The four separate service inception dates (one for each tranche) are at the beginning of each year.

Case B: Performance Targets Are Established at Some Time in the Future

55-95 If the arrangement had instead provided that the annual performance targets would be established during January of each year, the grant date (and, therefore, the measurement date) for each tranche would be that date in January of each year (20X5 through 20X8) because a mutual understanding of the key terms and conditions would not be reached until then. In that case, each tranche of 10,000 share options has its own service inception date, grant-date fair value, and 1-year requisite service period. The fair value measurement of compensation cost for each tranche would be affected because not all of the key terms and conditions of each award are known until the compensation committee sets the performance targets and, therefore, the grant dates are those dates.

Case C: Performance Targets Established Up Front but Vesting Is Tied to the Vesting of a Preceding Award

55-96 If the arrangement in Case A instead stated that the vesting for awards in periods from 20X6 through 20X8 was dependent on satisfaction of the performance targets related to the preceding award, the requisite service provided in exchange for each preceding award would not be independent of the requisite service provided in exchange for each successive award. In contrast to the arrangement described in Case A, failure to achieve the annual performance targets in 20X5 would result in forfeiture of all awards. The requisite service provided in exchange for each successive award is dependent on the requisite service provided for each preceding award. In that circumstance, all awards have the same service inception date and the same grant date (January 1, 20X5); however, each award has its own explicit service period (for example, the 20X5 grant has a one-year service period, the 20X6 grant has a two-year service period, and so on) over which compensation cost would be recognized. Because this award contains a performance condition, it is not subject to the attribution guidance in paragraph 718-10-35-8.

Case A of Example 3 in ASC 718-10-55-94 above illustrates a scenario in which the grant date precedes the service inception date. The example describes four tranches with four annual performance targets (i.e., performance conditions) and notes that “the failure to satisfy the performance condition in any one particular year has no effect on the outcome of any preceding or subsequent period.” In accordance with the example, each tranche should be accounted for as a separate award with its own service inception date. This conclusion was reached on the basis of the following facts:

All performance conditions are set at the inception of the arrangement.
The performance condition for each tranche is independent of the other tranches.
The grantee’s ability to vest in the award for each tranche is not based on the service provided beyond the vesting term of that specific tranche.

The guidance in this example should not be applied by analogy to other scenarios. See Section 3.2.3 for additional discussion.

3.7.3.2 Multiple Service Periods Related to Exercise Price

ASC 718-10

Example 4: Employee Share-Based Payment Award With a Service Condition and Multiple Service Periods

55-97 The following Cases illustrate the guidance in paragraph 718-10-30-12 to determine the service period for employee awards with multiple service periods:

Exercise price established at subsequent dates (Case A)
Exercise price established at inception (Case B).

Case A: Exercise Price Established at Subsequent Dates

55-98 The chief executive officer of Entity T enters into a five-year employment contract on January 1, 20X5. The contract stipulates that the chief executive officer will be given 10,000 fully vested share options at the end of each year (50,000 share options in total). The exercise price of each tranche will be equal to the market price at the date of issuance (December 31 of each year in the five-year contractual term). In this Case, there are five separate grant dates. The grant date for each tranche is December 31 of each year because that is the date when there is a mutual understanding of the key terms and conditions of the agreement — that is, the exercise price is known and the chief executive officer begins to benefit from, or be adversely affected by, subsequent changes in the price of the employer’s equity shares (see paragraphs 718-10-55-80 through 55-83 for additional guidance on determining the grant date). Because the awards’ terms do not include a substantive future requisite service condition that exists at the grant date (the options are fully vested when they are issued), and the exercise price (and, therefore, the grant date) is determined at the end of each period, the service inception date precedes the grant date. The requisite service provided in exchange for the first award (pertaining to 20X5) is independent of the requisite service provided in exchange for each consecutive award. The terms of the share-based compensation arrangement provide evidence that each tranche compensates the chief executive officer for one year of service, and each tranche shall be accounted for as a separate award with its own service inception date, grant date, and one-year service period; therefore, the provisions of paragraph 718-10-35-8 would not be applicable to this award because of its structure.

Case B: Exercise Price Established at Inception

55-99 If the arrangement described in Case A provided instead that the exercise price for all 50,000 share options would be the January 1, 20X5, market price, then the grant date (and, therefore, the measurement date) for each tranche would be January 1, 20X5, because that is the date at which there is a mutual understanding of the key terms and conditions. All tranches would have the same service inception date and the same grant date (January 1, 20X5). Because of the nature of this award, Entity T would make a policy decision pursuant to paragraph 718-10-35-8 as to whether it considers the award as in-substance, multiple awards each with its own requisite service period (that is, the 20X5 grant has a one-year service period, the 20X6 grant has a two-year service period, and so on) or whether the entity considers the award as a single award with a single requisite service period based on the last separately vesting portion of the award (that is, a requisite service period of five years). Once chosen, this Topic requires that accounting policy be applied consistently to all similar awards.

3.7.3.3 Multiple Service Periods Related to Transferability

ASC 718-20

Example 4: Share Option Award With Other Performance Conditions

55-47 This Example illustrates the guidance in paragraph 718-10-30-15.

55-47A This Example (see paragraphs 718-20-55-48 through 55-50) describes employee awards. However, the principles on how to account for the various aspects of employee awards, except for the compensation cost attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, the concepts about valuation, expected term, and total compensation cost that should be recognized (that is, the consideration of whether it is probable that performance conditions will be achieved) in paragraphs 718-20-55-48 through 55-50 are equally applicable to nonemployee awards with the same features as the awards in this Example (that is, awards with performance conditions that affect inputs to an award’s fair value). Therefore, the guidance in those paragraphs may serve as implementation guidance for similar nonemployee awards.

55-47B Compensation cost attribution for awards to nonemployees may be the same or different for employee awards. That is because an entity is required to recognize compensation cost for nonemployee awards in the same manner as if the entity had paid cash in accordance with paragraph 718-10-25-2C. Additionally, valuation amounts used in this Example could be different because an entity may elect to use the contractual term as the expected term of share options and similar instruments when valuing nonemployee share-based payment transactions.

55-48 While performance conditions usually affect vesting conditions, they may affect exercise price, contractual term, quantity, or other factors that affect an award’s fair value before, at the time of, or after vesting. This Topic requires that all performance conditions be accounted for similarly. A potential grant-date fair value is estimated for each of the possible outcomes that are reasonably determinable at the grant date and associated with the performance condition(s) of the award (as demonstrated in Example 3 [see paragraph 718-20-55-41)]. Compensation cost ultimately recognized is equal to the grant-date fair value of the award that coincides with the actual outcome of the performance condition(s).

55-49 To illustrate the notion described in the preceding paragraph and attribution of compensation cost if performance conditions have different service periods, assume Entity C grants 10,000 at-the-money share options on its common stock to an employee. The options have a 10-year contractual term. The share options vest upon successful completion of phase-two clinical trials to satisfy regulatory testing requirements related to a developmental drug therapy. Phase-two clinical trials are scheduled to be completed (and regulatory approval of that phase obtained) in approximately 18 months; hence, the implicit service period is approximately 18 months. Further, the share options will become fully transferable upon regulatory approval of the drug therapy (which is scheduled to occur in approximately four years). The implicit service period for that performance condition is approximately 30 months (beginning once phase-two clinical trials are successfully completed). Based on the nature of the performance conditions, the award has multiple requisite service periods (one pertaining to each performance condition) that affect the pattern in which compensation cost is attributed. Paragraphs 718-10-55-67 through 55-79 and 718-10-55-86 through 55-88 provide guidance on estimating the requisite service period of an award. The determination of whether compensation cost should be recognized depends on Entity C’s assessment of whether the performance conditions are probable of achievement. Entity C expects that all performance conditions will be achieved. That assessment is based on the relevant facts and circumstances, including Entity C’s historical success rate of bringing developmental drug therapies to market.

55-50 At the grant date, Entity C estimates that the potential fair value of each share option under the 2 possible outcomes is $10 (Outcome 1, in which the share options vest and do not become transferable) and $16 (Outcome 2, in which the share options vest and do become transferable). The difference in estimated fair values of each outcome is due to the change in estimate of the expected term of the share option. Outcome 1 uses an expected term in estimating fair value that is less than the expected term used for Outcome 2, which is equal to the award’s 10-year contractual term. If a share option is transferable, its expected term is equal to its contractual term (see paragraph 718-10-55-29). If Outcome 1 is considered probable of occurring, Entity C would recognize $100,000 (10,000 × $10) of compensation cost ratably over the 18-month requisite service period related to the successful completion of phase-two clinical trials. If Outcome 2 is considered probable of occurring, then Entity C would recognize an additional $60,000 [10,000 × ($16 – $10)] of compensation cost ratably over the 30-month requisite service period (which begins after phase-two clinical trials are successfully completed) related to regulatory approval of the drug therapy. Because Entity C believes that Outcome 2 is probable, it recognizes compensation cost in the pattern described. However, if circumstances change and it is determined at the end of Year 3 that the regulatory approval of the developmental drug therapy is likely to be obtained in six years rather than four, the requisite service period for Outcome 2 is revised, and the remaining unrecognized compensation cost would be recognized prospectively through Year 6. On the other hand, if it becomes probable that Outcome 2 will not occur, compensation cost recognized for Outcome 2, if any, would be reversed.

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