4.1 Fair-Value-Based Measurement

ASC 718-10 — Glossary

Fair Value

The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale.

ASC 718-10

General

30-1 While some of the material in this Section was written in terms of awards classified as equity, it applies equally to awards classified as liabilities.

Fair-Value-Based

30-2 A share-based payment transaction shall be measured based on the fair value (or in certain situations specified in this Topic, a calculated value or intrinsic value) of the equity instruments issued.

30-3 An entity shall account for the compensation cost from share-based payment transactions in accordance with the fair-value-based method set forth in this Topic. That is, the cost of goods obtained or services received in exchange for awards of share-based compensation generally shall be measured based on the grant-date fair value of the equity instruments issued or on the fair value of the liabilities incurred. The cost of goods obtained or services received by an entity as consideration for equity instruments issued or liabilities incurred in share-based compensation transactions shall be measured based on the fair value of the equity instruments issued or the liabilities settled. The portion of the fair value of an instrument attributed to goods obtained or services received is net of any amount that a grantee pays (or becomes obligated to pay) for that instrument when it is granted. For example, if a grantee pays $5 at the grant date for an option with a grant-date fair value of $50, the amount attributed to goods or services provided by the grantee is $45. An entity shall apply the guidance in paragraph 606-10-32-26 when determining the portion of the fair value of an equity instrument attributed to goods obtained or services received from a customer.

30-4 However, this Topic provides certain exceptions (see paragraph 718-10-30-21) to that measurement method if it is not possible to reasonably estimate the fair value of an award at the grant date. A nonpublic entity also may choose to measure its liabilities under share-based payment arrangements at intrinsic value (see paragraphs 718-10-30-20 and 718-30-30-2).

Terms of the Award Affect Fair Value

30-5 The terms of a share-based payment award and any related arrangement affect its value and, except for certain explicitly excluded features, such as a reload feature, shall be reflected in determining the fair value of the equity or liability instruments granted. For example, the fair value of a substantive option structured as the exchange of equity shares for a nonrecourse note will differ depending on whether the grantee is required to pay nonrefundable interest on the note.

ASC 718 requires entities to measure compensation cost for share-based payments awarded to grantees on the basis of the fair value of the equity instruments exchanged or the liabilities incurred. Such measurement is referred to as a fair-value-based measurement because the entity does not consider the effects of certain features that it would take into account in a true fair value measurement in determining the fair value of the share-based payment award. Although ASC 820 excludes from its scope the valuation of share-based payments that are subject to ASC 718, the concepts in ASC 820 and ASC 718 are closely aligned. When accounting for share-based payment transactions, entities should apply the measurement guidance in ASC 820 unless it is inconsistent with the requirements in ASC 718. The most significant difference between the terms “fair value” as defined in ASC 820 and “fair-value-based” as used in ASC 718 is that the latter term excludes the effects of (1) service and performance conditions that apply only to vesting or exercisability, (2) reload features, and (3) certain contingent features.

For the rare situations in which fair value cannot be reasonably estimated (e.g., the terms of an award are highly complex), ASC 718 provides an exception to fair-value-based measurement under which entities measure an award at its intrinsic value and remeasure it in each reporting period until settlement. See Section 4.11 for additional information. Entities may also use a simplified method for determining an expected term for their options and similar instruments if certain conditions are met. The discussion in Section 4.9.2.2.2 applies to public entities, and the discussion in Section 4.9.2.2.3 applies to nonpublic entities.

Further, two other exceptions to fair-value-based measurement are available to nonpublic entities. Under the first exception, nonpublic entities that cannot reasonably estimate the expected volatility of their share price for options or similar instruments are required to substitute the historical volatility of an appropriate industry sector index for their expected volatility. This measure is referred to as a calculated value rather than as a fair-value-based measure. Under the second exception, nonpublic entities are permitted to make an accounting policy election to measure all liability-classified awards at their intrinsic value (instead of at their fair-value-based measure or calculated value) as of the end of each reporting period until the awards are settled. See Section 4.13 for additional discussion of each measurement exception.

4.1.1 Vesting Conditions

ASC 718-10

Forfeitability

30-11 A restriction that stems from the forfeitability of instruments to which grantees have not yet earned the right, such as the inability either to exercise a nonvested equity share option or to sell nonvested shares, is not reflected in estimating the fair value of the related instruments at the grant date. Instead, those restrictions are taken into account by recognizing compensation cost only for awards for which grantees deliver the good or render the service.

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.

30-13 The fair-value-based method described in paragraphs 718-10-30-6 and 718-10-30-10 through 30-14 uses fair value measurement techniques, and the grant-date share price and other pertinent factors are used in applying those techniques. However, the effects on the grant-date fair value of service and performance conditions that apply only during the employee’s requisite service period or a nonemployee’s vesting period are reflected based on the outcomes of those conditions. This Topic refers to the required measure as fair value.

Market, Performance, and Service Conditions

30-27 Performance or service conditions that affect vesting are not reflected in estimating the fair value of an award at the grant date because those conditions are restrictions that stem from the forfeitability of instruments to which grantees have not yet earned the right. However, the effect of a market condition is reflected in estimating the fair value of an award at the grant date (see paragraph 718-10-30-14). For purposes of this Topic, a market condition is not considered to be a vesting condition, and an award is not deemed to be forfeited solely because a market condition is not satisfied.

30-28 In some cases, the terms of an award may provide that a performance target that affects vesting could be achieved after an employee completes the requisite service period or a nonemployee satisfies a vesting period. That is, the grantee would be eligible to vest in the award regardless of whether the grantee is rendering service or delivering goods on the date the performance target is achieved. A performance target that affects vesting and that could be achieved after an employee’s requisite service period or a nonemployee’s vesting period shall be accounted for as a performance condition. As such, the performance target shall not be reflected in estimating the fair value of the award at the grant date. Compensation cost shall be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the service or goods already have been provided. If the performance target becomes probable of being achieved before the end of the employee’s requisite service period or the nonemployee’s vesting period, the remaining unrecognized compensation cost for which service or goods have not yet been provided shall be recognized prospectively over the remaining employee’s requisite service period or the nonemployee’s vesting period. The total amount of compensation cost recognized during and after the employee’s requisite service period or the nonemployee’s vesting period shall reflect the number of awards that are expected to vest based on the performance target and shall be adjusted to reflect those awards that ultimately vest. An entity that has an accounting policy to account for forfeitures when they occur in accordance with paragraph 718-10-35-1D or 718-10-35-3 shall reverse compensation cost previously recognized, in the period the award is forfeited, for an award that is forfeited before completion of the employee’s requisite service period or the nonemployee’s vesting period. The employee’s requisite service period and the nonemployee’s vesting period end when the grantee can cease rendering service or delivering goods and still be eligible to vest in the award if the performance target is achieved. As indicated in the definition of vest, the stated vesting period (which includes the period in which the performance target could be achieved) may differ from the employee’s requisite service period or the nonemployee’s vesting period.

SEC Staff Accounting Bulletins

SAB Topic 14.D.2, Certain Assumptions Used in Valuation Methods: Expected Term [Excerpt]

Question 2: Should forfeitures or terms that stem from forfeitability be factored into the determination of expected term?

Interpretive Response: No. FASB ASC Topic 718 indicates that the expected term that is utilized as an assumption in a closed-form option-pricing model or a resulting output of a lattice option pricing model when determining the fair value of the share options should not incorporate restrictions or other terms that stem from the pre-vesting forfeitability of the instruments. Under FASB ASC Topic 718, these pre-vesting restrictions or other terms are taken into account by ultimately recognizing compensation cost only for awards for which grantees deliver the good or render the service.62

______________________________

62 FASB ASC paragraph 718-10-30-11.

An entity should consider all relevant terms and conditions of a share-based payment award in determining an appropriate fair-value-based measure. Each of these terms and conditions may have a direct or indirect effect on the fair-value-based measure of the award. A service or performance condition that affects either the vesting or the exercisability of an award is considered a vesting condition. Vesting conditions are not directly incorporated into an award’s fair-value-based measure. Rather, they govern whether the award has been earned and therefore whether an entity records compensation cost for it. However, a vesting condition can indirectly affect the fair-value-based measure. Since the expected term of an option award cannot be shorter than the vesting period (because the expected term should not incorporate prevesting forfeitures), a longer vesting period would typically result in an increase in the expected term of an award. See Sections 3.4.1 and 3.4.2 for a discussion of how service and performance conditions affect the recognition of compensation cost.

By contrast, a service or performance condition that affects a factor (e.g., exercise price, contractual term, quantity, conversion ratio) other than vesting or exercisability of an award will be directly factored into the award’s fair-value-based measure. See Section 4.6 for a discussion of how service and performance conditions that affect factors other than vesting or exercisability of an award affect the award’s fair-value-based measure.

A market condition is not considered a vesting condition under ASC 718-10-30-27. Accordingly, it will be directly factored into the fair-value-based measure of an award and will not be used to determine (other than indirectly if a derived service period is required to be determined) whether compensation cost will be recorded. ASC 718-10-30-14 states, in part, that the “effect of a market condition is reflected in the grant-date fair value of an award.” See Section 3.5 for a discussion of how a market condition affects the recognition of compensation cost and Section 4.5 for a discussion of how a market condition affects an award’s fair-value-based measure.

If an award is indexed to a factor other than a market, performance, or service condition, it contains an “other” condition. Other conditions are factored into the fair-value-based measure of an award and result in its classification as a liability. See Section 4.6.2 for discussion of other conditions.

4.1.2 Reload and Contingent Features

ASC 718-10 — Glossary

Reload Feature and Reload Option

A reload feature provides for automatic grants of additional options whenever a grantee exercises previously granted options using the entity’s shares, rather than cash, to satisfy the exercise price. At the time of exercise using shares, the grantee is automatically granted a new option, called a reload option, for the shares used to exercise the previous option.

ASC 718-10

Reload and Contingent Features

30-23 The fair value of each award of equity instruments, including an award of options with a reload feature (reload options), shall be measured separately based on its terms and the share price and other pertinent factors at the grant date. The effect of a reload feature in the terms of an award shall not be included in estimating the grant-date fair value of the award. Rather, a subsequent grant of reload options pursuant to that provision shall be accounted for as a separate award when the reload options are granted.

30-24 A contingent feature of an award that might cause a grantee to return to the entity either equity instruments earned or realized gains from the sale of equity instruments earned for consideration that is less than fair value on the date of transfer (including no consideration), such as a clawback feature (see paragraph 718-10-55-8), shall not be reflected in estimating the grant-date fair value of an equity instrument.

Fair Value Measurement Objectives and Application

55-8 Reload features and contingent features that require a grantee to transfer equity shares earned, or realized gains from the sale of equity instruments earned, to the issuing entity for consideration that is less than fair value on the date of transfer (including no consideration), such as a clawback feature, shall not be reflected in the grant-date fair value of an equity award. Those features are accounted for if and when a reload grant or contingent event occurs. A clawback feature can take various forms but often functions as a noncompete mechanism. For example, an employee that terminates the employment relationship and begins to work for a competitor is required to transfer to the issuing entity (former employer) equity shares granted and earned in a share-based payment transaction.

Contingency Features That Affect the Option Pricing Model

55-47 Contingent features that might cause a grantee to return to the entity either equity shares earned or realized gains from the sale of equity instruments earned as a result of share-based payment arrangements, such as a clawback feature (see paragraph 718-10-55-8), shall not be reflected in estimating the grant-date fair value of an equity instrument. Instead, the effect of such a contingent feature shall be accounted for if and when the contingent event occurs. For instance, a share-based payment arrangement may stipulate the return of vested equity shares to the issuing entity for no consideration if the grantee terminates the employment or vendor relationship to work for a competitor. The effect of that provision on the grant-date fair value of the equity shares shall not be considered. If the issuing entity subsequently receives those shares (or their equivalent value in cash or other assets) as a result of that provision, a credit shall be recognized in the income statement upon the receipt of the shares. That credit is limited to the lesser of the recognized compensation cost associated with the share-based payment arrangement that contains the contingent feature and the fair value of the consideration received. The event is recognized in the income statement because the resulting transaction takes place with a grantee as a result of the current (or prior) employment or vendor relationship rather than as a result of the grantee’s role as an equity owner. Example 10 (see paragraph 718-20-55-84) provides an illustration of the accounting for an employee award that contains a clawback feature, which also applies to nonemployee awards.

Some stock options include a “reload feature.” This feature entitles a grantee to automatic grants of additional stock options whenever the grantee exercises previously granted stock options and pays the exercise price in the entity’s shares rather than in cash. Typically, the grantee is granted a new stock option, called a reload option, for each share surrendered to satisfy the exercise price of the previously granted stock option. The exercise price of the reload option is usually set at the market price of the shares on the date the reload option is granted. For stock options that include a reload feature, the reload feature is not incorporated into the grant-date fair-value-based measure of the stock option but is accounted for instead as a new award and calculated on the basis of its grant-date fair-value-based measure.

Some awards also include contingent features that may require a grantee to return earned equity instruments or gains realized from the sale of equity instruments in certain situations (either for no consideration or for consideration that is less than the fair value of the equity instrument on the date of transfer). Such contingent features are not reflected in the fair-value-based measurement of an equity instrument, and they do not affect the recognition of compensation cost if they are triggered after the equity instrument is earned. Therefore, a contingent feature has no day-one impact on the accounting for an award; it is accounted for if and when the contingent event occurs. Examples of contingent features, also referred to as clawback features, include provisions triggered upon terminations for cause, noncompete and nonsolicitation violations, and material misstatements. Clawback provisions are discussed further in Section 3.9.

Confidential and Proprietary — for Use Solely by Authorized Personnel

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.