4.6 Conditions That Affect Factors Other Than Vesting or Exercisability
ASC 718-10
Market, Performance, and Service Conditions That Affect Factors Other Than Vesting or Exercisability
30-15 Market, performance, and
service conditions (or any combination thereof) may affect
an award’s exercise price, contractual term, quantity,
conversion ratio, or other factors that are considered in
measuring an award’s grant-date fair value. A grant-date
fair value shall be estimated for each possible outcome of
such a performance or service condition, and the final
measure of compensation cost shall be based on the amount
estimated at the grant date for the condition or outcome
that is actually satisfied. Paragraphs 718-10-55-64 through
55-66 provide additional guidance on the effects of market,
performance, and service conditions that affect factors
other than vesting or exercisability. Examples 2 (see
paragraph 718-20-55-35); 3 (see paragraph 718-20-55-41); 4
(see paragraph 718-20-55-47); 5 (see paragraph
718-20-55-51); and 7 (see paragraph 718-20-55-68) provide
illustrations of accounting for awards with such
conditions.
Market, Performance, and Service Conditions That Affect Factors Other Than
Vesting and Exercisability
55-64 Market, performance, and
service conditions may affect an award’s exercise price,
contractual term, quantity, conversion ratio, or other
pertinent factors that are relevant in measuring an award’s
fair value. For instance, an award’s quantity may double, or
an award’s contractual term may be extended, if a
company-wide revenue target is achieved. Market conditions
that affect an award’s fair value (including exercisability)
are included in the estimate of grant-date fair value (see
paragraph 718-10-30-15). Performance or service conditions
that only affect vesting are excluded from the estimate of
grant-date fair value, but all other performance or service
conditions that affect an award’s fair value are included in
the estimate of grant-date fair value (see that same
paragraph). Examples 3, 4, and 6 (see paragraphs
718-20-55-41, 718-20-55-47, and 718-20-55-61) provide
further guidance on how performance conditions are
considered in the estimate of grant-date fair value.
55-65 An award may be indexed to a factor in addition to the entity’s share price. If that factor is not a market,
performance, or service condition, that award shall be classified as a liability for purposes of this Topic (see
paragraphs 718-10-25-13 through 25-14A). An example would be an award of options whose exercise price is
indexed to the market price of a commodity, such as gold. Another example would be a share award that will
vest based on the appreciation in the price of a commodity, such as gold; that award is indexed to both the
value of that commodity and the issuing entity’s shares. If an award is so indexed, the relevant factors shall be
included in the fair value estimate of the award. Such an award would be classified as a liability even if the entity
granting the share-based payment instrument is a producer of the commodity whose price changes are part or
all of the conditions that affect an award’s vesting conditions or fair value.
As discussed in Section
4.1.1, service and performance conditions typically affect either the
vesting or the exercisability of a share-based payment award, and such vesting
conditions are not directly factored into the fair-value-based measure of an award
under ASC 718. However, if service or performance conditions affect factors other than vesting or exercisability (e.g., exercise price,
contractual term, quantity, or conversion ratio), the grant-date fair-value-based
measure should be calculated for each possible outcome. As discussed in Section 3.4.2, initial
accruals of compensation cost should be based on the probable outcome, and the final
measure of compensation cost should be adjusted to reflect the grant-date
fair-value-based measure of the outcome that is actually achieved. See the next
section for examples that illustrate the application of this guidance.
4.6.1 Market, Performance, and Service Conditions
The example below illustrates the accounting for an award that contains a
performance condition that affects the number of options that will vest.
ASC 718-20
Example 2: Share Option Award Under Which the Number of Options to Be Earned Varies
55-35 This Example illustrates the guidance in paragraph 718-10-30-15.
55-35A This
Example (see paragraphs 718-20-55-36 through 55-40)
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, all of the following
are equally applicable to nonemployee awards with the
same features as the awards in this Example (that is,
the number of options earned varies on the basis of the
achievement of particular performance conditions):
-
Certain valuation assumptions in paragraph 718-20-55-36
-
Total compensation cost considerations provided in paragraphs 718-20-55-37 through 55-39 (that is, an entity must consider if it is probable that specific performance conditions will be achieved for an award with a specified time period for vesting and performance conditions)
-
Forfeiture adjustments in paragraph 718-20-55-40.
55-35B
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.
55-36 This Example shows the computation of compensation cost if Entity T grants an award of share options
with multiple performance conditions. Under the award, employees vest in differing numbers of options
depending on the amount by which the market share of one of Entity T’s products increases over a three-year
period (the share options cannot vest before the end of the three-year period). The three-year explicit service
period represents the requisite service period. On January 1, 20X5, Entity T grants to each of 1,000 employees
an award of up to 300 10-year-term share options on its common stock. If market share increases by at least
5 percentage points by December 31, 20X7, each employee vests in at least 100 share options at that date.
If market share increases by at least 10 percentage points, another 100 share options vest, for a total of 200.
If market share increases by more than 20 percentage points, each employee vests in all 300 share options.
Entity T’s share price on January 1, 20X5, is $30 and other assumptions are the same as in Example 1 (see
paragraph 718-20-55-4). The grant-date fair value per share option is $14.69. While the vesting conditions in
this Example and in Example 1 (see paragraph 718-20-55-4) are different, the equity instruments being valued
have the same estimate of grant-date fair value. That is a consequence of the modified grant-date method,
which accounts for the effects of vesting requirements or other restrictions that apply during the vesting period
by recognizing compensation cost only for the instruments that actually vest. (This discussion does not refer
to awards with market conditions that affect exercisability or the ability to retain the award as described in
paragraphs 718-10-55-60 through 55-63.)
55-37 The compensation cost of the award depends on the estimated number of options that will vest. Entity
T must determine whether it is probable that any performance condition will be achieved, that is, whether
the growth in market share over the 3-year period will be at least 5 percent. Accruals of compensation cost
are initially based on the probable outcome of the performance conditions — in this case, different levels
of market share growth over the three-year vesting period — and adjusted for subsequent changes in the
estimated or actual outcome. If Entity T determines that no performance condition is probable of achievement
(that is, market share growth is expected to be less than 5 percentage points), then no compensation cost
is recognized; however, Entity T is required to reassess at each reporting date whether achievement of any
performance condition is probable and would begin recognizing compensation cost if and when achievement
of the performance condition becomes probable.
55-38 Paragraph 718-10-25-20 requires accruals of cost to be based on the probable outcome of performance
conditions. Accordingly, this Topic prohibits Entity T from basing accruals of compensation cost on an amount
that is not a possible outcome (and thus cannot be the probable outcome). For instance, if Entity T estimates
that there is a 90 percent, 30 percent, and 10 percent likelihood that market share growth will be at least 5
percentage points, at least 10 percentage points, and greater than 20 percentage points, respectively, it would
not try to determine a weighted average of the possible outcomes because that number of shares is not a
possible outcome under the arrangement.
55-39 The following table shows the compensation cost that would be recognized in 20X5, 20X6, and 20X7 if
Entity T estimates at the grant date that it is probable that market share will increase at least 5 but less than 10
percentage points (that is, each employee would receive 100 share options). That estimate remains unchanged
until the end of 20X7, when Entity T’s market share has increased over the 3-year period by more than 10
percentage points. Thus, each employee vests in 200 share options.
55-40 As in Example 1, Case A (see paragraph 718-20-55-10), Entity T experiences actual forfeiture rates of
5 percent in 20X5, and in 20X6 changes its estimate of forfeitures for the entire award from 3 percent to 6
percent per year. In 20X6, cumulative compensation cost is adjusted to reflect the higher forfeiture rate. By the
end of 20X7, a 6 percent forfeiture rate has been experienced, and no further adjustments for forfeitures are
necessary. Through 20X5, Entity T estimates that 913 employees (1,000 × .973) will remain in service until the
vesting date. At the end of 20X6, the number of employees estimated to remain in service is adjusted for the
higher forfeiture rate, and the number of employees estimated to remain in service is 831 (1,000 × .943). The
compensation cost of the award is initially estimated based on the number of options expected to vest, which
in turn is based on the expected level of performance and the fair value of each option. That amount would
be adjusted as needed for changes in the estimated and actual forfeiture rates and for differences between
estimated and actual market share growth. The amount of compensation cost recognized (or attributed) when
achievement of a performance condition is probable depends on the relative satisfaction of the performance
condition based on performance to date. Entity T determines that recognizing compensation cost ratably over
the three-year vesting period is appropriate with one-third of the value of the award recognized each year.
The examples below illustrate the accounting for an award with either a
performance condition (Example 3) or a market condition (Example 7) that affects
the exercise price of stock options.
ASC 718-20
Example 3: Share Option Award Under Which the Exercise Price Varies
55-41 This Example illustrates the guidance in paragraph 718-10-30-15.
55-41A This
Example (see paragraphs 718-20-55-42 through 55-46)
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, both of the following
are equally applicable to nonemployee awards with the
same features as the awards in this Example (that is, an
immediately vested and exercisable award with an
exercise price that varies on the basis of the
achievement of particular performance conditions):
-
Certain valuation assumptions in paragraphs 718-20-55-42 through 55-43
-
The total compensation cost considerations provided in paragraphs 718-20-55-44 through 55-46 (that is, an entity must consider if it is probable that specific performance conditions will be achieved).
Therefore, the guidance in those paragraphs may serve as
implementation guidance for similar nonemployee
awards.
55-41B
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.
55-42 This Example shows the computation of compensation cost if Entity T grants a share option award with
a performance condition under which the exercise price, rather than the number of shares, varies depending
on the level of performance achieved. On January 1, 20X5, Entity T grants to its chief executive officer 10-year
share options on 10,000 shares of its common stock, which are immediately vested and exercisable (an
explicit service period of zero). The share price at the grant date is $30, and the initial exercise price also is
$30. However, that price decreases to $15 if the market share for Entity T’s products increases by at least
10 percentage points by December 31, 20X6, and provided that the chief executive officer continues to be
employed by Entity T and has not previously exercised the options (an explicit service period of 2 years, which
also is the requisite service period).
55-43 Entity T estimates at the grant date the expected level of market share growth, the exercise price of the
options, and the expected term of the options. Other assumptions, including the risk-free interest rate and
the service period over which the cost is attributed, are consistent with those estimates. Entity T estimates at
the grant date that its market share growth will be at least 10 percentage points over the 2-year performance
period, which means that the expected exercise price of the share options is $15, resulting in a fair value of
$19.99 per option. Option value is determined using the same assumptions noted in paragraph 718-20-55-7
except the exercise price is $15 and the award is not exercisable at $15 per option for 2 years.
55-44 Total compensation cost to be recognized if the performance condition is satisfied would be $199,900
(10,000 × $19.99). Paragraph 718-10-30-15 requires that the fair value of both awards with service conditions
and awards with performance conditions be estimated as of the date of grant. Paragraph 718-10-35-3 also
requires recognition of cost for the number of instruments for which the requisite service is provided. For this
performance award, Entity T also selects the expected assumptions at the grant date if the performance goal is
not met. If market share growth is not at least 10 percentage points over the 2-year period, Entity T estimates
a fair value of $13.08 per option. Option value is determined using the same assumptions noted in paragraph
718-20-55-7 except the award is immediately vested.
55-45 Total compensation cost to be recognized if the performance goal is not met would be $130,800 (10,000
× $13.08). Because Entity T estimates that the performance condition would be satisfied, it would recognize
compensation cost of $130,800 on the date of grant related to the fair value of the fully vested award and
recognize compensation cost of $69,100 ($199,900 – $130,800) over the 2-year requisite service period related
to the condition. Because of the nature of the performance condition, the award has multiple requisite service
periods that affect the manner in which compensation cost is attributed. Paragraphs 718-10-55-67 through
55-79 provide guidance on estimating the requisite service period.
55-46 During the two-year requisite service period, adjustments to reflect any change in estimate about
satisfaction of the performance condition should be made, and, thus, aggregate cost recognized by the end of
that period reflects whether the performance goal was met.
Example 7: Share Option With Exercise Price That Increases by a Fixed Amount or Fixed Percentage
55-68 This Example illustrates the guidance in paragraph 718-10-30-15.
55-68A This Example (see
paragraphs 718-20-55-69 through 55-70) 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 in
paragraphs 718-20-55-69 through 55-70 are equally
applicable to nonemployee awards with the same features
as the awards in this Example (that is, awards with
exercise prices that increase by a fixed amount or fixed
percentage). Therefore, the guidance in those paragraphs
may serve as implementation guidance for similar
nonemployee awards.
55-68B
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.
55-69 Some entities grant share options with exercise prices that increase by a fixed amount or a constant
percentage periodically. For example, the exercise price of the share options in Example 1 (see paragraph
718-20-55-4) might increase by a fixed amount of $2.50 per year. Lattice models and other valuation
techniques can be adapted to accommodate exercise prices that change over time by a fixed amount. Such an
arrangement has a market condition and may have a derived service period.
55-70 Share options with exercise prices that increase by a constant percentage also can be valued using an
option-pricing model that accommodates changes in exercise prices. Alternatively, those share options can be
valued by deducting from the discount rate the annual percentage increase in the exercise price. That method
works because a decrease in the risk-free interest rate and an increase in the exercise price have a similar
effect — both reduce the share option value. For example, the exercise price of the share options in Example
1 (see paragraph 718-20-55-4) might increase at the rate of 1 percent annually. For that example, Entity T’s
share options would be valued based on a risk-free interest rate less 1 percent. Holding all other assumptions
constant from that Example, the value of each share option granted by Entity T would be $14.34.
The example below illustrates the accounting for an award with performance
conditions that affect the vesting and transferability of stock options.
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.
The example below illustrates the accounting for an award with a performance
condition that affects the quantity of restricted stock awards earned.
Example 4-1
On January 1, 20X6, Entity A grants 100,000 restricted stock awards to its employees. The restricted stock awards have a grant-date fair-value-based measure of $30 per share and vest at the end of the third year of service. The number of restricted stock awards that vest at the end of the three-year service period is based on the target EBITDA growth rate (performance condition) as indicated in the following table:
Compensation cost for the awards is based on the probable outcome of the performance condition. If, on the grant date, the probable outcome is that the EBITDA growth rate target of 8 percent will be met, initial accruals of compensation cost should reflect vesting of 100,000 restricted stock awards. Accruals of compensation cost should be adjusted for subsequent changes in the estimated or actual outcome. For example, if the actual EBITDA growth rate at the end of the three-year period is 6 percent, or it becomes probable that the EBITDA growth rate will be 6 percent, the cumulative compensation cost recognized should be adjusted to reflect vesting of 50,000 restricted stock awards (100,000 restricted stock awards × 50 percent payout).
The journal entries below illustrate the accounting for the awards.
As of December 31, 20X8, the actual EBITDA growth rate is 6 percent, resulting in a 50 percent payout.
4.6.2 Other Conditions
An entity must carefully evaluate the terms and conditions of an award. If the entity determines that
the award is indexed to a factor other than a market, performance, or service condition (i.e., an “other”
condition), the award is classified as a share-based liability under ASC 718-10-25-13 (unless certain
exceptions apply). Such other condition should also be reflected in the estimate of the award’s fair-value-based
measure. For example, an entity may grant a restricted stock award that indexes the quantity
of shares that will vest to oil price changes. Even if the entity is in the oil and gas industry, the award is
classified as a liability. Accordingly, the fair-value-based measure of the award should be remeasured at
the end of each reporting period until settlement and should reflect changes in the market price of oil.