5.5 Indexation to Other Factors
ASC 718-10
25-13 An award may be indexed to a factor in addition to the entity’s share price. If that additional factor is not a market, performance, or service condition, the award shall be classified as a liability for purposes of this Topic, and the additional factor shall be reflected in estimating the fair value of the award. Paragraph 718-10-55-65 provides examples of such awards.
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.
ASC 718-10-25-13 indicates that when an award is indexed to a factor in addition
to the entity’s share price and that factor is not a market, performance, or service
condition (i.e., it is an “other” condition), the award must be classified as a liability. For example, an entity may link the exercise price of a stock option to the change in the CPI or another similar index (such as the retail price index in the United Kingdom) to eliminate the effect of inflation on the option’s value. Paragraph B127 of the Basis for Conclusions of FASB Statement 123(R) explains the
FASB’s reasoning for this treatment as follows:
The Board concluded that the terms of such an award do not establish an ownership relationship because the extent to which (or whether) the employee benefits from the award depends on something other than changes in the entity’s share price. That conclusion is consistent with the Board’s conclusion in Statement 150 that a share-settled obligation is a liability
if it does not expose the holder of the instrument to certain risks and
rewards, including the risk of changes in the price of the issuing entity’s
equity shares, that are similar to those to which an owner is exposed.
A feature that adjusts the exercise price of an option for changes in the CPI
does not meet the definition of a market, performance, or service condition.
Accordingly, such an award must be classified as a liability. By contrast, an entity
may (1) estimate the change in the CPI (or another similar index) over an option’s
vesting period or its expected life and (2) set a fixed exercise price that is
adjusted for that estimate. Because the exercise price is established as of the
grant date and not linked to the actual change in the CPI (or another similar
index), the option is not considered to be indexed to a factor other than a market,
performance, or service condition. Accordingly, such an award, if it otherwise meets
the criteria for equity classification, is classified as equity.
In addition, questions have arisen related to the evaluation of
whether an award is indexed to an “other” condition or includes a feature that is a
vesting or market condition. A vesting condition that is based on an entity’s
financial performance and is referenced solely to the grantor’s own operation in
relation to a peer group (e.g., attaining an EPS growth rate that outperforms the
average EPS growth rate of peer companies in the same industry) is a performance
condition (see Sections
3.4.2 and 9.3.2.2 for discussions of employee and nonemployee awards,
respectively). Note that in these circumstances, ASC 718 requires the performance
measure ascribed to the award to be “defined by reference to the same
performance measure of another entity or group of entities” (emphasis added). That
is, if the performance measures are not equivalent, the condition is not a
performance condition as defined in ASC 718-10-20 and would result in the award’s
classification as a liability. Examples of market conditions that are defined by
reference to an index include (1) a specified return on an entity’s stock (often
referred to as total shareholder return, or TSR) that exceeds the average return of
a peer group of entities or a specified index (such as the S&P 500) and (2) a
percentage increase in an entity’s stock price that is greater than the average
percentage increase of the stock price of a peer group of entities or a specified
index (see Section
3.5). An entity must carefully evaluate the terms and conditions of each
award and use judgment in determining whether an award is indexed to a factor that
is not a market, performance, or service condition.
Example 5-16
Liability-Classified Award
Entity A grants employee stock options with a grant-date exercise price equal to the market price of A’s shares that increases monthly for inflation (on the basis of changes in the CPI) through the date of exercise.
Because the options’ value is indexed to the CPI and the change in the CPI is a factor that is not considered a market, performance, or service condition, the options must be classified as a liability. Entity A must remeasure the options at their fair-value-based measure in each reporting period until settlement.
Alternatively, if the options’ terms only require monthly adjustments to the exercise price for changes in CPI through the vesting date, the options would be classified as a liability only until the vesting date. That is, A only must remeasure the options at their fair-value-based measure in each reporting period until the vesting date. On the vesting date, the options’ value no longer is indexed to the CPI; therefore, as long as all the other criteria for equity classification have been met, the award would be reclassified as equity.
Example 5-17
Equity-Classified Award
Entity A grants employee stock options with a grant-date exercise price equal to the grant-date market price of A’s shares that increases annually by 3 percent (on the basis of A’s estimate of annual inflation) through the date of exercise. Before considering the effects of the 3 percent annual increase to the exercise price, A determines that the options should be classified as equity.
Because the options’ value is not indexed to a factor other than a market, performance, or service condition (e.g., a change in the CPI), the options would be classified as equity. Accordingly, the fair-value-based measure of the options is fixed on the grant date, and the increasing exercise price is incorporated into the fair-value-based measure of the options.
ASC 718 provides an exception to liability classification when the exercise price of stock options is denominated in a foreign currency and certain conditions are met. See Section 5.7.1 for a discussion of this exception.