Chapter 5 — Classification
Chapter 5 — Classification
5.1 General
ASC 718-10
Determining Whether to Classify a Financial Instrument as a Liability or as Equity
25-6 This paragraph through paragraph 718-10-25-19A provide guidance for determining whether certain financial instruments awarded in share-based payment transactions are liabilities. In determining whether an instrument not specifically discussed in those paragraphs shall be classified as a liability or as equity, an entity shall apply generally accepted accounting principles (GAAP) applicable to financial instruments issued in transactions not involving share-based payment.
An entity’s measurement of compensation cost for awards within the scope of ASC
718 differs depending on whether the entity determines that the awards are
classified as equity or liabilities (i.e., a fair-value-based measure as of the
grant date for most equity-classified awards versus a fair-value-based measure as of
the end of each reporting period until settlement for liability-classified awards).
The classification of share-based payment awards can be complex. While classifying a
cash-settled award as a liability may seem straightforward, entities must consider
the features and conditions of every award. Generally, the following types of awards
(with certain exceptions, including those noted below) must be classified as
liabilities in accordance with ASC 718-10-25-6 through 25-19A:
Types of Awards | Discussion | Exceptions |
---|---|---|
Awards that would be classified as liabilities under ASC 480 | Although share-based payment awards subject to ASC 718 are outside the scope of ASC 480, ASC 718-10-25-7 requires an entity to apply the classification criteria in ASC 480-10-25 and in ASC 480-10-15-3 and 15-4 unless ASC 718-10-25-8 through 25-19A require otherwise. See ASC 718-10-25-7 and 25-8 and Section 5.2 for a discussion of how to apply the classification criteria in ASC 480 to share-based payment awards. | In determining the classification of share-based payment awards under ASC 480,
entities should take into account the scope exceptions
related to ASC 480, as discussed in ASC 718-10-25-8 and
Section 5.2.1, as
well as any specific exceptions in ASC 718-10-25-8 through
25-19A. |
Stock awards subject to repurchase features that do not subject the grantee to
the risks and rewards of equity share ownership for a
reasonable period | ASC 718-10-25-9 and 25-10 distinguish between repurchase features that are within the control of the issuer and those that are not within the control of the issuer. See Section 5.3 for guidance on determining the classification of callable and puttable stock awards. | ASC 718-10-25-9(a) does not require liability classification for contingent
repurchase features that are not within the grantee’s
control and for which it is not probable that the
contingency will occur. In addition, ASC 718-10-25-18
exempts from liability classification, under certain
circumstances, repurchases that are used to satisfy the
employer’s statutory tax withholding requirements. See
Section 5.7.2. |
Stock options or similar instruments for which (1) the underlying shares are
classified as liabilities or (2) the options or similar
instruments can be required to be settled in cash or other
assets | ASC 718-10-25-11 and 25-12 require that stock options or similar instruments be classified as a liability if the (1) underlying shares are classified as a liability or (2) the options or similar instruments must be settled in cash or the grantee can require the entity to settle in cash. See Section 5.4 for guidance on determining the classification of stock options for which cash settlement could be required. | ASC 718-10-25-11(b) does not require liability classification for contingent
cash settlement features that are not within the grantee’s
control and for which it is not probable that the
contingency will occur. ASC 718-10-25-16 and 25-17 exempt
from liability classification, under certain circumstances,
broker-assisted cashless exercises. In addition, ASC
718-10-25-18 exempts from liability classification, under
certain circumstances, repurchases of shares upon option
exercises that are used to satisfy the employer’s statutory
tax withholding requirements. See Section 5.7.2. |
Awards with conditions or other features that are indexed to something other
than a market, performance, or service condition | Under ASC 718-10-25-13, awards indexed to something other than a market, performance, or service condition must be classified as a liability. See Section 5.5 for a discussion of other conditions. | ASC 718-10-25-14 and 25-14A exempt stock options with a fixed exercise price in
a foreign currency awarded to a grantee of a foreign
operation from liability classification provided that the
exercise price is denominated in (1) the foreign operation’s
functional currency, (2) the currency in which the foreign
operation's employees are paid, or (3) the currency of a
market in which a substantial portion of the entity’s equity
securities trades. |
Awards that are substantive liabilities because (1) the grantee has the choice
of settlement in cash or shares or (2) the entity can choose
the method of settlement but does not have the intent, past
practice, or ability to settle with shares | ASC 718-10-25-15 states that to determine an award’s classification, an entity should evaluate the award’s substantive terms as well as the entity’s past practices and its ability to settle in shares. See Section 5.6 for a discussion of factors that an entity with a choice of settlement method may consider in determining an award’s classification. | ASC 718-10-25-15(a) states that a requirement to deliver registered shares does not imply, by itself, that an entity does not have the ability to settle the award in shares. |
Certain awards that may become subject to other applicable GAAP | Other applicable GAAP (e.g., ASC 815) may apply to awards that are originally
accounted for as share-based payment awards under ASC 718
but are modified after a grantee (1) whose awards are vested
is no longer providing goods or services, (2) whose awards
are vested is no longer a customer, or (3) is no longer an
employee. In addition, once vested, a convertible instrument
award granted to a nonemployee becomes subject to other
applicable GAAP. See ASC 718-10-35-9 through 35-14 in
Section 5.8 as well as Section
9.5 for a discussion of when share-based
payment awards subject to ASC 718 become subject to other
applicable GAAP. | Under ASC 718-10-35-9 through 35-14, certain freestanding instruments issued to
grantees may never become subject to other GAAP. In
addition, an award would not be subject to other GAAP if the
award is modified (after a grantee whose awards are vested
is no longer providing goods or services, after a grantee
whose awards are vested is no longer a customer, or the
grantee is no longer an employee) solely to reflect an
equity restructuring that meets certain conditions under ASC
718-10-35-10A. |
5.2 ASC 480
ASC 718-10
25-7 Topic 480 excludes from its scope instruments that are accounted for under this Topic. Nevertheless, unless paragraphs 718-10-25-8 through 25-19A require otherwise, an entity shall apply the classification criteria in Section 480-10-25 and paragraphs 480-10-15-3 through 15-4 in determining whether to classify as a liability a freestanding financial instrument given to a grantee in a share-based payment transaction. Paragraphs 718-10-35-9 through 35-14 provide criteria for determining when instruments subject to this Topic subsequently become subject to Topic 480 or to other applicable GAAP.
25-8 In determining the classification of an instrument, an entity shall take into account the classification requirements as established by Topic 480. In addition, a call option written on an instrument that is not classified as a liability under those classification requirements (for example, a call option on a mandatorily redeemable share for which liability classification is not required for the specific entity under the requirements) also shall be classified as equity so long as those equity classification requirements for the entity continue to be met, unless liability classification is required under the provisions of paragraphs 718-10-25-11 through 25-12.
ASC 480-10
Mandatorily Redeemable Financial Instruments
25-4 A mandatorily redeemable financial instrument shall be classified as a liability unless the redemption is required to occur only upon the liquidation or termination of the reporting entity.
25-5 A financial instrument that embodies a conditional obligation to redeem the instrument by transferring assets upon an event not certain to occur becomes mandatorily redeemable if that event occurs, the condition is resolved, or the event becomes certain to occur.
25-6 In determining if an instrument is mandatorily redeemable, all terms within a redeemable instrument shall be considered. The following items do not affect the classification of a mandatorily redeemable financial instrument as a liability:
- A term extension option
- A provision that defers redemption until a specified liquidity level is reached
- A similar provision that may delay or accelerate the timing of a mandatory redemption.
25-7 If a financial instrument will be redeemed only upon the occurrence of a conditional event, redemption of that instrument is conditional and, therefore, the instrument does not meet the definition of mandatorily redeemable financial instrument in this Subtopic. However, that financial instrument would be assessed at each reporting period to determine whether circumstances have changed such that the instrument now meets the definition of a mandatorily redeemable instrument (that is, the event is no longer conditional). If the event has occurred, the condition is resolved, or the event has become certain to occur, the financial instrument is reclassified as a liability.
Obligations to Repurchase Issuer’s Equity Shares by Transferring Assets
25-8 An entity shall classify as a liability (or an asset in some circumstances) any financial instrument, other than an outstanding share, that, at inception, has both of the following characteristics:
- It embodies an obligation to repurchase the issuer’s equity shares, or is indexed to such an obligation.
- It requires or may require the issuer to settle the obligation by transferring assets.
25-9 In this Subtopic, indexed to is used interchangeably with based on variations in the fair value of. The phrase requires or may require encompasses instruments that either conditionally or unconditionally obligate the issuer to transfer assets. If the obligation is conditional, the number of conditions leading up to the transfer of assets is irrelevant.
25-10 Examples of financial instruments that meet the criteria in paragraph 480-10-25-8 include forward purchase contracts or written put options on the issuer’s equity shares that are to be physically settled or net cash settled.
25-11 All obligations that permit the holder to require the issuer to transfer assets result in liabilities, regardless of whether the settlement alternatives have the potential to differ.
25-12 Certain financial instruments that embody obligations that are liabilities within the scope of this Subtopic also may contain characteristics of assets but be reported as single items. Some examples include the following:
- Net-cash-settled or net-share-settled forward purchase contracts
- Certain combined options to repurchase the issuer’s shares.
25-13 An instrument that requires the issuer to settle its obligation by issuing another instrument (for example, a note payable in cash) ultimately requires settlement by a transfer of assets, accordingly:
- When applying paragraphs 480-10-25-8 through 25-12, this also would apply for an instrument settled with another instrument that ultimately may require settlement by a transfer of assets (warrants for puttable shares).
- It is clear that a warrant for mandatorily redeemable shares would be a liability under this Subtopic.
Certain Obligations to Issue a Variable Number of Shares
25-14 A financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares shall be classified as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominantly on any one of the following:
- A fixed monetary amount known at inception (for example, a payable settleable with a variable number of the issuer’s equity shares)
- Variations in something other than the fair value of the issuer’s equity shares (for example, a financial instrument indexed to the Standard and Poor’s S&P 500 Index and settleable with a variable number of the issuer’s equity shares)
- Variations inversely related to changes in the fair value of the issuer’s equity shares (for example, a written put option that could be net share settled). . . .
Although share-based payment awards subject to ASC 718 are outside the scope of
ASC 480, ASC 718-10-25-7 requires entities to
apply the classification criteria in ASC 480-10-25
and in ASC 480-10-15-3 and 15-4 unless ASC
718-10-25-8 through 25-19A require otherwise.
Under ASC 480-10-25 and ASC 480-10-15-3 and 15-4,
liability classification is required if an award
meets any of the criteria in the table below. In
addition, ASC 718-10-25-8 clarifies that the scope
exceptions in ASC 480 for certain mandatorily
redeemable financial instruments also apply to
share-based payment awards within the scope of ASC
718. See Section 5.2.1 for
more information.
ASC 480 Instruments | Examples of Share-Based Payment Awards | Comments |
---|---|---|
Mandatorily redeemable financial instruments described in ASC 480-10-25-4
through 25-7, and defined in the ASC master glossary as “financial instruments
issued in the form of shares that embody an unconditional obligation requiring
the issuer to redeem the instrument by transferring its assets at a specified or
determinable date (or dates) or upon an event that is certain to occur.” |
| The repurchase or redemption feature must be unconditional (i.e., the entity and grantee cannot choose the method of settlement). In addition, no other features of the instrument’s terms can exist that would cause the shares not to be redeemed. For example, preferred shares that may be converted into common shares before the specified redemption date(s) would not result in liability classification for the preferred shares if the conversion feature is substantive.
ASC 480 includes a scope exception for certain mandatorily redeemable financial
instruments of nonpublic entities and certain mandatorily redeemable
noncontrolling interests of all entities (public and nonpublic). See Section 5.2.1. |
A financial instrument, other than an outstanding share, that embodies (or is indexed to) an obligation to repurchase shares (conditionally or unconditionally) by transferring cash or other assets as described in ASC 480-10-25-8 through 25-13. |
| The guidance in ASC 480 only applies if the repurchase feature is considered
“freestanding” (e.g., a legally detachable written put option). Most share
repurchase features are embedded and not legally detachable.
Under ASC 718, the following
exceptions apply to certain awards with repurchase features that would otherwise
be classified as liabilities under ASC 480:
|
A financial instrument that embodies certain obligations to issue a variable
number of shares when the obligation’s monetary value is based, solely or
predominantly, on any one of the following items described in ASC 480-10-25-14:
|
| Awards that are based on monetary values at inception unrelated to increases in the fair value of an entity’s equity and settled in a variable number of shares will most likely result in share-settled debt arrangements, accounted for as share-based liabilities. |
In accordance with ASC 480-10-25-14, an entity must classify a share-based
payment award as a liability if the award requires the entity to issue a variable number of
shares when the obligation’s monetary value is fixed. An obligation of this nature does not
expose the grantee to the risks and rewards of a typical equity ownership in an entity
because the monetary value of the award is not indexed to the fair value of the underlying
shares that will be provided upon settlement. In the examples below, the entity’s obligation
related to awards granted to employees would meet the criteria under ASC 480-10-25-14 and
thus liability classification would be required.
Example 5-1
Variations in Something Other Than the Fair Value of the Issuer’s Equity Shares
Entity A grants employee stock options with an exercise price established on the grant date equal to a fixed multiple of its trailing 12 months EBITDA. It is assumed that the EBITDA multiple does not represent a reasonable approximation of the fair value of A’s equity shares. The settlement price of the options as of the vesting date is also established according to a fixed multiple of the same trailing 12 months EBITDA of A. Any excess of the options’ settlement price as of the vesting date over the options’ exercise price as of the grant date is paid to the employees in a variable number of A’s shares on the basis of the fair value of A’s shares on the vesting date. Because the monetary value of the options (1) is indexed solely to variations in an operating performance measure of A (i.e., EBITDA) and (2) will be settled in a variable number of A’s shares, the options will be classified as a share-based liability.
Example 5-2
Settlement
in a Variable Number of Shares on the Basis of a
Fixed Monetary Amount
Entity B is a real estate
brokerage firm that has a network of real estate agents who are employees. Upon
hiring an agent as an employee, B and the employee enter into a share-based
payment arrangement. The terms of the agreement specify that upon the closing of
the employee’s first real estate sale, B will issue to the employee shares of
common stock equal to $1,000 on the basis of the fair value of B’s common stock
as of the date of the closing. The agent will vest in the award at the end of
the second year of service following the date of the closing (cliff vesting).
Because B has granted an award for a fixed monetary amount to be settled in a
variable number of shares, the award is initially classified as a liability.
Once the number of shares of common stock to be issued under the award is fixed
(upon the closing of the employee’s first real estate sale), and as long as all
criteria for equity classification are met, the award would be reclassified as
equity.
Example 5-3
Variable Number of Shares Based on Earnings That Exceed a Specified
Amount
Entity A grants employees an award of options on A’s common stock. The number
of options that vest is based on A’s earnings over a 12-month period. The award
cliff-vests at the end of the 12-month period. The number of awards that vest is
calculated as follows: for each $500,000 increment of A’s earnings that exceed
$2 million, not to exceed $5 million for the 12-month period after the grant
date, 25,000 options will vest.
Although awards subject to ASC 718 are outside the scope of ASC 480, ASC
718-10-25-7 requires entities to apply the classification criteria in ASC
480-10-25 and in ASC 480-10-15-3 and 15-4 unless ASC 718-10-25-8 through 25-19A
require otherwise. A similar arrangement in which awards are not within the
scope of ASC 718 would meet the criteria for classification as a liability under
ASC 480-10-25-14(b) because under such an arrangement, the entity would be
required to issue a variable number of options on its common shares that derive
their value from something other than the fair value of the entity’s equity
shares (e.g., value derived from earnings over a 12-month period). However, ASC
718 does not require these awards to be classified as a liability because the
issuance of a variable number of shares is indexed to A’s earnings, which
represents a performance condition under ASC 718. Accordingly, as long as all
other criteria for equity classification are met, the award would be classified
as equity.
5.2.1 ASC 480 Scope Exceptions That Apply to Share-Based Payments Within the Scope of ASC 718
In determining the classification of
share-based payment awards under ASC 480,
nonpublic entities should consider the scope
exceptions related to ASC 480 described in ASC
718-10-25-8. The exceptions apply to certain
mandatorily redeemable financial instruments that
either represent noncontrolling interests or are
issued by nonpublic entities that are not SEC
registrants. For example, the classification
guidance in ASC 480 does not apply to mandatorily
redeemable financial instruments of nonpublic
entities that are not SEC registrants unless they
are mandatorily redeemable on fixed dates for
amounts that are either fixed or are determined by
reference to an external index (e.g., an interest
rate index or currency index).
In addition, if a mandatorily
redeemable financial instrument qualifies for one of the exceptions in ASC 480-10, the
issuer should consider the applicability of ASC 480-10-S99-3A to that instrument. See
Section 5.10 for a
discussion and examples of the application of ASR 268 and ASC 480-10-S99-3A to certain
redeemable securities. For detailed guidance on the application of ASC 480, see Deloitte’s
Roadmap Distinguishing Liabilities
From Equity.
5.3 Share Repurchase Features
ASC 718-10
25-9 Topic 480 does not apply to outstanding shares embodying a conditional obligation to transfer assets, for example, shares that give the grantee the right to require the grantor to repurchase them for cash equal to their fair value (puttable shares). A put right may be granted to the grantee in a transaction that is related to a share-based compensation arrangement. If exercise of such a put right would require the entity to repurchase shares issued under the share-based compensation arrangement, the shares shall be accounted for as puttable shares. A puttable (or callable) share awarded to a grantee as compensation shall be classified as a liability if either of the following conditions is met:
- The repurchase feature permits the grantee to avoid bearing the risks and rewards normally associated with equity share ownership for a reasonable period of time from the date the good is delivered or the service is rendered and the share is issued. A grantee begins to bear the risks and rewards normally associated with equity share ownership when all the goods are delivered or all the service has been rendered and the share is issued. A repurchase feature that can be exercised only upon the occurrence of a contingent event that is outside the grantee’s control (such as an initial public offering) would not meet this condition until it becomes probable that the event will occur within the reasonable period of time.
- It is probable that the grantor would prevent the grantee from bearing those risks and rewards for a reasonable period of time from the date the share is issued.
25-10 A puttable (or callable) share that does not meet either of those conditions shall be classified as equity (see paragraph 718-10-55-85).
Classification of Certain Awards With Repurchase Features
55-84 The following paragraph further explains the guidance in paragraphs 718-10-25-9 through 25-12.
55-85 An entity may, for example, grant shares under a share-based compensation arrangement that the grantee can put (sell) to the grantor (the entity) shortly after the vesting date for cash equal to the fair value of the shares on the date of repurchase. That award of puttable shares would be classified as a liability because the repurchase feature permits the grantee to avoid bearing the risks and rewards normally associated with equity share ownership for a reasonable period of time from the date the share is issued (see paragraph 718-10-25-9(a)). Alternatively, an entity might grant its own shares under a share-based compensation arrangement that may be put to the grantor only after the grantee has held them for a reasonable period of time after vesting but at a fixed redemption amount. Those puttable shares also would be classified as liabilities under the requirements of this Topic because the repurchase price is based on a fixed amount rather than variations in the fair value of the grantor’s shares. The grantee cannot bear the risks and rewards normally associated with equity share ownership for a reasonable period of time because of that redemption feature. However, if a share with a repurchase feature gives the grantee the right to sell shares back to the entity for a fixed amount over the fair value of the shares at the date of repurchase, paragraph 718-20-35-7 requires that the fixed amount over the fair value be recognized and attributed as additional compensation cost over the employee’s requisite service period (with a corresponding liability being accrued). The fixed amount over the fair value of a nonemployee award should be recognized as additional compensation cost over the vesting period (with a corresponding liability being accrued) in accordance with paragraph 718-10-25-2C.
A stock award (e.g., restricted stock) may include repurchase
features on the underlying shares (e.g., puttable and
callable shares). The type of an award’s repurchase features
can affect its classification. Call options and put options
are the most common types of repurchase features. A call
option repurchase feature allows (but does not require) the
entity to repurchase vested shares held by a grantee. A put
option repurchase feature allows (but does not require) the
grantee to cause the entity to repurchase vested shares that
the grantee holds. The repurchase price associated with call
and put options can vary (e.g., fair value, fixed amount,
cost, formula value). In addition, the ability to exercise a
repurchase feature is often contingent on certain events
(e.g., termination of employment, change in control). A
right of first refusal, which gives the grantor the ability
to repurchase shares from the grantee before the grantee
sells the shares to a third party, is an example of a
contingent call option.
|
To determine the classification of a stock award (i.e., as liability or equity),
an entity must understand the terms of the repurchase features associated with it.
The decision trees and discussion throughout this section are intended to help an
entity determine how such features affect the classification of awards. The guidance
applies only to stock awards subject to ASC 718 that contain conditional features (e.g., call or put options) to transfer cash or other
assets at settlement. This section therefore does not apply
to the following awards:
-
Stock awards subject to ASC 718 that contain unconditional obligations to transfer cash or other assets. These awards are generally classified as share-based liabilities under ASC 718-10-25-7. See Section 5.2 for a discussion of applying the classification criteria in ASC 480 to share-based payment awards.
-
Stock options or similar instruments that have cash settlement or repurchase features subject to ASC 718. These awards are generally classified in accordance with ASC 718-10-25-11 and 25-12. See Section 5.4 for a discussion of the steps to follow in determining the classification of stock options with cash settlement or repurchase features. However, because ASC 718-10-25-11 requires liability classification for options and similar instruments if the underlying shares are classified as liabilities, ASC 718-10-25-9 and 25-10 apply to stock options or similar instruments in which the underlying shares are puttable or callable. Accordingly, an entity would apply the guidance in this section to determine the classification of those types of stock options or similar instruments. In addition, while grantees generally begin to bear the risks and rewards of share ownership when stock awards vest, they do not do so when stock options vest. Rather, grantees begin to bear the risks and rewards of share ownership when the stock options are exercised and the underlying shares are issued or issuable.
The determination of whether the grantee bears the risks and rewards normally
associated with equity share ownership for a reasonable period is based on whether
the repurchase feature is measured at fair value upon repurchase. If the repurchase
feature is measured at fair value, the grantee bears the risks and rewards of equity
share ownership by holding the shares (upon vesting for stock awards and upon
exercise for stock option awards) for six months or more. If the repurchase feature
is not measured at fair value, the grantee may not bear the risks and rewards of
equity share ownership as long as the repurchase feature is outstanding, and the
six-month period does not apply. As a result, many non–fair value repurchase
features result in an award’s classification as a liability. However, the
classification analysis will also depend on whether the repurchase feature is
exercisable upon a contingent event, as further discussed below.
Much of the guidance below is based on analogies to Issue 23 of EITF Issue 00-23. While EITF Issue 00-23 was superseded by ASC 718 (previously issued as FASB Statement 123(R)), some of the superseded guidance is still relevant in the determination of whether a grantee bears the risks and rewards of equity share ownership (provided that it is consistent with ASC 718-10-25-9 and 25-10).
5.3.1 Repurchase Features — Puttable Stock Awards
To appropriately classify a stock award with a put option, an entity must first
determine whether the put option’s exercisability is contingent on the occurrence of
an event. If the contingent event is solely within the control of the grantee (e.g.,
voluntary termination), the repurchase feature should be analyzed as if it is
noncontingent. Noncontingent puttable shares are generally classified as liabilities
unless the put option is measured at fair value and cannot be exercised for at least
six months after the shares have vested. Contingently puttable shares may require
liability classification depending, in part, on whether the contingent event is
solely within the grantee’s control. See the next section and Section 5.3.1.2 for
discussions of how such noncontingent puttable shares and contingently puttable
shares, respectively, should be evaluated under ASC 718-10-25-9(a).
If the put option does not result in liability classification, SEC registrants must consider the requirements of ASR 268 (FRR Section 211) and ASC 480-10-S99-3A, as discussed in SAB Topic 14.E. In accordance with that guidance, SEC registrants must present as temporary (or mezzanine) equity stock awards (otherwise classified as equity) that are subject to redemption features that are not solely within the control of the issuer. Temporary-equity classification is required if the puttable stock awards qualify for equity classification under the requirements of ASC 718 (e.g., a stock award that is puttable at fair value by the grantee more than six months after vesting). Puttable stock awards classified as temporary equity should be recognized at their redemption value. See Section 5.10 for discussion and examples of the application of ASR 268 and ASC 480-10-S99-3A to share-based payment awards with repurchase features.
5.3.1.1 Repurchase Features — Noncontingent Puttable Stock Awards
1
If the repurchase feature is measured at fair
value, the employee bears the risks and rewards of equity share
ownership by holding the shares for six months or more after the
shares are issued or issuable (i.e., the shares become
“mature”). If the repurchase feature is not measured at fair
value, the employee may not bear the risks and rewards of equity
share ownership as long as the repurchase feature is
outstanding.
Liability classification is required if the noncontingent put option permits the
grantee to avoid bearing the risks and rewards normally associated with
share ownership for a reasonable period from the date on which the stock
award is vested and the shares are issued or issuable. When determining
classification, an entity also needs to consider the option’s repurchase
price.
If the repurchase price is measured at fair value upon repurchase, to avoid
liability classification, a grantee must bear the risks and rewards of share
ownership for at least a period of six months from the date on which the
stock award is vested and the shares are issued or issuable (for stock
options, this would be the period from the date on which the award is
exercised). A noncontingent put option (the exercise of which is in the
grantee’s control) that allows the grantee to exercise the put option
within six months of the vesting of the stock award results in
liability classification of the stock award, even if the grantee is unlikely
to exercise the put option during that period. If the grantee holds the
shares for six months, the shares become “mature” and are reclassified to
equity. If the noncontingent put option cannot be exercised within six
months of vesting, the put option would not cause the stock award to be
classified as a liability.
If the repurchase price is not measured at fair value as of the repurchase date (e.g., repurchase at a formula price), the grantee may not be subject to the risks and rewards of share ownership for as long as the put option is outstanding, regardless of whether the repurchase feature can only be exercised six months after the stock award vests. Therefore, if the repurchase price is not measured at fair value, the stock award (or some portion of the award) will generally be classified as a liability until the put option expires or is settled.
An exception to this requirement is a repurchase feature that enables entities
to satisfy their statutory tax withholding requirements (see Example 5-5). See ASC
718-10-25-18 and Section
5.7.2 for a discussion of the effect of statutory tax
withholding amounts on the classification of share-based payment awards.
Entities must continually assess their stock awards to ensure that they are
appropriately classified. This assessment should occur in each reporting
period on an individual-grantee basis. Awards that are initially classified
as liability awards may subsequently be classified as equity awards if, for
example, the repurchase feature expires or, for fair value repurchase
features, the shares are held for at least six months from the date the
stock awards vested (i.e., the shares are no longer immature). See
Section 6.8.2 for a discussion of
liability-to-equity modifications.
The examples below illustrate noncontingent put options commonly found in share-based payment arrangements.
Example 5-4
Repurchase at Fair Value
Entity A grants 1,000 shares of restricted stock to an employee that vest at the end of the second year of service (cliff vesting). The stock awards give the employee the right to require A to buy back its shares at their then-current fair value 12 months from the date the stock awards are fully vested.
The repurchase feature will not result in liability classification of the stock awards since the employee is required to bear the risks and rewards of share ownership for more than 6 months (i.e., 12 months) after the stock awards have vested. However, if A is an SEC registrant, it must apply the requirements in ASR 268 and ASC 480-10-S99-3A.
Example 5-5
Repurchase at Fair Value — Statutory Tax Withholding Requirements
Entity A grants 1,000 shares of restricted stock to an employee that vest at the end of the second year of service (cliff vesting). When the awards vest, the employee can require A to repurchase a portion of its shares at their then-current fair value to meet A’s statutory tax withholding requirements.
The repurchase feature will not result in liability classification of the stock awards under ASC 718-10-25-18 as long as the employee cannot require A to repurchase its shares in an amount that exceeds the maximum statutory tax rate(s) in its applicable jurisdiction(s) and A has a statutory tax withholding requirement. A repurchase feature giving the employee the right to require the repurchase of shares in excess of the maximum statutory tax rate(s) in its applicable jurisdiction(s) or in circumstances in which A does not have a statutory tax withholding requirement as of the vesting date will result in liability classification for the entire award.
Example 5-6
Repurchase at a Fixed Price — Award With Two
Components
Entity A grants 1,000 shares of restricted stock to an employee that vest at the end of the second year of service (cliff vesting). The stock awards give the employee the right to require A to buy back its shares at a fixed amount 12 months from the date the stock awards are fully vested.
The repurchase feature will result in liability classification of the stock awards since the employee is not subject to the risks and rewards of share ownership for as long as the repurchase feature is outstanding, regardless of whether the repurchase feature can only be exercised more than six months after the shares vest. That is, the repurchase price is fixed at the inception of the arrangement and is therefore not measured at fair value. The stock award would generally be accounted for as an award with a liability and equity component in a manner similar to a combination award, as described in ASC 718-10-55-120 through 55-130. The liability component is based on the fixed amount for which the employee can require A to repurchase its shares, and the equity component is recognized as a call option with an exercise price equal to the fixed amount for which the employee can require A to repurchase its shares. If the fixed-price repurchase feature expires, the liability component is reclassified to equity.
Example 5-7
Repurchase at a Fixed Amount Over Fair Value
Entity A grants 1,000 shares of restricted stock to an employee that vest at the end of the second year of service (cliff vesting). The stock awards give the employee the right to require A to buy back its shares 12 months from the date the stock awards are fully vested. The repurchase amount will be based on the fair value of A’s shares on the date the employee exercises the put option plus $100 per share.
The repurchase feature will not result in liability
classification of the stock awards for the
portion of the awards subject to the repurchase
feature at fair value since the employee is required
to bear the risks and rewards of share ownership for
more than 6 months (i.e., 12 months) after the stock
awards have vested. However, if A is an SEC
registrant, it must apply the requirements in ASR
268 and ASC 480-10-S99-3A. In addition, ASC
718-20-35-7 and ASC 718-10-55-85 require the
recognition of additional compensation cost for the
excess of the repurchase price over the
fair-value-based measure of an award (i.e., $100 per
share). The additional compensation cost is
recognized over the requisite service period of the
stock awards (i.e., two years), with a corresponding
amount recognized as a liability.
Example 5-8
Repurchase at a Formula Price
Entity A grants 1,000 shares of restricted stock to an employee that vest at the end of the second year of service (cliff vesting). The stock awards give the employee the right to require A to buy back its shares 12 months from the date the stock awards are fully vested. The repurchase amount will be based on a multiple of A’s earnings.
The repurchase feature will result in liability
classification of the stock awards if the
repurchase amount is not measured at fair value;
therefore, the employee would not be subject to the
risks and rewards of share ownership regardless of
whether the repurchase feature can only be exercised
more than six months after the shares vest. Entity A
will recognize the liability at its fair-value-based
measure by using the formula price as of each
reporting period.
Example 5-9
Repurchase Stock Options at Fair Value
Entity A grants 1,000 stock options to an employee
that vest at the end of the second year of service
(cliff vesting). The stock options give the employee
the right to require A to buy back its shares at
their then-current fair value 12 months from the
date the stock options are exercised.
The repurchase feature will not result in
liability classification of the stock options
since the employee is required to bear the risks and
rewards of share ownership for more than 6 months
(i.e., 12 months) after the stock options have been
exercised and the shares are outstanding.
5.3.1.2 Repurchase Features — Contingently Puttable Stock Awards
3
The probability analysis for a fair value
repurchase feature is performed for the six-month “window” that
the shares are “immature” (i.e., within six months of vesting).
For a non–fair value repurchase feature, the analysis is
performed for the entire period that the repurchase feature is
outstanding. The analysis is generally performed on an
individual-grantee basis and must be updated continually.
An entity should analyze a put option that becomes exercisable only upon the occurrence of a specified future event (i.e., the triggering event) to determine whether the triggering event is solely within the control of the grantee (i.e., the party that can exercise the put option). An entity should disregard triggering events solely within the control of the grantee and analyze the repurchase feature as if it is noncontingent (i.e., as if the triggering event already occurred) to determine whether it permits the grantee to avoid bearing the risks and rewards normally associated with share ownership for a reasonable period from the date the stock award is vested and the share is issued or issuable. See Section 5.3.1.1 for a discussion of the effect of noncontingent repurchase features on the classification of puttable stock awards.
If the triggering event is not solely within the control of the grantee, the
entity should assess, on an individual-grantee basis, the probability that
the triggering event will occur. Liability classification is required for
stock awards with fair value repurchase features if (1) it is probable that
the triggering event will occur within six months of the date the stock
awards vest and (2) the repurchase feature will permit the grantee to avoid
bearing the risks and rewards normally associated with share ownership for
six or more months after the date the stock award is vested and the shares
are issued or issuable. In addition, liability classification is generally
required for stock awards with non–fair value repurchase features if (1) it
is probable that the triggering event will occur while the repurchase
feature is outstanding and (2) the repurchase feature will permit the
grantee to avoid bearing the risks and rewards normally associated with
share ownership while the repurchase feature is outstanding.
Equity classification is appropriate for stock awards with fair value repurchase features in which
occurrence of the triggering event is (1) not solely within the control of the grantee and (2) not probable
or only probable after the grantee has been subject to the risks and rewards normally associated with
share ownership for six or more months from the date the stock award is vested and the shares are
issued or issuable. If repurchase features are not measured at fair value, equity classification would
generally only be appropriate for stock awards in which occurrence of the triggering event is (1) not
solely within the control of the grantee and (2) not probable while the repurchase feature is outstanding.
Common triggering events for employee awards
include:
Entities must continually assess their stock awards to ensure that they are
appropriately classified. This assessment should occur in each reporting
period on an individual-grantee basis. Awards that are initially classified
as equity awards may be subsequently classified as liability awards as a
result of a change in probability assessment. Likewise, awards that are
initially classified as liability awards may subsequently be classified as
equity awards if, for example, (1) there is a change in probability
assessment, (2) the repurchase feature expires, or, (3) for fair value
repurchase features, the shares are held for at least six months from the
date on which the stock awards vested (i.e., the shares are no longer
immature). See Section 6.8.2 for a
discussion of liability-to-equity modifications.
Example 5-10
Contingent Put Right — Change in Control
Entity A grants 1,000 shares of restricted stock to an employee that vest at the end of the second year of service (cliff vesting). The stock awards give the employee the right to require A to buy back its shares once a change in control occurs. The repurchase amount will be based on the fair value of A’s shares on the date the employee exercises the put option.
The repurchase feature will not result in liability classification of the stock awards but may result in liability classification when it becomes probable that a change in control will occur. As discussed in Section 3.4.2.1, it is generally not considered probable that a change in control will occur until the change in control is consummated.
If the change in control occurs six months after the stock awards vest, equity classification will remain appropriate since the employee would have been subject to the risks and rewards normally associated with share ownership for at least a period of six months from the date the stock awards vested. However, if A is an SEC registrant, it must apply the requirements in ASR 268 and ASC 480-10-S99-3A.
5.3.2 Repurchase Features — Callable Stock Awards
In a manner similar to its treatment of a put option, an entity that grants a stock award with a call option must, to appropriately classify it, first determine whether the call option’s exercisability is contingent on the occurrence of a triggering event. However, unlike contingently puttable shares, all contingent events are assessed for probability, irrespective of whether the triggering event is solely within the grantee’s control. See Sections 5.3.2.1 and 5.3.2.2 for a discussion of how such noncontingent callable shares and contingently callable shares, respectively, should be evaluated under ASC 718-10-25-9(b).
Unlike put options, call options that do not result in liability classification are not assessed by SEC registrants in accordance with the requirements of ASR 268 and ASC 480-10-S99-3A because the redemption feature is solely within the control of the issuer, and that guidance applies only to awards with redemption features not solely within the control of the issuer. That is, a stock award with terms that only permit the entity to repurchase the shares will never be classified as temporary equity.
5.3.2.1 Repurchase Features — Noncontingent Callable Stock Awards
4
See footnote 3.
ASC 718-10-25-9(b) requires liability classification of stock awards when (1) the entity has the ability to
call the shares upon the vesting of the award (i.e., the call option is noncontingent) and (2) it is probable
that the call option will be exercised before the grantee has been subject to the risks and rewards
normally associated with share ownership for a reasonable period from the date the stock award is
vested and the shares are issued or issuable. The requirement to assess probability is different from
the requirement in ASC 718-10-25-9(a). That guidance does not permit an assessment of the grantee’s
probability of exercising a noncontingent put option. That is, a repurchase feature allowing grantees
to exercise a noncontingent put option within six months of the vesting of the stock awards will always
result in liability classification of the stock award, even if the grantee is unlikely to exercise the put
option.
The probability assessment in ASC 718-10-25-9(b) should be based on (1) the
entity’s stated representations that it has the positive intent not to call
the shares while they are immature (i.e., within six months of vesting for
fair value repurchase features and while the call option is outstanding for
non–fair value repurchase features) and (2) all other relevant facts and
circumstances. In assessing all other relevant facts and circumstances, the
entity may analogize to the guidance in superseded Issue 23(a) of EITF Issue
00-23, which indicates that an entity should consider the following
additional factors:
-
“The frequency with which the [grantor] has called immature shares in the past.”
-
“The circumstances under which the [grantor] has called immature shares in the past.”
-
“The existence of any legal, regulatory, or contractual limitations on the [grantor’s] ability to repurchase shares.”
-
“Whether the [grantor] is a closely held, private company.”
If the repurchase price is measured at fair value upon repurchase, to avoid liability classification, a grantee must bear the risks and rewards of share ownership for at least a period of six months from the date the stock award is vested and the shares are issued or issuable. A noncontingent call option (the exercise of which is in the entity’s control) that allows the entity to exercise the call option within six months of the vesting of the stock award results in liability classification of the stock award if it is probable that the entity will exercise the call option within those six months. If it is not probable that the entity will exercise the call option within those six months, the call option will not cause the stock award to be classified as a liability. In addition, if the noncontingent call option cannot be exercised within six months of vesting, the call option would not cause the stock award to be classified as a liability, and a probability assessment is not required.
An exception to liability classification is a repurchase feature that enables
entities to satisfy their statutory tax withholding requirements (see
Example
5-5). See ASC 718-10-25-18 and Section 5.7.2 for a discussion of the
effect of statutory tax withholding amounts on the classification of
share-based payment awards.
If the repurchase price is not measured at fair value on the repurchase date
(e.g., a formula price), the grantee may not be subject to the risks and
rewards of share ownership for as long as the call option is outstanding,
regardless of whether the repurchase feature can only be exercised more than
six months after the stock award vests. Therefore, the probability
assessment should be performed for all periods for which the repurchase
feature is outstanding. If the repurchase price is not measured at fair
value, the stock award will generally be classified as a liability if it is
probable that the entity will exercise the call option while the call option
is outstanding. If it is not probable that the entity will exercise the call
option while the call option is outstanding, the call option will not cause
the stock award to be classified as a liability. An exception to liability
classification can be applied if the repurchase price is at a fixed amount
over the fair value on the repurchase date. In this case, if it is not
probable that the call option will be exercised for at least six months from
the date the stock awards vest but it is still probable that the call option
will be exercised while the repurchase feature is outstanding, only the
fixed amount in excess of fair value would be classified as a liability
award. Further, it is generally probable that a noncontingent call feature
that allows the entity to repurchase shares at a price that is below fair value or potentially below fair value on
the repurchase date will be exercised irrespective of the holding period.
However, the entity should evaluate the repurchase provision to determine
whether, in substance, it represents a vesting condition or clawback feature
(see Section
5.3.4 for further discussion).
Entities must continually assess their stock awards to ensure that they are
appropriately classified. This assessment should occur in each reporting
period on an individual-grantee basis. Awards may initially be classified as
equity awards but, as a result of a change in the probability assessment,
may subsequently be classified as liability awards. Likewise, awards that
are initially classified as liability awards may subsequently be classified
as equity awards if, for example, (1) there is a change in the probability
assessment, (2) the repurchase feature expires, or (3) for fair value
repurchase features, the shares are held for at least six months from the
date the stock awards vested (i.e., the shares are no longer immature). See
Section 6.8.2 for a discussion of
liability-to-equity modifications.
Example 5-11
Noncontingent Call Right
Entity A grants 1,000 shares of restricted stock to an employee that vest at the end of the second year of service (cliff vesting). The employee is restricted from selling A’s shares to a third party for 12 months after they vest. During this 12-month period, A has the right to call its shares at their then-current fair value.
Entity A should assess the probability that it will call the shares within six months of the vesting of the stock awards. Liability classification is required if it is probable that the shares will be called within six months from the date the stock awards vest.
If A is an SEC registrant and the stock awards are not classified as a liability, temporary equity classification of the stock awards will not be required under ASC 480-10-S99-3A because that guidance does not apply to stock awards with redemption features that are solely within the control of the issuer.
5.3.2.2 Repurchase Features — Contingently Callable Stock Awards
5
See footnote 3.
An entity should analyze a contingent call option that becomes exercisable only
upon the occurrence of a specified future event (i.e., the triggering event)
to determine whether it is probable that the triggering event will occur on
an individual-grantee basis. For repurchase features that are measured at
fair value as of the repurchase date, the probability assessment should
cover the period during which the shares are immature (i.e., within six
months of vesting). For repurchase features that are not measured at fair
value as of the repurchase date, the probability assessment should generally
cover the period during which the repurchase feature is outstanding. In the
latter situation, whether the shares are immature or mature is generally not
relevant to the probability assessment since the grantee would generally not
be subject to the risks and rewards of share ownership if the non–fair value
repurchase feature is exercised, regardless of whether the repurchase
feature is exercised more than six months after the shares vest. In
addition, unlike the put option assessment, the probability assessment may
be performed regardless of whether the occurrence of the triggering event is
solely in the control of the party that can exercise the repurchase feature
(i.e., the entity for call options). If it is not probable that the
triggering event will occur while the shares are immature (for fair value
repurchase features) or at any time before the repurchase feature expires
(for non–fair value repurchase features), the repurchase feature will not
result in liability classification. If it is probable that the triggering
event will occur while the shares are immature (for fair value repurchase
features) or at any time before the repurchase feature expires (for non–fair
value repurchase features), the entity should analyze the repurchase feature
as if it is noncontingent (i.e., as if the triggering event already
occurred). See Section
5.3.2.1 for a discussion of the accounting for noncontingent
repurchase features associated with a call option.
Like noncontingent callable stock awards, contingently callable stock awards
must be continually assessed by entities to ensure that they are
appropriately classified. This assessment should occur in each reporting
period on an individual-grantee basis. Awards may be initially classified as
equity awards but, as a result of a change in the probability assessment,
may be subsequently classified as liability awards. Likewise, awards that
are initially classified as liability awards may be subsequently classified
as equity awards if, for example, (1) there is a change in the probability
assessment, (2) the repurchase feature expires, or (3) for fair value
repurchase features, the shares are held for at least six months after the
awards vest (i.e., the shares are no longer immature). See Section 6.8.2 for a discussion of
liability-to-equity modifications.
Example 5-12
Contingent Call
Right — Termination
Entity A grants 1,000 shares of restricted stock to an employee that vest at the end of the second year of service (cliff vesting). If employment is terminated for any reason after vesting, A has the right to call its shares at their then-current fair value.
Entity A should assess the probability that employment will terminate within six months of the vesting of the stock awards (this assessment is performed on an individual-employee basis). If it is not probable that employment will terminate within six months of vesting, the stock awards are classified as equity. If it is probable that employment will terminate within six months of vesting, A should treat the repurchase feature as if it is noncontingent and determine whether it is probable that it will call the shares within six months from the date the stock awards vest.
Example 5-13
Contingent Call Right — Termination
Entity A grants 1,000 shares of restricted stock to an employee that vest at the end of the second year of service (cliff vesting). If employment is terminated for any reason after vesting, A has the right to call its shares at a formula price that is not fair value. The call option expires if A effects an IPO or undergoes a change in control.
Entity A should assess the probability that employment will terminate while the
repurchase feature is outstanding. While it is
certain that employment will terminate at some
point, in certain circumstances it may be
appropriate to perform the probability assessment
(on an individual-employee basis) for the period
before an expected IPO or change in control (e.g.,
there is a single controlling shareholder that has
an exit strategy for the entity and a past practice
of fulfilling similar exit strategies for its
investments). If it is not probable that employment
will terminate during that period, the stock awards
are classified as equity. If it is probable that
employment will terminate during that period, A
should treat the repurchase feature as if it is
noncontingent and determine whether it is probable
that it will call the shares during that period. If
the formula price could potentially be below fair
value on the repurchase date, it is generally
probable that the call feature will be exercised and
that the award would therefore typically be
classified as a liability.
5.3.3 Book-Value Plans for Employees
ASC 718-10
Example 8: Book Value Plans for Employees
55-131 A nonpublic entity that is not a Securities and Exchange Commission (SEC) registrant has two classes of stock. Class A is voting and held only by the members of the founding family, and Class B (book value shares) is nonvoting and held only by employees. The purchase price of Class B shares is a formula price based on book value. Class B shares require that the employee, six months after retirement or separation from the entity, sell the shares back to the entity for cash at a price determined by using the same formula used to establish the purchase price. Class B shares may not be required to be accounted for as liabilities pursuant to Topic 480 because the entity is a nonpublic entity that is not an SEC registrant. Nevertheless, Class B shares may be classified as liabilities if they are granted as part of a share-based payment transaction and those shares contain certain repurchase features meeting criteria in paragraph 718-10-25-9; this Example assumes that Class B shares do not meet those criteria. Because book value shares of public entities generally are not indexed to their stock prices, such shares would be classified as liabilities pursuant to this Topic.
55-132 Determining whether a transaction involving Class B shares is compensatory will depend on the terms of the arrangement. For instance, if an employee acquires 100 shares of Class B stock in exchange for cash equal to the formula price of those shares, the transaction is not compensatory because the employee has acquired those shares on the same terms available to all other Class B shareholders and at the current formula price based on the current book value. Subsequent changes in the formula price of those shares held by the employee are not deemed compensation for services.
55-133 However, if an employee acquires 100 shares of Class B stock in exchange for cash equal to 50 percent of the formula price of those shares, the transaction is compensatory because the employee is not paying the current formula price. Therefore, the value of the 50 percent discount should be attributed over the requisite service period. However, subsequent changes in the formula price of those shares held by the employee are not compensatory.
Certain employee share-based payment transactions that are based on a book or
formula plan may not be compensatory or classified as liabilities. If employees
purchase shares at a formula price and the shares have repurchase features that
use that same formula price, there may be no compensation cost if the same
formula price is used for all transactions in the same class of shares (or in
substantially similar classes of shares). In such circumstances, the formula
price essentially establishes the fair value of the shares. The entity must
still evaluate the repurchase feature under ASC 718-10-25-9 to determine whether
it would cause the shares to be classified as liabilities. If the repurchase
price essentially is measured at fair value, liability classification would not
be required if the repurchase feature can only be exercised after six months.
See Sections 5.3.1
and 5.3.2 for a
discussion of the treatment of repurchase features with a fair value repurchase
price.
5.3.4 Repurchase Features That Function as Vesting Conditions or Clawback Features
Some awards have repurchase features exercisable by an entity (i.e., call options) with a repurchase price that is (1) equal to the cost of the shares or (2) the lower of cost or fair value. The repurchase features for such awards function as in-substance vesting conditions or clawback features, and do not affect the awards’ classification (i.e., the analysis in Sections 5.3.1 and 5.3.2 related to repurchase features is not required) because they do not represent, in substance, cash settlement features. See Sections 3.4.3 and 3.9 for further discussion of features that function as vesting conditions and clawback features.
Footnotes
1
If the repurchase feature is measured at fair
value, the employee bears the risks and rewards of equity share
ownership by holding the shares for six months or more after the
shares are issued or issuable (i.e., the shares become
“mature”). If the repurchase feature is not measured at fair
value, the employee may not bear the risks and rewards of equity
share ownership as long as the repurchase feature is
outstanding.
3
The probability analysis for a fair value
repurchase feature is performed for the six-month “window” that
the shares are “immature” (i.e., within six months of vesting).
For a non–fair value repurchase feature, the analysis is
performed for the entire period that the repurchase feature is
outstanding. The analysis is generally performed on an
individual-grantee basis and must be updated continually.
4
See footnote 3.
5
See footnote 3.
5.4 Stock Options
ASC 718-10
25-11 Options or similar instruments on shares shall be classified as liabilities if either of the following conditions is met:
- The underlying shares are classified as liabilities.
- The entity can be required under any circumstances to settle the option or similar instrument by transferring cash or other assets. A cash settlement feature that can be exercised only upon the occurrence of a contingent event that is outside the grantee’s control (such as an initial public offering) would not meet this condition until it becomes probable that event will occur.
25-12 For example, a Securities and Exchange Commission (SEC) registrant may grant an option to a grantee that, upon exercise, would be settled by issuing a mandatorily redeemable share. Because the mandatorily redeemable share would be classified as a liability under Topic 480, the option also would be classified as a liability.
The sections below discuss guidance on the classification of stock options and similar instruments. See Section 5.3 for guidance on determining the
classification of puttable and callable stock awards.
5.4.1 Classification of Underlying Shares
Stock options and similar instruments are classified as liabilities if the underlying shares are classified as liabilities. For example, if the underlying shares of an option award have repurchase features, an entity would first consider whether to classify the underlying shares as liabilities under ASC 718. See Section 5.3 for guidance on the classification of shares with repurchase features. While grantees generally begin to bear the risks and rewards of share ownership when stock awards vest, they do not do so when stock options vest. Rather, grantees begin to bear the risks and rewards of share ownership when the stock options are exercised and the underlying shares are issued or issuable.
5.4.2 Cash Settlement Features
When stock option awards contain cash settlement features, an entity should
perform the steps indicated in the table and decision tree below. Note that
these steps only apply to stock options and similar
instruments subject to ASC 718 that contain features that transfer cash or other
assets upon settlement. They therefore do not apply to
the following awards:
-
Stock options and similar instruments that will be settled upon the issuance of shares that themselves must be classified as liabilities under ASC 718-10-25-11(a) and 25-12. See the previous section.
-
Share-based payment awards of puttable or callable shares subject to ASC 718. Such awards must be classified in accordance with ASC 718-10-25-9 and 25-10. See Section 5.3 for guidance on determining the classification of puttable and callable stock awards. ASC 718-10-25-9 and 25-10 also apply to stock options and similar instruments in which the underlying shares are puttable or callable. The grantee does not begin to bear the risks and rewards normally associated with share ownership of such instruments until they are exercised.
The table and decision tree below outline an entity’s step-by-step analysis in determining the
classification of stock options and similar instruments with cash settlement features.
Determining the Classification of Employee Stock Options and Similar Instruments With Cash
Settlement Features | ||
---|---|---|
Step | Question | Answer |
1
|
Is cash settlement required, or can the
grantee elect either cash or
share settlement of the stock option or similar
instrument (i.e., is the method of settlement within the
grantee’s control)?
|
If yes, proceed to step 1a. If no,
proceed to step 2.
|
a. Is the requirement to cash settle or the
grantee’s election to cash settle contingent on the
occurrence of an event?
|
If yes, proceed to step 1b. If no,
classify the stock option or similar instrument as a
share-based liability.
| |
b. If the requirement to cash settle or the
grantee’s election to cash settle is contingent on
the occurrence of an event, is the contingent event
within the grantee’s control (e.g., voluntary
termination of employment)?
|
If yes, classify the stock option or
similar instrument as a share-based liability. If no,
proceed to step 1c.
| |
c. If the requirement to cash settle or the
grantee’s election to cash settle is contingent on
the occurrence of an event that is not within the
grantee’s control (e.g., a change in control), is it
probable that the contingent event will occur?
|
If yes, classify the stock option or
similar instrument as a share-based liability. If no,
proceed to step 2.
| |
2
|
Can the entity
choose the method of settlement (i.e., cash or share
settlement) of the stock option or similar
instrument?
|
If yes, proceed to step 2a. If no,
proceed to step 3.
|
a. Is the entity’s election contingent on the
occurrence of an event?
|
If yes, proceed to step 2b. If no,
proceed to step 2c.
| |
b. If the entity’s election is contingent on the
occurrence of an event, is the contingent event
solely within the grantee’s control or is it
probable that the event will occur?
|
If yes, proceed to step 2c. If no,
proceed to step 3.
| |
c. Does the entity have the intent and ability to
settle the stock option or similar instrument in the
entity’s shares?
|
If yes, proceed to step 3. If no,
classify the stock option or similar instrument as a
share-based liability.
| |
3 | Is temporary-equity classification of the stock
option or similar instrument required under SAB
Topic 14.E? This step applies to SEC registrants,
and non-SEC registrants may elect not to apply it. | If yes, classify the stock option or similar
instrument outside of permanent equity as
temporary (or mezzanine) equity. If no, classify the
stock option or similar instrument as permanent
equity. |
5.4.2.1 Noncontingent Cash Settlement Features (Including Tandem and Combination Awards)
Many cash settlement features are not contingent on the occurrence of an event.
If an entity is required to settle stock options or similar instruments in
cash or other assets (e.g., cash-settled SARs), the awards should be
classified as liabilities. Similarly, if the grantee can elect either cash
or share settlement of stock options or similar instruments (e.g., tandem
awards), the awards should be classified as liabilities. ASC 718 provides
the examples below of tandem and combination awards for which the grantee
can elect the method of settlement.
ASC 718-10
Example 7: Tandem Awards
55-116 A tandem award is an award with two or more components in which exercise of one part cancels the other(s). In contrast, a combination award is an award with two or more separate components, all of which can be exercised. The following Cases illustrates one aspect of the guidance in paragraph 718-10-25-15:
- Share option or cash settled stock appreciation rights (Case A)
- Phantom shares or share options (Case B).
55-116A
Cases A and B of this Example (see paragraphs
718-10-55-117 through 55-130) describe employee
awards. However, the principles on accounting for
employee awards, except for compensation cost
attribution, are the same for nonemployee awards.
Therefore, the guidance in these Cases may serve as
implementation guidance for nonemployee awards.
55-116B
Compensation cost attribution for awards to
nonemployees may be the same as or different from
the attribution for the employee awards in Case A
(see paragraph 718-10-55-119) and Case B (see
paragraph 718-10-55-130). 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 the Cases 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
transactions.
Case A: Share Option or Cash Settled Stock Appreciation Rights
55-117 This Case illustrates the accounting for a tandem award in which employees have a choice of either share options or cash-settled stock appreciation rights. Entity T grants to its employees an award of 900,000 share options or 900,000 cash-settled stock appreciation rights on January 1, 20X5. The award vests on December 31, 20X7, and has a contractual life of 10 years. If an employee exercises the stock appreciation rights, the related share options are cancelled. Conversely, if an employee exercises the share options, the related stock appreciation rights are cancelled.
55-118 The tandem award results in Entity T’s incurring a liability because the employees can demand settlement in cash. If Entity T could choose whether to settle the award in cash or by issuing stock, the award would be an equity instrument unless Entity T’s predominant past practice is to settle most awards in cash or to settle awards in cash whenever requested to do so by the employee, indicating that Entity T has incurred a substantive liability as indicated in paragraph 718-10-25-15. In this Case, however, Entity T incurs a liability to pay cash, which it will recognize over the requisite service period. The amount of the liability will be adjusted each year to reflect changes in its fair value. If employees choose to exercise the share options rather than the stock appreciation rights, the liability is settled by issuing stock.
55-119 The fair value of the stock appreciation rights at the grant date is $12,066,454, as computed in Example 1 (see paragraph 718-30-55-1), because the value of the stock appreciation rights and the value of the share options are equal. Accordingly, at the end of 20X5, when the assumed fair value per stock appreciation right is $10, the amount of the liability is $8,214,060 (821,406 cash-settled stock appreciation rights expected to vest × $10). One-third of that amount, $2,738,020, is recognized as compensation cost for 20X5. At the end of each year during the vesting period, the liability is remeasured to its fair value for all stock appreciation rights expected to vest. After the vesting period, the liability for all outstanding vested awards is remeasured through the date of settlement.
Case B: Phantom Shares or Share Options
55-120 This Case illustrates a tandem award in which the components have different values after the grant date, depending on movements in the price of the entity’s stock. The employee’s choice of which component to exercise will depend on the relative values of the components when the award is exercised.
55-121 Entity T grants to its chief executive officer an immediately vested award consisting of the following two parts:
- 1,000 phantom share units (units) whose value is always equal to the value of 1,000 shares of Entity T’s common stock
- Share options on 3,000 shares of Entity T’s stock with an exercise price of $30 per share.
55-122 At the grant date, Entity T’s share price is $30 per share. The chief executive officer may choose whether to exercise the share options or to cash in the units at any time during the next five years. Exercise of all of the share options cancels all of the units, and cashing in all of the units cancels all of the share options. The cash value of the units will be paid to the chief executive officer at the end of five years if the share option component of the tandem award is not exercised before then.
55-123 With a 3-to-1 ratio of share options to units, exercise of 3 share options will produce a higher gain than receipt of cash equal to the value of 1 share of stock if the share price appreciates from the grant date by more than 50 percent. Below that point, one unit is more valuable than the gain on three share options. To illustrate that relationship, the results if the share price increases 50 percent to $45 are as follows.
55-124 If the price of Entity
T’s common stock increases to $45 per share from its
price of $30 at the grant date, each part of the
tandem grant will produce the same net cash payment
(ignoring transaction costs) to the chief executive
officer. If the price increases to $44, the value of
1 share of stock exceeds the gain on exercising 3
share options, which would be $42 [3 × ($44 – $30)].
But if the price increases to $46, the gain on
exercising 3 share options, $48 [3 × ($46 – $30)],
exceeds the value of 1 share of stock.
55-125 At the grant date, the chief executive officer could take $30,000 cash for the units and forfeit the share options. Therefore, the total value of the award at the grant date must exceed $30,000 because at share prices above $45, the chief executive officer receives a higher amount than would the holder of 1 share of stock. To exercise the 3,000 options, the chief executive officer must forfeit the equivalent of 1,000 shares of stock, in addition to paying the total exercise price of $90,000 (3,000 × $30). In effect, the chief executive officer receives only 2,000 shares of Entity T stock upon exercise. That is the same as if the share option component of the tandem award consisted of share options to purchase 2,000 shares of stock for $45 per share.
55-126 The cash payment obligation associated with the units qualifies the award as a liability of Entity T. The maximum amount of that liability, which is indexed to the price of Entity T’s common stock, is $45,000 because at share prices above $45, the chief executive officer will exercise the share options.
55-127 In measuring compensation cost, the award may be thought of as a combination — not tandem — grant of both of the following:
- 1,000 units with a value at grant of $30,000
- 2,000 options with a strike price of $45 per share.
55-128 Compensation cost is measured based on the combined value of the two parts.
55-129 The fair value per share option with an exercise price of $45 is assumed to be $10. Therefore, the total value of the award at the grant date is as follows.
55-130 Therefore, compensation cost recognized at the date of grant (the award is immediately vested) would be $30,000 with a corresponding credit to a share-based compensation liability of $30,000. However, because the share option component is the substantive equivalent of 2,000 deep out-of-the-money options, it contains a derived service period (assumed to be 2 years). Hence, compensation cost for the share option component of $20,000 would be recognized over the requisite service period. The share option component would not be remeasured because it is not a liability. That total amount of both components (or $50,000) is more than either of the components by itself, but less than the total amount if both components (1,000 units and 3,000 share options with an exercise price of $30) were exercisable. Because granting the units creates a liability, changes in the liability that result from increases or decreases in the price of Entity T’s share price would be recognized each period until exercise, except that the amount of the liability would not exceed $45,000.
Many compensation arrangements include payments of both equity and cash. In some cases, the cash component represents a liability-classified share-based payment award that is accounted for separately from the equity-classified component (i.e., as a combination award). The examples below illustrate the accounting for arrangements that are settled partially in cash and partially in equity.
Example 5-14
Entity A grants to an executive
restricted stock and stock options that vest at the
end of four years (cliff vesting). The award
requires A to reimburse the executive in cash for
federal income taxes at a rate of 37 percent when
the employee is taxed, which is when the employee
vests in the restricted stock or exercises its stock
options. Provided that all the criteria for equity
classification have been met, the restricted stock
and stock options will be separately accounted for
as equity-classified share-based payment awards
under ASC 718. In addition, because A is required to
pay the executive in cash amounts that are indexed
to the fair value of the underlying stock, those
obligations are separately accounted for as
liability-classified awards under ASC 718. The tax
obligation associated with the restricted stock is
accounted for as cash-settled RSUs and measured on
the basis of 37 percent of the value of the
underlying restricted stock. In addition, the tax
obligation associated with the stock options is
accounted for as cash-settled SARs. Both
liability-classified awards are required to be
remeasured in each reporting period and recognized
as compensation cost.
Example 5-15
Entity A establishes an entity-wide
bonus program that provides each employee with an
annual targeted compensation rate. At the beginning
of every year, each employee is notified of his or
her targeted rate and the composition in shares of
common stock and cash, which both vest over a
one-year period (cliff vesting). Employee B’s
targeted rate is $100,000 with a 50/50
equity-to-cash split, and each share is worth $50;
therefore, B will receive a cash bonus of $50,000
and a stock award worth $50,000 (1,000 shares, which
is $50,000 divided by the stock price of $50). If,
upon vesting, the value of B’s total compensation is
below the targeted rate, B will receive an
additional cash bonus for the difference. If the
stock price increases from the grant date, no
additional cash bonus is paid. However, if the stock
price decreases from the grant date, B will receive
a cash bonus equal to the decrease in value. For
example, if B receives stock worth $60,000 on the
vesting date, B will not receive any additional cash
bonus. By contrast, if the stock is worth $40,000 on
the vesting date, B will receive an additional cash
bonus of $10,000. In effect, A has guaranteed that
the employee will be paid a minimum of $100,000 in
cash and equity upon earning the bonus.
The $50,000 cash bonus is not
subject to ASC 718 since it is not indexed to A’s
equity value (i.e., it is recognized as a
fixed-price liability over the one-year vesting
period). Provided that all the criteria for equity
classification have been met, the restricted stock
award will be separately accounted for as an
equity-classified award under ASC 718 and recognized
as compensation cost over the one-year requisite
service period. The cash-settled guarantee is
indexed to A’s common stock and is therefore
accounted for as a put option under ASC 718. That
cash-settled share-based liability should be
remeasured in each reporting period and recognized
as compensation cost over the one-year requisite
service period.
An entity that can elect a settlement method should consider the guidance in ASC
718-10-25-15, which requires an entity to continually evaluate its intent
and ability to settle in shares. In addition, an entity’s past practices
related to cash settlement could indicate that the awards should be
classified as substantive liabilities. Section 5.6 discusses considerations
for an entity that can choose the method of settlement in determining the
classification of options and similar instruments.
5.4.2.2 Contingent Cash Settlement Features
An entity should analyze a contingent cash settlement feature that becomes exercisable only upon the
occurrence of a specified future event (i.e., the triggering event) to determine whether the triggering
event is within the control of the grantee. Triggering events within the grantee’s control should be
ignored in the entity’s analysis, and the entity should assess the options or similar instruments as if the
triggering event has already occurred. Options or similar instruments that require or permit the grantee
to cash settle the options or similar instruments must be classified as liabilities. Alternatively, options or
similar instruments that permit the entity to choose settlement in cash or shares are not classified as
liabilities unless they are substantive liabilities under ASC 718-10-25-15.
ASC 718-10-25-11 states that if a contingent cash settlement feature becomes
exercisable upon a triggering event that is not within the control of the
grantee, and the grantee can choose the method of
settlement or the entity is required to settle in cash or other assets, the
stock option or similar instrument will not result in liability
classification if it is not probable that the triggering event will occur.
The assessment of probability is required while an award is within the scope
of ASC 718 and is generally performed on an individual-grantee basis. For
example, a stock option that can require cash settlement upon a change in
control should not be classified as a liability unless a change in control
is considered probable. Generally, a change in control is not considered
probable until the event that triggers it has occurred (e.g., when a
business combination has been consummated).
If a contingent cash settlement feature becomes exercisable upon a triggering
event that is not within the control of the grantee, and the entity can determine the method of settlement, the
stock option or similar instrument will not result in liability
classification if it is not probable that the event will occur. The
probability assessment is required while an award is within the scope of ASC
718 and is generally performed on an individual-grantee basis. If it becomes
probable that the triggering event will occur, the entity must consider the
substantive terms of the option or similar instrument under ASC
718-10-25-15, including the entity’s intent and ability to settle the option
or similar instrument in shares and the entity’s past practices of settling
options or similar instruments. Section 5.6 discusses considerations
for an entity that can choose the method of settlement in determining the
classification of options and similar instruments.
Note that SEC registrants must consider the requirements of ASR 268 (FRR Section
211) and ASC 480-10-S99-3A, as discussed in SAB Topic 14.E. In accordance
with that guidance, SEC registrants must present outside of permanent equity
(i.e., as temporary or mezzanine equity) options and similar instruments
(otherwise classified as equity) that are subject to cash settlement
features that are not solely within the control of the issuer. Temporary
equity classification is required even if the options or similar instruments
otherwise qualify for equity classification under ASC 718 (e.g., an option
that can be cash settled upon a change in control). See Section 5.10 for a
discussion and example of the application of ASR 268 and ASC 480-10-S99-3A
to stock options with a contingent cash settlement feature.
The redemption value at issuance is based on the cash settlement feature of the
option or similar instrument. For example, the redemption value of an option
that can be cash settled at intrinsic value is the intrinsic value of the
option. Thus, if a stock option is granted at-the-money, its initial
carrying value would be zero. Subsequent remeasurement in temporary equity
is not required under ASC 480-10-S99-3A unless it is probable that the
triggering event will occur, in which case the option or similar instrument
would be reclassified as a liability under ASC 718. As indicated in ASC
718-10-35-15, an entity would account for a reclassified stock option or
similar instrument in essentially the same way it would account for a
modification that changes the award’s classification from equity to
liability. See Section
6.8.1 for a discussion and examples of the accounting for the
modification of an award that changes the award’s classification from equity
to liability.
An entity does not need to consider ASC 480-10-S99-3A if it can choose the method of settlement (i.e., cash or share settlement) since that guidance applies only to awards with redemption features not solely within the control of the issuer. An option or similar instrument with terms that allow the entity to choose the method of settlement will never be classified as temporary equity.
5.4.2.3 Early Exercise of a Stock Option or Similar Instrument
An early exercise refers to a grantee’s ability to change his or her tax position by exercising an option or similar instrument and receiving shares before the award is vested.
Because the awards are exercised before vesting, if the grantee ceases to provide goods or services before the end of this period, the entity issuing the shares usually can repurchase the shares for either of the following:
- The lesser of the fair value of the shares on the repurchase date or the exercise price of the award.
- The exercise price of the award.
The purpose of the repurchase feature is effectively to require the grantee to provide goods or
services to receive any economic benefit from the award. Because the repurchase feature functions
as a forfeiture provision, an entity would not consider the provisions of ASC 718-10-25-9 and 25-10 to
determine the classification of the award. In addition, because the early exercise is not considered to
be a substantive exercise for accounting purposes, the payment received by the entity for the exercise
price should generally be recognized as a deposit liability. See Section 3.4.3 for additional discussion on an early exercise of a stock option or similar instrument.
5.4.3 Net Share Settlement Features
Some share-based payment arrangements contain features that allow grantees to net share settle
vested options or similar instruments. These features, which are sometimes referred to as stock option
pyramiding, phantom stock-for-stock exercises, or immaculate cashless exercises, allow the grantee to
exercise an option without having to pay the exercise price in cash. As a result of the settlement feature,
the grantee receives upon exercise a number of shares with a fair value equal to the intrinsic value of
the exercised options.
A net share settlement feature by itself does not result in liability
classification of an option. An option that can be net share settled is no
different from a share-settled SAR and is not required to be classified as a
share-based liability. However, an option may include other features that result
in liability classification. See Section 5.4.2 for guidance on determining
the classification of stock options with cash settlement features.
5.4.4 Broker-Assisted Cashless Exercise
ASC 718-10 — Glossary
Broker-Assisted Cashless Exercise
The simultaneous exercise by a grantee of a share option and sale of the shares through a broker (commonly
referred to as a broker-assisted exercise).
Generally, under this method of exercise:
- The grantee authorizes the exercise of an option and the immediate sale of the option shares in the open market.
- On the same day, the entity notifies the broker of the sale order.
- The broker executes the sale and notifies the entity of the sales price.
- The entity determines the minimum statutory tax-withholding requirements.
- By the settlement day (generally three days later), the entity delivers the stock certificates to the broker.
- On the settlement day, the broker makes payment to the entity for the exercise price and the minimum statutory withholding taxes and remits the balance of the net sales proceeds to the grantee.
ASC 718-10
25-16 A provision that permits grantees to effect a broker-assisted cashless exercise of part or all of an award of share options through a broker does not result in liability classification for instruments that otherwise would be classified as equity if both of the following criteria are satisfied:
- The cashless exercise requires a valid exercise of the share options.
- The grantee is the legal owner of the shares subject to the option (even though the grantee has not paid the exercise price before the sale of the shares subject to the option).
25-17 A broker that is a related party of the entity must sell the shares in the open market within a normal settlement period, which generally is three days, for the award to qualify as equity.
The exercise of stock options and similar instruments is often accomplished through a broker. A feature that permits grantees to effect a broker-assisted cashless exercise would not be deemed a cash settlement feature (that could cause liability classification) if the criteria in ASC 718-10-25-16 and 25-17 are met.
In addition, while ASC 718 does not define a “legal owner,” paragraph 245 of EITF Issue 00-23 states:
As the legal owner of the shares, the employee assumes market risk from
the moment of exercise4 until the broker effects the sale in
the open market. While the period of time that the employee is exposed
to such risk may be inconsequential, it is no less of a period of time
than might lapse if the employee paid cash for the full exercise price
and immediately sold the shares through an independent broker. If the
employee were never the legal owner of the option shares, the stock
option would be in substance a stock appreciation right for which
[liability] accounting is required. If the related-party broker acquires
the shares for its own account rather than selling the shares in the
open market, the grantor has, in effect, paid cash to an employee to
settle an award, which is a transaction for which compensation expense
should be recognized. Conversely, the sale of the option shares in the
open market provides evidence that the marketplace, not the grantor
(through its affiliate), has acquired the option shares.
_________________________________________________
4 Under many cashless exercise programs, the broker will
notify the employee if the aggregate sales price for the option shares
is less than the aggregate exercise price. In that situation, the
employee may elect not to exercise the options. As a result, the moment
of exercise is deemed to be the moment that the shares are sold.
While EITF Issue 00-23 was not codified in ASC 718, we believe that it is
appropriate for entities to consider in determining whether the grantee is the
legal owner of the shares.
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.
5.6 Substantive Terms
ASC 718-10
25-15 The accounting for an award of share-based payment shall reflect the substantive terms of the award and any related arrangement. Generally, the written terms provide the best evidence of the substantive terms of an award. However, an entity’s past practice may indicate that the substantive terms of an award differ from its written terms. For example, an entity that grants a tandem award under which a grantee receives either a stock option or a cash-settled stock appreciation right is obligated to pay cash on demand if the choice is the grantee’s, and the entity thus incurs a liability to the grantee. In contrast, if the choice is the entity’s, it can avoid transferring its assets by choosing to settle in stock, and the award qualifies as an equity instrument. However, if an entity that nominally has the choice of settling awards by issuing stock predominantly settles in cash or if the entity usually settles in cash whenever a grantee asks for cash settlement, the entity is settling a substantive liability rather than repurchasing an equity instrument. In determining whether an entity that has the choice of settling an award by issuing equity shares has a substantive liability, the entity also shall consider whether:
- It has the ability to deliver the shares. (Requirements to deliver registered shares do not, by themselves, imply that an entity does not have the ability to deliver shares and thus do not require an award that otherwise qualifies as equity to be classified as a liability.)
- It is required to pay cash if a contingent event occurs (see paragraphs 718-10-25-11 through 25-12).
An entity with the ability to choose the method of settlement (i.e., cash or share settlement) must consider its intent and ability to settle the awards in cash or shares in determining whether to classify the awards as equity or as a liability. The entity’s past practices related to the following may indicate that some or all of the awards must be classified as a liability:
- Repurchasing awards for cash generally or whenever requested by a grantee.
- Net cash settling options.
The entity’s ability to deliver shares upon the vesting of stock awards or upon
the exercise of stock option awards must also be considered. The grantor must have
enough unissued and authorized shares to settle the awards. A requirement to provide
registered shares does not, by itself, imply that the entity does not have the
ability to deliver shares. However, if (1) the entity does not have enough unissued
and authorized shares to settle the awards in shares and (2) obtaining authorization
for such shares is not perfunctory, liability classification of the awards may be
required. An entity should continue to evaluate the substantive terms while the
award is within the scope of ASC 718. If a reclassification is required, this should
be accounted for as a modification as discussed in Section 6.8.
If the entity can choose the method of settlement (i.e., cash or share settlement), ASC 480-10-S99-3A does not need to be considered since that guidance only applies to awards with redemption features that are not solely within the control of the issuer. An award with terms that allow the entity to choose the method of settlement will never be classified as temporary equity unless there are other redemption features that are not solely within the entity’s control.
Example 5-18
Intent and Ability to Deliver Shares
On February 5, 20X3, Entity A granted a 1,000,000 award of
stock options that vest at the end of the first year of
service (cliff vesting). The award may be settled in either
cash or shares, at A’s election.
Entity A currently has 750,000 shares authorized and unissued
for its stock option plan. To authorize additional shares, A
must obtain shareholder approval, which is considered a
substantive contingency that is not perfunctory.
Because A does not currently have the
ability to satisfy the exercise of 250,000 of the options,
those options would be classified as a liability at the time
of the grant. However, if an additional 250,000 shares are
subsequently authorized for A’s stock option plan and A has
the intent to settle the award in shares (and liability
classification is not required because of other features),
the 250,000 options would be reclassified from a liability
to equity and accounted for as a modification of an award
that changes the award’s classification.
5.7 Exceptions to Liability Classification
5.7.1 Foreign Currency
ASC 718-10
25-14 For this purpose, an award of equity share options granted to a grantee of an entity’s foreign operation
that provides for a fixed exercise price denominated either in the foreign operation’s functional currency or in
the currency in which the foreign operation’s employee’s pay is denominated shall not be considered to contain
a condition that is not a market, performance, or service condition. Therefore, such an award is not required to
be classified as a liability if it otherwise qualifies as equity. For example, equity share options with an exercise
price denominated in euros granted to employees or nonemployees of a U.S. entity’s foreign operation whose
functional currency is the euro are not required to be classified as liabilities if those options otherwise qualify
as equity. In addition, options granted to employees and nonemployees are not required to be classified as
liabilities even if the functional currency of the foreign operation is the U.S. dollar, provided that the foreign
operation’s employees are paid in euros.
25-14A For purposes of applying paragraph 718-10-25-13, a share-based payment award with an exercise
price denominated in the currency of a market in which a substantial portion of the entity’s equity securities
trades shall not be considered to contain a condition that is not a market, performance, or service condition.
Therefore, in accordance with that paragraph, such an award shall not be classified as a liability if it otherwise
qualifies for equity classification. For example, a parent entity whose functional currency is the Canadian dollar
grants equity share options with an exercise price denominated in U.S. dollars to grantees of a Canadian entity
with the functional and payroll currency of the Canadian dollar. If a substantial portion of the parent entity’s
equity securities trades on a U.S. dollar denominated exchange, the options are not precluded from equity
classification.
Stock options may have an exercise price that is denominated in a foreign currency (i.e., a currency that is not the entity’s functional currency). While such foreign currency would not be a service, performance, or market condition (i.e., it is an “other” condition), indexation to the currency, by itself, would not result in liability classification of the stock options if:
- A grantee of an entity’s foreign operation is awarded stock options with a fixed exercise price denominated in the foreign operation’s functional currency.
- A grantee of an entity’s foreign operation is awarded stock options with a fixed exercise price denominated in the currency in which the employee’s pay is denominated.
- A grantee is awarded stock options with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades.
5.7.2 Statutory Tax Withholding Obligation
ASC 718-10
25-18 Similarly, a provision for either direct or indirect (through a net-settlement feature) repurchase of shares issued upon exercise of options (or the vesting of nonvested shares), with any payment due employees withheld to meet the employer’s statutory withholding requirements resulting from the exercise, does not, by itself, result in liability classification of instruments that otherwise would be classified as equity. However, if the amount that is withheld, or may be withheld at the employee’s discretion, is in excess of the maximum statutory tax rates in the employees’ applicable jurisdictions, the entire award shall be classified and accounted for as a liability. That is, to qualify for equity classification, the employer must have a statutory obligation to withhold taxes on the employee’s behalf, and the amount withheld cannot exceed the maximum statutory tax rates in the employees’ applicable jurisdictions. The maximum statutory tax rates are based on the applicable rates of the relevant tax authorities (for example, federal, state, and local), including the employee’s share of payroll or similar taxes, as provided in tax law, regulations, or the authority’s administrative practices, not to exceed the highest statutory rate in that jurisdiction, even if that rate exceeds the highest rate that may be applicable to the specific award grantee.
25-19 Paragraph superseded by Accounting Standards Update No. 2016-09.
25-19A Paragraph 230-10-45-15 provides guidance on the classification on the statement of cash flows for cash paid to a tax authority by an employer when withholding shares from an employee’s award for tax-withholding purposes.
In connection with an entity’s statutory tax withholding obligation, many
share-based payment awards permit the entity to repurchase, either directly or
indirectly through a net settlement feature, a portion of the shares that would
otherwise be issued to employees (e.g., upon vesting of restricted stock or upon
stock option exercise). ASC 718-10-25-18 contains an exception to liability
classification for this share repurchase feature. Specifically, the net
settlement of an award for statutory tax withholding purposes would not, by
itself, result in liability classification of the award provided that (1) the
entity has a statutory obligation to withhold taxes on the employees’ behalf and
(2) the amount withheld for taxes does not exceed the maximum statutory tax
rates in the employees’ relevant tax jurisdictions. The maximum statutory tax
rate is based on the highest statutory tax rate in the employees’ jurisdictions
(determined on a jurisdiction-by-jurisdiction basis), even if that rate is more
than the highest rate applicable to a specific employee. If the amount withheld
exceeds the maximum statutory tax rate, the entire award is classified as a
liability.
If an entity issues an award to a grantee that meets the definition of an
employee under ASC 718-10 (i.e., is a common law employee) but the entity does
not have a statutory obligation to withhold taxes on behalf of the common law
employee, the exception to liability accounting under ASC 718-10-25-18 does not
apply.
5.7.2.1 Hypothetical Withholdings
If employees work in multiple jurisdictions (e.g., mobile employees) or are on
international assignment (e.g., “ex-pat” employees), an entity may apply a
“hypothetical” withholding rate to net settle their share-based payment
awards. The hypothetical amount for an ex-pat employee, for example, might
be based on the rate that would apply if the employee remained in the United
States. To avoid liability classification, the entity must have a statutory
obligation to withhold taxes on the employee’s behalf, and the amount
withheld cannot exceed the maximum statutory tax rates in the employee’s
relevant tax jurisdictions. If a third-party service provider is involved in
administering a company’s stock plan, management should take steps to ensure
that the service provider is (1) sufficiently conversant with the statutory
tax withholding obligations in the applicable jurisdiction(s) and (2) has
access to the necessary human resources and employment information needed to
calculate the minimum withholding.
5.7.2.2 Cash Settlement of Fractional Shares
Because shares are typically withheld from employees in whole-number increments (the issuance of fractional shares is typically prohibited), the value of a fractional share may be paid in cash directly to the employee. For example, if 24.3 shares would be withheld to satisfy the entity’s statutory tax withholding obligation, the entity typically withholds 25 shares and pays the difference (the value of a fractional 0.7 share) in cash directly to the employee. ASC 718-10-25-18 does not appear to require liability classification of an award as a result of a policy in which fractional shares must be cash settled. Therefore, if the cash-settled portion is considered de minimis to the employee, it is not considered a violation of ASC 718-10-25-18 to round up shares to meet the entity’s statutory tax withholding obligation (up to the maximum statutory tax rate(s) in the employee’s applicable jurisdiction(s)). However, an entity should evaluate the facts and circumstances of each arrangement to ensure that (1) its substance does not create a liability and (2) the cash settlement of the fractional share is, in fact, de minimis to the employee.
An arrangement may be a liability in substance, though, if (1) there are multiple exercises in small increments (thereby increasing the number of fractional shares that are cash settled and thus the amount of cash paid to a single employee) and (2) the entity’s per-share stock price is so high that the cash paid for a fractional share could be significant.
5.7.2.3 Changes in the Amount Withheld
The classification of awards can be affected by the manner in which an entity
remits tax savings to employees as a result of overpayments made during the
year to tax authorities to meet the entity’s statutory tax withholding
obligation. The example below illustrates how changes in the amount withheld
to meet an entity’s statutory tax withholding obligation can affect an
award’s classification.
Example 5-19
Entity A has a statutory tax withholding obligation for an employee’s restricted
stock award. The tax authorities allow A to
calculate the amount of taxes due on any date from
the vesting date of an award to A’s year-end. For
administrative ease, on the vesting date, A (1)
withheld, on the basis of the fair value of the
shares on that date, the amount of shares whose fair
value is equal to the employee’s taxes by applying
the maximum statutory tax rate in the employee’s
jurisdiction and (2) remitted that amount to the tax
authorities. At year-end, A decides to recalculate
the tax withholding amount (also by applying the
maximum statutory tax rate in the employee’s
jurisdiction), which results in a decreased
withholding because of a decrease in the fair value
of the entity’s shares from the vesting date. The
entity requests a refund from the tax authorities
for the overpayment and then remits the overpayment
to the employee.
Entity A’s classification of the award depends on how it remits the tax savings
(i.e., refund of overpayment) to the employee. If
the overpayment is remitted to the employee in cash,
the transaction substantively represents the
repurchase of shares for an amount in excess of the
maximum statutory tax rate in the employee’s
jurisdiction. As a result, in such circumstances,
the entire award would have to be classified as a
liability in accordance with ASC 718-10-25-18.
Alternatively, if the tax savings are remitted to
the employee in shares, A should, to avoid any
adverse accounting consequences, determine the
number of shares remitted to the employee by using
the fair value of the shares on the vesting date. In
essence, A would divide the employee’s tax
withholding determined at year-end (on the basis of
the maximum statutory tax rate in the employee’s
jurisdiction and the fair value of the shares on
that date) by the fair value of the shares as of the
vesting date to determine the amount that would have
been withheld as of the vesting date if A had known
the employee’s year-end taxes (on the basis of the
maximum statutory tax rate) as of the vesting date.
The excess number of shares between the new
calculation and initial calculation would then be
remitted to the employee.
5.7.2.4 Nonemployee Director Tax Withholdings
While a nonemployee member of an entity’s board of directors may be treated similarly to an employee under ASC 718 (see Section 2.3), the director is not considered an employee under the IRS’s statutory withholding requirements. Because an entity does not have any statutory tax withholding requirements in the United States related to nonemployee directors, the entity would not qualify for the exception to liability classification in ASC 718-10-25-18. Thus, an entity’s practice of withholding shares to satisfy the director’s tax obligation would result in liability classification of the entire award. The same would be true for other nonemployee recipients of share-based payment awards for which statutory tax withholding requirements would not apply (e.g., partners of partnerships or limited liability companies).
5.8 Awards That Become Subject to Other Guidance
ASC 718-10
Awards May Become Subject to Other Guidance
35-9 Paragraphs 718-10-35-10 through 35-14 are intended to apply to those instruments issued in share-based payment transactions with employees and nonemployees accounted for under this Topic, and to instruments exchanged in a business combination for share-based payment awards of the acquired business that were originally granted to grantees of the acquired business and are outstanding as of the date of the business combination.
35-9A Paragraph superseded by
Accounting Standards Update No. 2020-06.
35-10 A freestanding financial
instrument or a convertible security issued to a grantee
that is subject to initial recognition and measurement
guidance within this Topic shall continue to be subject to
the recognition and measurement provisions of this Topic
throughout the life of the instrument, unless its terms are
modified after any of the following:
- Subparagraph superseded by Accounting Standards Update No. 2019-08.
- Subparagraph superseded by Accounting Standards Update No. 2019-08.
- A grantee vests in the award and is no longer providing goods or services.
- A grantee vests in the award and is no longer a customer.
- A grantee is no longer an employee.
35-10A Only for
purposes of paragraph 718-10-35-10, a modification does not
include a change to the terms of an award if that change is
made solely to reflect an equity restructuring provided that
both of the following conditions are met:
- There is no increase in fair value of the award (or the ratio of intrinsic value to the exercise price of the award is preserved, that is, the holder is made whole) or the antidilution provision is not added to the terms of the award in contemplation of an equity restructuring.
- All holders of the same class of equity instruments (for example, stock options) are treated in the same manner.
35-11 Other modifications of
that instrument that take place after a grantee vests in the
award and is no longer providing goods or services, is no
longer a customer, or is no longer an employee should be
subject to the modification guidance in paragraph
718-10-35-14. Following modification, recognition and
measurement of the instrument shall be determined through
reference to other applicable GAAP.
35-12 Once the classification of an instrument is determined, the recognition and measurement provisions of this Topic shall be applied until the instrument ceases to be subject to the requirements discussed in paragraph 718-10-35-10. Topic 480 or other applicable GAAP, such as Topic 815, applies to a freestanding financial instrument that was issued under a share-based payment arrangement but that is no longer subject to this Topic. This guidance is not intended to suggest that all freestanding financial instruments shall be accounted for as liabilities pursuant to Topic 480, but rather that freestanding financial instruments issued in share-based payment transactions may become subject to that Topic or other applicable GAAP depending on their substantive characteristics and when certain criteria are met.
35-13 Paragraph superseded by Accounting Standards Update No. 2016-09.
35-14 An entity may modify (including cancel and replace) or settle a fully vested, freestanding financial
instrument after it becomes subject to Topic 480 or other applicable GAAP. Such a modification or settlement
shall be accounted for under the provisions of this Topic unless it applies equally to all financial instruments of
the same class regardless of the holder of the financial instrument. Following the modification, the instrument
continues to be accounted for under that Topic or other applicable GAAP. A modification or settlement of a
class of financial instrument that is designed exclusively for and held only by grantees (or their beneficiaries)
may stem from the employment or vendor relationship depending on the terms of the modification or
settlement. Thus, such a modification or settlement may be subject to the requirements of this Topic. See
paragraph 718-10-35-10 for a discussion of changes to awards made solely to reflect an equity restructuring.
5.8.1 Awards Modified When the Grantee Is No Longer Providing Goods or Services
A share-based payment award that is subject to ASC 718 generally does not become
subject to other applicable GAAP unless the award is modified when (1) the
individual is no longer an employee, (2) the nonemployee has vested in the award
and is no longer providing goods or services, or (3) the grantee is no longer a
customer. Modifications made to an award when the holder is no longer an
employee or the nonemployee has vested in the award and is no longer providing
goods or services should be accounted for under ASC 718-10-35-11 through 35-14.
After the modification, the award will become subject to other applicable GAAP
(e.g., ASC 815 and ASC 480). Note that once the award becomes subject to other
applicable GAAP, it is ineligible for any of ASC 718’s exceptions to liability
classification.
There are two exceptions to this guidance, however, related to (1) certain
equity restructurings (see the next section) and (2) convertible instruments
issued to nonemployees (see Section 9.5).
5.8.2 Equity Restructurings
ASC 718-10-35-10A clarifies the accounting treatment of changes to the terms of
a share-based payment award that are made solely to reflect an equity
restructuring. While an equity restructuring is considered a modification under
ASC 718-20-35-6, an entity does not treat it as a modification when applying ASC
718-10-35-10A (i.e., it is not subject to other applicable GAAP) if both of the
following conditions are met:
-
There is no increase in fair value of the award (or the ratio of intrinsic value to the exercise price of the award is preserved. . .) or the antidilution provision is not added to the terms of the award in contemplation of an equity restructuring.
-
All holders of the same class of equity instruments . . . are treated in the same manner.
5.9 Change in Classification Due to Change in Probable Settlement Outcome
ASC 718-10
Change in Classification Due to Change in Probable Settlement Outcome
35-15 An option or similar instrument that is classified as equity, but subsequently becomes a liability because the contingent cash settlement event is probable of occurring, shall be accounted for similar to a modification from an equity to liability award. That is, on the date the contingent event becomes probable of occurring (and therefore the award must be recognized as a liability), the entity recognizes a share-based liability equal to the portion of the award attributed to past performance (which reflects any provision for acceleration of vesting) multiplied by the award’s fair value on that date. To the extent the liability equals or is less than the amount previously recognized in equity, the offsetting debit is a charge to equity. To the extent that the liability exceeds the amount previously recognized in equity, the excess is recognized as compensation cost. The total recognized compensation cost for an award with a contingent cash settlement feature shall at least equal the fair value of the award at the grant date. The guidance in this paragraph is applicable only for options or similar instruments issued as part of compensation arrangements. That is, the guidance included in this paragraph is not applicable, by analogy or otherwise, to instruments outside share-based payment arrangements.
An award’s classification can change even if the terms and conditions are not modified. For example, an entity that can choose the settlement method of a stock option award could classify the award as equity upon initially concluding that it has the intent and ability to settle the award with shares. However, the entity could subsequently reclassify the award as a liability if it concludes that it no longer has the intent or ability to settle the award with shares (i.e., it will cash settle the option award). In addition, an entity that initially classifies a stock award as a liability (because a grantee has a noncontingent fair value put option on the shares) could reclassify the award as equity once the grantee has borne the risks and rewards of equity share ownership for six months after the stock award has vested, or for awards of stock options, six months after the option has been exercised.
If an award’s classification changes as a result of changes in an entity’s facts and circumstances (e.g., from equity-classified to liability-classified or vice versa), the entity should account for the change in a manner similar to a modification that changes classification, even if the award has not been modified. The accounting will depend on the classification of the award before and after the change in facts and circumstances. See Section 6.8 for further discussion of changes to the classification of an award as a result of its modification.
5.10 SEC Guidance on Temporary Equity
ASC 480-10 — SEC Materials — SEC Staff Guidance
SEC Staff Announcement: Classification and Measurement of Redeemable Securities
Background
1. This SEC staff announcement provides
the SEC staff’s views regarding the application of
Accounting Series Release No. 268, Presentation in
Financial Statements of “Redeemable Preferred
Stocks.”FN1
Scope
2. ASR 268 requires preferred securities
that are redeemable for cash or other assets to be
classified outside of permanent equity if they are
redeemable (1) at a fixed or determinable price on a fixed
or determinable date, (2) at the option of the holder, or
(3) upon the occurrence of an event that is not solely
within the control of the issuer. As noted in ASR 268, the
Commission reasoned that “[t]here is a significant
difference between a security with mandatory redemption
requirements or whose redemption is outside the control of
the issuer and conventional equity capital. The Commission
believes that it is necessary to highlight the future cash
obligations attached to this type of security so as to
distinguish it from permanent capital.”
3. Although ASR 268 specifically
describes and discusses preferred securities, the SEC staff
believes that ASR 268 also provides analogous guidance for
other redeemable equity instruments including, for example,
common stock, derivative instruments, noncontrolling
interests,FN2 securities held by an employee
stock ownership plan,FN3 and share-based payment
arrangements with employees.FN4 The SEC staff’s
views regarding the applicability of ASR 268 in certain
situations is described below. . . .
d. Share-based payment awards.
Equity-classified share-based payment arrangements
with employees are not subject to ASR 268 due solely
to either of the following:
-
Net cash settlement would be assumed pursuant to Paragraphs 815-40-25-11 through 25-16 solely because of an obligation to deliver registered shares.FN7
-
A provision in an instrument for the direct or indirect repurchase of shares issued to an employee exists solely to satisfy the employer’s minimum statutory tax withholding requirements (as discussed in Paragraphs 718-10-25-18 through 25-19). . . .
Classification
4. ASR 268 requires equity instruments
with redemption features that are not solely within the
control of the issuer to be classified outside of permanent
equity (often referred to as classification in “temporary
equity”). The SEC staff does not believe it is appropriate
to classify a financial instrument (or host contract) that
meets the conditions for temporary equity classification
under ASR 268 as a liability.FN10
5. Determining whether an equity
instrument is redeemable at the option of the holder or upon
the occurrence of an event that is solely within the control
of the issuer can be complex. The SEC staff believes that
all of the individual facts and circumstances surrounding
events that could trigger redemption should be evaluated
separately and that the possibility that any
triggering event that is not solely within the
control of the issuer could occur — without regard to
probability — would require the instrument to be classified
in temporary equity. . . .
Measurement
12. Initial measurement. The SEC
staff believes the initial carrying amount of a redeemable
equity instrument that is subject to ASR 268 should be its
issuance date fair value, except as follows: FN12
- For share-based payment arrangements with employees, the initial amount presented in temporary equity should be based on the redemption provisions of the instrument and the proportion of consideration received in the form of employee services at initial recognition. For example, upon issuance of a fully vested option that allows the holder to put the option back to the issuer at its intrinsic value upon a change in control, an amount representing the intrinsic value of the option at the date of issuance should be presented in temporary equity. . . .
13. Subsequent measurement. The
SEC staff’s views regarding the subsequent measurement of a
redeemable equity instrument that is subject to ASR 268 are
included in paragraphs 14–16. Paragraphs 14 and 15 discuss
the general views regarding subsequent measurement.
Paragraph 16 discusses the application of those general
views in the context of certain types of redeemable equity
instruments.
14. If an equity instrument subject to
ASR 268 is currently redeemable (for example, at the option
of the holder), it should be adjusted to its maximum
redemption amount at the balance sheet date. If the maximum
redemption amount is contingent on an index or other similar
variable (for example, the fair value of the equity
instrument at the redemption date or a measure based on
historical EBITDA), the amount presented in temporary equity
should be calculated based on the conditions that exist as
of the balance sheet date (for example, the current fair
value of the equity instrument or the most recent EBITDA
measure). The redemption amount at each balance sheet date
should also include amounts representing dividends not
currently declared or paid but which will be payable under
the redemption features or for which ultimate payment is not
solely within the control of the registrant (for example,
dividends that will be payable out of future
earnings).FN13
15. If an equity instrument subject to
ASR 268 is not currently redeemable (for example, a
contingency has not been met), subsequent adjustment of the
amount presented in temporary equity is unnecessary if it is
not probable that the instrument will become redeemable. If
it is probable that the equity instrument will become
redeemable (for example, when the redemption depends solely
on the passage of time), the SEC staff will not object to
either of the following measurement methods provided the
method is applied consistently:
- . Accrete changes in the redemption value over the period from the date of issuance (or from the date that it becomes probable that the instrument will become redeemable, if later) to the earliest redemption date of the instrument using an appropriate methodology, usually the interest method. Changes in the redemption value are considered to be changes in accounting estimates
- Recognize changes in the redemption value (for example, fair value) immediately as they occur and adjust the carrying amount of the instrument to equal the redemption value at the end of each reporting period. This method would view the end of the reporting period as if it were also the redemption date for the instrument.
16. The following additional guidance is
relevant to the application of the SEC staff’s views in
paragraphs 14 and 15:
- For share-based payment arrangements with employees, the amount presented in temporary equity at each balance sheet date should be based on the redemption provisions of the instrument and should take into account the proportion of consideration received in the form of employee services (that is, the pattern of recognition of compensation cost pursuant to Topic 718). FN14 . . .
Reclassifications Into Permanent Equity
18. If classification of an equity instrument as temporary equity is no longer required (if, for example, a redemption feature lapses, or there is a modification of the terms of the instrument), the existing carrying amount of the equity instrument should be reclassified to permanent equity at the date of the event that caused the reclassification. Prior financial statements are not adjusted. Additionally, the SEC staff believes that it would be inappropriate to reverse any adjustments previously recorded to the carrying amount of the equity instrument (pursuant to paragraphs 14–16) in conjunction with such reclassifications.
__________________________________
FN1 ASR 268 (SEC Financial Reporting
Codification, Section No. 211, Redeemable Preferred
Stocks) is incorporated into SEC Regulation S-X,
Articles 5-02.27, 7-03.21, and 9-03.19. Hereafter, reference
is made only to ASR 268.
FN2 The Master Glossary defines noncontrolling
interest as “The portion of equity (net assets) in a
subsidiary not attributable, directly or indirectly, to a
parent. A noncontrolling interest is sometimes called a
minority interest.” ASR 268 applies to redeemable
noncontrolling interests (provided the redemption feature is
not considered a freestanding option within the scope of
Subtopic 480-10). Where relevant, specific classification
and measurement guidance pertaining to redeemable
noncontrolling interests has been included in this SEC staff
announcement.
FN3 ASR 268 applies to equity securities held by
an employee stock ownership plan (whether or not allocated)
that, by their terms, can be put to the registrant (sponsor)
for cash or other assets. Where relevant, specific
classification and measurement guidance pertaining to
employee stock ownership plans has been included in this SEC
staff announcement.
FN4 As indicated in Section 718-10-S99, ASR 268
applies to redeemable equity-classified instruments granted
in conjunction with share-based payment arrangements with
employees. Where relevant, specific classification and
measurement guidance pertaining to share-based payment
arrangements with employees has been included in this SEC
staff announcement.
FN7 See footnote 84 of Section 718-10-S99.
FN10 At the June 14, 2007 EITF meeting, the SEC
Observer stated that a financial instrument (or host
contract) that otherwise meets the conditions for temporary
equity classification may continue to be classified as a
liability provided the financial instrument (or host
contract) was classified and accounted for as a liability in
fiscal quarters beginning before September 15, 2007 and has
not subsequently been modified or subject to a remeasurement
(new basis) event.
FN12 SAB Topic 3C, Redeemable Preferred
Stock, states that the initial carrying amount of
redeemable preferred stock should be its fair value at date
of issue. The SEC staff believes this guidance should also
be applied to other similar redeemable equity instruments.
Consistent with Paragraph 820-10-30-3, the transaction price
will generally represent the initial fair value of the
equity instrument when the issuance occurs in an
arm’s-length transaction with an unrelated party and there
are no other unstated rights or privileges.
FN13 See also Section 260-10-45.
FN14 See also the Interpretative Response to
Question 2 in Section E of Section 718-10-S99.
SEC Staff Accounting Bulletins
SAB Topic 14.E, FASB ASC Topic 718,
Compensation — Stock Compensation, and Certain Redeemable
Financial Instruments
Certain financial instruments awarded in
conjunction with share-based payment arrangements have
redemption features that require settlement by cash or other
assets upon the occurrence of events that are outside the
control of the issuer.77 FASB ASC Topic 718
provides guidance for determining whether instruments
granted in conjunction with share-based payment arrangements
should be classified as liability or equity instruments.
Under that guidance, most instruments with redemption
features that are outside the control of the issuer are
required to be classified as liabilities; however, some
redeemable instruments will qualify for equity
classification.78 SEC Accounting Series
Release No. 268, Presentation in Financial Statements of
“Redeemable Preferred Stocks,”79 (“ASR 268”) and
related guidance80 address the classification and
measurement of certain redeemable equity instruments.
Facts: Under a
share-based payment arrangement, Company F grants to an
employee shares (or share options) that all vest at the end
of four years (cliff vest). The shares (or shares underlying
the share options) are redeemable for cash at fair value at
the holder’s option, but only after six months from the date
of share issuance (as defined in FASB ASC Topic 718).
Company F has determined that the shares (or share options)
would be classified as equity instruments under the guidance
of FASB ASC Topic 718. However, under ASR 268 and related
guidance, the instruments would be considered to be
redeemable for cash or other assets upon the occurrence of
events (e.g., redemption at the option of the holder)
that are outside the control of the issuer.
Question 1: While
the instruments are subject to FASB ASC Topic 718, is ASR
268 and related guidance applicable to instruments issued
under share-based payment arrangements that are classified
as equity instruments under FASB ASC Topic 718?
Interpretive
Response: Yes. The staff believes that registrants
must evaluate whether the terms of instruments granted in
conjunction with share-based payment arrangements that are
not classified as liabilities under FASB ASC Topic 718
result in the need to present certain amounts outside of
permanent equity (also referred to as being presented in
“temporary equity”) in accordance with ASR 268 and related
guidance.81
When an instrument ceases to be subject to
FASB ASC Topic 718 and becomes subject to the recognition
and measurement requirements of other applicable GAAP, the
staff believes that the company should reassess the
classification of the instrument as a liability or equity at
that time and consequently may need to reconsider the
applicability of ASR 268.
Question 2: How
should Company F apply ASR 268 and related guidance to the
shares (or share options) granted under the share-based
payment arrangements with employees that may be unvested at
the date of grant?
Interpretive
Response: Under FASB ASC Topic 718, when
compensation cost is recognized for instruments classified
as equity instruments, additional
paid-in-capital82 is increased. If the award
is not fully vested at the grant date, compensation cost is
recognized and additional paid-in-capital is increased over
time as services are rendered over the requisite service
period. A similar pattern of recognition should be used to
reflect the amount presented as temporary equity for
share-based payment awards that have redemption features
that are outside the issuer’s control but are classified as
equity instruments under FASB ASC Topic 718. The staff
believes Company F should present as temporary equity at
each balance sheet date an amount that is based on the
redemption amount of the instrument, but takes into account
the proportion of consideration received in the form of
employee services. Thus, for example, if a nonvested share
that qualifies for equity classification under FASB ASC
Topic 718 is redeemable at fair value more than six months
after vesting, and that nonvested share is 75% vested at the
balance sheet date, an amount equal to 75% of the fair value
of the share should be presented as temporary equity at that
date. Similarly, if an option on a share of redeemable stock
that qualifies for equity classification under FASB ASC
Topic 718 is 75% vested at the balance sheet date, an amount
equal to 75% of the intrinsic83 value of the
option should be presented as temporary equity at that
date.
Question 3: Would
the methodology described for employee awards in the
Interpretive Response to Question 2 above apply to
nonemployee awards to be issued in exchange for goods or
services with similar terms to those described above?
Interpretive
Response: The staff believes it would generally be
appropriate to apply the methodology described in the
Interpretive Response to Question 2 above to nonemployee
awards.
______________________________
77 The terminology “outside the
control of the issuer” is used to refer to any of the three
redemption conditions described in Rule 5-02.27 of
Regulation S-X that would require classification outside
permanent equity. That rule requires preferred securities
that are redeemable for cash or other assets to be
classified outside of permanent equity if they are
redeemable (1) at a fixed or determinable price on a fixed
or determinable date, (2) at the option of the holder, or
(3) upon the occurrence of an event that is not solely
within the control of the issuer.
78 FASB ASC paragraphs
718-10-25-6 through 718-10-25-19A.
79 ASR 268, July 27, 1979, Rule
5-02.27 of Regulation S-X.
80 Related guidance includes EITF Topic No. D-98, "Classification and Measurement of
Redeemable Securities," included in the FASB ASC in
paragraph 480-10-S99-3A.
81 Instruments granted in
conjunction with share-based payment arrangements with
employees that do not by their terms require redemption for
cash or other assets (at a fixed or determinable price on a
fixed or determinable date, at the option of the holder, or
upon the occurrence of an event that is not solely within
the control of the issuer) would not be assumed by the staff
to require net cash settlement for purposes of applying ASR
268 in circumstances in which FASB ASC Section 815-40-25,
Derivatives and Hedging — Contracts in Entity’s Own Equity —
Recognition, would otherwise require the assumption of net
cash settlement. See FASB ASC paragraph 815-40-25-11
(See FASB ASC paragraph 815-10-65-1 for the transition and
effective date information related to FASB ASU No. 2020-06,
Debt — Debt With Conversion and Other Options
(Subtopic 470-20) and Derivatives and Hedging —
Contracts in Entity's Own Equity (Subtopic 815-40):
Accounting for Convertible Instruments and Contracts in
an Entity's Own Equity, which superseded FASB ASC
paragraph 815-40-25-11.), which states, in part: “. . . the
events or actions necessary to deliver registered shares are
not controlled by an entity and, therefore, except under the
circumstances described in FASB ASC paragraph 815-40-25-16,
if the contract permits the entity to net share or
physically settle the contract only by delivering registered
shares, it is assumed that the entity will be required to
net cash settle the contract.” See also FASB ASC
subparagraph 718-10-25-15(a).
82 Depending on the fact pattern,
this may be recorded as common stock and additional paid in
capital.
83 The potential redemption
amount of the share option in this illustration is its
intrinsic value because the holder would pay the exercise
price upon exercise of the option and then, upon redemption
of the underlying shares, the company would pay the holder
the fair value of those shares. Thus, the net cash outflow
from the arrangement would be equal to the intrinsic value
of the share option. In situations where there would be no
cash inflows from the share option holder, the cash required
to be paid to redeem the underlying shares upon the exercise
of the put option would be the redemption value.
To determine the classification of an award otherwise classified as equity under
ASC 718, SEC registrants must consider the requirements of ASR 268 (FRR Section 211)
and ASC 480-10-S99-3A, as discussed in SAB Topic 14.E, on redeemable securities. SEC
registrants must present outside of permanent equity (i.e., as temporary or
mezzanine equity) share-based payment awards (otherwise classified as equity) that
are subject to redemption features not solely within the control of the issuer
(e.g., upon the occurrence of a triggering event such as a change in control of the
issuer). Temporary-equity classification may be required even if the share-based
payment awards otherwise qualify for equity classification under ASC 718 (e.g., a
stock award that is contingently puttable by the grantee more than six months after
vesting at the then-current fair value). Exceptions include the following:
-
The award does not require redemption for cash or other assets, and cash settlement would be possible only upon the issuer’s inability to deliver registered shares (as described in ASC 815-40-25-11 through 25-16).
-
The award permits direct or indirect share repurchases only to satisfy the issuer’s statutory tax withholding requirements (as described in ASC 718-10-25-18).
The following are examples of situations in which awards would be classified in
temporary equity (provided that liability classification would not be required
because of other features):
-
A stock award that may allow the grantee the right to require the issuer to repurchase shares for fair value at any time after six months from the date on which the shares are fully vested.
-
A stock award that would be settled in cash upon a triggering event that is not solely within the control of the issuer (e.g., upon a change in control of the issuer).
-
A stock option that may give the grantee the right to require the issuer to repurchase the option at the current intrinsic value upon a change in control.
ASC 480-10-S99-3A and SAB Topic 14.E require that SEC registrants recognize and measure an award with redemption features not solely within the control of the issuer in temporary equity as follows:
- At the award’s issuance, the entity should base the carrying value on its redemption value and the proportion attributed to the employee requisite service rendered or nonemployee’s vesting period recognized to date. This view is consistent with the treatment of compensation cost that increases over time as services are rendered over the requisite service period, which is addressed in the SEC staff’s response to Question 2 of SAB Topic 14.E.
- Until the award’s settlement, the entity should remeasure the award at the end of the reporting period on the basis of its redemption value and the proportion attributed to the employee requisite services rendered or nonemployee’s vesting period recognized to date. In other words, as the award begins to vest, the redemption amount would be accreted to temporary equity in accordance with the employee requisite services rendered or the nonemployee’s vesting period. Note that remeasurement is not required for an award issued with contingent repurchase features if it is not considered probable that the contingency would occur. The assessment of probability is generally performed on an individual-grantee basis.
- The amount of compensation cost recognized should be based on the award’s grant-date fair-value-based measure. Changes in the redemption value after the award is granted are recorded in equity and not as compensation cost recognized in earnings.
The redemption value at issuance is based on the redemption feature of the
award. For example, the redemption value of an award that is redeemable at intrinsic
value is the intrinsic value of the award. Thus, if a stock option is granted
at-the-money, its initial redemption value is zero. This is because when an option
is settled, the grantee receives the difference between the fair value of the
underlying shares and the exercise price (which are the same for an at-the-money
option). Alternatively, the redemption value of an option that is redeemable at fair
value is the fair value of the option. In a situation in which a stock option is
granted and the underlying share is redeemable at fair value, the redemption value
of the stock option is the intrinsic value and, after exercise, the redemption value
of the share is the fair value of the share. Subsequent remeasurement (if required
under ASC 480-10-S99-3A) will be based on the fair value of the issuer’s shares in
each period, less the exercise price of the award, if any. For guidance on
reclassifications between permanent and temporary equity, see Section 9.7.4 of Deloitte’s
Roadmap Distinguishing
Liabilities From Equity.
The example below illustrates the application of ASR 268 and ASC 480-10-S99-3A
to stock awards with repurchase features. Example 5-21 illustrates the application of
ASR 268 and ASC 480-10-S99-3A to stock options with a contingent cash settlement
feature.
Example 5-20
On January 1, 20X1, Entity A, an SEC registrant, grants 100,000 shares of restricted stock to an employee. The stock awards vest at the end of the fourth year of service (cliff vesting). The stock awards give the employee the right to require A to buy back A’s shares at their then-current fair value any time after six months from the date the stock awards are fully vested. The fair value of the shares is as follows:
- $10 on January 1, 20X1.
- $12 on December 31, 20X1.
- $7 on December 31, 20X2.
- $11 on December 31, 20X3.
- $14 on December 31, 20X4.
The repurchase feature will not result in liability classification of the stock awards since the employee will bear the risks and rewards of share ownership for a period of more than six months after the stock awards have vested. However, as an SEC registrant, A must apply ASR 268 and ASC 480-10-S99-3A. That guidance requires an SEC registrant to present outside of permanent equity (i.e., as temporary or mezzanine equity) share-based payment awards (otherwise classified as equity) that are subject to redemption features not solely within the control of the issuer.
Entity A should record the following journal entries:
Example 5-21
On January 1, 20X1, Entity A, an SEC registrant, grants 100,000 stock options to
an employee, each with a grant-date fair-value-based measure
of $8. The options are granted with a $10 exercise price
when A’s share price is $15 (i.e., the options have an
intrinsic value of $5 per share on the grant date). The
options vest at the end of the second year of service (cliff
vesting) and give the employee the right to require A to net
cash settle the options upon a change in control. On
February 1, 20X3, when the fair-value-based measure of the
options is $15, a change in control becomes probable. Note
that in accordance with ASC 805-20-55-50 and 55-51, which
discuss liabilities that are triggered upon the consummation
of a business combination, a change in control is generally
not considered probable until it occurs.
From the date of issuance, January 1, 20X1, to January 31, 20X3, the cash
settlement feature will not result in liability
classification of the options since the change in control is
not considered probable. However, on February 1, 20X3, when
the change in control becomes probable (i.e., the date it
occurs), the options must be reclassified as a share-based
liability. The reclassification is accounted for in a manner
similar to a modification that changes the awards’
classification from equity to liability. That is, on the
date the change in control occurs, A recognizes a
share-based liability for the portion of the options that
are related to prior service, multiplied by the options’
fair-value-based measure on that date. If the amount
recognized as a share-based liability is less than or equal
to the amount previously recognized in equity, the
offsetting amount is recorded to APIC (i.e., final
compensation cost cannot be less than the grant-date
fair-value-based measure). If, on the other hand, the amount
recognized as a share-based liability is greater than the
amount previously recognized in equity, the excess is
recognized as compensation cost either immediately (for
vested options) or over the remaining service (vesting)
period (for unvested options). Because the options are now
classified as a liability, they are remeasured at a
fair-value-based measure in each reporting period until
settlement.
In addition, as an SEC registrant, A must apply ASR 268 and ASC 480-10-S99-3A. As a result, from the date of issuance, January 1, 20X1, to January 31, 20X3, A must classify any grant-date intrinsic value outside of permanent equity (i.e., as temporary or mezzanine equity). ASC 480-10-S99-3A does not require subsequent remeasurement in temporary equity unless it is probable that the triggering event will occur. However, as noted above, on February 1, 20X3, when the change in control becomes probable, the options must be reclassified as a share-based liability.
Entity A should record the following journal entries: