6.10 Repurchases and Settlements

ASC 718-20

Repurchase or Cancellation

35-7 The amount of cash or other assets transferred (or liabilities incurred) to repurchase an equity award shall be charged to equity, to the extent that the amount paid does not exceed the fair value of the equity instruments repurchased at the repurchase date. Any excess of the repurchase price over the fair value of the instruments repurchased shall be recognized as additional compensation cost. An entity that repurchases an award for which the promised goods have not been delivered or the service has not been rendered has, in effect, modified the employee’s requisite service period or nonemployee’s vesting period to the period for which goods have already been delivered or service already has been rendered, and thus the amount of compensation cost measured at the grant date but not yet recognized shall be recognized at the repurchase date.

A settlement is a payment (usually in the form of shares or cash) made to fulfill a share-based payment award. Stock options are typically settled in shares, while many phantom stock unit plans are settled in cash. In addition, certain share-based payment plans may give the entity the option to repurchase the underlying shares in cash, may give the grantee the option to sell them for cash, or do both.

An entity must carefully consider whether any cash-settlement features affect an award’s classification. Even if an award’s terms do not permit cash settlement, an entity’s past practice of settling or intending to settle awards in cash before the risks and rewards of share ownership are borne by grantees (generally six months from the date options are exercised or shares are vested) may indicate that awards are in-substance liabilities. See Chapter 5 for a detailed discussion of determining the classification of an award.

Because cash settlement is often required under the terms of liability-classified awards, use of the term “settlement” in this section generally refers to the payment made to satisfy an award that is equity-classified and includes the repurchase of equity instruments. While the next section discusses the settlement of share-based payment awards in cash, the guidance also applies to settlements in other assets or liabilities.

6.10.1 Cash Settlements

The amount of cash paid to settle an equity-classified award is charged directly to equity as long as that amount is equal to or less than the fair-value-based measure of the award on the settlement date. To the extent that the settlement consideration exceeds the fair-value-based measure of the equity-classified award on the settlement date, that difference is recognized as additional compensation cost.

If an entity settles an unvested award (i.e., an award for which the goods or services have not been provided), the entity has effectively modified the award to accelerate the vesting conditions associated with it. Accordingly, any remaining unrecognized compensation cost is generally recognized immediately on the settlement date.

The example below is based on the same facts as in Example 1 in ASC 718-20-55-4 through 55-9 (see Section 6.1).

ASC 718-20

Example 12: Modifications and Settlements

Case D: Cash Settlement of Nonvested Share Options

55-102 Rather than modify the share option terms, Entity T offers on January 1, 20X6, to settle the original January 1, 20X5, grant of share options for cash. Because the share price decreased from $30 at the grant date to $20 at the date of settlement, the fair value of each share option is $5.36, the same as in Case C. If Entity T pays $5.36 per share option, it would recognize that cash settlement as the repurchase of an outstanding equity instrument and no incremental compensation cost would be recognized. However, the cash settlement of the share options effectively vests them. Therefore, the remaining unrecognized compensation cost of $9.79 per share option would be recognized at the date of settlement.

Example 6-32

On January 1, 20X1, Entity A grants 1,000 equity-classified at-the-money employee stock options, each with a grant-date fair-value-based measure of $9. The options vest at the end of the fourth year of service (cliff vesting). On December 31, 20X2, the market price of A’s stock has declined so dramatically that A wishes to settle the options because they provide little future incentive value to its employees. In this case, the employees may be willing to relinquish the options for an amount less than their then-current fair-value-based measure because payment would be immediate, settlement would not require future service, and the options may not become in-the-money during the expected term. The fair-value-based measure of the options on the settlement date is $3.50, and A settles the options for $2 in cash.

Before settlement, A recorded compensation cost of $4,500 on the basis of the number of options expected to vest (1,000 options, assuming no forfeitures), the grant-date fair-value-based measure of the options ($9), and the amount of services rendered (50 percent for two of four years of services rendered). On the settlement date, A would record the amount of cash paid ($2,000 = 1,000 options × $2 cash paid per option), with a corresponding charge to equity. Simultaneously, A would record the remaining unrecognized compensation cost ($4,500) because the options have fully vested as a result of the settlement. See the journal entries below (recorded on the settlement date).

An entity may make a cash payment to a grantee and concurrently cancel that grantee’s awards. While the transaction would typically be accounted for as a settlement, the determination of whether such a payment is a modification, settlement, or other action is based on the facts and circumstances of each situation. For example, an entity may enter into a separation agreement with an employee to terminate employment or terminate an arrangement with a nonemployee in which the entity (1) will make a termination payment in cash and (2) separately cancel all of the grantee’s outstanding share-based payment awards. The entity should account for the separation agreement and cancellation of the awards as a single transaction. That is, the entity should view the termination arrangement and related termination payment as the repurchase of all outstanding awards for cash. Accordingly, as long as the settlement consideration does not exceed the fair-value-based measure of the equity-classified awards as of the settlement date, the entity records no additional compensation cost and charges the amount of cash paid to settle the awards directly to equity. If the settlement consideration exceeds the fair-value-based measure of the equity-classified awards as of the settlement date, the entity recognizes the amount in excess of the fair-value-based measure as additional compensation cost.

In determining the accounting for the awards that are settled, the entity should consider the vested and unvested awards as follows:

Vested awards — Since the termination payment for the vested awards is a settlement, the entity should recognize as a charge to equity the amount paid to repurchase the vested awards that is less than or equal to the fair-value-based measure of the vested awards on the repurchase date.
Unvested awards — Since the grantee will not render the services or deliver the goods to earn the awards, the unvested awards are not expected to vest as of the separation date. Therefore, the entity should reverse any previously recognized compensation cost related to the unvested awards. The termination payment is an improbable-to-probable modification of the unvested awards. (See Sections 6.3 and 6.3.3 for a discussion of improbable-to-probable modifications.) That is, as a result of the termination arrangement, the grantee would not have vested in these awards upon termination of employment or the arrangement with a nonemployee (improbable). The termination payment effectively accelerated the awards’ vesting (i.e., made it probable that the awards would vest upon cash settlement). Accordingly, the total fair-value-based measure of the unvested awards is zero immediately before settlement on the separation date (0 awards expected to vest × fair-value-based measure of the unvested awards as of the date of the separation agreement). To determine the incremental compensation cost resulting from the settlement, the entity would subtract this value (zero) from the cash paid for the unvested awards (i.e., any cash paid in excess of the fair-value-based measure of the vested awards). Therefore, the entity would recognize the amount of cash paid for the unvested awards as compensation cost on the date of the termination arrangement. No amount should be recognized as a charge to equity for the repurchase of the unvested equity-classified award.

The decision tree below addresses cash settlement as part of an employee separation.

Example 6-33

On January 1, 20X3, Entity A enters into a separation agreement with one of its executives, who also terminates employment on that date:

In connection with the separation agreement, A agrees to pay $1 million in cash to the executive upon termination of employment.
The executive concurrently agrees to cancel all outstanding employee options to purchase A’s common stock (both vested and unvested).
The executive has 10,000 vested employee stock options, each with a grant-date fair-value-based measure of $30 and a fair-value-based measure of $40, on January 1, 20X3.
The executive has 10,000 unvested employee stock options, each with a grant-date fair-value-based measure of $35 and a fair-value-based measure of $42, on January 1, 20X3. The options were granted on January 1, 20X1, and vest at the end of the fourth year of service (cliff vesting).

In determining the fair-value-based measure of the outstanding options that are settled, A should consider the vested and unvested options as follows:

Vested Options

The termination payment is viewed as a settlement of the vested options. Therefore, A should recognize in equity the amount of cash paid to settle the options up to the fair-value-based measure of the options. See the journal entry below.

To record the repurchase of the vested options on the date of the separation agreement (10,000 options × $40 fair-value-based measure as of the date of the separation agreement).

Unvested Options

Since the executive’s unvested options are no longer expected to vest as of the date of the separation agreement, A should reverse any previously recognized compensation cost associated with these options on the date of the separation agreement. The termination payment is then treated as an improbable-to-probable modification of the unvested options. Accordingly, the total fair-value-based measure of the unvested options is zero immediately before the date of the separation agreement (0 options expected to vest × $42 fair-value-based measure of the unvested options as of the date of the separation agreement). The cash paid for the unvested options is $600,000, which is the total amount of cash paid for the vested and unvested options ($1 million) less the fair-value-based measure of the vested options ($400,000). Therefore, A recognizes the $600,000 settlement of the unvested options as compensation cost on the date of the separation agreement. See the journal entries below.

6.10.2 Cash Settlements Versus Modifications

As discussed in Section 6.7, modification accounting generally applies to short-term inducements (1) to which the award holder can subscribe for a limited period and (2) that are accepted by the award holder. However, the accounting consequences could be considerably different depending on whether the repurchase of an equity-classified share-based payment award for cash or other assets in the future constitutes (1) a short-term offer that is, in substance, a settlement of the equity award or (2) a modification of the equity award that changes the award’s classification from equity to liability followed by a settlement of the now liability-classified award.

If the repurchase of (or offer to repurchase) the equity award is considered a settlement, the requirements of ASC 718-20-35-7 apply. That is, as long as the settlement consideration (cash, other assets, or liabilities incurred) does not exceed the fair-value-based measure of the equity award as of the settlement date, no additional compensation cost is recorded. The amount of cash, other assets, or liabilities incurred to settle an award is charged directly to equity. To the extent that the settlement consideration exceeds the fair-value-based measure of the equity award on the settlement date, that difference is recognized as additional compensation cost.

Alternatively, if the repurchase of (or offer to repurchase) the equity award is considered a modification that changes the award’s classification from equity to liability followed by a subsequent settlement of the now liability-classified award, an entity may need to recognize additional compensation cost as of the modification date on the basis of the fair-value-based measure of the liability award. That is, upon changing the award’s classification from equity to liability, an entity would adjust the carrying value of the equity award to its then-current fair-value-based measure as a share-based liability. Additional compensation cost would be recorded if the fair-value-based measure of the liability award on the modification date is greater than the original grant-date fair-value-based measure of the equity award. (See Section 6.8.1 for a more detailed discussion of the accounting for a modification that changes an award’s classification from equity to liability.) Because the award is now a share-based liability, the entity would remeasure it at its fair-value-based amount in each reporting period until settlement. (See Chapter 7 for a more detailed discussion of the accounting for liability awards.) In addition, the amount of cumulative compensation cost recognized cannot be less than the original grant-date fair-value-based measure. When the cash is paid to settle the liability award at an amount equal to its fair value, the share-based liability is settled with a corresponding credit to cash.

An entity must determine whether to account for a repurchase transaction in which it offers to settle the equity award for cash or other assets (or liabilities incurred) on some future date as a settlement or a modification of the equity award. The FASB clarified in FSP FAS 123(R)-6 that its intent was not for an award’s classification to change from equity to liability as a result of an offer to repurchase the award for a limited period. Paragraph 11 of FSP FAS 123(R)-6 states, in part:

The Board did not intend for a short-term inducement that is deemed to be a settlement to affect the classification of the award for the period it remains outstanding (for example, change the award from an equity instrument to a liability instrument). Therefore, an offer (for a limited time period) to repurchase an award should be excluded from the definition of a short-term inducement and should not be accounted for as a modification pursuant to paragraph 52 of Statement 123(R) [codified in ASC 718-20-35-5].

Entities should use judgment to determine whether an offer to repurchase an equity award is outstanding for more than a “limited time period”; that is, whether the repurchase of the equity award should be accounted for as (1) a short-term offer that is, in substance, a settlement of the equity award or (2) a modification of the equity award followed by the settlement of a liability award.

The following are among the items an entity should consider in determining whether an offer to repurchase an award that has been accepted by the holder is a modification that changes the award’s classification from equity to liability:

The amount that would be paid to settle the awards continues to be indexed to the grantor’s equity (i.e., the settlement amount is not fixed or determinable).
Whether substantive future service is required.

Note that if an entity’s practice or intent is to repurchase (or offer to repurchase) equity awards, it should evaluate the substantive terms of all outstanding share-based payment awards in accordance with ASC 718-10-25-15. An entity’s consistent pattern of cash settling, or its intent to cash settle, awards may suggest that its outstanding awards’ substantive terms permit cash settlement and therefore require liability classification. This concept was emphasized in paragraph 11 of FSP FAS 123(R)-6, which states, in part:

[I]f an entity has a history of settling its awards for cash, the entity should consider whether at the inception of the awards it has a substantive liability pursuant to paragraph 34 of Statement 123(R) [codified in ASC 718-10-25-15].

Example 6-34

On January 1, 20X1, Entity A granted 1,000 equity-classified at-the-money employee stock options, each with a grant-date fair-value-based measure of $10. Throughout the options’ life, they are classified as equity. After the options are fully vested, A offers to repurchase them for cash equal to their then-current fair-value-based measure ($12 per option). If the offer to repurchase the options is considered a settlement, because, for example, the options will be settled immediately, the entire $12,000 (1,000 options × $12 fair-value-based measure on the settlement date) will be charged to equity, with the corresponding credit to cash. See the journal entry below.

Alternatively, if the offer to repurchase the options is considered a modification because, for example, the options will be settled in one year for cash on the basis of their fair-value-based measure at that time, the options are first reclassified as a share-based liability, and the difference ($2) between the grant-date fair-value-based measure ($10) and the current fair-value-based measure ($12) is recorded as additional compensation cost. Because the award is now a share-based liability, the entity would remeasure it at its fair-value-based amount in each reporting period until settlement, which is $15 per option one year later (the fair-value-based measure at that time). When the cash is paid to settle the liability award, the share-based liability is settled with a corresponding credit to cash. See the journal entries below.

In some cases, the repurchase of an equity-classified share-based payment award for cash constitutes both (1) a settlement and (2) a modification that changes the award’s classification to a liability. For example, an entity may modify an award to require cash settlement but subject only a portion of the cash payment to vesting, or it may pay a large, nonrecurring cash dividend to all award holders in connection with an equity restructuring but, for unvested awards, subject a portion of the cash dividend to vesting. The accounting for large, nonrecurring cash dividends is different from that in ASC 718 for dividend protected awards (see Section 3.10) because such dividends meet the definition of an equity restructuring (see Section 6.5). Exchanges of stock options or other equity instruments or changes to their terms in conjunction with an equity restructuring are modifications and therefore subject to the accounting guidance in ASC 718-20-35-2A. Further, a “large, nonrecurring dividend” is not defined in U.S. GAAP; therefore, an entity should apply judgment when determining whether a dividend gives rise to an equity restructuring transaction and modification accounting under ASC 718. An entity may wish to seek the opinion of legal counsel when determining whether a dividend represents an equity restructuring that triggers a nondiscretionary antidilution provision.

In these circumstances, the cash payment should be allocated to (1) the portion of the awards that has been settled and (2) the portion of the awards that has been modified.

Example 6-35

On January 1, 20X1, Entity A granted to an employee 1,000 equity-classified RSUs, each with a grant-date fair-value-based measure of $10. The RSUs vest on a graded basis over four years (25 percent each year on December 31). Entity A has a policy of recognizing compensation cost on a straight-line basis over the total requisite service period of four years and has therefore recognized compensation cost of $2,500 each year.

On January 1, 20X3, A declares a large, nonrecurring cash dividend of $5 per share which meets the definition of an equity restructuring. The RSUs have (1) a nondiscretionary antidilution provision that requires an equitable adjustment or payment in the event of an equity restructuring (and therefore are subject to the modification accounting guidance in ASC 718-20-35-2A) and (2) a fair-value-based measure of $20 per RSU on January 1, 20X3 (the $20 value includes the value of the $5 dividend), both immediately before and after the modification. Each RSU is entitled to the cash dividend, including the unvested RSUs that are subject to continued vesting on the basis of their original vesting terms.

One acceptable approach is to separately account for the fully vested RSUs and the unvested RSUs (which have two years of remaining service). Therefore, for 500 of the RSUs that are fully vested, there is a partial cash settlement for 25 percent of the RSUs ($5 dividend per share ÷ $20 fair-value-based measure per RSU on January 1, 20X3). For the 500 unvested RSUs, there is a partial modification from an equity-classified award to a liability-classified award for 25 percent of the RSUs; the remaining 75 percent of the RSUs are deemed not to be settled or modified. The journal entries and related calculations below illustrate this approach to accounting for the partial cash settlement and modification.

6.10.3 Repurchases That Change Substantive Terms

As discussed in Section 6.10.2, it is important to determine whether an entity accounts for the repurchase of an award granted by the entity as a settlement or as a modification that changes the award’s classification to a liability. Further, an entity’s past practice or history of repurchasing an award may indicate that the substantive terms of its share-based payment plan include a cash settlement feature, which may result in liability classification. Private entities may offer to repurchase their grantees’ awards upon specific events, such as a preferred round of financing. In these instances, an entity should evaluate whether it has established a practice of repurchasing awards upon the occurrence of a specific event and whether the substantive terms of its share-based payment arrangements include a contingent cash settlement feature.

Example 6-36

Before July 1, 20X1, Entity A had established a history of offering to repurchase up to 10 percent of its grantees’ equity-classified vested awards upon completing a preferred financing round. While the written terms of the award do not include a right for the grantee to put the awards to A, management evaluated the substantive terms of its share-based payment plan in accordance with ASC 718-10-25-15 and determined that, in substance, the plan terms included a put option that is contingent on a preferred financing round for 10 percent of the grantees’ awards. Further, management concluded that it is not probable that a preferred financing occurs until it takes place.

On July 1, 20X1, A completed a new preferred financing round. In a manner consistent with A’s past practice, all employees holding equity-classified vested awards can participate in the tender offer and may sell up to 10 percent of their holdings at fair market value.

Entity A evaluates the guidance in ASC 718-10-25-9 to determine whether the put option prevents the grantees from bearing the risk and rewards of share ownership for a reasonable period. Because the repurchase feature is at fair market value, A quantifies the number of immature awards eligible to be put by the grantees during the offer period and reclassifies these awards from equity to liabilities regardless of whether the grantee exercises the put option. Once the put option expires at the end of the offer period, management reclassifies from liabilities to equity any portion of these awards for which the grantees have not exercised the put.

Further, as discussed in Section 4.12.3.2, we do not believe that a reporting entity would generally consider a history of investor purchases of immature shares from grantees — regardless of whether such purchases are conducted at fair value or at an amount that exceeds fair value — in its assessment of whether it has established a past practice of settling immature shares that result in a substantive liability.

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