Chapter 7 — Liability-Classified Awards

This chapter discusses the accounting for share-based payment awards for which liability classification is required under ASC 718. Unlike equity-classified awards, liability-classified awards must be remeasured at the end of each reporting period until settlement. By contrast, equity-classified awards are measured at their fair-value-based amount (or, for nonpublic entities, at a calculated value if a fair-value-based measure is not reasonably estimable) on the grant date (i.e., the award’s fair-value-based measure is fixed on the grant date). In addition, because the measurement date for liability-classified awards is the settlement date, the related income tax effects are remeasured at the end of each reporting period until settlement.

7.1 Fair-Value-Based Measurement

ASC 718-10

55-9 The fair value measurement objective for liabilities incurred in a share-based payment transaction is the same as for equity instruments. However, awards classified as liabilities are subsequently remeasured to their fair values (or a portion thereof until the promised good has been delivered or the service has been rendered) at the end of each reporting period until the liability is settled.

ASC 718-30

Measurement Objective and Measurement Date

Public Entity

30-1 At the grant date, the measurement objective for liabilities incurred under share-based compensation arrangements is the same as the measurement objective for equity instruments awarded to grantees as described in paragraph 718-10-30-6. However, the measurement date for liability instruments is the date of settlement.

Nonpublic Entity

30-2 A nonpublic entity shall make a policy decision of whether to measure all of its liabilities incurred under share-based payment arrangements (for employee and nonemployee awards) issued in exchange for distinct goods or services at fair value or at intrinsic value. However, a nonpublic entity shall initially and subsequently measure awards determined to be consideration payable to a customer (as described in paragraph 606-10-32-25) at fair value.

Measurement

35-1 The fair value of liabilities incurred in share-based payment transactions shall be remeasured at the end of each reporting period through settlement.

35-2 Changes in the fair value (or intrinsic value for a nonpublic entity that elects that method) of a liability incurred under a share-based payment arrangement issued in exchange for goods or services that occur during the employee’s requisite service period or the nonemployee’s vesting period shall be recognized as compensation cost over that period. The percentage of the fair value (or intrinsic value) that is accrued as compensation cost at the end of each period shall equal the percentage of the requisite service that has been rendered for an employee award or the percentage that would have been recognized had the grantor paid cash for the goods or services instead of paying with a nonemployee award at that date. Changes in the fair value (or intrinsic value) of a liability issued in exchange for goods or services that occur after the end of the employee’s requisite service period or the nonemployee’s vesting period are compensation cost of the period in which the changes occur. Any difference between the amount for which a liability award issued in exchange for goods or services is settled and its fair value at the settlement date as estimated in accordance with the provisions of this Subtopic is an adjustment of compensation cost in the period of settlement. Example 1 (see paragraph 718-30-55-1) provides an illustration of accounting for a liability award issued in exchange for service from the grant date through its settlement.

Public Entity

35-3 A public entity shall measure a liability award under a share-based payment arrangement based on the award’s fair value remeasured at each reporting date until the date of settlement. Compensation cost for each period until settlement shall be based on the change (or a portion of the change, depending on the percentage of the requisite service that has been rendered for an employee award or the percentage that would have been recognized had the grantor paid cash for the goods or services instead of paying with a nonemployee award at the reporting date) in the fair value of the instrument for each reporting period. Example 1 (see paragraph 718-30-55-1) provides an illustration of accounting for an instrument classified as a liability using the fair-value-based method.

Nonpublic Entity

35-4 Regardless of the measurement method initially selected under paragraph 718-10-30-20, a nonpublic entity shall remeasure its liabilities under share-based payment arrangements at each reporting date until the date of settlement. The fair-value-based method is preferable for purposes of justifying a change in accounting principle under Topic 250. Example 1 (see paragraph 718-30-55-1) provides an illustration of accounting for an instrument classified as a liability using the fair-value-based method. Example 2 (see paragraph 718-30-55-12) provides an illustration of accounting for an instrument classified as a liability using the intrinsic value method. A nonpublic entity shall subsequently measure awards determined to be consideration payable to a customer (as described in paragraph 606-10-32-25) at fair value.

The measurement objective for liability-classified awards is the same as that for equity-classified awards. (See Chapter 4 for a detailed discussion of how the fair-value-based measure of share-based payment award is determined.) For public entities, liability-classified awards must be measured at their fair-value-based amount, which is the same measurement method required for equity-classified awards. However, since the measurement date for liability-classified awards is the date of settlement rather than the grant date for equity-classified awards, liability-classified awards are remeasured at their fair-value-based amount at the end of each reporting period until settlement. As discussed in Section 4.13.3 and Section 7.3, nonpublic entities can make a policy decision to elect, as an alternative to a fair-value-based measure, to measure liability-classified awards issued in exchange for goods or services at intrinsic value.

If a nonpublic entity elects to measure its liability-classified awards issued in exchange for goods or services at intrinsic value, those awards must still be remeasured at the end of each reporting period until settlement. However, the use of the intrinsic-value method reduces the burden of calculating a fair-value-based measure for options and similar instruments at the end of each reporting period. For example, if an entity grants SARs that it classifies as a liability and calculates by using a fair-value-based measurement, it will be required to use a valuation technique such as an option pricing model and update the assumptions at the end of each reporting period. See Section 4.9 for a more detailed discussion of selecting a valuation technique.

7.2 Recognition

As indicated in Section 7.1, the fair-value-based measure (or intrinsic value for a nonpublic entity that elects that method for awards issued in exchange for goods or services) of a share-based payment award that is classified as a liability is remeasured at the end of each reporting period until settlement. Therefore, for all liability-classified awards, the settlement amount will ultimately be the total amount of compensation cost recognized. The changes in the fair-value-based measure (or intrinsic value) are recognized as compensation cost (with a corresponding increase or decrease in the share-based liability) either immediately or over the employee’s remaining requisite service period or nonemployee’s vesting period, depending on the vested status of the award. For unvested awards, the percentage of the fair-value-based measure (or intrinsic value) that is recognized as compensation cost at the end of each period is based on (1) the percentage of the requisite service that has been rendered (for employee awards) or (2) the percentage that would have been recognized had the grantor paid cash for the goods or services instead of paying with a share-based payment award as of that date (for nonemployee awards).

7.2.1 Cash-Settled SARs

The example in ASC 718-30 below illustrates the accounting for a cash-settled SAR associated with an award that is recognized on the basis of its fair-value-based measure. The example also illustrates how the classification of a share-based payment award affects the accounting for income taxes.

ASC 718-30

Illustrations

Example 1: Cash-Settled Stock Appreciation Right

55-1 This Example illustrates the guidance in paragraphs 718-30-35-2 through 35-4 and 718-740-25-2 through 25-4.

55-1A This Example (see paragraphs 718-30-55-2 through 55-11) describes employee awards. However, the principles on how to account for the various aspects of employee awards, except for the compensation cost attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, the concepts about valuation and forfeiture estimation and remeasurement of awards, exercise, and expiration in paragraphs 718-30-55-2 through 55-11 are equally applicable to nonemployee awards with the same features as the awards in this Example (that is, awards with a specified period of time for vesting classified as liabilities). Therefore, the guidance in those paragraphs may serve as implementation guidance for similar nonemployee awards.

55-1B Compensation cost attribution for awards to nonemployees may be the same or different for employee awards. That is because an entity is required to recognize compensation cost for nonemployee awards in the same manner as if the entity had paid cash in accordance with paragraph 718-10-25-2C. Additionally, valuation amounts used in this Example could be different because an entity may elect to use the contractual term as the expected term of share options and similar instruments when valuing nonemployee share-based payment transactions.

55-2 Entity T, a public entity, grants share appreciation rights with the same terms and conditions as those described in Example 1 (see paragraph 718-20-55-4). As in Example 1, Case A, Entity T makes an accounting policy election in accordance with paragraph 718-10-35-3 to estimate the number of forfeitures expected to occur and includes that estimate in its initial accrual of compensation costs. Each stock appreciation right entitles the holder to receive an amount in cash equal to the increase in value of 1 share of Entity T stock over $30. Entity T determines the grant-date fair value of each stock appreciation right in the same manner as a share option and uses the same assumptions and option-pricing model used to estimate the fair value of the share options in that Example; consequently, the grant-date fair value of each stock appreciation right is $14.69 (see paragraphs 718-20-55-7 through 55-9). The awards cliff-vest at the end of three years of service (an explicit and requisite service period of three years). The number of stock appreciation rights for which the requisite service is expected to be rendered is estimated at the grant date to be 821,406 (900,000 × .973). Thus, the fair value of the award as of January 1, 20X5, is $12,066,454 (821,406 × $14.69). For simplicity, this Example assumes that estimated forfeitures equal actual forfeitures.

55-3 Paragraph 718-30-35-4 permits a nonpublic entity to measure share-based payment liabilities at either fair value (or, in some cases, calculated value) or intrinsic value. If a nonpublic entity elects to measure those liabilities at fair value, the accounting demonstrated in this Example would be applicable. Paragraph 718-30-35-3 requires that share-based compensation liabilities be recognized at fair value or a portion thereof (depending on the percentage of requisite service rendered at the reporting date) and be remeasured at each reporting date through the date of settlement; consequently, compensation cost recognized during each year of the three-year vesting period (as well as during each year thereafter through the date of settlement) will vary based on changes in the award’s fair value. As of December 31, 20X5, the assumed fair value is $10 per stock appreciation right; hence, the fair value of the award is $8,214,060 (821,406 × $10). The share-based compensation liability as of December 31, 20X5, is $2,738,020 ($8,214,060 ÷ 3) to account for the portion of the award related to the service rendered in 20X5 (1 year of the 3-year requisite service period). For convenience, this Example assumes that journal entries to account for the award are performed at year-end. The journal entries for 20X5 are as follows.

55-4 As of December 31, 20X6, the fair value is assumed to be $25 per stock appreciation right; hence, the award’s fair value is $20,535,150 (821,406 × $25), and the corresponding liability at that date is $13,690,100 ($20,535,150 × 2/3) because service has been provided for 2 years of the 3-year requisite service period. Compensation cost recognized for the award in 20X6 is $10,952,080 ($13,690,100 – $2,738,020). Entity T recognizes the following journal entries for 20X6.

55-5 As of December 31, 20X7, the fair value is assumed to be $20 per stock appreciation right; hence, the award’s fair value is $16,428,120 (821,406 × $20), and the corresponding liability at that date is $16,428,120 ($16,428,120 × 1) because the award is fully vested. Compensation cost recognized for the liability award in 20X7 is $2,738,020 ($16,428,120 – $13,690,100). Entity T recognizes the following journal entries for 20X7.

55-6 The share-based liability award is as follows.

55-7 For simplicity, this Example assumes that all of the stock appreciation rights are exercised on the same day, that the liability award’s fair value is $20 per stock appreciation right, and that Entity T has already recognized its income tax expense for the year without regard to the effects of the exercise of the employee stock appreciation rights. In other words, current tax expense and current taxes payable were recognized based on taxable income and deductions before consideration of additional deductions from exercise of the stock appreciation rights. The amount credited to cash for the exercise of the stock appreciation rights is equal to the share-based compensation liability of $16,428,120.

55-8 At exercise the journal entry is as follows.

55-9 The cash paid to the employees on the date of exercise is deductible for tax purposes. The tax benefit is $5,749,842 ($16,428,120 × .35).

55-10 At exercise the journal entry is as follows.

55-11 If the stock appreciation rights had expired worthless, the share-based compensation liability account and deferred tax asset account would have been adjusted to zero through the income statement as the award’s fair value decreased.

Since a liability-classified SAR is remeasured at the end of each reporting period until settlement, the settlement amount and ultimate amount of compensation cost recognized will generally be equal to the award’s intrinsic value, even if recognized on the basis of its fair-value-based measure. This is because upon settlement, there is no remaining time value. Therefore, the ultimate amount of compensation cost recognized for a cash-settled SAR will be the same regardless of whether a nonpublic entity elects to measure its liability-classified awards issued in exchange for goods or services on the basis of their fair-value-based measure or intrinsic value. (See Section 7.3 for a discussion of the intrinsic-value practical expedient available for nonpublic entities.) In addition, as noted in ASC 718-30-55-11, if a cash-settled SAR is worthless at expiration, the ultimate amount of compensation cost recognized will be zero. By contrast, an equity-classified stock option or SAR will be recognized at its grant-date fair-value-based measure, and compensation cost cannot be reversed if the award is worthless at expiration as long as the vesting conditions are met (i.e., the good is delivered or the service is rendered).

7.2.2 Changes to the Requisite Service Period

As discussed in ASC 718-30-35-1, liability-classified awards must be remeasured at the end of each reporting period until settlement of the award. When the service period is explicit or implicit, the requisite service period is generally updated in each reporting period conjointly with the award remeasurement. If the requisite service period is based on a market condition’s derived service period, we believe that a company should a establish an accounting policy by using one of the following two acceptable approaches for determining the requisite service period:

Grant-date method — The derived service period is established on the grant date and is not subsequently adjusted when the award is remeasured in each reporting period. Those that adopt this accounting policy believe that ASC 718-10-55-77 establishes an applicable principle even though that guidance is specific to equity-classified awards.
Remeasurement method — Update the derived service period on each reporting date conjointly with the award remeasurement. Those that adopt this approach believe that ASC 718-10-55-77 does not apply to liability-classified awards and that adjusting the derived service period cannot be separated from the remeasurement of the award in each reporting period.

See Section 3.6.3 for a more detailed discussion of the derived service period for employee awards.

7.2.3 Liability-Classified Awards With Market Conditions

As discussed in Section 3.5, the effect of a market condition is reflected in the fair-value-based measure of an award. If an award with a market condition is classified as equity, and the good is delivered or the service is rendered, compensation cost is recognized regardless of whether the market condition is satisfied. However, the same is not true for a liability-classified award that is earned only if a market condition is satisfied. Because liability-classified awards are remeasured at the end of each reporting period until settlement, the final compensation cost will be zero even if the good is delivered or the service is rendered since the market condition has not been satisfied and therefore the award has not been earned.

7.3 Intrinsic-Value Practical Expedient for Nonpublic Entities

ASC 718-30

Nonpublic Entity

As noted in Section 7.1, nonpublic entities can elect, as a policy decision, to measure liability-classified awards issued in exchange for goods or services at intrinsic value instead of a fair-value-based measure (or at a calculated value if a fair-value-based measure is not reasonably estimable) as of the end of each reporting period until the awards are settled. To justify a change in accounting principle under ASC 250, it is preferable for a nonpublic entity to use the fair-value-based method (see Section 4.13.4 for a discussion of how to record the effects of an entity’s change from nonpublic to public entity). Therefore, a nonpublic entity that has elected to measure its liability-classified awards at a fair-value-based amount (or calculated value) would not be permitted to subsequently change to the intrinsic-value method.

The example in ASC 718-30 below illustrates the use of the intrinsic-value method for measuring liability-classified awards, which is available to nonpublic entities.

ASC 718-30

Example 2: Award Granted by a Nonpublic Entity That Elects the Intrinsic Value Method

55-12 This Example illustrates the guidance in paragraphs 718-30-35-4 and 718-740-25-2 through 25-4.

55-12A This Example (see paragraphs 718-30-55-13 through 55-20) describes employee awards. However, the principles on how to account for the various aspects of employee awards, except for the compensation cost attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, a nonpublic entity can make the accounting policy election in paragraph 718-30-30-2 to change its measurement of all liability-classified nonemployee awards from fair value to intrinsic value and remeasure those awards each reporting period as illustrated in this Example. Therefore, the guidance in this Example may serve as implementation guidance for similar liability-classified nonemployee awards.

55-12B Compensation cost attribution for awards to nonemployees may be the same or different for liability-classified employee awards. That is because an entity is required to recognize compensation cost for nonemployee awards in the same manner as if the entity had paid cash in accordance with paragraph 718-10-25-2C. Additionally, valuation amounts used in this Example could be different because an entity may elect to use the contractual term as the expected term of share options and similar instruments when valuing nonemployee share-based payment transactions.

55-13 On January 1, 20X6, Entity W, a nonpublic entity that has chosen the accounting policy of using the intrinsic value method of accounting for share-based payments that are classified as liabilities in accordance with paragraphs 718-30-30-2 and 718-30-35-4, grants 100 cash-settled stock appreciation rights with a 5-year life to each of its 100 employees. Each stock appreciation right entitles the holder to receive an amount in cash equal to the increase in value of 1 share of Entity W’s stock over $7. The awards cliff-vest at the end of three years of service (an explicit and requisite service period of three years). For simplicity, the Example assumes that no forfeitures occur during the vesting period and does not reflect the accounting for income tax consequences of the awards.

55-14 Because of Entity W’s accounting policy decision to use intrinsic value, all of its share-based payments that are classified as liabilities are recognized at intrinsic value (or a portion thereof, depending on the percentage of requisite service that has been rendered) at each reporting date through the date of settlement; consequently, the compensation cost recognized in each year of the three-year requisite service period will vary based on changes in the liability award’s intrinsic value. As of December 31, 20X6, Entity W stock is valued at $10 per share; hence, the intrinsic value is $3 per stock appreciation right ($10 – $7), and the intrinsic value of the award is $30,000 (10,000 × $3). The compensation cost to be recognized for 20X6 is $10,000 ($30,000 ÷ 3), which corresponds to the service provided in 20X6 (1 year of the 3-year service period). For convenience, this Example assumes that journal entries to account for the award are performed at year-end. The journal entry for 20X6 is as follows.

55-15 As of December 31, 20X7, Entity W stock is valued at $8 per share; hence, the intrinsic value is $1 per stock appreciation right ($8 – $7), and the intrinsic value of the award is $10,000 (10,000 × $1). The decrease in the intrinsic value of the award is $20,000 ($10,000 – $30,000). Because services for 2 years of the 3-year service period have been rendered, Entity W must recognize cumulative compensation cost for two-thirds of the intrinsic value of the award, or $6,667 ($10,000 × 2/3); however, Entity W recognized compensation cost of $10,000 in 20X5. Thus, Entity W must recognize an entry in 20X7 to reduce cumulative compensation cost to $6,667.

55-16 As of December 31, 20X8, Entity W stock is valued at $15 per share; hence, the intrinsic value is $8 per stock appreciation right ($15 – $7), and the intrinsic value of the award is $80,000 (10,000 × $8). The cumulative compensation cost recognized as of December 31, 20X8, is $80,000 because the award is fully vested. The journal entry for 20X8 is as follows.

55-17 The share-based liability award at intrinsic value is as follows.

55-18 For simplicity, this Example assumes that all of the stock appreciation rights are settled on the day that they vest, December 31, 20X8, when the share price is $15 and the intrinsic value is $8 per share. The cash paid to settle the stock appreciation rights is equal to the share-based compensation liability of $80,000.

55-19 At exercise the journal entry is as follows.

55-20 If the stock appreciation rights had not been settled, Entity W would continue to remeasure those remaining awards at intrinsic value at each reporting date through the date they are exercised or otherwise settled.

7.4 Modifications

ASC 718-30

Modification of an Award

35-5 A modification of a liability award is accounted for as the exchange of the original award for a new award. However, because liability awards are remeasured at their fair value (or intrinsic value for a nonpublic entity that elects that method) at each reporting date, no special guidance is necessary in accounting for a modification of a liability award that remains a liability after the modification (see Example 15, Case C [paragraph 718-20-55-135] for what happens when the modification causes the award to no longer be a liability).

As discussed in Chapter 6, a modification is considered an exchange of an original award for a new award. This principle also applies to liability-classified awards that are modified. Since liability-classified awards are remeasured at the end of each reporting period until settlement, an entity accounts for a modification by measuring the modified award at its fair-value-based amount (or intrinsic value for a nonpublic entity that has elected that method for awards issued in exchange for goods or services) on the modification date. If the award is unvested, the entity determines the cumulative compensation cost to be recorded by calculating the award’s fair-value-based measure (or intrinsic value) and multiplying this amount by the percentage of the requisite service that has been rendered for an employee award or the percentage that would have been recognized had the grantor paid cash for the goods or services instead of paying with a share-based payment award on the modification date. The entity then compares (1) the cumulative compensation cost to be recorded for the modified award and (2) the cumulative compensation cost recognized for the original award and records the difference as either an increase or decrease in compensation cost. The implementation example in ASC 718-20 below illustrates the accounting for the modification of a liability-classified award that remains a liability after the modification and is based on the facts as described in ASC 718-30-55-1 through 55-11 (see Section 7.2.1).1

ASC 718-20

Example 16: Modifications Regarding an Award’s Classification

Case D: Liability to Liability Modification (Cash-Settled to Cash-Settled Stock Appreciation Rights)

55-139 This Case is based on the facts given in Example 1 (see paragraph 718-30-55-1). Entity T grants stock appreciation rights to its employees. The fair value of the award on January 1, 20X5, is $12,066,454 (821,406 × $14.69).

55-140 On December 31, 20X5, the fair value of each stock appreciation right is assumed to be $5; therefore, the fair value of the award is $4,107,030 (821,406 × $5). The share-based compensation liability at December 31, 20X5, is $1,369,010 ($4,107,030 ÷ 3), which reflects the portion of the award related to the requisite service provided in 20X5 (1 year of the 3-year requisite service period). For convenience, this Case assumes that journal entries to account for the award are performed at year-end. The journal entries to recognize compensation cost for 20X5 are as follows.

55-141 On January 1, 20X6, Entity T reprices the stock appreciation rights, giving each holder the right to receive an amount in cash equal to the increase in value of 1 share of Entity T stock over $10. The modification affects no other terms or conditions of the stock appreciation rights and does not change the number of stock appreciation rights expected to vest. The fair value of each stock appreciation right based on its modified terms is $12. The incremental compensation cost is calculated per the method in Example 12 (see paragraph 718-20-55-93).

55-142 Entity T also could determine the incremental value of the modified stock appreciation right award by multiplying the fair value of the modified stock appreciation right award by the portion of the award that is earned and subtracting the cumulative recognized compensation cost [($9,856,872 ÷ 3) – $1,369,010 = $1,916,614]. As a result, Entity T would record the following journal entries at the date of the modification.

55-143 Entity T would continue to remeasure the liability award at each reporting date until the award’s settlement.

Footnotes

See ASC 718-20-55-122A through 55-122C for considerations related to the application of Example 16 to nonemployee awards.