8.9 Look-Back Plans
The guidance in this section applies to common types of ESPPs that have
look-back features. The examples in the guidance illustrate how entities value ESPPs
with look-back features and separate the award into components to estimate the
fair-value-based measure (see Sections 8.9.1 through 8.9.5). For example, an ESPP that allows
employees to purchase stock at a discount from the lesser of the market price on the
enrollment date or the purchase date would be valued as two components: (1) a
restricted stock award equal in value to the purchase discount and (2) an
at-the-money stock option equal to the discounted purchase price.
ASC 718-50
Variations on Basic Look-Back Plans
55-2 The following are some of the more common types of employee share purchase plans with a look-back option that currently exist and the features that differentiate each type:
- Type A plan — Maximum number of shares. This type of plan permits an employee to have withheld a fixed amount of dollars from the employee’s salary (or a stated percentage of the employee’s salary) over a one-year period to purchase stock. At the end of the one-year period, the employee may purchase stock at 85 percent of the lower of the grant date stock price or the exercise date stock price. If the exercise date stock price is lower than the grant date stock price, the employee may not purchase additional shares (that is, the maximum number of shares that may be purchased by an employee is established at the grant date based on the stock price at that date and the employee’s elected withholdings); any excess cash is refunded to the employee. This is the basic type of employee share purchase plan shown in Example 1, Case A [see paragraph 718-50-55-10]).
- Type B plan — Variable number of shares. This type of plan is the same as the Type A plan except that the employee may purchase as many shares as the full amount of the employee’s withholdings will permit, regardless of whether the exercise date stock price is lower than the grant date stock price (see Example 1, Case B [paragraph 718-50-55-22]).
- Type C plan — Multiple purchase periods. This type of plan permits an employee to have withheld a fixed amount of dollars from the employee’s salary (or a stated percentage of the employee’s salary) over a two-year period to purchase stock. At the end of each six-month period, the employee may purchase stock at 85 percent of the lower of the grant date stock price or the exercise date stock price based on the amount of dollars withheld during that period (see Example 1, Case C [paragraph 718-50-55-26]).
- Type D plan — Multiple purchase periods with a reset mechanism. This type of plan is the same as the Type C plan except that the plan contains a reset feature if the market price of the stock at the end of any six-month purchase period is lower than the stock price at the original grant date. In that case, the plan resets so that during the next purchase period an employee may purchase stock at 85 percent of the lower of the stock price at either the beginning of the purchase period (rather than the original grant date price) or the exercise date (see Example 1, Case D [paragraph 718-50-55-28]).
- Type E plan — Multiple purchase periods with a rollover mechanism. This type of plan is the same as the Type C plan except that the plan contains a rollover feature if the market price of the stock at the end of any six-month purchase period is lower than the stock price at the original grant date. In that case, the plan is immediately cancelled after that purchase date, and a new two-year plan is established using the then-current stock price as the base purchase price (see Example 1, Case D [paragraph 718-50-55-28]).
- Type F plan — Multiple purchase periods with semifixed withholdings. This type of plan is the same as the Type C plan except that the amount (or percentage) that the employee may elect to have withheld is not fixed and may be changed (increased or decreased) at the employee’s election immediately after each six-month purchase date for purposes of all future withholdings under the plan (see Example 1, Case D [paragraph 718-50-55-28]).
- Type G plan — Single purchase period with variable withholdings. This type of plan permits an employee to have withheld an amount of dollars from the employee’s salary (or a stated percentage of the employee’s salary) over a one-year period to purchase stock. That amount (or percentage) is not fixed and may be changed (increased or decreased) at the employee’s election at any time during the term of the plan for purposes of all future withholdings under the plan. At the end of the one-year period, the employee may purchase stock at 85 percent of the lower of the grant date stock price or the exercise date stock price (see Example 1, Case D [paragraph 718-50-55-28]).
- Type H plan — Multiple purchase periods with variable withholdings. This type of plan combines the characteristics of the Type C and Type G plans in that there are multiple purchase periods over the term of the plan and an employee is permitted to change (increase or decrease) withholding amounts (or percentages) at any time during the term of the plan for purposes of all future withholdings under the plan (see Example 1, Case D [paragraph 718-50-55-28]).
- Type I plan — Single purchase period with variable withholdings and cash infusions. This type of plan is the same as the Type G plan except that an employee is permitted to remit catch-up amounts to the entity when (and if) the employee increases withholding amounts (or percentages). The objective of the cash infusion feature is to permit an employee to increase withholding amounts (or percentages) during the term of the plan and remit an amount to the entity such that, on the exercise date, it appears that the employee had participated at the new higher amount (or percentage) during the entire term of the plan (see Example 1, Case E [paragraph 718-50-55-32]).
55-3 The distinguishing characteristic between the Type A plan and the Type B plan is whether the maximum number of shares that an employee is permitted to purchase is fixed at the grant date based on the stock price at that date and the expected withholdings. Each of the remaining plans described above (Type C through Type I plans) incorporates the features of either a Type A plan or a Type B plan. The above descriptions are intended to be representative of the types of features commonly found in many existing plans. The accounting guidance in this Subtopic shall be applied to all plans with characteristics similar to those described above.
55-4 The measurement approach described in Example 1, Case A (see paragraph 718-50-55-10) was developed to illustrate how the fair value of an award under a basic type of employee share purchase plan with a look-back option could be determined at the grant date by focusing on the substance of the arrangement and valuing separately each feature of the award. Although that general technique of valuing an award as the sum of the values of its separate components applies to all types of employee share purchase plans with a look-back option, the fundamental components of an award may differ from plan to plan thus affecting the individual calculations. For example, the measurement approach described in that Case assumes that the maximum number of shares that an employee may purchase is fixed at the grant date based on the grant date stock price and the employee’s elected withholdings (that is, the Type A plan described in paragraph 718-50-55-2). That approach needs to be modified to appropriately determine the fair value of awards under the other types of plans described in that paragraph, including a Type B plan, that do not fix the number of shares that an employee is permitted to purchase.
55-5 Although many employee share purchase plans with a look-back option initially limit the maximum number of shares of stock that the employee is permitted to purchase under the plan (Type A plans), other employee share purchase plans (Type B plans) do not fix the number of shares that the employee is permitted to purchase if the exercise date stock price is lower than the grant date stock price. In effect, an employee share purchase plan that does not fix the number of shares that may be purchased has guaranteed that the employee can always receive the value associated with at least 15 percent of the stock price at the grant date (the employee can receive much more than 15 percent of the grant date value of the stock if the stock appreciates during the look-back period). That provision provides the employee with the equivalent of a put option on 15 percent of the shares with an exercise price equal to the stock price at the grant date. In contrast, an employee who participates in a Type A plan is only guaranteed 15 percent of the lower of the stock price as of the grant date or the exercise date, which is the equivalent of a call option on 85 percent of the shares (as described more fully in paragraph 718-50-55-16). A participant in a Type B plan receives the equivalent of both a put option and a call option.
Illustrations
Example 1: Look-Back Plans
55-6 The following Cases illustrate the guidance in paragraphs 718-50-30-1 through 30-2.
55-7 The following Cases illustrate the fundamental differences between different types of look back plans:
- Basic look-back plans (Case A)
- Look-back plan variable versus maximum number of shares (Case B)
- Look-back plan with multiple purchase periods (Case C)
- Look-back plans with reset or rollover mechanisms (Case D)
- Look-back plans with retroactive cash infusion election (Case E).
55-8 The assumptions used for the numerical calculations in Cases B–E are not intended to be the same as those in Case A. Rather, they are independent and designed to illustrate how the component measurement approach in Case A would be modified to reflect various features of employee stock purchase plans.
55-9 This Example does not take into consideration the effect of interest forgone by the employee on the fair value of an award for which the exercise price is paid over time (for instance, through payroll withholdings). Awards for which part or all of the exercise price is paid before the exercise date are less valuable than awards for which the exercise price is paid at the exercise date, and it is appropriate to recognize that difference in applying the guidance in this Subtopic. However, for simplicity, the effect of forgone interest is not reflected in the fair value calculations in this Example.
8.9.1 Basic Look-Back Plans
ASC 718-50
Case A: Basic Look-Back Plans
55-10 Some entities offer share options to employees under Section 423 of the U.S. Internal Revenue Code, which provides that employees will not be immediately taxed on the difference between the market price of the stock and a discounted purchase price if several requirements are met. One requirement is that the exercise price may not be less than the smaller of either:
- 85 percent of the stock’s market price when the share option is granted
- 85 percent of the price at exercise.
55-11 A share option that provides the employee the choice of either option above may not have a term in excess of 27 months. Share options that provide for the more favorable of two (or more) exercise prices are referred to as look-back share options. A look-back share option with a 15 percent discount from the market price at either grant or exercise is worth more than a fixed share option to purchase stock at 85 percent of the current market price because the holder of the look-back share option is assured a benefit. If the share price rises, the holder benefits to the same extent as if the exercise price was fixed at the grant date. If the share price falls, the holder still receives the benefit of purchasing the stock at a 15 percent discount from its price at the date of exercise. An employee share purchase plan offering share options with a look-back feature would be compensatory because the look-back feature is an option feature (see paragraph 718-50-25-1).
55-12 For example, on January
1, 20X5, when its share price is $30, Entity A offers
its employees the opportunity to sign up for a payroll
deduction to purchase its stock at either 85 percent of
the share’s current price or 85 percent of the price at
the end of the year when the share options expire,
whichever is lower. The exercise price of the share
options is the lesser of $25.50 ($30 × .85) or 85
percent of the share price at the end of the year when
the share options expire.
55-13 The look-back share option can be valued as a combination position. (This Case presents one of several existing valuation techniques for estimating the fair value of a look-back option. In accordance with this Topic, an entity shall use a valuation technique that reflects the substantive characteristics of the instrument being granted in the estimate of fair value.) In this situation, the components are as follows:
- 0.15 of a share of nonvested stock
- 0.85 of a 1-year share option held with an exercise price of $30.
55-14 Supporting analysis for the two components is discussed below.
55-15 Beginning with the
first component, a share option with an exercise price
that equals 85 percent of the value of the stock at the
exercise date will always be worth 15 percent (100% –
85%) of the share price upon exercise. For a stock that
pays no dividends, that share option is the equivalent
of 15 percent of a share of the stock. The holder of the
look-back share option will receive at least the
equivalent of 0.15 of a share of stock upon exercise,
regardless of the share price at that date. For example,
if the share price falls to $20, the exercise price of
the share option will be $17 ($20 × .85), and the holder
will benefit by $3 ($20 – $17), which is the same as
receiving 0.15 of a share of stock for each share
option.
55-16 If the share price upon
exercise is more than $30, the holder of the look-back
share option receives a benefit that is worth more than
15 percent of a share of stock. At prices of $30 or
more, the holder receives a benefit for the difference
between the share price upon exercise and $25.50 — the
exercise price of the share option (.85 × $30). If the
share price is $40, the holder benefits by $14.50 ($40 –
$25.50). However, the holder cannot receive both the
$14.50 value of a share option with an exercise price of
$25.50 and 0.15 of a share of stock. In effect, the
holder gives up 0.15 of a share of stock worth $4.50
($30 × .15) if the share price is above $30 at exercise.
The result is the same as if the exercise price of the
share option was $30 ($25.50 + $4.50) and the holder of
the look-back share option held 85 percent of a 1-year
share option with an exercise price of $30 in addition
to 0.15 of a share of stock that will be received if the
share price is $30 or less upon exercise.
55-17 An option-pricing model can be used to value the 1-year share option on 0.85 of a share of stock represented by the second component. Thus, assuming that the fair value of a share option on one share of Entity A’s stock on the grant date is $4, the compensation cost for the look-back option at the grant date is as follows.
55-18 For a look-back option on a dividend-paying share, both the value of the nonvested stock component and the value of the share option component would be adjusted to reflect the effect of the dividends that the employee does not receive during the life of the share option. The present value of the dividends expected to be paid on the stock during the life of the share option (one year in this Case) would be deducted from the value of a share that receives dividends. One way to accomplish that is to base the value calculation on shares of stock rather than dollars by assuming that the dividends are reinvested in the stock.
55-19 For example, if Entity A pays a quarterly dividend of 0.625 percent (2.5% ÷ 4) of the current share price, 1 share of stock would grow to 1.0252 (the future value of 1 using a return of 0.625 percent for 4 periods) shares at the end of the year if all dividends are reinvested. Therefore, the present value of 1 share of stock to be received in 1 year is only 0.9754 of a share today (again applying conventional compound interest formulas compounded quarterly) if the holder does not receive the dividends paid during the year.
55-20 The value of the share option component is easier to compute; the appropriate dividend assumption is used in an option-pricing model in estimating the value of a share option on a whole share of stock. Thus, assuming the fair value of the share option is $3.60, the compensation cost for the look-back share option if Entity A pays quarterly dividends at the annual rate of 2.5 percent is as follows.
55-21 The first component, which is worth $4.39 at the grant date, is the minimum amount of benefits to the holder regardless of the price of the stock at the exercise date. The second component, worth $3.06 at the grant date, represents the additional benefit to the holder if the share price is above $30 at the exercise date.
8.9.2 Variable Versus Maximum Number of Shares
ASC 718-50
Case B: Look-Back Plan Variable Versus Maximum Number of Shares
55-22 On January 1, 20X0, when its stock price is $50, Entity A offers its employees the opportunity to sign up for a payroll deduction to purchase its stock at the lower of either 85 percent of the stock’s current price or 85 percent of the stock price at the end of the year when the options expire. Thus, the exercise price of the options is the lesser of $42.50 ($50 × 85 percent) or 85 percent of the stock price at the end of the year when the option is exercised. Two employees each agree to have $4,250 withheld from their salaries; however, Employee A is not allowed to purchase any more shares than the $4,250 would buy on the grant date (that is, 100 shares [$4,250/$42.50]) and Employee B is permitted to buy as many shares as the $4,250 will permit under the terms of the plan. In both cases, the 15 percent purchase price discount at the grant date is worth $750 (100 shares × $50 × 15 percent). Depending on the stock price at the end of the year, the value of the 15 percent discount for each employee is as follows.
55-23 As illustrated above, both awards provide the same value to the employee if the stock price at the exercise date has increased (or remained unchanged) from the grant date stock price. However, the award under the Type B plan is more valuable to the employee if the stock price at the exercise date has decreased from the grant date stock price because it guarantees that the employee always will receive at least 15 percent of the stock price at the grant date, whereas the award under the Type A plan only guarantees that the employee will receive 15 percent of the ultimate (lower) stock purchase price.
55-24 Using the component measurement approach described in Case A as the base, the additional feature associated with a Type B plan that shall be included in the fair value calculation is 15 percent of a put option on the employer’s stock (valued by use of a standard option-pricing model, using the same measurement assumptions that were used to value the 85 percent of a call option). If the plan in that Case had the provisions of a Type B plan (that is, a plan that does not fix the number of shares that may be purchased), the fair value of the award would be calculated at the grant date as follows.
With the
same values the fair value of the Type A employee share
purchase plan award described in Case A is determined as
follows:
55-25 In Cases B through E, total compensation cost would be measured at the grant date based on the number of shares that can be purchased using the estimated total withholdings and market price of the stock as of the grant date, and not based on the potentially greater number of shares that may ultimately be purchased if the market price declines. In other words, assume that on January 1, 20X0, Employee A elects to have $850 withheld from his pay for the year to purchase stock. Total compensation cost for the Type B plan award to Employee A would be $291 ($14.57 × 20 grant-date-based shares [$850/$42.50]). For purposes of determining the number of shares on which to measure compensation cost, the stock price as of the grant date less the discount, or $50 × 85 percent in this case, is used.
8.9.3 Multiple Purchase Periods
ASC 718-50
Case C: Look-Back Plan With Multiple Purchase Periods
55-26 In substance, an employee share purchase plan with multiple purchase periods (a Type C plan) is a series of linked awards, similar in nature to how some view a graded vesting stock option plan. Accordingly, the fair value of an award under an employee share purchase plan with multiple purchase periods shall be determined at the grant date in the same manner as an award under a graded vesting stock option plan. Under the graded vesting approach, awards under a two-year plan with purchase periods at the end of each year would be valued as having two separate option tranches both starting on the initial grant date (using the Case A approach if the plan has the characteristics of a Type A plan or using the Case B approach if the plan has the characteristics of a Type B plan) but with different lives of 12 and 24 months, respectively. All other measurement assumptions would need to be consistent with the separate lives of each tranche.
55-27 For example, if the plan in Case A was a two-year Type C plan with purchase periods at the end of each year, the fair value of each tranche of the award would be calculated at the grant date as follows.
8.9.4 Reset or Rollover Mechanisms
ASC 718-50
Case D: Look-Back Plans With Reset or Rollover Mechanisms
55-28 The basic measurement approach described in Case C for a Type C plan also should be used to value awards under employee share purchase plans with multiple purchase periods that incorporate reset or rollover mechanisms (that is, Type D and Type E plans). The fair value of those awards initially can be determined at the grant date using the graded vesting measurement approach. However, at the date that the reset or rollover mechanism becomes effective, the terms of the award have been modified (the exercise price has been decreased and, for a grant under a Type E plan, the term of the award has been extended), which, in substance, is similar to an exchange of the original award for a new award with different terms. Share-based payment modification accounting (see paragraphs 718-20-35-3 through 35-9) shall be applied at the date that the reset or rollover mechanism becomes effective to determine the amount of any incremental fair value associated with the modified grant.
55-29 Likewise, although not a change to the terms of the employee share purchase plan, an election by an employee to increase withholding amounts (or percentages) for future services (Type F through Type H plans) is a modification of the terms of the award to that employee, which, in substance, is similar to an exchange of the original award for a new award with different terms. Accordingly, the fair value of an award under an employee share purchase plan with variable withholdings shall be determined at the grant date (using the Type A, Type B, or Type C measurement approach, as applicable) based on the estimated amounts (or percentages) that a participating employee initially elects to withhold under the terms of the plan. After the grant date (except as noted in paragraph 718-50-35-1), any increases in withholding amounts (or percentages) for future services shall be accounted for as a plan modification in accordance with the guidance in paragraph 718-20-35-3.
55-30 To illustrate, if the plan described in Case C allowed an employee to elect to change withholdings at the end of the first year, modification accounting would be applied at the date the employee elected to increase withholdings to determine the amount, if any, of incremental compensation cost. Assume that on January 1, 20X0, Employee A initially elected to have $850 per year withheld from his pay for each purchase period. However, at the end of Year 1 when the stock price is $60 (and assume that no other factors have changed), Employee A elects to have a total of $1,275 withheld for the second purchase period. At that date, $1,275 is equivalent to 30 shares eligible for purchase at the end of the second year ($1,275/$42.50). At the date Employee A elects to increase withholdings, modification accounting shall be applied to determine the amount of any incremental fair value associated with the modified award as follows.
55-31 The incremental value is determined based on the fair value measurements at the date of the modification using the then-current stock price. To simplify the illustration, the fair value at the modification date is based on the same assumptions about volatility, the risk-free interest rate, and expected dividend yield as at the grant date.
8.9.5 Retroactive Cash Infusion Election
ASC 718-50
Case E: Look-Back Plans With Retroactive Cash Infusion Election
55-32 As with all employee share purchase plans, the objective of the measurement process for employee share purchase plans with a look-back option is to reasonably measure the fair value of the award at the grant date. Unlike Type F through Type H plans, which permit an employee to increase withholding amounts (or percentages) only prospectively, the Type I plan permits an employee to make a retroactive election to increase withholdings. Under a Type I plan, an employee may elect not to participate (or to participate at a minimal level) in the plan until just before the exercise date, thus making it difficult to determine when there truly is a mutual understanding of the terms of the award, and thus the date at which the grant occurs. For example, assume that the Type A employee share purchase plan in Case A permits an employee to remit catch-up amounts (up to a maximum aggregate withholding of 15 percent of annual salary) to Entity A at any time during the term of the plan. On January 1, 20X0, Employee A elects to participate in the plan by having $100 (0.04 percent) of her $250,000 salary withheld monthly from her pay over the year. On December 20, 20X0, when the stock price is $65, Employee A elects to remit a check to Entity A for $36,300, which, together with the $1,200 withheld during the year, represents 15 percent of her salary.
55-33 In that situation, December 20, 20X0 is the date at which Entity A and Employee A have a mutual understanding of the terms of the award in exchange for the services already rendered and Entity A becomes contingently obligated to issue equity instruments to Employee A upon the fulfillment of vesting requirements. The fair value of the entire award to Employee A is therefore measured as of December 20, 20X0.