Deloitte's Roadmap: Share-Based Payment Awards

55-4 The following Cases illustrate the guidance in paragraphs 718-10-35-1D through 35-1E for nonemployee awards, paragraphs 718-10-35-2 through 35-7 for employee awards, and paragraphs 718-740-25-2 through 25-3 for both nonemployee and employee awards, except for the vesting provisions:

1. Share options with cliff vesting and forfeitures estimated in initial accruals of compensation cost (Case A)
2. Share options with graded vesting and forfeitures estimated in initial accruals of compensation cost (Case B)
3. Share options with cliff vesting and forfeitures recognized when they occur (Case C).

55-4A Cases A through C (see paragraphs 718-20-55-10 through 55-34G) describe employee awards. However, the principles on accounting for employee awards, except for the compensation cost attribution, are the same for nonemployee awards. Consequently, all of the following in Case A are equally applicable to nonemployee awards with the same features as the awards in Cases A through C (that is, awards with a specified time period for vesting):

1. The assumptions in paragraphs 718-20-55-6 through 55-9
2. Total compensation cost considerations (including estimates of forfeitures) in paragraphs 718-20-55-10 through 55-12
3. Changes in the estimation of forfeitures in paragraphs 718-20-55-14 through 55-15
4. Exercise or expiration considerations in paragraphs 718-20-55-18 through 55-21 and 718-20-55-23.

Therefore, the guidance in those paragraphs may serve as implementation guidance for nonemployee awards. Similarly, an entity also may elect to account for nonemployee award forfeitures as they occur as illustrated in Case C (see paragraph 718-20-55-34A).

55-4B Nonemployee awards may be similar to employee awards (that is, cliff vesting or graded vesting). However, the compensation cost attribution for awards to nonemployees may be the same as or different from 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 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 payment transactions.

55-5 Cases A, B, and C share all of the assumptions in paragraphs 718-20-55-6 through 55-34G, with the following exceptions:

1. In Case C, Entity T has an accounting policy to account for forfeitures when they occur in accordance with paragraph 718-10-35-3.
2. In Cases A and B, Entity T has an accounting policy to estimate the number of forfeitures expected to occur, also in accordance with paragraph 718-10-35-3.
3. In Case B, the share options have graded vesting.
4. In Cases A and C, the share options have cliff vesting.

55-6 Entity T, a public entity, grants at-the-money employee share options with a contractual term of 10 years. All share options vest at the end of three years (cliff vesting), which is an explicit service (and requisite service) period of three years. The share options do not qualify as incentive stock options for U.S. tax purposes. The enacted tax rate is 35 percent. In each Case, Entity T concludes that it will have sufficient future taxable income to realize the deferred tax benefits from its share-based payment transactions.

55-7 The following table shows assumptions and information about the share options granted on January 1, 20X5 applicable to all Cases, except for expected forfeitures per year, which does not apply in Case C.

55-8 A suboptimal exercise factor of two means that exercise is generally expected to occur when the share price reaches two times the share option’s exercise price. Option-pricing theory generally holds that the optimal (or profit-maximizing) time to exercise an option is at the end of the option’s term; therefore, if an option is exercised before the end of its term, that exercise is referred to as suboptimal. Suboptimal exercise also is referred to as early exercise. Suboptimal or early exercise affects the expected term of an option. Early exercise can be incorporated into option-pricing models through various means. In this Case, Entity T has sufficient information to reasonably estimate early exercise and has incorporated it as a function of Entity T’s future stock price changes (or the option’s intrinsic value). In this Case, the factor of 2 indicates that early exercise would be expected to occur, on average, if the stock price reaches $60 per share ($30 × 2). Rather than use its weighted average suboptimal exercise factor, Entity T also may use multiple factors based on a distribution of early exercise data in relation to its stock price.

55-9 This Case assumes that each employee receives an equal grant of 300 options. Using as inputs the last 7 items from the table in paragraph 718-20-55-7, Entity T’s lattice-based valuation model produces a fair value of $14.69 per option. A lattice model uses a suboptimal exercise factor to calculate the expected term (that is, the expected term is an output) rather than the expected term being a separate input. If an entity uses a Black-Scholes-Merton option-pricing formula, the expected term would be used as an input instead of a suboptimal exercise factor.

Case A: Share Options With Cliff Vesting and Forfeitures Estimated in Initial Accruals of Compensation Cost

55-10 Total compensation cost recognized over the requisite service period (which is the vesting period in this Case) shall be the grant-date fair value of all share options that actually vest (that is, all options for which the requisite service is rendered). This Case assumes that Entity T’s accounting policy is to estimate the number of forfeitures expected to occur in accordance with paragraph 718-10-35-3. As a result, Entity T is required to estimate at the grant date the number of share options for which the requisite service is expected to be rendered (which, in this Case, is the number of share options for which vesting is deemed probable). If that estimate changes, it shall be accounted for as a change in estimate and its cumulative effect (from applying the change retrospectively) recognized in the period of change. Entity T estimates at the grant date the number of share options expected to vest and subsequently adjusts compensation cost for changes in the estimated rate of forfeitures and differences between expectations and actual experience. This Case also assumes that none of the compensation cost is capitalized as part of the cost of an asset.

55-11 The estimate of the number of forfeitures considers historical employee turnover rates and expectations about the future. Entity T has experienced historical turnover rates of approximately 3 percent per year for employees at the grantees’ level, and it expects that rate to continue over the requisite service period of the awards. Therefore, at the grant date Entity T estimates the total compensation cost to be recognized over the requisite service period based on an expected forfeiture rate of 3 percent per year. Actual forfeitures are 5 percent in 20X5, but no adjustments to cumulative compensation cost are recognized in 20X5 because Entity T still expects actual forfeitures to average 3 percent per year over the 3-year vesting period. As of December 31, 20X6, management decides that the forfeiture rate will likely increase through 20X7 and changes its estimated forfeiture rate for the entire award to 6 percent per year. Adjustments to cumulative compensation cost to reflect the higher forfeiture rate are made at the end of 20X6. At the end of 20X7 when the award becomes vested, actual forfeitures have averaged 6 percent per year, and no further adjustment is necessary.

55-12 The first set of calculations illustrates the accounting for the award of share options on January 1, 20X5, assuming that the share options granted vest at the end of three years. (Case B illustrates the accounting for an award assuming graded vesting in which a specified portion of the share options granted vest at the end of each year.) The number of share options expected to vest is estimated at the grant date to be 821,406 (900,000 × .973). Thus, the compensation cost to be recognized over the requisite service period at January 1, 20X5, is $12,066,454 (821,406 × $14.69), and the compensation cost to be recognized during each year of the 3-year vesting period is $4,022,151 ($12,066,454 ÷ 3). The journal entries to recognize compensation cost and related deferred tax benefit at the enacted tax rate of 35 percent are as follows for 20X5.

55-13 The net after-tax effect on income of recognizing compensation cost for 20X5 is $2,614,398 ($4,022,151 – $1,407,753).

55-14 Absent a change in estimated forfeitures, the same journal entries would be made to recognize compensation cost and related tax effects for 20X6 and 20X7, resulting in a net after-tax cost for each year of $2,614,398. However, at the end of 20X6, management changes its estimated employee forfeiture rate from 3 percent to 6 percent per year. The revised number of share options expected to vest is 747,526 (900,000 × .943). Accordingly, the revised cumulative compensation cost to be recognized by the end of 20X7 is $10,981,157 (747,526 × $14.69). The cumulative adjustment to reflect the effect of adjusting the forfeiture rate is the difference between two-thirds of the revised cost of the award and the cost already recognized for 20X5 and 20X6. The related journal entries and the computations follow.

At December 31, 20X6, to adjust for new forfeiture rate.

55-15 The related journal entries are as follows.

55-16 Journal entries for 20X7 are as follows.

55-17 As of December 31, 20X7, the entity would examine its actual forfeitures and make any necessary adjustments to reflect cumulative compensation cost for the number of shares that actually vested.

55-18 All 747,526 vested share options are exercised on the last day of 20Y2. Entity T has already recognized its income tax expense for the year without regard to the effects of the exercise of the employee share options. In other words, current tax expense and current taxes payable were recognized based on income and deductions before consideration of additional deductions from exercise of the employee share options. Upon exercise, the amount credited to common stock (or other appropriate equity accounts) is the sum of the cash proceeds received and the amounts previously credited to additional paid-in capital in the periods the services were received (20X5 through 20X7). In this Case, Entity T has no-par common stock and at exercise, the share price is assumed to be $60.

55-19 At exercise the journal entries are as follows.

55-20 In this Case, the difference between the market price of the shares and the exercise price on the date of exercise is deductible for tax purposes pursuant to U.S. tax law in effect in 2004 (the share options do not qualify as incentive stock options). Paragraph 718-740-35-2 requires that the tax effect be recognized as income tax expense or benefit in the income statement for the difference between the deduction for an award for tax purposes and the cumulative compensation cost of that award recognized for financial reporting purposes. With the share price of $60 at exercise, the deductible amount is $22,425,780 [747,526 × ($60 – $30)], and the tax benefit is $7,849,023 ($22,425,780 × .35).

55-21 At exercise the journal entries are as follows.

55-22 Paragraph superseded by Accounting Standards Update No. 2016-09.

55-23 If instead the share options expired unexercised, previously recognized compensation cost would not be reversed. There would be no deduction on the tax return and, therefore, the entire deferred tax asset of $3,843,405 would be charged to income tax expense.

55-23A If employees terminated with out-of-the-money vested share options, the deferred tax asset related to those share options would be written off when those options expire.

30-28 In some cases, the terms of an award may provide that a performance target that affects vesting could be achieved after an employee completes the requisite service period or a nonemployee satisfies a vesting period. That is, the grantee would be eligible to vest in the award regardless of whether the grantee is rendering service or delivering goods on the date the performance target is achieved. A performance target that affects vesting and that could be achieved after an employee’s requisite service period or a nonemployee’s vesting period shall be accounted for as a performance condition. As such, the performance target shall not be reflected in estimating the fair value of the award at the grant date. Compensation cost shall be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the service or goods already have been provided. If the performance target becomes probable of being achieved before the end of the employee’s requisite service period or the nonemployee’s vesting period, the remaining unrecognized compensation cost for which service or goods have not yet been provided shall be recognized prospectively over the remaining employee’s requisite service period or the nonemployee’s vesting period. The total amount of compensation cost recognized during and after the employee’s requisite service period or the nonemployee’s vesting period shall reflect the number of awards that are expected to vest based on the performance target and shall be adjusted to reflect those awards that ultimately vest. An entity that has an accounting policy to account for forfeitures when they occur in accordance with paragraph 718-10-35-1D or 718-10-35-3 shall reverse compensation cost previously recognized, in the period the award is forfeited, for an award that is forfeited before completion of the employee’s requisite service period or the nonemployee’s vesting period. The employee’s requisite service period and the nonemployee’s vesting period end when the grantee can cease rendering service or delivering goods and still be eligible to vest in the award if the performance target is achieved. As indicated in the definition of vest, the stated vesting period (which includes the period in which the performance target could be achieved) may differ from the employee’s requisite service period or the nonemployee’s vesting period.

55-86 This Example illustrates the guidance in paragraphs 718-10-30-25 through 30-26.

55-87 Assume that Entity A uses a point system for retirement. An employee who accumulates 60 points becomes eligible to retire with certain benefits, including the retention of any nonvested share-based payment awards for their remaining contractual life, even if another explicit service condition has not been satisfied. In this case, the point system effectively accelerates vesting. On January 1, 20X5, an employee receives at-the-money options on 100 shares of Entity A’s stock. All options vest at the end of 3 years of service and have a 10-year contractual term. At the grant date, the employee has 60 points and, therefore, is eligible to retire at any time.

55-88 Because the employee is eligible to retire at the grant date, the award’s explicit service condition is nonsubstantive. Consequently, Entity A has granted an award that does not contain a service condition for vesting, that is, the award is effectively vested, and thus, the award’s entire fair value should be recognized as compensation cost on the grant date. All of the terms of a share-based payment award and other relevant facts and circumstances must be analyzed when determining the requisite service period.

55-84 This Example illustrates the guidance in paragraph 718-20-35-2.

55-84A This Example (see paragraphs 718-20-55-85 through 55-86) 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 accounting for a contingent feature (such as a clawback) of an award that might cause a grantee to return to the entity either equity instruments earned or realized gains from the sale of the equity instruments earned is equally applicable to nonemployee awards with the same feature as the awards in this Example (that is, the clawback feature). Therefore, the guidance in this Example also serves as implementation guidance for similar nonemployee awards.

55-84B 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.

55-85 On January 1, 20X5, Entity T grants its chief executive officer an award of 100,000 shares of stock that vest upon the completion of 5 years of service. The market price of Entity T’s stock is $30 per share on that date. The grant-date fair value of the award is $3,000,000 (100,000 × $30). The shares become freely transferable upon vesting; however, the award provisions specify that, in the event of the employee’s termination and subsequent employment by a direct competitor (as defined by the award) within three years after vesting, the shares or their cash equivalent on the date of employment by the direct competitor must be returned to Entity T for no consideration (a clawback feature). The chief executive officer completes five years of service and vests in the award. Approximately two years after vesting in the share award, the chief executive officer terminates employment and is hired as an employee of a direct competitor. Paragraph 718-10-55-8 states that contingent features requiring an employee to transfer equity shares earned or realized gains from the sale of equity instruments earned as a result of share-based payment arrangements to the issuing entity for consideration that is less than fair value on the date of transfer (including no consideration) are not considered in estimating the fair value of an equity instrument on the date it is granted. Those features are accounted for if and when the contingent event occurs by recognizing the consideration received in the corresponding balance sheet account and a credit in the income statement equal to the lesser of the recognized compensation cost of the share-based payment arrangement that contains the contingent feature ($3,000,000) and the fair value of the consideration received. This guidance does not apply to cancellations of awards of equity instruments as discussed in paragraphs 718-20-35-7 through 35-9. The former chief executive officer returns 100,000 shares of Entity T’s common stock with a total market value of $4,500,000 as a result of the award’s provisions. The following journal entry accounts for that event.

55-86 If instead of delivering shares to Entity T, the former chief executive officer had paid cash equal to the total market value of 100,000 shares of Entity T’s common stock, the following journal entry would have been recorded.

55-87 Paragraphs 718-10-25-3 through 25-4 require that the accounting for all share-based payment transactions with employees or others reflect the rights conveyed to the holder of the instruments and the obligations imposed on the issuer of the instruments, regardless of how those transactions are structured. Some share-based compensation arrangements with employees may contain noncompete provisions. Those noncompete provisions may be in-substance service conditions because of their nature. Determining whether a noncompete provision or another type of provision represents an in-substance service condition is a matter of judgment based on relevant facts and circumstances. This Example illustrates a situation in which a noncompete provision represents an in-substance service condition.

55-88 Entity K is a professional services firm in which retention of qualified employees is important in sustaining its operations. Entity K’s industry expertise and relationship networks are inextricably linked to its employees; if its employees terminate their employment relationship and work for a competitor, the entity’s operations may be adversely impacted.

55-89 As part of its compensation structure, Entity K grants 100,000 restricted share units to an employee on January 1, 20X6. The fair value of the restricted share units represents approximately four times the expected future annual total compensation of the employee. The restricted share units are fully vested as of the date of grant, and retention of the restricted share units is not contingent on future service to Entity K. However, the units are transferred to the employee based on a 4-year delayed-transfer schedule (25,000 restricted share units to be transferred beginning on December 31, 20X6, and on December 31 in each of the 3 succeeding years) if and only if specified noncompete conditions are satisfied. The restricted share units are convertible into unrestricted shares any time after transfer.

55-90 The noncompete provisions require that no work in any capacity may be performed for a competitor (which would include any new competitor formed by the employee). Those noncompete provisions lapse with respect to the restricted share units as they are transferred. If the noncompete provisions are not satisfied, the employee loses all rights to any restricted share units not yet transferred. Additionally, the noncompete provisions stipulate that Entity K may seek other available legal remedies, including damages from the employee. Entity K has determined that the noncompete is legally enforceable and has legally enforced similar arrangements in the past.

55-91 The nature of the noncompete provision (being the corollary condition of active employment), the provision’s legal enforceability, the employer’s intent to enforce and past practice of enforcement, the delayed-transfer schedule mirroring the lapse of noncompete provisions, the magnitude of the award’s fair value in relation to the employee’s expected future annual total compensation, and the severity of the provision limiting the employee’s ability to work in the industry in any capacity are facts that provide a preponderance of evidence suggesting that the arrangement is designed to compensate the employee for future service in spite of the employee’s ability to terminate the employment relationship during the service period and retain the award (assuming satisfaction of the noncompete provision). Consequently, Entity K would recognize compensation cost related to the restricted share units over the four-year substantive service period.

55-92 Example 10 (see paragraph 718-20-55-84) provides an illustration of another noncompete agreement. That Example and this one are similar in that both noncompete agreements are not contingent upon employment termination (that is, both agreements may activate and lapse during a period of active employment after the vesting date). A key difference between the two Examples is that the award recipient in that Example must provide five years of service to vest in the award (as opposed to vesting immediately). Another key difference is that the award recipient in that Example receives the shares upon vesting and may sell them immediately without restriction as opposed to the restricted share units, which are transferred according to the delayed-transfer schedule. In that Example, the noncompete provision is not deemed to be an in-substance service condition. In making a determination about whether a noncompete provision may represent an in-substance service condition, the provision’s legal enforceability, the entity’s intent to enforce the provision and its past practice of enforcement, the employee’s rights to the instruments such as the right to sell them, the severity of the provision, the fair value of the award, and the existence or absence of an explicit employee service condition are all factors that shall be considered. Because noncompete provisions can be structured differently, one or more of those factors (such as the entity’s intent to enforce the provision) may be more important than others in making that determination. For example, if Entity K did not intend to enforce the provision, then the noncompete provision would not represent an in-substance service condition.

Estimating the Employee’s Requisite Service Period

55-67 Paragraph 718-10-35-2 requires that compensation cost be recognized over the requisite service period. The requisite service period for an award that has only a service condition is presumed to be the vesting period, unless there is clear evidence to the contrary. The requisite service period shall be estimated based on an analysis of the terms of the award and other relevant facts and circumstances, including co-existing employment agreements and an entity’s past practices; that estimate shall ignore nonsubstantive vesting conditions. For example, the grant of a deep out-of-the-money share option award without an explicit service condition will have a derived service period. Likewise, if an award with an explicit service condition that was at-the-money when granted is subsequently modified to accelerate vesting at a time when the award is deep out-of-the-money, that modification is not substantive because the explicit service condition is replaced by a derived service condition. If a market, performance, or service condition requires future service for vesting (or exercisability), an entity cannot define a prior period as the requisite service period. The requisite service period for awards with market, performance, or service conditions (or any combination thereof) shall be consistent with assumptions used in estimating the grant-date fair value of those awards.

55-92 The following Cases illustrate employee share-based payment awards with a performance condition (see paragraphs 718-10-25-20 through 25-21; 718-10-30-27; and 718-10-35-4) and multiple service dates:

1. Performance targets are set at the inception of the arrangement (Case A).
2. Performance targets are established at some time in the future (Case B).
3. Performance targets established up front but vesting is tied to the vesting of a preceding award (Case C).

55-93 Cases A, B, and C share the following assumptions:

1. On January 1, 20X5, Entity T enters into an arrangement with its chief executive officer relating to 40,000 share options on its stock with an exercise price of $30 per option.
2. The arrangement is structured such that 10,000 share options will vest or be forfeited in each of the next 4 years (20X5 through 20X8) depending on whether annual performance targets relating to Entity T’s revenues and net income are achieved.

Case A: Performance Targets Are Set at the Inception of the Arrangement

55-94 All of the annual performance targets are set at the inception of the arrangement. Because a mutual understanding of the key terms and conditions is reached on January 1, 20X5, each tranche would have a grant date and, therefore, a measurement date, of January 1, 20X5. However, each tranche of 10,000 share options should be accounted for as a separate award with its own service inception date, grant-date fair value, and 1-year requisite service period, because the arrangement specifies for each tranche an independent performance condition for a stated period of service. The chief executive officer’s ability to retain (vest in) the award pertaining to 20X5 is not dependent on service beyond 20X5, and the failure to satisfy the performance condition in any one particular year has no effect on the outcome of any preceding or subsequent period. This arrangement is similar to an arrangement that would have provided a $10,000 cash bonus for each year for satisfaction of the same performance conditions. The four separate service inception dates (one for each tranche) are at the beginning of each year.

Case B: Performance Targets Are Established at Some Time in the Future

55-95 If the arrangement had instead provided that the annual performance targets would be established during January of each year, the grant date (and, therefore, the measurement date) for each tranche would be that date in January of each year (20X5 through 20X8) because a mutual understanding of the key terms and conditions would not be reached until then. In that case, each tranche of 10,000 share options has its own service inception date, grant-date fair value, and 1-year requisite service period. The fair value measurement of compensation cost for each tranche would be affected because not all of the key terms and conditions of each award are known until the compensation committee sets the performance targets and, therefore, the grant dates are those dates.

Case C: Performance Targets Established Up Front but Vesting Is Tied to the Vesting of a Preceding Award

55-96 If the arrangement in Case A instead stated that the vesting for awards in periods from 20X6 through 20X8 was dependent on satisfaction of the performance targets related to the preceding award, the requisite service provided in exchange for each preceding award would not be independent of the requisite service provided in exchange for each successive award. In contrast to the arrangement described in Case A, failure to achieve the annual performance targets in 20X5 would result in forfeiture of all awards. The requisite service provided in exchange for each successive award is dependent on the requisite service provided for each preceding award. In that circumstance, all awards have the same service inception date and the same grant date (January 1, 20X5); however, each award has its own explicit service period (for example, the 20X5 grant has a one-year service period, the 20X6 grant has a two-year service period, and so on) over which compensation cost would be recognized. Because this award contains a performance condition, it is not subject to the attribution guidance in paragraph 718-10-35-8.

55-97 The following Cases illustrate the guidance in paragraph 718-10-30-12 to determine the service period for employee awards with multiple service periods:

1. Exercise price established at subsequent dates (Case A)
2. Exercise price established at inception (Case B).

Case A: Exercise Price Established at Subsequent Dates

55-98 The chief executive officer of Entity T enters into a five-year employment contract on January 1, 20X5. The contract stipulates that the chief executive officer will be given 10,000 fully vested share options at the end of each year (50,000 share options in total). The exercise price of each tranche will be equal to the market price at the date of issuance (December 31 of each year in the five-year contractual term). In this Case, there are five separate grant dates. The grant date for each tranche is December 31 of each year because that is the date when there is a mutual understanding of the key terms and conditions of the agreement — that is, the exercise price is known and the chief executive officer begins to benefit from, or be adversely affected by, subsequent changes in the price of the employer’s equity shares (see paragraphs 718-10-55-80 through 55-83 for additional guidance on determining the grant date). Because the awards’ terms do not include a substantive future requisite service condition that exists at the grant date (the options are fully vested when they are issued), and the exercise price (and, therefore, the grant date) is determined at the end of each period, the service inception date precedes the grant date. The requisite service provided in exchange for the first award (pertaining to 20X5) is independent of the requisite service provided in exchange for each consecutive award. The terms of the share-based compensation arrangement provide evidence that each tranche compensates the chief executive officer for one year of service, and each tranche shall be accounted for as a separate award with its own service inception date, grant date, and one-year service period; therefore, the provisions of paragraph 718-10-35-8 would not be applicable to this award because of its structure.

Case B: Exercise Price Established at Inception

55-99 If the arrangement described in Case A provided instead that the exercise price for all 50,000 share options would be the January 1, 20X5, market price, then the grant date (and, therefore, the measurement date) for each tranche would be January 1, 20X5, because that is the date at which there is a mutual understanding of the key terms and conditions. All tranches would have the same service inception date and the same grant date (January 1, 20X5). Because of the nature of this award, Entity T would make a policy decision pursuant to paragraph 718-10-35-8 as to whether it considers the award as in-substance, multiple awards each with its own requisite service period (that is, the 20X5 grant has a one-year service period, the 20X6 grant has a two-year service period, and so on) or whether the entity considers the award as a single award with a single requisite service period based on the last separately vesting portion of the award (that is, a requisite service period of five years). Once chosen, this Topic requires that accounting policy be applied consistently to all similar awards.

55-47 This Example illustrates the guidance in paragraph 718-10-30-15.

55-47A This Example (see paragraphs 718-20-55-48 through 55-50) 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, expected term, and total compensation cost that should be recognized (that is, the consideration of whether it is probable that performance conditions will be achieved) in paragraphs 718-20-55-48 through 55-50 are equally applicable to nonemployee awards with the same features as the awards in this Example (that is, awards with performance conditions that affect inputs to an award’s fair value). Therefore, the guidance in those paragraphs may serve as implementation guidance for similar nonemployee awards.

55-47B 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.

55-48 While performance conditions usually affect vesting conditions, they may affect exercise price, contractual term, quantity, or other factors that affect an award’s fair value before, at the time of, or after vesting. This Topic requires that all performance conditions be accounted for similarly. A potential grant-date fair value is estimated for each of the possible outcomes that are reasonably determinable at the grant date and associated with the performance condition(s) of the award (as demonstrated in Example 3 [see paragraph 718-20-55-41)]. Compensation cost ultimately recognized is equal to the grant-date fair value of the award that coincides with the actual outcome of the performance condition(s).

55-49 To illustrate the notion described in the preceding paragraph and attribution of compensation cost if performance conditions have different service periods, assume Entity C grants 10,000 at-the-money share options on its common stock to an employee. The options have a 10-year contractual term. The share options vest upon successful completion of phase-two clinical trials to satisfy regulatory testing requirements related to a developmental drug therapy. Phase-two clinical trials are scheduled to be completed (and regulatory approval of that phase obtained) in approximately 18 months; hence, the implicit service period is approximately 18 months. Further, the share options will become fully transferable upon regulatory approval of the drug therapy (which is scheduled to occur in approximately four years). The implicit service period for that performance condition is approximately 30 months (beginning once phase-two clinical trials are successfully completed). Based on the nature of the performance conditions, the award has multiple requisite service periods (one pertaining to each performance condition) that affect the pattern in which compensation cost is attributed. Paragraphs 718-10-55-67 through 55-79 and 718-10-55-86 through 55-88 provide guidance on estimating the requisite service period of an award. The determination of whether compensation cost should be recognized depends on Entity C’s assessment of whether the performance conditions are probable of achievement. Entity C expects that all performance conditions will be achieved. That assessment is based on the relevant facts and circumstances, including Entity C’s historical success rate of bringing developmental drug therapies to market.

55-50 At the grant date, Entity C estimates that the potential fair value of each share option under the 2 possible outcomes is $10 (Outcome 1, in which the share options vest and do not become transferable) and $16 (Outcome 2, in which the share options vest and do become transferable). The difference in estimated fair values of each outcome is due to the change in estimate of the expected term of the share option. Outcome 1 uses an expected term in estimating fair value that is less than the expected term used for Outcome 2, which is equal to the award’s 10-year contractual term. If a share option is transferable, its expected term is equal to its contractual term (see paragraph 718-10-55-29). If Outcome 1 is considered probable of occurring, Entity C would recognize $100,000 (10,000 × $10) of compensation cost ratably over the 18-month requisite service period related to the successful completion of phase-two clinical trials. If Outcome 2 is considered probable of occurring, then Entity C would recognize an additional $60,000 [10,000 × ($16 – $10)] of compensation cost ratably over the 30-month requisite service period (which begins after phase-two clinical trials are successfully completed) related to regulatory approval of the drug therapy. Because Entity C believes that Outcome 2 is probable, it recognizes compensation cost in the pattern described. However, if circumstances change and it is determined at the end of Year 3 that the regulatory approval of the developmental drug therapy is likely to be obtained in six years rather than four, the requisite service period for Outcome 2 is revised, and the remaining unrecognized compensation cost would be recognized prospectively through Year 6. On the other hand, if it becomes probable that Outcome 2 will not occur, compensation cost recognized for Outcome 2, if any, would be reversed.