Chapter 3 — Accounting Considerations Related to a Carve-Out Entity’s Statement of Comprehensive Income

3.4 Share-Based Payment Awards

Carve-out financial statements should reflect all stock compensation expense attributable to the carve-out entity. The associated expense may be specifically attributable to a stock compensation plan of the carve-out entity or allocated to the carve-out entity. If a stock compensation plan is directly attributable to the carve-out entity (e.g., the carve-out entity is a separate legal entity with its own stock compensation plan), the related stock compensation expense should be included in the carve-out financial statements.

Since stock compensation information is available at the individual-employee level, the determination of the related expense to be included in the carve-out entity is generally straightforward unless the expense is related to employees who spend only a portion of their time on the carve-out entity’s business. In such cases, a reasonable and supportable allocation method should be used (see Section 3.1 for further discussion). Management’s method of allocating share-based compensation expense is typically the same as its method of allocating cash-based compensation expense, as described in Section 3.3.

In addition, the notes to the carve-out financial statements must comply with the disclosure requirements in ASC 718. For a carve-out of a separate legal entity with its own stock compensation plan, the carve-out entity should present its ASC 718 disclosures at the level of its own plan. In situations in which stock compensation was allocated to the carve-out entity for employees that were dedicated to the entity, the carve-out entity should disclose in its financial statements information similar to that provided in the parent’s consolidated stock compensation disclosures (e.g., price, quantity, term) along with the allocation method.

For information about the accounting for share-based compensation awards (including accounting for modifications to awards), see Deloitte’s Roadmap Share-Based Payment Awards.

3.4.1 Modifications to Awards

In contemplation of a carve-out transaction, management may choose to modify stock compensation awards. In addition, such awards may have a provision in which their vesting is accelerated because of the carve-out transaction’s completion. Management should consider how much of (1) the incremental compensation costs from a modification and (2) the costs associated with the acceleration of vesting (if any) should be allocated to the carve-out entity.

3.4.1.1 Incremental Compensation Costs From a Modification

ASC 718-10-20 defines a modification as a “change in the terms or conditions of a share-based payment award.” A modification under ASC 718 is viewed as an exchange of the original award for a new award, typically one with equal or greater value. Any incremental value of the new (or modified) award usually is recorded as additional compensation cost on the modification date (for vested awards) or over the remaining service (vesting) period (for unvested awards). The incremental value (i.e., incremental compensation cost) is computed as the excess of the fair-value-based measure of the modified award on the modification date over the fair-value-based measure of the original award immediately before the modification.

In addition to considering whether a modification results in incremental compensation cost that must be recognized, an entity must determine whether it should recognize the award’s original grant-date fair-value-based measure. Generally, total recognized compensation cost attributable to an award that has been modified is at least the grant-date fair-value-based measure of the original award unless the original award is not expected to vest under its original terms (i.e., the service condition, the performance condition, or neither is expected to be achieved). Therefore, total recognized compensation cost attributable to an award that has been modified is typically the sum of (1) the grant-date fair-value-based measure of the original award for which the required service has been provided (i.e., the number of awards that have been earned) or is expected to be provided and (2) the incremental compensation cost conveyed to the holder of the award as a result of the modification. However, if the original award is not expected to vest under its original terms, any compensation cost recognized is based on the modification-date fair-value-based measure of the modified award (i.e., the grant-date fair-value-based measure of the original award is disregarded).

In contemplation of a carve-out transaction, an entity may decide to add a nondiscretionary, antidilution provision to its stock awards. An entity that adjusts the terms of an award to maintain the holder’s value in response to an equity restructuring (e.g., a spin-off) could trigger the recognition of significant compensation cost if (1) the adjustment is not required under the existing terms of the award and (2) the provision that requires an adjustment is added in contemplation of an equity restructuring. If an entity does not contemplate an equity restructuring when it adds an antidilution provision, the addition would generally result in the same fair-value-based measure before and after the modification. While adding a nondiscretionary antidilution provision generally increases the value of an award, a market participant would typically not place significant value on such a provision if an equity restructuring is not anticipated since it would be difficult to determine the provision’s effect on the valuation of the award. Accordingly, modification accounting would not be applied as long as there are no other changes to the award that would affect vesting or classification. As a result, no incremental compensation cost would be recorded. In determining whether an adjustment is required in the event of an equity restructuring (i.e., whether the antidilution provision is nondiscretionary or discretionary), an entity should carefully review the terms of its awards and may need to obtain the opinion of legal counsel. See Chapter 6 of Deloitte’s Roadmap Share-Based Payment Awards, particularly Section 6.5.1.3, for additional information.

3.4.1.2 Costs Associated With the Acceleration of Vesting

Vesting for share-based payment awards may be accelerated in connection with a carve-out (e.g., through either a modification or a preexisting change-in-control provision). Questions have arisen regarding whether an entity should allocate to the carve-out financial statements any of the costs associated with the acceleration of vesting (including accelerated recognition of previously unrecognized compensation costs as well as incremental compensation costs, if any, recorded as a result of modification accounting).

The carve-out financial statements would include compensation costs associated with the acceleration of vesting if those costs are related to awards held by employees of the carve-out entity. Conversely, compensation costs associated with the acceleration of vesting of awards held by employees of the parent generally would not need to be attributed to the carve-out entity unless those employees have otherwise been providing services to the carve-out entity, in which case an allocation of such costs might be necessary. If, however, the costs are related to the acceleration of vesting for awards issued to service providers associated with the carve-out transaction (e.g., a success fee owed by the parent entity to an investment banker), such costs should be evaluated under SAB Topic 1.B.1 as discussed in Section 3.1 to determine whether they represent a cost attributable to the carve-out business. Management will need to exercise judgment in making that determination.

Many modifications are made before a transaction (e.g., an IPO) date but are not effective unless the transaction occurs. While the date on which the contingent modification is made is generally the modification date used in the measurement of compensation cost, the accounting consequence may not be recognized until the transaction’s effective date if the modification is contingent on the transaction’s occurrence. For example, an award could be modified to increase the quantity of underlying shares upon a successful IPO. In such a circumstance, any additional compensation cost (as determined on the modification date) would not be recognized until the IPO is effective since IPOs are typically not considered probable until they occur.