{"schema_version":2,"canonical_url":"https://asc.understandingaccounting.org/asc/718/10/","source":"FASB Accounting Standards Codification, Basic View","usage":"Study and research edition. Verify current requirements with the official source. Summaries, enrichment, and tags are machine-generated study aids. Paragraph html preserves source markup; snippet is abbreviated. Pending content is not necessarily effective.","number":"718-10","topic":"718","title":"Overall","area":"Expenses","paragraphs":314,"summary":"ASC 718-10 is the \"Overall\" subtopic for share-based payment arrangements, setting the pervasive scope, recognition, measurement, classification, and disclosure principles that apply to both equity- and liability-classified awards granted to employees and nonemployees (and, by cross-reference, to customers). Its core rule is that cost must be recognized for all share-based payment transactions using a fair-value-based measurement method, generally grant-date fair value of the equity instruments issued (or fair value of liabilities incurred), recognized as the goods are obtained or services are received (718-10-10-2; 718-10-25-2; 718-10-30-3). Classification as liability or equity follows Topic 480 criteria as modified by 718-10-25-8 through 25-19A, and performance conditions are accrued based on the probable outcome while market conditions are reflected in grant-date fair value.","concepts":["share-based payment arrangement","grant-date fair value","requisite service period","liability versus equity classification","performance, market, and service conditions","forfeiture policy election","calculated value and intrinsic value","nonemployee awards"],"categories":["Stock compensation","Compensation and benefits","Recognition","Initial measurement"],"level":"intermediate","topic_title":"Compensation—Stock Compensation","sections":[{"number":"00","label":"00 Status","anchor":"00-status","is_sec":false,"groups":[{"block":null,"heading":null,"paragraphs":[{"citation":"718-10-00-1","para":"00-1","html":"The following table identifies the changes made to this Subtopic.
The Compensation—Stock Compensation Topic provides guidance on
share-based payment transactions. This Topic includes the following Subtopics:
- a
Overall
- b
Awards Classified as Equity
- c
Awards Classified as Liabilities
- d
- e
Employee Stock Purchase Plans
- f
Income Taxes.
This Topic provides guidance for employee and nonemployee share-based payment transactions.
This Subtopic provides general guidance related to
share-based payment arrangements. This Subtopic and Subtopics
718-20 and
718-30 are interrelated and the required guidance may be located in either this Subtopic or one of the other Subtopics. In general, material that relates to both equity and liability instruments is included in this Subtopic, while material more specifically related to either equity or liability instruments is included in their respective Subtopics.
Guidance referencing grantees is intended to be applicable to recipients of both employee and nonemployee awards, and guidance referencing employees or nonemployees is only applicable to those specific types of awards.The objective of accounting for transactions under share-based payment arrangements is to recognize in the financial statements the goods or services received in exchange for equity instruments granted or liabilities incurred and the related cost to the entity as those goods or services are received. This Topic uses the terms compensation and payment in their broadest senses to refer to the consideration paid for goods or services or the consideration paid to a customer. This Topic requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. This Topic establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value-based measurement method in accounting for share-based payment transactions except for equity instruments held by employee stock ownership plans. The Scope Section of the Overall Subtopic establishes the pervasive scope for all Subtopics of the Compensation—Stock Compensation Topic. Unless explicitly addressed within specific Subtopics, the following scope guidance applies to all Subtopics of the Compensation—Stock Compensation Topic, with the exception of Subtopic
718-50, which has its own discrete scope.
The guidance in the Compensation—Stock Compensation Topic applies to all entities that enter into
share-based payment transactions.
The guidance in the Compensation—Stock Compensation Topic applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in the grantor's own operations or provides consideration payable to a customer by issuing (or offering to issue) its shares, share options, or other equity instruments or by incurring liabilities to an employeeor a nonemployee that meet either of the following conditions: - a
The amounts are based, at least in part, on the price of the entity's shares or other equity instruments. (The phrase at least in part is used because an award of share-based compensation may be indexed to both the price of an entity's shares and something else that is neither the price of the entity's shares nor a market, performance, or service condition.) - b
The awards require or may require settlement by issuing the entity's equity shares or other equity instruments.
(P) December 16, 2024; (N) December 16, 2025
718-10-65-17The guidance in the Compensation—Stock Compensation Topic applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in the grantor's own operations or provides consideration payable to a customer by either of the following:- a
Issuing (or offering to issue) its shares, share options, or other equity instruments to an employee or a nonemployee - b
Incurring liabilities to an employee or a nonemployee that meet either of the following conditions:
- 1
The amounts are based, at least in part, on the price of the entity's shares or other equity instruments. (The phrase at least in part is used because an award of share-based compensation may be indexed to both the price of an entity's shares and something else that is neither the price of the entity's shares nor a market, performance, or service condition.) - 2
The awards require or may require settlement by issuing the entity's equity shares or other equity instruments.
Paragraphs provide guidance on accounting for share-based compensation granted by an investor to employees or nonemployees of an equity method investee that provide goods or services to the investee that are used or consumed in the investee's operations. (P) December 16, 2024; (N) December 16, 2025
718-10-65-17An entity shall apply the guidance in paragraph 718-10-15-3 to determine whether a profits interest or similar award is within the scope of this Topic. Paragraphs illustrate how the guidance in paragraph 718-10-15-3 applies to common features in a profits interest or similar award.Share-based payments awarded to a grantee by a related party or other holder of an economic interest in the entity as compensation for goods or services provided to the reporting entity are share-based payment transactions to be accounted for under this Topic unless the transfer is clearly for a purpose other than compensation for goods or services to the reporting entity. The substance of such a transaction is that the economic interest holder makes a capital contribution to the reporting entity, and that entity makes a share-based payment to the grantee in exchange for services rendered or goods received. An example of a situation in which such a transfer is not compensation is a transfer to settle an obligation of the economic interest holder to the grantee that is unrelated to goods or services to be used or consumed in a grantor's own operations. The guidance in this Topic does not apply to transactions involving share-based payment awards granted to a lender or an investor that provides financing to the issuer. However, see paragraphs , 815-40-35-18, 815-40-55-49, and 815-40-55-52 for guidance on an issuer's accounting for modifications or exchanges of written call options to compensate grantees.- a
- b
- c
Share-based payment awards granted to a customer shall be measured and classified in accordance with the guidance in this Topic (see paragraph 606-10-32-25A) and reflected as a reduction of the transaction price and, therefore, of revenue in accordance with paragraph 606-10-32-25 unless the consideration is in exchange for a distinct good or service. If share-based payment awards are granted to a customer as payment for a distinct good or service from the customer, then an entity shall apply the guidance in paragraph 606-10-32-26. (P) December 16, 2026; (N) December 16, 2026
606-10-65-2Share-based consideration granted to a customer (or to other parties that purchase the grantor’s goods or services from the customer) shall be measured and classified in accordance with the guidance in this Topic (see paragraph 606-10-32-25A) and reflected as a reduction of the transaction price and, therefore, of revenue in accordance with paragraph 606-10-32-25 unless the consideration is in exchange for a distinct good or service. If share-based payment awards are granted to a customer as payment for a distinct good or service from the customer, then the grantor shall apply the guidance in paragraph 606-10-32-26. See also paragraph 606-10-55-88AB.(P) December 16, 2026; (N) December 16, 2026
606-10-65-2A grantor shall not apply by analogy the aspects of the definition of performance condition that are specific to share-based consideration payable to a customer described in paragraph 606-10-55-88AA to awards granted to employees or nonemployees in which the grantor acquires goods or services to be used or consumed in the grantor’s own operations that are solely within the scope of the guidance in this Topic. See also paragraphs .Paragraphs provide guidance on determining whether share-based payment awards issued in a business combination are part of the consideration transferred in exchange for the acquiree, and therefore in the scope of Topic 805, or are for continued service to be recognized in the postcombination period in accordance with this Topic. The guidance in the Overall Subtopic does not apply to equity instruments held by an employee stock ownership plan.
Paragraph 805-60-25-8 provides guidance on determining whether share-based payment awards issued by a joint venture upon formation are part of the joint venture formation transaction and, therefore, are within the scope of Subtopic 805-60, or are for continued service to be recognized in the postformation period in accordance with this Topic. The guidance in this Section is organized as follows:
- a
- b
- c
Determining whether to classify a financial instrument as a liability or as equity
- d
- e
- f
Payroll taxes.
An entity shall recognize the goods acquired or services received in a share-based payment transaction when it obtains the goods or as services are received, as further described in paragraphs . The entity shall recognize either a corresponding increase in equity or a liability, depending on whether the instruments granted satisfy the equity or liability classification criteria (see paragraphs 718-10-25-6 through 25-19A). Employee services themselves are not recognized before they are received. As the services are consumed, the entity shall recognize the related cost. For example, as services are consumed, the cost usually is recognized in determining net income of that period, for example, as expenses incurred for employee services. In some circumstances, the cost of services may be initially capitalized as part of the cost to acquire or construct another asset, such as inventory, and later recognized in the income statement when that asset is disposed of or consumed. This Topic refers to recognizing compensation cost rather than compensation expense because any compensation cost that is capitalized as part of the cost to acquire or construct an asset would not be recognized as compensation expense in the income statement. Transactions with nonemployees in which share-based payment awards are granted in exchange for the receipt of goods or services may involve a contemporaneous exchange of the share-based payment awards for goods or services or may involve an exchange that spans several financial reporting periods. Furthermore, by virtue of the terms of the exchange with the grantee, the quantity and terms of the share-based payment awards to be granted may be known or not known when the transaction arrangement is established because of specific conditions dictated by the agreement (for example, performance conditions). Judgment is required in determining the period over which to recognize cost, otherwise known as the nonemployee's vesting period.
This guidance does not address the period(s) or the manner (that is, capitalize versus expense) in which an entity granting the share-based payment award (the purchaser or grantor) to a nonemployee shall recognize the cost of the share-based payment award that will be issued, other than to require that an asset or expense be recognized (or previous recognition reversed) in the same period(s) and in the same manner as if the grantor had paid cash for the goods or services instead of paying with or using the share-based payment award. A share-based payment award granted to a customer shall be reflected as a reduction of the transaction price and, therefore, of revenue as described in paragraph 606-10-32-25 unless the payment to the customer is in exchange for a distinct good or service, in which case the guidance in paragraph 606-10-32-26 shall apply. The accounting for all share-based payment transactions shall 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. For example, the rights and obligations embodied in a transfer of equity shares for a note that provides no recourse to other assets of the grantee (that is, other than the shares) are substantially the same as those embodied in a grant of equity share options. Thus, that transaction shall be accounted for as a substantive grant of equity share options.
Assessment of both the rights and obligations in a share-based payment award and any related arrangement and how those rights and obligations affect the fair value of an award requires the exercise of judgment in considering the relevant facts and circumstances. As a practical accommodation, in determining the grant date of an award subject to this Topic, assuming all other criteria in the grant date definition have been met, a mutual understanding of the key terms and conditions of an award to an individual grantee shall be presumed to exist at the date the award is approved in accordance with the relevant corporate governance requirements (that is, by the Board or management with the relevant authority) if both of the following conditions are met: - a
The award is a unilateral grant and, therefore, the recipient does not have the ability to negotiate the key terms and conditions of the award with the grantor.
- b
The key terms and conditions of the award are expected to be communicated to an individual recipient within a relatively short time period from the date of approval. A relatively short time period is that period in which an entity could reasonably complete all actions necessary to communicate the awards to the recipients in accordance with the entity's customary practices.
For additional guidance see paragraphs
.
This paragraph through paragraph 718-10-25-19A provide guidance for determining whether certain financial instruments awarded in share-based payment transactions are liabilities. In determining whether an instrument not specifically discussed in those paragraphs shall be classified as a liability or as equity, an entity shall apply generally accepted accounting principles (GAAP) applicable to financial instruments issued in transactions not involving share-based payment. Topic 480 excludes from its scope instruments that are accounted for under this Topic. Nevertheless, unless paragraphs 718-10-25-8 through 25-19A require otherwise, an entity shall apply the classification criteria in Section 480-10-25 and paragraphs in determining whether to classify as a liability a freestanding financial instrument given to a grantee in a share-based payment transaction. Paragraphs provide criteria for determining when instruments subject to this Topic subsequently become subject to Topic 480 or to other applicable GAAP. In determining the classification of an instrument, an entity shall take into account the classification requirements as established by Topic 480. In addition, a call option written on an instrument that is not classified as a liability under those classification requirements (for example, a call option on a mandatorily redeemable share for which liability classification is not required for the specific entity under the requirements) also shall be classified as equity so long as those equity classification requirements for the entity continue to be met, unless liability classification is required under the provisions of paragraphs . Topic 480 does not apply to outstanding shares embodying a conditional obligation to transfer assets, for example, shares that give the grantee the right to require the grantor to repurchase them for cash equal to their fair value (puttable shares). A put right may be granted to the grantee in a transaction that is related to a share-based compensation arrangement. If exercise of such a put right would require the entity to repurchase shares issued under the share-based compensation arrangement, the shares shall be accounted for as puttable shares. A puttable (or callable) share awarded to a grantee as compensation shall be classified as a liability if either of the following conditions is met: - a
The repurchase feature permits the grantee to avoid bearing the risks and rewards normally associated with equity share ownership for a reasonable period of time from the date the good is delivered or the service is rendered and the share is issued. A grantee begins to bear the risks and rewards normally associated with equity share ownership when all the goods are delivered or all the service has been rendered and the share is issued. A repurchase feature that can be exercised only upon the occurrence of a contingent event that is outside the grantee's control (such as an initial public offering) would not meet this condition until it becomes probable that the event will occur within the reasonable period of time. - b
It is probable that the grantor would prevent the grantee from bearing those risks and rewards for a reasonable period of time from the date the share is issued.
For this purpose, a period of six months or more is a reasonable period of time. A puttable (or callable) share that does not meet either of those conditions shall be classified as equity (see paragraph 718-10-55-85). Options or similar instruments on shares shall be classified as liabilities if either of the following conditions is met: - a
The underlying shares are classified as liabilities.
- b
The entity can be required under any circumstances to settle the option or similar instrument by transferring cash or other assets. A cash settlement feature that can be exercised only upon the occurrence of a contingent event that is outside the grantee's control (such as an initial public offering) would not meet this condition until it becomes probable that event will occur.
For example, a Securities and Exchange Commission (SEC) registrant may grant an option to a grantee that, upon exercise, would be settled by issuing a mandatorily redeemable share. Because the mandatorily redeemable share would be classified as a liability under Topic 480, the option also would be classified as a liability. An award may be indexed to a factor in addition to the entity's share price. If that additional factor is not a market, performance, or service condition, the award shall be classified as a liability for purposes of this Topic, and the additional factor shall be reflected in estimating the fair value of the award. Paragraph 718-10-55-65 provides examples of such awards. For this purpose, an award of equity share options granted to a grantee of an entity's foreign operation that provides for a fixed exercise price denominated either in the foreign operation's functional currency or in the currency in which the foreign operation's employee's pay is denominated shall not be considered to contain a condition that is not a market, performance, or service condition. Therefore, such an award is not required to be classified as a liability if it otherwise qualifies as equity. For example, equity share options with an exercise price denominated in euros granted to employees or nonemployees of a U.S. entity's foreign operation whose functional currency is the euro are not required to be classified as liabilities if those options otherwise qualify as equity. In addition, options granted to employees and nonemployees are not required to be classified as liabilities even if the functional currency of the foreign operation is the U.S. dollar, provided that the foreign operation's employees are paid in euros.
For purposes of applying paragraph 718-10-25-13, a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trades shall not be considered to contain a condition that is not a market, performance, or service condition. Therefore, in accordance with that paragraph, such an award shall not be classified as a liability if it otherwise qualifies for equity classification. For example, a parent entity whose functional currency is the Canadian dollar grants equity share options with an exercise price denominated in U.S. dollars to grantees of a Canadian entity with the functional and payroll currency of the Canadian dollar. If a substantial portion of the parent entity's equity securities trades on a U.S. dollar denominated exchange, the options are not precluded from equity classification. The accounting for an award of share-based payment shall reflect the substantive terms of the award and any related arrangement. Generally, the written terms provide the best evidence of the substantive terms of an award. However, an entity's past practice may indicate that the substantive terms of an award differ from its written terms. For example, an entity that grants a tandem award under which a grantee receives either a stock option or a cash-settled stock appreciation right is obligated to pay cash on demand if the choice is the grantee's, and the entity thus incurs a liability to the grantee. In contrast, if the choice is the entity's, it can avoid transferring its assets by choosing to settle in stock, and the award qualifies as an equity instrument. However, if an entity that nominally has the choice of settling awards by issuing stock predominantly settles in cash or if the entity usually settles in cash whenever a grantee asks for cash settlement, the entity is settling a substantive liability rather than repurchasing an equity instrument. In determining whether an entity that has the choice of settling an award by issuing equity shares has a substantive liability, the entity also shall consider whether: - a
It has the ability to deliver the shares. (Requirements to deliver registered shares do not, by themselves, imply that an entity does not have the ability to deliver shares and thus do not require an award that otherwise qualifies as equity to be classified as a liability.)
- b
It is required to pay cash if a contingent event occurs (see paragraphs ).
A provision that permits grantees to effect a broker-assisted cashless exercise of part or all of an award of share options through a broker does not result in liability classification for instruments that otherwise would be classified as equity if both of the following criteria are satisfied: - a
The cashless exercise requires a valid exercise of the share options.
- b
The grantee is the legal owner of the shares subject to the option (even though the grantee has not paid the exercise price before the sale of the shares subject to the option).
A broker that is a related party of the entity must sell the shares in the open market within a normal settlement period, which generally is three days, for the award to qualify as equity. Similarly, a provision for either direct or indirect (through a net-settlement feature) repurchase of shares issued upon exercise of options (or the vesting of nonvested shares), with any payment due employees withheld to meet the employer's statutory withholding requirements resulting from the exercise, does not, by itself, result in liability classification of instruments that otherwise would be classified as equity. However, if the amount that is withheld, or may be withheld at the employee's discretion, is in excess of the maximum statutory tax rates in the employees' applicable jurisdictions, the entire award shall be classified and accounted for as a liability. That is, to qualify for equity classification, the employer must have a statutory obligation to withhold taxes on the employee's behalf, and the amount withheld cannot exceed the maximum statutory tax rates in the employees' applicable jurisdictions. The maximum statutory tax rates are based on the applicable rates of the relevant tax authorities (for example, federal, state, and local), including the employee's share of payroll or similar taxes, as provided in tax law, regulations, or the authority's administrative practices, not to exceed the highest statutory rate in that jurisdiction, even if that rate exceeds the highest rate that may be applicable to the specific award grantee. Paragraph 230-10-45-15 provides guidance on the classification on the statement of cash flows for cash paid to a tax authority by an employer when withholding shares from an employee's award for tax-withholding purposes. Accruals of compensation cost for an award with a performance condition shall be based on the probable outcome of that performance condition—compensation cost shall be accrued if it is probable that the performance condition will be achieved and shall not be accrued if it is not probable that the performance condition will be achieved. If an award has multiple performance conditions (for example, if the number of options or shares a grantee earns varies depending on which, if any, of two or more performance conditions is satisfied), compensation cost shall be accrued if it is probable that a performance condition will be satisfied. In making that assessment, it may be necessary to take into account the interrelationship of those performance conditions. Example 2 (see paragraph 718-20-55-35) provides an illustration of how to account for awards with multiple performance conditions. If an award requires satisfaction of one or more market, performance, or service conditions (or any combination thereof), compensation cost shall be recognized if the good is delivered or the service is rendered, and no compensation cost shall be recognized if the good is not delivered or the service is not rendered. Paragraphs provide guidance on applying this provision to awards with market, performance, or service conditions (or any combination thereof). A liability for employee payroll taxes on employee stock compensation shall be recognized on the date of the event triggering the measurement and payment of the tax to the taxing authority (for a nonqualified option in the United States, generally the exercise date).
Payroll taxes, even though directly related to the appreciation on stock options, are operating expenses and shall be reflected as such in the statement of operations.
While some of the material in this Section was written in terms of awards classified as equity, it applies equally to awards classified as liabilities.
A share-based payment transaction shall be measured based on the fair value (or in certain situations specified in this Topic, a calculated value or intrinsic value) of the equity instruments issued. An entity shall account for the compensation cost from share-based payment transactions in accordance with the fair-value-based method set forth in this Topic. That is, the cost of goods obtained or services received in exchange for awards of share-based compensation generally shall be measured based on the grant-date fair value of the equity instruments issued or on the fair value of the liabilities incurred. The cost of goods obtained or services received by an entity as consideration for equity instruments issued or liabilities incurred in share-based compensation transactions shall be measured based on the fair value of the equity instruments issued or the liabilities settled. The portion of the fair value of an instrument attributed to goods obtained or services received is net of any amount that a grantee pays (or becomes obligated to pay) for that instrument when it is granted. For example, if a grantee pays $5 at the grant date for an option with a grant-date fair value of $50, the amount attributed to goods or services provided by the grantee is $45. An entity shall apply the guidance in paragraph 606-10-32-26 when determining the portion of the fair value of an equity instrument attributed to goods obtained or services received from a customer. However, this Topic provides certain exceptions (see paragraph 718-10-30-21) to that measurement method if it is not possible to reasonably estimate the fair value of an award at the grant date. A nonpublic entity also may choose to measure its liabilities under share-based payment arrangements at intrinsic value (see paragraphs 718-10-30-20 and 718-30-30-2). The terms of a share-based payment award and any related arrangement affect its value and, except for certain explicitly excluded features, such as a reload feature, shall be reflected in determining the fair value of the equity or liability instruments granted. For example, the fair value of a substantive option structured as the exchange of equity shares for a nonrecourse note will differ depending on whether the grantee is required to pay nonrefundable interest on the note. The measurement objective for equity instruments awarded to grantees is to estimate the fair value at the grant date of the equity instruments that the entity is obligated to issue when grantees have delivered the good or rendered the service and satisfied any other conditions necessary to earn the right to benefit from the instruments (for example, to exercise share options). That estimate is based on the share price and other pertinent factors, such as expected volatility, at the grant date. The fair value of an equity share option or similar instrument shall be measured based on the observable market price of an option with the same or similar terms and conditions, if one is available (see paragraph 718-10-55-10). Such market prices for equity share options and similar instruments granted in share-based payment transactions are frequently not available; however, they may become so in the future.
As such, the fair value of an equity share option or similar instrument shall be estimated using a valuation technique such as an option-pricing model. For this purpose, a similar instrument is one whose fair value differs from its intrinsic value, that is, an instrument that has time value. For example, a share appreciation right that requires net settlement in equity shares has time value; an equity share does not. Paragraphs provide additional guidance on estimating the fair value of equity instruments, including the factors to be taken into account in estimating the fair value of equity share options or similar instruments as described in paragraphs . To satisfy the measurement objective in paragraph 718-10-30-6, the restrictions and conditions inherent in equity instruments awarded are treated differently depending on whether they continue in effect after the requisite service period or the nonemployee's vesting period. A restriction that continues in effect after an entity has issued awards, such as the inability to transfer vested equity share options to third parties or the inability to sell vested shares for a period of time, is considered in estimating the fair value of the instruments at the grant date. For equity share options and similar instruments, the effect of nontransferability (and nonhedgeability, which has a similar effect) is taken into account by reflecting the effects of grantees' expected exercise and postvesting termination behavior in estimating fair value (referred to as an option's expected term). On an award-by-award basis, an entity may elect to use the contractual term as the expected term when estimating the fair value of a nonemployee award to satisfy the measurement objective in paragraph 718-10-30-6. Otherwise, an entity shall apply the guidance in this Topic in estimating the expected term of a nonemployee award, which may result in a term less than the contractual term of the award. When a nonpublic entity chooses to measure a nonemployee share-based payment award by estimating its expected term and applies the practical expedient in paragraph 718-10-30-20A, it must apply the practical expedient to all nonemployee awards that meet the conditions in paragraph 718-10-30-20B. However, a nonpublic entity may still elect, on an award-by-award basis, to use the contractual term as the expected term as described in paragraph 718-10-30-10A. A restriction that stems from the forfeitability of instruments to which grantees have not yet earned the right, such as the inability either to exercise a nonvested equity share option or to sell nonvested shares, is not reflected in estimating the fair value of the related instruments at the grant date. Instead, those restrictions are taken into account by recognizing compensation cost only for awards for which grantees deliver the good or render the service. Awards of share-based compensation ordinarily specify a performance condition or a service condition (or both) that must be satisfied for a grantee to earn the right to benefit from the award. No compensation cost is recognized for instruments forfeited because a service condition or a performance condition is not satisfied (for example, instruments for which the good is not delivered or the service is not rendered). Examples 1 through 2 (see paragraphs ) and Example 1 (see paragraph 718-30-55-1) provide illustrations of how compensation cost is recognized for awards with service and performance conditions. The fair-value-based method described in paragraphs 718-10-30-6 and uses fair value measurement techniques, and the grant-date share price and other pertinent factors are used in applying those techniques. However, the effects on the grant-date fair value of service and performance conditions that apply only during the employee's requisite service period or a nonemployee's vesting period are reflected based on the outcomes of those conditions. This Topic refers to the required measure as fair value. Some awards contain a market condition. The effect of a market condition is reflected in the grant-date fair value of an award. (Valuation techniques have been developed to value path-dependent options as well as other options with complex terms. Awards with market conditions, as defined in this Topic, are path-dependent options.) Compensation cost thus is recognized for an award with a market condition provided that the good is delivered or the service is rendered, regardless of when, if ever, the market condition is satisfied. Market, performance, and service conditions (or any combination thereof) may affect an award's exercise price, contractual term, quantity, conversion ratio, or other factors that are considered in measuring an award's grant-date fair value. A grant-date fair value shall be estimated for each possible outcome of such a performance or service condition, and the final measure of compensation cost shall be based on the amount estimated at the grant date for the condition or outcome that is actually satisfied. Paragraphs provide additional guidance on the effects of market, performance, and service conditions that affect factors other than vesting or exercisability. Examples 2 (see paragraph 718-20-55-35); 3 (see paragraph 718-20-55-41); 4 (see paragraph 718-20-55-47); 5 (see paragraph 718-20-55-51); and 7 (see paragraph 718-20-55-68) provide illustrations of accounting for awards with such conditions. A nonvested equity share or nonvested equity share unit shall be measured at its fair value as if it were vested and issued on the grant date. Nonvested shares granted in share-based payment transactions usually are referred to as restricted shares, but this Topic reserves that term for fully vested and outstanding shares whose sale is contractually or governmentally prohibited for a specified period of time. A restricted share awarded to a grantee, that is, a share that will be restricted after the grantee has a vested right to it, shall be measured at its fair value, which is the same amount for which a similarly restricted share would be issued to third parties. Example 8 (see paragraph 718-20-55-71) provides an illustration of accounting for an award of nonvested shares to employees. Similar to employee equity share options and similar instruments, a nonpublic entity may not be able to reasonably estimate the fair value of nonemployee awards because it is not practicable for the nonpublic entity to estimate the expected volatility of its share price. In that situation, the nonpublic entity shall account for nonemployee equity share options and similar instruments on the basis of a value calculated using the historical volatility of an appropriate industry sector index instead of the expected volatility of the nonpublic entity's share price (the calculated value) in accordance with paragraph 718-10-30-20. A nonpublic entity's use of calculated value shall be consistent between employee share-based payment transactions and nonemployee share-based payment transactions. A nonpublic entity may not be able to reasonably estimate the fair value of its equity share options and similar instruments because it is not practicable for it to estimate the expected volatility of its share price. In that situation, the entity shall account for its equity share options and similar instruments based on a value calculated using the historical volatility of an appropriate industry sector index instead of the expected volatility of the entity's share price (the calculated value). Throughout the remainder of this Topic, provisions that apply to accounting for share options and similar instruments at fair value also apply to calculated value. Paragraphs and Example 9 (see paragraph 718-20-55-76) provide additional guidance on applying the calculated value method to equity share options and similar instruments granted by a nonpublic entity. For an award that meets the conditions in paragraph 718-10-30-20B, a nonpublic entity may make an entity-wide accounting policy election to estimate the expected term using the following practical expedient: - a
If vesting is only dependent upon a service condition, a nonpublic entity shall estimate the expected term as the midpoint between the employee's requisite service period or the nonemployee's vesting period and the contractual term of the award.
- b
If vesting is dependent upon satisfying a performance condition, a nonpublic entity first would determine whether the performance condition is probable of being achieved. - 1
If the nonpublic entity concludes that the performance condition is probable of being achieved, the nonpublic entity shall estimate the expected term as the midpoint between the employee's requisite service period (a nonpublic entity shall consider the guidance in paragraphs when determining the requisite service period of the award) or the nonemployee's vesting period and the contractual term. - 2
If the nonpublic entity concludes that the performance condition is not probable of being achieved, the nonpublic entity shall estimate the expected term as either:
- i
The contractual term if the service period is implied (that is, the requisite service period or the nonemployee's vesting period is not explicitly stated but inferred based on the achievement of the performance condition at some undetermined point in the future)
- ii
The midpoint between the employee's requisite service period or the nonemployee's vesting period and the contractual term if the requisite service period is stated explicitly.
Paragraph 718-10-55-50A provides implementation guidance on the practical expedient. A nonpublic entity that elects to apply the practical expedient in paragraph 718-10-30-20A shall apply the practical expedient to a share option or similar award that has all of the following characteristics: - a
The share option or similar award is granted at the money.
- b
The grantee has only a limited time to exercise the award (typically 30-90 days) if the grantee no longer provides goods, terminates service after vesting, or ceases to be a customer.
- c
The grantee can only exercise the award. The grantee cannot sell or hedge the award.
- d
The award does not include a market condition.
A nonpublic entity that elects to apply the practical expedient in paragraph 718-10-30-20A may always elect to use the contractual term as the expected term when estimating the fair value of a nonemployee award as described in paragraph 718-10-30-10A. However, a nonpublic entity must apply the practical expedient in paragraph 718-10-30-20A for all nonemployee awards that have all the characteristics listed in this paragraph if that nonpublic entity does not elect to use the contractual term as the expected term and that nonpublic entity elects the accounting policy election to apply the practical expedient in paragraph 718-10-30-20A. As a practical expedient, a nonpublic entity may use a value determined by the reasonable application of a reasonable valuation method as the current price of its underlying share for purposes of determining the fair value of an award that is classified as equity in accordance with paragraphs at grant date or upon a modification. This practical expedient may not be used for awards classified as liabilities in accordance with paragraphs . The determination of whether a valuation method is reasonable, or whether an application of a valuation method is reasonable, shall be made based on the facts and circumstances as of the measurement date. Factors to be considered under a reasonable valuation method include, as applicable: - a
The value of tangible and intangible assets of the nonpublic entity
- b
The present value of anticipated future cash flows of the nonpublic entity
- c
The market value of stock or equity interests in similar corporations and other entities engaged in trades or businesses substantially similar to those engaged in by the nonpublic entity for which the stock is to be valued, the value of which can be readily determined through nondiscretionary, objective means (such as through trading prices on an established securities market or an amount paid in an arm's-length private transaction)
- d
Recent arm's-length transactions involving the sale or transfer of stock or equity interests of the nonpublic entity
- e
Other relevant factors such as control premiums or discounts for lack of marketability and whether the valuation method is used for other purposes that have a material economic effect on the nonpublic entity, its stockholders, or its creditors
- f
The nonpublic entity's consistent use of a valuation method to determine the value of its stock or assets for other purposes, including for purposes unrelated to compensation of service providers.
The use of a valuation method is not reasonable if that valuation method does not take into consideration when applying its methodology all available information material to the value of the nonpublic entity.
The use of a value previously calculated under a valuation method is not reasonable as of a later date if either of the following conditions is met: - a
The calculation fails to reflect information available after the date of the calculation that may materially affect the value of the nonpublic entity (for example, the resolution of material litigation or the issuance of a patent).
- b
The value was calculated with respect to a date that is more than 12 months earlier than the date for which the valuation is being used.
A valuation performed in accordance with Treasury Regulation Section 1.409A-1(b)(5)(iv)(B) having the characteristics described in paragraphs is an example of a valuation that is reasonable under the practical expedient in those paragraphs. A nonpublic entity that elects the practical expedient in paragraphs shall do so on a measurement-date-by-measurement-date basis. That is, the practical expedient shall be applied to all share-based awards within the scope of the practical expedient having the same underlying share and the same measurement date. It should be possible to reasonably estimate the fair value of most equity share options and other equity instruments at the date they are granted. Section 718-10-55 illustrates techniques for estimating the fair values of several instruments with complicated features. However, in rare circumstances, it may not be possible to reasonably estimate the fair value of an equity share option or other equity instrument at the grant date because of the complexity of its terms. An equity instrument for which it is not possible to reasonably estimate fair value at the grant date shall be accounted for based on its intrinsic value (see paragraph 718-20-35-1 for measurement after issue date). The fair value of each award of equity instruments, including an award of options with a reload feature (reload options), shall be measured separately based on its terms and the share price and other pertinent factors at the grant date. The effect of a reload feature in the terms of an award shall not be included in estimating the grant-date fair value of the award. Rather, a subsequent grant of reload options pursuant to that provision shall be accounted for as a separate award when the reload options are granted.
A contingent feature of an award that might cause a grantee to return to the entity either equity instruments earned or realized gains from the sale of equity instruments earned for consideration that is less than fair value on the date of transfer (including no consideration), such as a clawback feature (see paragraph 718-10-55-8), shall not be reflected in estimating the grant-date fair value of an equity instrument. An entity shall make its initial best estimate of the requisite service period at the grant date (or at the service inception date, if that date precedes the grant date) and shall base accruals of compensation cost on that period. The initial best estimate and any subsequent adjustment to that estimate of the requisite service period for an award with a combination of market, performance, or service conditions shall be based on an analysis of all of the following: - a
All vesting and exercisability conditions
- b
All explicit, implicit, and derived service periods
- c
The probability that performance or service conditions will be satisfied.
Performance or service conditions that affect vesting are not reflected in estimating the fair value of an award at the grant date because those conditions are restrictions that stem from the forfeitability of instruments to which grantees have not yet earned the right. However, the effect of a market condition is reflected in estimating the fair value of an award at the grant date (see paragraph 718-10-30-14). For purposes of this Topic, a market condition is not considered to be a vesting condition, and an award is not deemed to be forfeited solely because a market condition is not satisfied. 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. This Subtopic is interrelated with Subtopics
718-20 and
718-30. Material that equally applies to both liabilities and equity is generally found in this Subtopic. However, material may have been placed in one of the other Subtopics.
A grantor shall recognize the goods acquired or services received in a share-based payment transaction with nonemployees when it obtains the goods or as services are received. A grantor may need to recognize an asset before it actually receives goods or services if it first exchanges a share-based payment for an enforceable right to receive those goods or services. Nevertheless, the goods or services themselves are not recognized before they are received.
If fully vested, nonforfeitable equity instruments are granted at the date the grantor and nonemployee enter into an agreement for goods or services (no specific performance is required by the nonemployee to retain those equity instruments), then, because of the elimination of any obligation on the part of the nonemployee to earn the equity instruments, a grantor shall recognize the equity instruments when they are granted (in most cases, when the agreement is entered into). Whether the corresponding cost is an immediate expense or a prepaid asset (or whether the debit should be characterized as contra-equity under the requirements of paragraph 718-10-45-3) depends on the specific facts and circumstances. An entity may grant fully vested, nonforfeitable equity instruments that are exercisable by the nonemployee only after a specified period of time if the terms of the agreement provide for earlier exercisability if the nonemployee achieves specified performance conditions. Any measured cost of the transaction shall be recognized in the same period(s) and in the same manner as if the entity had paid cash for the goods or services instead of paying with, or using, the share-based payment awards.
The total amount of compensation cost recognized for share-based payment awards to nonemployees shall be based on the number of instruments for which a good has been delivered or a service has been rendered. To determine the amount of compensation cost to be recognized in each period, an entity shall make an entity-wide accounting policy election for all nonemployee share-based payment awards, including share-based payment awards granted to customers, to do either of the following: - a
Estimate the number of forfeitures expected to occur. The entity shall base initial accruals of compensation cost on the estimated number of nonemployee share-based payment awards for which a good is expected to be delivered or a service is expected to be rendered. The entity shall revise that estimate if subsequent information indicates that the actual number of instruments is likely to differ from previous estimates. The cumulative effect on current and prior periods of a change in the estimates shall be recognized in compensation cost in the period of the change.
- b
Recognize the effect of forfeitures in compensation cost when they occur. Previously recognized compensation cost for a nonemployee share-based payment award shall be reversed in the period that the award is forfeited.
(P) December 16, 2026; (N) December 16, 2026
606-10-65-2The total amount of compensation cost recognized for share-based payment awards to nonemployees shall be based on the number of instruments for which a good has been delivered or a service has been rendered. To determine the amount of compensation cost to be recognized in each period, an entity shall make an entity-wide accounting policy election for nonemployee share-based payment awards, including share-based payment awards granted to customers in exchange for a distinct good or service, to do either of the following: - a
Estimate the number of forfeitures expected to occur. The entity shall base initial accruals of compensation cost on the estimated number of nonemployee share-based payment awards for which a good is expected to be delivered or a service is expected to be rendered. The entity shall revise that estimate if subsequent information indicates that the actual number of instruments is likely to differ from previous estimates. The cumulative effect on current and prior periods of a change in the estimates shall be recognized in compensation cost in the period of the change.
- b
Recognize the effect of forfeitures in compensation cost when they occur. Previously recognized compensation cost for a nonemployee share-based payment award shall be reversed in the period that the award is forfeited.
For share-based consideration payable to a customer that is not in exchange for a distinct good or service (or that is in exchange for a distinct good or service and can result in a reduction of the transaction price in accordance with paragraph 606-10-32-26), a grantor shall estimate the number of forfeitures expected to occur in accordance with paragraph 718-10-35-1D(a). If share-based consideration payable to a customer is a payment for a distinct good or service from the customer and the grantor accounts for any portion of the share-based consideration as a reduction of the transaction price in accordance with paragraph 606-10-32-26, the grantor shall estimate the number of forfeitures expected to occur for the entire award (including the portion that is not accounted for as a reduction of the transaction price).A recognized asset or expense shall not be reversed if a stock option that the nonemployee has the right to exercise expires unexercised.
A grantor shall recognize either a corresponding increase in equity or a liability, depending on whether the instruments granted satisfy the equity or liability classification criteria established in paragraphs 718-10-25-6 through 25-19A. As the goods or services are disposed of or consumed, the grantor shall recognize the related cost. For example, when inventory is sold, the cost is recognized in the income statement as cost of goods sold, and as services are consumed, the cost usually is recognized in determining net income of that period, for example, as expenses incurred for services. In some circumstances, the cost of services (or goods) may be initially capitalized as part of the cost to acquire or construct another asset, such as inventory, and later recognized in the income statement when that asset is disposed of or consumed. The compensation cost for an award of share-based employee compensation classified as equity shall be recognized over the requisite service period, with a corresponding credit to equity (generally, paid-in capital). The requisite service period is the period during which an employee is required to provide service in exchange for an award, which often is the vesting period. The requisite service period is estimated based on an analysis of the terms of the share-based payment award. The total amount of compensation cost recognized at the end of the requisite service period for an award of share-based compensation shall be based on the number of instruments for which the requisite service has been rendered (that is, for which the requisite service period has been completed). Previously recognized compensation cost shall not be reversed if an employee share option (or share unit) for which the requisite service has been rendered expires unexercised (or unconverted). To determine the amount of compensation cost to be recognized in each period, an entity shall make an entity-wide accounting policy election for all employee share-based payment awards to do either of the following:- a
Estimate the number of awards for which the requisite service will not be rendered (that is, estimate the number of forfeitures expected to occur). The entity shall base initial accruals of compensation cost on the estimated number of instruments for which the requisite service is expected to be rendered. The entity shall revise that estimate if subsequent information indicates that the actual number of instruments is likely to differ from previous estimates. The cumulative effect on current and prior periods of a change in the estimated number of instruments for which the requisite service is expected to be or has been rendered shall be recognized in compensation cost in the period of the change.
- b
Recognize the effect of awards for which the requisite service is not rendered when the award is forfeited (that is, recognize the effect of forfeitures in compensation cost when they occur). Previously recognized compensation cost for an award shall be reversed in the period that the award is forfeited.
An entity shall reverse previously recognized compensation cost for an award with a market condition only if the requisite service is not rendered. The requisite service period for employee awards may be explicit or it may be implicit, being inferred from an analysis of other terms in the award, including other explicit service or performance conditions. The requisite service period for an award that contains a market condition can be derived from certain valuation techniques that may be used to estimate grant-date fair value (see paragraph 718-10-55-71). An award may have one or more explicit, implicit, or derived service periods; however, an award may have only one requisite service period for accounting purposes unless it is accounted for as in-substance multiple awards. An award with a graded vesting schedule that is accounted for as in-substance multiple awards is an example of an award that has more than one requisite service period (see paragraph 718-10-35-8). Paragraphs and provide guidance on estimating the requisite service period and provide examples of how that period shall be estimated if an award's terms include more than one explicit, implicit, or derived service period. The service inception date is the beginning of the requisite service period. If the service inception date precedes the grant date (see paragraph 718-10-55-108), accrual of compensation cost for periods before the grant date shall be based on the fair value of the award at the reporting date. In the period in which the grant date occurs, cumulative compensation cost shall be adjusted to reflect the cumulative effect of measuring compensation cost based on fair value at the grant date rather than the fair value previously used at the service inception date (or any subsequent reporting date). Example 6 (see paragraph 718-10-55-107) illustrates the concept of service inception date and how it is to be applied. An entity shall adjust that initial best estimate in light of changes in facts and circumstances. Whether and how the initial best estimate of the requisite service period is adjusted depends on both the nature of the conditions identified in paragraph 718-10-30-26 and the manner in which they are combined, for example, whether an award vests or becomes exercisable when either a market or a performance condition is satisfied or whether both conditions must be satisfied. Paragraphs provide guidance on adjusting the initial estimate of the requisite service period. An entity shall make a policy decision about whether to recognize compensation cost for an employee award with only service conditions that has a graded vesting schedule in either of the following ways: - a
On a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in-substance, multiple awards
- b
On a straight-line basis over the requisite service period for the entire award (that is, over the requisite service period of the last separately vesting portion of the award).
However, the amount of compensation cost recognized at any date must at least equal the portion of the grant-date value of the award that is vested at that date. Example 1, Case B (see paragraph 718-20-55-25) provides an illustration of the accounting for an award with a graded vesting schedule. Paragraphs are intended to apply to those instruments issued in share-based payment transactions with employees and nonemployees accounted for under this Topic, and to instruments exchanged in a business combination for share-based payment awards of the acquired business that were originally granted to grantees of the acquired business and are outstanding as of the date of the business combination. A freestanding financial instrumentor a convertible securityissued to a grantee that is subject to initial recognition and measurement guidance within this Topic shall continue to be subject to the recognition and measurement provisions of this Topic throughout the life of the instrument, unless its terms are modified after any of the following: - a
- b
- c
A grantee vests in the award and is no longer providing goods or services.
- d
A grantee vests in the award and is no longer a customer.
- e
A grantee is no longer an employee.
Only for purposes of paragraph 718-10-35-10, a modification does not include a change to the terms of an award if that change is made solely to reflect an equity restructuring provided that both of the following conditions are met: - a
There is no increase in fair value of the award (or the ratio of intrinsic value to the exercise price of the award is preserved, that is, the holder is made whole) or the antidilution provision is not added to the terms of the award in contemplation of an equity restructuring. - b
All holders of the same class of equity instruments (for example, stock options) are treated in the same manner.
Other modifications of that instrument that take place after a grantee vests in the award and is no longer providing goods or services, is no longer a customer, or is no longer an employee should be subject to the modification guidance in paragraph 718-10-35-14. Following modification, recognition and measurement of the instrument shall be determined through reference to other applicable GAAP. Once the classification of an instrument is determined, the recognition and measurement provisions of this Topic shall be applied until the instrument ceases to be subject to the requirements discussed in paragraph 718-10-35-10. Topic 480 or other applicable GAAP, such as Topic 815, applies to a freestanding financial instrument that was issued under a share-based payment arrangement but that is no longer subject to this Topic. This guidance is not intended to suggest that all freestanding financial instruments shall be accounted for as liabilities pursuant to Topic 480, but rather that freestanding financial instruments issued in share-based payment transactions may become subject to that Topic or other applicable GAAP depending on their substantive characteristics and when certain criteria are met. An entity may modify (including cancel and replace) or settle a fully vested, freestanding financial instrument after it becomes subject to Topic 480 or other applicable GAAP. Such a modification or settlement shall be accounted for under the provisions of this Topic unless it applies equally to all financial instruments of the same class regardless of the holder of the financial instrument. Following the modification, the instrument continues to be accounted for under that Topic or other applicable GAAP. A modification or settlement of a class of financial instrument that is designed exclusively for and held only by grantees (or their beneficiaries) may stem from the employment or vendor relationship depending on the terms of the modification or settlement. Thus, such a modification or settlement may be subject to the requirements of this Topic. See paragraph
718-10-35-10 for a discussion of changes to awards made solely to reflect an equity restructuring.
An option or similar instrument that is classified as equity, but subsequently becomes a liability because the contingent cash settlement event is probable of occurring, shall be accounted for similar to a modification from an equity to liability award. That is, on the date the contingent event becomes probable of occurring (and therefore the award must be recognized as a liability), the entity recognizes a share-based liability equal to the portion of the award attributed to past performance (which reflects any provision for acceleration of vesting) multiplied by the award's fair value on that date. To the extent the liability equals or is less than the amount previously recognized in equity, the offsetting debit is a charge to equity. To the extent that the liability exceeds the amount previously recognized in equity, the excess is recognized as compensation cost. The total recognized compensation cost for an award with a contingent cash settlement feature shall at least equal the fair value of the award at the grant date. The guidance in this paragraph is applicable only for options or similar instruments issued as part of compensation arrangements. That is, the guidance included in this paragraph is not applicable, by analogy or otherwise, to instruments outside share-based payment arrangements. Topic 260 requires that equity share options, nonvested shares, and similar equity instruments granted under share-based payment transactions be treated as potential common shares in computing diluted earnings per share (EPS). Diluted EPS shall be based on the actual number of options or shares granted and not yet forfeited regardless of the entity's accounting policy for forfeitures in accordance with paragraphs 718-10-35-1D and 718-10-35-3, unless doing so would be antidilutive. If vesting in or the ability to exercise (or retain) an award is contingent on a performance or market condition, such as the level of future earnings, the shares or share options shall be treated as contingently issuable shares in accordance with paragraphs . If equity share options or other equity instruments are outstanding for only part of a period, the shares issuable shall be weighted to reflect the portion of the period during which the equity instruments are outstanding. Paragraphs and Example 8 (see paragraph 260-10-55-68) provide guidance on applying the treasury stock method for equity instruments granted in share-based payment transactions in determining diluted EPS. As discussed in paragraph 718-10-35-1B, a grantor may conclude that an asset (other than a note or a receivable) has been received in return for fully vested, nonforfeitable, nonemployee share-based payment awards that are issued at the date the grantor and nonemployee enter into an agreement for goods or services (and no specific performance is required by the nonemployee to retain those equity instruments). Such an asset shall not be displayed as contra-equity by the grantor of the award. The transferability (or lack thereof) of the awards shall not affect the balance sheet display of the asset. This guidance is limited to transactions in which awards are transferred to nonemployees in exchange for goods or services. An entity with one or more share-based payment arrangements shall disclose information that enables users of the financial statements to understand all of the following: - a
The nature and terms of such arrangements that existed during the period and the potential effects of those arrangements on shareholders
- b
The effect of compensation cost arising from share-based payment arrangements on the income statement
- c
The method of estimating the fair value of the equity instruments granted (or offered to grant), during the period - d
The cash flow effects resulting from share-based payment arrangements.
This disclosure is not required for interim reporting. For interim reporting see Topic
270. See Example 9 (paragraphs
) for an illustration of this guidance.
(P) December 16, 2027; (N) December 16, 2028
270-10-65-1An entity with one or more share-based payment arrangements shall disclose information that enables users of the financial statements to understand all of the following: - a
The nature and terms of such arrangements that existed during the period and the potential effects of those arrangements on shareholders
- b
The effect of compensation cost arising from share-based payment arrangements on the income statement
- c
The method of estimating the fair value of the equity instruments granted (or offered to grant), during the period - d
The cash flow effects resulting from share-based payment arrangements.
This disclosure is not required for interim reporting. See Example 9 (paragraphs
) for an illustration of this guidance.
The following list indicates the minimum information needed to achieve the objectives in paragraph 718-10-50-1 and illustrates how the disclosure requirements might be satisfied. In some circumstances, an entity may need to disclose information beyond the following to achieve the disclosure objectives: - a
A description of the share-based payment arrangement(s), including the general terms of awards under the arrangement(s), such as:
- 1
The employee's requisite service period(s) and, if applicable, the nonemployee's vesting period and any other substantive conditions (including those related to vesting) - 2
The maximum contractual term of equity (or liability) share options or similar instruments - 3
The number of shares authorized for awards of equity share options or other equity instruments.
- b
The method it uses for measuring compensation cost from share-based payment arrangements.
- c
For the most recent year for which an income statement is provided, both of the following:
- 1
The number and weighted-average exercise prices (or conversion ratios) for each of the following groups of share options (or share units): - i
Those outstanding at the beginning of the year
- ii
Those outstanding at the end of the year
- iii
Those exercisable or convertible at the end of the year
- iv
Those that during the year were:
- 01
Granted
- 02
Exercised or converted
- 03
Forfeited
- 04
Expired.
- 2
- i
Those nonvested at the beginning of the year
- ii
Those nonvested at the end of the year
- iii
Those that during the year were:
- 01
Granted
- 02
Vested
- 03
Forfeited.
- d
For each year for which an income statement is provided, both of the following:
- 1
The weighted-average grant-date fair value (or calculated value for a nonpublic entity that uses that method or intrinsic value for awards measured at that value pursuant to paragraphs ) of equity options or other equity instruments granted during the year - 2
The total intrinsic value of options exercised (or share units converted), share-based liabilities paid, and the total fair value of shares vested during the year.
- e
For fully vested share options (or share units) and share options expected to vest (or unvested share options for which the employee's requisite service period or the nonemployee's vesting period has not been rendered but that are expected to vest based on the achievement of a performance condition, if an entity accounts for forfeitures when they occur in accordance with paragraph 718-10-35-1D or 718-10-35-3) at the date of the latest statement of financial position, both of the following: - 1
The number, weighted-average exercise price (or conversion ratio), aggregate intrinsic value (except for nonpublic entities), and weighted-average remaining contractual term of options (or share units) outstanding
- 2
The number, weighted-average exercise price (or conversion ratio), aggregate intrinsic value (except for nonpublic entities), and weighted-average remaining contractual term of options (or share units) currently exercisable (or convertible).
- f
For each year for which an income statement is presented, both of the following (An entity that uses the intrinsic value method pursuant to paragraphs is not required to disclose the following information for awards accounted for under that method): - 1
A description of the method used during the year to estimate the fair value (or calculated value) of awards under share-based payment arrangements
- 2
A description of the significant assumptions used during the year to estimate the fair value (or calculated value) of share-based compensation awards, including (if applicable):
- i
Expected term of share options and similar instruments, including a discussion of the method used to incorporate the contractual term of the instruments and grantees' expected exercise and postvesting termination behavior into the fair value (or calculated value) of the instrument.
- ii
Expected volatility of the entity's shares and the method used to estimate it. An entity that uses a method that employs different volatilities during the contractual term shall disclose the range of expected volatilities used and the weighted-average expected volatility. A nonpublic entity that uses the calculated value method shall disclose the reasons why it is not practicable for it to estimate the expected volatility of its share price, the appropriate industry sector index that it has selected, the reasons for selecting that particular index, and how it has calculated historical volatility using that index. - iii
Expected dividends. An entity that uses a method that employs different dividend rates during the contractual term shall disclose the range of expected dividends used and the weighted-average expected dividends.
- iv
Risk-free rate(s). An entity that uses a method that employs different risk-free rates shall disclose the range of risk-free rates used.
- v
Discount for postvesting restrictions and the method for estimating it.
- vi
Practical expedient for current price input. A nonpublic entity that elects to apply the practical expedient in paragraphs shall disclose that election.
- g
An entity that grants equity or liability instruments under multiple share-based payment arrangements shall provide the information specified in paragraph (a) through (f) separately for different types of awards (including nonemployee versus employee) to the extent that the differences in the characteristics of the awards make separate disclosure important to an understanding of the entity's use of share-based compensation. For example, separate disclosure of weighted-average exercise prices (or conversion ratios) at the end of the year for options (or share units) with a fixed exercise price (or conversion ratio) and those with an indexed exercise price (or conversion ratio) could be important. It also could be important to segregate the number of options (or share units) not yet exercisable into those that will become exercisable (or convertible) based solely on fulfilling a service condition and those for which a performance condition must be met for the options (share units) to become exercisable (convertible). It could be equally important to provide separate disclosures for awards that are classified as equity and those classified as liabilities. In addition, an entity that has multiple share-based payment arrangements shall disclose information separately for different types of awards under those arrangements to the extent that differences in the characteristics of the awards make separate disclosure important to an understanding of the entity's use of share-based compensation. - h
For each year for which an income statement is presented, both of the following:
- 1
Total compensation cost for share-based payment arrangements
- i
Recognized in income as well as the total recognized tax benefit related thereto
- ii
Capitalized as part of the cost of an asset.
- 2
- i
The terms of the modifications
- ii
The number of grantees affected
- iii
The total (or lack of) incremental compensation cost resulting from the modifications.
- i
As of the latest balance sheet date presented, the total compensation cost related to nonvested awards not yet recognized and the weighted-average period over which it is expected to be recognized
- j
- k
If not separately disclosed elsewhere, the amount of cash used to settle equity instruments granted under share-based payment arrangements - l
A description of the entity's policy, if any, for issuing shares upon share option exercise (or share unit conversion), including the source of those shares (that is, new shares or treasury shares). If as a result of its policy, an entity expects to repurchase shares in the following annual period, the entity shall disclose an estimate of the amount (or a range, if more appropriate) of shares to be repurchased during that period. - m
If not separately disclosed elsewhere, the policy for estimating expected forfeitures or recognizing forfeitures as they occur.
Another item of minimum information needed to achieve the objectives in paragraph 718-10-50-1 is the following:- a
If not separately disclosed elsewhere, the amount of cash received from exercise of share options and similar instruments granted under share-based payment arrangements and the tax benefit from stock options exercised during the annual period
In addition to the information required by this Topic, an entity may disclose supplemental information that it believes would be useful to investors and creditors, such as a range of values calculated on the basis of different assumptions, provided that the supplemental information is reasonable and does not lessen the prominence and credibility of the information required by this Topic. The alternative assumptions shall be described to enable users of the financial statements to understand the basis for the supplemental information.
This Subtopic and Subtopics
718-20 and
718-30 are interrelated and the required guidance may be located in either this Subtopic or one of the other Subtopics. In general, material that relates to both equity and liability instruments is included in this Subtopic, while material more specifically related to either equity or liability instruments is included in their respective Subtopics.
Implementation guidance is provided on the following matters:
- a
- b
Fair-value-based instruments in a share-based transaction
- c
Valuation techniques
- d
Selecting assumptions for use in an option pricing model
- 1
Consistent use of valuation techniques and methods for selecting assumptions
- 2
Selecting or estimating the risk-free rate for the expected term
- 3
Selecting or estimating the expected term
- 4
- 5
Selecting or estimating expected dividends
- 6
Dividend protected awards
- 7
Selecting or considering credit risk
- 8
Contingency features that affect the option pricing model
- 9
Consider dilution.
- dd
Nonpublic entity—practical expedient for expected term
- e
- f
- 1
Market, performance, and service conditions that affect vesting and exercisability
- 2
Market, performance, and service conditions that affect factors other than vesting and exercisability
- 3
- 4
Explicit, implicit, and derived employee's requisite service periods.
- g
- h
- i
- j
Classification of certain awards with repurchase features
- k
Employee of a physician practice.
In this Section fair value also applies to nonpublic entities that use the calculated value method pursuant to paragraph 718-10-30-20. The measurement objective for equity instruments granted in share-based payment transactions is to estimate the grant-date fair value of the equity instruments that the entity is obligated to issue when grantees have delivered the good or have rendered the service and satisfied any other conditions necessary to earn the right to benefit from the instruments. That estimate is based on the share price and other pertinent factors (including those enumerated in paragraphs , if applicable) at the grant date and is not remeasured in subsequent periods under the fair-value-based method. A restriction that continues in effect after the entity has issued instruments to grantees, such as the inability to transfer vested equity share options to third parties or the inability to sell vested shares for a period of time, is considered in estimating the fair value of the instruments at the grant date. For instance, if shares are traded in an active market, postvesting restrictions may have little, if any, effect on the amount at which the shares being valued would be exchanged. For share options and similar instruments, the effect of nontransferability (and nonhedgeability, which has a similar effect) is taken into account by reflecting the effects of grantees' expected exercise and postvesting termination behavior in estimating fair value (referred to as an option's expected term). In contrast, a restriction that stems from the forfeitability of instruments to which grantees have not yet earned the right, such as the inability either to exercise a nonvested equity share option or to sell nonvested shares, is not reflected in the fair value of the instruments at the grant date. Instead, those restrictions are taken into account by recognizing compensation cost only for awards for which grantees deliver the goods or render the service. Note that performance and service conditions are vesting conditions for purposes of this Topic. Market conditions are not vesting conditions for purposes of this Topic but market conditions may affect exercisability of an award. Market conditions are included in the estimate of the grant-date fair value of awards (see paragraphs ). Reload features and contingent features that require a grantee to transfer equity shares earned, or realized gains from the sale of equity instruments earned, to the issuing entity for consideration that is less than fair value on the date of transfer (including no consideration), such as a clawback feature, shall not be reflected in the grant-date fair value of an equity award. Those features are accounted for if and when a reload grant or contingent event occurs. A clawback feature can take various forms but often functions as a noncompete mechanism. For example, an employee that terminates the employment relationship and begins to work for a competitor is required to transfer to the issuing entity (former employer) equity shares granted and earned in a share-based payment transaction. 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. The definition of fair value refers explicitly only to assets and liabilities, but the concept of value in a current exchange embodied in it applies equally to the equity instruments subject to this Topic. Observable market prices of identical or similar equity or liability instruments in active markets are the best evidence of fair value and, if available, shall be used as the basis for the measurement of equity and liability instruments awarded in a share-based payment transaction. Determining whether an equity or liability instrument is similar is a matter of judgment, based on an analysis of the terms of the instrument and other relevant facts and circumstances. For example, awards to grantees of a public entity of shares of its common stock, subject only to a service or performance condition for vesting (nonvested shares), shall be measured based on the market price of otherwise identical (that is, identical except for the vesting condition) common stock at the grant date. If observable market prices of identical or similar equity or liability instruments of the entity are not available, the fair value of equity and liability instruments awarded to grantees shall be estimated by using a valuation technique that meets all of the following criteria: - a
It is applied in a manner consistent with the fair value measurement objective and the other requirements of this Topic.
- b
It is based on established principles of financial economic theory and generally applied in that field (see paragraph 718-10-55-16). Established principles of financial economic theory represent fundamental propositions that form the basis of modern corporate finance (for example, the time value of money and risk-neutral valuation). - c
It reflects all substantive characteristics of the instrument (except for those explicitly excluded by this Topic, such as vesting conditions and reload features).
That is, the fair values of equity and liability instruments granted in a share-based payment transaction shall be estimated by applying a valuation technique that would be used in determining an amount at which instruments with the same characteristics (except for those explicitly excluded by this Topic) would be exchanged. An estimate of the amount at which instruments similar to share options and other instruments granted in share-based payment transactions would be exchanged would factor in expectations of the probability that the good would be delivered or the service would be rendered and the instruments would vest (that is, that the performance or service conditions would be satisfied). However, as noted in paragraph 718-10-55-4, the measurement objective in this Topic is to estimate the fair value at the grant date of the equity instruments that the entity is obligated to issue when grantees have delivered the good or rendered the service and satisfied any other conditions necessary to earn the right to benefit from the instruments. Therefore, the estimated fair value of the instruments at grant date does not take into account the effect on fair value of vesting conditions and other restrictions that apply only during the employee's requisite service period or the nonemployee's vesting period. Under the fair-value-based method required by this Topic, the effect of vesting conditions and other restrictions that apply only during the employee's requisite service period or the nonemployee's vesting period is reflected by recognizing compensation cost only for instruments for which the good is delivered or the service is rendered. In applying a valuation technique, the assumptions used shall be consistent with the fair value measurement objective. That is, assumptions shall reflect information that is (or would be) available to form the basis for an amount at which the instruments being valued would be exchanged. In estimating fair value, the assumptions used shall not represent the biases of a particular party. Some of those assumptions will be based on or determined from external data. Other assumptions, such as the employees' expected exercise behavior, may be derived from the entity's own historical experience with share-based payment arrangements. The fair value of any equity or liability instrument depends on its substantive characteristics. Paragraphs list the minimum set of substantive characteristics of instruments with option (or option-like) features that shall be considered in estimating those instruments' fair value. However, a share-based payment award could contain other characteristics, such as a market condition, that should be included in a fair value estimate. Judgment is required to identify an award's substantive characteristics and, as described in paragraphs , to select a valuation technique that incorporates those characteristics. Valuation techniques used for share options and similar instruments granted in share-based payment transactions estimate the fair value of those instruments at a single point in time (for example, at the grant date). The assumptions used in a fair value measurement are based on expectations at the time the measurement is made, and those expectations reflect the information that is available at the time of measurement. The fair value of those instruments will change over time as factors used in estimating their fair value subsequently change, for instance, as share prices fluctuate, risk-free interest rates change, or dividend streams are modified. Changes in the fair value of those instruments are a normal economic process to which any valuable resource is subject and do not indicate that the expectations on which previous fair value measurements were based were incorrect. The fair value of those instruments at a single point in time is not a forecast of what the estimated fair value of those instruments may be in the future.
A lattice model (for example, a binomial model) and a closed-form model (for example, the Black-Scholes-Merton formula) are among the valuation techniques that meet the criteria required by this Topic for estimating the fair values of share options and similar instruments granted in share-based payment transactions. A Monte Carlo simulation technique is another type of valuation technique that satisfies the requirements in paragraph 718-10-55-11. Other valuation techniques not mentioned in this Topic also may satisfy the requirements in that paragraph. Those valuation techniques or models, sometimes referred to as option-pricing models, are based on established principles of financial economic theory. Those techniques are used by valuation professionals, dealers of derivative instruments, and others to estimate the fair values of options and similar instruments related to equity securities, currencies, interest rates, and commodities. Those techniques are used to establish trade prices for derivative instruments and to establish values in adjudications. As discussed in paragraphs , both lattice models and closed-form models can be adjusted to account for the substantive characteristics of share options and similar instruments granted granted in share-based payment transactions. This Topic does not specify a preference for a particular valuation technique or model in estimating the fair values of share options and similar instruments granted in share-based payment transactions. Rather, this Topic requires the use of a valuation technique or model that meets the measurement objective in paragraph 718-10-30-6 and the requirements in paragraph 718-10-55-11. The selection of an appropriate valuation technique or model will depend on the substantive characteristics of the instrument being valued. Because an entity may grant different types of instruments, each with its own unique set of substantive characteristics, an entity may use a different valuation technique for each different type of instrument. The appropriate valuation technique or model selected to estimate the fair value of an instrument with a market condition must take into account the effect of that market condition. The designs of some techniques and models better reflect the substantive characteristics of a particular share option or similar instrument granted in share-based payment transactions. Paragraphs discuss certain factors that an entity should consider in selecting a valuation technique or model for its share options or similar instruments. The Black-Scholes-Merton formula assumes that option exercises occur at the end of an option's contractual term, and that expected volatility, expected dividends, and risk-free interest rates are constant over the option's term. If used to estimate the fair value of instruments in the scope of this Topic, the Black-Scholes-Merton formula must be adjusted to take account of certain characteristics of share options and similar instruments that are not consistent with the model's assumptions (for example, exercising before the end of the option's contractual term when estimating expected term). Because of the nature of the formula, those adjustments take the form of weighted-average assumptions about those characteristics. In contrast, a lattice model can be designed to accommodate dynamic assumptions of expected volatility and dividends over the option's contractual term, and estimates of expected option exercise patterns during the option's contractual term, including the effect of blackout periods. Therefore, the design of a lattice model more fully reflects the substantive characteristics of particular share options or similar instruments. Nevertheless, both a lattice model and the Black-Scholes-Merton formula, as well as other valuation techniques that meet the requirements in paragraph 718-10-55-11, can provide a fair value estimate that is consistent with the measurement objective and fair-value-based method of this Topic. Regardless of the valuation technique or model selected, an entity shall develop reasonable and supportable estimates for each assumption used in the model, including the share option or similar instrument's expected term, taking into account both the contractual term of the option and the effects of grantees' expected exercise and postvesting termination behavior. The term supportable is used in its general sense: capable of being maintained, confirmed, or made good; defensible. An application is supportable if it is based on reasonable arguments that consider the substantive characteristics of the instruments being valued and other relevant facts and circumstances.
An entity shall change the valuation technique it uses to estimate fair value if it concludes that a different technique is likely to result in a better estimate of fair value (see paragraph 718-10-55-27). For example, an entity that uses a closed-form model might conclude, when information becomes available, that a lattice model or another valuation technique would provide a fair value estimate that better achieves the fair value measurement objective and, therefore, change the valuation technique it uses. If an observable market price is not available for a share option or similar instrument with the same or similar terms and conditions, an entity shall estimate the fair value of that instrument using a valuation technique or model that meets the requirements in paragraph 718-10-55-11 and takes into account, at a minimum, all of the following: - a
The exercise price of the option.
- b
The expected term of the option. This should take into account both the contractual term of the option and the effects of grantees' expected exercise and postvesting termination behavior. In a closed-form model, the expected term is an assumption used in (or input to) the model, while in a lattice model, the expected term is an output of the model (see paragraphs , which provide further explanation of the expected term in the context of a lattice model). - c
The current price of the underlying share.
- d
The expected volatility of the price of the underlying share for the expected term of the option.
- e
The expected dividends on the underlying share for the expected term of the option (except as provided in paragraphs ). - f
The risk-free interest rate(s) for the expected term of the option.
The term expected in (b); (d); (e); and (f) in paragraph 718-10-55-21 relates to expectations at the measurement date about the future evolution of the factor that is used as an assumption in a valuation model. The term is not necessarily used in the same sense as in the term expected future cash flows that appears elsewhere in the Codification. The phrase expected term of the option in (d); (e); and (f) in paragraph 718-10-55-21 applies to both closed-form models and lattice models (as well as all other valuation techniques). However, if an entity uses a lattice model (or other similar valuation technique, for instance, a Monte Carlo simulation technique) that has been modified to take into account an option's contractual term and grantees' expected exercise and postvesting termination behavior, then (d); (e); and (f) in paragraph 718-10-55-21 apply to the contractual term of the option. There is likely to be a range of reasonable estimates for expected volatility, dividends, and term of the option. If no amount within the range is more or less likely than any other amount, an average of the amounts in the range (the expected value) shall be used. In a lattice model, the assumptions used are to be determined for a particular node (or multiple nodes during a particular time period) of the lattice and not over multiple periods, unless such application is supportable.
Historical experience is generally the starting point for developing expectations about the future. Expectations based on historical experience shall be modified to reflect ways in which currently available information indicates that the future is reasonably expected to differ from the past. The appropriate weight to place on historical experience is a matter of judgment, based on relevant facts and circumstances. For example, an entity with two distinctly different lines of business of approximately equal size may dispose of the one that was significantly less volatile and generated more cash than the other. In that situation, the entity might place relatively little weight on volatility, dividends, and perhaps grantees' exercise and postvesting termination behavior from the predisposition (or disposition) period in developing reasonable expectations about the future. In contrast, an entity that has not undergone such a restructuring might place heavier weight on historical experience. That entity might conclude, based on its analysis of information available at the time of measurement, that its historical experience provides a reasonable estimate of expected volatility, dividends, and grantees' exercise and postvesting termination behavior. This guidance is not intended to suggest either that historical volatility is the only indicator of expected volatility or that an entity must identify a specific event in order to place less weight on historical experience. Expected volatility is an expectation of volatility over the expected term of an option or similar instrument; that expectation shall consider all relevant factors in paragraph 718-10-55-37, including possible mean reversion. Paragraphs provide further guidance on estimating expected volatility. In certain circumstances, historical information may not be available. For example, an entity whose common stock has only recently become publicly traded may have little, if any, historical information on the volatility of its own shares. That entity might base expectations about future volatility on the average volatilities of similar entities for an appropriate period following their going public. A nonpublic entity will need to exercise judgment in selecting a method to estimate expected volatility and might do so by basing its expected volatility on the average volatilities of otherwise similar public entities. For purposes of identifying otherwise similar entities, an entity would likely consider characteristics such as industry, stage of life cycle, size, and financial leverage. Because of the effects of diversification that are present in an industry sector index, the volatility of an index should not be substituted for the average of volatilities of otherwise similar entities in a fair value measurement. This guidance is organized as follows:
- a
Selecting consistent assumptions
- b
Selecting or estimating the risk-free rate for the expected term
- c
Selecting or estimating the expected term
- d
Selecting or estimating the expected volatility
- e
Selecting or estimating expected dividends
- f
Dividend protected awards
- g
Selecting or considering credit risk
- h
Contingency features that affect the option pricing model
- i
Consider dilution.
Assumptions used to estimate the fair value of equity and liability instruments granted in share-based payment transactions shall be determined in a consistent manner from period to period. For example, an entity might use the closing share price or the share price at another specified time as the current share price on the grant date in estimating fair value, but whichever method is selected, it shall be used consistently. The valuation technique an entity selects to estimate fair value for a particular type of instrument also shall be used consistently and shall not be changed unless a different valuation technique is expected to produce a better estimate of fair value. A change in either the valuation technique or the method of determining appropriate assumptions used in a valuation technique is a change in accounting estimate for purposes of applying Topic 250, and shall be applied prospectively to new awards. Option-pricing models call for the risk-free interest rate as an assumption to take into account, among other things, the time value of money. A U.S. entity issuing an option on its own shares must use as the risk-free interest rates the implied yields currently available from the U.S. Treasury zero-coupon yield curve over the contractual term of the option if the entity is using a lattice model incorporating the option's contractual term. If the entity is using a closed-form model, the risk-free interest rate is the implied yield currently available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term used as the assumption in the model. For entities based in jurisdictions outside the United States, the risk-free interest rate is the implied yield currently available on zero-coupon government issues denominated in the currency of the market in which the share (or underlying share), which is the basis for the instrument awarded, primarily trades. It may be necessary to use an appropriate substitute if no such government issues exist or if circumstances indicate that the implied yield on zero-coupon government issues is not representative of a risk-free interest rate.
The fair value of a traded (or transferable) share option is based on its contractual term because rarely is it economically advantageous to exercise, rather than sell, a transferable share option before the end of its contractual term. Employee share options generally differ from transferable share options in that employees cannot sell (or hedge) their share options—they can only exercise them; because of this, employees generally exercise their options before the end of the options' contractual term. Thus, the inability to sell or hedge an employee share option effectively reduces the option's value because exercise prior to the option's expiration terminates its remaining life and thus its remaining time value. In addition, some employee share options contain prohibitions on exercise during blackout periods. To reflect the effect of those restrictions (which may lead to exercise before the end of the option's contractual term) on employee options relative to transferable options, this Topic requires that the fair value of an employee share option or similar instrument be based on its expected term, rather than its contractual term (see paragraphs 718-10-55-5 and 718-10-55-21). Paragraph 718-10-30-10A states that, on an award-by-award basis, an entity may elect to use the contractual term as the expected term when estimating the fair value of a nonemployee award to satisfy the measurement objective in paragraph 718-10-30-6. Otherwise, an entity shall apply the guidance in this Topic in estimating the expected term of a nonemployee award, which may result in a term less than the contractual term of the award. If an entity does not elect to use the contractual term as the expected term, similar considerations discussed in paragraph 718-10-55-29, such as the inability to sell or hedge a nonemployee award, apply when estimating its expected term. The expected term of an employee share option or similar instrument is the period of time for which the instrument is expected to be outstanding (that is, the period of time from the service inception date to the date of expected exercise or other expected settlement). The expected term is an assumption in a closed-form model. However, if an entity uses a lattice model that has been modified to take into account an option's contractual term and employees' expected exercise and post-vesting employment termination behavior, the expected term is estimated based on the resulting output of the lattice. For example, an entity's experience might indicate that option holders tend to exercise their options when the share price reaches 200 percent of the exercise price. If so, that entity might use a lattice model that assumes exercise of the option at each node along each share price path in a lattice at which the early exercise expectation is met, provided that the option is vested and exercisable at that point. Moreover, such a model would assume exercise at the end of the contractual term on price paths along which the exercise expectation is not met but the options are in-the-money at the end of the contractual term. The terms at-the-money, in-the-money, and out-of-the-money are used to describe share options whose exercise price is equal to, less than, or greater than the market price of the underlying share, respectively. The valuation approach described recognizes that employees' exercise behavior is correlated with the price of the underlying share. Employees' expected post-vesting employment termination behavior also would be factored in. Expected term, which is a required disclosure (see paragraphs 718-10-50-2 through 50-2A), then could be estimated based on the output of the resulting lattice. An example of an acceptable method for purposes of financial statement disclosures of estimating the expected term based on the results of a lattice model is to use the lattice model's estimated fair value of a share option as an input to a closed-form model, and then to solve the closed-form model for the expected term. Other methods also are available to estimate expected term. Other factors that may affect expectations about employees' exercise and post-vesting employment termination behavior include the following: - a
The vesting period of the award. An option's expected term must at least include the vesting period. Under some share option arrangements, an option holder may exercise an option prior to vesting (usually to obtain a specific tax treatment); however, such arrangements generally require that any shares received upon exercise be returned to the entity (with or without a return of the exercise price to the holder) if the vesting conditions are not satisfied. Such an exercise is not substantive for accounting purposes.
- b
Employees' historical exercise and post-vesting employment termination behavior for similar grants.
- c
Expected volatility of the price of the underlying share. An entity also might consider whether the evolution of the share price affects an employee's exercise behavior (for example, an employee may be more likely to exercise a share option shortly after it becomes in-the-money if the option had been out-of-the-money for a long period of time).
- d
Blackout periods and other coexisting arrangements such as agreements that allow for exercise to automatically occur during blackout periods if certain conditions are satisfied.
- e
Employees' ages, lengths of service, and home jurisdictions (that is, domestic or foreign).
If sufficient information about employees' expected exercise and post-vesting employment termination behavior is available, a method like the one described in paragraph 718-10-55-30 might be used because that method reflects more information about the instrument being valued (see paragraph 718-10-55-18). However, expected term might be estimated in some other manner, taking into account whatever relevant and supportable information is available, including industry averages and other pertinent evidence such as published academic research. Option value increases at a decreasing rate as the term lengthens (for most, if not all, options). For example, a two-year option is worth less than twice as much as a one-year option, other things equal. Accordingly, estimating the fair value of an option based on a single expected term that effectively averages the differing exercise and postvesting employment termination behaviors of identifiable groups of employees will potentially misstate the value of the entire award.
Aggregating individual awards into relatively homogeneous groups with respect to exercise and postvesting employment termination behaviors and estimating the fair value of the options granted to each group separately reduces such potential misstatement. An entity shall aggregate individual awards into relatively homogeneous groups with respect to exercise and postvesting employment termination behaviors regardless of the valuation technique or model used to estimate the fair value. For example, the historical experience of an employer that grants options broadly to all levels of employees might indicate that hourly employees tend to exercise for a smaller percentage gain than do salaried employees.
A nonpublic entity may make an accounting policy election to apply a practical expedient to estimate the expected term for certain awards that do not include a market condition (see paragraphs ). Paragraph 718-10-55-50A provides implementation guidance on the practical expedient. As with other aspects of estimating fair value, the objective is to determine the assumption about expected volatility that marketplace participants would be likely to use in determining an exchange price for an option. Volatility is a measure of the amount by which a financial variable, such as share price, has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. Option-pricing models require expected volatility as an assumption because an option's value is dependent on potential share returns over the option's term. The higher the volatility, the more the returns on the shares can be expected to vary—up or down. Because an option's value is unaffected by expected negative returns on the shares, other things equal, an option on a share with higher volatility is worth more than an option on a share with lower volatility. This Topic does not specify a method of estimating expected volatility; rather, the following paragraph provides a list of factors that shall be considered in estimating expected volatility. An entity's estimate of expected volatility shall be reasonable and supportable.
Factors to consider in estimating expected volatility include the following: - a
Volatility of the share price, including changes in that volatility and possible mean reversion of that volatility. Mean reversion refers to the tendency of a financial variable, such as volatility, to revert to some long-run average level. Statistical models have been developed that take into account the mean-reverting tendency of volatility. In computing historical volatility, for example, an entity might disregard an identifiable period of time in which its share price was extraordinarily volatile because of a failed takeover bid if a similar event is not expected to recur during the expected or contractual term. If an entity's share price was extremely volatile for an identifiable period of time, due to a general market decline, that entity might place less weight on its volatility during that period of time because of possible mean reversion. Volatility over the most recent period is generally commensurate with either of the following:
- 1
The contractual term of the option if a lattice model is being used to estimate fair value
- 2
The expected term of the option if a closed-form model is being used. An entity might evaluate changes in volatility and mean reversion over that period by dividing the contractual or expected term into regular intervals and evaluating evolution of volatility through those intervals.
- b
The implied volatility of the share price determined from the market prices of traded options or other traded financial instruments such as outstanding convertible debt, if any.
- c
For a public entity, the length of time its shares have been publicly traded. If that period is shorter than the expected or contractual term of the option, the term structure of volatility for the longest period for which trading activity is available shall be more relevant. A newly public entity also might consider the expected volatility of similar entities. In evaluating similarity, an entity would likely consider factors such as industry, stage of life cycle, size, and financial leverage. A nonpublic entity might base its expected volatility on the expected volatilities of entities that are similar except for having publicly traded securities.
- d
Appropriate and regular intervals for price observations. If an entity considers historical volatility in estimating expected volatility, it shall use intervals that are appropriate based on the facts and circumstances and that provide the basis for a reasonable fair value estimate. For example, a publicly traded entity would likely use daily price observations, while a nonpublic entity with shares that occasionally change hands at negotiated prices might use monthly price observations.
- e
Corporate and capital structure. An entity's corporate structure may affect expected volatility (see paragraph 718-10-55-24). An entity's capital structure also may affect expected volatility; for example, highly leveraged entities tend to have higher volatilities.
Although use of unadjusted historical volatility may be appropriate for some entities (or even for most entities in some time periods), a marketplace participant would not use historical volatility without considering the extent to which the future is likely to differ from the past.
A closed-form model, such as the Black-Scholes-Merton formula, cannot incorporate a range of expected volatilities over the option's expected term (see paragraph 718-10-55-18). Lattice models can incorporate a term structure of expected volatility; that is, a range of expected volatilities can be incorporated into the lattice over an option's contractual term. Determining how to incorporate a range of expected volatilities into a lattice model to provide a reasonable fair value estimate is a matter of judgment and shall be based on a careful consideration of the factors listed in paragraph 718-10-55-37 as well as other relevant factors that are consistent with the fair value measurement objective of this Topic. An entity shall establish a process for estimating expected volatility and apply that process consistently from period to period (see paragraph 718-10-55-27). That process: - a
Shall comprehend an identification of information available to the entity and applicable factors such as those described in paragraph 718-10-55-37 - b
Shall include a procedure for evaluating and weighting that information.
The process developed by an entity shall be determined by the information available to it and its assessment of how that information would be used to estimate fair value. For example, consistent with paragraph 718-10-55-24, an entity's starting point in estimating expected volatility might be its historical volatility. That entity also shall consider the extent to which currently available information indicates that future volatility will differ from the historical volatility. An example of such information is implied volatility (from traded options or other instruments). Option-pricing models generally call for expected dividend yield as an assumption. However, the models may be modified to use an expected dividend amount rather than a yield. An entity may use either its expected yield or its expected payments. Additionally, an entity's historical pattern of dividend increases (or decreases) shall be considered. For example, if an entity has historically increased dividends by approximately 3 percent per year, its estimated share option value shall not be based on a fixed dividend amount throughout the share option's expected term. As with other assumptions in an option-pricing model, an entity shall use the expected dividends that would likely be reflected in an amount at which the option would be exchanged (see paragraph 718-10-55-13). As with other aspects of estimating fair value, the objective is to determine the assumption about expected dividends that would likely be used by marketplace participants in determining an exchange price for the option.
Expected dividends are taken into account in using an option-pricing model to estimate the fair value of a share option because dividends paid on the underlying shares reduce the fair value of those shares and option holders generally are not entitled to receive those dividends. However, an award of share options may be structured to protect option holders from that effect by providing them with some form of dividend rights. Such dividend protection may take a variety of forms and shall be appropriately reflected in estimating the fair value of a share option. For example, if a dividend paid on the underlying shares is applied to reduce the exercise price of the option, the effect of the dividend protection is appropriately reflected by using an expected dividend assumption of zero.
In certain situations, grantees may receive the dividends paid on the underlying equity shares while the option is outstanding. Dividends or dividend equivalents paid to grantees on the portion of an award of equity shares or other equity instruments that vests shall be charged to retained earnings. If grantees are not required to return the dividends or dividend equivalents received if they forfeit their awards, dividends or dividend equivalents paid on instruments that do not vest shall be recognized as additional compensation cost. If an entity's accounting policy is to estimate the number of awards expected to be forfeited in accordance with paragraph 718-10-35-1D or 718-10-35-3, the estimate of compensation cost for dividends or dividend equivalents paid on instruments that are not expected to vest shall be consistent with an entity's estimates of forfeitures. Dividends and dividend equivalents shall be reclassified between retained earnings and compensation cost in a subsequent period if the entity changes its forfeiture estimates (or actual forfeitures differ from previous estimates). If an entity's accounting policy is to account for forfeitures when they occur in accordance with paragraph 718-10-35-1D or 718-10-35-3, the entity shall reclassify to compensation cost in the period in which the forfeitures occur the amount of dividends and dividend equivalents previously charged to retained earnings relating to awards that are forfeited. An entity may need to consider the effect of its credit risk on the estimated fair value of liability awards that contain cash settlement features because potential cash payoffs from the awards are not independent of the entity's risk of default. Any credit-risk adjustment to the estimated fair value of awards with cash payoffs that increase with increases in the price of the underlying share is expected to be de minimis because increases in an entity's share price generally are positively associated with its ability to liquidate its liabilities. However, a credit-risk adjustment to the estimated fair value of awards with cash payoffs that increase with decreases in the price of the entity's shares may be necessary because decreases in an entity's share price generally are negatively associated with an entity's ability to liquidate its liabilities.
Contingent features that might cause a grantee to return to the entity either equity shares earned or realized gains from the sale of equity instruments earned as a result of share-based payment arrangements, such as a clawback feature (see paragraph 718-10-55-8), shall not be reflected in estimating the grant-date fair value of an equity instrument. Instead, the effect of such a contingent feature shall be accounted for if and when the contingent event occurs. For instance, a share-based payment arrangement may stipulate the return of vested equity shares to the issuing entity for no consideration if the grantee terminates the employment or vendor relationship to work for a competitor. The effect of that provision on the grant-date fair value of the equity shares shall not be considered. If the issuing entity subsequently receives those shares (or their equivalent value in cash or other assets) as a result of that provision, a credit shall be recognized in the income statement upon the receipt of the shares. That credit is limited to the lesser of the recognized compensation cost associated with the share-based payment arrangement that contains the contingent feature and the fair value of the consideration received. The event is recognized in the income statement because the resulting transaction takes place with a grantee as a result of the current (or prior) employment or vendor relationship rather than as a result of the grantee's role as an equity owner. Example 10 (see paragraph 718-20-55-84) provides an illustration of the accounting for an employee award that contains a clawback feature, which also applies to nonemployee awards. Traded options ordinarily are written by parties other than the entity that issues the underlying shares, and when exercised result in an exchange of already outstanding shares between those parties. In contrast, exercise of share options as part of a share-based payment transaction results in the issuance of new shares by the entity that wrote the option (the grantor), which increases the number of shares outstanding. That dilution might reduce the fair value of the underlying shares, which in turn might reduce the benefit realized from option exercise.
If the market for an entity's shares is reasonably efficient, the effect of potential dilution from the exercise of share options that are part of a share-based payment transaction will be reflected in the market price of the underlying shares, and no adjustment for potential dilution usually is needed in estimating the fair value of the grantee share options. For a public entity, an exception might be a large grant of options that the market is not expecting, and also does not believe will result in commensurate benefit to the entity. For a nonpublic entity, on the other hand, potential dilution may not be fully reflected in the share price if sufficient information about the frequency and size of the entity's grants of equity share options is not available for third parties who may exchange the entity's shares to anticipate the dilutive effect.
An entity shall consider whether the potential dilutive effect of an award of share options needs to be reflected in estimating the fair value of its options at the grant date. For public entities, the expectation is that situations in which such a separate adjustment is needed will be rare.
In accordance with paragraph 718-10-30-20A, a nonpublic entity may elect a practical expedient to estimate the expected term. For liability-classified awards, an entity would update the estimate of the expected term each reporting period until settlement. The updated estimate should reflect the loss of time value associated with the award and any change in the assessment of whether a performance condition is probable of being achieved. Nonpublic entities may have sufficient information available on which to base a reasonable and supportable estimate of the expected volatility of their share prices. For example, a nonpublic entity that has an internal market for its shares, has private transactions in its shares, or issues new equity or convertible debt instruments may be able to consider the historical volatility, or implied volatility, of its share price in estimating expected volatility. Alternatively, a nonpublic entity that can identify similar public entities for which share or option price information is available may be able to consider the historical, expected, or implied volatility of those entities' share prices in estimating expected volatility. Similarly this information may be used to estimate the fair value of its shares or to benchmark various aspects of its performance (see paragraph 718-10-55-25). This Topic requires all entities to use the fair-value-based method to account for share-based payment arrangements that are classified as equity instruments. However, if it is not practicable for a nonpublic entity to estimate the expected volatility of its share price, paragraphs require it to use the calculated value method. Alternatively, it may not be possible for a nonpublic entity to reasonably estimate the fair value of its equity share options and similar instruments at the date they are granted because the complexity of the award's terms prevents it from doing so. In that case, paragraphs require that the nonpublic entity account for its equity instruments at their intrinsic value, remeasured at each reporting date through the date of exercise or other settlement. Many nonpublic entities that plan an initial public offering likely will be able to reasonably estimate the fair value of their equity share options and similar instruments using the guidance on selecting an appropriate expected volatility assumption provided in paragraphs . Estimating the expected volatility of a nonpublic entity's shares may be difficult and that the resulting estimated fair value may be more subjective than the estimated fair value of a public entity's options. However, many nonpublic entities could consider internal and industry factors likely to affect volatility, and the average volatility of comparable entities, to develop an estimate of expected volatility. Using an expected volatility estimate determined in that manner often would result in a reasonable estimate of fair value.
For purposes of this Topic, it is not practicable for a nonpublic entity to estimate the expected volatility of its share price if it is unable to obtain sufficient historical information about past volatility, or other information such as that noted in paragraph 718-10-55-51, on which to base a reasonable and supportable estimate of expected volatility at the grant date of the award without undue cost and effort. In that situation, this Topic requires a nonpublic entity to estimate a value for its equity share options and similar instruments by substituting the historical volatility of an appropriate industry sector index for the expected volatility of its share price as an assumption in its valuation model. All other inputs to a nonpublic entity's valuation model shall be determined in accordance with the guidance in paragraphs . There are many different indexes available to consider in selecting an appropriate industry sector index. For example, Dow Jones Indexes maintain a global series of stock market indexes with industry sector splits available for many countries, including the United States. The historical values of those indexes are easily obtainable from its website. An appropriate industry sector index is one that is representative of the industry sector in which the nonpublic entity operates and that also reflects, if possible, the size of the entity. If a nonpublic entity operates in a variety of different industry sectors, then it might select a number of different industry sector indexes and weight them according to the nature of its operations; alternatively, it might select an index for the industry sector that is most representative of its operations. If a nonpublic entity operates in an industry sector in which no public entities operate, then it shall select an index for the industry sector that is most closely related to the nature of its operations. However, in no circumstances shall a nonpublic entity use a broad-based market index like the S&P 500, Russell 3000, or Dow Jones Wilshire 5000 because those indexes are sufficiently diversified as to be not representative of the industry sector, or sectors, in which the nonpublic entity operates.
A nonpublic entity shall use the selected index consistently, unless the nature of the entity's operations changes such that another industry sector index is more appropriate, in applying the calculated value method in both the following circumstances: - a
For all of its equity share options or similar instruments
- b
In each accounting period.
The calculation of the historical volatility of an appropriate industry sector index shall be made using the daily historical closing values of the index selected for the period of time prior to the grant date (or service inception date) of the equity share option or similar instrument that is equal in length to the expected term of the equity share option or similar instrument. If daily values are not readily available, then an entity shall use the most frequent observations available of the historical closing values of the selected index. If historical closing values of the index selected are not available for the entire expected term, then a nonpublic entity shall use the closing values for the longest period of time available. The method used shall be consistently applied (see paragraph 718-10-55-27). Example 9 (see paragraph 718-20-55-77) provides an illustration of accounting for an equity share option award granted by a nonpublic entity that uses the calculated value method. This guidance is organized as follows:
- a
Market, performance, and service conditions that affect vesting and exercisability
- b
Market, performance, and service conditions that affect factors other than vesting and exercisability
- c
Estimating the employee's requisite service period
- d
Explicit, implicit, and derived employee's requisite service periods.
A grantee's share-based payment award becomes vested at the date that the grantee's right to receive or retain equity shares, other equity instruments, or assets under the award is no longer contingent on satisfaction of either a performance condition or a service condition. This Topic distinguishes among market conditions, performance conditions, and service conditions that affect the vesting or exercisability of an award (see paragraphs 718-10-30-12 and 718-10-30-14). Exercisability is used for market conditions in the same context as vesting is used for performance and service conditions. Other conditions affecting vesting, exercisability, exercise price, and other pertinent factors in measuring fair value that do not meet the definitions of a market condition, performance condition, or service condition are discussed in paragraph 718-10-55-65. Analysis of the market, performance, or service conditions (or any combination thereof) that are explicit or implicit in the terms of an award is required to determine the employee's requisite service period or the nonemployee's vesting period over which compensation cost is recognized and whether recognized compensation cost may be reversed if an award fails to vest or become exercisable (see paragraph 718-10-30-27). If exercisability or the ability to retain the award (for example, an award of equity shares may contain a market condition that affects the grantee's ability to retain those shares) is based solely on one or more market conditions compensation cost for that award is recognized if the grantee delivers the promised good or renders the service, even if the market condition is not satisfied. If exercisability (or the ability to retain the award) is based solely on one or more market conditions, compensation cost for that award is reversed if the grantee does not deliver the promised good or render the service, unless the market condition is satisfied prior to the end of the employee's requisite service period or the nonemployee's vesting period, in which case any unrecognized compensation cost would be recognized at the time the market condition is satisfied. If vesting is based solely on one or more performance or service conditions, any previously recognized compensation cost is reversed if the award does not vest (that is, the good is not delivered or the service is not rendered or the performance condition is not achieved). Examples 1 through 4 (see paragraphs ) provide illustrations of awards in which vesting is based solely on performance or service conditions. An employee award containing one or more market conditions may have an explicit, implicit, or derived service period. Paragraphs provide guidance on explicit, implicit, and derived service periods. Vesting or exercisability may be conditional on satisfying two or more types of conditions (for example, vesting and exercisability occur upon satisfying both a market and a performance or service condition). Vesting also may be conditional on satisfying one of two or more types of conditions (for example, vesting and exercisability occur upon satisfying either a market condition or a performance or service condition). Regardless of the nature and number of conditions that must be satisfied, the existence of a market condition requires recognition of compensation cost if the good is delivered or the service is rendered, even if the market condition is never satisfied.
Even if only one of two or more conditions must be satisfied and a market condition is present in the terms of the award, then compensation cost is recognized if the good is delivered or the service is rendered, regardless of whether the market, performance, or service condition is satisfied (see Example 5 [paragraph 718-10-55-100] for an example of such an employee award). Market, performance, and service conditions may affect an award's exercise price, contractual term, quantity, conversion ratio, or other pertinent factors that are relevant in measuring an award's fair value. For instance, an award's quantity may double, or an award's contractual term may be extended, if a company-wide revenue target is achieved. Market conditions that affect an award's fair value (including exercisability) are included in the estimate of grant-date fair value (see paragraph 718-10-30-15). Performance or service conditions that only affect vesting are excluded from the estimate of grant-date fair value, but all other performance or service conditions that affect an award's fair value are included in the estimate of grant-date fair value (see that same paragraph). Examples 3, 4, and 6 (see paragraphs 718-20-55-41, 718-20-55-47, and 718-20-55-61) provide further guidance on how performance conditions are considered in the estimate of grant-date fair value. An award may be indexed to a factor in addition to the entity's share price. If that factor is not a market, performance, or service condition, that award shall be classified as a liability for purposes of this Topic (see paragraphs 718-10-25-13 through 25-14A). An example would be an award of options whose exercise price is indexed to the market price of a commodity, such as gold. Another example would be a share award that will vest based on the appreciation in the price of a commodity, such as gold; that award is indexed to both the value of that commodity and the issuing entity's shares. If an award is so indexed, the relevant factors shall be included in the fair value estimate of the award. Such an award would be classified as a liability even if the entity granting the share-based payment instrument is a producer of the commodity whose price changes are part or all of the conditions that affect an award's vesting conditions or fair value. The following flowchart provides guidance on determining how to account for an award based on the existence of market, performance, or service conditions (or any combination thereof). 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. An employee's share-based payment award becomes vested at the date that the employee's right to receive or retain equity shares, other equity instruments, or cash under the award is no longer contingent on satisfaction of either a performance condition or a service condition. Any unrecognized compensation cost shall be recognized when an award becomes vested. If an award includes no market, performance, or service conditions, then the entire amount of compensation cost shall be recognized when the award is granted (which also is the date of issuance in this case). Example 1 (see paragraph 718-10-55-86) provides an illustration of estimating the requisite service period. A requisite service period for an employee may be explicit, implicit, or derived. An explicit service period is one that is stated in the terms of the share-based payment award. For example, an award that vests after three years of continuous employee service has an explicit service period of three years, which also would be the requisite service period. An implicit service period is one that may be inferred from an analysis of an award's terms. For example, if an award of share options vests only upon the completion of a new product design and the design is expected to be completed 18 months from the grant date, the implicit service period is 18 months, which also would be the requisite service period. A derived service period is based on a market condition in a share-based payment award that affects exercisability, exercise price, or the employee's ability to retain the award. A derived service period is inferred from the application of certain valuation techniques used to estimate fair value. For example, the derived service period for an award of share options that an employee can exercise only if the share price doubles at any time during a five-year period can be inferred from certain valuation techniques that are used to estimate fair value. This example, and others noted in this Section, implicitly assume that the rights conveyed by the instrument to the holder are dependent on the holder's being an employee of the entity. That is, if the employment relationship is terminated, the award lapses or is forfeited shortly thereafter. In a lattice model, that derived service period represents the duration of the median of the distribution of share price paths on which the market condition is satisfied. That median is the middle share price path (the midpoint of the distribution of paths) on which the market condition is satisfied. The duration is the period of time from the service inception date to the expected date of market condition satisfaction (as inferred from the valuation technique). For example, if the derived service period is three years, the requisite service period is three years and all compensation cost would be recognized over that period, unless the market condition is satisfied at an earlier date, in which case any unrecognized compensation cost would be recognized immediately upon its satisfaction. If the requisite service is not rendered, all previously recognized compensation cost would be reversed. If the requisite service is rendered, the recognized compensation is not reversed even if the market condition is never satisfied. An entity that uses a closed-form model to estimate the grant-date fair value of an award with a market condition may need to use another valuation technique to estimate the derived service period.
An award with a combination of market, performance, or service conditions may contain multiple explicit, implicit, or derived service periods. For such an award, the estimate of the requisite service period shall be based on an analysis of all of the following: - a
All vesting and exercisability conditions
- b
All explicit, implicit, and derived service periods
- c
The probability that performance or service conditions will be satisfied.
Thus, if vesting (or exercisability) of an award is based on satisfying both a market condition and a performance or service condition and it is probable that the performance or service condition will be satisfied, the initial estimate of the requisite service period generally is the longest of the explicit, implicit, or derived service periods. If vesting (or exercisability) of an award is based on satisfying either a market condition or a performance or service condition and it is probable that the performance or service condition will be satisfied, the initial estimate of the requisite service period generally is the shortest of the explicit, implicit, or derived service periods.
For example, a share option might specify that vesting occurs after three years of continuous employee service or when the employee completes a specified project. The employer estimates that it is probable that the project will be completed within 18 months. The employer also believes it is probable that the service condition will be satisfied. Thus, that award contains an explicit service period of 3 years related to the service condition and an implicit service period of 18 months related to the performance condition. Because it is considered probable that both the performance condition and the service condition will be achieved, the requisite service period over which compensation cost is recognized is 18 months, which is the shorter of the explicit and implicit service periods. As illustrated in the preceding paragraph , if an award vests upon the earlier of the satisfaction of a service condition (for example, four years of service) or the satisfaction of one or more performance conditions, it will be necessary to estimate when, if at all, the performance conditions are probable of achievement. For example, if initially the four-year service condition is probable of achievement and no performance condition is probable of achievement, the requisite service period is four years. If one year into the four-year requisite service period a performance condition becomes probable of achievement by the end of the second year, the requisite service period would be revised to two years for attribution of compensation cost (at that point in time, there would be only one year of the two-year requisite service period remaining).
If an award vests upon the satisfaction of both a service condition and the satisfaction of one or more performance conditions, the entity also must initially determine which outcomes are probable of achievement. For example, an award contains a four-year service condition and two performance conditions, all of which need to be satisfied. If initially the four-year service condition is probable of achievement and no performance condition is probable of achievement, then no compensation cost would be recognized unless the two performance conditions and the service condition subsequently become probable of achievement. If both performance conditions become probable of achievement one year after the grant date and the entity estimates that both performance conditions will be achieved by the end of the second year, the requisite service period would be four years as that is the longest period of both the explicit service period and the implicit service periods. Because the performance conditions are now probable of achievement, compensation cost will be recognized in the period of the change in estimate (see paragraph 718-10-35-3) as the cumulative effect on current and prior periods of the change in the estimated number of awards for which the requisite service is expected to be rendered. Therefore, compensation cost for the first year will be recognized immediately at the time of the change in estimate for the awards for which the requisite service is expected to be rendered. The remaining unrecognized compensation cost for those awards would be recognized prospectively over the remaining requisite service period. An entity that has an accounting policy to account for forfeitures when they occur in accordance with paragraph 718-10-35-3 would assume that the achievement of a service condition is probable when determining the amount of compensation cost to recognize unless the award has been forfeited. As indicated in paragraph 718-10-55-75, the initial estimate of the requisite service period based on an explicit or implicit service period shall be adjusted for changes in the expected and actual outcomes of the related service or performance conditions that affect vesting of the award. Such adjustments will occur as the entity revises its estimates of whether or when different conditions or combinations of conditions are probable of being satisfied. Compensation cost ultimately recognized is equal to the grant-date fair value of the award based on the actual outcome of the performance or service conditions (see paragraph 718-10-30-15). If an award contains a market condition and a performance or a service condition and the initial estimate of the requisite service period is based on the market condition's derived service period, then the requisite service period shall not be revised unless either of the following criteria is met: - a
The market condition is satisfied before the end of the derived service period
- b
Satisfying the market condition is no longer the basis for determining the requisite service period.
How a change to the initial estimate of the requisite service period is accounted for depends on whether that change would affect the grant-date fair value of the award (including the quantity of instruments) that is to be recognized as compensation. For example, if the quantity of instruments for which the requisite service is expected to be rendered changes because a vesting condition becomes probable of satisfaction or if the grant-date fair value of an instrument changes because another performance or service condition becomes probable of satisfaction (for example, a performance or service condition that affects exercise price becomes probable of satisfaction), the cumulative effect on current and prior periods of those changes in estimates shall be recognized in the period of the change. In contrast, if compensation cost is already being attributed over an initially estimated requisite service period and that initially estimated period changes solely because another market, performance, or service condition becomes the basis for the requisite service period, any unrecognized compensation cost at that date of change shall be recognized prospectively over the revised requisite service period, if any (that is, no cumulative-effect adjustment is recognized).
To summarize, changes in actual or estimated outcomes that affect either the grant-date fair value of the instrument awarded or the quantity of instruments for which the requisite service is expected to be rendered (or both) are accounted for using a cumulative effect adjustment, and changes in estimated requisite service periods for awards for which compensation cost is already being attributed are accounted for prospectively only over the revised requisite service period, if any.
This guidance expands on the guidance provided in paragraph
718-10-25-5.
The definition of grant date requires that a grantor and a grantee have a mutual understanding of the key terms and conditions of the share-based compensation arrangement. Those terms may be established through any of the following: - a
A formal, written agreement
- b
An informal, oral arrangement
- c
An entity's past practice.
A mutual understanding of the key terms and conditions means that there is sufficient basis for both the grantor and the grantee to understand the nature of the relationship established by the award, including both the compensatory relationship and the equity relationship subsequent to the date of grant. The grant date for an award will be the date that a grantee begins to benefit from, or be adversely affected by, subsequent changes in the price of the grantor's equity shares. In order to assess that financial exposure, the grantor and grantee must agree to the terms; that is, there must be a mutual understanding. Awards made under an arrangement that is subject to shareholder approval are not deemed to be granted until that approval is obtained unless approval is essentially a formality (or perfunctory). Additionally, to have a grant date for an award to an employee, the recipient of that award must meet the definition of an employee. The determination of the grant date shall be based on the relevant facts and circumstances. For instance, a look-back share option may be granted with an exercise price equal to the lower of the current share price or the share price one year hence. The ultimate exercise price is not known at the date of grant, but it cannot be greater than the current share price. In this case, the relationship between the exercise price and the current share price provides a sufficient basis to understand both the compensatory and equity relationship established by the award; the recipient begins to benefit from subsequent changes in the price of the grantor's equity shares. However, if the award's terms call for the exercise price to be set equal to the share price one year hence, the recipient does not begin to benefit from, or be adversely affected by, changes in the price of the grantor's equity shares until then. Therefore, grant date would not occur until one year hence. Awards of share options whose exercise price is determined solely by reference to a future share price generally would not provide a sufficient basis to understand the nature of the compensatory and equity relationships established by the award until the exercise price is known.
The following paragraph further explains the guidance in paragraphs
.
An entity may, for example, grant shares under a share-based compensation arrangement that the grantee can put (sell) to the grantor (the entity) shortly after the vesting date for cash equal to the fair value of the shares on the date of repurchase. That award of puttable shares would be classified as a liability because the repurchase feature permits the grantee to avoid bearing the risks and rewards normally associated with equity share ownership for a reasonable period of time from the date the share is issued (see paragraph 718-10-25-9(a)). Alternatively, an entity might grant its own shares under a share-based compensation arrangement that may be put to the grantor only after the grantee has held them for a reasonable period of time after vesting but at a fixed redemption amount. Those puttable shares also would be classified as liabilities under the requirements of this Topic because the repurchase price is based on a fixed amount rather than variations in the fair value of the grantor's shares. The grantee cannot bear the risks and rewards normally associated with equity share ownership for a reasonable period of time because of that redemption feature. However, if a share with a repurchase feature gives the grantee the right to sell shares back to the entity for a fixed amount over the fair value of the shares at the date of repurchase, paragraph 718-20-35-7 requires that the fixed amount over the fair value be recognized and attributed as additional compensation cost over the employee's requisite service period (with a corresponding liability being accrued). The fixed amount over the fair value of a nonemployee award should be recognized as additional compensation cost over the vesting period (with a corresponding liability being accrued) in accordance with paragraph 718-10-25-2C. A physician practice management entity shall determine whether an employee of the physician practice is considered an employee of the physician practice management entity for purposes of determining the method of accounting for that person's share-based compensation as follows: - a
An employee of a physician practice that is consolidated by the physician practice management entity shall be considered an employee of the physician practice management entity and its subsidiaries.
- b
An employee of a physician practice that is not consolidated by the physician practice management entity shall not be considered an employee of the physician practice management entity and its subsidiaries.
This Example illustrates the guidance in paragraphs
.
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.
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. This Example illustrates the evaluation as to whether an individual meets conditions to be considered an
employee under the definition of that term used in this Topic.
This Topic defines employee as an individual over whom the grantor of a share-based compensation award exercises or has the right to exercise sufficient control to establish an employer-employee relationship based on common law as illustrated in case law and currently under U.S. Internal Revenue Service (IRS) Revenue Ruling 87-41 . An example of whether that condition exists follows. Entity A issues options to members of its Advisory Board, which is separate and distinct from Entity A's board of directors. Members of the Advisory Board are knowledgeable about Entity A's industry and advise Entity A on matters such as policy development, strategic planning, and product development. The Advisory Board members are appointed for two-year terms and meet four times a year for one day, receiving a fixed number of options for services rendered at each meeting. Based on an evaluation of the relationship between Entity A and the Advisory Board members, Entity A concludes that the Advisory Board members do not meet the common law definition of employee. Accordingly, the awards to the Advisory Board members are accounted for as awards to nonemployees under the provisions of this Topic.
Nonemployee directors acting in their role as members of an entity's board of directors shall be treated as employees if those directors were elected by the entity's shareholders or appointed to a board position that will be filled by shareholder election when the existing term expires. However, that requirement applies only to awards granted to them for their services as directors. Awards granted to those individuals for other services shall be accounted for as awards to nonemployees in accordance with Section 505-50-25. Additionally, consolidated groups may have multiple boards of directors; this guidance applies only to either of the following: - a
The nonemployee directors acting in their role as members of a parent entity's board of directors
- b
Nonemployee members of a consolidated subsidiary's board of directors to the extent that those members are elected by shareholders that are not controlled directly or indirectly by the parent or another member of the consolidated group.
The following Cases illustrate employee share-based payment awards with a performance condition (see paragraphs
;
718-10-30-27; and
718-10-35-4) and multiple service dates:
- a
Performance targets are set at the inception of the arrangement (Case A).
- b
Performance targets are established at some time in the future (Case B).
- c
Performance targets established up front but vesting is tied to the vesting of a preceding award (Case C).
Cases A, B, and C share the following assumptions:
- a
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.
- b
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.
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.
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.
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. The following Cases illustrate the guidance in paragraph
718-10-30-12 to determine the service period for employee awards with multiple service periods:
- a
Exercise price established at subsequent dates (Case A)
- b
Exercise price established at inception (Case B).
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 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. 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. The following Cases illustrate the guidance in paragraph
718-10-35-5 applicable to employee awards in circumstances in which an award includes both a market condition and a service condition:
- a
When only one condition must be met (Case A)
- b
When both conditions must be met (Case B).
Cases A and B share the following assumptions.
On January 1, 20X5, Entity T grants an executive 200,000 share options on its stock with an exercise price of $30 per option. The award specifies that vesting (or exercisability) will occur upon the earlier of the following for Case A or both are met for Case B: - a
The share price reaching and maintaining at least $70 per share for 30 consecutive trading days
- b
The completion of eight years of service.
The award contains an explicit service period of eight years related to the service condition and a derived service period related to the market condition.
An entity shall make its best estimate of the derived service period related to the market condition (see paragraph 718-10-55-71). The derived service period may be estimated using any reasonable methodology, including Monte Carlo simulation techniques. For this Case, the derived service period is assumed to be six years. As described in paragraphs , if an award's vesting (or exercisability) is conditional upon the achievement of either a market condition or performance or service conditions, the requisite service period is generally the shortest of the explicit, implicit, and derived service periods. In this Case, the requisite service period over which compensation cost would be attributed is six years (shorter of eight and six years). (An entity may grant a fully vested deep out-of-the-money share option that would lapse shortly after termination of service, which is the equivalent of an award with both a market condition and a service condition. The explicit service period associated with the explicit service condition is zero; however, because the option is deep out-of-the-money at the grant date, there would be a derived service period.) Continuing with this Case, if the market condition is actually satisfied in February 20X9 (based on market prices for the prior 30 consecutive trading days), Entity T would immediately recognize any unrecognized compensation cost because no further service is required to earn the award. If the market condition is not satisfied as of that date but the executive renders the six years of requisite service, compensation cost shall not be reversed under any circumstances.
The initial estimate of the requisite service period for an award requiring satisfaction of both market and performance or service conditions is generally the longest of the explicit, implicit, and derived service periods (see paragraphs ). For example, if the award described in Case A required both the completion of 8 years of service and the share price reaching and maintaining at least $70 per share for 30 consecutive trading days, compensation cost would be recognized over the 8-year explicit service period. If the employee were to terminate service prior to the eight-year requisite service period, compensation cost would be reversed even if the market condition had been satisfied by that time. The following Example illustrates the guidance in paragraph
718-10-35-6.
This Topic distinguishes between service inception date and grant date. The service inception date is the date at which the requisite service period begins. The service inception date usually is the grant date, but the service inception date precedes the grant date if all of the following criteria are met: - a
An award is authorized. (Compensation cost would not be recognized before receiving all necessary approvals unless approval is essentially a formality [or perfunctory].)
- b
Service begins before a mutual understanding of the key terms and conditions of a share-based payment award is reached.
- c
Either of the following conditions applies:
- 1
The award's terms do not include a substantive future requisite service condition that exists at the grant date (see paragraph 718-10-55-113 for an example illustrating that condition). - 2
The award contains a market or performance condition that if not satisfied during the service period preceding the grant date and following the inception of the arrangement results in forfeiture of the award (see paragraph 718-10-55-114 for an example illustrating that condition).
In certain circumstances the service inception date may begin after the grant date (see paragraphs for an example illustrating that circumstance). For example, Entity T offers a position to an individual on April 1, 20X5, that has been approved by the chief executive officer and board of directors. In addition to salary and other benefits, Entity T offers to grant 10,000 shares of Entity T stock that vest upon the completion of 5 years of service (the market price of Entity T's stock is $25 on April 1, 20X5). The share award will begin vesting on the date the offer is accepted. The individual accepts the offer on April 2, 20X5, but is unable to begin providing services to Entity T until June 2, 20X5 (that is, substantive employment begins on June 2, 20X5). The individual also does not receive a salary or participate in other employee benefits until June 2, 20X5. On June 2, 20X5, the market price of Entity T stock is $40. In this Example, the service inception date is June 2, 20X5, the first date that the individual begins providing substantive employee services to Entity T. The grant date is the same date because that is when the individual would meet the definition of an employee. The grant-date fair value of the share award is $400,000 (10,000 × $40).
If necessary board approval of the award described in the preceding paragraph was obtained on August 5, 20X5, two months after substantive employment begins (June 2, 20X5), both the service inception date and the grant date would be August 5, 20X5, as that is the date when all necessary authorizations were obtained. If the market price of Entity T's stock was $38 per share on August 5, 20X5, the grant-date fair value of the share award would be $380,000 (10,000 × $38). Additionally, Entity T would not recognize compensation cost for the shares for the period between June 2, 20X5, and August 4, 20X5, neither during that period nor cumulatively on August 5, 20X5, when both the service inception date and the grant date occur. This is consistent with the definition of requisite service period, which states that if an award requires future service for vesting, the entity cannot define a prior period as the requisite service period. Future service in this context represents the service to be rendered beginning as of the service inception date.
If the service inception date precedes the grant date, recognition of compensation cost for periods before the grant date shall be based on the fair value of the award at the reporting dates that occur before the grant date. In the period in which the grant date occurs, cumulative compensation cost shall be adjusted to reflect the cumulative effect of measuring compensation cost based on the fair value at the grant date rather than the fair value previously used at the service inception date (or any subsequent reporting dates) (see paragraph 718-10-35-6). If an award's terms do not include a substantive future requisite service condition that exists at the grant date, the service inception date can precede the grant date. For example, on January 1, 20X5, an employee is informed that an award of 100 fully vested options will be made on January 1, 20X6, with an exercise price equal to the share price on January 1, 20X6. All approvals for that award have been obtained as of January 1, 20X5. That individual is still an employee on January 1, 20X6, and receives the 100 fully vested options on that date. There is no substantive future service period associated with the options after January 1, 20X6. Therefore, the requisite service period is from the January 1, 20X5, service inception date through the January 1, 20X6, grant date, as that is the period during which the employee is required to perform service in exchange for the award. The relationship between the exercise price and the current share price that provides a sufficient basis to understand the equity relationship established by the award is known on January 1, 20X6. Compensation cost would be recognized during 20X5 in accordance with the preceding paragraph.
If an award contains either a market or a performance condition, which if not satisfied during the service period preceding the grant date and following the date the award is given results in a forfeiture of the award, then the service inception date may precede the grant date. For example, an authorized award is given on January 1, 20X5, with a two-year cliff vesting service requirement commencing on that date. The exercise price will be set on January 1, 20X6. The award will be forfeited if Entity T does not sell 1,000 units of product X in 20X5. In this Example, the employee earns the right to retain the award if the performance condition is met and the employee renders service in 20X5 and 20X6. The requisite service period is two years beginning on January 1, 20X5. The service inception date (January 1, 20X5) precedes the grant date (January 1, 20X6). Compensation cost would be recognized during 20X5 in accordance with paragraph 718-10-55-112. In contrast, consider an award that is given on January 1, 20X5, with only a three-year cliff vesting explicit service condition, which commences on that date. The exercise price will be set on January 1, 20X6. In this Example, the service inception date cannot precede the grant date because there is a substantive future requisite service condition that exists at the grant date (two years of service). Therefore, there would be no attribution of compensation cost for the period between January 1, 20X5, and December 31, 20X5, neither during that period nor cumulatively on January 1, 20X6, when both the service inception date and the grant date occur. This is consistent with the definition of requisite service period, which states that if an award requires future service for vesting, the entity cannot define a prior period as the requisite service period. The requisite service period would be two years, commencing on January 1, 20X6.
A tandem award is an award with two or more components in which exercise of one part cancels the other(s). In contrast, a combination award is an award with two or more separate components, all of which can be exercised. The following Cases illustrates one aspect of the guidance in paragraph
718-10-25-15:
- a
Share option or cash settled stock appreciation rights (Case A)
- b
Phantom shares or share options (Case B).
Cases A and B of this Example (see paragraphs ) describe employee awards. However, the principles on accounting for employee awards, except for compensation cost attribution, are the same for nonemployee awards. Therefore, the guidance in these Cases may serve as implementation guidance for nonemployee awards. Compensation cost attribution for awards to nonemployees may be the same as or different from the attribution for the employee awards in Case A (see paragraph 718-10-55-119) and Case B (see paragraph 718-10-55-130). 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 transactions. This Case illustrates the accounting for a tandem award in which employees have a choice of either share options or cash-settled stock appreciation rights. Entity T grants to its employees an award of 900,000 share options or 900,000 cash-settled stock appreciation rights on January 1, 20X5. The award vests on December 31, 20X7, and has a contractual life of 10 years. If an employee exercises the stock appreciation rights, the related share options are cancelled. Conversely, if an employee exercises the share options, the related stock appreciation rights are cancelled.
The tandem award results in Entity T's incurring a liability because the employees can demand settlement in cash. If Entity T could choose whether to settle the award in cash or by issuing stock, the award would be an equity instrument unless Entity T's predominant past practice is to settle most awards in cash or to settle awards in cash whenever requested to do so by the employee, indicating that Entity T has incurred a substantive liability as indicated in paragraph 718-10-25-15. In this Case, however, Entity T incurs a liability to pay cash, which it will recognize over the requisite service period. The amount of the liability will be adjusted each year to reflect changes in its fair value. If employees choose to exercise the share options rather than the stock appreciation rights, the liability is settled by issuing stock. The fair value of the stock appreciation rights at the grant date is $12,066,454, as computed in Example 1 (see paragraph 718-30-55-1), because the value of the stock appreciation rights and the value of the share options are equal. Accordingly, at the end of 20X5, when the assumed fair value per stock appreciation right is $10, the amount of the liability is $8,214,060 (821,406 cash-settled stock appreciation rights expected to vest × $10). One-third of that amount, $2,738,020, is recognized as compensation cost for 20X5. At the end of each year during the vesting period, the liability is remeasured to its fair value for all stock appreciation rights expected to vest. After the vesting period, the liability for all outstanding vested awards is remeasured through the date of settlement. This Case illustrates a tandem award in which the components have different values after the grant date, depending on movements in the price of the entity's stock. The employee's choice of which component to exercise will depend on the relative values of the components when the award is exercised.
Entity T grants to its chief executive officer an immediately vested award consisting of the following two parts: - a
1,000 phantom share units (units) whose value is always equal to the value of 1,000 shares of Entity T's common stock
- b
Share options on 3,000 shares of Entity T's stock with an exercise price of $30 per share.
At the grant date, Entity T's share price is $30 per share. The chief executive officer may choose whether to exercise the share options or to cash in the units at any time during the next five years. Exercise of all of the share options cancels all of the units, and cashing in all of the units cancels all of the share options. The cash value of the units will be paid to the chief executive officer at the end of five years if the share option component of the tandem award is not exercised before then.
With a 3-to-1 ratio of share options to units, exercise of 3 share options will produce a higher gain than receipt of cash equal to the value of 1 share of stock if the share price appreciates from the grant date by more than 50 percent. Below that point, one unit is more valuable than the gain on three share options. To illustrate that relationship, the results if the share price increases 50 percent to $45 are as follows. ![](\"/asc-img/GUID-EEFDE090-F459-416F-8C83-5CE53F1084C5-low.gif\")
Units Exercise of Options Market value \" $45,000 \" \"($45 × 1,000)\" \" $135,000 \" \" ($45 × 3,000)\" Purchase price - \" 90,000 \" \" ($30 × 3,000)\" Net cash value \" $45,000 \" \" $45,000 \"
If the price of Entity T's common stock increases to $45 per share from its price of $30 at the grant date, each part of the tandem grant will produce the same net cash payment (ignoring transaction costs) to the chief executive officer. If the price increases to $44, the value of 1 share of stock exceeds the gain on exercising 3 share options, which would be $42 [3 × ($44-$30)]. But if the price increases to $46, the gain on exercising 3 share options, $48 [3 × ($46-$30)], exceeds the value of 1 share of stock.
At the grant date, the chief executive officer could take $30,000 cash for the units and forfeit the share options. Therefore, the total value of the award at the grant date must exceed $30,000 because at share prices above $45, the chief executive officer receives a higher amount than would the holder of 1 share of stock. To exercise the 3,000 options, the chief executive officer must forfeit the equivalent of 1,000 shares of stock, in addition to paying the total exercise price of $90,000 (3,000 × $30). In effect, the chief executive officer receives only 2,000 shares of Entity T stock upon exercise. That is the same as if the share option component of the tandem award consisted of share options to purchase 2,000 shares of stock for $45 per share.
The cash payment obligation associated with the units qualifies the award as a liability of Entity T. The maximum amount of that liability, which is indexed to the price of Entity T's common stock, is $45,000 because at share prices above $45, the chief executive officer will exercise the share options.
In measuring compensation cost, the award may be thought of as a combination —not tandem—grant of both of the following: - a
1,000 units with a value at grant of $30,000
- b
2,000 options with a strike price of $45 per share.
Compensation cost is measured based on the combined value of the two parts.
The fair value per share option with an exercise price of $45 is assumed to be $10. Therefore, the total value of the award at the grant date is as follows. ![](\"/asc-img/GUID-404C0824-13F0-4124-973B-EAF6991A370F-low.gif\")
\"Units (1,000 × $30)\" \" $30,000 \" \"Share options (2,000 × $10)\" \" 20,000 \" Value of award \" $50,000 \"
Therefore, compensation cost recognized at the date of grant (the award is immediately vested) would be $30,000 with a corresponding credit to a share-based compensation liability of $30,000. However, because the share option component is the substantive equivalent of 2,000 deep out-of-the-money options, it contains a derived service period (assumed to be 2 years). Hence, compensation cost for the share option component of $20,000 would be recognized over the requisite service period. The share option component would not be remeasured because it is not a liability. That total amount of both components (or $50,000) is more than either of the components by itself, but less than the total amount if both components (1,000 units and 3,000 share options with an exercise price of $30) were exercisable. Because granting the units creates a liability, changes in the liability that result from increases or decreases in the price of Entity T's share price would be recognized each period until exercise, except that the amount of the liability would not exceed $45,000.
A nonpublic entity that is not a Securities and Exchange Commission (SEC) registrant has two classes of stock. Class A is voting and held only by the members of the founding family, and Class B (book value shares) is nonvoting and held only by employees. The purchase price of Class B shares is a formula price based on book value. Class B shares require that the employee, six months after retirement or separation from the entity, sell the shares back to the entity for cash at a price determined by using the same formula used to establish the purchase price. Class B shares may not be required to be accounted for as liabilities pursuant to Topic 480 because the entity is a nonpublic entity that is not an SEC registrant. Nevertheless, Class B shares may be classified as liabilities if they are granted as part of a share-based payment transaction and those shares contain certain repurchase features meeting criteria in paragraph 718-10-25-9; this Example assumes that Class B shares do not meet those criteria. Because book value shares of public entities generally are not indexed to their stock prices, such shares would be classified as liabilities pursuant to this Topic. Determining whether a transaction involving Class B shares is compensatory will depend on the terms of the arrangement. For instance, if an employee acquires 100 shares of Class B stock in exchange for cash equal to the formula price of those shares, the transaction is not compensatory because the employee has acquired those shares on the same terms available to all other Class B shareholders and at the current formula price based on the current book value. Subsequent changes in the formula price of those shares held by the employee are not deemed compensation for services.
However, if an employee acquires 100 shares of Class B stock in exchange for cash equal to 50 percent of the formula price of those shares, the transaction is compensatory because the employee is not paying the current formula price. Therefore, the value of the 50 percent discount should be attributed over the requisite service period. However, subsequent changes in the formula price of those shares held by the employee are not compensatory.
This Example illustrates disclosures (see paragraphs ) of a public entity's share-based compensation arrangements. The illustration assumes that compensation cost has been recognized in accordance with this Topic for several years. The amount of compensation cost recognized each year includes both costs from that year's grants and costs from prior years' grants. The number of options outstanding, exercised, forfeited, or expired each year includes options granted in prior years. Although this Example focuses on employee share-based payment plans, the disclosures are equally applicable to share-based payment awards issued to nonemployees. An entity should refer to the guidance in paragraph 718-10-50-2(g) when evaluating whether separate disclosure of nonemployee share-based payment awards is warranted. On December 31, 20Y1, the Entity has two share-based compensation plans: The compensation cost that has been charged against income for those plans was $29.4 million, $28.7 million, and $23.3 million for 20Y1, 20Y0, and 20X9, respectively. The total income tax benefit recognized in the income statement for share-based compensation arrangements was $10.3 million, $10.1 million, and $8.2 million for 20Y1, 20Y0, and 20X9, respectively. Compensation cost capitalized as part of inventory and fixed assets for 20Y1, 20Y0, and 20X9 was $0.5 million, $0.2 million, and $0.4 million, respectively.
The following illustrates disclosure for a share option plan.
The Entity's 20X4 employee share option plan, which is shareholder-approved, permits the grant of share options and shares to its employees for up to 8 million shares of common stock. Entity A believes that such awards better align the interests of its employees with those of its shareholders. Option awards are generally granted with an exercise price equal to the market price of Entity A's stock at the date of grant; those option awards generally vest based on 5 years of continuous service and have 10-year contractual terms. Share awards generally vest over five years. Certain option and share awards provide for accelerated vesting if there is a change in control (as defined in the employee share option plan).
The fair value of each option award is estimated on the date of grant using a lattice-based option valuation model that uses the assumptions noted in the following table. Because lattice-based option valuation models incorporate ranges of assumptions for inputs, those ranges are disclosed. Expected volatilities are based on implied volatilities from traded options on Entity A's stock, historical volatility of Entity A's stock, and other factors. Entity A uses historical data to estimate option exercise and employee termination within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected term of options granted is derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding; the range given below results from certain groups of employees exhibiting different behavior. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
![](\"/asc-img/GUID-57931370-5913-4498-ADDA-672B3CBBF0EF-low.gif\")
20Y1 20Y0 20X9 Expected volatility 25%-40% 24%-38% 20%-30% Weighted-average volatility 33% 30% 27% Expected dividends 1.5% 1.5% 1.5% Expected term (in years) 5.3-7.8 5.5-8.0 5.6-8.2 Risk-free rate 6.3%-11.2% 6.0%-10.0% 5.5%-9.0%
A summary of option activity under the employee share option plan as of December 31, 20Y1, and changes during the year then ended is presented below.
![](\"/asc-img/GUID-68329FCF-C045-4CFC-A06D-8B848A5BD25B-low.gif\")
Options Shares (000) Weighted- Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value ($000) \"Outstanding at January 1, 20Y1\" \" 4,660 \" $42 Granted 950 60 Exercised (800) 36 Forfeited or expired (80) 59 \"Outstanding at December 31, 20Y1\" \" 4,730 \" $47 6.5 \" $85,140 \" \"Exercisable at December 31, 20Y1\" \" 3,159 \" $41 4.0 \" $75,816 \"
The weighted-average grant-date fair value of options granted during the years 20Y1, 20Y0, and 20X9 was $19.57, $17.46, and $15.90, respectively. The total intrinsic value of options exercised during the years ended December 31, 20Y1, 20Y0, and 20X9, was $25.2 million, $20.9 million, and $18.1 million, respectively.
A summary of the status of Entity A's nonvested shares as of December 31, 20Y1, and changes during the year ended December 31, 20Y1, is presented below.
![](\"/asc-img/GUID-2BAC01FE-888E-4BD9-A71C-442FE954D512-low.gif\")
Nonvested Shares Shares (000) \"Weighted-Average Grant-Date Fair Value\" \"Nonvested at January 1, 20Y1\" 980 $40.00 Granted 150 63.50 Vested (100) 35.75 Forfeited (40) 55.25 \"Nonvested at December 31, 20Y1\" 990 $43.35
As of December 31, 20Y1, there was $25.9 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the employee share option plan. That cost is expected to be recognized over a weighted-average period of 4.9 years. The total fair value of shares vested during the years ended December 31, 20Y1, 20Y0, and 20X9, was $22.8 million, $21 million, and $20.7 million, respectively.
During 20Y1, Entity A extended the contractual life of 200,000 fully vested share options held by 10 employees. As a result of that modification, the Entity recognized additional compensation expense of $1.0 million for the year ended December 31, 20Y1.
The following illustrates disclosure for a performance share option plan.
Under its 20X7 performance share option plan, which is shareholder-approved, each January 1 Entity A grants selected executives and other key employees share option awards whose vesting is contingent upon meeting various departmental and company-wide performance goals, including decreasing time to market for new products, revenue growth in excess of an index of competitors' revenue growth, and sales targets for Segment X. Share options under the performance share option plan are generally granted at-the-money, contingently vest over a period of 1 to 5 years, depending on the nature of the performance goal, and have contractual lives of 7 to 10 years. The number of shares subject to options available for issuance under this plan cannot exceed 5 million.
The fair value of each option grant under the performance share option plan was estimated on the date of grant using the same option valuation model used for options granted under the employee share option plan and assumes that performance goals will be achieved. If such goals are not met, no compensation cost is recognized and any recognized compensation cost is reversed. The inputs for expected volatility, expected dividends, and risk-free rate used in estimating those options' fair value are the same as those noted in the table related to options issued under the employee share option plan. The expected term for options granted under the performance share option plan in 20Y1, 20Y0, and 20X9 is 3.3 to 5.4 years, 2.4 to 6.5 years, and 2.5 to 5.3 years, respectively.
A summary of the activity under the performance share option plan as of December 31, 20Y1, and changes during the year then ended is presented below.
![](\"/asc-img/GUID-E7DCBC25-CE99-4A36-868A-190D098490BD-low.gif\")
Performance Options Shares (000) Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value ($000) \"Outstanding at January 1, 20Y1\" \"2,533 \" $44 Granted 995 60 Exercised (100) 36 Forfeited (604) 59 \"Outstanding at December 31, 20Y1\" \"2,824 \" $47 7.1 \" $50,832 \" \"Exercisable at December 31, 20Y1\" 936 $40 5.3 \" $23,400 \"
The weighted-average grant-date fair value of options granted during the years 20Y1, 20Y0, and 20X9 was $17.32, $16.05, and $14.25, respectively. The total intrinsic value of options exercised during the years ended December 31, 20Y1, 20Y0, and 20X9, was $5 million, $8 million, and $3 million, respectively. As of December 31, 20Y1, there was $16.9 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the performance share option plan; that cost is expected to be recognized over a period of 4 years.
Cash received from option exercise under all share-based payment arrangements for the years ended December 31, 20Y1, 20Y0, and 20X9, was $32.4 million, $28.9 million, and $18.9 million, respectively. The actual tax benefit for the tax deductions from option exercise of the share-based payment arrangements totaled $11.3 million, $10.1 million, and $6.6 million, respectively, for the years ended December 31, 20Y1, 20Y0, and 20X9.
Entity A has a policy of repurchasing shares on the open market to satisfy share option exercises and expects to repurchase approximately 1 million shares during 20Y2, based on estimates of option exercises for that period.
(P) December 16, 2024; (N) December 16, 2025
718-10-65-17This Example illustrates how an entity should apply the guidance in paragraph 718-10-15-3 to determine whether a profits interest or similar award is a share-based payment arrangement and is within the scope of this Topic or is not a share-based payment arrangement and, therefore, is within the scope of other Topics. The guidance in this Example is limited to the application of paragraph 718-10-15-3 and does not address how to apply other Sections of this Topic, including recognition, classification, initial measurement, subsequent measurement, other presentation matters, and disclosure.(P) December 16, 2024; (N) December 16, 2025
718-10-65-17Cases A, B, C, and D share the following assumptions:- a
Entity X is a partnership. Before June 1, 20X1, Entity X had Class A units outstanding. On June 1, 20X1, Entity X grants Class B incentive units to employees of a subsidiary of Entity X in exchange for services.
- b
An exit event may include an initial public offering, a change in control, or a liquidation of Entity X's assets.
(P) December 16, 2024; (N) December 16, 2025
718-10-65-17Additional assumptions are as follows:- a
The Class B units are profits interest units that are subordinated to the Class A units because after vesting they participate pro rata with the Class A units once the holders of the Class A units have received distributions equal to a predetermined distribution threshold established on the grant date of the Class B units.
- b
The Class B units cliff vest at the end of three years of service.
- c
Upon an exit event, the Class B units vest immediately if a grantee is still providing services to the subsidiary of Entity X. Upon such an event, the grantee would retain the vested Class B units, or if Class B units are settled through the exit event, Entity X would distribute proceeds to the Class B unit holders in the same manner as is described in (a).
- d
If a grantee of the Class B units terminates employment with the subsidiary of Entity X (whether voluntarily, upon death, disability, or retirement or at the election of Entity X for reasons other than cause), any unvested Class B units will be forfeited for no consideration. If a grantee of the Class B units terminates employment after vesting, the grantee retains ownership of the vested Class B units, but upon the grantee’s termination of employment, Entity X has a call right to repurchase the Class B units. If the call right is exercised, Entity X would pay the grantee of the Class B units an amount of cash equal to the fair value of the Class B units on the call date.
(P) December 16, 2024; (N) December 16, 2025
718-10-65-17Entity X evaluates the conditions in paragraph 718-10-15-3 to determine whether to account for the Class B units by applying the guidance in this Topic. The Class B units meet the condition in paragraph 718-10-15-3(a) because both of the following indicate that Entity X is offering to issue shares or other equity instruments:- a
Either upon three years of service or an exit event, the grantor will have received the agreed-upon consideration (that is, the service will have been provided and the performance condition will have been met, if applicable) and the award will vest.
- b
Holding the vested Class B units provides the grantee with the right to participate in the residual interest of Entity X through periodic distributions, upon an exit event, or upon settlement proportionate to ownership of Class B units of Entity X in accordance with the distribution waterfall described in paragraph 718-10-55-140(a).
Therefore, Entity X would account for the Class B units by applying the guidance in this Topic.(P) December 16, 2024; (N) December 16, 2025
718-10-65-17Additional assumptions are as follows:- a
The Class B units are profits interest units that are subordinated to the Class A units because once granted, they participate pro rata with the Class A units once the holders of the Class A units have received distributions equal to a predetermined distribution threshold established on the grant date of the Class B units.
- b
The grantee of the Class B units is eligible to begin participating in nonforfeitable operating distributions at the grant date.
- c
The Class B units only vest upon an exit event. Upon such an event, the grantee would retain the vested Class B units, or if Class B units are settled through the exit event, Entity X would distribute proceeds to the Class B unit holders in the same manner as is described in (a). Class B units are forfeitable upon the grantee’s termination for any reason at any time before an exit event.
(P) December 16, 2024; (N) December 16, 2025
718-10-65-17Entity X evaluates the conditions in paragraph 718-10-15-3 to determine whether to account for the Class B units by applying the guidance in this Topic. The Class B units meet the condition in paragraph 718-10-15-3(a) because both of the following indicate that Entity X is offering to issue shares or other equity instruments:- a
Upon an exit event, the grantor will have received the agreed-upon consideration (that is, the service will have been provided and the performance condition will have been met) and the award will vest.
- b
Holding the vested Class B units provides the grantee with the right to participate in the residual interest of Entity X through periodic distributions, upon an exit event, or upon settlement proportionate to ownership of Class B units of Entity X in accordance with the distribution waterfall described in paragraph 718-10-55-142(a).
Therefore, Entity X would account for the Class B units by applying the guidance in this Topic.(P) December 16, 2024; (N) December 16, 2025
718-10-65-17The grantee of the Class B units is not entitled to retain the units if the grantee ceases to provide services before an exit event. Upon termination of employment before an exit event, the grantee of the Class B units would forfeit all rights to future distributions and would forfeit Class B units for no consideration. Entity X would account for the grantee’s right to participate in nonforfeitable operating distributions in accordance with paragraph 718-10-55-45.(P) December 16, 2024; (N) December 16, 2025
718-10-65-17Additional assumptions are as follows: - a
The Class B units do not entitle the grantee to receive equity instruments of Entity X. This type of unit is often referred to as a phantom share unit.
- b
The grantee of the Class B units is not eligible to participate in distributions in the ordinary course of business.
- c
The grantee of the Class B units is eligible to receive cash upon an exit event. Upon an exit event, the Class B units vest immediately and must be settled in cash on the basis of the fair value of the Class B units. The fair value of the Class B units is calculated by reference to the price of Class A units of Entity X as determined at the date of the exit event.
- d
The grantee of the Class B units must be providing services when the exit event occurs to receive any proceeds, and the Class B units are forfeitable upon the grantee’s termination for any reason at any time before an exit event.
(P) December 16, 2024; (N) December 16, 2025
718-10-65-17Entity X evaluates the conditions in paragraph 718-10-15-3 to determine whether to account for the Class B units by applying the guidance in this Topic. The Class B units do not meet the condition in paragraph 718-10-15-3(a) because they do not entitle the grantee to receive shares or other equity instruments of Entity X; therefore, Entity X is not issuing, or offering to issue, shares, share options, or other equity instruments. However, the condition in paragraph 718-10-15-3(b)(1) is met because the cash proceeds received by the grantee upon settlement in an exit event are based, at least in part, on the price of Entity X’s shares. Therefore, Entity X would account for the Class B units by applying the guidance in this Topic.(P) December 16, 2024; (N) December 16, 2025
718-10-65-17Additional assumptions are as follows:- a
The Class B units do not entitle the grantee to receive equity instruments of Entity X. This type of unit is often referred to as a phantom share unit.
- b
The grantee of the Class B units is eligible to participate in operating distributions made by Entity X equal to 1 percent of the preceding fiscal year’s net income. The grantee of the Class B units is eligible to begin participating in these operating distributions after three years of service.
- c
The grantee of the Class B units is not eligible to participate in any proceeds distributed upon an exit event.
- d
The Class B units are forfeitable upon the grantee’s termination for any reason at any time (including after the grantee has rendered three years of service).
(P) December 16, 2024; (N) December 16, 2025
718-10-65-17Entity X evaluates the conditions in paragraph 718-10-15-3 to determine whether to account for the Class B units by applying the guidance in this Topic. The Class B units do not meet the condition in paragraph 718-10-15-3(a) because they do not entitle the grantee to receive shares or other equity instruments of Entity X; therefore, Entity X is not issuing or offering to issue shares, share options, or other equity instruments. In addition, the condition in paragraph 718-10-15-3(b)(1) is not met because the proceeds received by the grantee related to operating distributions are based on an operating metric (1 percent of the preceding fiscal year’s net income) of Entity X and are not based, at least in part, on the price of Entity X’s shares. Furthermore, the condition in paragraph 718-10-15-3(b)(2) is not met because there is no circumstance in which Entity X would be required to issue its equity shares or other equity instruments. Therefore, Entity X would not apply the guidance in this Topic to account for the Class B units and, instead, would account for the Class B units in accordance with other Topics.For guidance related to an investor providing stock compensation on behalf of an investee, see paragraph
505-10-25-3 for investee accounting.
For guidance on accounting for contractual termination benefits and curtailment losses under employee benefit plans that will be triggered by the consummation of a business combination, see paragraphs . For guidance related to equity-linked financial instruments issued to investors for purposes of establishing a market-based measure of the grant-date fair value of stock options granted in share-based payment transactions, see paragraph 815-40-15-5A. For guidance related to stock options in an unrelated entity granted in a share-based payment transaction, see paragraphs
.
Paragraph superseded on 03/30/2016 by Accounting Standards Update No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.
Paragraph superseded on 06/18/2012 after the end of the transition period stated in Accounting Standards Update No. 2010-13, Compensation—Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades.
Paragraph superseded on 07/05/2017 after the end of the transition period stated in Accounting Standards Update No. 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.
Paragraph superseded on 07/17/2019 after the end of the transition period stated in Accounting Standards Update No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.
Paragraph superseded on 07/17/2019 after the end of the transition period stated in Accounting Standards Update No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.
Paragraph superseded on 07/17/2019 after the end of the transition period stated in Accounting Standards Update No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.
Paragraph superseded on 07/17/2019 after the end of the transition period stated in Accounting Standards Update No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.
Paragraph superseded on 07/17/2019 after the end of the transition period stated in Accounting Standards Update No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.
Paragraph superseded on 07/17/2019 after the end of the transition period stated in Accounting Standards Update No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.
Paragraph superseded on 07/17/2019 after the end of the transition period stated in Accounting Standards Update No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.
Paragraph superseded on 08/19/2021 after the end of the transition period stated in Accounting Standards Update No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.
Paragraph superseded on 08/19/2021 after the end of the transition period stated in Accounting Standards Update No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.
Paragraph superseded on 08/19/2021 after the end of the transition period stated in Accounting Standards Update No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.
Paragraph superseded on 08/19/2021 after the end of the transition period stated in Accounting Standards Update No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.
Paragraph superseded on 08/19/2021 after the end of the transition period stated in Accounting Standards Update No. 2019-08, Compensation—Stock Compensation (Topic 718) and Revenue from Contracts with Customers (Topic 606): Codification Improvements—Share-Based Consideration Payable to a Customer.
Paragraph superseded on 07/10/2023 after the end of the transition period stated in Accounting Standards Update No. 2021-07, Compensation—Stock Compensation (Topic 718): Determining the Current Price of an Underlying Share for Equity-Classified Share-Based Awards.
The following represents the transition and effective date information related to Accounting Standards Update No. 2024-01, Compensation—Stock Compensation (Topic 718): Scope Application of Profits Interest and Similar Awards:- a
The pending content that links to this paragraph shall be effective for public business entities for annual periods beginning after December 15, 2024, and interim periods within those annual periods. - b
For entities other than public business entities, the pending content that links to this paragraph shall be effective for annual periods beginning after December 15, 2025, and interim periods within those annual periods.
- c
Early adoption of the pending content that links to this paragraph is permitted for both interim and annual financial statements that have not yet been issued or made available for issuance. If an entity adopts the pending content that links to this paragraph in an interim period, it shall adopt the pending content as of the beginning of the annual period that includes that interim period.
- d
An entity shall apply the pending content that links to this paragraph either:
- 1
Retrospectively to all prior periods presented in the financial statements in accordance with paragraphs . An entity that selects retrospective application shall provide the disclosures in paragraphs in the period of adoption. - 2
Prospectively to profits interest or similar awards granted or modified on or after the date at which the entity first applies the pending content that links to this paragraph with disclosure that describes the nature of and reason for the change in accounting principle.
The following table identifies the changes made to this Subtopic.
See paragraph 718-10-S99-1, SAB Topic 14.A, for SEC Staff views regarding the applicability of Topic 718 to transactions with nonemployees. See paragraph 718-10-S99-2: SEC Staff Announcement: Escrowed Share Arrangements and the Presumption of Compensation, for SEC Staff views on the accounting for escrowed share arrangements. See paragraph
480-10-S99-3A, SEC Staff Announcement: Classification and Measurement of Redeemable Securities, for SEC Staff views on the accounting for options or similar instruments granted in conjunction with share-based payment arrangements with employees for which the terms may permit redemption of the option or underlying share.
See paragraph 718-10-S99-1, SAB Topic 14.F, for SEC Staff views on income statement presentation of the expense related to share-based payment arrangements. See paragraph
480-10-S99-3A, SEC Staff Announcement: Classification and Measurement of Redeemable Securities, for SEC Staff views on classification of certain employee share-based payment awards with redemption features.
See paragraph 718-10-S99-1, SAB Topic 14.B, Question 4, for SEC Staff views on appropriate disclosures upon becoming a public entity in addition to those prescribed by paragraphs . See paragraph 718-10-S99-1, SAB Topic 14.C, Question 3, for SEC Staff views on disclosures pertaining to a change in valuation technique or model used to value instruments. See paragraph 718-10-S99-1, SAB Topic 14.D, for SEC Staff views on disclosures pertaining to changes in assumptions used in valuation models. See paragraph 718-10-S99-1, SAB Topic 14.D.1, Question 5, for SEC Staff views on disclosures pertaining to an entity's assumption of expected volatility. See paragraph
718-10-S99-1, SAB Topic 14.D.2, Question 6, for SEC Staff views on disclosures pertaining to an entity's assumption of expected term.
See paragraph 718-10-S99-1, SAB Topic 14.H, for SEC Staff views on interim disclosures pertaining to the first time adoption of Topic 718. See paragraph 718-10-S99-1, SAB Topic 14.K, for SEC Staff views on disclosures pertaining to the modification of significant terms of outstanding awards. See paragraph 718-10-S99-1, SAB Topic 14.B., for SEC Staff views on issues pertaining to the transition from a nonpublic to a public entity. See paragraph 718-10-S99-1, SAB Topic 14.C, for SEC Staff views on the use of valuation techniques or models to estimate fair value. See paragraph 718-10-S99-1, SAB Topic 14.D.1, for SEC Staff views on the factors to be considered when estimating expected volatility. See paragraph 718-10-S99-1, SAB Topic 14.D.2, for SEC Staff views on factors to be considered when estimating expected term. See paragraph 718-10-S99-1, SAB Topic 14.K, for SEC Staff views on the modification of employee share options before the adoption of Topic 718. See paragraph 718-10-S99-1, SAB Topic 14.L, for SEC Staff views on the application of the measurement provisions of Topic 718 to foreign private issuers. See paragraph 323-10-S99-4, SEC Observer Comment: Accounting by an Investor for Stock-based Compensation Granted to Employees of an Equity Method Investee, for SEC Staff views on classification by an investor of investor shares issued to employees of an equity method investee. The following is the text of SAB Topic 14, Share-Based Payment.
The interpretations in this SAB express views of the staff regarding the interaction between FASB ASC Topic 718, Compensation—Stock Compensation, and certain SEC rules and regulations and provide the staff's views regarding the valuation of share-based payment arrangements for public companies. FASB ASC Topic 718 is based on the underlying accounting principle that compensation cost resulting from share-based payment transactions be recognized in financial statements at fair value. FN1 Recognition of compensation cost at fair value will provide investors and other users of financial statements with more complete and comparable financial information. FN1 FASB ASC paragraphs .
FASB ASC Topic 718 addresses a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. FASB ASC Topic 718 replaced guidance originally issued in 1995 that established as preferable, but did not require, a fair-value-based method of accounting for share-based payment transactions with employees. It also replaced guidance originally issued in 1996 that provided different recognition and measurement requirements for share-based payment awards granted to nonemployees than for those granted to employees. The staff believes the guidance in this SAB will assist issuers in their application of FASB ASC Topic 718 and enhance the information received by investors and other users of financial statements, thereby assisting them in making investment and other decisions. This SAB includes interpretive guidance related to the transition from nonpublic to public entity FN2 status, valuation methods (including assumptions such as expected volatility, expected term, and current price of the underlying share, particularly when valuing spring-loaded awardsFN3), the accounting for certain redeemable financial instruments issued under share-based payment arrangements, the classification of compensation expense, and capitalization of compensation cost related to share-based payment arrangements. FN2 Defined in the FASB ASC Master Glossary.
FN3 A share-based payment award granted when a company is in possession of material nonpublic information to which the market is likely to react positively when the information is announced is sometimes referred to as being \"spring-loaded.\" The interpretive guidance included in this SAB with respect to spring-loaded share-based payment awards is not limited to share options, and applies to all instruments including, for example, restricted stock units.
The staff recognizes that there is a range of conduct that a reasonable issuer might use to make estimates and valuations and otherwise apply FASB ASC Topic 718, and the interpretive guidance provided by this SAB. Thus, throughout this SAB the use of the terms \"reasonable\" and \"reasonably\" is not meant to imply a single conclusion or methodology, but to encompass the full range of potential conduct, conclusions or methodologies upon which an issuer may reasonably base its valuation decisions. Different conduct, conclusions or methodologies by different issuers in a given situation does not of itself raise an inference that any of those issuers is acting unreasonably. While the zone of reasonable conduct is not unlimited, the staff expects that it will be rare, except when observable market prices of identical or similar equity or liability instruments in active markets are available, when there is only one acceptable choice in estimating the fair value of share-based payment arrangements under the provisions of FASB ASC Topic 718 and the interpretive guidance provided by this SAB in any given situation. In addition, as discussed in the Interpretive Response to Question 1 of Section C, Valuation Methods, estimates of fair value are not intended to predict actual future events, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made under FASB ASC Topic 718. A. Removed by SAB 120
B. Transition From Nonpublic to Public Entity Status
Facts: Company A is a nonpublic entity FN4 that first files a registration statement with the SEC to register its equity securities for sale in a public market on January 2, 20X8. As a nonpublic entity, Company A had been assigning value to its share options FN5 under the calculated value method prescribed by FASB ASC Topic 718, Compensation—Stock Compensation, FN6 and had elected to measure its liability awards based on intrinsic value. Company A is considered a public entity on January 2, 20X8 when it makes its initial filing with the SEC in preparation for the sale of its shares in a public market. FN4 Defined in the FASB ASC Master Glossary.
FN5 For purposes of this staff accounting bulletin, the phrase \"share options\" is used to refer to \"share options or similar instruments.\"
FN6 FASB ASC paragraph 718-10-30-20 requires a nonpublic entity to use the calculated value method when it is not able to reasonably estimate the fair value of its equity share options and similar instruments because it is not practicable for it to estimate the expected volatility of its share price. FASB ASC paragraph 718-10-55-51 indicates that a nonpublic entity may be able to identify similar public entities for which share or option price information is available and may consider the historical, expected, or implied volatility of those entities' share prices in estimating expected volatility. The staff would expect an entity that becomes a public entity and had previously measured its share options under the calculated value method to be able to support its previous decision to use calculated value and to provide the disclosures required by FASB ASC subparagraph 718-10-50-2(f)(2)(ii).
Question 1: How should Company A account for the share options that were granted prior to January 2, 20X8 for which the requisite service has not been rendered by January 2, 20X8?
Interpretive Response: Prior to becoming a public entity, Company A had been assigning value to its share options under the calculated value method. The staff believes that Company A should continue to follow that approach for those share options that were granted prior to January 2, 20X8, unless those share options are subsequently modified, repurchased or cancelled. FN7 If the share options are subsequently modified, repurchased or cancelled, Company A would assess the event under the public company provisions of FASB ASC Topic 718. For example, if Company A modified the share options on February 1, 20X8, any incremental compensation cost would be measured under FASB ASC subparagraph 718-20-35-3(a), as the fair value of the modified share options over the fair value of the original share options measured immediately before the terms were modified. FN8 FN7 This view is consistent with the FASB's basis for rejecting full retrospective application of FASB ASC Topic 718 as described in the basis for conclusions of Statement 123R, paragraph B251. FN8 FASB ASC paragraph 718-20-55-94. The staff believes that because Company A is a public entity as of the date of the modification, it would be inappropriate to use the calculated value method to measure the original share options immediately before the terms were modified.
Question 2: How should Company A account for its liability awards granted prior to January 2, 20X8 that are fully vested but have not been settled by January 2, 20X8?
Interpretive Response: As a nonpublic entity, Company A had elected to measure its liability awards subject to FASB ASC Topic 718 at intrinsic value. FN9 When Company A becomes a public entity, it should measure the liability awards at their fair value determined in accordance with FASB ASC Topic 718. FN10 In that reporting period there will be an incremental amount of measured cost for the difference between fair value as determined under FASB ASC Topic 718 and intrinsic value. For example, assume the intrinsic value in the period ended December 31, 20X7 was $10 per award. At the end of the first reporting period ending after January 2, 20X8 (when Company A becomes a public entity), assume the intrinsic value of the award is $12 and the fair value as determined in accordance with FASB ASC Topic 718 is $15. The measured cost in the first reporting period after December 31, 20X7 would be $5. FN11 Question 3: After becoming a public entity, may Company A retrospectively apply the fair-value-based method to its awards that were granted prior to the date Company A became a public entity?
Interpretive Response: No. Before becoming a public entity, Company A did not use the fair-value-based method for either its share options or its liability awards. The staff does not believe it is appropriate for Company A to apply the fair-value-based method on a retrospective basis, because it would require the entity to make estimates of a prior period, which, due to hindsight, may vary significantly from estimates that would have been made contemporaneously in prior periods. FN12
FN12 This view is consistent with the FASB's basis for rejecting full retrospective application of FASB ASC Topic 718 as described in the basis for conclusions of Statement 123R, paragraph B251.
Question 4: Upon becoming a public entity, what disclosures should Company A consider in addition to those prescribed by FASB ASC Topic 718? FN13 Interpretive Response: In the registration statement filed on January 2, 20X8, Company A should clearly describe in MD&A the change in accounting policy that will be required by FASB ASC Topic 718 in subsequent periods and the reasonably likely material future effects. FN14 In subsequent filings, Company A should provide financial statement disclosure of the effects of the changes in accounting policy. In addition, Company A should consider the requirements of Item 303(b)(3) of Regulation S-K regarding critical accounting estimates in MD&A. C. Valuation Methods
FASB ASC paragraph 718-10-30-6 (Compensation—Stock Compensation Topic) indicates that the measurement objective for equity instruments awarded to grantees is to estimate at the grant date the fair value of the equity instruments the entity is obligated to issue when grantees have delivered the good or rendered the service and satisfied any other conditions necessary to earn the right to benefit from the instruments. FN15 The Topic also states that observable market prices of identical or similar equity or liability instruments in active markets are the best evidence of fair value and, if available, should be used as the basis for the measurement for equity and liability instruments awarded in a share-based payment transaction. FN16 However, if observable market prices of identical or similar equity or liability instruments are not available, the fair value shall be estimated by using a valuation technique or model that complies with the measurement objective, as described in FASB ASC Topic 718. FN17 FN15 FASB ASC paragraph 718-10-30-1 states that this guidance applies equally to awards classified as liabilities.
Question 1: If a valuation technique or model is used to estimate fair value, to what extent will the staff consider a company's estimates of fair value to be materially misleading because the estimates of fair value do not correspond to the value ultimately realized by the grantees who received the share options?
Interpretive Response: The staff understands that estimates of fair value of share options, while derived from expected value calculations, cannot predict actual future events. FN18 The estimate of fair value represents the measurement of the cost of the grantee’s goods or services to the company. The estimate of fair value should reflect the assumptions marketplace participants would use in determining how much to pay for an instrument on the fair value measurement date FN19. For example, valuation techniques used in estimating the fair value of share options may consider information about a large number of possible share price paths, while, of course, only one share price path will ultimately emerge. If a company makes a good faith fair value estimate in accordance with the provisions of FASB ASC Topic 718 in a way that is designed to take into account the assumptions that underlie the instrument's value that marketplace participants would reasonably make, then subsequent future events that affect the instrument's value do not provide meaningful information about the quality of the original fair value estimate. As long as the share options were originally so measured, changes in a share option's value, no matter how significant, subsequent to its grant date do not call into question the reasonableness of the grant date fair value estimate. Question 2: In order to meet the fair value measurement objective in FASB ASC Topic 718, are certain valuation techniques preferred over others? Interpretive Response: FASB ASC paragraph 718-10-55-17 clarifies that the Topic does not specify a preference for a particular valuation technique or model. As stated in FASB ASC paragraph 718-10-55-11 in order to meet the fair value measurement objective, a company should select a valuation technique or model that (a) is applied in a manner consistent with the fair value measurement objective and other requirements of FASB ASC Topic 718, (b) is based on established principles of financial economic theory and generally applied in that field and (c) reflects all substantive characteristics of the instrument (except for those explicitly excluded by FASB ASC Topic 718).
The chosen valuation technique or model must meet all three of the requirements stated above. In valuing a particular instrument, certain techniques or models may meet the first and second criteria but may not meet the third criterion because the techniques or models are not designed to reflect certain characteristics contained in the instrument. For example, for a share option in which the exercisability is conditional on a specified increase in the price of the underlying shares, the Black-Scholes-Merton closed-form model would not generally be an appropriate valuation model because, while it meets both the first and second criteria, it is not designed to take into account that type of market condition. FN20
Further, the staff understands that a company may consider multiple techniques or models that meet the fair value measurement objective before making its selection as to the appropriate technique or model. The staff would not object to a company's choice of a technique or model as long as the technique or model meets the fair value measurement objective. For example, a company is not required to use a lattice model simply because that model was the most complex of the models the company considered.
Question 3: In subsequent periods, may a company change the valuation technique or model chosen to value instruments with similar characteristics? FN21
FN21 FASB ASC paragraph 718-10-55-17 indicates that an entity may use different valuation techniques or models for instruments with different characteristics.
Interpretive Response: As long as the new technique or model meets the fair value measurement objective as described in Question 2 above, the staff would not object to a company changing its valuation technique or model. FN22 A change in the valuation technique or model used to meet the fair value measurement objective would not be considered a change in accounting principle.FN23 As such, a company would not be required to file a preferability letter from its independent accountants as described in Rule 10-01(b)(6) of Regulation S-X when it changes valuation techniques or models. However, the staff would not expect that a company would frequently switch between valuation techniques or models, particularly in circumstances where there was no significant variation in the form of share-based payments being valued. Disclosure in the footnotes of the basis for any change in technique or model would be appropriate. FN24
FN22 The staff believes that a company should take into account the reason for the change in technique or model in determining whether the new technique or model meets the fair value measurement objective. For example, changing a technique or model from period to period for the sole purpose of lowering the fair value estimate of a share option would not meet the fair value measurement objective of the Topic.
Question 4: Must every company that issues share options or similar instruments hire an outside third party to assist in determining the fair value of the share options?
Interpretive Response: No. However, the valuation of a company's share options or similar instruments should be performed by a person with the requisite expertise.
D. Certain Assumptions Used in Valuation Methods
FASB ASC Topic 718's (Compensation—Stock Compensation Topic) fair value measurement objective for equity instruments awarded to grantees for goods or services is to estimate the grant-date fair value of the equity instruments that the entity is obligated to issue when grantees have delivered the good or rendered the service and satisfied any other conditions necessary to earn the right to benefit from the instruments. FN25 In order to meet this fair value measurement objective, management will generally be required to develop estimates regarding (1) the expected volatility of its company's share price; (2) the expected term of the option, taking into account both the contractual term of the option and the effects of grantees’ expected exercise and post-vesting termination behavior; and (3) the determination of the current price of the underlying share. The staff is providing guidance in the following sections related to the expected volatility, expected term and current share price assumptions to assist public entities in applying those requirements. FN25 FASB ASC paragraph 718-10-30-6. FASB ASC paragraph 718-10-30-1 states that this guidance applies equally to awards classified as liabilities.
1. Expected Volatility
FASB ASC paragraph 718-10-55-36 states, \"Volatility is a measure of the amount by which a financial variable, such as share price, has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. Option-pricing models require an estimate of expected volatility as an assumption because an option's value is dependent on potential share returns over the option's term. The higher the volatility, the more the returns on the share can be expected to vary—up or down. Because an option's value is unaffected by expected negative returns on the shares, other things [being] equal, an option on a share with higher volatility is worth more than an option on a share with lower volatility.\" Facts: Company B is a public entity whose common shares have been publicly traded for over twenty years. Company B also has multiple options on its shares outstanding that are traded on an exchange (\"traded options\"). Company B grants share options on January 2, 20X6.
Question 1: What should Company B consider when estimating expected volatility for purposes of measuring the fair value of its share options?
Interpretive Response: FASB ASC Topic 718 does not specify a particular method of estimating expected volatility. However, the Topic does clarify that the objective in estimating expected volatility is to ascertain the assumption about expected volatility that marketplace participants would likely use in determining an exchange price for an option. FN26 FASB ASC Topic 718 provides a list of factors entities should consider in estimating expected volatility. FN27 Company B may begin its process of estimating expected volatility by considering its historical volatility. FN28 However, Company B should also then consider, based on available information, how the expected volatility of its share price may differ from historical volatility. FN29 Implied volatility FN30 can be useful in estimating expected volatility because it is generally reflective of both historical volatility and expectations of how future volatility will differ from historical volatility. FN29 Ibid.
FN30 Implied volatility is the volatility assumption inherent in the market prices of a company's traded options or other financial instruments that have option-like features. Implied volatility is derived by entering the market price of the traded financial instrument, along with assumptions specific to the financial options being valued, into a model based on a constant volatility estimate (e.g., the Black-Scholes-Merton closed-form model) and solving for the unknown assumption of volatility.
The staff believes that companies should make good faith efforts to identify and use sufficient information in determining whether taking historical volatility, implied volatility or a combination of both into account will result in the best estimate of expected volatility. The staff believes companies that have appropriate traded financial instruments from which they can derive an implied volatility should generally consider this measure. The extent of the ultimate reliance on implied volatility will depend on a company's facts and circumstances; however, the staff believes that a company with actively traded options or other financial instruments with embedded options FN31 generally could place greater (or even exclusive) reliance on implied volatility. (See the Interpretive Responses to Questions 3 and 4 below.)
FN31 The staff believes implied volatility derived from embedded options can be utilized in determining expected volatility if, in deriving the implied volatility, the company considers all relevant features of the instruments (e.g., value of the host instrument, value of the option, etc.). The staff believes the derivation of implied volatility from other than simple instruments (e.g., a simple convertible bond) can, in some cases, be impracticable due to the complexity of multiple features.
The process used to gather and review available information to estimate expected volatility should be applied consistently from period to period. When circumstances indicate the availability of new or different information that would be useful in estimating expected volatility, a company should incorporate that information.
Question 2: What should Company B consider if computing historical volatility? FN32
Interpretive Response: The following should be considered in the computation of historical volatility:
1. Method of Computing Historical Volatility—
The staff believes the method selected by Company B to compute its historical volatility should produce an estimate that is representative of a marketplace participant’s expectations about Company B's future volatility over the expected (if using a Black-Scholes-Merton closed-form model) or contractual (if using a lattice model) term FN33 of its share options. Certain methods may not be appropriate for longer term share options if they weight the most recent periods of Company B's historical volatility much more heavily than earlier periods. FN34 For example, a method that applies a factor to certain historical price intervals to reflect a decay or loss of relevance of that historical information emphasizes the most recent historical periods and thus would likely bias the estimate to this recent history. FN35
FN33 For purposes of this staff accounting bulletin, the phrase \"expected or contractual term, as applicable\" has the same meaning as the phrase \"expected (if using a Black-Scholes-Merton closed-form model) or contractual (if using a lattice model) term of a share option.\"
FN34 FASB ASC subparagraph 718-10-55-37(a) states that entities should consider historical volatility over a period generally commensurate with the expected or contractual term, as applicable, of the share option. Accordingly, the staff believes methods that place extreme emphasis on the most recent periods may be inconsistent with this guidance. FN35 Generalized Autoregressive Conditional Heteroskedasticity (GARCH) is an example of a method that demonstrates this characteristic.
2. Amount of Historical Data—
FASB ASC subparagraph 718-10-55-37(a) indicates entities should consider historical volatility over a period generally commensurate with the expected or contractual term, as applicable, of the share option. The staff believes Company B could utilize a period of historical data longer than the expected or contractual term, as applicable, if it reasonably believes the additional historical information will improve the estimate. For example, assume Company B decided to utilize a Black-Scholes-Merton closed-form model to estimate the value of the share options granted on January 2, 20X6 and determined that the expected term was six years. Company B would not be precluded from using historical data longer than six years if it concludes that data would be relevant. 3. Frequency of Price Observations—
FASB ASC subparagraph 718-10-55-37(d) indicates an entity should use appropriate and regular intervals for price observations based on facts and circumstances that provide the basis for a reasonable fair value estimate. Accordingly, the staff believes Company B should consider the frequency of the trading of its shares and the length of its trading history in determining the appropriate frequency of price observations. The staff believes using daily, weekly or monthly price observations may provide a sufficient basis to estimate expected volatility if the history provides enough data points on which to base the estimate. FN36 Company B should select a consistent point in time within each interval when selecting data points. FN37 FN36 Further, if shares of a company are thinly traded the staff believes the use of weekly or monthly price observations would generally be more appropriate than the use of daily price observations. The volatility calculation using daily observations for such shares could be artificially inflated due to a larger spread between the bid and asked quotes and lack of consistent trading in the market.
FN37 FASB ASC paragraph 718-10-55-40 states that a company should establish a process for estimating expected volatility and apply that process consistently from period to period. In addition, FASB ASC paragraph 718-10-55-27 indicates that assumptions used to estimate the fair value of instruments granted in share-based payment transactions should be determined in a consistent manner from period to period.
4. Consideration of Future Events—
The objective in estimating expected volatility is to ascertain the assumptions that marketplace participants would likely use in determining an exchange price for an option. FN38 Accordingly, the staff believes that Company B should consider those future events that it reasonably concludes a marketplace participant would also consider in making the estimation. For example, if Company B has recently announced a merger with a company that would change its business risk in the future, then it should consider the impact of the merger in estimating the expected volatility if it reasonably believes a marketplace participant would also consider this event.
The staff believes that careful consideration is required to determine whether material non-public information is currently available (or would be available) to the issuer that would be considered by a marketplace participant in estimating the expected volatility. FN39 For example, if Company B has entered into a material transaction that has not yet been announced prior to its grant of equity instruments, the specific facts and circumstances of the material transaction may lead Company B to conclude that the impact of this event should be included in estimating the expected volatility when determining the grant-date fair value of those equity instruments.
FN39 FASB ASC paragraph 718-10-55-13 states \"assumptions shall reflect information that is (or would be) available to form the basis for an amount at which the instruments being valued would be exchanged. In estimating fair value, the assumptions used shall not represent the biases of a particular party.\"
5. Exclusion of Periods of Historical Data—
In some instances, due to a company's particular business situations, a period of historical volatility data may not be relevant in evaluating expected volatility. FN40 In these instances, that period should be disregarded. The staff believes that if Company B disregards a period of historical volatility, it should be prepared to support its conclusion that its historical share price during that previous period is not relevant to estimating expected volatility due to one or more discrete and specific historical events and that similar events are not expected to occur during the expected term of the share option. The staff believes these situations would be rare.
Question 3: What should Company B consider when evaluating the extent of its reliance on the implied volatility derived from its traded options?
Interpretive Response: To achieve the objective of estimating expected volatility as stated in FASB ASC paragraphs , the staff believes Company B generally should consider the following in its evaluation: 1) the volume of market activity of the underlying shares and traded options;
2) the ability to synchronize the variables used to derive implied volatility;
3) the similarity of the exercise prices of the traded options to the exercise price of the newly-granted share options;
4) the similarity of the length of the term of the traded and newly-granted share options; FN41 and
5) consideration of material non-public information.
FN41 See generally Options, Futures, and Other Derivatives by John C. Hull (Pearson, 11th Edition, 2021).
1. Volume of Market Activity—
The staff believes Company B should consider the volume of trading in its underlying shares as well as the traded options. For example, prices for instruments in actively traded markets are more likely to reflect a marketplace participant's expectations regarding expected volatility.
2. Synchronization of the Variables—
Company B should synchronize the variables used to derive implied volatility. For example, to the extent reasonably practicable, Company B should use market prices (either traded prices or the average of bid and asked quotes) of the traded options and its shares measured at the same point in time. This measurement should also be synchronized with the grant of the share options; however, when this is not reasonably practicable, the staff believes Company B should derive implied volatility as of a point in time as close to the grant of the share options as reasonably practicable.
3. Similarity of the Exercise Prices—
The staff believes that when valuing an at-the-money share option, the implied volatility derived from at- or near-the-money traded options generally would be most relevant. FN42 If, however, it is not possible to find at- or near-the-money traded options, Company B should select multiple traded options with an average exercise price close to the exercise price of the share option. FN43
FN42 Implied volatilities of options differ systematically over the \"moneyness\" of the option. This pattern of implied volatilities across exercise prices is known as the \"volatility smile\" or \"volatility skew.\" Studies such as \"Implied Volatility\" by Stewart Mayhew, Financial Analysts Journal, July-August 1995, as well as more recent studies, have found that implied volatilities based on near-the-money options do as well as sophisticated weighted implied volatilities in estimating expected volatility. In addition, the staff believes that because near-the-money options are generally more actively traded, they may provide a better basis for deriving implied volatility.
FN43 The staff believes a company could use a weighted-average implied volatility based on traded options that are either in-the-money or out-of-the-money. For example, if the share option has an exercise price of $52, but the only traded options available have exercise prices of $50 and $55, then the staff believes that it is appropriate to use a weighted average based on the implied volatilities from the two traded options; for this example, a 40% weight on the implied volatility calculated from the option with an exercise price of $55 and a 60% weight on the option with an exercise price of $50.
4. Similarity of Length of Terms—
The staff believes that when valuing a share option with a given expected or contractual term, as applicable, the implied volatility derived from a traded option with a similar term would be the most relevant. However, if there are no traded options with maturities that are similar to the share option's contractual or expected term, as applicable, then the staff believes Company B could consider traded options with a remaining maturity of six months or greater. FN44 However, when using traded options with a term of less than one year, FN45 the staff would expect the company to also consider other relevant information in estimating expected volatility. In general, the staff believes more reliance on the implied volatility derived from a traded option would be expected the closer the remaining term of the traded option is to the expected or contractual term, as applicable, of the share option.
FN44 The staff believes it may also be appropriate to consider the entire term structure of volatility provided by traded options with a variety of remaining maturities. If a company considers the entire term structure in deriving implied volatility, the staff would expect a company to include some options in the term structure with a remaining maturity of six months or greater.
FN45 The staff believes the implied volatility derived from a traded option with a term of one year or greater would typically not be significantly different from the implied volatility that would be derived from a traded option with a significantly longer term.
5. Consideration of Material Nonpublic Information—
When a company is in possession of material non-public information, the staff believes that the related guidance in the interpretive response to Question 2 above would also be relevant in determining whether the implied volatility appropriately reflects a marketplace participant’s expectations of future volatility.
The staff believes Company B's evaluation of the factors above should assist in determining whether the implied volatility appropriately reflects the market's expectations of future volatility and thus the extent of reliance that Company B reasonably places on the implied volatility.
Question 4: Are there situations in which it is acceptable for Company B to rely exclusively on either implied volatility or historical volatility in its estimate of expected volatility?
Interpretive Response: As stated above, FASB ASC Topic 718 does not specify a method of estimating expected volatility; rather, it provides a list of factors that should be considered and requires that an entity's estimate of expected volatility be reasonable and supportable. FN46 Many of the factors listed in FASB ASC Topic 718 are discussed in Questions 2 and 3 above. The objective of estimating volatility, as stated in FASB ASC Topic 718, is to ascertain the assumption about expected volatility that marketplace participants would likely use in determining an exchange price for an option. FN47 The staff believes that a company, after considering the factors listed in FASB ASC Topic 718, could, in certain situations, reasonably conclude that exclusive reliance on either historical or implied volatility would provide an estimate of expected volatility that meets this stated objective. FN46 FASB ASC paragraphs .
The staff would not object to Company B placing exclusive reliance on implied volatility when the following factors are present, as long as the methodology is consistently applied:
• Company B utilizes a valuation model that is based upon a constant volatility assumption to value its share options; FN48
FN48 FASB ASC paragraphs 718-10-55-18 and 718-10-55-39 discuss the incorporation of a range of expected volatilities into option pricing models. The staff believes that a company that utilizes an option pricing model that incorporates a range of expected volatilities over the option's contractual term should consider the factors listed in FASB ASC Topic 718, and those discussed in the Interpretive Responses to Questions 2 and 3 above, to determine the extent of its reliance (including exclusive reliance) on the derived implied volatility.
• The implied volatility is derived from options that are actively traded;
• The market prices (trades or quotes) of both the traded options and underlying shares are measured at a similar point in time to each other and on a date reasonably close to the fair value measurement date of the share options;
• The traded options have exercise prices that are both (a) near-the-money and (b) close to the exercise price of the share options; FN49
FN49 When near-the-money options are not available, the staff believes the use of a weighted-average approach, as noted previously, may be appropriate.
• The remaining maturities of the traded options on which the estimate is based are at least one year, and
• Material nonpublic information that would be considered in a marketplace participant’s expectation of future volatility does not exist.
The staff would not object to Company B placing exclusive reliance on historical volatility when the following factors are present, so long as the methodology is consistently applied:
• Company B has no reason to believe that its future volatility over the expected or contractual term, as applicable, is likely to differ from its past; FN50
FN50 See FASB ASC paragraph 718-10-55-38. A change in a company's business model that results in a material alteration to the company's risk profile is an example of a circumstance in which the company's future volatility would be expected to differ from its historical volatility. Other examples may include, but are not limited to, the introduction of a new product that is central to a company's business model or the receipt of U.S. Food and Drug Administration approval for the sale of a new prescription drug.
• The computation of historical volatility uses a simple average calculation method;
• A sequential period of historical data at least equal to the expected or contractual term of the share option, as applicable, is used; and
• A reasonably sufficient number of price observations are used, measured at a consistent point throughout the applicable historical period. FN51
FN51 If the expected or contractual term, as applicable, of the employee share option is less than three years, the staff believes monthly price observations would not provide a sufficient amount of data.
Question 5: What disclosures would the staff expect Company B to include in its financial statements and MD&A regarding its assumption of expected volatility?
Interpretive Response: FASB ASC paragraph 718-10-50-2 prescribes the minimum information needed to achieve the Topic's disclosure objectives. FN52 Under that guidance, Company B is required to disclose the expected volatility and the method used to estimate it. FN53 Accordingly, the staff expects that, at a minimum, Company B would disclose in a footnote to its financial statements how it determined the expected volatility assumption for purposes of determining the fair value of its share options in accordance with FASB ASC Topic 718. For example, at a minimum, the staff would expect Company B to disclose whether it used only implied volatility, historical volatility, or a combination of both, and how it determined any significant adjustments to historical volatility. In addition, Company B should consider the requirements of Regulation S-K Item 303(b)(3) regarding critical accounting estimates in MD&A. A company should determine whether its evaluation of any of the factors listed in Questions 2 and 3 of this section, such as consideration of future events in estimating expected volatility, resulted in an estimate that involves a significant level of estimation uncertainty and has had or is reasonably likely to have a material impact on the financial condition or results of operations of the company.
Facts: Company C is a newly public entity with limited historical data on the price of its publicly-traded shares and no other traded financial instruments. Company C believes that it does not have sufficient company-specific information regarding the volatility of its share price on which to base an estimate of expected volatility.
Question 6: What other sources of information should Company C consider in order to estimate the expected volatility of its share price?
Interpretive Response: FASB ASC Topic 718 provides guidance on estimating expected volatility for newly-public and nonpublic entities that do not have company-specific historical or implied volatility information available. FN54 Company C may base its estimate of expected volatility on the historical, expected or implied volatility of similar entities whose share or option prices are publicly available. In making its determination as to similarity, Company C would likely consider the industry, stage of life cycle, size and financial leverage of such other entities. FN55 The staff would not object to Company C looking to an industry sector index (e.g., NASDAQ Computer Index) that is representative of Company C's industry, and possibly its size, to identify one or more similar entities. FN56 Once Company C has identified similar entities, it would substitute a measure of the individual volatilities of the similar entities for the expected volatility of its share price as an assumption in its valuation model. FN57 Because of the effects of diversification that are present in an industry sector index, Company C should not substitute the volatility of an index for the expected volatility of its share price as an assumption in its valuation model. FN58
FN56 If a company operates in a number of different industries, it could look to several industry indices. However, when considering the volatilities of multiple companies, each operating only in a single industry, the staff believes a company should take into account its own leverage, the leverages of each of the entities, and the correlation of the entities' stock returns.
After similar entities have been identified, Company C should continue to consider the volatilities of those entities unless circumstances change such that the identified entities are no longer similar to Company C. Until Company C has sufficient information available, the staff would not object to Company C basing its estimate of expected volatility on the volatility of similar entities for those periods for which it does not have sufficient information available. FN59 Until Company C has either a sufficient amount of historical information regarding the volatility of its share price or other traded financial instruments are available to derive an implied volatility to support an estimate of expected volatility, it should consistently apply a process as described above to estimate expected volatility based on the volatilities of similar entities. FN60
FN59 FASB ASC paragraph 718-10-55-37. The staff believes that at least two years of daily or weekly historical data could provide a reasonable basis on which to base an estimate of expected volatility if a company has no reason to believe that its future volatility will differ materially during the expected or contractual term, as applicable, from the volatility calculated from this past information. If the expected or contractual term, as applicable, of a share option is shorter than two years, the staff believes a company should use daily or weekly historical data for at least the length of that applicable term.
2. Expected Term
FASB ASC paragraph 718-10-55-29 states, \"The fair value of a traded (or transferable) share option is based on its contractual term because rarely is it economically advantageous to exercise, rather than sell, a transferable share option before the end of its contractual term. Employee share options generally differ from transferable [or tradable] share options in that employees cannot sell (or hedge) their share options—they can only exercise them; because of this, employees generally exercise their options before the end of the options' contractual term. Thus, the inability to sell or hedge an employee share option effectively reduces the option's value [compared to a transferable option] because exercise prior to the option's expiration terminates its remaining life and thus its remaining time value.\" Accordingly, FASB ASC Topic 718 requires that when valuing an employee share option under the Black-Scholes-Merton framework the fair value of employee share options be based on the share options' expected term rather than the contractual term. FASB ASC paragraph 718-10-55-29A states, \"On an award-by-award basis, an entity may elect to use the contractual term as the expected term when estimating the fair value of a nonemployee award to satisfy the measurement objective in paragraph 718-10-30-6. Otherwise, an entity shall apply the guidance in [Topic 718] in estimating the expected term of a nonemployee award, which may result in a term less than the contractual term of the award. If an entity does not elect to use the contractual term as the expected term, similar considerations discussed in paragraph 718-10-55-29, such as the inability to sell or hedge a nonemployee award, apply when estimating its expected term.\" The staff believes the estimate of expected term should be based on the facts and circumstances available in each particular case. Consistent with our Topic 14 introductory guidance regarding reasonableness, the fact that other possible estimates are later determined to have more accurately reflected the term does not necessarily mean that the particular choice was unreasonable. The staff reminds registrants of the expected term disclosure requirements described in FASB ASC subparagraph 718-10-50-2(f)(2)(i). Facts: Company D utilizes the Black-Scholes-Merton closed-form model to value its share options for the purposes of determining the fair value of the options under FASB ASC Topic 718. Company D recently granted share options to its employees. Based on its review of various factors, Company D determines that the expected term of the options is six years, which is less than the contractual term of ten years. Question 1: When determining the fair value of the share options in accordance with FASB ASC Topic 718, should Company D consider an additional discount for nonhedgability and nontransferability? Interpretive Response: No. FASB ASC paragraph 718-10-55-29 indicates that nonhedgability and nontransferability have the effect of increasing the likelihood that an employee share option will be exercised before the end of its contractual term. Nonhedgability and nontransferability therefore factor into the expected term assumption (in this case reducing the term assumption from ten years to six years), and the expected term reasonably adjusts for the effect of these factors. Accordingly, the staff believes that no additional reduction in the term assumption or other discount to the estimated fair value is appropriate for these particular factors. FN61 FN61 The staff notes the existence of academic literature that supports the assertion that the Black-Scholes-Merton closed-form model, with expected term as an input, can produce reasonable estimates of fair value. Such literature includes J. Carpenter, \"The exercise and valuation of executive stock options,\" Journal of Financial Economics, May 1998, pp.127-158; C. Marquardt, \"The Cost of Employee Stock Option Grants: An Empirical Analysis,\" Journal of Accounting Research, September 2002, p. 1191-1217); and J. Bettis, J. Bizjak and M. Lemmon, \"Exercise behavior, valuation, and the incentive effect of employee stock options,\" Journal of Financial Economics, May 2005, pp. 445-470, as well as more recent studies.
Question 2: Should forfeitures or terms that stem from forfeitability be factored into the determination of expected term?
Interpretive Response: No. FASB ASC Topic 718 indicates that the expected term that is utilized as an assumption in a closed-form option-pricing model or a resulting output of a lattice option pricing model when determining the fair value of the share options should not incorporate restrictions or other terms that stem from the pre-vesting forfeitability of the instruments. Under FASB ASC Topic 718, these pre-vesting restrictions or other terms are taken into account by ultimately recognizing compensation cost only for awards for which grantees deliver the good or render the requisite service. FN62 Question 3: Can a company's estimate of expected term ever be shorter than the vesting period?
Interpretive Response: No. The vesting period forms the lower bound of the estimate of expected term. FN63
Question 4: FASB ASC paragraph 718-10-55-34indicates that an entity shall aggregate individual awards into relatively homogenous groups with respect to exercise and post-vesting employment termination behaviors for the purpose of determining expected term, regardless of the valuation technique or model used to estimate the fair value. How many groupings are typically considered sufficient? Interpretive Response: As it relates to employee groupings, the staff believes that an entity may generally make a reasonable fair value estimate with as few as one or two groupings. FN64
FN64 The staff believes the focus should be on groups of employees with significantly different expected exercise behavior. Academic research suggests two such groups might be executives and non-executives. A study by S. Huddart found executives and other senior managers to be significantly more patient in their exercise behavior than more junior employees. (Employee rank was proxied for by the number of options issued to that employee.) See S. Huddart, \"Patterns of stock option exercise in the United States,\" in: J. Carpenter and D. Yermack, eds., Executive Compensation and Shareholder Value: Theory and Evidence (Kluwer, Boston, MA, 1999), pp. 115-142. See also S. Huddart and M. Lang, \"Employee stock option exercises: An empirical analysis,\" Journal of Accounting and Economics, 1996, pp. 5-43.
Question 5: What approaches could a company use to estimate the expected term of its employee share options?
Interpretive Response: A company should use an approach that is reasonable and supportable under FASB ASC Topic 718's fair value measurement objective, which establishes that assumptions and measurement techniques should be consistent with those that marketplace participants would be likely to use in determining an exchange price for the share options. FN65 If, in developing its estimate of expected term, a company determines that its historical share option exercise experience is the best estimate of future exercise patterns, the staff will not object to the use of the historical share option exercise experience to estimate expected term. FN66 A company may also conclude that its historical share option exercise experience does not provide a reasonable basis upon which to estimate expected term. This may be the case for a variety of reasons, including, but not limited to, the life of the company and its relative stage of development, past or expected structural changes in the business, differences in terms of past equity-based share option grants, FN67 or a lack of variety of price paths that the company may have experienced. FN68
FN67 For example, if a company had historically granted share options that were always in-the-money, and will grant at-the-money options prospectively, the exercise behavior related to the in-the-money options may not be sufficient as the sole basis to form the estimate of expected term for the at-the-money grants.
FN68 For example, if a company had a history of previous equity-based share option grants and exercises only in periods in which the company's share price was rising, the exercise behavior related to those options may not be sufficient as the sole basis to form the estimate of expected term for current option grants.
FASB ASC Topic 718 describes other alternative sources of information that might be used in those cases when a company determines that its historical share option exercise experience does not provide a reasonable basis upon which to estimate expected term. For example, a lattice model (which by definition incorporates multiple price paths) can be used to estimate expected term as an input into a Black-Scholes-Merton closed-form model. FN69 In addition, FASB ASC paragraph 718-10-55-32 states that \"…expected term might be estimated in some other manner, taking into account whatever relevant and supportable information is available, including industry averages and other pertinent evidence such as published academic research.\" For example, data about exercise patterns of employees in similar industries and/or situations as the company's might be used. Facts: Company E grants equity share options to its employees that have the following basic characteristics: FN70
• The share options are granted at-the-money;
• Exercisability is conditional only on performing service through the vesting date; FN71
• If an employee terminates service prior to vesting, the employee would forfeit the share options;
• If an employee terminates service after vesting, the employee would have a limited time to exercise the share options (typically 30-90 days); and
• The share options are nontransferable and nonhedgeable.
Company E utilizes the Black-Scholes-Merton closed-form model for valuing its employee share options.
Question 6: As share options with these \"plain vanilla\" characteristics have been granted in significant quantities by many companies in the past, is the staff aware of any \"simple\" methodologies that can be used to estimate expected term?
Interpretive Response: The staff understands that an entity that is unable to rely on its historical exercise data may find that certain alternative information, such as exercise data relating to employees of other companies, is not easily obtainable. As such, some companies may encounter difficulties in making a refined estimate of expected term. Accordingly, if a company concludes that its historical share option exercise experience does not provide a reasonable basis upon which to estimate expected term, the staff will accept the following \"simplified\" method for \"plain vanilla\" options consistent with those in the fact set above: Expected term = ((vesting term + original contractual term) / 2). Assuming a ten year original contractual term and graded vesting over four years (25% of the options in each grant vest annually) for the share options in the fact set described above, the resultant expected term would be 6.25 years. FN72 Academic research on the exercise of options issued to executives provides some general support for outcomes that would be produced by the application of this method. FN73
FN72 Calculated as [[[1 year vesting term (for the first 25% vested) plus 2 year vesting term (for the second 25% vested) plus 3 year vesting term (for the third 25% vested) plus 4 year vesting term (for the last 25% vested)] divided by 4 total years of vesting] plus 10 year contractual life] divided by 2; that is, (((1+2+3+4)/4) + 10) /2 = 6.25 years.
FN73 J.N. Carpenter, \"The exercise and valuation of executive stock options,\" Journal of Financial Economics, 1998, pp.127-158 studies a sample of 40 NYSE and AMEX firms over the period 1979-1994 with share option terms reasonably consistent to the terms presented in the fact set and example. The mean time to exercise after grant was 5.83 years and the median was 6.08 years. The \"mean time to exercise\" is shorter than expected term since the study's sample included only exercised options. Other research on executive options includes (but is not limited to) J. Carr Bettis; John M. Bizjak; and Michael L. Lemmon, \"Exercise behavior, valuation, and the incentive effects of employee stock options,\" Journal of Financial Economics, May 2005, pp. 445-470. One of the few studies on nonexecutive employee options the staff is aware of is S. Huddart, \"Patterns of stock option exercise in the United States,\" in: J. Carpenter and D. Yermack, eds., Executive Compensation and Shareholder Value: Theory and Evidence (Kluwer, Boston, MA, 1999), pp. 115-142.
Examples of situations in which the staff believes that it may be appropriate to use this simplified method include the following:
• A company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time its equity shares have been publicly traded.
• A company significantly changes the terms of its share option grants or the types of employees that receive share option grants such that its historical exercise data may no longer provide a reasonable basis upon which to estimate expected term.
• A company has or expects to have significant structural changes in its business such that its historical exercise data may no longer provide a reasonable basis upon which to estimate expected term.
The staff understands that a company may have sufficient historical exercise data for some of its share option grants but not for others. In such cases, the staff will accept the use of the simplified method for only some but not all share option grants. The staff also does not believe that it is necessary for a company to consider using a lattice model before it decides that it is eligible to use this simplified method. Further, the staff will not object to the use of this simplified method in periods prior to the time a company's equity shares are traded in a public market.
If a company uses this simplified method, the company should disclose in the notes to its financial statements the use of the method, the reason why the method was used, the types of share option grants for which the method was used if the method was not used for all share option grants, and the periods for which the method was used if the method was not used in all periods. Companies that have sufficient historical share option exercise experience upon which to estimate expected term may not apply this simplified method. In addition, this simplified method is not intended to be applied as a benchmark in evaluating the appropriateness of more refined estimates of expected term.
The staff does not expect that such a simplified method would be used for share option grants when more relevant detailed information becomes widely available.
3. Current Price of the Underlying Share (Including Considerations for Spring-Loaded Grants)
FASB ASC paragraph 718-10-55-21 states that \"if an observable market price is not available for a share option or similar instrument with the same or similar terms and conditions, an entity shall estimate the fair value of that instrument using a valuation technique or model that meets the requirements in paragraph718-10-55-11,\" and requires such valuation technique or model to take into account, at a minimum a number of factors including the current price of the underlying share. FASB ASC paragraph 718-10-55-27 states, \"Assumptions used to estimate the fair value of equity and liability instruments granted in share-based payment transactions shall be determined in a consistent manner from period to period. For example, an entity might use the closing share price or the share price at another specified time as the current share price on the grant date in estimating fair value, but whichever method is selected, it shall be used consistently.\" For a valuation technique to be consistent with the fair value measurement objective and the other requirements of Topic 718, the staff believes that a consistently applied method to determine the current price of the underlying share should include consideration of whether adjustments to observable market prices (e.g.,the closing share price or the share price at another specified time) are required. Such adjustments may be required, for example, when the observable market price does not reflect certain material non-public information known to the company but unavailable to marketplace participants at the time the market price is observed. Determining whether an adjustment to the observable market price is necessary, and if so, the magnitude of any adjustment, requires significant judgment. The staff acknowledges that companies generally possess non-public information when entering into share-based payment transactions. The staff believes that an observable market price on the grant date is generally a reasonable and supportable estimate of the current price of the underlying share in a share-based payment transaction, for example, when estimating the grant-date fair value of a routine annual grant to employees that is not designed to be spring-loaded.
However, companies should carefully consider whether an adjustment to the observable market price is required, for example, when share-based payments arrangements are entered into in contemplation of or shortly before a planned release of material non-public information, and such information is expected to result in a material increase in share price. The staff believes that non-routine spring-loaded grants merit particular scrutiny by those charged with compensation and financial reporting governance. Additionally, when a company has a planned release of material non-public information within a short period of time after the measurement date of a share-based payment, the staff believes a material increase in the market price of the company’s shares upon release of such information indicates marketplace participants would have considered an adjustment to the observable market price on the measurement date to determine the current price of the underlying share.
Facts: Company D is a public company that entered into a material contract with a customer after market close. Subsequent to entering into the contract but before the market opens the next trading day, Company D awards share options to its executives. The share option award is non-routine, and the award is approved by the Board of Directors in contemplation of the material contract. Company D expects the share price to increase significantly once the announcement of the contract is made the next day. Company D’s accounting policy is to consistently use the closing share price on the day of the grant as the current share price in estimating the grant-date fair value of share options.
Question 1: Should Company D make an adjustment to the closing share price to determine the current price of shares underlying share options?
Interpretive Response: Prior to awarding share options in this fact pattern, the staff expects Company D to consider whether such awards are consistent with its policies and procedures, including the terms of the compensation plan approved by shareholders, other governance policies, and legal requirements. The staff reminds companies of the importance of strong corporate governance and controls in granting share options, as well as the requirements to maintain effective internal control over financial reporting and disclosure controls and procedures.
In estimating the grant-date fair value of share options in this fact pattern, absent an adjustment to the closing share price to reflect the impact of Company D’s new material contract with a customer, the staff believes the closing share price would not be a reasonable and supportable estimate and, without an adjustment the valuation of the award would not meet the fair value measurement objective of FASB ASC Topic 718 because the closing share price would not reflect a price that is unbiased for marketplace participants at the time of the grant. FN74 Question 2: What disclosures would the staff expect Company D to include in its financial statements regarding its determination of the current price of shares underlying newly-granted share options?
Interpretive Response: FASB ASC paragraph 718-10-50-1 requires disclosure of information that enables users of the financial statements to understand, among other things, the nature and terms of share-based payment arrangements that existed during the period and the potential effects of those arrangements on shareholders. FASB ASC paragraph 718-10-50-2 prescribes the minimum information needed to achieve the Topic’s disclosure objectives, including a description of the method used and significant assumptions used to estimate the fair value of awards under share-based payment arrangements. Accordingly, the staff expects that, at a minimum, Company D would disclose in a footnote to its financial statements how it determined the current price of shares underlying share options for purposes of determining the grant-date fair value of its share options in accordance with FASB ASC Topic 718. For example, the staff would expect Company D to disclose its accounting policy related to how it identifies when an adjustment to the closing price is required, how it determined the amount of the adjustment to the closing share price, and any significant assumptions used to determine such adjustment, if material. Further, the characteristics of the share options, including their spring-loaded nature, may differ from Company D’s other share-based payment arrangements to such an extent Company D should disclose information regarding these share options separately from other share-based payment arrangements to allow investors to understand Company D’s use of share-based compensation. FN75 Additionally, Company D should consider the applicability of MD&A and other disclosure requirements, including those related to liquidity and capital resources, results of operations, critical accounting estimates, executive compensation, and transactions with related persons. FN76
E. FASB ASC Topic 718, Compensation—Stock Compensation, and Certain Redeemable Financial Instruments
Certain financial instruments awarded in conjunction with share-based payment arrangements have redemption features that require settlement by cash or other assets upon the occurrence of events that are outside the control of the issuer. FN77 FASB ASC Topic 718 provides guidance for determining whether instruments granted in conjunction with share-based payment arrangements should be classified as liability or equity instruments. Under that guidance, most instruments with redemption features that are outside the control of the issuer are required to be classified as liabilities; however, some redeemable instruments will qualify for equity classification. FN78 SEC Accounting Series Release No. 268, Presentation in Financial Statements of \"Redeemable Preferred Stocks,\" FN79 (\"ASR 268\") and related guidance FN80 address the classification and measurement of certain redeemable equity instruments. FN77 The terminology “outside the control of the issuer” is used to refer to any of the three redemption conditions described in Rule 5-02.27 of Regulation S-X that would require classification outside permanent equity. That rule requires preferred securities that are redeemable for cash or other assets to be classified outside of permanent equity if they are redeemable (1) at a fixed or determinable price on a fixed or determinable date, (2) at the option of the holder, or (3) upon the occurrence of an event that is not solely within the control of the issuer.
FN78 FASB ASC paragraphs . FN79 ASR 268, July 27, 1979, Rule 5-02.27 of Regulation S-X.
FN80 Related guidance includes EITF Topic No. D-98, Classification and Measurement of Redeemable Securities, included in the FASB ASC paragraph 480-10-S99-3A.
Facts: Under a share-based payment arrangement, Company F grants to an employee shares (or share options) that all vest at the end of four years (cliff vest). The shares (or shares underlying the share options) are redeemable for cash at fair value at the holder's option, but only after six months from the date of share issuance (as defined in FASB ASC Topic 718). Company F has determined that the shares (or share options) would be classified as equity instruments under the guidance of FASB ASC Topic 718. However, under ASR 268 and related guidance, the instruments would be considered to be redeemable for cash or other assets upon the occurrence of events (e. g., redemption at the option of the holder) that are outside the control of the issuer. Question 1: While the instruments are subject to FASB ASC Topic 718, is ASR 268 and related guidance applicable to instruments issued under share-based payment arrangements that are classified as equity instruments under FASB ASC Topic 718? Interpretive Response: Yes. The staff believes that registrants must evaluate whether the terms of instruments granted in conjunction with share-based payment arrangements that are not classified as liabilities under FASB ASC Topic 718 result in the need to present certain amounts outside of permanent equity (also referred to as being presented in \"temporary equity\") in accordance with ASR 268 and related guidance. FN81 FN81 Instruments granted in conjunction with share-based payment arrangements with employees that do not by their terms require redemption for cash or other assets (at a fixed or determinable price on a fixed or determinable date, at the option of the holder, or upon the occurrence of an event that is not solely within the control of the issuer) would not be assumed by the staff to require net cash settlement for purposes of applying ASR 268 in circumstances in which FASB ASC Section 815-40-25, Derivatives and Hedging—Contracts in Entity's Own Equity—Recognition, would otherwise require the assumption of net cash settlement. See FASB ASC paragraph 815-40-25-11 (See FASB ASC paragraph 815-10-65-1 for the transition and effective date information related to FASB ASU No. 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, which superseded FASB ASC paragraph 815-40-25-11.), which states, in part: \"…the events or actions necessary to deliver registered shares are not controlled by an entity and, therefore, except under the circumstances described in FASB ASC paragraph 815-40-25-16, if the contract permits the entity to net share or physically settle the contract only by delivering registered shares, it is assumed that the entity will be required to net cash settle the contract.\" See also FASB ASC subparagraph 718-10-25-15(a).
When an instrument ceases to be subject to FASB ASC Topic 718 and becomes subject to the recognition and measurement requirements of other applicable GAAP, the staff believes that the company should reassess the classification of the instrument as a liability or equity at that time and consequently may need to reconsider the applicability of ASR 268. Question 2: How should Company F apply ASR 268 and related guidance to the shares (or share options) granted under the share-based payment arrangements with employees that may be unvested at the date of grant?
Interpretive Response: Under FASB ASC Topic 718, when compensation cost is recognized for instruments classified as equity instruments, additional paid-in-capital FN82 is increased. If the award is not fully vested at the grant date, compensation cost is recognized and additional paid-in-capital is increased over time as services are rendered over the requisite service period. A similar pattern of recognition should be used to reflect the amount presented as temporary equity for share-based payment awards that have redemption features that are outside the issuer’s control but are classified as equity instruments under FASB ASC Topic 718. The staff believes Company F should present as temporary equity at each balance sheet date an amount that is based on the redemption amount of the instrument, but takes into account the proportion of consideration received in the form of employee services. Thus, for example, if a nonvested share that qualifies for equity classification under FASB ASC Topic 718 is redeemable at fair value more than six months after vesting, and that nonvested share is 75% vested at the balance sheet date, an amount equal to 75% of the fair value of the share should be presented as temporary equity at that date. Similarly, if an option on a share of redeemable stock that qualifies for equity classification under FASB ASC Topic 718 is 75% vested at the balance sheet date, an amount equal to 75% of the intrinsic FN83 value of the option should be presented as temporary equity at that date. FN82 Depending on the fact pattern, this may be recorded as common stock and additional paid in capital.
FN83 The potential redemption amount of the share option in this illustration is its intrinsic value because the holder would pay the exercise price upon exercise of the option and then, upon redemption of the underlying shares, the company would pay the holder the fair value of those shares. Thus, the net cash outflow from the arrangement would be equal to the intrinsic value of the share option. In situations where there would be no cash inflows from the share option holder, the cash required to be paid to redeem the underlying shares upon the exercise of the put option would be the redemption value.
Question 3: Would the methodology described for employee awards in the Interpretive Response to Question 2 above apply to nonemployee awards to be issued in exchange for goods or services with similar terms to those described above?
Interpretive Response: The staff believes it would generally be appropriate to apply the methodology described in the Interpretive Response to Question 2 above to nonemployee awards.
F. Classification of Compensation Expense Associated with Share-Based Payment Arrangements
Facts: Company G utilizes both cash and share-based payment arrangements to compensate its employees and nonemployee service providers. Company G would like to emphasize in its income statement the amount of its compensation that did not involve a cash outlay.
Question: How should Company G present in its income statement the non-cash nature of its expense related to share-based payment arrangements?
Interpretive Response: The staff believes Company G should present the expense related to share-based payment arrangements in the same line or lines as cash compensation paid to the same employees or nonemployees. FN84 The staff believes a company could consider disclosing the amount of expense related to share-based payment arrangements included in specific line items in the financial statements. Disclosure of this information might be appropriate in a parenthetical note to the appropriate income statement line items, on the cash flow statement, in the footnotes to the financial statements, or within MD&A.
FN84 FASB ASC 718 does not identify a specific line item in the income statement for presentation of the expense related to share-based payment arrangements, with the exception of the guidance in FASB ASC paragraph 718-10-15-5A on share-based payment awards granted to a customer.
G. Removed by SAB 114
H. Removed by SAB 114
I. Capitalization of Compensation Cost Related to Share-Based Payment Arrangements
Facts: Company K is a manufacturing company that grants share options to its production employees. Company K has determined that the cost of the production employees' service is an inventoriable cost. As such, Company K is required to initially capitalize the cost of the share option grants to these production employees as inventory and later recognize the cost in the income statement when the inventory is consumed. FN85
Question: If Company K elects to adjust its period end inventory balance for the allocable amount of share-option cost through a period end adjustment to its financial statements, instead of incorporating the share-option cost through its inventory costing system, would this be considered a deficiency in internal controls?
Interpretive Response: No. FASB ASC Topic 718, Compensation—Stock Compensation, does not prescribe the mechanism a company should use to incorporate a portion of share-option costs in an inventory-costing system. The staff believes Company K may accomplish this through a period end adjustment to its financial statements. Company K should establish appropriate controls surrounding the calculation and recording of this period end adjustment, as it would any other period end adjustment. The fact that the entry is recorded as a period end adjustment, by itself, should not impact management’s ability to determine that the internal control over financial reporting, as defined by the SEC's rules implementing Section 404 of the Sarbanes-Oxley Act of 2002, FN86 is effective. FN86 Release No. 34-47986, June 5, 2003, Management’s Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Period Reports.
J. Removed by SAB 114
K. Removed by SAB 114
L. Removed by SAB 114
M. Removed by SAB 114
This SEC staff announcement provides the SEC staff's views regarding Escrowed Share Arrangements and the Presumption of Compensation.
- The SEC Observer made the following announcement of the SEC staff's position on escrowed share arrangements. The SEC Observer has been asked to clarify SEC staff views on overcoming the presumption that for certain shareholders these arrangements represent compensation.
Historically, the SEC staff has expressed the view that an escrowed share arrangement involving the release of shares to certain shareholders based on performance-related criteria is presumed to be compensatory, equivalent to a reverse stock split followed by the grant of a restricted stock award under a performance-based plan. FN 1
When evaluating whether the presumption of compensation has been overcome, registrants should consider the substance of the arrangement, including whether the arrangement was entered into for purposes unrelated to, and not contingent upon, continued employment. For example, as a condition of a financing transaction, investors may request that specific significant shareholders, who also may be officers or directors, participate in an escrowed share arrangement. If the escrowed shares will be released or canceled without regard to continued employment, specific facts and circumstances may indicate that the arrangement is in substance an inducement made to facilitate the transaction on behalf of the company, rather than as compensatory. In such cases, the SEC staff generally believes that the arrangement should be recognized and measured according to its nature and reflected as a reduction of the proceeds allocated to the newly-issued securities. FN 2, 3
The SEC staff believes that an escrowed share arrangement in which the shares are automatically forfeited if employment terminates is compensation, consistent with the principle articulated in paragraph 805-10-55-25(a). FN 1 Under these arrangements, which can be between shareholders and a company or directly between the shareholders and new investors, shareholders agree to place a portion of their shares in escrow in connection with an initial public offering or other capital-raising transaction. Shares placed in escrow are released back to the shareholders only if specified performance-related criteria are met.
FN 2 The SEC staff notes that discounts on debt instruments are amortized using the effective interest method as discussed in Section 835-30-35, while discounts on common equity are not generally amortized. FN 3 Consistent with the views in paragraph 220-10-S99-4, SAB Topic 5.T., Accounting for Expenses or Liabilities Paid by Principal Stockholder(s), and paragraph 220-10-S99-3, SAB Topic 1.B., Allocation of Expenses and Related Disclosure in Financial Statements of Subsidiaries, Divisions or Lesser Business Components of Another Entity, the SEC staff believes that the benefit created by the shareholder's escrow arrangement should be reflected in the company's financial statements even when the company is not party to the arrangement.
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