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Accounting for Equity Compensation
by Barbara A. Baksa
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Format: Perfect-bound book, 166 pages
Edition: Twelfth edition (March 2015)
Status: In stock
Chapter 2: Overview of the Standard
Chapter 3: Measurement Date
Chapter 4: Measurement of Expense
Chapter 5: Expense Attribution
Chapter 6: Accounting for Tax Effects
Chapter 7: Financing Exercise Transactions and Tax Withholding
Chapter 8: Modifications
Chapter 9: Business Combinations
Chapter 10: Earnings per Share
Chapter 11: Employee Stock Purchase Plans
Chapter 12: Stock Appreciation Rights
Chapter 13: Private Companies
Chapter 14: Disclosures
Chapter 15: Effective Date and Transition Methods
Chapter 16: Examples
From Chapter 3, "Measurement Date"Where outstanding grants are not fully vested when an employee changes to nonemployee status and no modification occurs, practitioner opinions vary as to how the grants should be accounted for.
One approach holds that the unvested portion of the grants must be accounted for as if granted to a nonemployee. Expense will be recomputed for the portion of the grant that is attributable to the percentage of the service period that elapses after the change in status. Since the grant is now held by a nonemployee, this expense will be re-estimated each accounting period until the grant is vested, as described in section 3.1 of this chapter.
For example, assume that an employee is granted an award that vests in full four years after the date of grant. The employee changes to consultant status one year after the award is granted, and under the original terms of the grant, vesting continues so long as the award holder continues to provide services to the company. Because the award is not modified as a result of the change in status, no adjustment is made to the expense that has already been recorded. For 75% of the award, however (only 25% of the service period had elapsed at the time of the award holder's change in status), expense must now be re-estimated every accounting period until the award is vested.
A second approach looks to the guidance in ASC 718-10-35 (formerly FSP FAS 123(R)-1), which provides that, until further guidance is issued, awards granted to employees remain under the scope of ASC 718 throughout their life, unless modified when the award holder is no longer an employee. Under this approach, there would be no change to the accounting treatment of the award, provided it is not modified in connection with the change in status or thereafter.
Because the treatment of changes from employee to nonemployee status is currently unclear where the award is not modified as a result of the change in status, companies should consult their accounting advisors regarding this matter.
If, at the time of the change in status, the terms of the grant are modified (for example, if under its original terms, the grant would have cancelled upon a change in the grant holder's employment status and the grant is modified to prevent this), the change in status is viewed as a cancellation of the original award and grant of a new award. No further expense is recognized for the original award (and any previously recognized expense related to the unvested portion of the award is reversed). Expense is computed for the new grant and recorded over the remaining service period. Because the grant holder is no longer an employee, the fair value of the new grant will be re-estimated each accounting period until it is vested, and expense will be recorded based on the estimates.
In all situations involving a change from employee to nonemployee status, an assessment should be made as to whether the continued service provided by the individual will be substantive. Some factors to consider in this assessment include whether the ongoing compensation provided is commensurate with the services that will be performed by the individual, as well as how clearly the additional services are defined and whether performance will be monitored. Where the continued service is not deemed substantive, the change in status is accounted for as a termination of employment. Any remaining compensation cost associated with the awards that will vest after termination, as well as any additional cost resulting from modification of awards held by the individual, is recognized immediately in the period that the change in status occurs.
From Chapter 5, "Expense Attribution" (tables omitted)An extra layer of complexity applies to options and stock appreciation rights (as opposed to restricted stock awards) with graded vesting. Here, not only is the forfeiture rate applied separately to each vesting tranche, but each tranche may also have a different fair value. Although not required, ASC 718 permits companies to value each vesting tranche as a separate option. This allows the company to assume different exercise behavior (e.g., a shorter expected term, if the Black-Scholes model is used for valuation) for the portions of the option that vest earlier. This will generally result in a lower fair value for the tranches that vest earlier and thus a lower overall expense.
Assume that the instruments granted on January 1, 20X6, in the prior example were stock options vesting in three annual increments of 100,000 shares each. The company computes the following fair values for each vesting increment:
- The tranche vesting on January 1, 20X7, has a fair value of $8 per share and an aggregate fair value of $800,000.
- The tranche vesting on January 1, 20X8, has a fair value of $10 per share and an aggregate fair value of $1,000,000.
- The tranche vesting on January 1, 20X9, has a fair value of $12 per share and an aggregate fair value of $1,200,000.
- The aggregate expense for the options before adjusting for forfeitures is $3,000,000 ($800,000 plus $1,000,000 plus $1,200,000).
- For the tranche vesting on January 1, 20X7, $720,000 worth of shares have vested ($800,000 x 90%).
- For the tranche vesting on January 1, 20X8, $810,000 worth of shares are expected to vest ($1,000,000 x 90% x 90%).
- For the tranche vesting on January 1, 20X9, $874,800 worth of shares are expected to vest ($1,200,000 x 90% x 90% x 90%).
- The aggregate expense for the awards, after adjusting for expected forfeitures, is $2,404,800 ($720,000 plus $810,000 plus $874,800).