Accounting for Equity Compensation

Chapter 1: Introduction: How Did We Get Here?
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
Glossary
Index

From Chapter 4, "Measurement of Expense"

Although ASC 718 precludes including the likelihood of forfeiture as a model input, it does allow the use of models that incorporate a variety of other inputs, such as blackout periods or Rule 10b5-1 trading plans. In some cases, different types of stock options may require one to use a different model. Options in which vesting is contingent on performance goals related to stock price performance should be valued using a model that takes into account the likelihood of the price targets being achieved. Indexed options should be valued using a model that takes into account the possibility of the option price changing over time.

One challenge in applying lattice models to employee stock options is the amount of data required to apply these models. To determine the suboptimal exercise factor, it is necessary to analyze historical exercises based on the market value at the time of exercise, and the historical data must be relevant to the options the company is currently granting. If the options in the historical analysis were granted while the company was private and the company is now publicly held, or if the options were exercised in a different market environment than currently exists, the historical exercise behavior may not be indicative of how employees will exercise the current option grants. It may be necessary to analyze the historical transactions based on population data as of the time the exercises occurred so that trends can be identified by population characteristics, enabling the model to be applied differently to each group of employees. It is also necessary to analyze the probability of employees terminating while holding vested options, which is likely to differ by employee population. These two inputs require a substantial amount of exercise and termination data. In addition to these inputs, it is now necessary to estimate not just a single future volatility but how the stock volatility is expected to change over the contractual term of the option (usually a 10-year period). The same evaluation must be applied to the estimate of expected dividend yield.

From Chapter 11, "Employee Stock Purchase Plans"

Where the offering period and purchase period are the same length, expense is recognized on a straight-line basis over the length of the offering.

Where purchases occur periodically throughout an offering, companies can choose to recognize expense on a straight-line basis over the duration of the offering or can choose to treat each purchase as a separate option (sometimes referred to as the "accelerated attribution method"). Under the accelerated attribution approach, expense for the first purchase under the offering is recognized over its respective purchase period, expense for the second purchase is recognized over the period from the offering begin date to the second purchase date, expense for the third purchase (if there is one) is recognized from the offering begin date to the third purchase date, and so on. This effectively front-loads the expense recognition (hence the term "accelerated attribution"), since the company is recognizing expense for multiple purchases at the same time.

Upon implementing an ESPP, companies must make a policy decision as to which attribution method they are going to apply. This decision should not be treated lightly; companies wishing to change attribution methods will have to demonstrate that the new method is better suited to the ESPP and may even be required to file a preferability letter from the company's auditors with their financial statements for the period in which the change is made. Generally, it is expected that most companies will use the same attribution method for the ESPP that they use for other service-based awards under their stock compensation programs.