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Accounting is one of the most crucial areas in the equity compensation field. This book is not a general guide to the subject (for that, see our book Accounting for Equity Compensation by Barbara Baksa) but rather is an advanced study of some of the most important topics that arise. Author Takis Makridis, a leading expert in the field, selects a handful of issues spanning valuation and financial reporting. The ninth edition includes changes to several chapters, most notably to take account of how, following ASU 2018-07, nonemployee awards are now under the purview of ASC 718.
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Table of Contents
Chapter 1: Valuation Models
Chapter 2: Expected Term
Chapter 3: Volatility Estimation
Chapter 4: Expense Recognition for Market, Performance, and Service Conditions
Chapter 5: Making Sense of Forfeiture Rates
Chapter 6: Modification Accounting
Chapter 7: IFRS 2: Today and Tomorrow
Chapter 8: Design Features Driving the Fair Value of a Relative TSR Award
Chapter 9: Accounting for Assumed Awards Under ASC 805
Chapter 10: FASB's Revisions to ASC 718 Under ASU 2016-09
About the Authors
About the NCEO
From Chapter 5, "Making Sense of Forfeiture Rates" (footnotes omitted)
One major element of ASC 718 has been the derivation of a forfeiture rate and its correct application within an amortization model. Under SFAS 123, companies did not estimate forfeitures, and instead merely reversed expense previously disclosed or recognized upon an actual forfeiture event. ASC 718 changed that, requiring companies to estimate expected forfeitures, base their accruals on the corresponding value of awards they expect to vest, and true-up to the value of awards actually earned.
ASC 2016-09 has changed that requirement by giving companies a choice whether they apply a forfeiture rate or simply record forfeitures as they occur. This optionality is discussed in greater detail in section 10.4 of chapter 10, which is entirely devoted to ASU 2016-09. Since a majority of large companies and 60% of companies overall are so far choosing to keep using a forfeiture rate, this chapter will discuss estimation and application considerations.
For those companies choosing to stop using a forfeiture rate, their processes become relatively simple: As forfeitures occur, previously recognized expense on those awards is reversed. While simple, this will worsen forecasting precision and is not extendable to situations involving modifications, business combinations, and IFRS 2 statutory reporting.
Therefore, this chapter aims to demystify confusion surrounding forfeiture rates. How does the process of deriving a forfeiture rate differ from that of applying a forfeiture rate? What is meant by a “static” versus “dynamic” forfeiture rate approach? We begin with the conceptual objective of applying a forfeiture rate. Thereafter, we review certain best practices in deriving or estimating a forfeiture rate. Finally, the core content of this chapter evaluates the different techniques for applying a forfeiture rate within an amortization model, including the comparative merits of the “static” and “dynamic” approaches.